Post-MFA Challenges Twist Garment Sector Knickers

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