How Trade Restrictions are Inflating Urban Housing Costs in Sri Lanka

By Ashanthi Abayasekara and Yasmin Raji

A glance at Colombo’s (and suburban) housing prices will quickly establish that buying or renting a house is expensive for a vast majority of Sri Lankans. Advocata Institute in a study found that 70% of Sri Lankans cannot afford to own even a basic 500 square foot house in their lifetime. But what is driving up urban housing prices making house ownership unaffordable?

A recent study by Advocata Institute on the ‘Impact of Anti-Competitive Practices in the Construction Industry on Affordable Housing in Urban Sri Lanka’, reveals that urban housing prices are inflated partly due to restrictive trade policies and anti-competitive practices in the markets for housing construction materials.

The study examined the tiles, cement, and aluminum markets, all essential inputs in urban housing construction. These industries were found to be highly concentrated, with few firms involved. Barriers to entry are high due to substantial capital requirements and the need for economies of scale, which new entrants cannot afford. Additionally, market players benefit from significant trade protection through high import tariffs, cementing the dominance of domestic players.

In the case of domestically produced cement, the raw material used in the production of cement, clinker, has been subjected to a cumulative tariff ranging between 16% and 25% from 2014 to 2022. In comparison, importers of bulk and bag cement—the direct competitors of domestic manufacturers—have faced an additional para tariff of CESS consistently over the same period, ranging between 8% and 14%. This put cumulative tariffs for bulk and bag importers significantly higher than for clinker importers, ranging between 27.5% - 38.5% and 26% - 32.5% for bulk and bag cement importers respectively..

Figure 1: Changes to quantity of cement imported, prices, and tariff structures

A similar situation can be observed in the tile market, where imported tiles have been subjected to a total tariff rate ranging between 79% and 89.5% from 2013 to 2022 while tile raw materials were only subjected to a VAT of 8%. This discrepancy in tariff rates creates an uneven playing field, giving domestic manufacturers an unfair advantage over their importing counterparts. 

In addition to the high border tariffs, quantity restrictions have also been utilized to curtail imports. This was predominantly observed in the sweeping import restrictions imposed in April 2020 owing to the foreign exchange shortage prevailing at the time. This saw the quantity of bag cement imported reducing by 65% and tiles reducing by 87%. While most of these restrictions were placed as an attempt to conserve foreign exchange during the forex crisis, the inconsistent way in which these policies have been implemented has disproportionately benefited the larger domestic players in the markets. 

Apart from its implications on the producers and importers of construction materials, the high border tariffs coupled with import suspensions (protectionist trade policies) have resulted in a limited supply of construction materials available for customers, not only limiting their choices but more importantly, driving up the prices of goods exponentially. For example, high tariffs and import restrictions in the tile market led to customers being subjected to price increases of 93%-123% by August 2022 compared to April 2020. Customers also reported waiting times of over a year to receive the goods. 

So how does all of this impact housing affordability? With rising prices of construction materials due to these protectionist trade policies and the lack of competition in the domestic market, the cost of constructing a house has also seen a significant increase over the years, making it unaffordable to a vast majority of Sri Lankans. 

Given these impacts on necessities like housing, the corrective action would be to abolish tariffs altogether as soon as possible, and boost competition in construction material materials. However, due to Sri Lanka’s constrained fiscal space, reducing tariffs and removing trade restrictions should be done gradually. This approach will steadily increase the import of these goods, boost their supply, gradually drive down prices, and ultimately minimize housing affordability issues.

Housing affordability in Sri Lanka: The looming crisis and need for multifaceted approach

By Advocata Institute

Originally appeared on the Daily FT

Sri Lanka is at a crossroads, confronting with a mounting crisis in housing affordability that demands immediate and comprehensive attention. The complexity of this challenge is underscored by the stark disparities between the escalating housing demand and the sluggish pace of housing supply growth. Data derived from the 2012 Census of Population and Housing Survey paints a stark reality: housing demand has surged by 11.9%, reaching 5,875,009 units from 2012 to 2022. In contrast, housing supply has lagged, with an increase of only 9.5% to 5,685,151 units. This glaring gap which is approximately 3.23% of housing units (189,858) raises a red flag, necessitating urgent and effective policy interventions.

Delving deeper into the district-wise dynamics exposes the severity of the issue. Colombo, as a critical urban hub, experienced a 10% surge in housing demand, reaching 635,385 units in 2022. However, the corresponding supply increase was a mere 7.4%, resulting in a substantial shortfall of approximately 26,978 units. This scarcity not only exerts upward pressure on house prices but fundamentally challenges the broader affordability of housing, impacting citizens across various socioeconomic strata.

Challenges

At the heart of this crisis lies a multifaceted challenge. Urbanisation, population growth, and evolving societal needs have outpaced the pace at which housing supply is expanding. A legacy of historical housing policies, coupled with limited private sector participation, has left the Government shouldering the bulk of responsibility. The absence of a robust regulatory framework and streamlined approval processes further impedes the swift execution of housing projects. This perfect storm of factors has led to a housing deficit that reverberates across the nation.

To this, in the housing landscape in Sri Lanka, a disconcerting reality emerges from the statistics. Out of the 6,094,115 families, a fraction grapples with precarious living conditions, with 0.73% residing in cadjan/palmyrah houses, 4.56% in temporary structures, and 6.35% inhabiting partly constructed houses. The prevalence of households not yet plastered stands at 13.79%, while 7.25% have roofs consisting of galvanised sheets. Alarmingly, 3.55% represent homeless-landless families, and 0.49% temporarily dwell in quarters for job requirements. Another 2.74% of families are categorised as homeless yet possess a block of land, and 1.31% are temporarily living on rent while maintaining a permanent residence elsewhere. Additionally, 8.39% face challenges with proper water supply, 2.97% lack adequate access to roads, 3.19% lack proper sanitation facilities, and 2.74% are without electricity. These realities underscore the multifaceted challenges faced by a significant portion of the population in securing decent and dignified housing.

Housing demand, a pivotal component, is linked to demographic trends, housing finance accessibility and cost, and Government policies encompassing taxation and subsidies. The precarious nature of property rights, particularly insecure tenure, has the potential to hinder investments in housing. Conversely, housing supply is contingent upon factors such as land availability, robust infrastructure, construction material costs, and market efficiency. The interplay of consumer, producer, and Government behaviour further shapes the delicate equilibrium of demand and supply in the housing sector. Government policies, notably those governing land use and building regulations, wield significant influence over housing construction, subsequently impacting the supply of affordable housing.

Multifaceted approach

To navigate this housing affordability crisis, a multifaceted approach is imperative. Reforming housing policies is imperative for the Government, necessitating an alignment with contemporary needs and fostering adaptability to evolving trends. Priority should be given to strategic reforms that emphasise affordable housing development in both urban and rural areas. Facilitating collaboration between the public and private sectors emerges as a key solution to bridge the housing gap. Incentivising private developers to partake in affordable housing projects, coupled with supportive measures like infrastructure and regulatory facilitation, can yield significant positive outcomes. A pivotal aspect involves strengthening the role and capacity of the National Housing Development Authority (NHDA). This entails regular leadership by the NHDA in conducting comprehensive housing needs assessments that encompass qualitative dimensions. Securing adequate funding, autonomy, and an unwavering commitment to improving living standards within NHDA are indispensable components of this multifaceted strategy.

Housing affordability is not just an economic metric; it's a barometer of societal well-being. A secure, affordable home is the bedrock upon which individuals build their lives. It impacts education, healthcare, and overall community prosperity. Failure to address this crisis risks leaving a lasting scar on the nation's social fabric.

The absence of a cohesive, long-term housing policy focused on low-income housing has significantly contributed to the limited construction of affordable houses. Historically, the Government's housing initiatives, especially in the past two decades, primarily aimed at clearing slums for land development rather than addressing affordable housing concerns directly (The World Bank 2012). Resolving housing policy issues is crucial, and it's equally vital to address market failures in land, building materials, and the construction industry to enhance housing affordability (World Bank 1993).

To enhance the business environment, the Government should transition from being the sole provider of housing to creating a legislative, administrative, and policy framework that fosters a competitive market. Direct Government involvement in construction, coupled with regulatory roles, may lead to conflicts of interest. Instead, policies should incentivise private entities to engage in affordable housing construction. This involves eliminating protectionist measures like import tariffs, para-tariffs, and addressing concentration issues in building materials industries.

Addressing institutional failures is paramount. Multiple agencies with overlapping functions create bottlenecks, hindering policy development and project execution for adequate and affordable housing. Streamlining these agencies, ensuring coordination, and establishing a robust regulatory framework are necessary. Regulatory issues, such as land availability and titling problems, are major barriers. Unlocking Government-owned land for housing projects, improving titling processes, and digitizing land registries can facilitate development and clear ownership, enabling better access to finance.

Provision of infrastructure and support services is crucial. Government investment in public services like water, sanitation, and public transportation can unlock regions for housing development. Improving the efficiency and productivity of the construction industry, potentially through standardised housing units and prefabrication, would significantly reduce construction costs.

Reducing the cost of borrowing and enhancing financing options for low-income households is a challenge. Mortgage guarantees, encouragement for banks to access low-cost wholesale funding, and addressing issues related to land titling and borrower risk can enhance access to affordable financing. Additionally, focusing on the underdeveloped incremental housing finance market can cater to the unique needs of low-income households.

Improving data availability is essential for effective planning. Establishing a centralized mechanism to collect, analyse, and disseminate recent housing data is crucial for long-term planning and achieving sector and economic objectives. Conducting regular surveys and censuses will provide up-to-date insights into the state of the housing sector in Sri Lanka.

In conclusion, addressing these multifaceted challenges requires a holistic and well-coordinated approach involving comprehensive policy reforms, market enhancements, and improvements in data collection and analysis mechanisms.

Middle class caught in housing dilemma

By Dhananath Fernando

Originally appeared on the Morning

The system in Sri Lanka often categorises many individuals in the middle class as products of failure, not because they have failed themselves, but because the system has failed them. An evident sign of this failure emerges when individuals strive to afford a house, as the decision to build or buy a basic house in Sri Lanka frequently forces them to sacrifice many other life choices due to the exorbitant cost of construction.

Dr. Roshan Perera and Dr. Malathy Knight of the Advocata Institute recently authored a research report revealing that property prices in Colombo exceed the same income-to-property ratio found in New York, Tokyo, Beijing, and London.

The exorbitant cost of construction primarily stems from the steep prices of raw materials in Sri Lanka. For instance, a tonne of cement costs about $ 114 in Sri Lanka, compared to $ 53 in Thailand. Similarly, the cost of a tonne of steel in Sri Lanka is around $ 760, in contrast to $ 561 in Singapore.

Factors behind high costs

Two main factors force consumers to pay higher prices. First, Sri Lankans encounter restricted access to construction materials at lower prices due to import restrictions or tariff barriers, even when Free Trade Agreements (FTAs) are in place, as most construction items remain on the negative list. A negative list refers to an exclusion clause in an FTA that prevents an item from being imported.

Second, the high tariffs or import protection for construction materials are often justified under the narrative of ‘saving dollars’ or ‘preserving valuable foreign exchange’. However, the truth lies in the high cost structures of local manufacturers, making them unable to compete if import bans or tariffs are reduced.

For example, the total tariffs on tiles were approximately 83% in 2021, with para-tariffs such as CESS and PAL making up about 50%. High energy prices in Sri Lanka contribute to the high costs for local companies, and importing tiles may actually reduce foreign exchange expenditure due to energy savings.

Far-reaching impact

The high cost of construction for the middle class results in sacrificing many life choices, including higher education, education for children, investments, and wealth creation. This challenge becomes even more pronounced when faced with an interest rate of 10% for housing loans or business expansion.

The impact of the high cost of construction extends beyond housing to the tourism sector. Hotels require refurbishment approximately every five years to remain competitive, and with high construction costs, room rates tend to be high. This puts a strain on hoteliers, including small and medium-scale hotels, making them less competitive with markets like Thailand or the Maldives.

According to research, a 500 sq ft house can only be affordable for Sri Lankans in the 70th income percentile, while a 1,000 sq ft house is attainable only for those in the 75th income percentile, highlighting the underlying tragedy of the high cost of construction. Many construction inputs in the market exhibit characteristics of monopolies or oligopolies.

The solution to reduce construction costs involves first removing construction materials from the negative list and eliminating imposed para-tariffs. This competitive market approach will lead to lower prices, benefiting consumers. As a result, aspirational Sri Lankans will have more space in life for better choices, rather than spending their entire lives paying off housing loans. When the middle class has more choices in life, their decisions become a source of income for many other industries, fostering economic growth.

Environment vs. development: It's all about land

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Dhananath Fernando

The question of how to develop Sri Lanka without obstructing our valuable environmental ecosystems has come to the forefront yet again. The recent incidents surrounding the development of a road in the territory of the Sinharaja Rainforest, a World Heritage Site, is one prominent discussion.

The deforestation in Haputale for cardamom cultivation and the establishment of a prawn farm in Anawilundawa, a Ramsar wetland, also raised serious concerns among the general public and environmental activists, adding more fuel to the debate on development vs. environmental protection.

This debate has come to a point where questions are being asked on whether Sri Lanka can be developed without disrupting the environment, and whether environmental activism is hindering the development of the country.

This is not the first time this topic had taken centre stage. “Save Wilpattu”, the Mount Lavina beach expansion project and the development of the Port City have been popular thematic stories over the years; the human-elephant conflict (HEC) is a continuous battle that gets primetime news coverage too.

What’s the real problem?

On the surface, it seems that all the incidents are a result of efforts to strike a balance between development and environment – which is true to an extent. However, if we dig a little deeper, in economic terms, it is a clear case of an attempt to maximise the utility of a scarce resource – “land”; at the same time, it is an issue of property rights.

And all that we’re seeing is an outcome of our inability to maximise the utility of land by improving productivity, alongside the absence of “property rights”.

Let me explain why and how.

Forests are sacrificed due to the absence of property rights

One of Sri Lanka’s most limited and precious resources is “land”; being a tiny island which is just a dot on the world map, land is not in abundance for us. Our size as a country is quite smaller than average cities or states in the rest of the world. Unlike other resources, land is fixed in size, and increasing the extent of land (similar to what was done with the Colombo Port City) is an extremely expensive affair, both monetarily and environmentally.

Sri Lanka’s total land extent is about 6.6 million hectares. Can you take a guess on the amount of land owned by the Government and the amount of land owned privately by its own Sri Lankan citizens?

Only about 18% (1.2 million hectares) of the land is owned privately by its citizens while about 82% (5.4 million hectares) of the total land is owned by the Government.

About 28% of our total land is forest cover, according to the FAO (Food and Agriculture Organisation of the US). Out of this, about 573,400 hectares (2,214 sq. mi.) of land is categorised as “Protected Nature Reserves”.

So in reality, the Government owns about half of Sri Lanka’s land (more than 50%), and this can be used for economic activity and environmental purposes. We should not be misled into thinking that private land is owned by anyone else other than our fellow Sri Lankans. In other words, many Sri Lankans do not have the rights to their property; they do not have deed titles; many of our fellow Sri Lankans do not have access to land, and the limited access some Sri Lankans have to government land is on a license basis.

According to news reports, a Sri Lankan has to visit 20 institutions just to get clearance (not to obtain a deed title) on land for cultivation on a lease basis. They have to take a licence from the government office if they are to cultivate on land owned by the government; as they do not own it, they have no incentive to use it sustainably.

As a result of agriculture, illegal settlements, and economic activity, the borders of forest land have always been blurred. It has been reported that usually, surrounding villagers and elite businessmen who have political and influential power encroach forest land for commercial purposes. Information reported on deforestation and obstructions on environmental ecosystems make up just a fraction of the ground reality. This is because most illegal deforestation takes place in obscure locations close to forest cover, which is difficult to track.

Inability to maximise on lands and its utility

The inability to protect our land and forest cover is a completely internal issue and of course a political football pertaining to a very sensitive issue. Whether we like it or not, the “market” works in good-case scenarios and worst-case scenarios. When Sri Lanka has a rising population with more households, and when people do not have land and property rights for agriculture or many more economic activities including housing and investments, what do you think would be the outcome if we fail to improve productive usage of land? For example, if we fail to improve the productivity of land by constructing vertical buildings, what would the outcome be if all five million households expect to build houses on 10 to 20-perch plots of land? The same applies to agricultural land, and this is one of the main contributory factors to deforestation across the globe.

According to the Economic Census in 2013/2014, about 2.2 million hectares were used for agriculture, an increase of 18% from 2002. It is obvious that in order to feed our population and sustain economic activity, our land usage has increased. However, we need to focus on improving productivity and efficiency by utilising it effectively for agricultural purposes if we are serious about protecting our forest cover. We have to move to high-yield varieties and vertical farming, and again, it boils down to accessing property rights if we were to increase the utility of land through investment. No person would invest in land they would not want to own. Unfortunately, most of Sri Lanka’s land is dead capital. No one uses it and there is no economic activity. Now, Sri Lanka expects to be self-sufficient in paddy, milk, maize, and vegetables and is aiming to supply the entire demand for rubber within the country. Sri Lanka is also aiming to expand coconut product exports by fewfold; where do we have the land to do all this? We need to take our land policy seriously or else we will put our forest cover into further risk.

President received firsthand information

The President received firsthand information on the gravity of the land issue. One of the main requests by the people or fellow Sri Lankans is for the Government to provide them with land.

His Excellency the President, in his policy statement, stated that land issues are one of his priority areas. Moreover, there were recent news reports on his directives to the relevant institutions to issue title deeds within three months which pertained to unresolved land issues.

Land issues are very sensitive, and all conspiracy theorists have a collective voice; they all suspect that foreigners and other parties may take over our land. However, since 1948, it’s been purely Sri Lankans who’ve owned the land. The responsibility cannot be passed on as it is our own leaders who control 82% of our land. (According to Sri Lanka’s regulations, there is minimal room for anyone who is not a legal citizen of Sri Lanka to buy land. Even the apartments and condominiums can be bought only if it’s above the fourth floor).

According to data, Sri Lanka lost about 490,000 hectares, or 20.9% of its forest cover, in just 20 years, from 1990 to 2010. If the majority of the land is governed by the State and if there is no room for any outsider to exploit our land, doesn’t this mean that we have really failed in our public policy and in understanding the economics of land management?

However, instead of looking inward, we have become masters of pointing fingers at outsiders and fearmongering to cover up our failure, and sadly, our forest cover has become the victim.

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.