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Thursday December 1st, 2022

Sri Lanka import controls and their impact

ECONOMYNEXT – Sri Lanka’s import controls have created shortages and inflated prices giving profits to some domestic producers from farmers to others who have always hidden behind import protection to target consumers.

Though a few producers benefit, restricting trade has other negative fallouts.

Asanka Wijesinghe, a research economist as Colombo based Institute of Policy Studies of Sri Lanka looks at the impact on the domestic economy as well as broader international trade relations.

Beyond Turmeric: How Import Controls are Impacting Sri Lanka’sEconomy

Raw turmeric roots on the shelves of roadside vendors is a frequent sight nowadays. Thanks to the import controls, turmeric now fetches a higher price domestically; prices having soared by as much as 275% from Rs. 80 per kilo to Rs. 300 per kilo.

The turmeric shortage, reports of adulterated turmeric powder, the ceiling price, black-market sales, and sensational stories of busting smuggling attempts are the manifestations of the impact of import controls.

The recent waves of import restrictions imposed by the Sri Lankan government have different justifications such as boosting domestic production and avoiding re-exporting substandard products and foreign exchange leakage. However, protectionism has costs. The significant costs are: 1) possibility of tariff retaliation by the trading partners; 2) impact on domestic manufacturing for exporting;and 3) resource misallocation.

These costs will have a severe impact on the recovery of the COVID-19 affected economy. In this article, the costs of protectionist trade policies and opportunities available for a faster post-COVID economic recovery are discussed.

Possibility of Trade Retaliation by Trading Partners

The economic literature documents the political and economic costof the China-US trade war thoroughly. China’s targeted agricultural tariffs, which were in retaliation to Trump’s unilateral tariffs, cost the Republican party the 2018 House election.

From a mercantilist point of view, countries like to export but are reluctant to import.

But trade is no longer a one-way street. The EU,in a statement on Sri Lanka’s new import controls,points out that “a prolonged import ban is not in line with World Trade Organization regulations.”

Returning to the turmeric story, Sri Lanka’s primary turmeric import source was India. In 2017, 97% (USD7 million) of Sri Lanka’s turmeric imports came from India. Media reports show that Indian farmers and merchants have raised concerns over Sri Lanka’s turmeric ban.

While these concerns have no immediate damage on the country’s exports, Sri Lanka should still be cautious to avoid the Trump administration’s blunderof getting into a series of tariff battles with crucial trade partners.

Impact on Domestic Manufacturing

Nowadays, the vertically linked manufacturing process through global value chains (GVCs) is the norm. Manufacturing in Sri Lanka is no exception. Around 49% of Sri Lanka’s imports are intermediate goods, and 14% are capital goods (Figure 1).

Import controls disrupt the input supply and may harm the export performance of industries that use foreign raw materials. One significant China-US trade war harm was on the US manufacturing sector. Comparably, Sri Lanka’s import controls in April 2020 seriously hurt the sectors which used imported raw materials.

It is, however, commendable that the government relaxed some of the import controls in June to ensure an uninterrupted supply of raw materials.

Resource Misallocation

Economic theory dictates that a country should produce and eventually specialise in products for which the country has a relative productivity advantage (production patterns correlate with predictions from Ricardo’s comparative advantage theory). Import controls distort production and induce the allocation of scarce resources (land, water, and labour resources that have high-valued alternative uses) to relatively unproductive sectors.

Sri Lanka imported around 75% of the turmeric requirement, and 97% of imports came from India. The Revealed Comparative Advantage (RCA) index for turmeric shows that India has a superior export performance (Table 1).

Sri Lanka traded turmeric following the “revealed comparative advantage” logic, but the import controls distorted it. The prospect of exporting domestic turmeric is not promising. India dominates the global turmeric market currently and has a cost advantage. It is doubtful if Sri Lanka can grab a sizeable chunk of world trade through protectionism. However, now the resources are diverted to the protected sector, and domestic consumers pay an exorbitant price.

A Way Forward

Historically, the government resorted to import controls when there was a balance of payment crisis. The current import controls have the same underlying rationale.

However, the trade deficit’s temporary shrinkage may not be sustainable if there is no increase in exports. To increase exports, Sri Lanka needs to remove hurdles on input supply, remove distortionary tariffs, exploit market opportunities under the rule-based free trade system, and in the long run, improve the country’s GVC participation.

Sri Lanka successfully realigned the production process to produce widely demanded COVID-19 related medical supplies showing the benefits and opportunities of free trade (Figure 2). The high demand may continue to another year, and countries have removed tariffs on medical supplies. Some countries have banned the exports of medical supplies like PPE opening substantial market opportunities for Sri Lanka.

Increasing GVC participation by producing products closely related to the current competitive sectors but have higher complexity, is a practical approach. Sri Lanka may not make the final good within the country, but the country may process the materials it currently exports by a little. Participation in downstream, as well as upstream GVCs, makes countries better off.

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Sri Lanka’s inflation eases to 61-pct in November

ECONOMYNEXT – Sri Lanka’s 12-month inflation in the capital Colombo fell to 61 percent in November 2022 from 66 percent in October as price stabilized after interest rates were allowed to go up and the exchange rate was pegged around 360 to the US dollar.

The widely watched Colombo Consumer Price Index fell absolutely 0.5 percent to 242.6 points in November after falling .04 percent in the October.

Food prices fell 1.5 percent after falling 2.0 percent a month earlier. The sub-index containing gas fell 0.5r percent and transport fell 3.6 percent.

But some services continued to go up, as relative prices adjusted to the steep fall in the currency after two years of money printing to suppress rates.

Health costs went up 5.7 percent. Furnishing and routine maintenance rose 0.4 percent.

Sri Lanka’s central bank hiked policy rates to 15.5 percent in April and pulled back on longer term money printing, allowing market rates to go to around 30 percent.

The exchange rater is pegged around 363 rupees with a surrender rule where banks are forced to sell dollars to the central bank for new liquidity.

The ongoing currency and inflation crisis is the worst in the history of the central bank.

Sri Lanka’s Latin America style central bank was set up in 1950 giving powers to the country’s macro-economists the power to mis-target rates, create currency crisis and high inflation. (Colombo/Nov30/2022)

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Sri Lanka shares close at one-month high

ECONOMYNEXT – Sri Lanka shares closed at one month high on Wednesday gaining for the fourth session on news that government is in talks with ADB and World Bank to get a 1.9 billion dollar loan facility, brokers said.

The main All Share Price Index (ASPI) closed 3.3 percent or 276.02 points higher at 8,651.23, highest index gain in since November 01.

“Investor participation improved on the back of confirmed talks with multilateral and bilateral lenders including world banks and ADB for USD 1.9Bn after IMF board level agreement is reached,” First Capital Market Research said in it’s daily note.

Former Central Bank Governor Indrajit Coomaraswamy said in a forum on Monday that the government is in discussion with ADB and World Bank to get loans of 1.9 billion US dollars after a reform program with International Monetary Fund is approved

A policy loan now being discussed with the World Bank may bring around 700 million US dollars, Coomaraswamy told a business forum organized by CT CLSA Securities, a Colombo-based brokerage.

The Asian Development Bank may also give around 1.2 billion US dollars most of which will be budget support, he said.

The market witnessed a turnover of 3.3 billion rupees, higher than this year’s daily average turnover of 2.9 billion rupees. This is the highest turnover generated since October 04.

In the last few sessions market gained after Central bank governor said market rates should eventually ease despite the fears of a domestic debt restructuring as inflation falls, increased liquidity in dollar markets, and the inter-bank liquidity improves.

In the past sessions, the index continued to fall on the speculation of a local debt restructuring although no proper decision has been taken so far.

The market saw a foreign inflow of 39 million rupees. The total net foreign inflow stood at 18.33 billion rupees so far for this year.

The more liquid index S&P SL20 closed 3.4 percent or 89.78 points higher at 2,730.08.

The ASPI has fallen 0.5 percent in November after losing 13.4 percent in October.

It has lost 29.2 percent year-to-date after being one of the world’s best stock markets with an 80 percent return last year when large volumes of money were printed.

Sampath Bank pushed the index up to close at 10.9 percent to 36.6 rupees.

Other top gainers were Browns Investment gained 15.4 percent to close at 7.5 rupees and LOLC gained 9.4 percent to close at 411.3 rupees.(Colombo/Nov30/2022)

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Sri Lanka bonds, T-bills ease, overall market dull

ECONOMYNEXT – Sri Lanka’s treasury bonds eased and T-bill yields fell on the speculation on talks with ADB and World Bank to obtain financial aid but the over all market was dull on Wednesday while the Central Bank’s guidance peg remained unchanged, dealers said.

“During the day, secondary market witnessed some buying interest on the back of speculations on yields easing while talks about financial aid from ADB and World Bank further strengthened interest,” First Capital Market Research said in it’s daily note.

A bond maturing on 01.05.2024 closed at 32.00/60 percent on Wednesday, down from 32.30/90 percent on Tuesday.

A bond maturing on 07.07.2025 bond closed at 30.80/31.30 percent up from 30.30/31.25 percent on Tuesday.

A bond maturing on 15.05.2026 closed at 31.00/30 percent down from 31.10/31.30 percent on Tuesday.

The three-month T-bills closed at 32.30/33.25 percent, down from 32.60/33.00 percent.

The Central Bank’s guidance peg for interbank transactions remained unchanged at 363.19 rupees against the US dollar.

Commercial banks offered dollars for telegraphic transfers between 371.79 and 372.10 for small transactions, data showed.

Buying rates are between 361.79 – 362.00 rupees. (Colombo/Nov 30/2022)

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