EU grants GSP Plus; now Sri Lanka must unlock the gains

Duty-free access is beneficial, but not enough to grow exports to Europe

GSP Plus duty-free concessions will benefit Sri Lankan exports to Europe, but the immediate impact will be limited—only large clothing exporters are likely to gain—and growth will be subdued because manufacturers aren’t ready to meet rising demand and comply with stringent EU quality standards and safety rules.

Clothing, coconut oil, fish, fruits and vegetables are some of the exports to Europe likely to make immediate gains from GSP Plus with EU import duties down to zero from an earlier 9-18%. In 2016, Sri Lankan exports to the EU amounted $3.3 billion (31% of total exports).

The immediate impact of duty-free access to Europe will likely be a 15% increase in exports to $3.8 billion, or a $480 million gain, according to the Institute of Policy Studies (IPS), an economic policy think tank. But, this is not a transformational impact, with export earnings as a share of GDP declining for over a decade.

According to IPS, clothing exports dominated by a few family controlled firms will account for 90% of the $480 million immediate gain. Clothing accounts for 60% of Sri Lanka’s total exports to Europe and is the highest earner at $1.9 billion in 2016. The second-highest export to Europe is rubber tyres, at only $0.2 billion, a tenth of clothing exports. This highlights the dominance and success of the clothing industry. Apart from clothing, the rest will collectively gain just $55 million immediately from GSP Plus, according to IPS.

Most exporters are not in a position to reap the benefits of GSP Plus. “Duty-free concession is just one aspect of growing exports. We haven’t ticked the other boxes for export growth, like capacity and quality,” says Indira Malwatte, chairperson of the Export Development Board. Duty-free access will not guarantee new orders or better prices. Any immediate gains will depend on exporters’ ability to negotiate better terms, she says. Large clothing exporters are better placed than anyone else to negotiate better terms, but it will be tough because the clothing industry is margins-driven.

The challenge for the rest is twofold: Firms already exporting to Europe are not prepared to meet the additional demand, and those firms aspiring to enter European markets to benefit from zero duty will have to deal with costly compliance.

Processed and fresh food exports to Europe have grown 15% each year during 2010-16 (to $87 million). That’s five times faster than apparel. Demand is growing even without GSP Plus. “Europeans will buy all the fresh fruit like pineapples that we can sell them. But, we can’t grow enough. There’s not enough land,” says Dawn Austin, managing director of Nidro Supply, a exporter, speaking at a seminar on ‘Gearing to Fully Leverage the Benefits of GSP Plus’ organised by KPMG, an audit firm, and the Chartered Management Institute.

Large firms, like listed Hayleys, are buying land in Bangladesh and Myanmar to grow fruits and vegetables for processing here. Small and medium- sized firms don’t have the money to do this. For exporters aspiring to enter European markets, the certification process is long and expensive. So is compliance. Exporters need to maintain records of their produce at every stage of production, from soil preparation to final delivery. Minute details need recording, like who picked what fruit from which patch and when. The Export Development Board has promised to part-finance the certification for small and medium-sized businesses.

Virgin coconut oil is another booming export to Europe, growing 138% annually over 2010-16 (to $33 million) even without GSP Plus. “Demand for virgin coconut oil is growing,” Malwatte says. However, coconut production here is inadequate. The government wants to allow coconut imports to be processed here for export. This will present opportunities for new entrants, but quality is critical. “The Japanese loved our virgin coconut oil, but they suddenly stopped buying,” Malwatte says. “Why? Because unscrupulous exporters were selling them white coconut oil!” Virgin coconut oil is golden.

Fish exporters are the biggest beneficiaries of GSP Plus. Earlier, fish exports were subject to 18.5% duty at European ports. The duty is now down to zero. “The sad news is, there’s no fish,” says Channa Weerathunga, general manager at Global Fisheries. Over-fishing in Sri Lankan waters has taken a toll on fish stocks.

“Duty-free concession is just one aspect of growing exports. We haven’t ticked the other boxes for export growth, like capacity and quality”
– Indira Malwatte

Fish farms account for more than 50% of the global commercial stock, Weerathunga says. “In Sri Lanka, it’s less than 0.1%,” he says. A public-private project for a 3,000-acre fish farm in Mannar, on the west coast of Sri Lanka, is on the drawing board. “The government wants fish exports to grow five-fold to $1.5 billion over the next few years. To do this, we will need at least 10 fish farms like this. But, finding land is an issue,” Weerathunga says. Tourism and conservation needs already compete for limited coastal land.

The fish export business is a good example of what can go wrong with GSP Plus. Fish exports to Europe grew 24% annually to $115 million over 2005-10 when Sri Lanka first enjoyed GSP Plus status. Exports fell to $85 million by 2012 when Sri Lanka lost GSP Plus, but recovered quickly. However, since then, exports gradually declined to $36 million by 2016 because of an EU ban on Sri Lankan fish exports. This was due to illegal fishing methods like bottom trawling, mostly by foreign vessels, in Sri Lankan waters. The EU lifted the ban in 2016 after Sri Lanka changed its maritime laws to deal with illegal fishing and depleting stocks.

“When we first enjoyed GSP Plus, we didn’t think much about EU requirements and conditions around fishing. We let foreign vessels poach unhindered. Had we taken action back then, we could have sustained exports even after we lost GSP Plus,” Weerathunga says.

Time is running out…
Sri Lanka is not the only country enjoying duty-free access to Europe. Eight other countries (Armenia, Bolivia, Cape Verde, Kyrgyzstan, Mongolia, Pakistan, Paraguay, the Philippines) enjoy GSP Plus duty-free concessions for over 6,000 goods. Forty nine other countries enjoy duty-free access for everything except arms, under a separate scheme for poor countries.

Sri Lankan exports clearly have to deliver a distinct value proposition to compete in Europe, but there is not enough time.

Sri Lanka’s GDP per head at $3,800 in 2016 could reach $4,100 by 2018 if annual economic growth is around 5%. This will place Sri Lanka among the upper-middle income category of countries. The EU withdraws GSP Plus three years after a country reaches this stage. So, Sri Lanka may lose GSP Plus around 2021, according to the Joint Apparel Association Forum (JAAF), the clothing exporters body. The Export Development Board estimates that GSP Plus could be withdrawn in 2024. “Either way, we have a lot of work to do, and we don’t have a lot of time,” Malwatte says. “Forget GSP Plus. Improving competitiveness is the best way forward. If we can do that, exports will grow with or without trade concessions,” she says.

The EU withdraws GSP Plus three years after a country reaches upper-middle income status. So, Sri Lanka may lose GSP Plus around 2021, according to JAAF

Sri Lanka first enjoyed GSP Plus concessions in 2005-10 before the European Commission withdrew it, dissatisfied with the human rights record here. During this period, clothing exports to Europe grew 11% annually, slowing to 3% over 2010-16. Had it maintained the faster growth rate, apparel exports to the EU would have amounted to $4.1 billion in 2016, and not $1.9 billion that it actually made that year.

Large clothing exporters like Brandix, Hirdaramani and MAS have moved on. They invested in Bangladesh, India, Vietnam and Africa for scale, cheap labour and proximity to raw materials. In Sri Lanka, they invested in talent, innovation, research and development. Sri Lanka remains the innovation hub for these firms who specialise in sophisticated clothing mostly for mid-to-highend consumers in Europe and the US. The reinstatement of GSP Plus promises exciting times ahead. According to JAAF, the clothing industry will have to invest up to $1 billion to expand capacity to meet new demand arising from GSP Plus.

“Exporters have a lot to learn from the apparel sector,” Malwatte says. However, small and medium-sized clothing makers worry that they’ll miss an opportunity. Clothing stitched from Chinese fabrics don’t get duty concessions under GSP Plus. “This our biggest challenge. Since we lost GSP Plus in 2010, the fabric import base moved to the far East,” says Yohan Lawrence, deputy chairman of JAAF. The cost dynamics of importing fabrics from South Asia, which the EU allows, is not compelling. Also, investors are not likely to invest in a fabric mill here, given that Sri Lanka will no longer be eligible for GSP Plus in a few years, Lawrence says.

For most exporters, GSP Plus is more a lifeline rather than an opportunity to grow. “It’s all about survival,” says Ranmal Jayasinghe, president of the National Chamber of Exporters. He concedes that the duty-free concession is only one aspect of many that need to fall into place for sustainable exports growth. “Capacity, sourcing raw materials, branding, marketing, research and development are challenges we continued to grapple with,” he says.