Quick Update – Trump’s 44% reciprocal tariff on Sri Lanka – What’s next?
The much-awaited reciprocal tariff announcement by the US has ended up characteristically different from what the world was expecting. Many countries, even those who are net importers from the US, have been affected by reciprocal tariffs. Tariff rates have been highly varied. While we highlighted in our recent Focus that the Trump administration’s actions are highly uncertain, Sri Lanka getting a 44% tariff, higher than most countries, is a surprise for us and can have significant consequences. According to global analysts these tariffs would make the historical US average effective tariff the highest since the 1930s.
While the future with the tariffs is likely to be chaotic and uncertain, we’re setting out a few key thoughts on this to start with.
The full note sent to clients includes a more detailed exploration of these questions. A few limited extracts of these are given below -
Why did Sri Lanka get a 44% tariff on its exports?
Sri Lanka doesn’t have a very large trade surplus with the US but has been tariffed at a higher rate than most others with higher trade surpluses. Why is this the case?
How the US government has calculated this is by taking Sri Lanka’s goods trade surplus with the US, which is about USD 2.6 billion, and dividing that by Sri Lanka’s goods exports to the US, which is around US 3 billion. This gives a value of 88%, which the US claims is Sri Lanka’s “tariff” on the US through direct tariffs, non-tariffs barriers, and currency manipulation. The reciprocal tariff is 88% divided by 2, which is 44%.
What is the 44% tariff on?
The 44% tariffs appear to apply to all goods exports to the US. There appears to be a list of exempted items, but these don’t cover any of Sri Lanka’s main exports to the US such apparels and rubber products.
“Some goods will not be subject to the Reciprocal Tariff. These include: (1) articles subject to 50 USC 1702(b); (2) steel/aluminum articles and autos/auto parts already subject to Section 232 tariffs; (3) copper, pharmaceuticals, semiconductors, and lumber articles; (4) all articles that may become subject to future Section 232 tariffs; (5) bullion; and (6) energy and other certain minerals that are not available in the United States.”
What did other countries get taxed at?
Many countries got the minimum 10% reciprocal tariff, while a list of other countries also got taxed through “reciprocal tariffs” through the same calculation. This calculation also has excluded trade in services. This method has been heavily criticized as not reflective of actual trade dynamics.
When will these impact us?
These tariffs are meant to come online on the 9th of April. This gives some time for countries to “negotiate” the tariffs and come up with deals with the US. However, this also is meant to give time for the US to increase the actual tariffs, if countries react in “adversarial” manner to these tariffs – for example by raising tariffs of their own.
Could Sri Lanka have avoided this?
Countries like India and Vietnam have done varied trade and non-trade actions in recent weeks and months to try and hold off any tariffs but they have been tariffed on the same basis, nevertheless. Countries like Australia which actually have an overall goods and services trade deficit with the US have also been tariffed, because the US has excluded purchases of services when calculating. Even Israel, got a 17% tariff imposed despite the political closeness between the two countries.
Will this continue or will the tariffs change?
So far, the tariff policy of the Trump administration has been directionally consistent – more tariffs – but operationally inconsistent – tariffs coming on and off haphazardly. Overall, the specifics of these tariffs might not be what continues but the overall direction is likely to be a world of higher tariffs.
What is the impact onto Sri Lanka as a result of this?
The direct impact would be that the ability of the Sri Lankan exporter to export to the US at the same price is much lower. On a one-to-one basis, this should mean lower exports to the US and a hit on the external account of Sri Lanka, and a general increase in the price of “risk and uncertainty” across global trade – so higher forward costs, higher hedging costs, etc.
However, this is still not a straightforward impact in our view. There are still countries with higher tariffs than we have received, including competitors such as Vietnam. In this context, the actual impact on our exports might not be so direct. Whether Sri Lankan exporters end up having countries they can move operations to, whether changes in the cost of raw material will affect the supply chain, and how other countries respond with their own measures will all come into play.
What second order impacts can come into play?
A higher-than-expected US tariff increase is going to lead to reduced growth and demand forecasts across countries and sectors. This can lead to downward pressure on global commodity prices and aspects such as freight charges. These can help offset part of the cost of tariffs, as exporters benefit from lower input costs.
For Sri Lanka in particular, lower oil prices and lower cotton yarn prices (and lower imports) can significantly contain overall imports in a year that was expected to see an increase in non-fuel, non-textile imports. As a result, the impact of lower exports to the US (especially in apparel and rubber products) might not mean a one-to-one impact on the current account balance.
What should a business and an investor do?
In our view, this extent of tariffs, especially in the form they are calculated, was a surprise. However, with the Trump administration, as we explored in our “Other Hand” report a few weeks ago, such “surprises” are almost to be expected.
“Further dramatic changes that are taken to their extreme are unlikely to be the base case expectation that one can engage with. Yet the very fact that there have already been dramatic policies actually implemented tells us that further similar moves are not out of the picture at all. Across varied contexts in history, when large changes are undertaken, they tend to be self-reinforcing. This could be due to the institutional changes that occur alongside massive policy changes, it could be due to the norm-defying nature of such changes, or it could simply be the fact that dramatic changes are, by definition, dramatic and not slow, hedged, or guarded. Big bangs tend to be big bangs because they “break” things a lot.”
Fundamentally, this is a period of rapid change and big underlying costs. In such a context, our usual advice to a client is to take a conservative and cautious position that allows you to stay afloat and not be “knocked out of the game”. From business to business, investment to investment, this will be a different decision that a client will need to make – but the basic premise is to be defensive. Identify the areas that will be least hit, that will be most resilient, that will last the storm and heavily move behind those walls.
Frontier usually restricts sharing of their research and advisory notes. In exceptional situations, such as the currently volatile global environment, we are okay with limited sharing of our work. We just ask that you inform us ahead of time of such a limited sharing.
For limited time access to the full note, please reach out to us on research@frontiergroup.info. Clients who have access to Frontier Athena can visit athena.frontiergroup.info
(Frontier Research is a Colombo-based firm that engages in macroeconomic research and advisory for corporate and investment clients on Sri Lanka, South Asia, and South East Asia.)