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14th February 1999
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Produce more or we perish

Lal de Mel, Managing Director and General Manager of CIC Paints Ltd last month took over as president of the powerful Federation of Chambers of Commerce and Industry (FCCI). He replaces Patrick Amarasinghe, who had a long stint as president before deciding to go into active politics.
In an interview with The Sunday Times Business, Mr de Mel explains plans for the future of the federation and also talks on a range of issues that confront Sri Lankan industry. He says that he is not opposed to the recent free trade deal with India but points out that Sri Lanka must be competitive. "Productivity must improve and we need to allow the mobility of labour, if we are to stay competitive in a global environment," he said.
By Feizal Samath
Your thoughts on productivity: The focus on productivity in Sri Lanka is poor. Productivity measurements are inadequate. When the Minister of Industrial Development C.V. Gooneratne met the Imageprofessional associations, we made a request that productivity measures should be given high priority in the Central Bank report.

What do you mean by productivity measurements?

Productivity is a measurement of output versus input. In a developed country, they are able to say at what level productivity has improved in a particular manufacturing or service segment and by what percentage has salaries increased. It indicates whether that segment is becoming more competitive or not. If salaries go up faster than productivity, we become less competitive.

Productivity measurement has become important today because economically, all this while we were an island. If we did badly, our industries became less competitive, but to a great extent we were cushioned by tariff barriers. But with the signing of the India-Sri Lanka Free Trade agreement we have ceased to be an island. We have become, economically, a part of the Indian sub-continent. Now the race has begun. In five to eight years time the competition between these two countries in the economic battlefield will increase and at that time, we have to be competitive.

Wouldn't we face the same problem when SAFTA comes into being?

You may call this the beginning of the SAFTA process. I am not against this agreement because all over the world, every country is becoming part of a free trade area. We have followed the general international trend in becoming part of a free trade area, which the economists say is essential for survival.

At the same time, productivity and being competitive assume much greater importance. In many ways we have to follow the strategies of Singapore and Hong Kong. They are small countries. They have been competitive and they have prospered. If we want to meet the competition from India as well as the South Asian region, then we need to follow similar strategies as much as possible and turn the game of comparative advantage to our advantage.

Our disadvantage is that we don't have the economies of scale which the Indian manufacturers as well as agricultural producers enjoy. So we have to find other ways of competing. In Singapore, low tax has been used as a weapon to meet the competition. We have also taken the first step in that direction with taxation on agricultural activities being removed from the tax net in the last budget. That is a very good move. If we want our industries to provide employment, we need to adapt a similar strategy for industry. 

With poor infrastructure, particularly bad roads, the cost of production outside the Western Province is very high. All industries located outside the Western Province should be allowed to operate on a tax free basis. The industries in the Western Province should have a reduced rate of tax of 15 percent, which has already been given to the construction sector, to meet the competition from foreign contractors.

If this happens, we will get the taxation part right. But the basic problem of bad roads, which cannot handle container traffic must be rectified. It means investing in providing roads where container vehicles and trucks can move on one track, while faster moving vehicles can go on a different track. Without that you can't overtake a container truck. Overtaking a container vehicle is a major hazard nowadays since there are no special lanes. 

Income to invest in roads can come from privatisation. With the privatisation of plantations and Airlanka, government gets income tax on the profits of these organisations. Income flows can improve considerably, if privatisation process is expedited.

The second area to increase tax revenue is imports. Statistics are not yet available, but with the introduction of the Goods and Services Tax (GST), taxation on imports has come down. Earlier there was an equitable collection of taxes at one point - the port, since it is difficult to collect taxes from a large number of small importers once the goods leave the port. With the introduction of GST, this was removed. There is no longer a level playing field because the big importers and the local manufacturers have to pay GST on their wholesale prices while the smaller importers often escape. Earlier, everyone paid tax not only on the CIF value but also on an estimated value-addition. This could be corrected by imposing a national value addition payment in the port and allowing the importers to claim a refund later, if they find they have paid too much - thus tightening tax net. 

Is GST a practical form of taxation? 

Yes it is, but it should be modified to suit our conditions. And the example I gave earlier is one area where a modification is desirable. It is like income taxes in many countries - pay up-front and then apply for a refund.

Mobility of labour:

With imports coming in via the India-Sri Lanka free trade deal, certain industries will face a drop in demand and may have to close down. Traditionally the Indian community has been very strong in the import sector. When you have a situation where some items come practically duty free and other items at 30 percent duty, a trader can easily reduce the price of the high duty item and increase the price of the low duty item to minimise the customs duty payment. As a result competition for local manufacturers will increase further. 

With this type of manipulation and under invoicing, the 30 percent duty barrier will not necessarily reflect the real situation. With demand falling, local industries would need to shed excess labour - after paying proper redundancy payments. If they are unable to do this, they become loss-making units and finally end up in closure. In many ways it is better to shed excess labour and keep the other workers, than keep excess staff in the pay roll and make the unit uneconomical. 

If we had a straight for- ward regulation to shed the excess labour, we would have a viable textile industry. When the demand for textiles fell, the industry was unable to reduce its wage bill. Mobility of labour works well in the USA where the movement of labour is very high and unemployment levels are the lowest in the world. In Europe, the mobility of labour is lower and unemployment is high. We need to be very competitive with India, as well as the rest of the world. 

Are there enough jobs around for a mobile labour scenario?

Oh yes If you look at the garment industry, industrialists would say their biggest problem is workers moving from one factory to another, for higher pay. This is one area where the mobility of labour is extremely high. 

But aren't textile industries also facing a kind of a crisis with a gradual end to quota items? 

I don't think so, because today's concept is cluster industries, in which downward integration takes place, optimising economies of scale. Sri Lanka's garment industry is world class and I don't believe we will be affected, because we are competitive in this area.

What other positions have you held in industrial and trade chambers? 

I have been the president of the Institute of Marketing and, often when I speak, I speak from a marketing perspective. I was also the president of the Sri Lanka branch of the International Advertising Association and before that the Chairman of the Ceylon National Chamber of industries. In the past I have made several representations to the government on the problems facing industry. 

The Federation of Chambers of Commerce and Industry has a membership covering all sectors of industry, with a predominance in the small and medium scale industry.

Whose interests do you represent here?

I was sponsored by the Ceylon National Chamber of Industries and the Institute of Marketing, but now I need to focus on the interests of all members of FCCISL. I am interested in looking at the possibility of getting the main Chambers, the Chamber of Commerce and the National Chamber of Commerce back into the fold, and having one umbrella organisation.

On the role of the business community in the peace effort?

I am a member of this group and we are proceeding slowly with the government and the opposition in trying to narrow the gap. The leaders have agreed that they will not leak any information and restrict news to the official communiqués. 

What would your focus be at the federation?

What I would like to do is to look at the needs of the members and focus on those issues. 

Another area I would like to focus on is the ageing of Sri Lanka's population and the lack of super annuation benefits for private sector employees. The pension scheme is only for the public sector. 

Private sector employees are left "high and dry" after retirement. 

Provident fund contributions are taxed. In USA and England, every one has the right to invest a certain amount of money in a designated retirement fund so that people can save for their retirement without such savings being taxed. On retirement, they can transfer these savings into a pension fund without any taxation. 

The present retirement benefit structure for private sector employees is very poor. We can use the Mexican model where every employee has become an entrepreneur, and invests the provident fund payment in nominated mutual funds. Investors can switch from one fund to another, depending on which is doing better. Large amounts of savings are raised and harnessed in to these mutual funds. 

Our provident funds do not bring adequate returns and often the return is negative. Employees should have the freedom to invest in the existing provident funds or any other approved fund, which generates a greater return.

Seylan Merchant debentures have posed new issues 

By Mel Gunasekera
Seylan Merchant Bank's private issue of Rs. 250 mn unquoted debentures has raised eyebrows in banking circles. Although a perfectly legal private issue, the bank is accepting public funds, analysts pointed out. 

Their main concern was whether the investors were adequately aware of the risks of buying unsecured, unsubordinated debentures. 

The issue opened in October 1998 and was to close in December 1998, but was extended until March due to lack of subscrption. 

The issue comes with an option of a second issue of Rs. 250 million in the event of an oversubscription.

At present, Seylan Merchant is on an aggressive marketing campaign to promote their four-year debenture through their offices in Colombo, Kurunegala, Kandy, Matara and Negombo. 

Higher interest rates are offered for larger subscriptions. Fixed rates range from 14.25 per cent monthly for a minimum Rs. 10,000 subscription to 16 per cent per annum for a minimum subscription of Rs. I million. All debentures are with a one year put option. The issue was open last October and is to be closed by March 31st 1999.

Though Seylan Merchant Bank is listed the issued prospectus clearly states in all three languages that the debenture is not listed. 

Last year, Seylan Merchant's major shareholder Seylan Bank issued a Rs. 600 mn quoted debenture. There could be a misconception in the minds of certain people, especially in the outstation areas, that since Seylan Merchant is listed company, the present debenture is also quoted, banking analysts said. 

While Seylan Merchant has acted within the legal framework, there is concern that other merchant banks and financial service companies would follow suit, especially to tap the large deposit base in the rural areas.

Unlike a quoted issue, the regulatory authorities do not whet the prospectus. Hence, there is some concern since most prospective retail investors are not vigilant to look out for such details, but are only interested in the bottom line of earning an interest rate ranging from 14 per cent to 16 per cent, banking sources said.

The prospectus states the money would be used to raise long term funds to expand long-term credit and leasing facilities extended by Seylan Merchant Bank to its customers.

"At a time when our corporate debts are not rated and most corporates are trying to raise long term funds, its time the authorities began to regulate merchant banks," a debt market specialist said.

Another debt specialist said that the Central Bank must take serious steps to regulate merchant banking operations. In other countries when merchant banks issue liquidated debt instruments it is treated as taking public deposits.

"Seylan Merchant's move could be a trendsetter for other merchant banking operations. With little or no regulatory hassle at the moment, the authorities should introduce some form of regulation as such crisis can boomerang on other merchant banks," he said.

Another merchant banker said they would welcome some sort of formal regulation. "I can't see anything illegal in the matter, though it's of great concern to the industry," he said.

Seylan Merchant Bank's General Manager, Rohan Senanayake says the bank is well within the law. The Bank had earlier tested the waters last August with a Rs. 50 mn unquoted debenture issue. The issue was oversubscribed within 19 days and our own customers and shareholders subscribed to it, he said.

He said the bank was being regulated through the Central Bank, as the Central Bank has the right to supervise Seylan Merchant Bank's operations through Seylan Bank's involvement.

"We are confident that our present issue would be subscribed by end of March," he said.

While the merchant banks are not regulated by the Central Bank or any other authority, The Sunday Times Business learns that an authority could only issue a directive if there is evidence that retail investors are believed to have been misled that they were subscribing to a listed debenture issued by a listed company.

Banking analyst also recommend that in order to protect future retail investors, especially those in the outstations, the regulatory authorities could bring in a rule to prevent listed companies from issuing unquoted debt. The Companies Act would also have to be amended with regards to debenture issues, they said.

International bond market review

Emerging market debt as a major asset class does not have a long history. Large inflows of portfolio capital into these markets only began in earnest in the early 1990s. In addition, the market is small relative to equities, with total bonds outstanding at the end of 1997 amounting to US$ 800bn., around one-third of the capitalisation of the emerging equity markets covered by the IFC (US$ 2,070bn.). 

Given the enormous dislocation that has hit emerging market debt, particularly since mid-1998, this lack of history and liquidity is a disadvantage and will keep the non-dedicated investor cautious in 1999. But there still appears to be scope for price appreciation next year.

The yield on emerging market bonds is built up of two components; the interest rate, effectively risk-free, on equivalent US treasuries and the spread over this yield which reflects the sovereign default risk in each individual emerging market.

The spread over US treasuries dropped sharply between mid 1995 and late 1997 to a recent low of 300-400 basis points (3-4% percentage points). From late 1997 until early September 1998, the spread soared to a peak of almost 1800 basis points in the wake of Russia's devaluation and moratorium on debt payments.

Spreads have come in since then to around 1200 basis points, but still provide an attractive total yield of around 17% p.a.

The 1994-95 Tequila crisis and 1997-98 Asia crisis have inevitably taken their toll on emerging market bonds. Returns since the early 1990s, given the relatively high risk and volatility attached to this asset class, have been disappointing.

Since end 1993, the return from emerging market bonds, as measured by the JP Morgan EMBI + index, has been virtually the same as that from US Treasuries, at just under 8% p.a., and slightly under the return on US high yield credits; US corporate bonds with sub-investment grade ratings.

But in periods of crisis, sovereign bonds are the best place for the emerging market investor to be, as returns have been significantly better than those from emerging markets equities which, as measured by the IFC's composite index are down 10% p.a. since end 1993.

Spread Performance

Spreads on emerging market sovereign debt, over equivalent US Treasury yields, have risen sharply since end 1996. The performance of spreads reflects two factors; changes in international liquidity and perceived market risk, and changes in more fundamental country credit risk, specifically the probability that a country defaults on its foreign payment obligations or reschedules these obligations.

The 1998 bear market reflects a deterioration on both counts due to the Asia crisis. This made investors more risk averse and, in the third quarter of 1998 following Russia's August rouble devaluation, led to a severe deleveraging out of emerging market bonds.

But in bear markets, the rise in yields (fall in prices) tends to be too generalised and indiscriminate, and moves out of line with relative, more fundamental, country credit risk.


Emerging market bonds, especially in Asia, have rallied since their September lows on four factors. Firstly, US interest rate cuts and the stronger yen have boosted local currencies and reduced the threat of hedge-fund attacks. 

This has allowed lower interest rates, improving the prospect of Asia's recessions bottoming in 1999.

Secondly, Brazil has made a start on fiscal reform and the IMF has secured the funding to help Brazil and other countries adjust to potentially low 1999 capital inflows Thirdly, the market has effectively ring-fenced the default problems in Russia and should continue to make progress even if the worst is assumed about Russia's 1999 outlook.

Fourthly, liquidity is much improved, especially in Asia, as external trade has moved into substantial surplus, progress on structural reform has continued, boosting direct investment and portfolio capital inflows, and foreign reserves have risen. Nevertheless, spreads remain significantly higher than at end 1996 levels.

Sovereign credit ratings

Credit ratings in Asia have been marked down sharply since mid-1997, with the largest number of downgrades in Korea and Indonesia where volatile local politics delayed the implementation of appropriate adjustments to the regional currency crisis. 

Recent improvements have not yet been reflected in better sovereign risk ratings. But investors, rightly in our view, have been buying bonds on the expectation that ratings upgrades will come through in the first half of 1999, especially for Asia's best reformer, South Korea.

Ratings in Latin America are generally lower, reflecting the historical legacy of heavier external debt burdens. The changes since 1996 have been smaller and generally upgrades reflecting continued progress on structural reform and disciplined macro-economic stabilisation policies which have brought down inflation.

The reform effort is far from complete, and the retrenchment of the emerging bonds market will make continued adjustment more difficult, but current Latin ratings appear to adequately capture the 1999 risks.

Few ratings changes look likely next year, but in the region's major economies upgrades look more likely than downgrades. 

Country risk

How vulnerable in 1999 are other emerging markets to the payment problems being encountered now in Russia and Pakistan? One way of assessing the probability of default is to look at three types of risk; event risk, solvency risk, and liquidity risk. 

All emerging markets are subject to high event risks, but this vulnerability is only likely to lead to imminent payment problems if the shock coincides with poor liquidity, as in Russia and Pakistan in 1998. An event shock and poor solvency alone are probably not sufficient to trigger payment problems.

Event Risk: This is the vulnerability to an external, or domestic, political and policy shock which has the potential to significantly change economic performance. The shock in Pakistan was the imposition of sanctions after May's nuclear tests. In Asia in 1997 and Russia now, the vulnerabilities are local politics which prevent the implementation of appropriate economic policies.

Liquidity Risk: Liquidity refers to a country's cash-flow position, the amount of foreign reserves available to cover any shortfall in export receipts or capital inflow. Improved policy has helped lift foreign reserves in Latin America, but overvalued exchange rates and the long run dependence on debt capital means that financing gaps, and short-term debt remain very large. 

Therefore, liquidity is tight in most countries apart from Venezuela. Economic slowdowns will narrow financing gaps in 1999, but foreign reserves will still typically cover only 40-50% of the amount that has to be raised on international markets. Reserves will also, typically, stay below short-term debt levels, signaling a vulnerability if confidence falters and foreign banks start calling in rather than rolling over credit lines. 

Nevertheless, both these ratios are significantly better than the 1998 values in Russia and Pakistan. Liquidity in Asia has improved sharply in 1998 as large current account surpluses emerged. These surpluses will decline in 1999, but capital inflows should pick up as recessions bottom and reform continues. Liquidity, therefore, should stay satisfactory.

Solvency Risk: Solvency refers to the burden of debt on the economy as a whole. Both foreign and domestic debt burdens are generally higher in Latin America than in Asia. In Asia, budget deficits are deteriorating sharply as banking systems are recapitalised, social safety nets created, and public spending is lifted to put a floor under the 1997-98 recessions. But the deterioration is recent and will add to a relatively light existing debt stock.

Vulnerable countries: The 1998 combination of event, solvency and liquidity risks in Russia and Pakistan probably will not be repeated in 1999. None of the other countries covered look to have the same degree of vulnerability.

Solvency is as bad in Latin America as in Pakistan, but liquidity, although uncomfortably tight, is still significantly better. On liquidity alone the most vulnerable are South Africa, Indonesia and the big three Latinos: Argentina, Brazil and Mexico. 

Both solvency and liquidity are significantly better in the Asian countries covered. 

The outlook

The emerging market bond rally which started in September looks sustainable and the asset class should deliver above average returns for most of 1999. Returns should be significantly better than 1998, but a return to the very strong performance of 1996-97 looks unlikely. 

Still weak commodity prices, and slower growth in the US and Europe, will hold back many emerging markets, whilst the move down to sub-investment grade for several countries will limit the potential investor pool.

Asia should outperform: By region, sovereign bonds in Asia look more attractive than Latin American bonds. Next year will be difficult for Asia, and recovery will be very gradual, but the probability of default is low and current spreads look to provide more than adequate compensation for this risk.

Banking and corporate sector reforms should stay on track, and recessions will probably bottom by mid-1999. This will lift capital inflows, help offset the inevitable unwinding of current account surpluses as imports pick up, and keep liquidity, at the very least, adequate.

There are also few worries on the solvency side, where existing debt burdens are relatively low and so the substantial issuance likely over the next 12 months should not significantly undermine creditworthiness. 

The new issuance could cause some absorption problems. But primary issues are likely to be priced at a premium to the secondary market and, if a prolonged sell-off is threatened, countries probably have enough liquidity to be able to wait until market conditions improve.

In addition, the increased pool of better rated Asia sovereign credits could also raise the relative attractiveness of this region compared to the generally lower rated Latin American countries.

By country, we prefer the sovereign bonds of Korea, Thailand and the Philippines. Policies in all three are likely to stay sound and external positions comfortable, whilst low inflation points to further interest rate cuts. We are more nervous about China where spreads look too low a compensation for what will be a very difficult 1999.

Liquidity is very strong. but growth next year is likely to slow further, devaluation is still probable, and markets appear too relaxed about the acute systemic problems in China's financial sector.

Tougher for Latin America: Solvency and liquidity indicators in Latin America are weaker than in Asia and the 1999 outlook is more bearish, increasing the risk of a political or policy shock. Latin bonds are therefore likely to underperform Asia and will probably be more volatile. 

But most of this outlook has probably been factored into current credit ratings, and current spreads on major sovereign credits still look to be overstating the risk of default. As a result, there is scope for further modest gains.

Latin America in 1999 will be pulled down by continued commodity price weakness, and the slower US economy, which will keep up the pressure on external deficits, currencies and local interest rates. In addition, likely economic slowdowns, and recession in Brazil will make it more difficult to keep fiscal deficits under control.

The most likely outlook is that Brazil avoids a large destablising devaluation in 1999. But the government faces more battles with Congress over reform and Brazil credits at current levels do not look particularly attractive on the risk/reward trade-off.

Argentina and Mexico, where policies are sound and fundamentals stronger, look more attractive. Both countries should be able to raise the foreign finance they need next year and, despite imminent elections (in 1999 in Argentina, 2000 in Mexico) political and policy risks look low.

Venezuelan bonds have rallied sharply on hopes that new President Hugo Chavez will use his strong political powerbase to push through structural reform. It is too early to judge. Liquidity is good and Venezuela's bonds have probably been oversold. But a sustained rally looks unlikely in 1999.

What could go wrong?

Aside from possible recession and deflation in major markets, there are two main regional risks;

1. Further country upsets: The countries to watch in 1999 are Brazil, China and possibly, South Africa. The risk that Brazil's fiscal-adjustment-alone strategy does not work is uncomfortably high and there could be a large market-induced devaluation. But the risk that this then leads to a Russia-type default looks very low. Compared to Russia, politics and economic policy in Brazil are far more supportive of sustained adjustment and respond better in a crisis. Nevertheless, a large devaluation in Brazil could well topple Argentina's dollar peg and send the rest of the region into recession. China's continued economic slowdown could cause severe financial sector and, possibly, political problems. South Africa's external accounts are very weak, Iiquidity low and political risks are rising.

2. Prolonged Asia recession: We could be underestimating the recessionary impact of the credit crunch and overcapacity. Recovery in Asia could come through much later than we expect. This would potentially increase political/social unrest, and reform fatigue, and hold back capital inflow.

Free Trade Agreement: Who benefits - Sri Lanka or India? 

The National Chamber of Exporters of Sri Lanka (NCE) as the primary representative of Sri Lankan Exporters has the legitimate right, bounden duty and responsibility to evaluate the pros and cons of the Free Trade Agreement between Sri Lanka and India, says a press release. The logical extension of the liability of the NCE is to apprise the exporting entrepreneurs on the concomitant impact of the bilateral agreement. We, the Chamber of Exporters do appreciate the benefits of "Free Trade" in the context of sustainable long term economic growth for our country. We do accept also that our trade partners expect an equitable benefit.Our contention is that the benefit through "Free Trade" should be acquired by competition on a level playing field in an environment of equitably comparable economic, legal and industrial policy.Regrettably, as a primary premise, NCE cannot reckon this, so called, bi-lateral agreement as a "Free Trade" agreement. The agreement suffers much by not having the salient ingredients for a sufficient agreement towards free trade, particularly in the context of the status of the trading environments in the two countries.

The agreement focuses on the elimination of "tariffs" (defined as the "basic customs duties in the national schedules of the countries to the agreement") with regard to the selected items. Since much emphasis is placed on "negative" and "positive" items for trading, the final outcome of this agreement will be dependent on the contribution of the items to the economies of the respective participants to the agreement.

NCE foresees many problems in the methodology to identify "positive" visa-vis "negative" items, since these items have not been classified before the agreement was signed. Free trading between the two countries will be necessarily constrained to that extent.

The second, yet salient requirement, to this agreement is the concept of "reciprocity". In the context of free trade, priority to reciprocity would not be meaningful unless matched and based on the trading strengths of either party. At the SMRC meeting held in Colombo in 1998, India initially agreed to lift import restrictions on more than 2000 products in favour of SMRC countries. 

This concession was made by India without a bargain on reciprocity from member countries. This offer is more in line with the principle of free trade. Yet, strangely and inexplicably according to our understanding, India has not implemented the pledge. 

Third, the concept of "Free Trade" must presuppose an in-depth understanding of the need to remove not only tariff barriers but also the reduction of non-tariff barriers. Sri Lankan exporters deem this obstacle of being confronted with tariff and non-tariff barriers as a major constraint in exports to India. Non-tariff barriers have been more an impediment than tariff barriers. 

It is of grave concern to observe that the removal of non-tariff barriers has not been considered in this agreement. "Free Trade" would be meaningless unless non -tariff barriers are brought in level with that of Sri Lanka.

Non-tariff barriers are, in effect, even in the U.S.A., Japan and a host of European nations, to safeguard critical and economically and socially sensitive psyche of the nation. However, these barriers do not obstruct free trading.

In the context of the Free Trade Agreement with India, the tariff barriers prevailing in India have shut the doors to the Indian market for products which have a market potential in India. Furthermore, non-tariff barriers vary from product to product and also from state government to state government, making trading a complex process.

In India, there are several taxes which range from taxes imposed on the movement of goods between states to auxiliary taxes other than customs duty viz., Special customs duty and central excise duty. In addition there are several state taxes for which the central government does not profess to have much control. These taxes are in addition to the 12% sales tax (VAZ, BTT).

In the sub-continent of India, the multifarious tax and customs duties structure; both particular to the various states and those general to the whole of the nation makes the "agreement" incongruent in the light of the economic, industrial and legal policy environments of the two countries. 

It is very necessary to have a clear and finite understanding on the bearing of taxes and duties to the trade agreement. Unfortunately our inquiries from the Sri Lankan authorities related to the signing of the agreement reveal an ungainly story - no proper study has been done in this regard.

It is quite evident that there exists an inequitable balance in the economic, industrial, legal and overall policy environments of the two countries. This imbalance quite obviously is tilted to favour India. The question then is: "Whither the concept of free trade"? 

Strengths and weaknesses
The complexity of the question must be addressed in terms of the strengths, weaknesses, opportunities and threats in the whole equation. There are significant differences in the policy environments of the two countries. 

In the Indian trade scenario the economic opportunities, industrial strengths, the absence of stringent labour laws governing particularly cottage industries give India distinct advantages in free trade under the agreement. 

India is a vast sub-continent having the required raw materials for most of the industries. On the contrary, Sri Lanka is not in a comparable position even with regard to the garment industry - its major export industry. In the Sri Lankan industrial sector save for rubber based and ceramic products almost all other industrial products are dependent on the import of even the basic raw materials. 

Therefore, meeting the value addition criteria as per the agreement would be difficult in respect of most products exported from Sri Lanka. Further, the question of at what stage of the production is value added, who will monitor the quantum of the added value? must be addressed and deserves careful examination. 

The scale of operation in so-called, small and medium sized Indian industries is large. As a case in point, the bicycle tyre industry rejects of 5% exceed the total production capacity of the Sri Lankan bicycle tyre industry!

In India, industries categorized as cottage industries enjoy a variety of financial benefits by way of subsidies, low bank interest rates and a guaranteed market i.e. exclusivity in supply to state organizations viz. hospitals, armed forces, police dept., schools, welfare organizations, etc. 

These cottage industries enjoy also the privilege to export their products. The irony of the situation is that these so-called cottage industries are comparable in scale and size to Sri Lankan medium and large sized industries. 

India has announced a five year (1997 - 2002) plan which represents a designed plan to remove existing regulatory policies to afford Indian industrialists scope to accelerate expansion of trade. 

In this context India has provided a variety of export promotion schemes viz. concessional duty rate for the import of capital goods for exports (EPCG). 

This EPCG scheme is designed to be extended to agricultural and allied sectors, incentives to improve the quality of export products and the promotion of the gem and jewellery trade.

An analysis of export promotion endeavours made by India in a multifaceted drive does render a competitive edge on Sri Lankan products for export to India in an awkwardly disadvantageous position.

Unlike in Sri Lanka, the labour regulation in India permit particularly the cottage level industries to thrive on the payment of low wages.

Under this agreement, Indian products produced at low costs and permitted entry duty free at low prices would certainly affect the competitiveness of the locally produced goods. Sri Lankan products with standards and targets aimed at QUALITY would lose out in this bargain. By the time the local consumer is able to discern between the Indian product vis-a-vis the locally produced item, the local industry would have suffered a serious set-back in curtailed production. If the local industry is constrained to close down owing to inequitable competition, re-starting would not be possible owing to financial constraints. Then whither our industry and economy?

Sri Lanka does not have stringent regulations to prevent "dumping". The entry of goods owing to, under invoicing, spurious brand names, etc,.. would spell further disaster to our industrialists striving and struggling to survive. Our struggling and national minded industrialists need protection against accusations and acrimony of not being able to face "foreign competition". We ask, is this agreement affording healthy competition or is it casting our industry and industrialists to the wolves?

The Indian bureaucracy being strong would view with reservation the import of products under the positive list and would scrutinize and question the qualification of 35% value addition. The Indian authorities could and would dwell on the computation of value addition.

Sri Lanka would be required to provide documentation in respect of cost structures and the process will take many months to arrive at an agreement. Whither then our industry, whilst the Indian importer strategy to make the Sri Lankan product uncompetitive? 

NCE would wish also to highlight "MYTHS" in regard to this agreement:- 

a. Those who are barely initiated to economics, sociology and industrial psychology argue on the premise that India is the largest market in Asia. The premise being that the sub-continent holds a population of one billion. Some also stress the view that India is the "biggest economic power in the region". 

Some others say correctly that lndia has the fourth largest standing military force in the world. But the question is purely reduced to economic terms of India versus Sri Lanka. We need to address the following questions in respect of the Indian economy.

i. What is the purchasing/buying power of the population (majority of the population is below the poverty line)?

ii. Strength of the economy (per capita-income is half that of Sri Lanka).

iii. The price at which Sri Lanka could penetrate the Indian Market, even with ZERO duty (because the Indian market, ostensibly, is price conscious - not so much quality conscious)..

iv. Sri Lankan manufacturing has the potential and propensity quality-wise to target niche markets. Yet this agreement would thwart their attempts. 

India enjoys the impact of multi-national collaboration and the benefits of affording franchises. They have a plethora of joint ventures to build cars, aircraft and oil rigs. The cars manufactured in India are flooding the local market and also some of their fixed winged aircraft built in Bangalore (HS748) have taken wing in Sri Lanka.

This brings us to the question as to why Sri Lanka should dream of joint venture projects and the realization of BOI projects when India next door is:

a. Liberalizing its economy and adopting open market policies.

b. Low cost of manpower (available for food & lodging) - low cost of production.

c. Wealth of resources (land & raw materials & labour).

d. Availability of skilled (technically trained) and academically qualified personnel.

The National Chamber of Exporters of Sri Lanka (NCE) accepts the reality of mu tual benefits to both Sri Lankan and Indian entrepreneurs as a result of the free trade agreement. 

Yet, owing to the prevalent economic climate in the two countries - parties to the agreement, we are of the opinion that Sri Lankan exporters are not in a position to optimize on the opportunities.

On the contrary, Indian exporters and entrepreneurs will be able to establish their manufacturing facilities in Sri Lanka. This is a strange dilemma. In business truth can be stranger than fiction. For a small country like Sri Lanka the export strategy should be based on value added products and services and niche marketing. This fact has been accepted by Sri Lanka and it has adopted this strategy over the last several years with success in our export markets. However, with regard to the lndian market this approach has to be questioned because of the very nature of the Indian consumer and due to the competition from developed countries for value added products. 

Sri Lankan products may not be competitive in India where price levels are concerned. Through our practical experience as exporters it is possible to provide ample evidence to this effect. 

Therefore, in conclusion the Sri Lankan entrepreneurs are right now, not in a position to capitalize on the opportunities that will be offered through the implementation of this agreement to their benefit. 

However, India is placed in an advantageous position to make maximum benefits of this agreement. We also wish to mention that there is a vast trade gap between the two countries and this is likely to widen further as a result of this agreement.

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