Trump tariffs expose Sri Lanka’s uncompetitive trade policy: Advocata

By Advocata Institute

The recent imposition of tariffs on trade by the United States on Sri Lankan exports is a wake-up call. While concerns about the bilateral US-Sri Lanka trade imbalance have been noted, a close reading of the Office of the US Trade Representative’s (USTR) findings suggests deeper grievances—rooted not only in tariffs, but in the wide array of non-tariff barriers and para-tariffs Sri Lanka continues to maintain.  

Sri Lanka’s protectionist trade regime—characterised by ad hoc levies, price controls, import quotas, midnight gazettes and opaque customs practices—has long been a source of concern for trading partners. Many of these measures lie outside the WTO framework, creating both inefficiencies and unpredictability in the trading environment. 

This moment should be seen not merely as a diplomatic challenge, but as a strategic opportunity to initiate and accelerate long-overdue trade reform. Rationalising our tariff structure, rapidly phasing out para-tariffs, addressing behind-the-border barriers, and improving trade facilitation will not only help rebuild trust with key partners like the US, but also improve Sri Lanka’s overall competitiveness and resilience as well as the appreciation of gains on trade. 

Trade policy must now move beyond protectionism and towards enabling integration into global value chains. The cost of inaction will be borne by Sri Lankan exporters, consumers, and our broader growth ambitions. 

While tariff rationalisation and the removal of non-tariff barriers are urgent priorities, they are only the first steps toward a broader, more strategic reset of Sri Lanka’s trade and competitiveness agenda. 

Global trade patterns are shifting rapidly, shaped by geopolitical rivalry, supply chain realignments, and the revival of regional trade agreements. From the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) to the Regional Comprehensive Economic Partnership (RCEP), countries are moving decisively to lock in market access, deepen integration, and improve resilience. Sri Lanka, however, risks being left behind. 

Sri Lanka must now actively consider accession to regional trade blocs and seek bilateral agreements with both traditional and emerging partners. Improving trade facilitation, digital trade readiness, and regulatory coherence will further boost productivity and investor confidence 

India and Sri Lanka share a unique and evolving economic relationship rooted in geography, history, and culture. With India projected to become the world’s third-largest economy by 2030 and Sri Lanka seeking to stabilise and grow post-crisis, deepening bilateral economic integration offers mutual benefits. The Indo-Sri Lanka Free Trade Agreement (FTA), in force since 2000, provides a strong foundation, enabling over 60% of Sri Lankan exports to benefit from preferential access. However, Sri Lanka has not fully realised the benefits of this agreement. Due to non-tariff barriers (NTBs), complex rules of origin, and tariff quotas on key export items—such as tea and garments—have constrained trade. Moreover, Sri Lankan manufacturers have struggled to integrate into Indian supply chains due to limited industrial alignment and technical bottlenecks. These are not reasons to abandon the agreement, but rather imperatives to improve it. 

It is time to revive and conclude the Comprehensive Economic Partnership Agreement (CEPA) with India—a framework negotiated over 13 rounds and nearly finalised in 2008. CEPA aims to go beyond goods to cover services, investments, and regulatory cooperation. If well-designed and transparently negotiated, it could address many of the constraints holding back Sri Lankan exporters, support investment inflows, and enable service-sector expansion—particularly in IT, logistics, and education. 

Gain from greater integration

Sri Lanka can gain from greater integration, especially by tapping into India’s expanding middle-class—expected to reach 700 million by 2030—and attracting Indian investment into tradable sectors. Investment in ports, energy, IT, and hospitality can enhance Sri Lanka’s competitiveness, job creation, and foreign exchange earnings. Colombo and Trincomalee ports, grid connectivity for affordable power, and service sector integration—particularly in IT, aligned with Sri Lanka’s ambition to grow its tech workforce—are promising avenues. 

Sri Lanka’s path to deeper integration must also address domestic constraints: a narrow export base, protectionist policies, and ageing demographics. However, with targeted reforms and investment, Sri Lanka can participate in India’s supply chains through niche products and intra-industry trade, rather than competing head-on. Indian firms investing in Sri Lanka can re-export to India, leveraging their networks while transferring skills and technology locally. 

Policymakers can institutionalise collaboration through a bilateral Economic Cooperation Council or joint task force focused on trade, investment, and regulatory alignment. Regular exchanges among academics, think tanks, and officials can help adapt successful Indian policy lessons to Sri Lanka’s context—paving the way for shared growth and regional stability. 

Globally, countries are deepening ties to protect against trade shocks and seize new markets. The EU has accelerated negotiations with ASEAN states and Mercosur; Canada is expanding its trade footprint across Asia; and blocs like the CPTPP and RCEP are fostering tighter regional integration. If Sri Lanka remains on the sidelines, it risks being left out of emerging trade frameworks that will define global commerce over the next decade. 

Deepening trade ties with India is not without challenges. But the alternative—continued stagnation and vulnerability to arbitrary tariffs or shifting investor sentiment—is far worse. Sri Lanka must move beyond domestic hesitation and re-engage India in good faith. A renewed CEPA—anchored in mutual benefit, transparency, and safeguards for sensitive sectors—can serve as a cornerstone of a modern, outward-oriented economic strategy. 

We urge the Government of Sri Lanka to seize this opportunity—push for the implementation of CEPA, invest in domestic capacity to meet quality standards, and remove barriers that hold our firms back from regional value chains. If we act decisively, Sri Lanka can transform a once-contentious FTA into a platform for inclusive growth and sustained global relevance. 

The Advocata Institute strongly urges the Sri Lankan Government to eliminate para-tariffs such as CESS and the Ports and Airports Levy (PAL), which have long hindered Sri Lanka’s trade competitiveness. These additional taxes that sit on top of general import duties increase costs for businesses making it expensive for inputs for manufacturing, disincentives entrepreneurs in taking risks in the global market ultimately making Sri Lankan exports less competitive in global markets. These tariffs also make day to day items expensive for the average Sri Lankan to serve a narrow interest of people. Removing para-tariffs and accelerating the current program of tariff reform to be more uniform would not only cushion the impact of US tariffs but also enhance Sri Lanka’s overall economic resilience. 

US trade tariff policy 

There is growing concern over the US government’s proposed tariff hikes, particularly the 44% tariff on Sri Lanka. These tariffs, part of a broader 10% universal duty on all imports, threaten to disrupt trade relationships, impact key industries such as the apparel sector, and exacerbate economic challenges for developing economies reliant on US markets. The new trade measures by the Trump administration include a universal 10% tariff on all imported goods, effective April 5, and additional “reciprocal tariffs” targeting specific countries with which the US has significant trade deficits, set to begin 9 April. Sri Lanka is set to be hit with a 44% tariff. The US is Sri Lanka’s largest export destination, accounting for approximately 23% of total merchandise exports in 2024, with apparel making up over 70% of these exports. The new tariff threatens the competitiveness of Sri Lankan garments in the US market, potentially leading to reduced orders. 

Trump’s trade policy is largely driven by domestic political pressures, and his desire to tap into populist sentiments of his electoral coalition, positioning himself to be the protector of American industry and Jobs. Another driver of the policy is the US strategic competition with China and the Trump administration’s desire to use tariffs as a blunt diplomatic instrument to assert its influence in a fractured world. 

These policies are however based on flawed economics. The notion that imposing tariffs will “balance” trade deficits between countries is rooted in outdated mercantilist thinking. Just as businesses and families buy goods and services from some people and sell their labour and products to others, so do countries. The idea that trade has to be balanced between two countries is as flawed as thinking that just because we buy our groceries from the supermarket we must also sell to them in order to benefit from the transaction. 

Illogical as they are, Trump policies expose the protectionist policies of Sri Lanka, and the country’s lack of export diversification and lack of integration into regional value chains. 

Sri Lanka’s protectionism

 For nearly 20 years, Sri Lanka has been engaging in a similar protectionist policy regime. Protecting domestic industrialists at the cost of the competitiveness of the overall economy. 

With Sri Lanka facing a 44% tariff, the country’s apparel and textile sector—one of its largest export industries—will suffer significant losses. Given Sri Lanka’s dependence on US demand, these trade measures, could lead to: 

1. Reduced competitiveness in key export industries. 

2. Global supply chain disruptions as buyers shift to countries with lower tariffs. 

3. Declines in investment and employment, further straining an already fragile economy. 

Similar consequences will be felt in Vietnam, Bangladesh, Cambodia, and Myanmar, where heavy tariffs will challenge their economic stability. The entire South Asian region faces risks of declining foreign investment and trade uncertainty, further slowing economic recovery efforts. 

Sri Lanka’s dependence on a few export markets is a direct result of pursuing a failed import substitution policy in the guise of ‘industrial policy’ that has caused corruption, political dysfunction and incentives domestic entrepreneurs and capital to produce for the domestic market in order ‘to save dollars’. Ironically, the logic that has shaped Sri Lanka’s trade policy is similar to the one pursued by Trump. 

Advocata Institute recommendations 

To strengthen Sri Lanka trade competitiveness and mitigate the impact of US tariffs, Advocata Institute recommends the following policy actions: 

1. Eliminate all para-tariffs on imports signalling Sri Lanka’s openness to trade with the world. 

2. Negotiate with the US on tariff levels with US imports with US tariff levels to promote fairer trade conditions.

3. Accelerate the program to move towards a more uniform and a simplified tariff facilitating trade and eliminating room for corruption. 

Trump’s tariffs hurt us all, including SL

By Dhananath Fernando

Originally appeared on the Morning

US President Donald Trump’s administration’s wave of tariffs may have been framed as a protectionist strategy to ‘make America great again,’ but its global ripple effects are undeniable, and for countries like Sri Lanka, the consequences are quietly but steadily piling up.

To truly grasp the impact of US tariffs, we must first understand who bears the immediate burden – American consumers. When prices rise due to tariffs, it is not foreign producers footing the bill – it is American families. And when US consumers, who account for roughly 20-25% of global consumption, tighten their belts, the world feels it. Sri Lanka is no exception.

The triple blow of tariffs

At their core, tariffs are a triple blow to consumers:

1. Higher prices: Consumers pay more for goods, many of which cannot be easily substituted locally.

2. Artificial subsidies: Local industries that cannot compete globally get propped up, with the consumer footing the bill.

3. Corruption and rent-seeking: Tariffs empower lobbyists and politically connected businesses, leading to corruption, cronyism, and distortions in policy-making.

This is not unique to America; the theory holds true anywhere, including right here in Sri Lanka.

When US consumers are forced to spend more for less, their overall consumption drops. And because Sri Lanka’s key exports – apparel, rubber, food, and gems – rely heavily on US demand, this can shrink our export revenue and threaten local jobs.

Flawed economics, real consequences

The US Trade Representative’s rationale for reciprocal tariffs rests on a flawed understanding of trade balances. They have calculated tariffs based on the trade deficit with individual countries, assuming this reflects both tariff and non-tariff barriers. It doesn’t.

Moreover, their economic modelling assumes a price elasticity of four and an import-tariff elasticity of 0.25. Multiplied together, these yield a neutral effect, essentially arguing that price and demand perfectly balance out. But that is theoretical fantasy. In reality, trade relationships are nuanced and complex.

Sri Lanka made a similar mistake in past free trade talks with India and Singapore, obsessing over trade deficits rather than economic opportunity. Now, we find ourselves at the receiving end of the same misguided thinking.

Tariffs don’t build industries 

Some argue tariffs create jobs and strengthen domestic industries. But Sri Lanka’s own experience disproves that. For decades, we have imposed tariffs of over 300% on vehicles. Has that turned us into a car manufacturing hub like Japan or South Korea? Not even close.

In fact, the sectors most protected in Sri Lanka – construction materials, footwear, and others – remain stagnant, rent-seeking, and politically captured. Consumers pay exorbitant prices, innovation is stifled, and exports are virtually nonexistent in these areas.

What should Sri Lanka do?

Given our size and economic position, retaliation is not an option. But this global shake-up gives us a golden opportunity for reform. 

Here is what we can do:

1. Unilaterally clean up our tariff system: Eliminate para-tariffs like Ports and Airport Development Levy (PAL) and Value-Added Tax (VAT) on imports. Not because the US is forcing our hand, but because it is the right move for our own competitiveness.

2. Engage strategically with the US: While we may not be a major trading partner to the US, our strategic location in the Indo-Pacific could be a valuable card at the negotiation table. A peaceful, open Indian Ocean is in everyone’s interest.

3. Leverage regional alliances: India has used tariff adjustments as a negotiation tool, and Sri Lanka could align with Indian supply chains to access broader markets. Since much of what we export – like high-value apparel – cannot easily shift to East Asia, regional strategies are critical.

4. Don’t import for the sake of it: Matching trade deficits by simply importing more from the US will not work. We cannot absorb their big-ticket exports – aircraft, weapons, or energy – and doing so irrationally would only hurt us further.

5. Join more regional trade agreements: But most importantly, let’s not wait for others. By unilaterally reforming our trade policies, we can unlock new markets and boost exports, while reducing consumer costs and curbing corruption.

Reform, not retaliation

Tariffs are not just about economics; they are about values. When governments shield inefficient industries and empower rent-seekers, it is the people who pay the price. Let us use this moment not to imitate protectionism, but to chart our own path – one that opens doors, not closes them.

The fundamentals of a healthy economy begin with open, fair, and efficient markets. Sri Lanka has the chance to lead by example.

Bracing for Trump’s tariff storm

By Dhananath Fernando

Originally appeared on the Morning

US President Donald Trump’s second term seems to be keeping all people around the world on their toes. The changes and policies, along with their implications, will be complicated, and we have to do our homework to gain an advantage or at least survive in this game.

The new Trump administration has suggested reciprocal tariffs, meaning the same tariff rates applied to each country that they charge for US products. 

Already, a 10% tariff is in effect for non-energy products from Canada and a 25% tariff on energy-related products from Canada. Additionally, a 25% tariff has been imposed on Mexican products, alongside an additional 10% tariff on Chinese products, bringing the total tariff on Chinese products to 21% (from around 11% previously).

SL’s opportunities and challenges

Before Sri Lanka gets affected by any reciprocal tariff, we first need to understand our total exports, including services. 

According to Harvard’s Atlas of Economic Complexity, we export about 21% to the United States. When it comes to apparel, about 40% of our apparel exports are destined for the US. 

Accordingly, the first line of impact for Sri Lanka would be potential consumption contraction in the US. With high tariffs even against Canada, China, and Mexico, as well as increased prices of essential products, the US consumer will likely reduce spending on non-essential items such as seasonal clothing. It is normal consumer behaviour to postpone purchasing decisions if expenditure on essentials like energy and rent increases.

The second line of impact has both positives and negatives. China and Mexico also supply apparel to the US. If relative prices of Sri Lankan apparel become lower following the 25% tariff for Mexico, we might gain an advantage. 

Similarly, we could become more competitive than China, which now faces an overall 21% tariff. Therefore, we must be cautious and prepared, recognising it is not just tariffs on Sri Lanka directly but also tariffs on others that can bring us opportunities or challenges.

The danger lies in the final stage if the US imposes reciprocal tariffs. The US would consider imposing the same tariffs for Harmonised System (HS) codes as the other trading country imposes on US products. 

There is discussion that the US might not only consider customs duties but also other tariff barriers and even non-tariff barriers. In that case, Port and Aviation Levy (PAL), Commodity Export Subsidy Scheme (CESS), Social Security Contribution Levy (SSCL), and Value-Added Tax (VAT) might be considered, according to some reports. 

This decision depends entirely on the Office of the US Trade Representative (USTR) defining ‘unfair trade practices.’ Media reports indicate that the USTR is expected to analyse all data and make a decision on reciprocal tariffs by 1 April.

We must recognise that Sri Lanka’s average tariff rates are significantly higher than those proposed by the US to China, Mexico, and Canada. A 25% tariff in Sri Lanka is considered low, as our effective tariff rates reach nearly 100%, and for vehicles with excise duties, it exceeds 200%. It is joked that even Trump would become confused if he learnt about Sri Lanka’s tariff structures and that he might learn a tough lesson from us.

In the context of reciprocal tariffs, price-sensitive product categories such as food, apparel, and rubber products may face higher prices in US markets. Ultimately, the real impact will depend on how other competing export markets are affected by US tariffs and non-tariff barriers and how these affect US consumption and global economic growth under new trade dynamics.

Meanwhile, Europe and other powerful countries are targeting the US with reciprocal tariffs, which could trigger global supply chains to consider relocation and create new incentive structures. This can present either an opportunity or a disaster for Sri Lanka.

Solutions

To attract new supply chains and assembly components, we must quickly work on basic factor market reforms. Having adequate land ready for industry and a flexible labour force with business consciousness is essential. Secondly, simplifying and lowering our tariff structure is critical, even though it might be somewhat late. 

Additionally, exploring exports towards East Asia and the Indian market is increasingly vital. Whether our US market shrinks or not, we should prepare to explore other markets, primarily India and East Asian countries. Strengthening foreign relationships, activating business chambers, and intensifying diplomatic missions to strengthen ties is necessary. 

Accelerating regional free trade agreements and conducting market sentiment research can help Sri Lankan entrepreneurs expand their exports. Fundamentally, economics never expires – even during trade wars or crises, strong economic fundamentals provide the best way to survive and thrive. We must move from hope to action.

Where did Sri Lanka export all products to in 2022?

Source: Harvard Atlas of Economic Complexity

Where did Sri Lanka export textiles to in 2022?

Source: Harvard Atlas of Economic Complexity

Beyond profit margins and scandals

By Dhananath Fernando

Originally appeared on the Morning

Blaming imports and importers has long been ingrained in Sri Lankan culture, often seen as a root cause of the country’s economic issues. This perspective not only overlooks the fact that many importers are also exporters, but also fails to recognise that imports and exports are fundamentally interconnected components of the global trade system.

Despite this, it is crucial to acknowledge that not all imports are conducted ethically or transparently. Recent scandals, such as the sugar scam, misinvoicing, bribery, and procedural irregularities at Customs, highlight the darker aspects of importation. However, casting imports in a universally negative light and fostering resentment based on ideological reasons could prove to be more harmful than beneficial.

Recent investigative reports have revealed staggering profits made by importers on essential commodities like green gram, B-onions, and potatoes. Some profit margins have been reported as high as 280% when comparing the Cost, Insurance, and Freight (CIF) value to the market prices of these goods.

Before rushing to judgement on these profit margins, it is essential to delve deeper into the circumstances surrounding these imports. For example, the importation of green gram has been severely restricted since the onset of the Covid-19 pandemic, requiring special approval from the Ministry of Agriculture. As a result, the quantity of green gram imported in 2023 has been minimal.

Thus, comparing the CIF value at the port to market prices can be misleading, as it does not accurately reflect the profits made by importers. This situation raises questions about the high market prices for green gram, pointing to inefficiencies in local production rather than exorbitant profits by importers.

The scenario with undu, a staple food item, is similar. With a Rs. 300 import tariff, the market price for 1 kg of undu ranges between Rs. 1,500-1,700. This high cost is partly because importers cannot bring in undu without approval from the Ministry of Agriculture, despite the imposition of tariffs.

Allowing imports could potentially reduce the price of undu to around Rs. 700 per kg, even after tariffs. The restriction on undu imports exacerbates price inflation, making it unaffordable for many, particularly those in estate regions and the northeast, leading to food insecurity among vulnerable populations.

During the recent economic crisis and the consequent shortage of foreign exchange, many imports were facilitated through informal payment channels and ‘open papers’ in undiyal markets. This practice, aimed at evading high tariffs and taxes through under-invoicing, underscores the complexity of Sri Lanka’s tariff structure and the urgent need for its simplification.

The report by the Ways and Means Committee suggests that focusing solely on the cost of goods at the port does not provide a complete picture of the import value, especially considering the prevalence of informal payments. This approach to calculating profits, based solely on declared document values, overlooks additional costs borne by importers, thus distorting the perception of their profit margins.

Moreover, the perishability of essential food items, along with the significant costs associated with storage, wastage, and the impact of rising fuel and electricity prices, further complicates the economic landscape. These factors, combined with high inflation rates, have significantly influenced the cost structure of both the wholesale and retail markets, affecting pricing and profit margins.

The impact of export controls on certain commodities, such as B-onions by India, has also played a role in inflating global prices, illustrating the complex interplay of international trade policies and local market dynamics.

This situation underscores the phenomenon of unintended consequences in economic policy, where well-intentioned policies can lead to outcomes that are diametrically opposed to their original goals. Sri Lanka’s intricate tariff structure and monetary instability have inadvertently encouraged informal payment methods on one hand and escalated costs on the other, placing the poorest members of society in an increasingly precarious position.

While it is undeniable that practices like misinvoicing represent clear violations of the law and must be addressed through appropriate legal channels, attributing the entirety of Sri Lanka’s economic challenges to importers overlooks the broader systemic issues at play. Simplifying the tariff structure, as this column has long advocated, could lead to increased Government revenue and minimise systemic leakages, offering a more sustainable solution to the economic challenges faced by importers and consumers alike.

In conclusion, while illicit practices within the import sector must be rigorously tackled, the solution to Sri Lanka’s economic dilemmas lies not in vilifying importers but in addressing the complex policy and structural issues that underpin the nation’s trade dynamics. A comprehensive approach, focusing on policy reform, tariff simplification, and enhancing local production efficiencies, is essential for creating a more stable and equitable economic environment.

High tariffs on basic food items: A blow to the struggling masses

By Dhananath Fernando

Originally appeared on the Morning

Last week it was reported that the Government has again imposed high tariffs (Special Commodity Levy) on some food items such as cowpea, finger millet, undu, maize, and a few others. At a time when seven million people are below the poverty line, tariffs on food items are a crime. Imposing tariffs on such food items is not done just to increase Government revenue.

The tariff on undu has increased to Rs. 300 from Rs. 200 per kg. For finger millet and other items, it has increased from Rs. 70 to Rs. 300. How much can a Government earn from a population of 22 million by imposing a Rs. 300 tariff on finger millet and cowpea?

According to the Ministry of Agriculture, the per annum demand for cowpea in Sri Lanka is 15,000 MT, while the demand for finger millet stands at 10,000 MT. Even if we import the entire demand for finger millet and cowpea, the amount the Government can earn as tariff is about Rs. 7.5 billion for the entire year.

This is a negligible amount compared to our expenditure. The expenditure for the President is about Rs. 5.8 billion as per the Budget estimate for 2024. It is clear that the increase of the Special Commodity Levy (SCL) for food items will have an impact beyond taxes, because at this tariff rate no one will import finger millet or cowpea.

However, it means that the consumer will lose the opportunity to purchase cowpea, undu, and finger millet for Rs. 300 less than what is available in the market. How can we justify people paying an additional Rs. 300 when seven million people – one-third of our country – live in poverty?

This general justification is that this tariff is imposed to protect local manufacturing of finger millet, cowpea, and maize. Even if this is true, what is the justification in terms of consumers when they no longer have access to affordable food items?

Given existing lifestyle changes, products such as undu, cowpea, and finger millet are mainly consumed not by the wealthiest section of the society but the poorest. Diabetes patients, pregnant mothers, estate workers, people in the north and east are the primary consumers of these food items.

It doesn’t stop there. High prices on maize will impact the entire food supply chain as maize is one of the main expenditures of the poultry industry. About 40% of the cost of poultry is on food, primarily driven by maize. This indicates that the cost of main protein sources such as chicken and eggs will increase.

The cost of chicken and eggs in turn impacts the costs of the bakery industry and all food items at restaurants and eateries.

Accordingly, the net impact on the entire food supply chain due to this ad hoc Special Commodity Levy is much greater than what we see at the surface level. Although it is not ideal, if the Government really wishes to protect finger millet, cowpea, and maize farmers, it can give a direct subsidy of Rs. 7.5 billion, based on the productivity and efficiency of farms.

This would mean that at least those who push for better cultivation methods receive an incentive to ensure a better harvest, rather than asking consumers to shoulder a flat price hike for all food items at a time when they are struggling to put three meals on the table per day. People are facing excessive burdens due to inflation and the high tax rate in order to pay for the mistakes of our policymakers.

The second argument against the high SCL on imported food items concerns saving foreign exchange. Firstly, we cannot save foreign exchange through higher tariffs because the demand for imports is determined by the money supply within the economy. People buy forex to import by spending the rupees they earn. When they buy forex in rupees, they have to reduce their consumption by some other means.

If we can save forex simply through higher tariffs and import controls, we have to question how we ran out of forex when import controls, in place since Covid, existed until very recently.

We even controlled some of our pharmaceutical imports but we were still unable to save forex. Foreign exchange cannot be saved by import controls or high tariffs.

Secondly, 40% of our imports is fuel. If we really want to cut down on our imports, we must reduce fuel imports, which this column has recommended multiple times, suggesting a market system for public transport. By imposing a Special Commodity Levy on food, we are simply asking the poorest of the poor to face starvation while providing the opportunity for rent-seeking behaviour of a few crony elites.

Whether in socialism or in capitalism or with the argument of saving foreign exchange, how can we justify a Special Commodity Levy of Rs. 300 on basic food items when one out of every three fellow Sri Lankans are forced to skip a meal due to poverty?

Understanding corruption: How Sri Lanka’s economic system favours a select few

By Dhananath Fernando

Originally appeared on the Morning

Dr. Sharmini Cooray, one of the Advisors to the Sri Lankan Government regarding the IMF, at the 73rd Oration at the Central Bank made an interesting comment, “Lots of Sri Lankans say nothing works in Sri Lanka. That’s not true. Things work well for a small group of people”. 

Unfortunately Sri Lankans do not understand how things are set up to work for a small group of people. The common narrative is that corrupt individuals created the system we are in today, but the stark reality is that the economic system has been set up in a way to incentivise corruption for individuals. Misdirected anger is then projected on individuals forgetting that the system itself creates the corrupt individuals. This is not to say that the individuals are completely absolved of responsibility, a part of the responsibility is on the individual, yet without fixing the system we cannot fix individuals. 

Below are a few examples of how the current system works for corruption.

Last week the President as the Minister of Finance issued a Gazette notification to increase the Special Commodity Levy (SCL) from Rs.0.25 (25 cents) per Kg to Rs.50 per Kg overnight. The problem here is twofold; it creates the possibility for corruption that incurs a cost to the consumer but also ensures that the government loses tax revenue. 

Information symmetry

Information symmetry or availability of information for all players in the market is very important. As the finance minister increases the tariff by almost 5000% if one importer gets to know of this decision before it is enacted he can easily import adequate stocks for about a year early at Rs. 25 cents per Kg before the festive season. The other players' prices now simply become uncompetitive because their 1Kg of sugar has to be at least higher than Rs. 49, given the tariff rate imposed overnight. As a result the small and medium sugar importers will be wiped out of  the market as they simply cannot compete where one or few players have already imported enough stocks at 25 cents tariff and now the rest have to import at Rs.50 per Kg tariff rate. That is how things are made to work only for a small group of people. One of the main criticisms for the Gotabhaya Rajapaksa Government was that the sugar scam was done in a similar manner. 

Most importantly the tariff increase on sugar will not generate revenue for the government because adequate sugar has been already imported. After about a year it is just a matter of another gazette notification to the finance minister to bring the tariff back to 25 cents and claiming that the relief has been provided to the betterment of the poor people. So ultimately a selected group of people are just getting benefited with the support of the politicians. The truth is the loss tariff revenue will be collected from the poverty stricken by increasing the indirect taxes such as VAT.  

This is one reason this column constantly highlighted the need for keeping a simple tariff structure with menial deviations among HS codes as well as over a period of time. This is just one way of how things are only getting worked out for a selected group of people. 

As a result the public builds a bad perception with a misunderstanding of markets that all businesses are run on the same operating system. The truth is the system affects other businesses very badly because of not having a level playing field. 

The solution is to change regulation where any tariff lines cannot be imposed just by the minister of finance. It ideally has to go through parliament and keep the tariffs on HS codes simple and consistent. The more we keep it complicated the more we incentivise corruption. 

The need for a competitive system has to be institutionalized. The best governance system is making sure competitiveness remains stable. We can only do that by removing laws empowering policy makers that further information asymmetry and provide more power to the people so the market system continues. 

Tax shenanigans 

Not only have we  increased SCL by 5000%, our VAT has also been increased by 3%. When we observe the VAT rate changes, the threshold changes over the last 5 years is very concerning. By doing so we have violated the tax principle of “Stability” by changing things often. When we make one mistake at the beginning, retroactively correcting it is not easy. The VAT increase may have come to compensate for the 20,000 salary hike for the 1.5 million government employees. To make things politically digestible, an attempt may be to increase the VAT before the budget as a press release and announce a big salary increase for government employees as victory. On top of it there vehicle permits and so many perks are the system of how things are making well for a small group of people.  

The simple truth is to make governance work, we have to make market works. Governance is the system of making markets work and making a level playing field. The moment we deviate from markets there is no way we can keep the governance going.  

New electricity tariff structure leaves room for considerable improvement

Originally appeared on the Daily Mirror, Timesonline.lk

By the Resident Fellow of Advocata Institute

The recent revision of electricity tariffs is a step towards reducing the fiscal burden caused by the supply of electricity below its cost of production. While the new tariff structure is an improvement on the previous one, anomalies remain.

 In determining tariffs, there are three characteristics of electricity that must be noted:

I. Electricity is a commodity that is interchangeable, both in its generation and use. One megawatt hour (MWh) of electricity produced from coal or hydropower contains the same amount of energy. Different categories of users consume the same product.

II. It must be produced and used simultaneously. Electricity storage is still prohibitively expensive. Supply must meet demand exactly in the power grid.

III. The cost of supplying electricity fluctuates throughout the day, depending on the power generation mix, cost of fuels used, transmission costs and energy losses.

As electricity is a commodity, there should be no difference in the prices charged to different users. The tariff should also reflect the varying cost of supply, depending on the time of day and should as far as possible, balance the generation of electricity with its use. For sustainability, the tariff needs to be on a cost-recovery basis.

The new tariff addresses some of the shortcomings of the existing structure but there is still considerable room for improvement.

1. The proposed structure reduces the discrimination between different types of bulk supply customers.

For users below 42kVA, the different rates that were charged to hotels, government and general-purpose bulk supply, have been amalgamated into a single general-purpose tariff but a lower rate remains applicable to ‘industrial’ customers. However, it is positive that the differential between the general-purpose bulk supply and customers categorised as ‘industrial’ has decreased.

For larger bulk customers, it is welcome that the distinction between categories has been done away with and a single tariff, close to cost recovery and reflecting time of use, has been applied.

The Public Utilities Commission of Sri Lanka (PUCSL) consultation document states that the average cost of generation is Rs.32.87 but the tariff charged to low-use industrial users (Rs.20) and low-use general-purpose customers (Rs.25 for those below 180kWh) is both below cost.

The only justification for a discriminatory tariff is for a lifeline tariff for the poor. While the domestic users below 90kWh do receive a subsidised tariff, the domestic consumers, who exceed this, pay the highest tariff (Rs.50 for usage between 90-180kWh, Rs.75 above 180kWh), which is almost double that of all bulk users. Thus, high-use domestic consumers are subsidising industrial and commercial users.

Moreover, instead of increasing the rate for each block of use, the moment domestic customers exceed 60 units, the tariff increases from an average of Rs.9 to Rs.16. A customer, who consumes 59 units, will pay Rs.9 but one who consumes 61 units will pay Rs.16 per unit. This is unfair and can promote corruption in meter reading. In general, such cross subsidies are undesirable, as they can lead to inefficient resource allocation or have unintended consequences.

For example, the higher domestic tariff may serve as a disincentive for remote work. Remote or flexible work arrangements can reduce transport costs, congestion, energy use and for some, enable a better work/life balance. The government should be facilitating flexible work but the higher rates applicable to some domestic consumers may be a disincentive.

The PUCSL has an unusual definition of industry. It includes, ‘agriculture’, ‘forestry and fishing’, ‘mining and quarrying’, ‘manufacturing’, ‘electricity, gas, steam and air conditioning supply’, ‘water supply, sewerage and waste management. As a matter of principle, the producer should not make judgment on how the product is used or attempt to encourage or discourage particular activities through prices. If the government does wish to encourage particular industries, it is more efficient to do this through a transparent system of grants, rather than distorting prices.

Economic activity is increasingly complex and a value chain can involve many different sectors. For example, the tea industry involves agriculture, processing in factories, transport, warehousing, blending, financing, marketing and exports. Moreover, products are now more knowledge intensive, so a greater part of the value addition arises in non-production-oriented components of the value chain. With differential tariffs, parts of the same value chain may pay different prices for use of the same commodity.

Religious and charitable bodies continue to enjoy preferential treatment under the domestic tariff category but there is a small decrease in the discount offered to these bodies. High-use customers in this category should also be subject to a time of use (TOU)-based tariff. Advocata reiterates that there should be no price discrimination between users; at most there should be two categories, households and businesses.

2. It is welcome to note that the new tariff structure extends the TOU tariff to the agriculture subsector but this should be extended to smaller bulk users and made compulsory for the high-use domestic category. For customers using solar power on a net metering basis, the export and import tariffs should be based on TOU. A TOU-based tariff reflects the changing cost of generation across the day. Generation during peak hours relies more heavily on thermal power, which is more costly. Tariffs charged to customers should reflect this, so that the consumers are incentivised to shift demand to off-peak hours.

3. The new tariff maintains a lower rate for low-use domestic customers and it is welcome that the new structure applies marginal tariffs based on different slabs of usage. The previous system was inherently unfair to the consumer; the new tariff removes this anomaly.

4. The decision to charge for street lighting, which should be paid for by the local authorities, is welcome. Previously, as the Ceylon Electricity Board (CEB) did not charge for street lighting, the local authorities, which have control over when the lights are switched on and off, had no particular incentive to switch off street lights during day time. A lower rate for street lighting is justified because the major part of the use falls into off-peak hours.

5. It is regrettable that the PUCSL permitted the CEB to compel selected clients to pay for electricity in US dollars. This is a step towards forced dollarisation of payments and is precluded under Section 4 of Monetary Law Act No. 58 of 1949. The proposal is meant to address the current shortage of US dollars for importation of fuel for the energy sector. However, this would only divert resources from other alternative users and may not be the most efficient way of allocating the scarce foreign exchange in the country. It would be preferable to allow US dollars to flow into the banking sector (by removing any restrictions and requirements such as forced conversions and surrendering requirements) and for those funds to be allocated based on price (exchange rate).

The increase in the electricity tariff is unavoidable but will impose an additional burden on consumers. Therefore, it is imperative that this must be accompanied by increased transparency and efficiency

within the utility.

Consumers may expect to pay for higher world prices but cannot be expected to pay higher costs, due to inefficiency, waste or corruption. State enterprises need to be open and transparent in their affairs, particularly in procurement and where possible should operate in competitive markets.

As a first step, the CEB should provide a detailed breakdown on the components of its tariff:

• Energy costs: (Own generation costs and that paid to the private generation companies). This must be broken down into the fuel cost and the costs of operating the power stations, such as the manpower and maintenance costs as well as the capital cost of the stations.

• Network costs: This reflects the cost of transporting electricity through the power grid.

• Overhead: This is to recover the costs of central administration, billing and meter reading, data management, retail market systems as well as market development initiatives.

The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

Taxes on Essential Products: Bringing The Debate Back to Where It Matters

Originally appeared on Colombo Telegraph, Citizen.lk, The Morning, Lanka Business Online and Daily Mirror

By Aneetha Warusavitarana

Sri Lanka’s exorbitant taxes on sanitary napkins had the media spotlight over the last few weeks - this is not a new issue. In 2018 the total tariffs on sanitary napkins was over 101.2%.  Since then we have seen some progress, with the tax being reduced from 101.2% to its current rate of 52%; a result of several tax revisions.

The 2020 budget revised down general duties for sanitary napkins to 15% and introduced a CESS tax of 15%, causing an uproar in social media and in parliament leading to fresh calls for the abolition of these taxes.  

Menstrual hygiene products are essential for girls and women, and this issue has put the interests of these consumers who want more variety and cheaper products against the interests of the local producers who want larger margins. Since the initial uproar last week, there have been claims that the local brands account for 95% of the local market and therefore import taxes do not have a bearing on the market price.  

Bringing the debate back to where it matters: impact on women

It is clear that for this issue, policy decisions have to be taken with the best interests of the consumer at heart - in this case, the millions of menstruating women. 

At the most basic level of analysis, when protectionist tariffs are placed on a good, it is the consumer who loses out. The tariffs will achieve two things: they will limit the range of products that enter the domestic market, and they will raise the prices of both imported products and locally manufactured products. How so? The inputs into the local production process are also taxed, which raises production costs, and therefore raises the final price of the locally manufactured product. Additionally, the tariff raises the price of the imported product, which allows local producers to raise their prices and keep substantial margins. In other words - tariffs cause both the locally produced goods and the imported goods to be sold at a higher price. 

These tariffs are also keeping more affordable options out of the market. At the time of writing, locally manufactured products can range in price (per pad) from LKR 11 to LKR 19. However, cheap imported alternatives are not available. For example, Indian supermarkets have products at the equivalent of LKR 5. The tariffs may not be deterring higher-priced imports from entering the market, but it could be possible that this is happening with more affordable imported options - it makes little sense to bring in a cheaper product if the tariff raises your costs to the point where you have to price the final good at the same price point as your more expensive product.

Will removing the tax only affect high-income earners?

An argument leveled against the removal of the tax has been that imported products are often out of reach of the average Sri Lankan woman, and as such has little relevance as a policy decision. This argument has also been coupled with the statement that as locally manufactured products exist, and women do purchase them - why should we care about bringing in imports? 

The example provided above makes it clear that removing the tax would actually bring more affordable products into the market. This is also where the importance of choice comes to play. Each woman will have different requirements at different points in their life. This is compounded by the fact that menstruation is often accompanied by pain and discomfort, which can range from mildly annoying to debilitating. In short, one size does not fit all when it comes to menstrual hygiene products. In response to this fact, the global industry has innovated - period cups, period underwear, reusable pads and more. These tariffs should be removed, and Sri Lankan women should also be given access to these choices. 

Economic Rents

By now it should be clear that there is only one winner, and it is not the millions of menstruating women. The basic explanation of the impact protectionist tariffs have is that they serve to benefit local producers, that are few in number. They shield them from the competition and allow them to price well above marginal costs. A classic case of ‘rent-seeking’ behaviour, where a company lobbies to secure itself protection in order to charge a higher price. The result is that the local consumer loses out. 

There is one area where the producer's complaints do have merits - that is the tariffs placed on their inputs.  Much of the input that goes into the production of sanitary napkins are also taxed.  The government should look into reducing these costs to help the local manufacturers stay price competitive.  

Given this, there is a clear call to reform - prioritise the requirements of women, and remove the taxes imposed on the final good and on the inputs into the production of these goods.

Aneetha Warusavitarana is the Research Manager at the Advocata Institute and can be contacted at aneetha@advocata.org or @AneethaW on Twitter. Learn more about Advocata’s work at www.advocata.org. 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.

Why Sri Lankans aim low

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

Over the years, a lot of weight has been put on building “aspirational Sri Lankans”. Different terminologies have been used to define them; however, the core group of the so-called aspirational Sri Lankans remains the same – “intellectuals”, “business professionals”, “young professionals”, and “members of professional movements”. The key question then is what makes aspirational Sri Lankans aspirational, and why have they been unsuccessful in placing Sri Lanka back on the map?

Where are our aspirations?

Many Sri Lankans aspire to build a house, buy a vehicle, and probably have a grand wedding and proceed on to provide a good education for their children. Achieving these aspirations continues throughout their lifecycle. Then, the next generation takes the baton and runs the same race. This is the constant marathon run by our “aspirational Sri Lankans” for decades.

The serious question we need to ask ourselves is why basic needs such as housing and transportation have become aspirations for the average Sri Lankan in the 21st Century. Moreover, attention should be given to the opportunity costs of obsessing over housing and transportation by these “aspirational Sri Lankans” – what could be achieved if this was not the case?

Why people consume capital by building a house

While it is true that the financial literacy of Sri Lankans is low and that we have failed at the formation of capital due to excessive consumption from our initial capital instead of investing, we also need to investigate the economic rationale behind such behaviour. The reason as to why basic needs such as housing have become a distant dream to the average Sri Lankan is deeply rooted in the distortion of prices in the housing market due to the implementation of misguided economic policies. Most of the construction material in Sri Lanka is far more expensive than the prices of the said material in the entire region. The total tax Sri Lankans pay for imported steel ranges between 19% and 64%.

The tax on imported tiles ranges between 19% and 93%, and at present, the Government has imposed a temporary import restriction on tiles and sanitaryware, driving the prices of local goods up. Anyone who has attempted to build a house would know how ridiculous the prices for light fittings, curtains, aluminium, and other material are. Sri Lanka also has a shortage of skilled labour, and finding a mason or a furniture craftsman is not only difficult but also expensive. They have become expensive on the basis of productivity. If you are wondering why Chinese labour has expanded beyond large-scale construction to small-scale residential construction, the answer is rooted in productivity. Chinese labourers are five times more productive (according to an in-depth interview conducted by the author with an apartment builder) than the Sri Lankan labourer.

High import tariffs and import bans have led to skyrocketing domestic prices, and now the simple transaction of buying or building a house has become a lifetime dream of the aspirational Sri Lankan. If you ask a banker for their reason for remaining in that job, they will tell you that it is the concessionary “housing loan’” and “vehicle loan” that attracted them. While a fortune will be spent on building a house, there will be limited funds to explore better education opportunities, hereby pushing the tertiary education of young professionals to the grave due to extra prices paid for inefficiencies in housing.

The existing land issues, the inability to transfer properties, and lack of property rights have made the situation worse. So in real terms, the “aspirational Sri Lankan’s” capital that they couldn’t invest for returns was not invested in their house, but rather in the extra price they paid for construction. More importantly, potential aspirational Sri Lankans are expending valuable energy in trying to overcome the consequences of these misguided economic policies.

Where is the capital for the vehicle?

It is no secret that Sri Lanka’s vehicle market is one of the most distorted markets. Based on the usage of the vehicle, the value increases, and we pay exorbitant amounts of tax at the point of importing a vehicle. Making things worse is the vehicle permit system that is only available to VVIPS and few professions.

So what is the incentive to be an aspirational Sri Lankan? Is it to take the risk of investing the capital and trying to consume from the yield, allowing the capital to multiply, while lobby groups and politically connected pressure groups not only get a vehicle permit but also the legal blessing to sell despite tax losses to the government?

The permit culture is not only in buying vehicles, but it is also in the public transportation system where route permits for public transportation are more expensive than the bus itself, even though the cost of a bus is multiplied several times over when you factor in the tax.

Yet again in the real world, the aspirational hardworking Sri Lankan’s capital, which they never invested (which they did not have the knowledge to invest), gets gobbled down in distorted markets that are protected from competition. 

Even when looking at leisure and recreation, the cost of recovering capital invested in the construction of a hotel is passed on as room rates at prices that are higher than those of similar destinations in the region, because of our high cost of construction. At weddings, the costs of the food they serve, electrical appliances, storage, and prices of cutlery, liquor, etc. are added to the final cost of a plate at a wedding. Hence, there is no alternative but to eat away at the capital that belongs to the average aspirational Sri Lankan. 

It is true many Sri Lankans get into this trap by trying to live beyond their means, spending lavishly at weddings, building bigger houses than they require, and buying vehicles due to a lack of financial literacy. But the reasons why artificial value has been created for basics such as housing and commuting is misguided economic policies.

What young entrepreneurs chase as aspirations are not the real aspirations that could put Sri Lanka back on the map. The very reason for this is that our prices do not indicate the true value of the product or service and the real value it offers. The concept of “price” is of paramount importance. It is the single indicator of value, resource scarcity, productivity, supply, demand, and so many variables that are all encapsulated in that single number called “price”.

When governments and policies intervene in demarcating prices, the price set is a result of people chasing the wrong things and the entirety of society has to bear the cost and loss of it.

What we need is to set a culture of hard work and free exchange where young entrepreneurs are provided with a level playing field, right incentive structures, and motivation to be productive and innovative – that is the real expectation of the aspirational Sri Lankan which has now been shadowed by glittery basics such as housing and buying a vehicle. Until we work towards that, we will not be able to see a new Sri Lanka nor will aspirational Sri Lankans ever prosper.

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.

Tariffs and the law of unintended consequences

Originally appeared on Sunday Times

By Aneetha Warusavitarana

The law of unintended consequences is a theory that dates back to Adam Smith, but was popularised by the sociologist Robert K. Merton. In short, the law explains the reality that when governments intervene to create a set of outcomes, as the theory of cetris paribus (holding other factors constant) cannot be achieved in a market situation - the result is a series of unintended consequences.

Colonial India and Cobras

This law is also known as the ‘Cobra Effect’, dating all the way back to when the British first colonised India. The British were understandably concerned about poisonous snakes in India, Cobras apparently being a source of some worry. The solution they presented was to provide a reward for every Cobra that was killed, creating a clear incentive for locals to capture and kill any Cobras in the vicinity. While this worked well in the short term, the British slowly realised that enterprising individuals were actively breeding Cobras; creating a very profitable business out of collecting bounties. Once this was clear, the British removed the bounty, and now as this was no longer a profitable venture, the breeders released all their Cobras. The final outcome of this was an increase in the general Cobra population, completely the opposite of what the intervention set out to achieve.

While this makes for a good anecdote, the economic realities of the law of unintended consequences are often more dire. Interventions into the market are often well-intended, but have the potential to backfire. A shining example of this is the case of tariffs. Forbes recently published an article which detailed the unintended consequences of a washing machine tariff imposed in the US. This well-meaning tariff was introduced to protect domestic producers in the US, and boost employment in that industry. If one evaluates the effectiveness of the tariff simply on those two criteria, then the tariff has been a resounding success; US washer and dryer industry created around 1,800 new jobs. This could easily be written off as a success story.

The Cobra effect on washing machines

However, the focus here is only on the producer, and the consumer has been removed from the narrative. The first unintended consequence was that as imported machines were now more expensive, domestic manufacturers could safely raise their prices, without fear of losing out on sales. The second unintended consequence was that dryers also became more expensive. As a complementary good to washing machines in the US, manufacturers of dryers saw this as the perfect window in which to raise their prices and increase their profits (clotheslines would save Sri Lanka from this unintended consequence).

Taking all this into account, according to Forbes, this has cost American consumers around USD 1.5 billion. One could argue that this increase in prices and resultant cost to consumers can be justified by the 1,800 jobs that were created. The reality is that each job is equivalent to USD 815,000 in increased consumer costs. This tariff policy effectively protects the local industry at the cost of their own consumers.

Why should Sri Lankans care about washing machine prices in the US?

While we can agree that this does appear to be an unfortunate example of unintended consequences, and that it is pretty clear that domestic consumers got a bad deal here, why should the average Sri Lankan care? After all, we have sunlight soap and clotheslines.

Sri Lankan consumers should care because the same unintended consequences that took place oceans away in the United States is happening here, in our little island nation. Tariffs have long been the favoured tool of successive governments. Tariffs sound really good on paper, and better if said paper is an election manifesto. ‘We will protect our domestic producers’ is a statement that tugs at the heartstrings of too many voters. The fine print ‘at the cost of domestic consumers’ is not something that is publicised, but it should be.

Tariffs have been imposed on goods ranging from household care, personal care and food. The price of items as diverse as school shoes and construction material are affected by this. The entire country complains about how the cost of living is too high, and unreasonably high tariffs are one of the drivers behind this. Unfortunately for us, the imposition of these tariffs create exactly the same series of unintended consequences that American consumers have to face. The price of the weekly shop an average Sri Lankan does whether it is from the delkanda pola, the closest supermarket or the handiye kade is affected by tariffs. A potato, even if it is locally produced is more expensive than it needs to be, because tariffs push the price of imported tomatoes up, allowing domestic producers to raise prices with the consumer losing out.

Tariffs on essential goods in Sri Lanka can range from 45% to 107.6%. There needs to be a serious re-evaluation of the role of tariffs in our economy – the rationale behind imposing them, the consequences of the tariff (which are well understood and cannot be discounted or ignored), and ideally a faster regime for phasing them out.