A Year of GSP+
Local and international media, lawmakers and industry leaders may be keeping their ears to the ground to determine how GSP+ will be aff ected by President Maithripala Sirisena’s lifting of a moratorium on the death penalty. Following a similar decision taken in Pakistan, the EU has made a reversal of such a policy a condition for Pakistan remaining in GSP+.
It may be a case of out of sight, out of mind; in the frenzy of speculation over Sri Lanka losing GSP+, the discussion has moved away from the fact that Sri Lanka completed 12 full months of participating in the trade programme in May 2018.
Sri Lanka was readmitted as a beneficiary of GSP+ in mid-May 2017, after the government made commitments to the EU that it would improve human rights conditions in the country. Having enjoyed the trade benefi ts for 5 years, Sri Lanka lost GSP+ in 2010 after the EU became concerned over allegations of human rights abuses during the country’s 25-year civil war which ended in 2009. According to the EU, Sri Lankan exports have an annual upside of $350 million through GSP+.
The apparel industry has been the biggest beneficiary of the trade facility since Sri Lanka’s readmission to GSP+, as it accounts for 60% of the country’s $3 billion exports to the EU. The Sri Lanka Apparel Exporters Association has set a $500 million target in increased exports to the EU to be achieved before Sri Lanka becomes ineligible for the concessions in 2023 by transitioning to an upper-middle income economy. With an increase in apparel exports to the EU by 8.2%, the apparel industry has already moved $170 million closer to its target in the 1st year which ended in May 2018. But for how long could this momentum be continued? A number of trends have developed since Sri Lanka regained GSP+, which may provide insights to answer that question.
1/ NEW CLIENTS, NEW MARKETS
The biggest markets in the EU for Sri Lankan apparel historically have been the UK, Germany, Italy and Belgium-Luxembourg.
Most of the EU markets, other than the UK, have been experiencing strong retail activity, according to the Consumer Confidence Index of the Organization for Economic Cooperation and Development.
“The UK is struggling because of Brexit,” said Arshad Sattar, managing director of Timex Garments (Pvt) Ltd.
The poor performance of the UK market is critical for Sri Lanka, as Britain has absorbed over 40% of Sri Lankan apparel exports to the EU in recent decades. Central Bank data also shows that the UK purchased less apparel products from Sri Lanka in 2017 compared to 2016, when the British voted to move out of the EU. With one of the biggest European markets in flux, local manufacturers are turning towards other countries in the EU which have traditionally not been strong buyers of Sri Lankan apparel.
“There is a lot of potential in smaller markets,” said Felix Fernando, chairman of the Sri Lanka Apparel Exporters Association.
Readmission to GSP+ is making Sri Lanka more attractive to countries that had never done business with Sri Lanka before. Sattar said that he has acquired a major buyer from Denmark, along with clients from other markets.
“We have signed high-end customers who have never worked in Sri Lanka. Some have worked here and have done business in a small way. Things have changed because of GSP+. It is a new avenue for us to grow,” he noted.
According to Sattar, the idea of GSP+ is marketable, especially among high-end buyers, as clients would save 12% on their imports. As highend apparel would have an average Free on Board (FOB) price of around $20 per product, a 12% saving is significant when compared to cheaper garments. Fernando said that the Export Development Board (EDB) has recognized the untapped markets that have opened up for Sri Lanka under GSP+.
“The EDB, to develop the markets, is trying to get into the Netherlands, Austria, Sweden and other countries,” he said, pleased with the work done by the state-run agency.
2/ A FLIGHT FROM HIGH COST PRODUCERS
These new clients are leaving other high-end, high-cost manufacturing destinations, as Sri Lanka has a reputation as a quality apparel producer, despite not having the lowest production costs.
“Customers that did business in Turkey, China and Vietnam, we’re now taking that share. That’s fantastic,” Sattar said. But some of these new orders may take time to generate revenue, according to him. He opines that this will be reflected in the exports for 2019, as the new clients are in the first stage of business, doing activities such as new style orders. But GSP+ cannot take the credit alone for business coming to Sri Lanka from China, according to Fernando, as the Trump effect has come into play, with the US-China trade spat sending jitters among foreign buyers to switch to alternative manufacturing destinations.
3/ CAPACITIES FULL
Sri Lanka is now in the limelight for European buyers. However, the country is unable to fully capitalize on the opportunities as GSP+ has brought all idling production lines into operation.
Fernando believes that many apparel manufacturers in Sri Lanka have had to decline a lot of new business as they do not have the capacities to produce orders for new clients; the existing clientele has fully taken up production capacities.
Even when the EDB is attempting to organise delegations of apparel exporters to markets it wants to develop, participation is poor as manufacturers aren’t able to promise production capacity, Fernando said.
Many apparel buyers looking to leave China have also been turned back by Sri Lanka, he noted.
“Orders moving out of China are not for thousands of pieces. They are for hundreds of thousands. We don’t have the capacity. That means lost exports. Most of these volumes have gone to Vietnam, Bangladesh and Cambodia,” Fernando explained.
According to both Sattar and Fernando, two reasons are holding back investment in the industry despite ample opportunity. First, as another election year approaches, the industry is looking towards political stability. Second, they also await the government’s view on labour market liberalisation, as there are no local workers to man new factories.
Fernando believes that while the biggest producers have fully invested in technology, most smaller players could still invest to automate around 15% of their processes to increase productivity and sign more orders
4/ FOB MARGINS TO FALL?
As competition increases not only among apparel producing countries, but also among retailers in Europe, Fernando believes that FOB prices of Sri Lankan producers will come under pressure.
“Although capacities are full and volumes are high, it looks like there will be some correction in the FOB prices,” he said.
This adjustment is likely to take place during the current summer sale season in Europe, according to Fernando, as the narrative continues to be spun around the tug of war between online retailers and traditional brands trying to capture the attention of strong European consumers. Many online retailers are emphasizing on the comfort of everyday wear and affordable luxuries over expensive high-end choices. Fernando believes that traditional luxury brands retailing through physical stores will continue to lose out. Sattar on the other hand opined that these high-end names will fight back as they too go online and close down enough stores to right-size their operations.
“Online has taken up some parts of the market share. But it’s not online that has reduced profits of high-end brands. It’s excess stores. They can’t continue to open a store at every mall. Of 1,000 stores, only a few will have good sales, so they have to right-size their stores,” he said. Local producers would have to keep their fingers crossed on a recovery for the high-end brands, as the cost structure of Sri Lanka is more suited for value-added products over mass consumption brands.
5/ EURO EFFECT
But a fillip to the exports will come from the cross currency trades between the US Dollar and the Euro. Fernando said that the euro, which had continuously gained against the dollar in 2017, had decreased the dollar revenue of Sri Lankan apparel exporters, who had to convert their earned euros.
“If the dollar/euro rate had remained on par, it would have helped our exports by another 3-4%,” he said.
The Euro/US Dollar rate which peaked out at 1.25 in February 2018 has since fallen gradually to 1.17, helping out Sri Lanka’s export record.
Different dynamics may have affected Sri Lanka’s apparel exports to the EU since the resumption of GSP+. However, it is clear that the trade facility has helped the industry emerge from stagnation. Delays in regaining GSP+ even led to the industry revising its export targets downwards.
“With GSP+, Sri Lanka has been highlighted, and it has brought in a new life to the industry,” Sattar said.
Fernando agreed, saying that apparel exports may have headed into negative growth in 2017 without GSP+. Looking to the future, Sattar said that Timex could manage to sustain a 10% growth until 2023 as the company switches to even shorter run production and higher end products.
Fernando, however, has a slightly different view for the industry.
“I don’t think it will be possible to maintain 10% growth year-on-year for 5 years, but this year, if we get to around 12.5-13% growth, then we will be able to hit our target,” he said.
Fernando believes that future growth would be lower unless there is more investment into capacity. If so, growth would only come through higher FOB prices stemming from value addition and moving up the value chain.