By Frank Jack Daniel
JAFFNA, Sri Lanka (Reuters) - From foreign hotel towers sprouting on Colombo's seafront to the new motorbikes and mobile phones buzzing in war-ravaged Jaffna, at first glance, Sri Lanka seems to be living up to its claim as Asia's latest frontier market.
But private businesses are not investing enough, threatening the boom that has swept the island since the end of a long ethnic conflict, while President Mahinda Rajapaksa and his family are tightening their grip on the economy and institutions with what critics see as an unusually personalized system of government.
The global economy may be in poor shape, but with 17 percent growth since the war ended in 2009 and an eye-popping 200 percent rise in the stock market, investors should be flocking to Sri Lanka's palm-fringed shores.
Instead, even home-grown businesses are shy.
The government reported $1 billion of foreign direct investment (FDI) last year, a record, but even officials accept that is not enough. More worrying, because it raises questions about the reliability of official data, the United Nations put FDI at just $300 million last year, its lowest level since 2005.
There are several possible explanations, but critics say that by making Sri Lanka something of a personal fiefdom and dragging his feet on reconciliation between the ethnic minority Tamil-dominated north and the majority Sinhalese Buddhist population, Rajapaksa shoulders some of the blame.
The president and his brothers control ministries and departments accounting for about 70 percent of the budget, including finance and defense. His elder son is an elected legislator and his eldest brother is the speaker of parliament, where the president holds a more-than two-thirds majority.
"A handful of people seems to have captured both political authority and the economy," said Harsha de Silva, spokesman on economic affairs for the main opposition United National Party.
"Almost four years after the end of the war, we are yet to see any established investors setting up businesses, apart for some big hotel chains."
One Rajapaksa brother, Economic Affairs Minister Basil Rajapaksa, justified the system, telling Reuters that politics was a family affair everywhere from the United States to India and pointing out that he and his relatives were elected parliamentarians.
"It is a dynasty, but by people's choice, a people's dynasty," he said in an interview, and suggested that more, rather than less, concentration of decision-making would help investment in a country where multiple permits slow start-ups.
"In other countries who are successful, they were successful because immediately one person he takes the decisions. In Sri Lanka, the main problem is that that is not there, more decisions have to be centralized."
Opponents say the extensive control of commerce by the president and his family is at the root of the country's problems.
"Half of all the ministries which are engaged in businesses are controlled by Rajapaksa family under his ruling. That is the main problem we are facing today," said Sunil Handunnetti, an opposition parliamentarian with the Marxist Janatha Vimukthi Peramuna, which used to support the president.
INDIANS AND CHINESE
Whatever the rights or wrongs of the argument, the investment shortfall is a problem for President Rajapaksa, whose goal of 8 percent annual economic growth largely rests on foreign inflows in the form of debt from multilateral lenders and friends like China.
Economists say this is not sustainable in the long run.
The president's model of rapid infrastructure development has helped Sri Lanka bounce back more successfully than most post-war countries, but economists and businesses are wary.
With Sri Lanka tipped as the top destination of 2013 by the Lonely Planet travel publisher and visitors up 30 percent last year, global hotel brands are lining up. But few are investing heavily, preferring to tie up with local players, some of which have links with the government.
Central Bank Governor Ajith Nivard Cabraal said negative reports about human rights violations during and after the war had a chilling affect on foreign direct investment, particularly from the West. The United Nations has urged the government to investigate reports of serious abuses during the war.
"Asian investors understand Asia better, as far as the ground situation is concerned, so you can see, the Indian investors are here, the Chinese investors are here," he said.
But de Silva said old problems worried people looking to do business.
"Investors will come only when they see stability. The stability will come with genuine peace. There is no cohesiveness. There is no position of the government for the devolution of power," de Silva said.
The Pathfinder Foundation economic think-tank warns that Sri Lanka is showing signs of "opportunistic state capitalism", with the government cherry-picking opportunities and creating confusion about the roles of the private and public sectors.
Luxman Siriwardena, Pathfinder's executive director, says Sri Lanka's investment rate of 30 percent of gross domestic product leaves a shortfall of about $3 billion needed to attain the government's target of 8 percent growth.
"There is also need for greater clarity regarding the respective roles of the private and state sectors, including the military, in economic activity," he said.
Jaffna, in the north where Tamils dominate, was once the second city and a major industrial hub. It is just emerging from isolation as an epicenter of the war that began in 1983. Up to 40,000 civilians may have been killed in the government's remorseless final offensive, according to the United Nations.
Public works and an appetite for consumer goods fuelled by remittances from exiles have spurred growth in a town of bombed out buildings, but businesses are gloomy about the future.
The seaside city was virtually cut off from the rest of the country during the war that pitted largely Hindu Tamils against mostly Buddhist Sinhalese. It could take months for people in the area to get permission from the army to travel south.
Now, buses run daily and two domestic airlines fly there with small prop aircraft.
The most successful is Helitours, which flies passengers for half the price of its rival, Expo Air. Helitours is able to do so because it is part of the air force and has lower overheads.
Helitours also flies tourists to a golf course at an armed forces resort in another former war zone in the east - part of a network of military businesses that extends from private security and farming to catering and whale-watching.
Some Jaffna residents complain the military controls too much land seized in the war. Others warn that government foot-dragging on local elections and easing ethnic tension has deterred both locals and wealthy overseas Tamils from investing.
Young Tamil businessman V. Kandappa came back from Britain at the end of the war to set up a business in his parent's bomb-damaged home - a rare returned exile. He builds homes for members of the diaspora who dream of coming back. Almost half the population left Jaffna during the war.
"The private sector is still not confident about what is going to happen on the ethnic front, people are scared to invest their money in the north and eastern provinces," Kandappa said.
Back in Colombo, a striking feature of the Sri Lankan model is how heavily it depends on the president, his family and aides, who have ties to businesses such as hotels and aviation.
Take the Hyatt Regency, a 43-floor tower being built by developer Sinolanka Hotels and Spa (Pvt) Ltd. Sinolanka is partly owned by the state insurance company, which is the main funder of the project. The insurer and Sinolanka are both headed by senior presidential aide Gamini Senerath.
The land was expropriated last year by Basil Rajapaksa's ministry from a developer that ran out of cash. The land belongs to the Urban Development Authority which comes under the Defense Ministry, where the top civil servant is another brother, Gotabaya Rajapaksa, who runs the military.
Or the airlines. The government runs two more commercial carriers along with the air force's Helitours. One is loss-maker Mihin Lanka, named after the president. Defense Secretary Gotabaya Rajapaksa and the head of the air force helped set up Mihin five years ago as a budget airline.
National carrier Sri Lankan Airlines is also fully state owned, since partner Emirates was bought out following an argument over seats for the president.
The airline in now run by Rajapaksa's brother-in-law and last year lost $147 million because of high fuel costs and low ticket prices, the central bank said.
Officially, government investment only accounts for 6 percent of total investment, but economists and diplomats privately say the number is higher because projects such as Mihin or the Hyatt get counted as private investment.
Basil Rajapaksa said the rapid development of power, telecoms and road networks since the war ended prove the success of the so-called Mahinda's Vision model. He said the government's role was partly to break private monopolies.
"In some sectors that are important to the people, the government has a responsibility to regulate, and if by regulating we can't control, we have to break the monopoly."
(Editing by John Chalmers and Robert Birsel)
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