Sri Lanka’s economy has displayed remarkably consistent economic performance since 2014. Although a small country, Sri Lanka’s gross domestic product (GDP) per capita is notably higher than some of the larger ASEAN economies, including Indonesia, the Philippines, and Vietnam. Within South Asia, its GDP per capita has also outperformed that of Bangladesh, India, and Pakistan.
Going forward, the new government is expected to restructure the economy by boosting growth through increased government spending on infrastructure and by attracting more foreign direct investment. While Sri Lanka offers many opportunities for multinationals especially in the services and industrial sectors, it is not without its challenges. Weak public finances remain a cause of concern as the country copes with soaring government debt and a persistent fiscal deficit, which can lead to dampened investor sentiment. Apart from its high debt situation, there are three other emerging trends that companies doing business in Sri Lanka should pay close attention to:
- Higher electricity tariffs will prevail in the future: Electricity tariffs in Sri Lanka are some of the highest in South Asia. Increasing power sector debts and recovering fuel costs are expected to drive electricity tariffs even higher. As such, a majority of the manufacturing businesses are likely to see lower profitability as their cost of production increases. Multinationals should prepare for electricity tariff hikes and plan for allowances to accommodate higher operating costs.
- Vague tax policies will slow investment activity: Tax rate uncertainty in Sri Lanka is likely to weigh on companies and investment as ad hoc tax policies create uncertainty in the business environment. An example of this was the change in value added tax rates in Sri Lanka, which had been in limbo while awaiting parliamentary approval for a tax hike last year. As a result, companies faced differing tax rates throughout the year (see chart above). Multinationals should analyze the impact of varying tax rates on demand for their products and revisit their pricing strategies as we expect similar unpredictability in tax rates going forward.
- Brexit will have a negative impact on Sri Lanka’s economy: Sri Lanka’s prime minister, Ranil Wickremesinghe, took to social media before the Brexit vote and expressed his concerns about the probable impact of a UK exit from the European Union (EU). The UK’s withdrawal from the EU will have a substantial bearing on Sri Lanka’s economy because of the significant trade and investment links between the two economies. Sri Lanka’s exports to the EU and the UK account for 30% and 10%, respectively, of the country’s overall export volume. Hence, developments in the EU are likely to weigh on the Sri Lankan economy. While a post-Brexit trade deal could take longer than the expected two years to finalize, it is still crucial for companies in Sri Lanka to evaluate their exposure to the UK. In the longer-term, companies in Sri Lanka importing from the UK should anticipate changes to their cost structure as trade agreements are renegotiated.
Overall, while many multinationals see long-term potential in Sri Lanka, the above three trends are likely to impact business operations for companies in the country. Multinationals should re-assess their long-term plans to ensure that they are in a robust position to respond to changes in the business environment.
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