If Sri Lanka manages to reduce the US tariffs imposed on its apparel exports to a rate lower than its rivals, the domestic apparel sector will then have more incoming orders, according to Ohio-based Oberlin College Associate Professor of Financial Economics Udara Peiris.

In an interview with The Sunday Morning Business, he said that a 10% rise in apparel prices through the imposition of US tariffs would cut the demand by 6-8%, while adding that a 44% tariff on apparel would shave GDP growth by 0.5-1 percentage points in 2025.

Prof. Peiris further noted that hard-hitting tariffs would lower export earnings, which would cut foreign exchange inflows and tax revenue, making it harder to meet the 2025 goals for reserves, while any sharp fall in exports could also weaken the rupee and force mark-to-market losses on banks holding Government securities.

Moreover, he said that achieving the full-year target of about Rs. 450 billion from vehicle import duties appeared attainable as long as the exchange rate remained steady and bank credit did not tighten sharply.

Following are excerpts:

Do you see an impact on Sri Lanka’s economic outlook from the US tariffs, despite the outcome of the negotiations?

It is essential to acknowledge that tariffs are being applied to many countries as part of Washington’s plan to narrow its current account deficit and that these are not targeted solely at Sri Lanka. The key question is what happens when the price of all apparel sold in the United States rises by 10%, not just the price of Sri Lankan goods.

Studies put the price elasticity of demand for US clothing at about 0.6 to 0.75, so a 10% price rise should cut demand by roughly 6-8%. If rival countries face duties higher than 10%, some orders will switch to Sri Lankan firms, softening the blow. Should Sri Lanka’s tariff remain at 10%, the loss of export income should be well below 10%, especially once buyers have time to adjust.

If Washington were to lift the duty on Sri Lankan goods to the announced 44%, the impact would be much larger; export earnings could fall enough to shave 0.5-1 percentage point from GDP growth in 2025 and slow the rebuilding of reserves. 

Still, exports account for only about 20-25% of Sri Lanka’s GDP (Thailand’s figure is around 65%). The long-term priority is therefore to press ahead with structural and governance reforms that make it easier to expand exports, rather than relying on short-term responses to tariff changes. Nevertheless, proactive and good-faith negotiations with the US are critical if the tariffs are to stay at 10%.

Will the increased tariffs on Sri Lanka have an impact on the ongoing International Monetary Fund (IMF) programme targets?

Yes. Lower export earnings would cut foreign exchange inflows and tax revenue, making it harder to meet the 2025 goals for reserves, the primary surplus of 2.3% of GDP, and the floor on social spending. 

The IMF has already listed the new duties as a risk in the debt sustainability discussions. Lower export revenues can only be offset by compressing imports further (which will be painful for consumers) or attracting Foreign Direct Investments (FDIs) (which will be difficult if exports are stagnating).

Will the delay by the Government to restructure State-Owned Enterprises (SOEs) have an impact on the debt targets that should be achieved according to the Debt Sustainability Analysis (DSA)?

The fiscal risks of delaying SOE reform are real. Each month of delay leaves large contingent liabilities on the Treasury and increases gross financing needs beyond the path set out in the DSA. Faster divestment or cost-recovery pricing for firms such as SriLankan Airlines and the Ceylon Electricity Board would help keep public debt on track to fall to 95% of GDP by 2032.

I have been writing for several years that an independently managed holding company should be created to own and supervise all major SOEs, separating ownership from day-to-day management and allowing commercial decisions. 

This public ownership and private management model has been successful in Russia and China, and the Government would do well to apply a similar model to Sri Lanka.

Sri Lanka’s banking sector has recovered from the crisis and is engaging in business as usual. Do you foresee any risks and benefits the sector will experience in the medium term?

Capital ratios have improved to about 18% and liquidity coverage remains well above the regulatory minimums, while Non-Performing Loans (NPLs) have begun to edge down. Even so, the NPL ratio is still high (about 12%), and any sharp fall in exports could weaken the rupee and force mark-to-market losses on banks holding Government securities.

Loan portfolios are also heavily weighted towards State firms and construction. The forthcoming Asset Quality Review and the new resolution fund should help supervisors manage shocks, yet credit growth is likely to stay modest until the tariff dispute and debt restructuring are resolved.

It seems that the National People’s Power (NPP) Government is adamant on keeping taxes on track and not giving concessions for businesses. Is the current tax structure on the correct path or should there be more adjustments?

The 2025 Budget aims to raise revenue to 15% of GDP, the threshold the IMF views as essential for debt sustainability. The NPP Government has ruled out ad hoc concessions and is focusing on better compliance, for example, through the new National Tax Week. 

The next steps are to roll out a modern property tax and plug Value-Added Tax (VAT) leakages. Stability and transparency in tax policy matter more than further cuts to headline rates; unpredictable changes and selective concessions deter investors more than high but predictable taxes.

Since the import ban was lifted in February, Customs has collected about Rs. 136 billion in four months and officials told Parliament’s Committee on Public Finance that the Treasury now collects roughly $ 1.7 in duties and taxes for every dollar of vehicles imported. With duties on many cars still near 300%, the full-year target of about Rs. 450 billion looks attainable as long as the exchange rate stays steady and bank credit does not tighten sharply.

In the present environment, every rupee counts; although these taxes are heavy, the alternative of higher income taxes or lower social spending would be harder to bear.