Notes from the Field

Post-Conflict, Sri Lanka’s Enterprises Struggle to Grow

October 13, 2010

Sri Lanka’s violent civil war that stretched over 25 years left thousands killed, and caused lasting emotional and economic hardship across the island. Although the war ended in May 2009, private businesses in the Northern and Eastern Provinces, their growth shackled by years of armed conflict, are now struggling to catch up. The North and East collectively contribute only 9 percent to GDP compared to the Western Province, where the capital Colombo is located, which contributes 50 percent.

Harvesting rice in Sri Lanka

Many farmers in the Eastern Province now want to use more modern farming techniques and equipment in their paddy fields. However, this equipment is expensive and requires better access to capital. Photo by Anushka Wijesinha.

Following the end of the war, many of the country’s top commercial and development banks have aggressively expanded to the North and East, opening up many new branches in the past year. Banks are interested in the North and East because it is an untapped market. There is an enormous pool of pent-up savings – people have had no place to put their money except under their mattresses. Banks are keen on tapping into this large pool of household savings; savers are looking to earn interest and be rewarded for their years of war-time frugality and thrift.

Sri Lankan officials recently declared the North and East “ripe for tourism and agriculture.” But despite the rapid takeoff in agriculture and fisheries as a result of more land being brought under cultivation and relaxation of security restrictions on coastal fishing, lending to private enterprises, especially small industries, has been slow. The private and state banks that have opened branches are largely engaged in retail banking and pawn brokering, not merchant banking.  They are extremely risk-averse, even when borrowers have the requisite collateral and legitimate title deeds to property. Many local entrepreneurs say that even when loans are approved, they are often as low as Sri Lankan Rupees 100,000 (around $900) – grossly insufficient for a local business wishing to expand or undertake new ventures, even in agro-businesses and fisheries.

At a recent regional Private-Public Dialogue (PPD) convened by The Asia Foundation in Polonnaruwa for private sector and local government representatives from the North and East, we discussed this issue with many local business leaders. They openly voiced their frustration about the difficulties they face accessing adequate capital for their enterprises. One leading entrepreneur, the authorized district distributor for Unilever products, remarked, “Eastern Province entrepreneurs lack capital due to years of conflict. For us to grow, we need to import capital, and more funds need to come from outside to bridge the gap.”

A Sri Lankan entrepreneur discusses business challenges

A participant at an Asia Foundation-led PPD discusses strengths and challenges of post-conflict economic development in the Eastern Province. Photo by Anushka Wijesinha.

Recently, several banks have begun offering concessional credit loans in the North and East to small and medium sized entrepreneurs through loans provided by foreign donor agencies. These loan schemes operate in the following way:  a large national development bank obtains a concessionary loan from a donor at a lower than commercial interest rate. This lead bank works with other partner banks with good local networks to “on-lend” the funds to SMEs in selected sectors such as agro-businesses, fisheries, and trade.

However, due to the pressure to sell their own loan products, banks have little incentive to actively market these concessionary credit lines. Some of the business owners at the dialogue said that even the special small enterprise loan schemes advertised by the Central Bank in the East are taking time to get off the ground at the grass-roots level.

Despite such challenges, some positive developments have emerged. Following a request by President Mahinda Rajapakse late last year to significantly reduce interest rates, combined with the Central Bank’s reduction in target rates, the cost of borrowing has been dramatically reduced. This has been supported by recent lower inflation rates.

Unfortunately, local borrowers in the East say that despite the 8-10 percent interest rates advertised, the available rates when they actually apply for loans can be as high as 14-15 percent. The participants attributed this to “hidden interest rates,” where various add-ons are applied to the basic rate – the computation of which is not easily understood by local borrowers.

Due to years of conflict and isolation, many potential borrowers in the North and East also struggle with lower levels of financial literacy than in the rest of the country. Throughout the dialogue, we noticed that many of the participants were often unable to wade through the complicated formulas and calculations for loan products, and found it difficult to understand the nuanced “small print.” Many were also frustrated with the “lack of transparency” in the banks’ lending practices, insisting that rules need to be simplified for better awareness.

The business owners also have limited capacity to produce bookkeeping records and accounting requirements of a standard that local bank managers need to consider for a loan. Additionally, many businesses looking to venture into new projects or expand existing ones find it challenging to produce business plans to convince bank managers of their borrowing needs. As identified by the participants in the PPD, the problem can be addressed in several ways:  improving the capacity of local business owners to produce credible and attractive businesses plans; expanding the provision of business development service (BDS) to assist local entrepreneurs in this exercise; and educating local branch managers on evaluating SME business plans in conflict-affected areas with a different mindset to regular loan applications. The Asia Foundation’s local economic governance program in Sri Lanka, supported by the Australian Agency for International Development, will continue to engage sub-national stakeholders in the coming months to seek practical solutions to improve the business climate in the Northern and Eastern Provinces.

Stimulating the growth of private enterprises and mobilising their unique strengths needs to be a key element of Sri Lanka’s post-war economic recovery strategy. For this, enabling better access to credit and bank financing is crucial. A sound technical understanding of the problem is not enough: institutional and procedural constraints stymie the best intentions of policy-makers. The Polonnaruwa dialogue made strong headway in giving regional voices an opportunity to express their views of the problem and consider solutions. Participants agreed on a series of Asia Foundation-Institute of Policy Studies-facilitated follow-up dialogues involving key private sector stakeholders (businesses and banks), along with government officials. In the short term, stakeholders will approach local and provincial bank managers and directors to discuss what procedural changes can be adopted to produce more loan-worthy business plans and free up lending. National bank executives and central government officials will also have to be brought into this dialogue to explore solutions.

Anushka Wijesinha is a research officer for The Asia Foundation’s partner organization in Sri Lanka, the Institute of Policy Studies (IPS). He can be reached at anushka@ips.lk.

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