FDI and trade sector go hand in hand

Rohantha N. A. Athukorala

FDI's: Traditionally, the view has been that FDI and trade are substitutes. This view goes back to the economic literature on FDI and the experience of both Latin America and South -East Asia in the 1960s and the 1970s.

The experience of Latin America and the theoretical literature both supported the 'tariff jumping' behaviour of FDI. It tends to increase in countries, with high tariff barriers but, with a large domestic opportunity that a foreign company finds it hard to resist.

The best case in point is India, where the mergers and acquisitions have quadrupled in the last three years. Intuitively, if a country's logistical framework is highly developed a country may switch from an exporting option to that country to setting up local production units(FDIs) because the high tariff makes exporting uncompetitive.

Sometimes when the source point has the potential becoming a production hub like the case of Sri Lanka, FDIs has the potential of increasing substantially.

With Sri Lanka importing over 18 percent of total imports from India we can attract investment from India provided that we set up strategies that will make exporting from India no viable to an Indian Exporter. The importance of this strategic thought is greater, given that the FTA agreements work on the reverse to this effect.

If we do not set up barriers which may be even non tariff in nature, Sri Lanka will not be able to achieve the objective of attractinbg 40 percent of the targeted FDI's from India purely from an economic significance.

Sri Lanka has the opportunity of becoming a production hub, given that the strategic location of Sri Lanka geographically with the key shipping lines passing the Sri Lanka shores the chances of us focusing on this proposition is greater. The opportunity is greater given that India and Pakistan has are becoming stronger trading partners for Sri Lanka.

But more work will have to be done to position ourself on this proposition in the region.

SRI LANKA-INDIA TRADE -VALUE IN SL Rs. Mn

	    Exports	Imports 	Trade		Import/
Year	    Rs. Mn.	Rs. Mn.		Balance		Export
					Rs.Mn.		ratio

1999	    3,423	36,013		[32590]		10.5:1
2000	    4,398	45,477		[41079]		10.3:1
2001	    6,433	53,750		[47317]		8.4:1
2002	   16,312	81,583		[65271]		5.0:1
2004	   39,616	145,625		[106009]	3.7:1
2005	   56,200	144,725		[88525]		2.6:1
2006
Jan-July   33,912	107,457		[73545]		3.17:1

Source: Sri Lanka Customs, Central Bank of Sri Lanka.

With the strong trading drive by Indian and Pakistan companies towards Sri Lanka the opportunity for these companies to set up production units will be attractive specialy if these companies are indirectly linked to the export industry of Sri Lanka which is booming.

Conversely, and based on the same logic, FDI would tend to decline in small markets as tariff barriers fall.

With the implementation of the FTA agreements with India and Pakistan the tariff structure will drop to a maximum of two percent and this can have an adverse impact towards FDIs from India and Pakistan.

Take an empirical example in support, FDI tended to exit Chile in the 1970s as Pinochet dismantled Tariff barriers yet tended to increase in Brazil when it reduced its tariff in the same period.

Yet the nature of FDI in recent years has undergone a sea of change. For one, FDI is not merely searching for regional markets nor is it souring for natural resources. In particular, FDI now does not merely involve setting up new manufacturing units which are termed greenfield investments.

But, it involves a whole chain of activities from production to technology to marketing. Most of the FDIs seen this year has been through mergers and acquisitions as companies become part of a global network.

We saw this in Sri Lanka when Dialog invested a 150 million dollars in Sri Lanka. So was the investment by HSBC global outsourcing unit.

This is natural as manufacturing dominated production structures in the 1960's and 1970's but today services are dominating the economies of the world. In Sri Lanka it is estimated to be above fifty percent.

In addition, while earlier natural resources and labour were prime determinants of cost advantages, today technological leadership is probably far more important in global trade.

With the many law suites in India by global out sourcing companies for forgery, Sri Lanka has a opportunity to ride on the ethical sourcing and strong work ethics of the Sri Lankan labour market on the area of copyright violations which are non existent with the likes of Chinas of the world.

The Partnership Summit in Bangalore could be an ideal opportunity to drive Sri Lanka's stake for Investments from India.

But more ground work will have to be done to make the proposition attractive to the current exporter of the 18 percent trade being done. Another opportunity can be investment in new areas of business namely technology based.

The mobile phone market and the BPO segment to name the top two drivers globally. This muddling of character of FDI becomes very clear if one looks at world trade today. In 2005, almost 40% of world trade was actually intra-firm trade.

Second, about two -thirds of exports come affiliates of transactional corporations but Sri Lanka is sure poised for a one billion dollars in foreign investments in the years to come.