Sri Lanka’s outward turn: Where the opportunities lie

Fewer restrictions to FDI will help with more competition and better services in key enabling sectors like logistics

Sri Lanka is going through the worst economic crisis in decades. Overcoming it requires genuine sources of foreign exchange, good quality jobs, and sustainable growth based on productivity upgrading. Macro policies conducive to stability and reduced uncertainty will pave the way to the needed productive investments. Yet, to ensure a strong supply response to these macro policies, structural reforms need to follow. Looking outwards through credible and consistent actions to encourage exports and foreign direct investment should be at the top of these reform priorities.

In the interim Budget Speech, President Ranil Wickremesinghe stressed the importance of tapping into regional and global value chains, as a key pillar of the Government’s reform program. 

This announcement is great news because the cost of looking inwards has been high. Increased trade barriers led to the export-to-GDP ratio falling from 39% in 2000 to 18% in 2021. This has had negative productivity implications. In industry, labour productivity during the past two decades grew slowly, at 3.2% per year, 10% below the South Asian average, and way below Southeast Asian peers.

World Bank analysis shows that the country’s untapped export potential for merchandise is at $ 10 billion annually. Tapping into this potential could double exports, create an additional 142,500 jobs, and put the country back on a sustainable growth path. 

International experience shows that increased global trade and FDI were key in achieving sustainable growth – think Vietnam, Malaysia, or Indonesia. When economies integrate with the world, consumers gain because of lower prices, domestic firms innovate to remain competitive and credit and talent to be allocated to the most productive uses.

More integration also exposes domestic firms to global knowledge and technologies, facilitating learning and the creation of better jobs. When Samsung first set shop in Vietnam in 2008 to assemble and export electronics, most – if not all – of its suppliers were foreign firms. Between 2014 and 2019, the number of Vietnamese companies chosen as first-tier suppliers of Samsung increased from 4 to 42, reaching 50 in 2020. Today, Samsung does not just assemble in Vietnam. It also produces semiconductor parts and conducts R&D. The firm sparked a reaction through the value chain. It trained its local suppliers, which helped improve their organisational practices and the quality of their products or services as a result. This, in turn, helped them secure other clients. And of course, Vietnam exports grew and diversified. 

So, what would it take for Sri Lanka to join a loop of integration, sustainable growth, and job creation? What holds back the emergence of high-value, export clusters around sweet Ceylon cinnamon, Ceylon tea, or coconuts? Or the emergence of new quality goods or services? 

A critical step is to reduce trade costs, to enable competitive enough companies to venture into world markets.

First, trade costs related to the ‘discovery’ or ‘search’ process. To export, firms need to find a product, a target client abroad and a way to add value to appeal to that client. Public policy can help through smart export promotion and branding. Trade information portals, if regularly updated, reduce these costs. Matchmaking services, such as the ones provided by Malaysia’s External Trade Development Corporation do their part too. Branding also matters. Branding makes production profitable, inducing clients to pay a premium. Ceylon tea is a case in point. Consumers all over the world recognise the brand and are willing to pay a premium for it. Boosting this brand by obtaining a ‘Geographical Indication’ certification, just as it was obtained for Ceylon Cinnamon in February 2022 could be a path to increased value added, as it provides a stamp of quality of a product.  

Second, trade costs related to trade policy. They typically take the form of import duties. When imposed on final goods, they shelter domestic firms from the threat of import competition. But also, from its benefits. They artificially increase prices above what is paid in global markets, discouraging Sri Lankan firms to export because they get better profits domestically. When they are imposed on inputs or machinery, they increase production costs and limit the technological choices domestic firms face. Sri Lanka has a long way to go in reducing this part of trade costs. It ranks top 5 in the world in terms of highest import duties on consumer goods, top 20 on inputs, and top 30 on machinery. Instead, countries that have benefited from trade have low import barriers: Vietnam’s import duties on inputs for example, stand at 5% and at 12% for consumer goods, compared to Sri Lanka’s 13 and 28% respectively. Deep trade agreements have helped other countries reduce these tariff (and non-tariff) barriers, and secure improved market access in exchange.

Third, trade costs related to moving goods across borders depend on the efficiency of what is known as the trade facilitation infrastructure. There are typically many agencies involved in trade related processes such as issuing permits and managing the movements of goods in or out of the country. Ensuring these agencies are coordinated, that rules are transparent and clear, and that infrastructure is adequate is crucial. In this respect, Sri Lanka’s determination to implement a National Single Window is a step in the right direction to reduce trade costs.

Complementary policies help maximise the benefits of lower trade costs. Fewer restrictions to FDI will help with more competition and better services in key enabling sectors like logistics. Supporting start-ups in developing export business plans helps them in better tapping into export opportunities. Reducing red tape will help small enterprises thrive, while protecting property rights will incentivise investments in innovation. Also, facilitating the mobility of workers across firms and sectors, and supporting skills upgrading will reduce labour adjustment costs. 

Sri Lanka has the potential to grow richer and more resilient, creating better opportunities for its people. Integration into the world through more trade and investment is a powerful platform to achieve that potential. Reducing trade costs and supporting firms in the process will make it possible.

(The writer is the World Bank Country Director, Maldives, Nepal and Sri Lanka, South Asia.)