US embassy cable - 05COLOMBO965

UNCLAS SECTION 01 OF 03 COLOMBO 000965 
 
SIPDIS 
 
DEPT PASS TO USTR JON ROSENBAUM 
GENEVA TO USTR 
 
SENSITIVE 
 
E.O 12958: N/A 
TAGS: ECON, ETRD, CE, ECONOMICS 
SUBJECT: Post-MFA Challenges Twist Garment Sector Knickers 
 
REF: (A) 04 Colombo 1604 (B) 04 Colombo 1271 
 
1.  (U) Summary:  Although, there was much concern in the 
last few months of 2004 about the end of the Multi-Fiber 
Agreement (MFA) and the possible loss of up to 30,000 jobs, 
this problem paled in comparison with the enormous loss of 
over 30,000 lives from the tsunami on the eve of the MFA 
expiry.  Now, four months after the two events, the Sri 
Lankan garment industry has begun to feel the impact of 
Chinese competition.  As expected, small and medium players 
with low-tech systems are facing problems.  Yet, even the 
large players have expressed surprise at the intensity of 
the increased Chinese exports.  Sri Lanka's apparel 
industry still pins it hopes on expectations of 
preferential access to US and EU markets.  Sri Lanka's 
Joint Apparel Association Forum (JAAF) continues to predict 
that overall garment exports from Sri Lanka will reach more 
than USD 4 Billion by 2007.  End Summary. 
 
Recent trends--Exports up January-February but sowing 
--------------------------------------------- -------- 
 
2.  (U) In spite of increased competition in the run up to 
the MFA expiry, Sri Lankan textile and apparel exports rose 
9 percent in 2004 to USD 2.8 billion and accounted for 49 
percent of total export revenue.  In volume terms, apparel 
exports were up 8 percent while prices rose by one percent, 
according to Central Bank statistics.  The positive trend 
in apparel exports continued into the first two months of 
2005 based on orders placed through 2004.  March exports, 
however, were flat compared with March 2004 figures. 
Presently, there is no indication of how much apparel 
exports from Sri Lanka will change during the course of the 
year.  Orders from small and medium companies have been low 
in March and from July onwards, according to Nihal 
Seneviratne, Chairman of the Sri Lanka Chamber of Garment 
Exporters (SLCGE), which represents small and medium 
exporters.  (According to Seneviratne, in previous years, 
exporters would have received confirmed orders by May for 
July-August).  According to EU Trade Commission Officials, 
apparel exports from Sri Lanka to EU have declined sharply 
through April.  Exports to the US increased during this 
period. 
 
Top brands are still here but with new sourcing plans 
--------------------------------------------- -------- 
 
3.  (U) Sri Lanka continues to attract top brands and 
buying houses such as May Department Stores, Next, Marks 
and Spencer, Nike, Gap and Limited Brands.  Some changing 
trends have emerged.  According to apparel industry 
sources, buyers are in the process of rationalizing the 
supplier base and relying on large manufacturers.  They are 
looking for manufacturers able to provide product 
development, deliver quick turnaround times, create new 
domestic input sourcing mechanisms, develop links with 
overseas suppliers and improve productivity.  Hence, Sri 
Lanka's largest apparel companies who collectively supply 
about 80 percent of exports should do well, as they have 
been focused on these very tasks for some time.  These 
companies recorded substantial growth in 2004.  MAS 
Holdings, the largest apparel exporter and a world leader 
in intimate apparel, experienced 22 percent growth in 
export earnings in 2004 and expects a growth of 10 percent 
in 2005.  Brandix, the second largest apparel exporter, 
recorded a 5 percent growth in 2004 and forecasts a 26 
percent growth in 2005.  Hirdaramani group, another large 
exporter, had flat growth in 2004, and expects exports to 
pick up by about 10 percent in 2005. Large orders and 
increased productivity have assisted these producers in 
adjusting to price pressures from buyers. 
 
Hoping for preferential access and China safeguards 
--------------------------------------------- -------- 
 
4. (U) Manufacturers in Sri Lanka, lacking a well-developed 
textile base and reliant on imports, have been pining for 
preferential access to Sri Lanka's two major markets, the 
US and EU, to survive in the post MFA era.  Most of these 
hopes have failed to materialize so far, causing concern in 
the industry.  The only positive recent move was when Sri 
Lanka became eligible for special incentive arrangements 
with the EU under the EU Generalized System of Preferences 
(GSP) scheme in February 2004.  These concessions were 
given in response to Sri Lanka's adherence to core ILO 
labor standards.  Under this scheme Sri Lankan garments 
(meeting Rule of Origin (ROO) requirements) receive 40 
percent duty concessions.  Consequently, garment exports to 
the EU rose by 27 percent to $985 million in 2004.   With 
the end of the MFA, however, such concessions have become 
inadequate to compete with cheaper Chinese and Indian 
exports.  Therefore, Sri Lanka has applied for duty free 
entry for its garments, under the EU "GSP-plus" scheme now 
expected to come into force in July 2005.  Once the GSP 
plus benefit becomes operational, however, Sri Lanka's 
exports will only get limited additional benefits due to 
tough ROO requirements.  Currently, EU ROO require the use 
of local fabric or fabric from the region.  If fabric from 
the region is used local value addition should be greater 
than 50 percent to qualify for duty free entry.  The EU is 
considering relaxing ROO requirements to about 30 to 35 
percent by year-end.  The industry is also lobbying to 
expand EU ROO to include ASEAN fabric. 
 
5.  (SBU) Former Sri Lankan Ambassador to the US, Devinda 
Subasinghe, who has been asked by the JAAF to be its 
advocate in Washington, said in an email to Econchief, that 
Sri Lanka could survive with a 35 percent ROO requirement. 
Meanwhile, a Sri Lankan ministerial delegation visited 
Europe to lobby for concessions for apparel exports under 
consideration by the EU for tsunami-hit countries. 
 
6.  (SBU) Manufacturers in Sri Lanka are also hoping for 
preferential access to the US.  In 2004, the US accounted 
for 58 percent of garment exports estimated at $1.54 
billion or about a quarter of total Sri Lankan exports (all 
goods).  This heavy dependence on the US market is 
worrisome now as Sri Lanka does not receive any 
preferential tariff benefits in the US markets and will 
have to compete directly with China and India.  Sri Lanka 
is hoping that textile exports will receive tariff 
concessions from the Trade Act of 2005, where Sri Lanka is 
included as a tsunami-affected country. 
 
7.  (U) At a recent seminar organized by Friedrich Ebert 
Stiftung, a German NGO, both the Econchief and a EU Trade 
Commission representative explained concerns in their 
respective countries and regions regarding tariff 
concessions on textile imports and described processes 
involved in decisions on China-related safeguards.  Sri 
Lankan manufacturers should benefit from the recent US 
decision to invoke safeguards on textile imports from 
China.  Sri Lanka is quite competitive in all three 
categories facing safeguard action: cotton shirts and 
blouses, cotton trousers and underwear. 
 
8.  (SBU) As expected, smaller manufacturers, who have not 
improved production processes and do not have ties with 
suppliers, have started to face serious problems.  In 
addition to a shortfall in orders smaller manufacturers 
also face problems with regard to financing.  Banks, on the 
look out for MFA expiry, have devised their own ways to 
minimize risk and losses from the fallout.  At an Amcham 
convened meeting with the Ambassador in 2004, apparel 
exporters complained that banks had already stopped lending 
to some small- and medium-sized operators.  This trend is 
continuing.  For example, Citibank NA has carried out a 
special portfolio review of its textile sector that 
comprises several mid-size companies and has classified 
companies as winners, survivors, and losers.  The bank, 
which offers short-term facilities tied to the trade cycle, 
expects to exit from firms falling under the last category 
as soon as possible.   According to SLCGE's Seneviratne 
some SME factories have already closed operations.  However, 
no reliable statistics are available on the closures. 
 
9.  (U) Some of the large Sri Lankan firms have also taken 
other measures to succeed in the quota free era.  They have 
moved operations overseas to be close to suppliers and to 
markets.  For example, MAS Holdings now has facilities in 
ten countries including China and India.  Brandix has 
opened a factory in Madagascar as well as marketing offices 
in the US and UK and a sourcing office in Bangalore. 
Brandix is also looking at opening an apparel factory in 
India.  Some of them have also forged stronger links with 
domestic input suppliers.  For instance, Brandix has small, 
up-start operations in textiles, thread, buttons and 
hangers.  MAS has invested in an elastic plant and a large 
nylon lace plant (a joint venture with a French Company). 
 
Government Efforts 
------------------ 
10. (U) The GSL's primary effort to deal with the MFA 
expiration has been to seek preferential market access for 
Sri Lankan garments in the US and EU.  Nonetheless, it has 
also worked with the industry to develop a productivity 
enhancement program, aimed specifically at small- and 
medium-size garment manufacturers.  It is also looking at 
possible Millennium Challenge Account funding to help boost 
the small and medium enterprise sector, with an eye toward 
enhancing the prospects of success for those garment 
manufacturers who can compete, and helping those that 
cannot in the transition to other business opportunities. 
 
Comment 
------- 
11. (SBU) JAAF's confidence and increased export 
predictions rest with the larger manufacturers and their 
efforts to improve productivity and greater supply chain 
consolidation.  Nonetheless, while the largest 
manufacturers will have to boost employment somewhat to 
achieve these targets, it is doubtful they would absorb all 
the potential job losses, without some increased access to 
either US and EU markets, or new markets in Asia.  From an 
economic perspective the impact of the MFA expiration will 
have to be closely monitored in Sri Lanka to assess and 
mitigate effects from unemployment to foreign exchange 
earnings. On the whole, no one is predicting the apparel 
sector's imminent demise, but the challenges posed by the 
quota-free era underscore the importance of economic 
reforms, incentives for diversification of export 
industries and the need for increased foreign investment, 
to help in both diversification and the introduction of 
greater productivity processes.  End Comment. 
Lunstead