Will Free Trade (FTAs) Lead to a ‘Powerful’ Sri Lanka?

March 20, 2017 at 4:20 pm

 

THE IMF IN SRI LANKA – Part IV

by C. R. de Silva, C.C.S. (Retd).
Small & Medium Enterprises (SMEs)
– Low Export Viability under FTAs.

Continued from Saturday

Caution by an Industrial Association.
The Ceylon National Chamber of Industries has commented adversely on a recent government disclosure in relation to the proposed China-Sri Lanka FTA about the reduction of the Sri Lankan negative list to 10%, from an original 40% of total tariff lines, and later reduced to 30%; and the phasing out of the CESS to zero, which was designed to protect local industries, within five years of signing the FTA. The Chamber’s claim is that at a time when the U.S. is considering a tariff/tax on imports from China, it is quite imprudent for a poor country like ours to relax safeguards for nascent local industries – even recognized as necessary by WTO. Phasing out the CESS “will sound the death knell for local industry, already burdened by high energy and labour costs, rising raw material costs, and an un-level playing field, eroding competitiveness already”.
“Removal of this protection will also prejudice the SMEs, seen already as dominating the industry sector, but are dependent on larger industries for backward/forward integration for supply sourcing of raw materials, marketing and allied services, leading to ultimate SME closure due to non-competitiveness, creating widespread unemployment, also adversely affecting the general economy;…also, bankruptcy of local industrialists who have borrowed funds by pledging their personal assets as security.” This Chamber has added that high bank interest rates, non-competitive parity rate for a floating Rupee (again on IMF insistence), labour laws affecting productivity improvements and problems relating to conflicting investment policies, have increased the opposition of majority of local industrialists to the proposed FTA. Since growth of Sri Lanka’s economy should be the end objective of any FTA, “such a policy framework should give adequate time to enable local industry to face such challenges, or a subsidy scheme should first be put in place for challenged industries to diversify into new lines, or pay-off their debts and secure their invested capital”.

SINGAPORE.
Next to Japan and China, Singapore is the City State, Sri Lanka is said to be emulating in Asia. Singapore is rushing into automation at top speed – building expertise in high tech niches such as robotics, 3D printing, biologics (making drugs from protein in cell cultures, rather than synthetic chemicals), and similar cutting edge production, to help it sustain a large, high-end manufacturing sector, employing more than 100,000, despite the exit of many labour-intensive, low-end industries to cheaper locations, potentially like Sri Lanka and elsewhere, where Singapore FDI may well invest.
Encouraged by low tax rates, and other similar incentives and subsidies, (spurned by the IMF in Sri Lanka), Singapore’s transformation from a sleepy trading post, which declared its independence only in the early-1960s, to an industrial and economic powerhouse is being proactively driven by its Government. Attractive policies and a high standard of living have induced 44% of global companies’ Asian headquarters to re-locate to Singapore.
Sri Lanka may also possibly benefit from Singapore focusing on developing a regional manufacturing supply chain, where its labour intensive work can be based in nearby countries, but not design, engineering and sophisticated manufacturing, which are done at home, often utilizing foreign expertise. So, Singapore has a target of attracting about 2,500 data analytics professionals by end-2017. Already, about one-half of South East Asia’s data centre capacity is in Singapore. (Extracted from “Singapore Targets Investment in ‘Disruptive’ Technologies). Conversely, Sri Lanka’s debilitating brain drain which really started about 1956, and accelerated in 1983, is still in full flow, showing little sign of reversing, certainly unlike India and possibly even Bangladesh, emerging ‘tiger’ economies, attracting qualified and experienced expatriates to return.
Sri Lankan trade policy concerns, similar to those with China, surround the Government’s aggressive push to finalize a bilateral free trade agreement with Singapore, which is unarguably the most highly industrialized and sophisticated manufacturing centre in South East Asia, as described earlier, starting as an independent country barely 55 years ago but following the ‘Development State’-oriented government interventionist and anti-western route to first world prosperity – articulated in this writer’s serialized essay titled “The Development Strategy of the ‘Miracle’ Economies of East Asia” (The Island, 11 February,2017).
While Sri Lanka currently has four trade agreements, Singapore has 21 bilateral and regional FTAs in force with 32 other countries, and generally imposes a zero rate of duty, on average, on all imports, and may demand reciprocal treatment from Sri Lanka, causing a revenue loss, but little gain. Singapore is now moving from a manufacturing economy to a service and investment base. Like China, Singapore is not an important export destination for Sri Lanka – with exports totaling only $ 85 million, while Singapore exported mainly refined petroleum products, electronics, chemicals, plastics, machinery and even food items to us, totaling over $900 million in 2015.
While a Sri Lanka/Singapore FTA may include liberalization of the services sector, the so-called ‘Global City’ has now turned conservative about admitting overseas workers, given the major influx of foreigners, high- as well as low-skilled, who now constitute two out of every five residents, causing a public backlash. The conclusion on the proposed FTA, of IPS trade policy analysts, whose above research the writer is indebted to, are that “Sri Lanka has little to gain…due to its minimum amount of exports and Singapore’s existing duty free access (to all imports)…Mobility of labour to Singapore should not be anticipated…”, but as mentioned earlier, a potential increase in FDI is possible (Benefits of a Potential Singapore-Sri Lanka FTA”, 20 July 2016, IPS).
Despite not entertaining yet any constructive suggestions or stakeholder comments, the concerned Ministry has decided that the proposed FTA will be entered into before end-June and will cover not only goods and services (financial, telecom and e-commerce), but also mainly investment, customs procedures, trade facilitation and economic cooperation more generally. (However, since no draft FTA has been released for industry or stakeholder review, most information results mainly from leaks, (which is a new tool of democratic governance in this country).

INDIA
The foregoing analysis shows that Sri Lanka is lagging behind the vast majority of booming Asian economies, as well as in relation to the rate of phenomenal growth and size of India’s massive economy. Sri Lanka’s experience with the already operational bilateral trading arrangements with India under an FTA, leaves much to be desired, due to discreet Indian obstructionism, already confronted by Sri Lankan exporters. These are non-tariff barriers, concealed State as well as Federal Government trade regulations, and the ‘fine print’ not obvious to simplistic-minded, domestic SME trading concerns, including “invisible” obstructionist measures, which the well-known, unique genius of the Indian bureaucracy and businessmen can be depended on to transpose, and will further continue to erode the already unbalanced, adverse historic, bilateral trade experience between Sri Lanka and the Indian import market. The latter is really a more equal challenge for American and European, even Chinese, exporters who originate from more highly industrialized and sophisticated, export-driven, better advanced economies, which have moved up the technological ladder to conquer futuristic, innovation-related obstacles and established new-age knowledge and product automation, as well as service-oriented development goals, leaving their surplus lower-end, sometimes lower quality, manufactures for export to developing countries, such as those in South Asia, and also to African countries.

Ongoing Sri Lanka/India FTA: Issues
In the context of the earlier South Asian regional FTA of 2000 failing to realize enhanced trade, and elaborating on the seven-year experience with the ongoing bilateral FTA with India, studies have concluded that “the rejection of Sri Lankan products entitled to concessions; non-acceptance of Sri Lankan standard certification; excessive time taken for product testing; complexity of and difficulties in, obtaining relevant information, and lack of efficient Indian border controls are some of the key barriers in trading with India”. Other important issues that have been likewise highlighted, which have reduced the potential utilization rate of FTA provisions to 60%, include the bulk of Sri Lankan exports to India being outside their purview; the utilization rate by Indian exporters being as low as 14%; non-tariff barriers referred to earlier, trade facilitation issues, lower prospects for vertical integration; strict quotas on Sri Lankan exports and stringent rules on product origin criteria, as pointed out in an IPS study by Dr Saman Kelegama (Executive Director of IPS), as far back as 2014. These clearly identified issues have not been corrected, as far as is known, in the aggressive political rush for a second broader ETCA.
Based on a negative list approach, the FTA in force, excludes 1180 Sri Lankan products, while excluded Indian products disproportionately amount to only 429; while in addition, India and Sri Lanka were given 3 and 8 years, respectively, to completely enforce the FTA’s zero duty provisions, recognizing the asymmetries between the two economies. In addition, both countries were required to produce ‘Proof of Origin’, requiring substantial value addition in-country, to qualify for duty exemption. Given the inclusion of an overwhelming share of imported components in most Sri Lankan manufactures, these operative caveats mean granting opportunities for subjective Indian value judgements, inhibiting FTA benefits, especially for a low-end industrial sector, as Sri Lanka has today.
Aside from a myriad other loopholes and bottlenecks experienced by Sri Lankan exporters to India, especially SMEs, IPS has identified several important FTA-related issues, at the Sri Lankan end, worth mentioning here: 1. In addition to the BOI, Ports and Customs, operations of other supporting and facilitating government agencies are not automated, e.g. the Commerce Department’s documentation, like Certificates of Origin, are still written manually; 2. Cargo from India arrives here in 24-48 hours, but notorious red tape and Indian bureaucratic delays affect arrival of needed documentation, delaying cargo clearance, especially of perishables; 3. Sometimes, delays in de-stuffing containers due to Colombo port congestion takes up to 7 days; and 4. The standard and quality requirements for imported products are set by different local organizations in India.

Likewise, issues faced by Sri Lankan exporters at the Indian end have been also identified in the same study, as follows: 1. Lack of efficient border control mechanisms in India and, of transparency and information sharing with officials, cause considerable delays in shipping and logistics, e.g. different ports demand different documentation, being not linked or automated; 2. Ignorance of Indian customs officials of FTA concessions for qualified, product categories, leading to delays and corruption; 3. Non-acceptance of standards certification by SLSI of Sri Lanka, despite reciprocal recognition of Indian certified products; 4. A major issue is excessive time taken for lab testing of perishable exports from Sri Lanka, often 5 days, with higher Indian food standard requirements than Japan or the EU; and also excessive spot testing of even garments!; 5. Complexity and difficulties in obtaining information on new regulations, especially by SME exporters, e.g. recent new food safety regulations; 6. Exporters’ need to make informal payments to oil the machine erode price competitiveness, where profit margins are slender; and 6. Absence of an Indian agency or ‘help desk’ to resolve problems like the above, where a quick response is critical due to ensuing high costs from delays, negating FTA benefits and discouraging Sri Lankan exporters. (Above points and arguments are extracted from “Facilitating Trade Between India and Sri Lanka”, IPS, March 2016).
To be Continued

Conclusions
The above IPS study of one year ago, includes Policy Recommendations to overcome the numerous constraints at both country ends which have been encountered in the operation of the existing FTA, but if after seven years, the experience of Sri Lankan businesses is not good, the bottom line is: Why are political leaders in Sri Lanka rushing into an expanded, new Economic and Technical Cooperation Agreement (ETCA), extending to wider economic cooperation, including labour and services, without resolving important existing trade issues with India?
Sri Lanka’s political and business community’s and professional bodies’ opposition to the proposed ETCA, which is a disguised, now abandoned Comprehensive Economic Cooperation Agreement (CEPA), has extended to the issue of allowing migrant labour and India’s unemployed millions to enter and saturate the Sri Lankan job market, to replace the large numbers of skilled and unskilled workers who have migrated to the Middle and Far East in search of more lucrative employment, thereby increasing labour costs here. Will these moves further discourage FDI in Sri Lanka, at its lowest historical ebb in 2016, due to increasing costs of imported Indian labour?
A Point of View
Meanwhile, a new but very perceptive national policy think tank ‘National Council for Sri Lanka’ has urged the Government to abandon the proposed ETCA, and stated that “it is the responsibility of the Government to conduct a comprehensive investigation of the ‘non-tax obstacles’ of both countries…Sri Lanka’s National Economic Planning Council needs to focus on the country’s total manufacturing and services’ key areas…including stabilizing the country’s manufacturing and service delivery processes…the present Government considers bilateral trade agreements as the foundation of foreign trade. Therefore, the Government continues to establish such bilateral agreements with a number of countries, including China, Singapore and India. In fact, these are outmoded instruments based on traditional development models. Therefore, instead of such bilateral agreements, the Government should focus on new mechanisms for establishing trade relations with many countries. Just as the previous regime proposed the CEPA with India, the present Government has proposed ETCA, and both of these are inequitable for Sri Lanka, and should therefore be abandoned…” (Ceylon FT, 3 March 2017).

Automation in India
Finally, India, which is globally the fastest growing economy, is also fast automating its industry, the momentum being driven by foreign robotics companies, which are cultivating the market and tapping into opportunities. Accordingly, India will have an installed base of 24,000 industrial robots by end-2017, while warehouse automation is expected to become a $ 32 Billion market by 2020 (from $ 1 Billion in 2013). ‘Robotic butlers’ are helping to pick, sort and package items in warehouses across India, while car manufacturing plants are relying on robots for speed, scale and accuracy – welding and painting cars – and buying 60% of all industrial robots made in India. Locally made robots are also cleaning radio-active components at India’s Atomic Research Centre; while an autonomous underwater vehicle is inspecting and repairing bridges, pipelines and hulls of ships.
So, robotics use and development in India is not waiting for the Government to formulate policy, but the private sector is quickly diversifying the market for automation (India’s Asian Dilemma : How Best to Grow Robotics Industry? – From Robotics Business Review). Finally, the six million dollar question arises: Can Sri Lanka compete in fair trade as an equal partner under a proposed ETCA with such an advanced, fast-automating industrialized country?
Sri Lanka : Economic Crisis – Update (as of 10 March)

Due to the convergence of many factors, including the worrisome 100 Billion Rupee level of recent exits from fixed securities; the well-known emerging markets specialist investor Templeton Funds, pulling out almost $ 1.5 Billion of its funds from the local stock market; as well as very low institutional investor (EPF, ETF, Unit Trusts and Insurance Companies) participation in equities – amounting to only 6.5% of the market’s Rs 3.1 Trillion capitalization) – mostly due to allegations of corruption and a low level of confidence in the market due partly to prolonged, unresolved, convoluted ‘bond scam’ news headlines; and absence of an enabling environment of macro-economic and political stability; also, a record high level of new money printing by CBSL – surpassing Rs 100 Billion at this time – to raise funds to pay locally raised debt, which itself has now exceeded Rs 9 Billion, contributing to attendant rising inflation, now over 5%; a low, net international foreign reserve falling to about $ 5.4 Billion, below IMF-agreed levels; continuing, loss-making Sri Lankan airline’s foreign exchange outflows; and rising cost of living due to two staples, rice and coconuts, running into supply shortages, combined with and partly due to, a prolonged and widespread drought affecting fourteen administrative districts; and with the Governor, CBSL announcing publicly late-February that “our export performance has deteriorated dramatically”, to one-half the export level reached in 2000 – high level IMF staff and management concern has been activated with reported visits by the latter to Colombo, in due course.
Do all these most unwelcome economic developments signify serious problems with unrealistic assumptions made in early-2016, when the amount of IMF assistance was evaluated, or wrong assumptions on which the IMF’s economic stabilization program itself was based, supported by a totally inadequate $ 1.5 Billion EFF commitment in mid-2016, which promised ‘take off’ of the economy of Sri Lanka in the foreseeable future? The IMF commitment of funds, was to be disbursed in small, six-monthly instalments, amounting to insignificant resource inflows, providing no foreign exchange buffer at all to the Government, which was instead saddled with numerous people-impoverishing, unpopular conditionality. These significant issues arising from the IMF’s recent role in Sri Lanka, were fully analyzed earlier by the writer’s series of articles, “Sri Lanka – Case for a $3-4.5 Billion in IMF Funding” in ‘The Island’ of 13 May 2016, followed by “Sri Lanka – Avoiding the ‘Road’ to Greece” in The Island of 13 June 2016. See also The IMF in Sri Lanka: ’Bull in a China Shop Syndrome’, 7 October 2016 and “Reliability of IMF Judgements and Program Efficacy”, The Island, 3-4 August 2016, none of which have evoked any comments from the IMF!
The developments enumerated above, and the prolonged drought referred to which has caused a serious shortage of rice, and the need to import rice once again, expending scarce foreign exchange, and also financial outlays so far amounting to Rs 82 million for drought relief and a (very difficult to administer) government pledge to provide Rs 10,000 per acre for unusable, dried-out rice fields – together contributing to greater challenges in reaching an already ambitious, IMF-agreed ‘austerity’-based, 4.6% fiscal target in 2017 (now looking more like well over 5%) – have caused Moody’s (the rating agency) to assign Sri Lanka a B1 rating with a negative outlook, prompting its analysts to comment :
“Majority of Sri Lanka’s macroeconomic indicators from inflation to interest rates and foreign exchange values to external economic outlook have worsened in recent times, mostly due to self-inflicted economic ills and partly due to legacy issues…the IMF will press the Government on certain delayed fiscal and structural reforms…the pressure would mount not just from the expenditure side but also from the revenue side…drought-caused lower agricultural output will lower economic growth…reduce exports, household consumption and incomes in affected areas, posing downside risks to GDP growth…now projected at 5% in 2017, materially lower than government’s 6% forecast…higher imports to substitute for the loss of domestic production will weigh on Sri Lanka’s current account deficit and foreign exchange reserve buffers, a key constraint to credit quality. Agricultural sector difficulties could also spill over into a multitude of socio-economic issues as the sector employs 28% of the labour force but accounts for just 10% of GDP”. (Moody’s analysis cited in Mirror Business, 3 March 2017).
Sri Lanka’s economic and net foreign reserve problems may become more aggravated with the next expected dollar rate increase by the Fed very soon, given the improving U.S. economy and no rate change in February, which will further contribute to depreciate the rupee, (given free Rupee exchange movements agreed with the IMF), and due to potential, accelerated outflows of foreigners’ fixed income investments. The Rupee will also come under more pressure from dollar demand by importers ahead of Sinhala-Tamil new year celebrations mid-April.

The western powers and their proxies (ably supported by our great neighbor, now feigning historic national intimacy), are also doing a ‘very good’ job through the usual neo-colonial agencies, of keeping our government authorities’ and public attention diverted away from the coming economic storm, and concentrated on issues relating to alleged war crimes, transitional justice, reconciliation, human rights, including allegations of torture, and therefore, need for new Constitution-making; and an ever-ready international financing agency is waiting in the wings, ready to bail-out one of (the very few remaining) client countries, periodically in BOP difficulties, with another paltry dose of just enough rescue funds to tide over another crisis, gaining an even better foot-hold here, and generating more business for itself, but with bigger and more people-impoverishing, onerous conditionality. So, the same sad saga keeps playing out time after time, until Sri Lanka adopts a very different development strategy, like the East Asian ‘miracles’, which will set our people finally free, like they did to their now liberated populations, enjoying much higher standards of living in inclusive prosperity.

Concluded
(The writer who was a member of the former C.C.S., was later a senior professional at World Bank Headquarters for over 30 years)..