Author: Udayan Gupta

In what is considered a first step for even bigger foreign direct investment to Sri Lanka, TPG Capital announced in August it would invest $113 million to buy a majority stake in Union Bank, a small distressed financial institution based in Colombo. The initial investment a 70% is expected to more than help meet Union Bank’s  $76.8 million Tier 1 capital requirements set by the Central Bank of Sri Lanka, the country’s banking regulator before it take effect on Jan. 1, 2016.

The success and ease with which the deal was closed suggests that Sri Lanka is ready for foreign investors, noted TPG’s Michael O’Hanlon at the Invest Sri Lanka conference at New York’s Essex Hotel in early September. To help complete the transaction, TPG received unparalleled support and cooperation from the government and the regulators, said O’Hanlon, who noted that TPG had engineered similar deals in South Korea, deals that had greatly benefited TPG and the banks in which it invested.

At the New York conference, attended by a number of Sri Lankan listed companies and many traders and investors who focus on frontier markets, Sri Lankan monetary and financial officials emphasized the country’s current average GDP growth of 6.6% per year, one of the highest in Asia.

After years of domestic strife and economic uncertainty, Sri Lanka is making a big play for foreign investors. It already has streamlined the rules for private investment, noted Ajith Nivard Cabraal, governor of Sri Lanka’s central bank. And by bringing down inflation to single digits for more than five years–the result of a moderation in global commodity prices- and a reduction of the fiscal deficit to less than 6% for 2013–the investment climate is more favorable than ever, Cabraal emphasized.

The stock market is undervalued, noted Vajira Kulatilaka, chairman of the Colombo Stock Exchange (CSE), which sponsored the conference. The CSE is a small exchange with fewer than 300 listed companies and a total capitalization of about $22 billion, but it has recorded spectacular returns in recent years, Kulatilaka said.

Still, Invest Sri Lanka may be preaching to the wrong choir. Brokers and traders who attended the meeting said that the investment climate was still too risky for long-term investing. And lack of transparency and disclosure would make it hard for them to recommend trading in most Sri Lankan stocks. Moreover, foreigners can still only invest in Sri Lanka through special investment instruments, not directly.

What most Sri Lankan companies need is strategic investors with the capital and knowhow to manage growth and global expansion, said Saumaya Dharshana Munasinghe, executive director of Access Engineering, a publicly listed construction company with a market capitalization of about $200 million. Although increased stock trading make a company more visible, it doesn’t necessarily expand business opportunities. Companies such as Access need strategic investors who not only provide capital but also management to build the business and expand it globally, he added.

Foreign Direct Investments have always posed a dilemma for developing countries. Foreign investors want rewards commensurate to the risks of investing in unpredictable frontier markets. In the 1990s, for example, Poland – in the aftermath of the fall of the Berlin Wall– faced such a dilemma. But it attracted strategic investors who brought in new capital and management savvy and used Poland as a springboard for expansion into Central and Eastern European markets.

By allowing private equity groups such as TPG to take controlling interests in local companies, or by dealing with countries such as China that are interested in acquiring foreign assets, Sri Lanka may be solving its short-term capital requirements but not addressing its overall development needs.