Sri Lanka’s commitment to being conducive to private-sector business development is reflected in its marked orientation towards trade and investor-friendly encouragement of foreign direct investment. Building on its strategic location at the gateway to India and between the Middle East, Africa and South-east Asia, the government of Sri Lanka is pushing an agenda of open and free-market economic policy to promote and expand trade and economic links, with the ultimate goal of becoming a regional trade centre.
Transitions
As the country edges towards achieving middle-income status, Sri Lanka’s economy has transitioned from being predominantly rural-based and agricultural to one that is urbanised and services driven. In 2015 the service sector accounted for 62.4% of GDP, followed by manufacturing (28.9%) and agriculture (8.7%), according to figures from the World Bank (WB).
In its drive to increase incomes across the island, the country is able to call upon domestically produced raw materials such as tea, rubber and coconut, a well-educated workforce and strong external ties with strategic trading partners. “I see Sri Lanka’s economic future as a services hub; a niche manufacturing destination to produce goods which plug into regional and global value chains, particularly light engineering; and a location for high-value agricultural products such as fruits, vegetables and dairy, both to service the rapidly growing tourism sector and for exports, especially, to the Middle Eastern and Indian markets,” Ranil Wickremesinghe, Sri Lanka’s prime minister, wrote in a speech prepared for the World Economic Forum’s 2016 meeting.
The prime minister went on to write that, in his view, industrialisation and urbanisation are key drivers of modernisation. In order to create the appropriate environment for these drivers to materialise, he proposed the creation of 45 new industrial parks around the country – to be developed and managed by the private sector – as well as the development of five second-tier cities to promote urbanisation throughout the island.
Industrial Policy & Strategy
The government of President Maithripala Sirisena has charted an economic policy that is on course to steer the country towards sustainable industrial development and the promotion of domestic industry. It stresses the importance of increasing income generation and creating employment via tapping unrealised domestic market opportunities and promoting domestically sourced value-added raw material as well as resource-based export industries. The policy also aims to spur industrial activity of all kinds around the country. To facilitate these policy goals the government is currently engaged in a massive infrastructure upgrade that will ultimately work to provide access to factories and raw materials in rural areas, and vice-versa.
In charge of steering this craft is the Ministry of Industry and Commerce (MIC), and its remit includes policy formulation to expand exports and increase employment while also encouraging diversification, value addition, environmental sustainability and regional industrial development. The MIC also formulates and implements infrastructure for the promotion and development of the industrial sector.
Working to assist both public and private-sector entrepreneurs and families, in addition to small, medium and large industrial enterprises, the MIC’s Industrial Development Board (IDB) aims to promote and develop Sri Lankan enterprises, individuals and institutions concerned with industry from a strategic, technological and commercial foundation. Its services run the gamut from identifying business opportunities, information and linkages to market, product development and promotion, productivity improvement, management and technology development and assistance, engineering services as well as the provision of infrastructure facilities and product-specific raw materials.
Each industry additionally has its own professional industry associations, such as the Tea Board and the Tiles and Sanitary Ware Importers Association.
There is, however, much work to do if the government is to succeed in its goal of becoming a regional trade hub. South Asia in general is the most closed trade region in the world, imposing an average 16.7% tariff on imported products, according to “Global Enabling Trade Report 2016”, published by the World Economic Forum (WEF) and the Global Alliance for Trade Facilitation. In the report Sri Lanka ranked 103rd and India ranked 102nd out of 136 economies. The report uses the enabling trade index to measure a country’s free flow of goods over borders and to their destination according to categories such as domestic and foreign market access, border administration, transport and ICT infrastructure and services, and operating environment. The ranking system found that Sri Lanka’s most problematic factors for exporting were identifying potential markets and buyers, access to imported inputs at competitive prices and tariff barriers abroad, while its most problematic factors for importing were tariffs and non-tariff barriers, burdensome import procedures and corruption at the border.
The volume of industrial production increased by 3.6% in February 2017, according to Department of Statistics data. In November and December 2016, the index indicated an increase in production of 4.5% and 3.6%, respectively, compared to average monthly production in 2015. Industrial production for the fourth quarter of 2016 increased by 4.3% year-on-year (y-o-y).
An Open Economy
In its 2017 budget speech the government laid out plans to propel the growth of a wide variety of industries in the country. A sample of the pro-growth initiatives includes the abolition of certain taxes and regulations on the tea industry and a ban on the export of “refuse tea”; allocations to modernise the Coconut Processing Research Division of the Coconut Research Institute in order to enable it to produce high-yielding planting material and to the Coconut Cultivation Board to engage in a mapping project of areas of major pest attacks; the importation of raw coconut oil products for value-adding and export; an invitation to local and foreign investors to invest in sugar mills in defined districts with the provision of a 100% capital allowance on such investments; and a mandate to the cinnamon industry to conduct value-adding activities to increase the value of cinnamon exports.
With regard to the fishery industry, the government proposed the construction of the country’s first cold room on a public-private partnership basis at the Dikowita Fishery Harbour, allocations for the Gandara Fishery Harbour development project, and to build up fishery harbours and anchorage infrastructure. In addition, it announced the development of Aquaculture Industry Zones in Hambantota, Mannar and Batticaloa, and the National Aquatic Resources Research and Development Agency was urged to engage in research to improve commercialisation in the fishery industry.
To enable the growth of the country’s services industry, specifically its business process outsourcing (BPO), knowledge process outsourcing and legal process outsourcing industries, the government proposed alterations to labour laws to include flexible working hours, an extension of the period allowed for contract work and the introduction of performance-based wages.
Presenting the budget, Ravi Karunanayake, then-minister of finance and current minister of foreign affairs, said the government would provide investment relief for the formation by the private sector of a textile cluster to include sizing, dyeing and finishing units. In addition, to create additional avenues for garment exports, it said it would permit enterprises to import branded products for reworking, and that the garments would be exported to countries where there is no preferential treatment. In the speech, Karunanayake announced the government would immediately implement the Rubber Master Plan, which will see the introduction of high-yielding plants, rain guarding technology and replanting programmes. It also proposed allocations for the establishment of a modern Finite Element Analysis Stimulation Centre at the Plastic and Rubber Institute of Sri Lanka. Lastly, Karunanayake said the government would make allocations to the Department of Commerce for promotional trade activities, especially for products made by small and medium-sized enterprises (SMEs), at international trading and promotional events.
Fostering Trade Partnerships
Sri Lanka is currently pursuing trade agreements with China and Singapore. The country already has free trade agreements (FTAs) with Pakistan and India, both of which have been in place for over a decade. However, these agreements have been restricted to selected goods only. However, trade representatives from Sri Lanka and India are currently in talks to expand the scope of the March 2000 FTA from only goods to include services, investments and technology cooperation. India continues to be Sri Lanka’s major trading partner in South Asia. In 2015-16, India exported goods worth $5.3bn, and its imports from Sri Lanka were worth $750m. The controversial economic and technology cooperation agreement (ETCA) with India was first broached in 2003, when a joint study group was established to widen the previous FTA. Negotiations for the ETCA began in February 2005, but have not progressed since due to broad-ranging concerns voiced by Sri Lanka’s services sector. “Boosting economic integration with India and other countries in the South Asian region appears to be the most obvious growth channel to boost Sri Lanka’s economic growth in the years ahead” Aelian Gunawardene, Managing Director of JAT Holdings, told OBG.
In November 2016 Sri Lanka held bilateral trade talks with Turkey. Sri Lanka’s trade with Turkey has surged by more than 130%, from $97m in 2005 to $230m in 2015. During the talks, Ismet Yılmaz, Turkey’s minister of education, suggested the two countries should target a trade volume of $500m by 2020. Sri Lanka’s major export items to Turkey comprise tea, staple fibres, apparel, and activated carbon and natural mineral products. The value of Sri Lanka’s tea exports to Turkey in 2015 accounted for 76% of Sri Lanka’s total exports.
In order to regain the generalised system of preferences plus (GSP+) benefits, the Sri Lankan government negotiated with the EU on a number of issues surrounding a failure to address human rights concerns, which resulted in the country losing the GSP+ concessions in 2010. The EU announced the reinstatement of GSP+ benefits in mid-May 2017, enabling Sri Lankan exporters to enjoy duty-free privileges.
Additionally, in November 2016 the EU launched a four-year, €8m assistance project to help Sri Lanka increase its trade competitiveness in regional and European markets. The project will be implemented by the International Trade Centre (ITC) and United Nations Industrial Development Organisation in collaboration with the Sri Lankan Department of Commerce.
The project will help Sri Lanka integrate World Trade Organisation policies and reforms to make the most of the potential opportunities from the EU GSP+ scheme and greater regional integration. It will also address compliance standards and efficiencies in cross-border procedures, which are key constraints to market access. Specific attention will be given to enhancing value chains in the spice, food and BPO sectors.
SMEs make up more than 80% of Sri Lankan businesses and represent 35% of total employment, according to Ashish Shah, director of country programmes at the ITC. “Strengthening the export capacities of SMEs in sectors with high potential for job creation is therefore a critical contribution to ensuring inclusive growth in Sri Lanka. Through this we will unlock Sri Lankan SME’s trade competitiveness and help them reap the benefits of participation in international trade,” Shah said.
Material Growth
The government is aiming to make Sri Lanka a commercial hub via trade deals and better supply chain management, and the apparel sector is expected to be a key accelerator in this. The government’s goal is to position Sri Lanka’s apparel sector among the top-10, high-quality apparel manufacturing countries in the world by 2020, and for the apparel industry to generate $8bn in export earnings by that year. Apparel was Sri Lanka’s number-one export in terms of value in 2015. As a percentage of total exports, garments and textiles comprise 46% of Sri Lanka’s total exports, according to central bank data (see analysis).
Trying Times For Tea
In 2015 tea was Sri Lanka’s second-biggest export product in terms of value ($1.3bn) and the country’s fourth-largest export earner, contributing 12.6% of Sri Lanka’s total export earnings. In a reversal of positive trends seen from 2011-14, the tea industry saw y-o-y declines in both the volume (-6%) and price (-12%) of tea exports in 2015, according to the Institute of Policy Studies (IPS), and tea export volumes continued to decrease by 9.5% in the first half of 2016.
The IPS attributed this decline to external market, currency and political conditions in Sri Lanka’s major tea export markets, which include Russia, Turkey, the Middle East, Azerbaijan, Japan, China, Germany and the US. Sri Lanka exported 73% of its total tea exports to these markets in 2015.
Output was also falling, with production figures hitting a 15-year low in September 2016, according to the Sri Lanka Tea Board, which said that September’s tea production of 19.8m kg was down 27% over the previous year’s figure of 27.2m kg. At 218.6m kg, production for the nine-month period to the end of September 2016 was also down almost 14% on the previous year’s corresponding figure of 252.9m kg. The drop in production was attributed to poor cropping conditions, floods and drought, inappropriate fertiliser application, low market prices and a government ban on the use of herbicides.
However, tea exports grew sharply – by 19% y-o-y – as of August 2016, the central bank said in an economic update. About 98% of Sri Lanka’s tea export volumes are in black tea, with green tea comprising only 1.5% of exports and instant tea 0.7%, according to the IPS. In addition, more than 40% of tea is exported in bulk form.
Since state plantations were privatised in the mid1990s, the number of workers employed in tea plantation companies has declined from 345,000 to an estimated 208,000. Yet labour costs still account for more than 70% of production costs at regional plantation companies (RPCs).
A collective agreement signed in October 2016 introduced a new wage formula that enables workers to earn up to LKR805 ($5.49) per day under certain conditions. The collective agreement is expected to cost plantation owners LKR4bn ($27.3m) In December 2016 the WB announced plans to provide $70m in funds to modernise RPCs’ estates and factories. The funds will be aimed at replanting, improving roads and tea factories, and water management to enable the RPCs to enhance their profitability.
A Plan For Rubber
Rubber and rubber finished products were the third-largest export in terms of value in 2015. Rubber had an export value of $787.3m and contributed 7.5% of Sri Lanka’s total export earnings in 2015. The major export markets for rubber and rubber finished products were the US, Germany, Belgium, Italy, Canada, the UK, Brazil, France, India, Japan, Australia, the Netherlands and Spain. Sri Lanka exported 76% of its total rubber exports to these countries in 2015.
“Sri Lankan rubber production is down 20% y-o-y in part due to a fall in global demand,” Ravi Dadlani, vice-president of sales and marketing at CEAT Kelani Holdings, told OBG. Production of natural rubber hit a high of 158,000 tonnes in 2011, but by 2015 production had decreased to 88,600 tonnes, according to the Rubber Development Department. Meanwhile, Thailand, Vietnam and Indonesia have all increased their rubber production by 10-25%.According to Prabhash Subasinghe, managing director of Global Rubber Industries, typical yields in Sri Lanka are 800 kg per hectare. “This amount needs to be doubled in order to become regionally competitive.”
Sri Lanka is the largest supplier of solid tyres globally, and its rubber products comprise the country’s premier value addition in the manufacturing sector. Locally harvested rubber features prominently in domestic manufacturing, totalling around $195m of raw rubber annually. In 2015 an estimated 72m kg of rubber was consumed domestically, according to Rubber Development Department statistics. However, Sri Lanka’s rubber industry export volumes have fallen dramatically, as export volume dropped y-o-y in 2015 by 37% and prices by 9%, according to the IPS. Since 2011 rubber export volumes and prices have declined 77% and 48%, respectively. From January to July 2016, earnings from rubber exports declined by 6.5% on a y-o-y basis. “We are facing difficult times in the rubber sector,” Rishad Bathiudeen, minister of industry and commerce, said during an industry conference in August 2016. The minister listed supply-side constraints, the global market situation, a lack of technology and artificial rubber imports as issues that require resolution in order for the rubber industry to develop.
The Rubber Industry Master Plan aims to achieve $4bn in rubber exports by 2024. To reach the goal, stakeholders will have to confront an issue endemic in the country: a lack of skilled labour. Growth in the rubber industry will depend on manufacturers’ ability to address the current shortage of rubber manufacturing skills and skilled technology knowledge in the rubber industry. Training for rubber industry technicians in the latest rubber technologies is taking place at India’s Cochin University of Science and Technology, and 25 students are set to attend the graduateship programme of the Plastic and Rubber Institute of Sri Lanka.
All That Glitters
The major export markets for Sri Lanka’s diamonds, gems and jewellery were Israel, Belgium, the US, Switzerland and Hong Kong, to which Sri Lanka exported 82.5% of its total in 2015. This segment constituted Sri Lanka’s fourth most valuable export basket in 2015. Together, diamonds, gems and jewellery had an export value of $331.6m and contributed 3.2% of Sri Lanka’s total export earnings in 2015.
Edibles & More
Food and beverages (F&B) were Sri Lanka’s sixth most valuable export in 2015. The segment had a combined export value of $302.2m and contributed 2.9% of Sri Lanka’s total export earnings in 2015. The major export markets for F&B were India, Belgium, the Maldives, the US, Ireland, Indonesia, Germany, the UK, Italy, the UAE, Vietnam and Australia. Sri Lanka exported 71.52% of its total F&B exports to these countries in 2015. Although it accounted for only 1.15% of Sri Lanka’s total export earnings, coconut oil netted an export value of $121.2m in 2015. The US, Canada, Japan and the UK comprised the major export markets for coconut oil. Sri Lanka exported 71% of its total coconut oil exports to these countries in 2015. The government perceives significant potential to increase the export proceeds of its fishery industry by at least five-fold in the next three to five years through the export of not only raw crabs, lobsters, prawns and oysters, but also through value-adding activities such as canning and processing. In 2015 Sri Lanka exported 73% of its total fisheries exports, with an export value of $180.6m and a contribution of 1.7% of the country’s total export earnings. The major export markets for Sri Lanka’s fisheries were the US, Japan, Italy, the UK, the Netherlands, France, Germany and Taiwan. Sri Lanka is the world’s leading exporter of cinnamon. The country’s cinnamon trees produce what is generally agreed to be the world’s best cinnamon and nearly 85% of the crop is exported in its raw form. Value addition is considered an opportunity for this industry to increase export values. Cinnamon had an export value of $131.2m and contributed 1.25% of Sri Lanka’s total export earnings in 2015. The major export markets for cinnamon were Mexico, the US, Peru and Colombia. Sri Lanka exported 72% of its total cinnamon exports to these countries in 2015.
In the tobacco segment, meanwhile, Ceylon Tobacco Company, a subsidiary of British American Tobacco, is the market leader in the country. In addition to domestic sales, the company also exports some of its produce. “The tobacco industry supports the lives of some 300,000 people in Sri Lanka through its wider value chain while contributing more than 7% of the government’s total tax revenue,” Michael Koest, managing director and CEO of Ceylon Tobacco Company, told OBG.
Electronics
The WB Enterprise Surveys show that Sri Lanka’s productivity in the electronics sector is higher than that of China ($24,701 vs. $22,382). Electrical and electronics products (EEP) had an export value of $293.9m and contributed 2.8% of export earnings in 2015. The major export markets for EEP in 2015 were China, India, the US, Switzerland, Germany, the UK, Hong Kong, the Maldives and Japan, with these countries accounting for 77% of the total.
Outlook
With the government proposing broad changes to open the country’s markets, the industrial sector is in a prime position to drive the economy to higher levels. Diversification and value-adding, in the tea and rubber segments for instance, as well as liberalisation for imports and investment in selected areas should allow many of the country’s industrial areas to gain larger global market shares. However, the sector will have to find near-term strategies in order to cope with the lack of skilled workers to increase production and innovation, as well as ramp up efforts to modernise.
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