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Cablegate: Potential Fallout of Mfa Expiration in 2005

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 COLOMBO 001271

SIPDIS

DEPT FOR SA/INS
DEPT FOR EB/TPP/ABT (EHEARTNEY)
DEPT PASS USTR

COMMERCE FOR ARI BENAISSA

E.O. 12958: N/A
TAGS: ECON ETRD EINV KTEX ELAB CE ECONOMICS
SUBJECT: Potential Fallout of MFA Expiration in 2005

1. Summary: There is heightened anxiety in Sri Lanka's
apparel sector, as expiration of the Multi-Fiber
Arrangement approaches in January 2005. Sri Lanka's top
end producers, controlling about 70% of exports, are
expected to be the least affected, as they have gone high-
tech, cut costs and lead times, and have formed strong ties
with buyers. The absence of sweatshops, and the existence
of numerous firm-level worker welfare programs have
prompted Sri Lanka to use social compliance as a key
marketing tool. On the negative side, Sri Lanka's lack of
a fabric base, distance from markets, and high electricity
charges could pose a challenge to the industry (even to
large manufacturers) trying to be competitive post MFA.
The plight of small and medium industries is very
uncertain. Factory closures and substantial job losses
will be certain, but cannot be quantified. A substantial
number of Sri Lankan expatriate garment factory workers
abroad will also return, compounding the problem. Sri
Lanka is yet to find a replacement for apparel as the key
growth engine in the industrial sector and key employment
generator. End Summary.

Industry response
-----------------

2. With no US-Sri Lanka FTA in sight and the January 1,
2005 expiration of the Multi-Fiber Arrangement (MFA) less
than 6 months away, there is increased anxiety in the
apparel industry regarding Sri Lanka's prospects. Hoping
against hope, stakeholders in the apparel industry - under
the Joint Apparel Associations Forum (JAAF), formed in 2002
to focus on meeting the 2005 challenge - are still holding
on to their goal of increasing apparel exports from $2.4
billion in 2002 to $4.5 billion in 2007. JAAF is working
to improve market access, marketing and designing
capabilities and labor standards, establish backward
linkages, increase productivity and lower costs. Their
strategy is to build a base here for four specific product
lines (active/sports wear, casual wear, children's wear,
and intimate apparel) and to move up-scale to department
stores and specialty stores. JAAF expects their efforts to
help transform the industry from a manufacturer to a
provider of a fully integrated service. Plans are underway
to set up three fabric mills, including a giant French
nylon lace plant. JAAF also plans to improve the image of
the Sri Lankan industry abroad, especially its adherence to
labor and environmental standards and focus on corporate
social responsibility.

MFA phase out
-------------

3. Even while these steps are being taken to meet the MFA
threat, there is growing concern about the many challenges
posed by MFA's phase out. A 2002 study showed that the top
12% of companies operating about 100 factories account for
nearly 72% of garment exports. These large-scale
manufacturers have begun programs for upgrading technology
and skills and some of them boast world class manufacturing
facilities and professionals. Many have succeeded in
shifting to the high-end of the global apparel market, but
most others have not made the necessary changes to confront
global competition. The negative effect of the MFA phase
out, therefore, is likely to be felt most severely by the
small and medium enterprise (SME) sector, which represents
about 70% of garment factories. According to a recent
report, 80% of the small and medium scale factories operate
on thin margins and could be easily forced out of business
once prices fall.

4. Further, over 60% of Sri Lanka's garment exports to the
US currently depend on quotas. Signs of shifting
competitiveness have already begun to emerge. According to
a recent OXFAM study, Sri Lanka's exports to the US in
products liberalized in stage 3 of the ATC (on January 1,
2002) have declined by over 50% between 2001-2003.
Similarly, Sri Lankan exports of these products to EU
dropped by over 20%. A closer look at data reveals that
Sri Lanka has lost market share to China for some products,
while in some other categories (high quality, up-market
products) Sri Lanka has gained market share.

Impact on employment
--------------------

5. There are also concerns regarding the impact of quota
expiration on employment. Currently, the industry directly
employs 339,000 people, but over a million jobs depend on
the industry. There are no comprehensive studies on the
phase-out's effect on labor. Some estimates place job
losses in the range of 100,000 to 150,000, including around
50,000 Sri Lankan expatriate garment factory workers in
Middle East and Maldives who will return as those locations
no longer receive quota concessions. (Note: some are
returning to factory jobs with their current employers, who
are simply shifting production back to Sri Lanka. Others
will certainly be unemployed as a result of the change. End
note.) Recently, worker rights groups have started
discussing the transition, and have requested ILO help to
develop a plan to deal with it.

6. The social consequences of these potential job losses,
especially in rural areas, remain a concern, and little has
been done to actually find sources of alternative
employment or provide retraining. The contribution of the
apparel industry to the rural and semi-urban economy has
been significant. Some factories are located in rural
areas (a result of the 1992 200 Garment Factories incentive
program sponsored by the GSL) and most of the machine
operators come from rural areas. According to ILO and NGO
contacts, awareness of MFA phase out among factory workers
and their dependants is also low.

7. In addition to job losses, a substantial reduction in
the apparel sector could ripple through supporting sectors.
It would be felt in export earnings, in port, air services,
cargo services, the packing industry, inland transport, and
the banking sector.

Labor Standards
---------------

8. The current discussion on the phase-out has also forced
the sector to rethink labor relations. Most of the apparel
industry is non-unionized, a result of past government
regulations prohibiting union activities in Export
Processing Zones (EPZ) and a general reluctance by
employers to support unions, due to their heavy
politicization and culture of violence. Instead, the
Government, through the Board of Investment (BOI),
supported the formation of employee councils, which have
worked well in protecting labor welfare. (ILO has ruled
that trade unions and employee councils can co-exist.)
Larger factories generally provide very good facilities to
workers including good working environments, free or
subsidized meals, free medical facilities, free transport,
and recreation. Some even provide free hostel facilities,
and training opportunities in IT and English.

9. The EU has recently granted enhanced tariff concessions
to Sri Lanka on the basis of its progress towards
implementing ILO core labor standards. Sri Lanka has
adopted all eight standards, but implementation of clauses
on freedom of association and collective bargaining has
been weak due to low tolerance of trade unions in the EPZs.
The BOI and the JAAF are working together to improve union
operations.

Strengths and weaknesses
------------------------

10. Sri Lanka seems to be better prepared than some of the
countries facing the MFA phase out as a result of
stakeholders forming JAAF in 2002. Following the JAAF
strategy, leading companies have already gone upscale and
consolidated their businesses. For instance, MAS Group,
the largest manufacturer in Sri Lanka, is the single
largest vendor worldwide to Victoria's Secret. The second
largest manufacturer, Brandix, has consolidated several
business units under one umbrella to attain economies of
scale. These companies plan to exploit Sri Lanka's
advantages, such as low labor costs (USITC studies indicate
hourly labor cost in Sri Lanka is about 40 US cents,
compared with 69 cents in coastal China and 57 cents in
India), a skilled and easily trainable workforce, positive
reputation, and strong relationships with buyers. Going
forward, Sri Lanka can benefit by exploiting these
advantages to create a positive perception among buyers and
consumers and position the country as a labor compliant
manufacturer with high social responsibility standards.
Meanwhile, the GSL is considering a relaxation of rules on
EPZ factories, to allow them to engage in subcontracting to
larger manufacturers, which is currently prohibited.

11. On the negative side, Sri Lanka does not enjoy
economies of scale to support a fabric base and fabric is
sourced from India, China, Hong Kong, Korea and Indonesia.
In addition, the distance from major markets (US and EU)
has resulted in longer lead times required to get goods to
store shelves. The high cost of electricity, the lack of a
good Electronic Data Interchange (EDI) system for export
documentation, and limited diversification of the economy
to absorb any fallout from MFA phase out are also serious
concerns. Sri Lanka's strict labor termination laws will
also hinder corporate restructuring and a smooth transition
to the new era. (Note: labor laws have been under review,
but a revamp of worker termination rules is politically
very difficult. End note.)

12. Comment: As Sri Lanka faces increased competition
after January 2005, garments may no longer be the growth
engine in the industrial sector, and also could be a drag
for services growth, as the garment industry feeds many
other sectors. Therefore, a contraction in the industry
does not augur well for Sri Lanka's economy. Although
there have been efforts to boost tourism, IT, rubber, and
to take advantage of Sri Lanka's strategic location in the
east west sea routes, nothing seems poised to take over
readily from apparel, which is Sri Lanka's largest
industrial sector (contributing to 65% of industrial
exports, 50% of total exports and sustaining over a million
jobs).

13. The dismantling of a large number of SMEs will be
quite disheartening to the GSL, as it has announced
development of the SME sector a top priority. Nonetheless,
Sri Lanka has been thinking about the MFA expiration and
its consequences for some time (it was one of the countries
to oppose expiration during ATS negotiations). The
industry's focus and determination to increase productivity
and reduce time to market should help it gain long-term
strategic advantages. Despite a commitment to excellence,
the question remains, will China's and India's vast sizes
simply overwhelm smaller suppliers? End Comment.
LUNSTEAD

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