From the frying pan..

Originally appeared on The Morning

By Dhananath Fernando

The dangerous precedent set by the sudden, outright ban on palm oil

Chief Seattle, a native American tribal chief back, in the 18th Century said: “Man does not weave this web of life. He is merely a strand of it. Whatever he does to the web, he does to himself.” Such wisdom is not only valid to man and the environment – it’s also valid to the concept of a market. 

Any interventions we make to one single market results in damage to the rest of the whole market, and to our own selves, but policymakers still don’t seem to understand this basic fact.  They do things with good intentions, but at an enormous cost to everyone else in the system. In the Sri Lankan context, some of the market interventions are made to gain political advantage, which ultimately ends up diluting political capital and worsening the problem further.  

Sri Lanka has a history of banning goods, and banning palm oil is only the latest example.  

Sometime ago, there was a discussion on banning 20-micron polythene, and then His Excellency  President Sirisena wanted to ban chainsaws and carpentry sheds. Then there were discussions on banning cattle slaughter and sachet packets – and now the spotlight is on banning palm oil.

It was reported that the Government decided to not only ban importation of palm oil, but also the operation of palm oil plantations. The decision further stated that the existing palm oil plantations are required to uproot the palm cultivation with a 10% annual phasing out, while replacing the cultivation with rubber and other products. It was justified on the grounds that the objective of this decision was to protect consumers from carcinogenic compounds in the market. However, on the very next day, it was announced that the Government expects to provide a license for palm oil importation, after listening to the concerns raised by the bakery and confectionary industries, where palm oil is a main ingredient. This creates a serious and valid  question: How can we import palm oil and allow the confectionery and bakery industries to operate, if palm oil has carcinogenic content? The justification does not make logical sense. 

The global palm oil industry 

Let’s first take a look at the numbers to understand the palm oil industry. According to United Nations statistics, palm oil is a $ 60 billion global industry that provides direct employment to 6 million and indirect employment to another 11 million. In 2018, around 21 million metric tonnes (MT) of palm oil was produced. Indonesia and Malaysia are the main palm oil producers in the world, where India, China, and the EU are the main importers. In terms of global vegetable oil production, palm oil has taken the lead over the last decade, compared to other edible oils such as soya, sesame, and sunflower oil. 

Local palm oil industry

If we look at the Sri Lankan palm oil industry, about Rs. 26 billion has been invested, with cultivation on over 11,000 hectares, which is just over 1% of the extent of our entire tea plantations, according to a research report published by Capital Alliance Research Team.

According to the same report, Sri Lanka’s actual coconut oil production is about 27,000 MT, whereas the palm oil annual requirement is about 217,000 MT. Industries such as margarine, soaps, shampoo, ice creams, and biscuits use palm oil as a main ingredient. 

Some of the organisations dependent on palm oil are multinationals and large locally-owned corporations. At micro level, small businesses such as restaurants and small-scale confectionery businesses and bakery industries, who are the main users of palm oil, will feel a significant impact from the decision. Additionally, five publicly listed companies (Watawala Plantation PLC – annual revenue of Rs. 2,675 million; Namunukula Plantations PLC – annual revenue of Rs. 1,049 million; Elpitiya Plantations PLC – annual revenue of Rs. 780 million; Agalawatte Plantations PLC – annual revenue of Rs. 456 million; and Kotagala Plantations PLC – annual revenue of Rs. 109 million) will be  directly affected.  

 Economic impact 

Like Chief Seattle said, humans and the environment are strands of the same web. Similarly, the palm oil industry is connected with so many other industries. This affects our overall economy, as all markets are interconnected. So the sudden decision will have an impact on the economy,  starting from the small “wade” shop down the road that uses palm oil as the main frying source, which is available for a reasonable price to large scale companies who are in plantation, confectionery industries along with listed companies.  

Most likely, the unavailability of palm oil will affect the higher demand for coconut oil, which will increase the demand for coconuts. Higher demand with stagnant supply will lead to increase in the domestic prices of coconuts and coconut oil. Higher coconut prices would negatively affect coconut exports, sales, and exporter margins. 

Since shifting to coconut oil is expensive for  small-scale businesses, usage of the same coconut oil multiple times for frying purposes will be incentivised. Black markets will be created for palm oil, or market manipulation will take place with further carcinogenic substances, which will be even more difficult to track. In some instances, prices of food may further increase, and some shops may have to close down permanently. 

 Negative signals to other markets undermines property rights 

Banning palm oil plantations overnight without any consultation, and requesting to uproot the existing plantations, will be considered by investors as undermining of private property. Uprooting incurs extra costs in addition to the losses that will be faced by plantations. Even if they shift to other cutivations such as rubber, the challenges imposed to these businesses would affect the ease of doing business and investor confidence, at an hour where we need their support the most. 

 Setting up a licence regime

The last few decisions made by the economic policymakers on banning certain products and services have seen Sri Lanka drifting towards a complete licensing regime, in which only the politically connected and privileged would be benefitted. Such culture would set up a bad example for all other markets and businesses, and it opens room for more corruption. Starting from banning tyres, bathware, and many other imports, the sequence of actions has been: Ban first; face resistance from the industry; and provide special licenses for importation to a handful of suppliers. 

This sequence of events is the setting up of a license regime. Such regimes are harmful to consumers and distribute profits to palm oil substitutes, which may not produce enough to make up for the reduction in imports. Consequently, such action would raise the price of coconut oil, which is used widely in Sri Lanka. In terms of economics, banning products creates the ideal situation for “rent seeking”, where an intervention distorts incentives. And, resources used to gain access to these profits creates deadweight losses (meaning both the consumer and the producer lose out).

Concerns of health and water usage of palm and palm oil 

Health concerns have been highlighted by scientists all over the world on edible oils, which are mainly not limited to palm oil. According to European Food Safety Authority (EFSA), the risks of cancer are mainly due to glycidyl fatty acid esters (GE), 3-monochloropropanediol (3-MCPD), and 2-monochloropropanediol (2-MCPD), and their fatty acid esters, which form when processing vegetable oil at high temperatures, which could be carcinogenic. 

Like consuming substandard sugar and salt, the edible oils could bring health concerns. This has been highlighted in many parts of the world. On the other hand, the usage of soil water has been a main concern for the resistance for palm cultivation. Palm cultivation is way more productive than coconut and other edible oil products, because it consumes more water than any of these. In other words, by utilising way less land, we can match the same oil requirement by palm, so at an overall level, it consumes less water and provides for more productivity. 

The way forward and solutions

As a way forward, there are multiple fronts the Government needs to address: First, to make sure not to make uninformed decisions – without industry consultation – which have a direct impact on their political capital and the wider business confidence. Secondly, banning is not a solution to the problem, but only worsens the problem further! 

Even if palm oil is proven to be carcinogenic and damaging to the water bed, then incentive structures have to be used to discourage its usage. Just because we are all aware that cigarettes, alcohol, and white sugar are cancer-causing, we don’t ban these products, as it would create further distortions. 

Thirdly, property rights have to be respected to attract investment; and fourthly, creating a licensing regime will further make the process unproductive, while further creating public health calamities that will end up in tarnishing the Government’s reputation and pushing public health towards further risk. Like Chief Seattle said, we all are a part of the same system. Banning is the same as distancing ourselves from the strands of a complicated web. It further weakens the web instead of straightening it out. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Confused by the coconut oil conundrum?

Originally appeared on The Morning

By Dhananath Fernando

As usual, Sri Lanka is cruising through another eventful week; this time with discussions on the topic of imported coconut oil that is said to contain carcinogenic compounds called aflatoxins. On social media, I saw people sharing posts saying that, to date, they were under the impression that the coconut oil they have been consuming was produced in Sri Lanka.

The government authorities, public health officers, Sri Lanka Customs, Sri Lanka Standards Institute (SLSI), and many other government agencies are running around scrambling to check whether the carcinogenic coconut consignments have been released to the market. As we get closer to the Sinhala New Year, it is the norm that the prices of coconuts increase, and also that coconut oil consumption increases. So, people were already confused as to whether to buy coconut oil or not and as to what substitutes are available.

This is yet again another example of closing the stable door after the horse has bolted. It’s quite unfortunate that no one thinks about the economics behind the coconut oil issue. Instead of trying to take political advantage of the situation, we need to explore the root cause of the issue.  

Let’s understand the numbers first. According to Coconut Development Authority (CDA) Director General Dasitha Niroshana, Sri Lanka’s total demand for coconut oil is about 180,000 MT (metric tonnes) per year. Out of that, about 90,000 MT are for domestic usage and the balance is for industrial usage. Over the last few years, our local coconut oil production was about 40,000 MT. Due to climate challenges, higher prices, and thin margins, coconut oil production has been negatively affected. For the last few years, local coconut oil production has come down to about 25,000 MT. According to these statistics, about 140,000-155,000 MT of coconut oil are being imported for industrial and domestic use. Refined as well as non-refined coconut oil is imported. Given the nature of the product, microbial activity can take place when it’s stored for a long period of time and also based on the handling process.

It takes about eight coconuts to produce 1 kg of coconut oil. For the domestic usage of coconut oil, estimating that the production levels are at 25,000 MT, about 200 million nuts will be required for domestic consumption alone. The total nuts we can produce per annum is about 2,600-3,000 million by utilising 20.6% of our arable land. As Sri Lankans consume quite a lot of coconut for personal use and for their cuisine, we are still short of about 600 million nuts per annum to meet the total national demand for coconuts.

As the coconut yield is somewhat sensitive to water levels, changes in weather affect the harvest and supply. Additionally, the coconut trees in Sri Lanka are very old, and only about 62 nuts can be produced per tree. Meanwhile, the best Sri Lankan yield amounts to about 6,000 nuts per hectare. If we look at competitive markets like Kerala, Malaysia, and the Philippines, it’s as high as 11,000-14,000 coconuts per hectare, while Indonesia has the highest productivity with 15,000 coconuts per hectare. However, the Sri Lankan coconut is specifically preferred for some industrial uses, as the aroma and taste of the Sri Lankan coconut is quite unique. However, we can’t match the demand. 

On the other hand, the edible oil market is changing drastically. With consumption patterns of customers who want a healthy heart and less cholesterol content, markets in Europe and America shifted to edible plant fats of soybeans, corn, peanut, sunflower oil, and other oil sources. 

The price of coconut is one key determinant for the import of coconut oil. Given that the margins are thin in the coconut oil industry, when the coconut prices go up, there is more incentive to import coconut oil instead of manufacture it locally at a higher cost.

Most of the coconut-based export businesses are also affected when coconut prices go up, as they have signed agreements with their buyers overseas. 

On the demand side, locally, the demand is increasing with the increase in population and usage in Sri Lanka. On the supply side, it’s stagnant or decreasing due to extremely low productivity. As a result, coconut prices go up, which affects the entire value chain of the business cycle. 

So the big question is, what have we done to increase productivity and take a count on the policy prescription we have been following?

When the coconut prices went up during the tenure of the last Government, they imposed a price control. Following in the same footsteps, the current Government too imposed a price control last November. Needless to say, none of the price controls really worked. Instead, it further distorted the market. When you have price controls, inferior-quality products are entering the market or the available products are disappearing and black markets are created. In the case of coconut oil, the market distortion by price controls on coconut has incentivised people to bring low-quality products and manipulate the market.

Additionally, one substitute product, which is palm oil, has been discontinued, due to environmental reasons. Palm oil is a substitute for coconut oil and produces a higher yield than coconuts. Rather than finding a solution for proper water management, complete interference in the market has now distorted the entire market with the introduction of products that allegedly contain carcinogens to the market. As a remedial action, the CDA has issued a five-star label to seven selected coconut suppliers where the production method is evaluated from end to end and monitored by government authorities so that consumers can be assured that the coconut oil is pure and good to use. Yet again, however, the prices are about Rs. 100-200 higher, according to the CDA Director General. Obviously when you only allow only seven players to supply authorised coconut oil, the suppliers are going to increase the prices, as they lobby to keep higher profit margins. In economic terms, we can call this a “rent” , due to the advantage of the restriction of access by new players.

In summary, we have distorted the concept of markets by introducing price controls and providing licences. As a result, our productivity is very low in the coconut sector and our solution for all problems has been market intervention again and again by consecutive governments. At the same time, as a result of focusing on unnecessary state-owned enterprises, the State has forgotten the role of necessary market regulations to ensure consumer protection. As a result, from time to time, we hear news stories of the importation of rotten tin fish and carcinogenic coconut oil, and we kill time till another similar story explodes. The problems remain the same or become worse; our attention diverts; life goes on… 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.