The 2016 budget will not open the tile and sanitary ware market, nor will it liberalise the lubricants market contrary to popular belief that Finance Minister Ravi Karunanayake had proposed to open these two sectors. Market leaders Royal Ceramics Lanka PLC (RCL) in tiles and sanitary ware, and Chevron Lubricants Lanka PLC (LLUB) in lubricants will see little change in the status quo. When the finance minister presented the budget on 20 November 2015, he said steps would be taken to address short supply and high prices in the construction sector. Import taxes on steel, tiles and sanitary ware would be reduced. “Further, I propose to remove tiles, ceramics and sanitary ware from the negative list of the BOI,” he said, adding later in the speech that he would do the same for lubricants.
Many mistakenly assumed this would open the domestic tiles and sanitary ware, and lubricants markets to cheaper imports, and was especially welcomed by middle-income households where homebuilding is too costly and out of reach to many.
Companies registered with the investment promotion agency the Board of Investment (BOI) are allowed duty-free imports of inputs not listed on the protectionist BOI negative list of items manufactured in Sri Lanka. If domestic supply is short or don’t meet required specifications,
BOI-registered firms need special approval to import items on this list. Companies like Royal Ceramics Lanka and Chevron Lanka Lubricants benefited from this extraordinary protectionism for years. Despite removing tiles and sanitary ware, and lubricants from the negative list, little will change for the firms.
Home-making could be more affordable to many people. For years, domestic floor and wall tile makers were protected by the state, and cheaper imports from countries with much lower production costs were kept out of people’s reach with taxes as high as 70-100%. The protectionist policy spawned a monopoly, Royal Ceramics Lanka PLC.
The Dhammika Perera-controlled firmbuilt a monopoly after its 2013 acquisition of three other listed firms in this sector – Lanka Ceramic PLC (CERA), Lanka Walltiles PLC (LWL) and Lanka Tiles PLC (TILE).
Benefiting from trade protection, Royal Ceramics’ revenue tripled from Rs7 billion in 2012 to Rs22.4 billion in 2015, and the firm now commands a 70% share of the tile market and a 51% share of the bath and sanitary ware market, according to market analysts Bartleet Religare Securities.
Royal Ceramics, which is a diversified company, generates 65% of its profits from tiles and sanitary ware; the rest comes from aluminium, paints, plantations, packing materials and financial services.
In the November budget speech, The finance minister said import taxes on tiles and sanitary ware will be reduced to meet rising demand and reducehigh prices. But t he proposed tax reduction was miniscule.
Average taxes on tile imports saw only a 14% reduction – down from 90% before the 2016 budget to around 76% after. “This is not a significant reduction, but it’s still something,” Tile and Sanitary Ware Importers Association Secretary General Kamil Hussain said.
“The cess on sanitary ware imports had been reduced from Rs75/kg to Rs40/kg, which means a bathroom set is now around Rs3,000 cheaper. Import duties on tiles have been adjusted slightly, giving us a Rs20,000 saving on each container load. We understand the need to protect the domestic industry, but imports can be a lot more affordable to a lot more people if not for high taxes”.
Taxes are determined per square meter for tiles. A square meter tile from China costs Rs540 on average at the port. After the 2016 budget, it is subject to a 30% customs duty (25% before the budget), 7.5% port and aviation levy (previously 5%), Rs100 cess (down from Rs200), 8% value-added tax (down from 11% before the budget) and 4% Nation Building Tax (increased from 2%). Before the budget, the total tax effect on the tile was 90%, now its 76%.
The proposal to remove tiles and sanitary ware from BOI’s negative list is not going to help households who will continue to pay high taxes.
Even before the 2016 budget, some investors sold their holdings of tile stocks on rumours that import duties would be reduced, a clear indication that without protection these companies are not worth quite much
Even before the 2016 budget, some investors sold their holdings of tile stocks on rumours that import duties would be reduced, a clear indication that without protection these companies are not worth quite much
By taking tiles out of BOI’s negative list, only large infrastructure projects like hotels and apartment complexes can freely import their tile requirements for much cheaper, provided they are registered with the BOI. So if Royal Ceramics is going to take a hit, it will only be felt two to three years from now because the company has already entered into agreements with developers and their order books are secure for the next few years, market analysts said.
“The removal (of tiles) from the negative list would barely affect Royal Ceramics’ volumes. Furthermore, the reduction in corporate tax from 28% to 15% would boost net earnings from FY 2017E onwards,” Bartleet Religare Securities said in a research paper in December 2015, recommending investors to buy the stock. Potential to grow market share in the exports market in Australia, New Zealand, the US, Japan, India, Maldives, Pakistan, Fiji, Singapore, Canada and the UAE weigh in the company’s favour.
However, Royal Ceramics cosseted by state protectionism was always harried by small-time importers. Despite inhibitive taxes and restrictions, import demand was high as household income improved, and post-conflict construction and tourism boomed. Imports from China, Bangladesh, India and Indonesia captured 30% of market share by the 2013/14 financial year, prompting Royal Ceramics Managing Director Nimal Perera to appeal for stringent anti-dumping laws.
Thankful for small mercies in the 14% tax cut, tile importers have reason to be worried. The 2016 budget proposed to introduce a pricing formula for imports to prevent under invoicing. The government’s pricing formulas have a bad reputation for not being fair, making imports more expensive and victimizing genuine importers and consumers. As far as the tiles sector is concerned, Royal Ceramics can sit happy with its crown. Like for tiles, panic greeted the finance minister’s proposal to remove lubricants from BOI’s negative list and ‘liberalise’ the market of 13 firms by inviting new investments to build refineries and blending plants.
This shook industry king Chevron Lubricants Lanka, which enjoys a 51% market share. The firm’s Chief Executive Kishu Gomes criticised the move and complained that 17 other firms were importing lubricants despite being on the negative list.
The company imports and blends lubricants for vehicles and industrial machines. BOI companies that needed lubricants not provided by Chevron or any of the other 13 firms had to get approval to import them. Now that it is taken out of the negative list, these and other lubricants can be imported tax free and without approval even though they are produced here.
Chevron could see its BOI client base erode and on the retail side, just like for tiles, the removal of lubricants from BOI’s negative list does not mean anyone can import lubricants to the country. So nothing really changes immediately for Chevron unless its BOI clients are not locked into longer-term contracts.
What is worrying Chevron is the government’s invitation to investors to set up value-added blending operations here. But this will take time and Chevron may as well reign for many more years to come.
Chevron is already facing stiff completion in the market of 13 and “17 unlicensed importers and blenders selling adulterated lubricants”, Gomes said. The company enjoyed a near monopoly after it won exclusive rights to sell its products in filling stations run by another monopoly the Ceylon Petroleum Corporation (CPC) for 10 years ending 2004.
According to the Public Utilities Commission, this exclusivity left no room for competition in the market despite allowing other firms to enter the market in 1999. Closest competitor Lanka-
Indian Oil Company PLC (Lanka IOC) only made inroads after it was allowed to run on filling stations in 2003. Since then, global brands such as Shell, BP, Exxon Mobil, Motul France and Gulf Oil International have also made inroads, selling their products at CPC filling stations. By 2014, Chevron’s market share had fallen to 50%. Only Chevron and Lanka IOC (LIOC) operate blending plants in Sri Lanka.
“We are not interested in market share. We are focused on growing our revenues with high-quality lubricants,” Gomes said. Chevron’s high-grade vehicle lubricants require fewer oil changes, leading to falling volumes. The company has had to increase prices to keep revenues up and is also relying on expansion in Bangladesh. The company also exports to the Maldives. This shows that competition does not destroy a good company and that it can charge premiums if consumers are satisfied with quality. The company reported profit of Rs2.7 billion in 2011, which grew to Rs3.5 billion in 2014.
The 2016 budget did not liberalise the tiles and sanitary ware, and lubricants markets, although many were led to believe so. But it did give protected companies a jolt.
Influential business leaders lobby governments to protect domestic industry at the expense of consumers who are denied the right of choice and forced to buy more expensive products because there is no incentive for cosseted producers to become more cost efficient.
Take tiles for instance; homemakers could buy good-quality tiles at much cheaper rates, but they are denied this. Building materials including tiles are so expensive that 67% of the rural population and 30% of the urban population don’t have access to toilets, as reported by sister publication EconomyNext.com.
As the economy grows and consumers become more informed and savvy, they will see through the shallow protectionist arguments of mercantilists who only want to enrich themselves at other people’s expense. What will happen to these protected industries when people lobby for freedom?
Even before the 2016 budget, some investors sold their holdings of tile stocks on rumours that import duties would be reduced, a clear indication that without protection these companies are not worth quite much.