Sri Lanka considers ways to narrow the trade deficit

An ideal entrepôt and with productive agricultural lands, Sri Lanka has nonetheless experienced persistent trade deficits that have had a significant impact on the currency and the economy. A number of options have been suggested in recent years. One solution is to retain additional value in-country by encouraging more domestic value-adding activities and processing. The government wants Sri Lanka to be more than a place where goods simply pass through or resources leave.

Sri Lanka already does a significant amount of processing onshore. Three-quarters of the country’s total exports are actually manufactured, but almost half of those are garments. While garments are a good example of value addition, there is still substantial area for growth in this segment. Many of the inputs are imported from abroad – including both components such as zippers and the fabric itself – when much of it could potentially be manufactured in-country. Opportunities also exist in Sri Lanka for more advanced processing of materials and manufactured goods, and some are being encouraged by Sri Lankan officials.

Tea Leaves

Tea is a prime area of focus. The commodity is already a major part of agricultural exports (with a share of 48% in 2015), and much of it is already processed in some way.

An estimated 50% of the tea that leaves the country is exported with some level of value added, including flavoured tea, organic tea, instant tea, iced tea, ready-to-drink tea, and tea-based soaps, bath gels, shampoos and cosmetics, according to the Export Development Board (EDB). The board adds that the country has the largest tea research institute in the world and that Colombo has one of the highest concentrations of tea bag factories.

The Sri Lanka Tea Board (SLTB), founded in 1976, offers a wide range of assistance relevant to adding value in the tea sector. Its lion logo is authorised for products made of 100% unblended, local teas which are screened by the board’s Tea Tasting Unit. To qualify, the tea must be packed in Sri Lanka, and it must be sold in consumer packs. This requirement ensures that teas that receive the certification undergo significant local processing. A wide range of packaging is available and used. This includes cloth bags, glass jars, porcelain and wood containers, and containers constructed of aluminium foil, reed and metal.

The EDB has been pushing for the move from bulk tea to retail-packaged tea, which involves the addition of value, and the trend seems to be in that direction. In 2014 the sale of bulk teas fell 3.36% while tea packet sales rose 11.43%, tea bag sales were up 9.69% and instant tea sales rose 12.77%.

For years, Sri Lanka has been challenged in the world markets by emerging producers, such as Kenya, and it is currently ranked third (behind Kenya and China). However, due to the quality of its tea and innovative practices, the island nation has been able to hold its own. Among the major tea exporting countries, it has recorded the highest market prices in recent years. The 2014 average price in Colombo was $3.56 per kg. That compares with $2.65 in Kolkata and $2.03 in Mombasa – the world average was $2.56.

Standards

Sri Lankan teas already undergo strict testing. To be exported, the product must be ISO3720 certified. This sets out details regarding acceptable packaging and the types of plants and parts that are to be used in the making of black tea. Meanwhile, the SLTB has its own standard requirements, and conducts additional testing with respect to the presence of foreign matter, micro-biological contamination, heavy metals and pesticides. In 2015, the tea board started offering good manufacturing practices certification for teas, which has been required for exports to Iran.

Beyond that, other standards are voluntary. Many companies have been getting their teas ISO 9001 certified, but they are quickly finding that they must seek and meet stricter quality control and purity regimes, such as ISO 22000 or HACCP. The latter is required for exporting tea to Europe.

A wide range of other certifications are available from the private sector, and some companies are seeking these in order to improve their position in the international markets.

These include those from the British Retail Council, the Ethical Tea Partnership and the Rain-forest Alliance. Individual companies, such as McDonald’s, also have their own standards, and companies are finding it important to meet them if they want to reach these customers.

The Institute of Policy Studies says that the many certifications required and available, however, challenge the Sri Lankan tea sector. The island lacks the necessary facilities and is unable to test for some contaminants as required under certain standards. Compliance costs are high and are difficult for some companies. Also, companies are faced with too many different types of standards and these standards are constantly changing and require regular monitoring.

Next Frontier

The frontier for value addition in the tea subsector is organic tea, which remains a small part of overall production and export, as organic teas require significantly more work than non-organic. Fair Trade is another designation that is good for differentiating product and marketing. In Europe especially, the trend is toward products that meet more stringent requirements (all of Marks & Spencer’s teas have been organic for more than a decade). Historically, though, most of Sri Lanka’s tea production has gone to the Middle East and to Central Asian countries, and in these places the demand for organic is still relatively low.

Other raw materials have been targeted for value addition. Coconuts are a good example. The actual production of the seed has been stagnant for years at approximately 2.8bn annually, with productivity per acre stuck at 3000. But by packaging coconut milk in Tetra Paks, companies are able to get more out of the raw product and higher profits from the seeds utilised.

The EDB would like to see more in terms of processing, particularly when it comes to spices. Historically, these products have been sold overseas in bulk, but the EDB is discouraging this and would like more to be locally packaged and better branded for overseas consumption. Spice exports have boomed in recent years, rising from $123m in 2009 to $355m in 2013 (though dropping back to $265m in 2014). 2015 proved to be a strong financial year, with exports up 42% to $377m.

The gem sector can also benefit from value addition (see Industry chapter). As of late 2015, most stones from the country are still exported in raw form, and the hope is to sell more processed gems and make the country a hub for the relevant work. Thailand, in particular, has traditionally processed much of Sri Lanka’s coloured stones.

Sri Lanka has the capacity to cut gems, but many of the people involved in this sector are losing business as foreign entrepreneurs buy the stones and take them overseas for value-added work. The EDB would like to see more domestic activity in terms of not only cutting and polishing, but also packaging, labelling and marketing.

Port Possibilities

With Sri Lanka developing port facilities, it is hoped that the country becomes more involved in international supply chains. Hong Kong has taken note of Sri Lanka’s potential for value addition. In an early 2015 research note, the Hong Kong Trade Development Council recommended companies to look at Sri Lanka as an alternative to China for value-added work. It notes that as wages on the mainland rise, Sri Lanka becomes more price competitive and has the advantage of being on major shipping routes. The council believes that the country can be relatively easily integrated with global supply chains because Sri Lanka is able to provide a comparatively well-skilled workforce at a price on par with South-east Asia and even some of the lower-cost jurisdictions, such as Bangladesh.

However, local Sri Lankan commentators have cautioned that market interventions, such as price controls, are no substitute for structural reforms. Whether the solution to be recommended is value addition or some other option, the risk is that the efforts will be both costly and ineffective.

Structural reforms can help make the country more competitive while addressing the issue of the trade deficit without risking the unintended consequences of more interventionist measures. While this may take more effort, the results could be greater and more sustainable in the long run.

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The Report: Sri Lanka 2016

Investment & Trade chapter from The Report: Sri Lanka 2016

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