Finbarr Bermingham reports from Colombo on the challenges facing Sri Lanka as it tries to move up the value chain.
It takes a couple of hours to reach the top of One Tree Hill from the Ashburnham Tea Estate, near Elkaduwa in Sri Lanka. But the view is worth it. A relatively small peak among forest-covered mountains, the hill is surrounded by tea plantations. Today is Diwali, the ancient Hindu festival of lights, so tea pickers are few and far between. Those that remain are scavenging firewood from the rows of fragrant bushes.
“There used to be more plantations,” says Aravinda Rathnayake, a guide and naturalist who grew up in the area. “But nowadays it’s hard to find the workers. Nobody wants to work on the tea plantations anymore. Everybody is educated and so are moving into the service sector. Soon we will have a small tea industry or none at all!”
The laugh that accompanies his words suggests that he is exaggerating: tea is still one of the most important industries and exports of Sri Lanka. But the point is well made: one of its other great assets are its people. Healthcare and third-level education are universal benefits here, a product of a longstanding socialist constitution combined with Buddhist values that run deep. The work on a plantation is hard and manual. While elsewhere the process is automated, in Sri Lanka all the tea is picked by hand. It’s this that allows the producers to charge a premium and which has helped create the prestigious Ceylon tea brand. But nobody goes to university to pick tea.
In an impressive modern building 200km away sits Iresha Somarathna, the head of engineering at apparel manufacturing company Brandix. He’s holding a plaque, an award received for the most innovative building in Sri Lanka. Everything here runs on renewable energy, he tells GTR proudly. They harness the power of the waves, clearly visible through the windows which cover every wall on this floor, the wind and the sun – and it’s a model they are rolling out into their factories too.
Brandix is a shining model of the new Sri Lanka. It produces wares for Victoria’s Secret, Tommy Hilfiger, Marks and Spencer and more, but what started as a simple outsourced production process is now changing. Brandix staff are designing products for their customers, employing highly-trained creatives and engineers to master production and design best practice. They have opened factories of their own in India and Bangladesh which are operated to the same standard as those in Sri Lanka, at a fraction of the cost.
Sri Lanka is a place where the old and new clash at every corner. Already considered a middle income country by the World Bank, it is undergoing huge transitions. It has recently emerged from a long and bloody conflict, but has spent recent years investing heavily in infrastructure and facilities, with the help of international finance. While it’s having a poor few years on paper – exports fell by 19% in 2015 and have been declining in their share of GDP since 2000 – the long-term trajectory is upward. This is a country with huge ambition and which intends to punch well above its weight.
Graduating to new sectors
“We have a situation where 60% of our product exports come from two sectors: apparel and tea. You have the head and a long tail, a number of other sectors. We have this overdependence on two sectors, so if anything goes wrong in the external environment then it impacts on these sectors, and that’s what has happened over the last couple of years,” says Nirmali Samarathunga, the former chief of the Exporters Association of Sri Lanka and co-chair of Mackwoods, a diversified company that seems to have fingers in every sector of the economy.
Government officials all over the world talk about the need for value addition in their economy. In Turkey, they want to stop exporting cotton and start selling t-shirts. In Indonesia, the government is taking drastic action to halt the export of unrefined ores, while in East Africa, the need for more refineries to process crude oil is pressing. In Sri Lanka, a country blessed with resources that are basic but plentiful, the conversation is fascinating.
“The sector has realised the need to move,” Samarathunga tells GTR over a cup of Ceylon tea. “With 20 million people there’s a limit to what we can do in terms of volume. We can’t compete with China or Thailand on economies of scale or simply as commodity exporters. Competitiveness is the bottom line for the exports sector here. As soon as the sector can transform into value addition, niche markets, the faster the exports sector can transform into the numbers it should have. We’re currently exporting US$10bn-US$11bn, but should be doing US$30bn-US$40bn if we get the equation right.”
It’s a realisation that many companies have made. While still exporting traditional produce, companies are moving into other areas. Tea companies are making tea extracts. In the apparel sector, they’re designing as well as manufacturing. Coconut producers are now producing activated carbon from coconut shells, coconut water and oils are being synthesised, and you taste desiccated Sri Lankan coconut when you bite into a Bounty bar. The number one manufacturer of solid rubber tyres is Loadstar in Sri Lanka, which has moved up the rubber value chain.
“I would think almost all Sri Lankan companies have already moved away from traditional exports, they’re not just looking at it,” says chief economist at the Ceylon Chamber of Commerce, Anushka Wijesinha. “The difference is it’s not as noticeable. We’re a small country, so we don’t have 50 or 60 companies in rubber or other industries making these moves. We have one Hayleys, one Mackwoods. But you have these champion firms doing a lot more here and overseas. So while it might still look like Sri Lanka is working in coconuts, Hayleys is working on activated carbon from coconut shells.”
As companies try to transcend their traditional business areas and court new markets abroad, getting access to finance is one of the major challenges. The single borrower limit essentially restricts the amount of finance one company can borrow. A mechanism introduced to secure the long-term health of the banking sector, it sees banks get together and decide how much one company is able to borrow across the sector. In effect, it’s a borrowing cap, applied to companies across the board.
“Here, when the company goes down you’re talking about taking down the entire local banking sector,” says Arul Sivagananathan, managing director at Hayleys Industrial Solutions, another diversified Sri Lankan giant. “We can borrow overseas in dollars but it does get covered in the single borrower limit as it comes through a local bank.”
The ruling makes sense: in such a small country, one major corporate collapse could have huge ramifications. It enabled Sri Lanka to negotiate the financial crisis painlessly. There was no recession when the world went down. Sri Lanka grew by 7%.
Its policies worked. The single borrower limit is only likely to affect the larger companies, but the troubles in Sri Lanka’s trade finance sector certainly don’t stop there. In the US, 98% of exporters are SMEs. In India and Thailand, the figure is 40%. But in Sri Lanka, just 5% of exporters are SMEs.
“You need to bring new exporters in and explore new markets. One thing preventing SMEs from exporting is a lack of access to export finance. There’s a certain risk involved. They have to keep their working capital to mitigate that. The banks demand collateral against extending financing. We’ve been strongly promoting, to make more SMEs exporters, that they extend facilities based on the project at hand,” says Samarathunga.
“We have limited tools for export finance,” she continues. “We’ve been asking to consider an Exim bank, lending to overseas buyers. We heard India Exim was using short-term buyers’ credit, where you transfer the risk from the seller to the buyer and a lot of India’s SMEs have entered the export market, who can’t take on the risk or put up their own working capital. We feel that instruments like that need to come into play here. It requires a change in the banking sector. Rather than low risk, they need to adopt a system whereby they can cover themselves but benefit the system.”
This lack of local capital for trade and investment has led to a huge increase in foreign direct investment in Sri Lanka. The country needed to rebuild much of its infrastructure after 30 years of war. The money came flowing in from China, but some are beginning to question whether that relationship has become too cosy.
Dilip Samarasinghe’s desk is a mess of books and papers, trophies and gifts. But one object catches the eye. “I’ve always read The Art of War,” he says, after GTR spies it in his compact director’s office at the Sri Lanka Board of Investment. “In terms of planning, it’s very sensible and logical. In fact, war is only the final outcome. It’s very often the last resort. If you see Chinese foreign policy, they really avoid getting into confrontations. If you look at what’s happening in the Middle East or Syria, a lot of countries are getting into this conflict but the Chinese are not. They don’t see immediate threat or danger to their interest. In some ways I think they have very deep insight into current affairs.”
Located bang in the middle of the east-west trade corridor and owner of the only deep-sea ports in the region, Sri Lanka is strategically crucial to China. While much of the world kept its distance during the Cold War, Sri Lanka’s non-aligned status meant it has always enjoyed good relations with China. In the aftermath of its 30-year war, the relationship bore fruit, with former President Mahinda Rajapaksa sealing over US$4bn in infrastructure loans throughout his time in office.
Chinese-built roads and highways have made Sri Lanka easily navigable, a boon for tourism and trade, but they came at a price. Residents will tell you that the 16 miles of highway connecting the airport to Colombo is the most expensive stretch of road in the world, a claim that is unverified. It was built with a US$292mn loan from China Exim and while the rate of interest was undisclosed, local media estimate it to be around 8% – hugely expensive for an Exim facility.
The new government of Maithripala Sirisena has taken a more measured approach to Chinese relations. One of his flagship policies was the scrapping of the Colombo Port City project, a US$1.5bn initiative in the capital built on reclaimed land, which would be Chinese-built, financed and operated. For some, it was a matter of sovereignty.
Others bemoaned the environmental impact. Upon leaving the Board of Investment – passing a delegation of would-be Chinese investors on the way out – GTR paid the site a visit, only to find nothing but idle excavators and piles of rubble – an eyesore on the glitzy water.
Opponents of the project say it lacks transparency and reeks of corruption. Documents have gone missing, contracts are full of holes, and the people of Sri Lanka voted to put it to a halt, which in return earned the ire of the Chinese. A diplomatic storm has ensued, right about the time that China is preparing to exercise its chequebook overseas to enormous levels (at the time of writing, the country’s finance minister Ravi Karunanayake said he’d seen enough assurances and given clearance for the project to restart in February).
“A lot of the things the earlier government did weren’t considered transparent in what investors would consider,” one export official, speaking on the condition of anonymity tells GTR. “There were special provisions to welcome certain large investors. A lot of Chinese companies came, but China will come anyway. Because China has money.”
Talks are underway about a bilateral free trade agreement, but the feeling among many of those involved in Sri Lankan trade is that the government shouldn’t put its eggs in one basket and needs to work to develop relationships with neighbouring India in order to balance the influence of China. For others the situation is clear: roads are expensive, but Sri Lanka needs them. It’s the accepted dichotomy of international commerce.
“Frankly, my personal view is I don’t think so,” Rohan Pethiyagoda, the chair of the Ceylon Tea Board and a renowned academic tells GTR when asked if there’s a wave of anti-China sentiment in Sri Lanka.
“I know it gets mentioned that the Chinese workers come here, but I haven’t seen a protest saying they’re taking our jobs. I think the investment is largely appreciated, even by people who don’t like China politically. They appreciate the fact that you can get from Colombo to Galle in an hour and 15 minutes. It used to take three hours. Chinese investment is making a difference, because eventually the investment is in Sri Lanka: these are services for us.”