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.

Can Sri Lanka’s Economic Revival Weather the Storm of a 2024 Election?

By Rehana Thowfeek

Originally appeared on Groundviews

Photo courtesy of EFE

By all estimates, Sri Lanka’s economy is expected to grow around 1.5% in 2024, making inroads into reversing the economic contraction the country experienced since 2020. Sri Lankan authorities have reached a staff level agreement with the IMF earlier this month and, pending executive board approval, Sri Lanka will receive the second tranche of $330 million soon.

Sri Lanka’s reserve position has improved somewhat from the record low levels it was once at – there are $3.5 million currently in reserves, which is sufficient to cover 2.6 months worth of imports, albeit still a worrisome situation. Tourism earnings and worker remittances are picking up and the cumulative trade deficit has narrowed in comparison to last year. Inflation is tapering at 0.8% in September (the base year has been revised to 2021), the result of the tight monetary policy stance taken by the Central Bank since April 2022.

Import restrictions brought in response to the dwindling foreign reserves are now being phased out with all but a few items still restricted. Due to the rapid decline in purchasing power experienced by the people in the past year, demand for imports may remain subdued but maybe offset by more favorable credit conditions. Policy rates have been further reduced and due to more favorable economic conditions banks are now showing greater willingness to lend in comparison to 2022, which bodes well for business revival.

The ability of Sri Lanka’s economy to redeem itself and firmly place itself on a path of inclusive and sustainable growth lies in how successfully the country can execute the necessary economic and governance reforms. Debt restructuring will ease the burden of external debt repayments in the medium term but eventually Sri Lanka will have to start servicing its external debts once again.

If Sri Lanka does not manage to adequately grow its economy to accommodate these payments with sufficient tax revenues and export earnings, the country risks slipping back into a situation similar to that experienced in 2021 and early 2022. The global situation is not favorable for economic recovery with many large economies undergoing recession and multiple wars being fought on different fronts.

The tourism industry shows signs of recovery but can be impeded by the labor migration. The tourism industry already faced issues with attracting labor, as it is not seen as an attractive or well-paying industry to work in. With workers either having left the industry to join other industries in the wake of the Easter attacks and the Covid impact or migrating to other countries due to the crisis, the industry will struggle to cater to the demand that it once managed to.

This calls for exploring the possibility of opening up the borders for foreign labor to work in Sri Lanka, which is a controversial issue to say the least. With mass migration, the country’s health sector is also in a bad state but opening up this sector to foreign labor is even more controversial than it would be to the tourism sector.

The importance of governance reforms cannot be overstated; addressing the governance failures that precipitated Sri Lanka’s economic decline over the past few decades is the only way to prevent reneging back into bad policy making. Checks and balances are important for a well-functioning economy and society. Since pockets have grown fat and powerful with lax governance structures for many decades, dismantling these systems that work in favor of a few and shaping them to work in favor of many is a difficult endeavor in the best of time.

Reforms to state owned enterprises are in the works, albeit at a slow pace. There are plans to pass the necessary laws to divest State Owned Enterprises (SOEs) and to set up a holding company to manage whatever SOEs remain. Reforms to SOE behemoths like the Ceylon Electricity Board are being tackled separately. The country’s flagship poverty program, Samurdhi, is being rehauled into a consolidated welfare program called Aswesuma with better targeting mechanisms, better entry criteria and exit clauses to make the program more effective. The new program also attempts to depoliticize welfare which hindered the effective function of its predecessor.

The budget, which can effectively signal the incumbent government’s commitment to reforms, is already off to a bad start. The government announced that public sector salaries would be increased. With no access to printed money from the Central Bank since the enactment of the new Central Bank Act nor access to foreign loans, the government has decided to increase VAT, perhaps to fund these salary increments.

The incumbent government has made no attempt to cut public sector expenditure and has instead opted to further increase its salary bill, which already swallows up a massive share of the tax revenue – 65% in 2022. This number is even higher when you add in the pensions bill. The government has fallen short of IMF targets on tax revenues in the recent review, so increasing expenditure further, especially just to pacify public sector workers in the light of elections, is utterly imprudent in the context.

Continuing to burden the general public with taxes to fund frivolous, unbridled expenses with no meaningful reform of public expenditure would serve as a harsh reminder to the people of Sri Lanka that the system change once demanded by the sea at Galle Face is yet to be seen, precipitating another wave of civil unrest.

It is not an understatement to say that the precarious stability that has been achieved hangs in the balance, and now with a looming election, the precarity worsens. There is no political consensus on the way forward which can solidify the reforms that the country ought to take – every possible reform is contested which does not bode well for the economy. The jostle is between the NPP, SJB, SLPP+UNP and other possible wildcards such as Dilith Jayaweera and Dhammika Perera, all of whom propose varying economic policies.

The resolution lies in a concerted effort towards comprehensive economic and governance reforms, fiscal prudence and a unified political will that transcends party divisions. The critical choices ahead will determine whether Sri Lanka can chart a stable, inclusive and sustainable economic course or succumb to the persistent vulnerabilities that always threaten its progress.

On PM's economic statement: most important is to liberalize trade and investment

By Ravi Ratanasabapathy

The article first appeared on the Daily News

The Prime Minister’s statement on the economy to parliament on October 27 struck many a right note and has the ingredients to take the country to the goal of doubling per capita income by 2025.

Most important was the promise of reforms to liberalise trade and investment, to attract foreign investment and restore emphasis on exports.

It is important that the sentiments expressed in the Prime Minister’s statement must follow with practical yet bold economic policy reform. A detailed policy document has been promised and would hopefully contain the necessary implementation plans.

The rest of this brief note is aimed at understanding the policy pronouncements in the context of Sri Lanka’s political and socio-economic priorities.

Improving the business and investment climate

The statement promises a lot: simplifying the process of registering a business, getting construction permits, electricity connections and bank credit, registering property, protecting minority investors, the payment of taxes, trading across borders, the enforcement of contracts, the resolution of insolvency and reforming labour laws.

The Prime Minister’s target to bring Sri Lanka into the top 70 countries in the World Bank’s Doing Business Index by 2020 is welcome. Sri Lanka currently languishes at 110 in the index amongst 185 countries and its position has actually dropped by one place under the current administration. Policy reform to increase the ease of doing business is uncontentious and will draw broad political support from across the spectrum.

However the government must be bolder. Whilst ease of doing business has improved in the last few years, Sri Lanka can do much more to expand general economic freedom in the economy. The Fraser Institute, which publishes the annual index of economic freedom ranked Sri Lanka 111 among 160 countries. The index now ranks countries in the region like Nepal higher in terms of economic freedom than Sri Lanka with India only just behind. Beyond just looking at ease of doing business, Sri Lanka should also focus on other aspects of economic freedom including removing of outdated and arbitrary regulation, reversing recent follies such as Soviet-style price controls and truly living up to the promises of liberalising international trade and investment. In this vein, the proposed establishment of a single window for investment approval in the Prime Minister’s speech is a welcome move.

Sri Lanka can emulate, and where necessary adapt, the best practice policies from other countries such as New Zealand and Australia which rank highly in terms of economic freedom

Trade liberalisation: repeal of the Export and Import Control Act

The Government promises to repeal this archaic piece of legislation and replace it with new legislation based on that of Singapore. If implemented in the true spirit of Singapore’s legislation, this would be extremely positive.

Singapore is generally regarded as a free port and the Government only restricts the import of goods seen as posing a threat to health, security, safety and social decency. Around 99% of imports to Singapore are duty-free.

The policy statement makes reference to “a low tax regime”, the lessons from East Asia and other parts of the world is that the tariff regime needs to be low and uniform. This minimises loopholes, corruption and simplifies customs processing. A low uniform rate of duty eliminates disputes with classification and enables documents to be processed on a self-declared basis (with customs only focusing on misstatements of price and quantities) which results in faster, simpler clearing of goods.

While sentiments to keep a low tax regimes are laudable, a commitment for a low uniform tariff policy should be the goal.

State enterprise reforms and financing of infrastructure

The proposed debt/equity swaps of the Mattala Airport and the Hambantota mark an important step towards reducing the Government’s debt burden. The Government should also convert other infrastructure projects such as the highways into PPP projects by auctioning operational rights.

The statement promises investment in infrastructure in logistics to improve connectivity to global supply chains. Whilst we all welcome investments in critical infrastructure, all new projects should be implemented through public private partnerships to prevent further accumulation of public debt.

The report published by the Advocata Institute on “The State of State Enterprises in 2015” shows that the state has over 245 enterprises in its books, of which only a small number actually reported their financial position. The proposed formation of a Public Commercial Enterprise Board to manage SOEs and the creation a Public Wealth Trust, a centralised body to hold the shares in SOEs is therefore timely. Hopefully these mechanisms may prove to be the first step in imposing accepted reporting practices and better management of State enterprises. Sri Lanka can learn from Singapore’s state enterprise holding company Temasek and other experiences around the world.

Additionally, the listing of the shares of SOE’s on the Stock Exchange would also impose discipline in reporting and is something the Government should explore. Minority stakes could be offered to the public which would raise revenue to the state, allow public participation in SOE’s and broad-base the CSE; even while the majority stake is still controlled by the Government.

The recent announcements regarding the closure and amalgamation of Mihin Lanka into SriLankan Airlines is encouraging but the previously announced partial privatisation of the debt-ridden airline has not yet materialised.

The proposed Public Enterprise Commercial Board should be given a wide mandate to restructure and reform SOE’s including assessing the strategic need for such enterprises, the closure of unviable enterprises and to privatise enterprises where there’s enough commercial interest. The new structure will hopefully be just the first step on the long road to improve overall accountability and governance of these state enterprises.

It is unlikely a one size fits all solution would work for reforming all state enterprises in what would inevitably become a politically charged issue. However the public appetite for bold reform in this area is high with the realisation that the cumulative losses over the last ten years amongst the 55 strategically important enterprises amounted to Rs.636 billion.

Some areas of concern: SME’s rural agriculture

Several proposals including the one to expand SME finance through quantitative targets enforced by the Central Bank must be viewed with caution. Dirigiste lending to push bank exposure further to higher-risk sectors may boomerang on lenders, especially public sector banks, resulting in losses. Any difficulties SME’s may face with access to credit need to be examined carefully and appropriate solutions developed in consultation with financiers.

The establishment of rural modernisation boards and agricultural marketing boards will need to be examined more closely. No details are available so the exact role of these bodies is not clear but the current flawed agricultural policies have pushed up food prices for consumers. Sri Lanka’s food prices are the highest in the region and the priority should be to lower the cost of living through appropriate reforms to the sector.

Apart from a few areas of doubt the overall economic statement is broadly in the right direction and if properly implemented could boost growth and improve the welfare and prosperity of Sri Lankans. The government however has a demonstrable problem with policy inconsistency over the last few years, even amongst its own ministries and between Ministers of the same party. Whilst some diversity of opinion is expected from a coalition government, some of the policies enacted in the recent past have run counter to this and other broad policy pronouncement from the Prime Minister.

These broad ideas will hopefully pass the implementation test and we await the publication of the detailed strategy document.

The writer is a Fellow of the Advocata Institute, a fee-market think tank based in Colombo. www.advocata.org