Business
Has Sri Lanka’s crisis-driven import controls incentivised import substitution?
By Dr Asanka Wijesinghe and Nilupulee Rathnayake
In response to the economic crisis, Sri Lanka implemented import controls that expanded significantly by the end of 2022, accounting for approximately 30% of the country’s total import value (Figure 1). The controls affected various categories, including consumption goods (46%), intermediate goods (31%), and capital goods (24%). As Sri Lanka gradually eases these controls, questions arise about the necessity of this strategy and its impact on economic growth.
Was implementing import controls a necessary strategy or the easiest option available to the government?
Were import controls applied optimally to limit damaging effects on growth?
Did they distort incentives, thereby promoting domestic production of substitutable products?
To shed light on these concerns, a comprehensive analysis was conducted using a unique dataset comprising eight waves of import controls. These controls encompassed quantitative and price restrictions at a disaggregated product level using a range of Gazette notifications issued between April 2020 to September 2022.
Were Import Controls Necessary? Unravelling the Policy Objectives
The objective behind the successive rounds of controls remains unclear, with the government declaring different goals at different times. These ranged from reducing foreign currency outflows to promoting domestic production as import substitutes. As such, assessing their longer-term impacts in distorting the incentive structures is crucial. Interestingly, implementing import controls may have inadvertently encouraged import substitution, even without a protectionist intent. The complexity of the measures employed, including credit-based requirements, import licenses, suspensions, and bans, highlights the intricacies of controlling imports.
Several hypotheses prevail in determining the government’s import control preferences.
Sri Lanka’s heavy reliance on imported intermediate and capital goods for domestic consumption and export-oriented production means that these are more likely to be exempted from minimising adverse impacts on domestic production.
The large agricultural labour force has significant electoral importance, and to gain political support, the government may seize the opportunity to protect domestic food production.
If import substitution is the goal, the government will prioritise less complex products, which are easily substitutable given resource endowments and technical know-how. Thus, food items, for instance, are more likely to face import controls over highly complex products. It is worth noting that if subsequent rounds of import controls consistently include less complex food products without exemptions, it could indicate an underlying incentive structure that promotes import substitution.
Even without a protectionist motive, the import control design could inadvertently incentivise import substitution.
Our analysis revealed that the government’s import control policy preference favoured less complex products, consumer goods, and food items. This unintentionally created an incentive structure for import substitution, even without a protectionist intent. Persistent import controls on food products and low-tech manufacturing products like consumer electronics inflate domestic prices and create opportunities for higher profit margins. As these products are within the set of products that are easily substitutable for a country like Sri Lanka, which has a comparative advantage in low-tech manufacturing and a significant labour force in agriculture, import substitution might happen even without a policy intent.
The quantitative analysis identified eight waves of import controls, which tightened over time and increased in coverage. The government’s targeting of food products, consumption goods, and less complex items was not always successful, particularly in the later waves of import controls. This can be attributed to a shrinking choice set available as control measures progressed. In some import control waves, the government extended import controls to encompass more intermediate and capital goods.
The process of import substitution typically follows a sequential pattern, starting with substituting easily replaceable products before moving on to more complex ones. Therefore, irrespective of the policy objective, the distortions introduced to the incentive structure align with observations from import substitution scenarios seen in countries like Sri Lanka.
Recommendations for Prioritising Import Control Revisions
As Sri Lanka gradually eases the import controls implemented during the economic crisis, it becomes crucial to prioritise the revision process. The deciding factors may be influenced by lobbying from industries reliant on restricted imports and feedback from industry and consumers. Our analysis suggests that revisions appear to prioritise intermediate and exempted food products, reflecting a policy preference for exempting intermediate imports .
To foster innovation and enable participation in global value chains, it is economically sensible to phase out import controls on intermediate goods. However, revisions should also target consumption goods, including food. Import controls inflate domestic prices, leading to the production of less complex consumer goods and food items for domestic consumption. This diverts resources away from export industries, impeding the country’s growth in the vital export sector.
To be Continued
Oil prices have fallen sharply amid tentative hopes for a deal to end the US-Israel war on Iran.
Brent crude, the primary benchmark for global oil prices, fell about 5 percent on Sunday as US President Donald Trump gave mixed signals on the prospects for a permanent end to the conflict.
Brent futures for July stood at $98.47 a barrel as of 01:05 GMT, down about 9 percent from a month ago but still up by more than a third compared with before the start of the war.
Japan’s benchmark stock index, the Nikkei 225, surged more than 3 percent in morning trading, hitting an all-time high after closing at a record peak on Friday.
Trump said in a social media post on Sunday that negotiations with Tehran were proceeding in an “orderly and constructive manner”, but he had instructed officials “not to rush into a deal”.
“Both sides must take their time and get it right. There can be no mistakes!” Trump wrote on Truth Social.
Trump’s remarks came after he raised hopes for a breakthrough on Saturday by announcing that a deal had been “largely negotiated,” with the terms including the reopening of the Strait of Hormuz.
“Fundamentally, there is no change to the underlying picture, where 10-11 million barrels per day of crude oil continue to be shut-in for every day the Strait of Hormuz remains shut,” June Goh, a senior oil market analyst at Sparta in Singapore, told Al Jazeera.
“However, markets are expecting a gush of 100 million barrels of crude oil from the stranded ships to flow out once the deal is in place.”
Goh said markets are likely to remain on edge for some time after any deal is finalised.
“Sparta estimates still about three to six months required to get everything back to status quo, including time to bring production and refineries back online,” Goh said.
Iran has effectively blockaded the strait since the start of the war in late February, disrupting about one-fifth of the global oil trade.
The US has imposed its own blockade of Iranian ports since mid-April, further disrupting commercial shipping in the waterway.
In his Truth Social post on Sunday, Trump said the US blockade would remain “in full force and effect until an agreement is reached, certified, and signed”.
[Aljazeera]
Investor appetite for Sri Lanka’s government securities strengthened sharply during the week ending May 22, with the Treasury Bill auction attracting bids amounting to about 1.7 times the offered volume, while secondary market transactions in Treasury Bills and Bonds surged 22.8 percent from the previous week, according to the latest weekly report of the Central Bank of Sri Lanka.
The renewed demand for government securities appears to reflect a growing preference among investors for safer and more liquid assets at a time when several segments of the economy are showing signs of uncertainty despite the broader macroeconomic recovery.
A market analyst told The Island Financial Review that the rise in demand for Treasury securities is likely driven by a combination of factors including rising inflation expectations, weakening equity market sentiment, currency depreciation pressures and investors may be attempting to lock in currently attractive yields before any further decline in market interest rates.
“The National Consumer Price Index-based headline inflation accelerated to 4.7 percent in April from 2.4 percent in March, while core inflation also rose to 4.4 percent. Such inflationary pressures may have encouraged institutional investors to lock into relatively attractive government yields before any future market volatility emerges,” he said.
At the same time, the Colombo stock market came under pressure during the week, with the All Share Price Index falling 4.26 percent and the S&P SL20 Index declining 3.55 percent.
The analyst said that part of the funds flowing into government securities may have shifted away from equities as investors sought more predictable returns.
“Another important factor supporting government securities is the persistent surplus liquidity in the banking system. The outstanding market liquidity remained in surplus at Rs. 141.27 billion by May 22, although slightly lower than the previous week’s Rs. 156.8 billion. Excess liquidity typically pushes banks and large institutional investors toward government debt instruments, particularly when private sector credit expansion remains subdued,” he noted.
“According to the data, foreign holdings of Treasury Bills and Bonds declined by 3.32 percent during the week. This suggests the recent demand surge was driven largely by domestic investors rather than foreign inflows, underscoring strong local institutional confidence in government-backed instruments,” he added.
In conclusion, he noted that the strong oversubscription at Treasury auctions reflects growing market confidence that Sri Lanka’s domestic debt market remains one of the few relatively stable investment avenues amid external vulnerabilities and domestic realities.
By Sanath Nanayakkare
INSEE Lanka, Sri Lanka’s fully integrated cement manufacturer and market leader, took center stage as the Corporate Sponsor of the Build Sri Lanka Housing & Construction Exhibition 2026, organised by the Chamber of Construction Industry of Sri Lanka (CCI). The partnership showcases INSEE’s commitment to advancing the country’s construction sector through quality, sustainability, and industry collaboration.
The exhibition was held from 22-24 May 2026 at BMICH. Stakeholders representing different sectors of the Construction Industry and international participants will be present.
As Sri Lanka’s construction sector enters a new era, the need to unite, innovate, and collaborate has never been greater. Build Sri Lanka is recognized as one of the industry’s most influential events and brings together the full construction value chain including manufacturers, suppliers, architects, engineers, developers, and homeowners into one dynamic platform.
Build Sri Lanka also plays a vital role in bridging industry knowledge with public understanding, enabling informed decision‑making for the construction ecosystem.
For INSEE Lanka, the exhibition is an opportunity to showcase capabilities to contribute to shaping the future of construction in Sri Lanka. Participation also highlights a dedication to drive progress to benefit the sector and the country, creating lasting value for communities and the environment.
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