In a move which may spell the death for more than 10 percent of Sri Lanka's industrial exports, the country's top association representing large rubber farms has called for effective taxes on value-added rubber product exporters to help farmers make easier profits.
Sri Lanka has a number of solid tyre factories that are now using up large volumes of rubber, reducing the total volumes that are exported raw. Rubber product factories also import raw rubber as they are on export industrial zones run by Sri Lanka's Board of Investment.
"Since most rubber manufacturers have their factories in the BOI zones, they have the facility of importing raw material on a duty free basis and the prices at the local auction too get affected as we are not competitive with the world market prices for natural rubber," Planters' Association Chairman Sunil Poholiyadde said addressing the group's annual meeting.
"We do hope adequate measures have been taken by the authorities concerned for controls on the duty free rubber imports in order to protect the local grower."
Poholiyadde had made the same appeal last year.
If Sri Lanka does not allow duty free import of rubber, factories inside the country will not be able to compete with competitors in countries like Vietnam and Thailand, new rubber growing nations like Laos or countries which produce no rubber at all, but have free trade.
Export of industrially processed rubber products alone accounted for 835.4 million dollars, or 9.8 percent of Sri Lanka's industrial sector exports in 2017, growing 8.8 percent from a year earlier, while rubber components are also used in other products exported.
Natural rubber exports amounted to 38.9 million dollars in 2017, up 19.1 percent from a year earlier.
Sri Lanka imported 287.8 million dollars of rubber as intermediate goods for processing at factories during 2017, up 3.3 percent from a year earlier.
Even a small 'dog-eat-dog' tax on raw materials has a much bigger hit on the margin and competitiveness of an exporter of a final good, a phenomenon which economists call effective taxation.
If latex accounts for 60 rupees of the cost of a rubber product sold at 100 rupees (40 percent value-added), a 10 percent tax on raw material will slash the margin of the final goods exporter by 6 rupees.
This is a 15 percent hit, or 'effective tax' on the margin of an exporter of manufactured goods.
If raw materials make up 70 percent of the final good, a 10 percent tax on inputs will result in a 23.33 percent hit or effective tax on the margin of the final good. If inputs are 80 percent of the final goods, a 10 percent protection will generate an effective tax of 40 percent.
Effective taxes are among the most potent tools of killing value-added exports. Effective taxes are believed to be one reason why Sri Lanka's exports have not diversified or innovated naturally.
A recent study of the Institute of Policy Studies had said that protective taxes had a possible hand in the low entry of foreign direct investments into Sri Lanka.
Harvard University Centre for International Development Research Fellow Tim O'Brien too said that protectionist para-tariffs hurt Sri Lanka's export potential as it had deterred would be investors and product diversification.
Global Value Chains
Since most goods which are the output of one sector are inputs for a final producer of another, Sri Lanka has missed out of the so-called global value chains that came up in East Asia, which has free trade. In a global value chain, margins at each stage of production are very thin.
A rubber product maker located in a country which does not produce rubber at all, and there is no protection, will be more competitive than Sri Lanka.
Already rubber product makers have to get state permission periodically for imports, a hassle they do not have to put up with, if they shift the factory out of Sri Lanka.
However when a large number of factories are located within a country, farmers could potentially get a higher than world price if domestic consumption is very high.
A producer located in Sri Lanka that is importing, will have to buy raw rubber at world market prices, and also pay freight.
As a result if there are domestic producers, an exporter of final goods will still benefit even if they pay a little higher than the world price and not lose competitiveness. Domestic supplies, if reliable could also reduce stock holding costs, providing another incentive.
If factories leave the country, farmers will only get the international price for rubber anyway, as they will have to export all of their produce at world market prices.
However an export cess can reduce the margin of a farmer by that amount.
An export cess could also give an unfair profit to a manufacturer of final goods by allowing them to buy inputs at a lower than world price. Export cesses which benefit producers higher up the value chain at the expense of farmers are just as wrong as import taxes, freedom advocates say.
Buyers abroad generally pay higher prices for Sri Lankan commodities including tea - compared to countries like Vietnam for example - due to fast shipping connections, which reduces stock holding costs and time, according to some analysts.
High stockpiles of natural rubber in South East Asian countries and the appreciating US dollar have resulted in falling rubber prices globally.
Continuing a long-term slide, six-month rubber futures at the benchmark Tokyo Commodity Exchange fell to 171.5 yen per kilogramme on Monday, after reaching a five year peak 331.3 yen per kilogramme in January 2017 a period when coconut prices also hit record highs.
Palm Oil Incentive
Poholiyadde said that rubber cultivation in Sri Lanka has fallen over the last five years, and the industry has to move into non-traditional areas to expand production.
He requested the government to allocate RPCs land in such areas to expand rubber cultivation, as climate change, with higher rainfall, has lowered production in traditional rubber lands.
How protectionism kills competitive export is also seen in rubber cultivation itself.
Some regional plantation companies have shifted from rubber in favour of oil palm, which has import protection and easy profits are possible.
Growing oil palm allows a producer to collect the difference between the global price, and the local price plus tariffs which economists call tax arbitrage, without engaging in innovation to be competitive.
The government, had approved a plan in the 1990s to expand oil palm cultivation up to 20,000 hectares, Poholiyadde said.
However, Poholiyadde said that the government has banned the planting of oil palm following public protests.
"We have now reached almost 11,000 hectares but unfortunately there are many obstacles in proceeding with the cultivation of this crop," he said.
An year earlier, the oil palm extent had been just below 10,000 hectares.
"Having imported the seeds following the government procedure and raising the planting material, we are in a totally unfortunate situation, where the companies have seedlings worth 450 million rupees in the nurseries," Poholiyadde said.
"Here too, not going by scientific evidence but only due to public agitation."
The ban was introduced after communities near oil palm plantations protested against environmental degredation from the industry, with the fast depletion of water in such areas.
Poholiyadde said if the seedlings are not planted during the north-east monsoon, they will have to be discarded.
Oil palm requires less labour than rubber or tea, benefiting planters.
Oil palm can be cultivated with 0.1 workers per hectare, while 2.5 workers per hectare are required for tea, and 1 worker per hectare for rubber. (Colombo/Oct01/2018)
Read more at Economy Next, <click here>