7. INDUSTRY. Overall Trends

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1 7. INDUSTRY Output in the industrial sector increased by 6.5 per cent in the first half of 23 compared with a decline of 2.4 per cent in the first half of 22. This growth was supported by improved performance in export oriented industries despite several unfavourable international developments such as the Iraq war, the outbreak of the Severe Acute Respiratory Syndrome (SARS) and sluggish international markets. Industrial output is estimated to increase by 4.8 per cent during the second half of 23, in view of the continuing slow recovery in global markets and the higher base in the second half of 22. The annual growth rate in 23 is expected to be 5.7 per cent, compared with a 2.8 per cent annual growth in 22. Overall Trends The growth in industrial output in the first half of 23 was mainly attributed to the higher production in export oriented industries such as apparel, textiles, rubber gloves, tyres, plastics and processed diamond. Apparel and rubber-based industries received higher export orders than expected in the first half of the year, as demand surged in the aftermath of the Iraq War. However, export prices improved at a slower rate than expected due to the depressed external market environment, continuing deflationary pressures in some international markets and intense competition from low cost manufacturing countries, such as China and those in East Europe. Paper Products 2% Fabricated metals 4% Non-metalic mineral 8% Chemical, petroleum, rubber and plastic 19% Chart 7.1 Composition of Industrial Production Other 2% Basic metal 1% Wood products 1% Food, beverages and tobacco 23% Textle,wearing apparel and leather 4% The competitiveness of Sri Lankan products was maintained with aggressive cost cutting and lower domestic inflation, despite the slower nominal depreciation of the domestic currency. The Free Trade Agreement with India was helpful for rubber-based products, soap and plastic products to penetrate the Indian market. 25, 2, 15, 1, 5, -5, -1, -15, Chart 7.2 Growth in Industrial Output (at 199 Constant Prices) First half Second half Projected for Second half 23 Despite the satisfactory progress in exportoriented industries, downside risks remain due to the uncertainty in continuing growth momentum in major countries such as the United State and Japan. The output of food, beverages and tobacco products, major domestic market oriented industries, grew moderately at 3.3 per cent during the first half of 23. Major industries in the sector are processed food, liquor, beverages, wheat flour, processed fruits and animal feed. The demand for these products is expected to increase further during the second half of 23 with falling interest rates, expansion of economic activity and improved commercial activity in the North and East. In addition to measures taken by industrialists to improve labour productivity, the government amended several labour laws in 22 and the first half of 23 to make the labour market more flexible. However, labour productivity is adversely affected by irregular power supplies, 35

2 fluctuations in voltage, poor transportation infrastructure, lack of skilled labour and poor working conditions. Industrial sector activities continued to suffer from several structural impediments such as long delays in court proceedings, slow progress in infrastructure development, unfair trade practices such as under invoicing and leakage of BOI products to the domestic market and unnecessary regulatory impediments. The rate of capacity utilisation in the industrial sector increased to 85 per cent in the first half of 23 from 78 per cent in the first half of the previous year. However, capacity expansion appears to have been deferred further due to uncertainty associated with the slow recovery in major export markets. Overall capacity in the industrial sector is expected to increase by 6 per cent in FH 1998SH Chart 7.3 Production in Major Industrial Sub Sectors (at 199 Constant Price) 1999FH 1999SH 2FH 2SH Performance in Major Sub-sectors Textiles, apparel and leather products 21FH Textiles and apparel Food, beverages and tobacco Chemical, petroleum and rubber Non-metalic minerals The output of the apparel and textile industry, the largest industrial sub-sector in factory industry, increased by 1.9 per cent in the first half of 23 in contrast to a 9.4 per cent decline in the first half of 22. On the basis of confirmed export orders received by major manufacturers, the textile and apparel sector is estimated to grow by 5.2 per cent in the second half of 23, attaining an 8.1 per cent annual growth in 23, compared with 1.2 per cent in SH 22FH 22SH 23FH 23SH The export orders for apparel, which began to increase form January 23 improved further following the end of the Iraq war. Some international buyers diverted orders to Sri Lanka from East Asian Countries affected by the SARS epidemic, in the first half of 23. Sri Lanka is gaining a reputation as the preferred source for apparel by major buyers because of high quality and prompt delivery. Sri Lankan apparel command an advantage as the country complies with international labour standards and refrains from malpractice such as using child labour. In a highly competitive market environment particularly after 25 with the expiry of the Multi Fibre Arrangement, the industry should restructure to consist of either efficient large factories or very lean factories in order to be cost effective and competitive. The industry also needs to be well supported with backward linkages. This should be addressed as early as possible since Sri Lanka does not have an established fabric base unlike competitors such as China, India and Hong Kong. The industry appears to have realised some of the challenges and is developing strategies to face them successfully. Most of the apparel manufacturing firms have streamlined their manufacturing processes and have taken measures to reduce production costs. Some factories are being clustered together and brought under a single firm for efficient management and product specialisation. Larger firms handle sales and marketing in foreign markets using their comparative advantage in design and market information, outsourcing orders to smaller factories. The apparel industry commenced preliminary discussions with the Ports Authority and the Customs to reduce delivery time from port to factories and simplify customs procedures. Eight task forces were set up by the Ministry of 36

3 15, 1, 5, Industries to drive a five-year strategy forward in key areas of logistics, backward integration, technology upgrade, labour, trade agreements, development of small and medium scale industries, image building and financing reforms. -5, -1, Chart 7.4 Output Growth in Textiles, Apparel and Leather Products (at 199 Constant Price) First half Second half Projected for Second half 23 Food, beverages and tobacco products The output of the food, beverages and tobacco category grew moderately by 3.3 per cent during the first half of 23. The output of food processing, liquor and beverages sub sectors increased by 5.4 per cent, 5.5 per cent and 1.8 per cent, respectively while the output of the tobacco sub sector declined by 5.1 per cent. The food, beverages and tobacco category is estimated to grow by 5.2 per cent in the second half of 23, realising an annual growth of 4.3 per cent in 23. competitive Chinese market, after gaining a foothold in other Asian and Middle Eastern markets. The carbonated soft drink industry grew only moderately due to the introduction of a new excise duty on carbonated drinks, which raised prices. The output of tobacco products declined in the first half of 23 due to a rise in smuggled foreign cigarettes and the increased awareness of tobacco related health problems. The illegal production of white cigarettes, which affected the demand for cigarettes produced by authorised manufacturers, was discouraged to a certain degree with the recent revision of excise duty on cigarettes. The revision has resulted in a reduction in the prices of low value cigarettes Chart 7.5 Output Growth in Food, Beverages and Tobacco Products (at 199 Constant Price) First half Second half Projected for Second half 23 Domestic demand for these products is expected to increase with increased economic activity in the North and East, lower interest rates, the resumption of delayed public investments, favourable weather and the uninterrupted supply of power during the second half of the year. The processed meat industry is estimated to grow at 9 per cent in 23 with higher domestic demand and the turnaround in the tourist industry. The exports of processed meat also improved in the first half of 23. Domestic demand for biscuits increased with continuous improvements in product quality, the introduction of smaller packets and improved distribution methods. Some biscuit manufacturers have entered the highly Chemical, rubber, petroleum and plastic products The output of chemical, petroleum, rubber and plastic products grew by 3.3 per cent in the first half of 23. Production increased in the sub categories of rubber-based products (22.5 per cent), plastic and PVC products (7.8 per cent) and pharmaceuticals and detergents (2.7 per cent). Output in the petroleum and chemical, paints and fertiliser sub sectors declined by 7.4 per cent and 3.2 per cent, respectively, in the first half of 23. The chemical, petroleum, rubber and plastic category is estimated to grow by 3.7 per cent in the second half realising a 3.5 per cent annual growth in

4 The output of petroleum products decreased as the oil refinery was closed for routine maintenance work and crude oil imports were reduced due to the Iraq war. Despite slower recovery in the international markets and severe price competition, especially from China, rubber gloves and industrial tyres received higher export orders as a result of close relations with global retailers, continuous improvements in quality and advanced marketing strategies. The cement manufacturing industry benefited from the recovery in the construction industry, the reduced tariffs on clinker and the commencement of construction activities in the North and the East. Exports of ceramic products continued to suffer from increased competition in international markets. 12 Chart 7.7 Output Growth in Non-Metalic Mineral Products (at 199 Constant Price) Chart 7.6 Output Growth in Chemical, Petroleum, Rubber and Plastic Products (at 199 Constant Price) First half Second half Projected for Second half 23 Commercial tyre manufacturers began exporting tyres to India under the Indo Lanka Free Trade Agreement. Domestic demand for tyres grew after the opening up of the Northern Province, which resulted in a rapid increase in local road transport. Rubber based product manufacturers faced difficulties in obtaining raw materials in the domestic market, as the domestic price of latex increased significantly, in line with international prices. Non-metallic mineral products The output of non-metallic mineral products increased by 5.3 per cent in the first half of 23 reflecting higher production in cement (8.6 per cent), processed diamonds (6.5 per cent), ceramic products (1.5 per cent) and building materials (1.8 per cent). The annual growth of this category is estimated at 5.1 per cent in 23 compared with 1.9 per cent in 22, on the assumption of moderate growth in exports and relatively higher sales in the domestic market in the second half of the year Investment in BOI Industries Foreign investment interests improved substantially during the first half of 23 benefiting from the on going peace process and improved macroeconomic condition in the country. The Board of Investment of Sri Lanka (BOI) approved 191 projects with an investment commitment of Rs.71,829 million in the first half of 23 as compared with 178 projects with an investment commitment of Rs.29,424 million in the first half of , 12, 1, 8, 6, 4, 2, First half Second half Projected for Second half 23 Chart 7.8 Approved Investments in BOI Enterprises First half Second half Projected for Second half 23 The investment approvals in the first half of 23 showed a diversification into new investments, reducing the concentration on the apparel sector. The new sectors included information technology, warehousing, education, health facilities, tourism, solar power, housing, energy, fabricated metal and jewellery. 38

5 Table 7.1 Approved and Contracted Investment in BOI Projects Categories Number of Projects First Half 22 Estimated Investment (Rs. Mn) First Half 23 (a) Number Estimated of Investment Projects (Rs. Mn) Foreign Local Foreign Local Projects Approved under Section ,943 15, ,542 24,287 Projects Contracted under Section ,426 8, ,893 9,744 Projects Approved under Section , , (a) Provisional Source : Board of Investment of Sri Lanka The local component of the projects approved under Section 17 of the BOI Act increased by 57 per cent mainly due to a significant increase in the approved projects owned by Sri Lankan investors. The realised investments of the BOI enterprises were Rs. 12,75 million in the first half of 23 compared with Rs.16,696 million in the first half of 22. The direct employment potential in approved and contracted projects under Section 17 of the BOI Act was estimated at 22,389 and 11,41 persons, respectively. Industrial Policy The long-term industrial policy should aim to develop a globally competitive manufacturing sector that can prosper without protection with tariffs or subsidies. In order to achieve that goal, the government s role in industrial sector development should be to move away from being regulator to facilitator. Accordingly, the industrial policy of the government was directed towards removing impediments and unnecessary controls in conducting business, improving the business environment, facilitating trade, enhancing competitiveness, improving corporate governance, removing restrictions on foreign investment flows and facilitating easy access to foreign technology and foreign direct investment. 8, 7, 6, 5, 4, 3, 2, 1, Chart 7.9 Contracted Investments in BOI Enterprises First half Second half Projected for Second half 23 Recognising the importance of recommendations made by the De-Regulation Committee, the government decided to simplify and unify, wherever possible procedures in Customs and tariffs, tax administration, labour laws, and land titles. As de-regulation is a continuous process, the government appointed a second De- 39

6 Regulation Committee to make further recommendations and to monitor the implementation of the recommendations that had been already made. Furthermore, the government announced the introduction of bankruptcy legislation to facilitate orderly exit for failed firms and to protect the interests of the creditors. Rigidities in labour markets have been impeding investment expansion, employment creation and labour productivity improvement. To address these problems, the government took a number of measures to increase flexibility and minimise distortions in labour markets. Section 68 of the Factories Ordinance of 1942 was amended to raise the permitted ceiling on overtime work for a female employee to 72 hours from 1 hours annually. During the first half of 23, the Industrial Disputes Act of 195, the Termination of Employment of Workmen Act of 1971 and the Employment of Women, Young Persons and Children Act of 1956 were amended to reduce rigidities in the labour market. In addition, the government has proposed in the Regaining Sri Lanka policy document to introduce an Employment and Industrial Relations Act to increase flexibility in labour markets, promote the upward mobility of labour and raise labour productivity. To promote an active dialogue with the private sector in policy formulation, the government set up eight sectoral task forces with private sector participation. These task forces have now completed respective five-year plans and the Ministry of Enterprise Development, Industrial Policy and Investment Promotion has commenced implementing some of recommendations in those plans. The private sector was invited to participate in the implementation of the plans. In order to assist small and medium-scale industries, the Ministry of Enterprise Development, Industrial Policy and Investment Promotion launched a credit scheme named Sahanya with funds amounting to approximately US dollars 6 million received on concessionary terms from the Asian Development Bank. According to the Ministry, about 711 loans amounting to approximately Rs.1,96 million had been approved by the end of June 23 and 281 loans amounting to approximately Rs.598 million were disbursed. These projects are estimated to create employment opportunities for about 3,927 persons. Under WTO rules and various regulations introduced by importing countries, exports have to conform to certain standards, especially some environmental standards. While negotiating with industrial countries to minimise or remove such requirements, it is important to educate domestic manufacturers on the various rules and regulations that govern international trade and assist them to comply with such regulations. For these purposes, a National Cleaner Production Centre (NCPC) was inaugurated in May 22 with the assistance of the Norwegian Government and the United Nations Industrial Development Organisation (UNIDO). The prudent use of natural and material resources, improving eco-efficiency of products to meet global standards and buyers requirements and pollution prevention at source constitute the mandate of the NCPC. During the period under review, about 2 awareness workshops were conducted by the NCPC. The Ports and Airports Development Levy, amounting to.75 per cent on all cargo imported for export oriented industries was reduced to.5 per cent in 23 to relieve the exporters. 4

7 Exchange controls liberalisation, announced in the 23 Budget, permitted rupee credit facilities to BOI enterprises approved under Section 17 of the BOI Act and controlled directly or indirectly by persons resident outside Sri Lanka. The liberalisation also permitted credit facilities up to 36 days to buyers resident in Sri Lanka, by a supplier of goods and services not resident in Sri Lanka, at a rate of interest not higher than international market rates, if the supplier insists on payment of interest. The first industrial incubator, Nawabima, to assist start up businesses, was set up in June 23 at the Moratuwa University. Initially 12 firms in the leather and IT sectors had been selected for projects. The incubator will offer on-site management, low cost business space, flexible leases and technology support under one roof. Other industries, selected after studying their potential and the need for assistance, will be incubated in the near future. Outlook for 24 The output in the industrial sector is expected to grow by 6.1 per cent in 24 compared to the estimated growth of 5.7 per cent in 23. The growth is expected to be supported by recovery in international markets and continuous expansion in domestic demand. The growth will be a composite outcome of expansion of output in BOI industries, estimated at 6.2 per cent and non-boi industries, estimated at 6. per cent. The output of public sector industries is expected to increase by 8. per cent with uninterrupted production at the oil refinery in 24. The impetus to growth in industrial output in 24 is expected to come from all industrial categories, textiles, wearing apparel and leather products (6.1 per cent), food, beverages and tobacco products (5. per cent), chemical, petroleum, rubber and plastic products (7.8 per cent), non metallic mineral products (5.9 per cent), fabricated metal products (6.3 per cent) and basic metal products (5. per cent). Investment expansion, including FDI, in the industrial sector is expected to increase in 24 with improved investor confidence in response to the peace prospects, recovery in the international markets and gradual improvements in infrastructure, especially in the areas of telecommunications, information technology and ports. The proposed Economic Partnership Agreement with India and the Free Trade Agreements with the United States and Pakistan would also help to increase investment inflows to the industrial sector in