The Narrative by Econsult Asia: Port City, the real economy, and IMF independence

EALThe Port City Colombo project is a potential game changer for the Sri Lankan economy, being the country’s first Special Economic Zone (SEZ) in decades, potentially adding about 1% to annual GDP (Gross Domestic Product) growth over the next 25 years while creating over 230,000 jobs. SEZs with unique administrative structures and economic regulations are not a new phenomenon. Their frameworks are generally intended to lower costs of production and improve ease of doing business, with the ultimate aim of acquiring new technology, improving competitiveness of local firms, and raising foreign currency.

The first SEZ was established in Shannon, Ireland in 1959. Sri Lanka experimented with the concept through the Greater Colombo Economic Commission in 1978, now known as the Board of Investment (BOI). China is perhaps the most famous example of a country that used SEZs to acquire technology, increase exports, and become the world’s leading manufacturer.

The Port City SEZ is envisaged to be a “World-Class City for South Asia”, a financial centre specialising in services such as international trade, shipping logistics, offshore banking, IT (information technology) and business process outsourcing, tourism, and more.

A financial SEZ may seem contradictory to government policy which has emphasised the need to develop production through agriculture and manufacturing. However, capital inflows to the Port City could have positive externalities on the real economy, leading to demand augmentation, technology transfer, and greater macroeconomic growth and stability, allowing for greater policy independence from the International Monetary Fund (IMF).

Demand augmentation

Once fully operational, the Port City is projected to have a transient population of about 250,000 people in a duty-free zone. Sri Lankan suppliers of goods and services can tap into this high-spending market, provided they improve their product standards. Off the bat, sectors such as agricultural processing, food and beverages, high-end apparel, furniture, and construction materials stand to gain from this new market.

An operational Port City is also projected to generate 232,000 jobs – equal to about half of the total unemployed population in Sri Lanka. The internationally competitive business standards and salary scales envisioned for Port City may also reduce brain drain. Professions such as doctors, bankers, financial analysts, and others who would otherwise leave the country can find employment within Port City and use their foreign currency earnings to spend, save, or invest within Sri Lanka.

On the fiscal side, the Government can make substantial revenue despite tax exemptions, thanks to income from sales and leases of land which will bring in about $ 1.8 billion, according to a study by PwC. Construction of the Port City will bring in about $ 2.8 billion in duties and taxes over 20 years. Once fully operational, the Government may earn up to $ 0.8 billion per year through taxes and fees. This revenue will boost the Government’s balance sheets and help meet welfare expenditure.

 

Technology transfer

The Port City is ideally placed to test new financial instruments and open commodity exchanges to complement Sri Lanka’s role as a transshipment and commodity hub in the Indian Ocean. Indeed, Section 56 of the Port City Economic Commission Bill indicates that the SEZ will include financial instruments such as “debentures, stocks, shares, funds, bonds, derivatives including futures and options”.

However, if the Port City is to cater to such high-end financial instruments, the entire country will have to scale up its IT and communication infrastructure, creating opportunities for investment in local production of electronic goods and components – manufacture of which has been traditionally neglected in Sri Lanka.

Similarly, Port City’s drive to be an example of a sustainable green city with low carbon emissions, international standards of construction, and modern waste and water management systems, will require technological inputs. This will be an opportunity for Sri Lankan firms to acquire green technologies and improve their environmental regulatory standards.

Finally, Port City’s relative isolation from the mainland makes it an ideal testing ground for new policies. For example, the Government can experiment with digital payment systems to improve ease of doing business, monitor transactions, and gain valuable insights into consumer habits. Such “big data” can be used to improve policymaking as well as identify niche markets for local producers.

 

Macroeconomic growth and stability

In the decade since the end of the war, Sri Lanka’s GDP grew at an average 5% per year and stood at $ 84 billion in 2020. Assuming a modestly higher growth rate of 6% for the next 25 years, without the inclusion of Port City, GDP should reach $ 360.5 billion by 2045.

However, when factoring in PwC’s projections of Port City’s contribution to GDP over 20 years of construction and five years of operation, GDP could reach $ 431.9 billion in 2045. This amounts to an annual 7% growth, and a difference of $ 71 billion. Port City’s 269 hectares of land could therefore contribute at least 1% of additional GDP growth every year.

According to a study by PwC, the reclamation, infrastructure, and land lease and construction of the Port City will attract about $ 9.7 billion in foreign direct investment (FDI) over about 25 years. Once fully operational, the Port City is projected to receive an annual FDI inflow of $ 0.7 billion in reinvested profits, a significant boost to Sri Lanka’s current annual FDI inflows of between $ 1 to 1.5 billion.

Inflows of foreign currency will have a direct impact on the country’s Balance of Payments (BOP), helping stabilize the exchange rate and ensure price stability for all Sri Lankans. The 20-year construction phase of Port City will add $ 205 million per year to the BOP, while the operational phase will add $ 4.6 billion per year.

 

An opportunity for IMF independence

Attempts at industrialization in Sri Lanka have often been derailed by social and political instability, often worsened by policy interventions by external entities. Starting from a weak production base at independence, Sri Lanka has historically consumed more than it can produce, leading to BOP crises which in turn require IMF bailouts.

However, IMF dictates to depreciate the currency, liberalize imports, and privatize SOEs have done little to curb this cycle, as evidenced by the fact that Sri Lanka has gone to the IMF 16 times since 1965 with nothing to show for it. Foreign currency inflows projected by the Port City offers the country an opportunity to break this cycle.

Inflows of non-debt, non-conditional foreign currency will provide the country some much-needed breathing room to forge a more independent path of development and carry out policies that are crucial for industrialisation, but antithetical to the ideology of the IMF.

(Econsult Asia is an economic research and management consultancy firm with an alternative development outlook, and the writer is a Research Analyst at Econsult Asia)

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