Tariff reform vs. the high-tariff lobby

By Dhananath Fernando

Originally appeared on The Morning

There was a recent news story that the Government is considering a new tariff policy. That may sound technical. It is not. It goes to the heart of how expensive life is in Sri Lanka.

A tariff, in simple terms, is a tax imposed by a government on goods imported from another country. The definition is straightforward. The system is not.

Millions of products cross borders every year. In Sri Lanka, each of these items is taxed at different rates at the point of entry. Every product that crosses the border is classified under what is known as an HS Code – the Harmonised Commodity Description and Coding System developed by the World Customs Organization (WCO).

At the global level, goods are identified using a six-digit code. Countries can then add additional digits to create more detailed classifications. That is where complexity begins. With eight or 10 digits, categories become narrower, rates become different – and discretion enters the system.

There are generally two types of tariffs. The first is an ad valorem tariff – a percentage of the value of the good. For example, a vehicle may be taxed at 20% of its declared value. The second is a specific tariff – a fixed amount per unit, such as a certain number of rupees per pair of shoes or per kilo of cement.

Not all tariffs are created equal. In principle, tariffs discourage trade. Governments justify them either as revenue measures or as tools to protect domestic industries. But when tariffs become excessively high, they stop being revenue instruments. They become barriers. Products simply do not enter the market because, after taxes, they are no longer affordable.

The type of tariff also matters. A specific tariff can disproportionately hurt lower-income consumers. Imagine a flat Rs. 500 tax on a pair of shoes. A pair worth Rs. 1,000 faces a 50% tax. A pair worth Rs. 30,000 faces less than 2%. The burden falls heavier on those buying lower-value goods. That is not progressive policy; that is distortion.

Sri Lanka’s deeper problem, however, is structural. We have operated for decades with a highly complex, cascading tariff system. Multiple rates across thousands of HS codes. Para-tariffs layered on top of Customs duties. Different treatment depending on how a product is classified.

Complexity creates discretion. Discretion creates room for corruption. When tariff rates differ significantly between similar HS codes, the official determining the classification holds enormous power. A small change in classification can mean a large difference in tax payable. That gap becomes fertile ground for rent-seeking.

But that is only one side of the story.

The real push for high tariffs does not primarily come from customs officials. It comes from vested interests within the private sector.

There are companies in selected industries that mainly serve the domestic market. If cheaper or better-quality imports were allowed to enter freely, many of these firms would struggle to compete. Instead of improving productivity or innovating, they lobby for protection.

Construction materials are a clear example. Tariffs in some segments go as high as 70% or 80%, often through para-tariffs such as Commodity Export Subsidy Scheme (CESS) and Ports and Airports Development Levy (PAL).

Over time, the high-tariff lobby has become highly organised. It operates almost like a cartel. It finances political campaigns across party lines. It frames the narrative around ‘saving dollars’ and ‘protecting local industry’ while consumers quietly pay the price. Many of these protected industries function as monopolies or oligopolies, operating in near-cartel structures with limited competition.

To further entrench protection, many of these products are placed on what is known as the ‘negative list.’ Even when Sri Lanka signs a free trade agreement, items on the negative list are excluded from tariff reductions. In effect, the agreement becomes hollow for those sectors.

The proposed new tariff policy seeks to address this. It is expected to introduce a simplified structure, perhaps four tariff bands such as 0%, 10%, 20%, and 30%, and to remove para-tariffs like CESS and PAL. If implemented properly, this would be one of the most significant trade reforms in decades.

But reform in Sri Lanka is never a straight road.

Lobbying groups typically use three tactics to dilute such reforms. First, they demand long phase-out periods of three to five years, arguing that the industry needs time to adjust. In practice, those years allow political pressure to build and reforms to stall.

Second, they push to expand the negative list, adding more items under protection so that even with a simplified tariff structure, meaningful competition never materialises.

Third, they invoke anti-dumping measures to reintroduce barriers through another door, effectively recreating protection under a different label.

Many governments have attempted tariff reform. The fact that we are still debating simplification after decades is itself evidence of how strong vested interests are.

Moving towards a four-band tariff system and eliminating para-tariffs is commendable. But it must be done decisively. Without expanding the negative list. Without excessive phasing. Without hidden backdoors.

Every delay strengthens cartels. Every compromise keeps prices high. And every year of hesitation quietly squeezes consumers, especially the poor, by denying them access to affordable goods and better living standards.

Tariff reform is not a technical adjustment. It is a test of political courage. The question is simple: do we design policy for protected producers, or for the broader public?

The answer will determine whether Sri Lanka remains a high-cost economy trapped by interests or becomes a competitive one driven by opportunity.

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.

Patriotism isn’t protectionism

By Dhananath Fernando

Originally appeared on the Morning

Ask any Sri Lankan what we should do to develop the country, and most will say we need to improve our exports. The same majority will also suggest that we must cut down imports to achieve this. While the need to grow exports is true, the belief that reducing imports is the way to do it is where things start to fall apart.

Many Sri Lankans even see boycotting imported goods and shifting to locally produced alternatives as an act of patriotism. The logic is simple: buying local helps local producers generate a surplus, which can then be reinvested to expand internationally. 

It is an emotional argument, but one that is deeply flawed when translated into policy. This sentiment often influences governments to raise import tariffs or impose outright bans on products that can be locally produced, believing that this will encourage domestic industry and, over time, boost exports.

But this approach misunderstands how exports work. Take the Donald Trump administration, for example. It also embraced this worldview, failing to recognise a basic economic truth: the ability to export doesn’t come from blocking imports, it comes from being competitive in price and quality. 

When we restrict better quality and lower-priced imports, we don’t support patriotism; we harm it. We shield local industries from global standards, stifle innovation, and force both consumers and other businesses to bear higher costs, weakening their global competitiveness in the process.

From an economic theory standpoint, protecting one sector of the economy often comes at the cost of others that are already competitive globally. 

Here is a simple example to illustrate this fact. Suppose Sri Lanka produces 100 coconuts a month. We consume 80 and have 20 left to export. But if we allow coconut substitutes or cheaper imported coconut oil for industrial use, we might reduce domestic consumption to 70, freeing up 30 coconuts for export. Better still, we could use imports for industrial purposes and reserve our highest-quality coconuts for premium export products like virgin or desiccated coconut.

All that we import is not final consumer goods. In fact, most of our imports are intermediary or investment goods. For instance, if the price of steel is high due to protectionist policies, it increases costs across all industries that rely on steel, from construction to manufacturing. The resulting job losses across those industries far outweigh the jobs ‘saved’ in the protected steel industry. 

In Sri Lanka’s case, nearly 80% of our imports are intermediary or investment goods. When we restrict these, it doesn’t help the economy – it hurts it. This is yet another reason why protectionism is not patriotism, but quite the opposite.

If we block these types of imports, domestic consumption remains high, and we are left with fewer coconuts – or fewer resources in general – to export or reinvest. This is the irony of protectionism; it reduces our export potential. 

We do a triple disservice: first, we make our exports uncompetitive, second, we increase the burden on local industries and consumers, and third, we create long-term dependency where protected industries lobby to maintain their privileges, making it politically costly to remove trade barriers even when they no longer make sense.

This is why governments find it so difficult to roll back import restrictions. Once protection is in place, it breeds cronyism. Protected industries band together, fund political campaigns, and perpetuate a cycle where economic power is concentrated in the hands of a few politically connected elites. In the name of ‘patriotism,’ we end up creating an unproductive, anti-competitive economy.

Another key misconception is the belief that a negative trade balance is caused by high imports. At face value, it seems logical since the trade balance is calculated as the difference between exports and imports. But in reality, imports and exports are not opposing forces; they are interconnected. Blocking imports hampers exports.

Let’s return to the example of coconuts. If we produce 100 coconuts, consume 80, and export 20, we might choose to invest 10 of those coconuts in planting new trees, increasing future production and export capacity. But we can only save and invest if we consume less. And we can only consume less if we have access to cheaper or more efficient alternatives, often through imports.

In economic theory, the trade balance is ultimately the difference between national savings and investment. Consumption is determined by the price of money – interest rates. This is why artificially lowering interest rates to stimulate growth can be disastrous. It increases consumption, and with it, imports, but without the productive capacity to match. 

When the situation inevitably unravels, we blame imports and turn to protectionist measures, instead of recognising that the true culprit is excessive consumption and insufficient savings.

The result? We reimpose import restrictions, raise tariffs, worsen the situation, and end up back at the International Monetary Fund (IMF) for a bailout. Then we repeat the same cycle, creating a class of politically connected cronies who thrive not by being competitive but by being protected.

And again, we tell ourselves we need to boost exports by cutting imports. It’s a tragic loop, reinforcing the very problems we claim we want to solve.

This is why protectionism is not patriotic. In fact, it is the exact opposite.

Nearing debt negotiation deal amid economic uncertainty

By Dhananath Fernando

Originally appeared on the Morning

Sri Lanka is hopeful that we can reach a debt negotiation before the first half of the year. Many are focused on the potential for reductions in principal and interest rates or extensions of debt maturities.

According to a recent update from the Ministry of Finance, we are yet to finalise a settlement with our bondholders, although we are close to an agreement. The Internal Rate of Return (IRR) for the Sri Lankan Government’s proposal is about 9.7%, while the bondholders’ proposal is 11.51%. The total cash outflow according to the bondholder proposal for 2024-2028 is approximately $ 16.6 billion, compared to $ 14.7 billion for the Government’s proposal. Ideally, we should reach a settlement close to the Government’s proposal if all goes well.

Both the initial and revised proposals indicate that bondholders are reluctant to reduce the interest accrued during the suspension of debt repayments. In both proposals, there have been no haircuts on $ 1,678 million of accumulated interest. Only a 4% interest rate has been proposed for 2024-2028.

Bondholders have suggested a 28% reduction on existing bonds, reducing the total bond value from $ 12,550 million to $ 9,036 million. Both parties appreciate the depth of the haircut, particularly with respect to economic growth. These adjustments depend heavily on adhering to the International Monetary Fund’s (IMF) baseline projections. If we fail to achieve the necessary growth rates, we will receive a deeper concession, and vice versa.

Achieving the best debt restructuring plan for Sri Lanka is crucial and our future hinges on economic growth. The debt level must be compared with the size and growth of the economy because only growth can ensure our ability to repay our debt. Our debt sustainability can only be secured through high growth rates, not solely through the debt relief offered by bondholders.

Economic and governance reforms are essential for growth. Notably, bondholders have proposed an innovative idea called Governance-Linked Bonds (GLB), where Sri Lanka would receive an additional benefit of 50 basis points on two selected bonds, each worth $ 800 million, if we implement two key governance reforms – one qualitative and one quantitative. The quantitative target is to reach a 14% tax-to-GDP ratio in 2026 and 14.1% in 2027.

A list of qualitative targets primarily focuses on publishing procurement contracts and tax exemptions, both of which are included in the IMF Staff-Level Agreement. However, the governance linked bonds, according to the proposal, would only apply to two bonds maturing in 2034 and 2035, each worth about $ 800 million.

While GLBs are an excellent idea, it is questionable whether the incentive is sufficient to encourage a strong governance programme. The savings from a 50 basis point cut in interest for $ 1,600 million would be about $ 80 million. Given that our accumulated interest is also about $ 1,600 million, there is a risk that governments could easily deviate.

Nevertheless, GLBs would send a strong signal to the market that the Sri Lankan administration is committed to governance reforms, which would enhance confidence in Sri Lanka.

Sri Lanka’s real challenge is avoiding a second debt restructuring. We can only achieve this by taking necessary steps and reforms to grow the economy, not solely relying on debt restructuring agreements.

Even if we secure a 30% haircut, our debt-to-GDP ratio in 2032 would still be approximately 95%. Over 50% of countries that have undergone a first debt restructuring have experienced a second. In Sri Lanka’s case, a second debt restructuring would be extremely painful for the population.

Moreover, our interest rates must remain high to meet the Government’s debt servicing requirements, attracting more funds. However, high interest rates discourage investment as people prefer to deposit their money in banks, leading to a low investment environment that could slow down growth. This slowdown would bring us back to the challenge of managing debt sustainability. This vicious cycle must be avoided.

Growth can only be achieved through improved productivity in a competitive environment, which arises when people are incentivised to perform. When the State dominates business and we try to manage everything independently, people do not become competitive.

Ultimately, growth is the only viable solution. Sadly, it is the only solution. Growth occurs when markets function effectively.