May exports were strong, but the export engine is still weak

By Dhananath Fernando

Originally appeared on The Morning

Sri Lanka has reported its highest-ever export performance for the first five months of a year. From January to May 2026, total exports reached $ 7.39 billion, recording a year-on-year growth of 7.5%.

The May numbers are particularly interesting. Merchandise exports grew by around 18%, while services exports also recorded a similar growth rate. For the first four months of the year, export growth was only around 4.3%. With May’s performance, the overall growth for the first five months was pushed up to about 7.5%.

What is more interesting is that this performance has not really come from the apparel industry. Tea exports were also low, partly due to tensions in the Middle East. The growth has come from areas such as electrical and electronic components, processed food and beverages, coconut products, seafood, and a few other sectors. On the services side, Information and Communication Technology/Business Process Management (ICT/BPM) has shown good growth.

This export performance is commendable. But we should not misunderstand one good month as proof that Sri Lanka has solved its export problem.

Building competitiveness

Exports are a function of competitiveness. Some parts of competitiveness come naturally. But most of it has to be built over time.

For example, Sri Lanka’s soil structure and climate may give our cinnamon a unique aroma and our coconut products a distinctive quality. But developing cinnamon and coconut as globally competitive products is a local game. Our coconut has to compete with coconut products from India, Indonesia, and the Philippines. At the same time, coconut-based products also compete with substitutes such as almond-based products, palm oil, and even olive oil in certain categories.

Cinnamon has a similar challenge. Sri Lankan cinnamon has to compete with cinnamon from Indonesia and Vietnam. At the same time, it also competes with other spices such as cloves, cardamom, and nutmeg in the wider global spice market.

So competitiveness is not just about one product competing with the same product from another country. It is also about one category competing with another category. That is where Sri Lanka still has a serious structural problem.

Factor market challenges

The first problem is our factor markets: land, labour, and capital.

For any product category or investor, accessing land has become a major issue. From a cinnamon cultivator to an electronic component manufacturer, land is a binding constraint. The solution is to invest more in Bim Saviya, speed up land titling, and identify industrial zones using underutilised Government land, including land held by major State-Owned Enterprises (SOEs).

But to make this happen, Sri Lanka needs institutions that can move fast. At the moment, we do not have that machinery.

Then comes labour. Sri Lanka has a serious labour problem. On one hand, we do not have enough workers in the domestic market, partly because many skilled people have migrated. On the other hand, female labour force participation remains low. Childcare, unsafe and unreliable public transport, and rigid workplace structures make it harder for women to join and remain in the labour market.

Our labour regulations are also rigid. Hiring is costly. Exiting is complicated. As a result, firms become cautious about expanding. This affects exporters directly, because export competitiveness depends not only on wages, but also on flexibility, productivity, and the ability to scale.

Land and labour constraints also affect access to capital. Because of land title issues, banks are reluctant to accept land as collateral or extend credit easily. For a long time, access to capital was also difficult because the Government was the main borrower in the economy. A large share of credit from financial institutions flowed to the Government and SOEs instead of the private sector.

Now private sector credit is recovering, but these changes take time. Exporters cannot become competitive overnight when the supporting system has been weak for years.

In simple terms, Sri Lanka’s factor markets do not really support our exporters to compete, either on price or quality.

A system lagging behind

Then there are the supporting costs. Construction costs are high. Electricity, which is a key input for almost every export product, is expensive. As a result, energy-intensive industries struggle to maintain their edge under the current cost structure.

On top of that, Customs procedures remain difficult and cumbersome. We still operate with a century-old Customs Ordinance. That does not support a modern export economy. Exporters need speed, predictability, and simplicity. What they often get is delay, discretion, and paperwork.

Another major issue is productivity. Sri Lanka’s productivity drive across sectors is weak. In coconut, tea, rubber, and dairy, the average output per unit remains low compared to many regional peers. Those countries also have problems. But we are far behind. Without improving productivity, we cannot expect our exports to compete purely through branding or sentiment.

In the modern world, competitiveness also comes through market access. When countries sign trade agreements or join trade blocs, their exporters get access to markets at lower tariff rates. That makes a big difference when investors decide where to locate production.

Sri Lanka receives some benefits through arrangements such as the Generalised Scheme of Preferences Plus (GSP+). But countries with wider trade agreement networks have a stronger advantage. They can offer investors access to more markets, better certainty, and greater scale.

Sri Lanka has free trade agreements with India and Pakistan. We also signed the Singapore-Sri Lanka Free Trade Agreement and a trade agreement with Thailand. But the status, implementation, and practical benefits of these agreements are still not very clear to the wider business community. Signing agreements is one thing. Using them to attract investment and expand exports is another.

No other choice

So while May’s export performance is good, Sri Lanka’s export structure is still not properly organised. One strong month has changed the narrative for the first five months of 2026. But it has not changed the fundamentals.

What Sri Lanka needs is export growth driven by structural reforms. That means fixing land markets, improving labour flexibility, expanding female labour force participation, easing access to capital, reducing input costs, modernising Customs, improving productivity, and widening market access.

Of course, structural reforms take time. They are complicated. Multiple teams have to work hand in hand for a reasonable period before we see real results.

But sadly, Sri Lanka has no other choice.

If we want exports to grow sustainably, we cannot depend on one good month. We have to fix the system that produces exports.

Two simple tests for a good budget

By Dhananath Fernando

Originally appeared on the Morning

How should the President judge whether his upcoming Budget is good or bad? A budget is not only about income, expenditure, and the gap in between. A national budget sets policy direction while balancing the books.

In Sri Lanka there is limited control on the expenditure side in the short term. The largest item is interest payments. Most of the rest is recurrent spending on salaries, pensions, and transfers. Even when capital allocations are made for public infrastructure, they are often underspent to plug rising recurrent bills.

So how do we judge the numbers fairly when interest costs are so high? Take interest out and see if our revenue covers all non-interest spending. That is the primary balance. If revenue exceeds non-interest expenditure, we have a primary surplus.

Interest payments are largely inherited liabilities, and there is very little a finance minister can change quickly. This means the first test of a sound budget is whether the primary balance improves credibly.

But budgets are also about policy signals. Do they show a pro-poor, pro-growth direction that reduces people’s cost of living and helps businesses invest? On that front, this Budget will tell us whether the President is serious about lowering the cost of construction.

Before being elected, while presenting the National People’s Power (NPP) economic manifesto, President Anura Kumara Dissanayake said the price of tiles was too high and that import controls had pushed construction costs up. Now there is an opportunity to correct this.

Among many inputs, four items matter for any basic building: cement, steel, tiles, and sanitary ware. If the Government wants growth, policy should aim to bring these costs down.

A practical way is to cut para tariffs like cess and the Ports and Airports Development Levy (PAL), and to rationalise Customs duties where possible. Border taxes hurt cash flow because they are paid upfront.

When you import cement or tiles, cess and PAL are charged at the point of entry, so the project’s cost is frontloaded. That pushes financing needs up on day one, raises interest costs on working capital, and can make projects unviable. House builders delay, small contractors scale down, and factory expansions stall.

Today a bag of cement in Sri Lanka often costs nearly twice what it does in Thailand, and other materials show similar gaps. The result is visible in half-built houses and delayed renovations across the country. Lowering these input costs will help families finish a home, schools stretch their budgets further, and firms add floor space to expand production.

So here are the two simple tests to judge this Budget.

First, does the primary balance improve in a way that is believable and sustained?

Second, does the Budget lower the cost of construction by cutting para tariffs, simplifying taxes, and allowing more competition and supply?

If both tests are met, the Budget will be pro-poor and pro-growth. If not, the numbers may look tidy for a year, but homes will stay unfinished and investments will remain on hold.

Why SL’s electricity sector keeps failing its users

By Dhananath Fernando

Originally appeared on the Morning

The tug of war between the Ceylon Electricity Board (CEB) and the Public Utilities Commission of Sri Lanka (PUCSL) is not new to Sri Lankans – or to taxpayers. 

At one point during President Maithripala Sirisena’s tenure, a Cabinet meeting was called off until the CEB and PUCSL reached an agreement on tariff revisions. In another bizarre chapter, the CEB even organised a special pooja to invoke rain gods, hoping to avoid power cuts and tariff hikes.

Now, the conversation has returned, with the International Monetary Fund (IMF) insisting that electricity tariffs must be cost-reflective as a condition for the release of the next tranche of funding. While there is a lot of noise about tariff hikes and methodologies, the critical push for structural reform remains absent. Once again, electricity users find themselves on the receiving end, with little clarity on a long-term path to reduce costs.

Concerns have deepened with proposed amendments to the Electricity Act that threaten to roll back past reforms. The outcome? Consumers and industries may have to bear higher electricity costs, whether as tariffs, taxes, or inflation.

Understanding the basics: What drives tariff structures?

There are three core principles when it comes to setting electricity tariffs:

Electricity is a homogeneous product: One kilowatt (kW) of electricity provides the same energy, regardless of whether it comes from coal, wind, or solar. While the cost of generation varies, the energy output is identical.

The cost of electricity varies by time of use: Although electricity is a homogeneous product, its cost fluctuates based on demand. Peak-hour electricity typically costs more, as it relies on expensive and quick-response generation sources.

Electricity is hard to store: Unlike other commodities, storing electricity is extremely costly. This means supply and demand must be balanced in real time, making pricing and grid stability critical.

Cost-reflective pricing is currently the principle we follow, largely in line with IMF recommendations. But cost-reflectivity alone is not enough. If the system’s inefficiencies remain unaddressed, then reflective prices will only continue to rise. 

Previously, we ignored this reality by allowing the CEB to operate at a loss. These losses didn’t vanish; they resurfaced as taxes, inflation (when financed by money printing), or higher interest rates (when financed through debt).

Why are costs high?

One of the main reasons for persistently high electricity costs is our outdated grid infrastructure. Our failure to connect to India’s electricity grid also leaves us with missed opportunities. A grid connection with India could help us stabilise our own grid and export surplus electricity – particularly solar power – thereby reducing domestic costs through offsetting.

Worse yet, the new amendments to the Electricity Act propose rebundling generation, transmission, and distribution, undoing previous reforms that sought to separate them. Unbundling improves accountability and productivity; rebundling risks taking us backward.

What should be done: Now and long-term

Long-overdue transmission upgrades require significant capital. For that, we need a structure that welcomes private investment while ensuring strong regulatory oversight. Currently, the regulator is weak, and the CEB, as a State monopoly, easily passes cost increases onto consumers without consequence.

Electricity reform is complicated and takes time. But while we figure out long-term changes, here are a few short-term, actionable steps that could help manage the situation:

1. Unify user categories: Sri Lanka currently maintains multiple user categories – domestic, religious, Government, etc. – violating the principle of homogeneity. A single unit of electricity cannot and should not be priced differently at the same time for different consumers. Instead of offering cross-subsidised tariffs, direct cash transfers should be used to support vulnerable consumers. This will promote demand-side efficiency and encourage responsible energy use.

2. Abolish Rate 1 and adopt Time-of-Use (TOU) pricing: The Rate 1 category for bulk users must be eliminated. Instead, TOU pricing should be applied universally. Uniform pricing flattens important price signals and discourages efficient energy use. TOU pricing, on the other hand, encourages load shifting, optimises grid use, and better reflects real costs.

3. Improve cost transparency: When reporting its cost structure, the CEB must clearly separate:

• Generation costs: Disaggregated by plant, including fuel, labour, maintenance, and capital, along with justifications for deviations from least-cost dispatch principles

• Network costs: Covering transmission and distribution infrastructure

• Overheads: Including administration, billing, metering, and customer services

Similarly, losses must be broken down into:

• Technical losses: From grid, transformers, and substations

• Commercial losses: From theft, faulty meters, or billing errors

• Collection losses: From non-payment or delays

Transparency will shine a light on inefficiencies, allowing policymakers and the public to demand reform based on evidence.

Cost-reflective pricing is necessary, but not sufficient. What matters more is reducing the cost itself. And that cannot be done by regulation alone. It requires competition, productivity, and bold structural reforms. 

Until we summon the political courage to tackle these long-standing issues, the electricity sector will remain trapped in a cycle of inefficiency, passing the burden from the State to the citizen, again and again.

(Source: Advocata submission to PUCSL on electricity tariffs)

The power of know-how over industry selection

By Dhananath Fernando

Originally appeared on the Morning

In most of our export strategies, the starting point has been the Government deciding which industries should drive exports – some of these decisions are data-driven. 

Accordingly, we examine current export figures and sometimes focus on expanding existing product segments. Secondly, we target additional industries with the expectation that exports can be boosted. While both approaches seem logical at first glance, we need to understand the broader framework of how to grow exports effectively.

Most of the time, we perceive exports as industry-specific, but in reality, exports are about know-how. Know-how becomes a product, and know-how makes a product competitive. However, know-how is not just knowledge – it is sometimes tangible, existing in tools, but more often, it is intangible. 

It is akin to Lasith Malinga’s bowling action and his ability to deliver pinpoint yorkers. We can analyse Malinga’s technique, attempt to replicate his action, and even learn from his strategies through interviews or YouTube videos. Yet, even with all this information, it is extremely difficult to replicate his unique skill set. 

Malinga possesses tangible components such as his slinging action, run-up, and release style, which can be considered tools. He also has knowledge that he shares through various platforms. However, his true know-how – what makes him exceptional – remains elusive, even to himself. 

This difficulty in transferring know-how is likely why the Mumbai Indians recruited Malinga both as a player and later as a coach in the Indian Premier League. If we consider Malinga as a product, he is export-competitive and his value lies in a combination of factors, primarily his unique know-how.

When a country seeks to expand exports, the know-how ecosystem is what determines success or failure. Our apparel manufacturers, for example, possess specialised knowledge that enables them to produce garments at the lowest cost while maintaining high quality. 

Initially, their products were relatively simple, but over time, they evolved in complexity. The industry experimented with various approaches – ethical garment production, lean manufacturing, and women’s empowerment – learning from both successes and failures to refine a sustainable model.

Today, Sri Lanka’s apparel exports are not merely about physical products but also the know-how that allows us to compete globally. Know-how thrives within an ecosystem that supports industries. 

For this to develop, the Government must provide entrepreneurs and businesses with the freedom to access and test resources – what economists refer to as factor markets. Land, labour, and capital must be available with minimal restrictions on a level playing field. 

This is why licensing requirements can be detrimental to exports; they obstruct access to essential resources, thereby stalling know-how development. For instance, if land acquisition is difficult, apparel firms may struggle to operate or innovate. Similarly, excessive labour regulations can increase operational costs, making products uncompetitive and disrupting the know-how ecosystem. Such obstacles discourage exports.

Another common discussion on boosting exports revolves around diversifying the export basket. To understand how diversification occurs, we can refer to Harvard’s Center for International Development, where Prof. Ricardo Hausmann uses the analogy of monkeys and trees in a forest.

In a forest, monkeys do not leap from one end to the other; they move from branch to branch. Similarly, export diversification does not occur in giant leaps but through adjacent product categories. Existing exporters and individuals within the know-how ecosystem expand into related fields. 

For instance, if we excel in gemstone exports, an adjacent category would be jewellery. This is why Government intervention in selecting export industries with large targets is often ineffective – diversification and expansion naturally occur within adjacent categories.

In making more complex products for export, Prof. Hausmann employs an economic theory likening diversification to a Scrabble board. If we have only three letters, our word combinations are limited. However, with four letters, the number of possible words increases exponentially. 

Therefore, minimising restrictions on factor markets – such as land and labour – enables more access to ‘letters,’ allowing for greater diversification.

Additionally, some ‘letters’ contribute significantly to forming words, like the letter ‘A,’ which is more versatile than a letter like ‘Z’. Similarly, removing barriers to factor markets increases the potential for new export combinations.

In Sri Lanka, our export strategy has traditionally relied on the Government selecting industries for growth. While this approach may work to some extent, if we seek rapid export expansion – like Vietnam – we must focus on the framework rather than forcefully pushing selected industries.

In today’s global economy, no country manufactures all its products on its own. Most nations produce parts, components, and assemblies, relying on international trade to complete final products. If we fail to open our economy to trade, our export ambitions will remain unfulfilled. Trade enhances competitiveness and provides access to multiple ‘letters’ at optimal costs.

Foreign Direct Investments (FDIs) are another crucial element in this equation. FDIs bring in individuals with specialised know-how, much like acquiring a player of Malinga’s calibre. They also introduce advanced technology, enabling the creation of more ‘letters’ and exponentially increasing the potential for new products over time.

If Sri Lanka is serious about exports, we need to focus on the process and the journey. We hope that the upcoming Budget will establish key milestones to guide us in the right direction.