Economy depends on export sector
Jay Shankar Chief Economist and Director Religare Capital markets
Sri Lanka’s future prosperity largely depends on its fast growing and
innovative exports sector.
The government policies are aimed at developing Sri Lanka as a
trading hub on the East-West route; perhaps in direct competition with
Singapore and Hong Kong.
Even though economic recovery in most developed markets like the US
and EU has been sluggish, leading to lower consumption demand, Sri
Lanka’s exports have increased substantially since 2010.
The Sri Lankan government has set an ambitious target of achieving
US$ 15bn worth annual exports by 2015. Although it may seem an uphill
task, we believe that it is certainly achievable through diversification
of product mix and also the destination.
In the short term, the renewed concerns on a double dip in western
economies may result in a moderation in exports.
However, recent concerns over debt sustainability and risks to
balance of payments are overdone, as are the Central Bank’s intervention
in the currency markets. Our 2011/2012 export forecast remains at US$
9.4bn to 11.1bn respectively.
Ambitious exports targets: The total value of exports has increased
from US$ 7.1bn in 2009 to US$ 8.3bn in 2010. The Sri Lankan government
has set an ambitious target of achieving US$ 15bn worth annual exports
by 2015 and US$ 20bn by 2020.
We believe that these targets can be achieved by diversifying and
expanding the destination and broad basing the export products avoiding
over dependence on a few basic products.
Foreign trade drivers: The government’s policy document, Mahinda
Chintana, envisages Sri Lanka to be transformed, as a strategically
important economic centre of the world. In this transformation, Sri
Lanka will be developed into a trading hub providing links between the
East and the West. The Hambantota port project is expected to provide
world class infrastructure for manufacturing as well as cargo projects.
There is constant urge to move from the exports of agriculture and
apparel products to more sophisticated manufactured products.
The 2011 budget focuses on development of export oriented
manufacturing units.
It has reduced duties and taxes on machinery, equipment and raw
material to enable enterprises to have affordable access to world class
technology, and also proposed to lower income tax from 15% to 10% for
industries with domestic value addition in excess of 65 percent.
The Export Development Board (EDB) has also focused its attention on
the service sectors such as cargo handling and information technology
services as means to increase the revenue.
Geographical diversification is the key: The United States and Europe
have been the major trading partners for Sri Lanka for years,
cumulatively accounting for about 65-70% of the country’s exports.
The apparels made for designer labels like Victoria’s Secret, Liz
Claiborne and Tommy Hilfiger etc. account for about 40% of the country’s
exports, while tea exports account for another 20-25% of the total
exports. Sri Lanka’s exports were hit very hard during the global
economic downturn.
The industry is still smarting from the slump in demand but the
recent move to diversify to emerging Asian economies - China and India -
should keep the exports growth momentum intact.
GSP scheme extended until 2013: Since 1971, the EU has had rules
ensuring that exporters from developing countries pay lower duties on
their exports. This gives them vital access to EU markets contributing
to the growth of smaller economies. This scheme, known as the
“Generalised System of Preferences”, has now been extended for Sri Lanka
until 2013.
This scheme provides access to 7,200 Sri Lankan products at zero duty
into the European Union.
Rupee dilemma: Sri Lanka’s dilemma is that making exports more
competitive (cheaper) by weakening the rupee also makes the cost of
imports, including food and fuel, expensive _ stoking inflation. In the
recent past, Sri Lankan Rupee has been gradually appreciating vis-a-vis
major foreign currencies mainly due to US dollar losing its value
steadily in the international financial markets. The exporters were not
generating enough revenue to make the government prioritise them over
keeping imports cheap. A stronger currency helps in easing the cost of
living in this import-dependent economy.
Concerns overdone: Of late, because of the renewed uncertainty in
global financial markets and the risk of another global recession
increasing, safe haven argument has made investors flocking to dollar,
leading to its appreciation.
However, with appreciating foreign currency, the country’s debt has
increased, raising questions on the debt sustainability of the economy,
if the trend continues.
After falling provisionally to 82% in 2010, the debt to GDP ratio is
expected to decline further to 80% in 2011. Foreign debt has accounted
for a little below half of the total debt over the last few years. We
believe that the rupee weakening pressure on Rupee is at best a very
short term trend, and the concerns on the balance of payments and debt
sustainability or even central bank intervention in currency market is
overdone.
Intervention necessary: The CBSL has often intervened on both sides
of the market to maintain stability while also allowing adequate
flexibility. The IMF has repeatedly asked the CBSL to limit currency
intervention and allow more flexibility in the exchange rates. However,
we believe that intervention may be necessary for an economy to avoid
excess volatility in the currency, as the economy is largely import
dependent for manufactured products and is also aiming at developing
itself into a major global trading hub because of its strategic
geographical location.
Identification of key sectors: The first step in developing a
strategy aimed at scaling the export targets should involve
identification of key sectors. As seen in Fig. 2, we believe that the
current export policies should be aimed at maximising potential in
Apparels, Tea and Rubber products sectors. These sectors form a large
part of the country’s exports and are likely to continue with the growth
momentum over the next five years. At the same time, in line with
government’s policy of moving to sophisticated manufactured exports, we
believe that special incentives should be provided to chemical products,
information technology and electrical sectors.
Future outlook: The high energy cost - electricity tariffs in the
country being one of the highest in South Asia reduces the global
competitiveness of Sri Lankan exporters. The stronger rupee has made it
even more difficult to survive in the global export market.
The persistent congestion at Sri Lanka’s major ports result in
shipping delays; which are likely to reduce when Hambantota port becomes
fully operational.
Resolution to such basic issues along with government export
incentives in the form of lower duties, are likely to further boost
exports over the next decade. In the short term, the renewed concerns on
a double dip in western economies may result in a slowdown in exports.
Our 2011/2012 export forecast remains at US$ 9.4bn and 11.1bn
respectively.
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