When goods don’t cross borders, soldiers will

By Dhananath Fernando

Originally appeared on the Morning

• The hidden costs of the Israel-Iran war for Sri Lanka

The escalating conflict between Israel and Iran carries serious repercussions for Sri Lanka on multiple fronts. 

In economic terms, there is no winner in any war; all parties, including those not directly involved, will suffer. Unfortunately, Sri Lanka is likely to be one of those casualties.

Humanitarian impact

An estimated 20,000 Sri Lankans live and work in Israel. If the conflict escalates and lives are lost, the Government will be under pressure to intervene and repatriate citizens. 

This would strain an already tight budget and add pressure to the national balance sheet. However, human life must take priority and any necessary rescue operations must be conducted swiftly.

Beyond the immediate human toll, loss of life could trigger political tensions at home, affecting community relations and domestic stability.

Exports and trade

Both Israel and Iran are key export markets for Sri Lanka. In 2023, exports to Israel were valued at approximately $ 90 million, with key products including bulk tea, rubber products, seafood, and coconut-based goods. Meanwhile, Iran accounted for $ 67 million in Sri Lankan exports, primarily bulk tea.

However, the bigger risk lies beyond these direct trade flows. As major markets like the US, UK, and European Union (EU) align themselves with different sides of the conflict, global trade dynamics could shift dramatically. Increased military expenditure, market polarisation, and slower consumer demand in Western economies could impact Sri Lanka’s export growth across the board.

Meanwhile, our imports from Israel – mainly tech products, plastics, and precious stones – amount to roughly $ 100 million annually. Some of these are intermediary goods essential for local production. 

Imports from Iran are smaller (about $ 25 million), largely fertilisers and food items, but equally vulnerable to disruption. War-driven supply chain breakdowns and rising costs will further strain sectors already under pressure.

Fuel prices and economic slowdown

Middle Eastern instability typically drives global oil prices higher. Already, crude and refined oil prices are rising – the Murban crude variant used at our Sapugaskanda Refinery is up by nearly 10%. Higher global prices must be transparently reflected in local pump prices to avoid market distortions.

It is vital that the Government allows these price signals to flow through while maintaining prudent monetary policy. Artificially low interest rates could lead to currency depreciation, accelerating inflation and further compounding the fuel price shock. If managed correctly, we can minimise the fallout. If not, we risk another wave of inflation at a critical juncture.

In addition, falling remittances and a global economic slowdown will directly impact one of the most critical requirements for Sri Lanka’s debt sustainability – economic growth. Weak growth could force the country into a second round of debt restructuring, and even a modest external shock could be enough to trigger a crisis, given the fragile fundamentals of our economy. 

The only solution is to accelerate economic reforms – removing trade barriers, restructuring State-Owned Enterprises (SOEs), and pursuing sound monetary policy – to build resilience and minimise risks.

Remittances

Sri Lanka receives about $ 40 million in remittances from Israel per quarter. Any major disruption to employment in Israel could directly impact these inflows. 

Moreover, broader instability in the Middle East could affect other labour markets where Sri Lankans are employed, reducing remittance income – a crucial source of foreign exchange for debt servicing and stabilising the currency.

Geopolitical risks

As global powers take sides, Sri Lanka faces new geopolitical challenges. The late Iranian President Ebrahim Raisi visited Sri Lanka last year to inaugurate the Uma Oya project, funded by Iran. Iran also donated the Sapugaskanda Refinery, a longstanding symbol of economic ties.

Israel, in turn, remains an important partner, offering employment opportunities and a growing trade relationship. But with key allies like the US and UK backing Israel, and powers like China and Russia leaning towards Iran, Sri Lanka risks being caught between competing camps.

We must now carefully manage these pressures. Maintaining neutrality while safeguarding national interests will require skilled diplomacy.

A wake-up call

This war is a stark reminder of the importance of global trade and the value of building strong, diversified economic relationships. The situation echoes the famous quote: “When goods and services do not cross borders, soldiers will.”

For Sri Lanka, the lesson is clear: deeper economic engagement and robust reforms are not just about prosperity, they are essential to protecting national stability in an uncertain world. 

Bracing for Trump’s tariff storm

By Dhananath Fernando

Originally appeared on the Morning

US President Donald Trump’s second term seems to be keeping all people around the world on their toes. The changes and policies, along with their implications, will be complicated, and we have to do our homework to gain an advantage or at least survive in this game.

The new Trump administration has suggested reciprocal tariffs, meaning the same tariff rates applied to each country that they charge for US products. 

Already, a 10% tariff is in effect for non-energy products from Canada and a 25% tariff on energy-related products from Canada. Additionally, a 25% tariff has been imposed on Mexican products, alongside an additional 10% tariff on Chinese products, bringing the total tariff on Chinese products to 21% (from around 11% previously).

SL’s opportunities and challenges

Before Sri Lanka gets affected by any reciprocal tariff, we first need to understand our total exports, including services. 

According to Harvard’s Atlas of Economic Complexity, we export about 21% to the United States. When it comes to apparel, about 40% of our apparel exports are destined for the US. 

Accordingly, the first line of impact for Sri Lanka would be potential consumption contraction in the US. With high tariffs even against Canada, China, and Mexico, as well as increased prices of essential products, the US consumer will likely reduce spending on non-essential items such as seasonal clothing. It is normal consumer behaviour to postpone purchasing decisions if expenditure on essentials like energy and rent increases.

The second line of impact has both positives and negatives. China and Mexico also supply apparel to the US. If relative prices of Sri Lankan apparel become lower following the 25% tariff for Mexico, we might gain an advantage. 

Similarly, we could become more competitive than China, which now faces an overall 21% tariff. Therefore, we must be cautious and prepared, recognising it is not just tariffs on Sri Lanka directly but also tariffs on others that can bring us opportunities or challenges.

The danger lies in the final stage if the US imposes reciprocal tariffs. The US would consider imposing the same tariffs for Harmonised System (HS) codes as the other trading country imposes on US products. 

There is discussion that the US might not only consider customs duties but also other tariff barriers and even non-tariff barriers. In that case, Port and Aviation Levy (PAL), Commodity Export Subsidy Scheme (CESS), Social Security Contribution Levy (SSCL), and Value-Added Tax (VAT) might be considered, according to some reports. 

This decision depends entirely on the Office of the US Trade Representative (USTR) defining ‘unfair trade practices.’ Media reports indicate that the USTR is expected to analyse all data and make a decision on reciprocal tariffs by 1 April.

We must recognise that Sri Lanka’s average tariff rates are significantly higher than those proposed by the US to China, Mexico, and Canada. A 25% tariff in Sri Lanka is considered low, as our effective tariff rates reach nearly 100%, and for vehicles with excise duties, it exceeds 200%. It is joked that even Trump would become confused if he learnt about Sri Lanka’s tariff structures and that he might learn a tough lesson from us.

In the context of reciprocal tariffs, price-sensitive product categories such as food, apparel, and rubber products may face higher prices in US markets. Ultimately, the real impact will depend on how other competing export markets are affected by US tariffs and non-tariff barriers and how these affect US consumption and global economic growth under new trade dynamics.

Meanwhile, Europe and other powerful countries are targeting the US with reciprocal tariffs, which could trigger global supply chains to consider relocation and create new incentive structures. This can present either an opportunity or a disaster for Sri Lanka.

Solutions

To attract new supply chains and assembly components, we must quickly work on basic factor market reforms. Having adequate land ready for industry and a flexible labour force with business consciousness is essential. Secondly, simplifying and lowering our tariff structure is critical, even though it might be somewhat late. 

Additionally, exploring exports towards East Asia and the Indian market is increasingly vital. Whether our US market shrinks or not, we should prepare to explore other markets, primarily India and East Asian countries. Strengthening foreign relationships, activating business chambers, and intensifying diplomatic missions to strengthen ties is necessary. 

Accelerating regional free trade agreements and conducting market sentiment research can help Sri Lankan entrepreneurs expand their exports. Fundamentally, economics never expires – even during trade wars or crises, strong economic fundamentals provide the best way to survive and thrive. We must move from hope to action.

Where did Sri Lanka export all products to in 2022?

Source: Harvard Atlas of Economic Complexity

Where did Sri Lanka export textiles to in 2022?

Source: Harvard Atlas of Economic Complexity