This Selected Issues paper on Sri Lanka provides background information on economic developments and on selected policy issues facing Sri Lanka. The main economic developments in 1996 and the first quarter of 1997 are discussed. The paper highlights that in 1996, a severe drought, power shortages, and an escalation in the military conflict contributed to a sharp deterioration in the economic situation. With the end of the drought and power shortages, and a rise in investor confidence, macroeconomic conditions in 1997 were more favorable.

Abstract

This Selected Issues paper on Sri Lanka provides background information on economic developments and on selected policy issues facing Sri Lanka. The main economic developments in 1996 and the first quarter of 1997 are discussed. The paper highlights that in 1996, a severe drought, power shortages, and an escalation in the military conflict contributed to a sharp deterioration in the economic situation. With the end of the drought and power shortages, and a rise in investor confidence, macroeconomic conditions in 1997 were more favorable.

II. Recent economic developments

A. Economic Activity and Prices1

Growth, saving, and investment

6. Economic growth slowed to 3.8 percent in 1996, down from 5.5 percent in 1995. The slowdown was mainly due to a supply shock in the agricultural sector following a severe drought and disrupted economic activity resulting from power cuts. Notwithstanding these shocks, the deterioration in the security situation, and the weakness in business confidence, the economy showed considerable resilience. Although power cuts dampened industrial production, manufacturing exports, predominantly textiles and garments, continued to grow rapidly, albeit not as fast as in previous years. Production and exports of tea and rubber also benefitted from favorable international price trends.

7. Gross domestic capital formation fell from 25.7 percent of GDP in 1995 to 24.2 percent in 1996. Public investment accounted for two-thirds of this decline, reflecting the government’s effort to cut expenditure as well as a slowdown in project implementation. Private investment was sluggish in the first half of the year on account of uncertainties caused by drought and power cuts, but then began to pick up during the second half as indicated by the growth in imports of investment goods.

8. Gross domestic savings were equivalent to 15.5 percent of GDP, in 1996, broadly unchanged from 1995. Public savings deteriorated while private savings increased as a result of higher corporate savings, especially in the plantation sector. Private transfers from abroad, amounting to 5.1 percent of GDP, continued to contribute significantly to the national saving effort, which amounted to 19.2 percent of GDP in 1996.

9. As a result of these developments, the savings/investment gap narrowed from 6.4 percent of GDP in 1995 to 5 percent in 1996, and represented an improvement of almost 3 percent of GDP from 1994. The trade deficit fell as imports of capital goods and consumer durables weakened. The service account, however, swung from a surplus recorded since 1993 to a deficit in 1996, owing mainly to a drop in tourism earnings and higher interest payments.

10. Signs of a recovery in growth emerged in the fourth quarter of 1996, as evidenced by a pickup in tourist arrivals and capital goods imports as well as an upturn in the stock market based on expectations of improved corporate profitability. Real GDP growth is hence expected to rise to 6 percent in 1997. Underpinning this projection is a recovery of agricultural output, particularly paddy, and adequate availability of hydroelectric power linked to normal rainfall and an expansion in thermal power capacity. Manufacturing output and exports are also expected to perform more strongly in 1997 as private and foreign direct investments pick up in tandem with improved business confidence. The main downside risks are related to the security situation and incidents of labor unrest. The savings/investment gap is expected to narrow further on account of improvements in public savings and continued buoyant private savings, particularly of corporations.

CHART II.1
CHART II.1

SRI LANKA: REAL SECTOR DEVELOPMENTS, 1992–96

Citation: IMF Staff Country Reports 1997, 095; 10.5089/9781451823370.002.A002

Source: Information provided by the Sri Lanka authorities.
CHART II.2
CHART II.2

SRI LANKA: INFLATION, 1993–97 1/

(In percent)

Citation: IMF Staff Country Reports 1997, 095; 10.5089/9781451823370.002.A002

Source: Information provided by the Sri Lanka authorities.1/ Colombo Consumer Price Index.

Sectoral developments

Agriculture

11. Agricultural output, which accounts for about 20 percent of GDP, fell by 4.6 percent in 1996, mainly owing to the 27 percent decline in paddy production which was severely affected by the drought. Coconut production fell by about 8 percent, but was offset by the production of tea and rubber, growing by 5 percent and 6 percent, respectively. The tea sector continued to benefit from progressive privatization of plantations and increasing efficiency gains for small plot production. Overall, plantation output fell slightly by 1 percent in 1996.

12. The sharp decline in paddy output translated into higher paddy price in the open market, which remained well above the guaranteed price during the course of the year. As a result, no purchases were made through the Paddy Marketing Board (PMB), compared to purchases of about 10 percent of the annual harvest in 1995. Sri Lanka had to import 341,000 metric tons of rice in 1996, the highest amount since 1977. This was facilitated by an import duty waiver from April 1996 to help relieve the burden on consumers.

13. The production of other field crops was mixed, with items such as potatoes, cowpeas, green gram, and sugar recording increased production. In the noncrop sectors, total fishery production declined by 4 percent, although aquaculture production increased as a result of ongoing investment. Marine fish output fell as a result of higher costs, especially fuel prices.

Manufacturing

14. Sri Lanka’s ability to maintain positive growth in 1996 despite the severe exogenous shocks was underpinned by the continued expansion of export-driven factory industries, which grew by 7.3 percent. The much smaller sub-sector of plantation crop processing grew by only 1 percent owing to input shortages, and remained concentrated on traditional products including tea, rubber, coconut, and tobacco. There has, however, been a notable increase in the production of fruit processing. Overall, manufacturing comprised about 16 percent of GDP in 1996.

15. Three major product categories contributed to over 80 percent of industrial output growth. Specifically, chemical, petroleum, rubber and plastic products grew by 14.2 percent in 1996; textile, wearing apparel and leather products grew by 5.1 percent; and the production of food, beverages, and tobacco products rose 6.9 percent in 1996. These growth rates, however, represented a slowdown from the previous year. Overall, private industrial output was estimated to have grown by 6.9 percent in 1996, down from 12.1 percent in 1995, and accounted for 90 percent of total industrial production. During this same period, public sector industrial output grew by 10.8 percent, reversing a 6.9 percent decline in 1995, owing to a significant rise in the production of the Ceylon Petroleum Corporation (CPC) after the petroleum refinery reopened following routine maintenance.

16. Overall, the growth of the manufacturing sector continued to represent mainly the expansion of Board of Investment (BOI) industries in the Export Processing Zone (EPZ). Their output expanded by 10.1 percent in 1996, mostly in textile, wearing apparel and leather products. The growth of non-BOI industries outside the EPZ was smaller at 3.7 percent, coming mainly from food, beverages, tobacco, and basic metal products.

17. Production in the EPZ was least affected by the prolonged power cuts, as these firms relied to a greater extent on their own generation of power. Over the past 2–3 years, demand for power has been increasing by about 10 percent annually, but there has not been a matching capacity expansion except for ad hoc measures to allow the expansion of thermal power generation as was the case in 1996. Private sector power generation has been encouraged by way of import duty concessions and special credit facilities through the National Development Bank and the Development Finance Corporation for the importing of generators, and by the national grid’s purchase of electricity generated by the private sector at a premium rate. In general, the government remains in favor of expanding the state-run hydroelectric power, although two concessions have been granted to the private sector to operate gas turbines and their output is expected to come on stream during the course of 1997.

Services

18. The consolidated service sector, which accounted for 52 percent of GDP, grew by 5.8 percent in real terms in 1996. The transport, storage, and communication and wholesale and retail trade activities grew faster than the previous year, up 7.5 percent and 5.2 percent, respectively. Banking, insurance, and real estate also continued to expand briskly by 10.1 percent. Insurance alone grew by 9.5 percent, and the relative size of this sector has expanded from 3.2 percent of GDP in the early 1980s to over 6 percent in 1996. Service categories recording slower growth were public administration and defense in line with fiscal consolidation; and electricity, gas, and water, which fell by 2 percent owing to a 28 percent drop in hydro-power generation.

Other

19. In 1996, mining and quarrying production rose 8.9 percent compared to 3.9 percent in the previous year, propelled by the expansion of gem mining and exports, which increased by 16 percent in SDR terms. Growth in the construction sector moderated from 4.9 percent in 1995 to 3.4 percent in 1996, linked to uncertainties over the economic situation and low business confidence. Overall, the construction and mining sectors accounted for about 9 percent of GDP in 1996.

Prices, wages, and employment

Prices

20. The deficiencies in the CCPI stemming from an outdated consumption basket and system of weights make it difficult to get a clear picture of inflation developments in Sri Lanka. The average annual rate of inflation, as measured by the CCPI increased to 15.9 percent in 1996, a sharp acceleration from 7.7 percent in 1995. Rapid monetary expansion through May 1996 fueled these inflationary pressures. In addition, the jump in the price level was associated with higher food prices, owing to the drought as well as upward adjustments of administered prices of wheat flour, fuel (including kerosene), electricity, and transport fares.

21. On a twelve-month basis, inflation peaked at 22 percent in September 1996. As the food supply situation eased and food prices fell sharply from their drought-related highs, inflation has steadily subsided, reaching 4 percent by June 1997. Although monetary policy does not appear to have accommodated the drought-induced pressure on prices, it has not succeeded in bringing down underlying inflationary pressures: nonfood price inflation remains at about 10 percent, virtually unchanged from end-1995.

22. An expenditure survey, conducted once every five years, was undertaken in 1995/96 and is being analyzed to determine the weights in an updated consumption basket to be used to construct a new consumer price index. The coverage of the survey is large and flexible enough for the construction of a wide-ranging set of indices categorized by region and income groups. It is expected that new price indices should be available by the end of 1997.

Wages

23. Following a significant wage increase in 1995 for the government civil service (especially government school teachers), civil service wages remained unchanged in 1996. Based on the recommendations of a Salary Commission, the civil service wage structure was revised in 1997. Basic pay and allowances have been merged and distortions in pay relativities are being corrected. This exercise is expected to lead to an increase in average civil service compensation by 12 percent in 1997, and by a further 14–15 percent in 1998.

24. Wages in the organized private sector, as measured by the Minimum Wage Rate Index for Workers in All Wages Boards Trades, increased on average by 8.3 percent in nominal terms.2 Wages for workers in agriculture rose by 9.3 percent, reflecting wage increases in the plantation sector. Nominal wages in industry and commerce increased by 4.8 percent while those in services rose 6.7 percent in 1996. In the unorganized sector, wages rose more sharply with those of small scale construction workers rising by 14–15 percent, of casual paddy workers by 6–13 percent, and of rubber workers by 7–14 percent.

25. In an increasing number of cases, wages are determined by collective agreements, usually at a premium over the minimum wage levels. During 1996 and the first five months of 1997, there have been several union demands for increased compensation in a variety of professions, including utility workers, doctors, and central bank personnel. In addition, owing to an increasing shortage of labor in the plantation sector, wages in the sector are likely to increase further in 1997.

Labor and employment

26. The unemployment rate was estimated to have fallen from 12 percent in 1995 to 11.6 percent by the third quarter of 1996, although overall employment creation was constrained by the slow economic activity. In 1996, the economy generated about 75,000 new employment opportunities, down from the annual average of 90,000 over the past five years. The increase in 1996 was largely on account of more job opportunities in the private sector, notably in BOI industries. Moreover, the decline in unemployment was mainly due to the growth of activities in the informal sector and increased migration for foreign employment.

27. Public employment was estimated to have fallen by 11 percent in 1996 on account of a 28 percent decline in semi-government sector employment (comprising public corporations, universities, boards, and banks, etc.) and the divestiture of ten plantation companies. However, employees in government institutions, mostly professional, technical, and related workers in the health area, rose by 2 percent over 1995. Overall, total public sector (government and semi-government) employment continued to decline during 1996.

28. Employment in BOI enterprises increased by 4 percent to 241,970 as of end-1996, representing mainly increases in employment in textile and wearing apparel industries. In the service sector, self-employed activities have been increasing, aided by the provision of credit facilities and skill upgrading through poverty alleviation programs. As for foreign employment, in spite of the fall in the Foreign Employment Bureau’s data of persons departing for overseas employment due to the adoption of voluntary reporting, the 10 percent increase in remittances in SDR terms suggested that there was an increase in foreign employment in 1996. In addition, there has been a gradual decline in labor migration to the Middle East, while the Maldives, Singapore, and Hong Kong have become more important sources of demand for Sri Lankan labor.

29. Existing labor laws and the apparatus for dispute resolution in Sri Lanka are not well-adapted for a modern, market economy. The two major regulations that continued to impede the flexibility of employment termination are the Termination of Employed Workmen Act and the Gratuity Act. Under these laws, employers must seek prior permission from the Labor Commissioner in terminating the employment of workers in the workplace of 15 or more workmen working for five years or more. Compensation is often costly and the arbitration procedure conducted by the Ministry of Labor is fraught with long delays and high administrative costs. Labor disputes in Sri Lanka have, to a large extent, been caused by the poor quality of the dialogue between employers and employees. Strike action is, therefore, usually taken as a first resort to get the government involved in resolving the differences. High labor protection also reflects a lack of fall-back position for redundant workers, owing to lack of job opportunities, linked partly to an inefficient flow of job information within the economy. In 1996, the labor situation worsened in the plantation sector, but improved in the nonplantation sector. According to the Department of Labor’s provisional estimate, the number of strikes in the plantation sector increased markedly from 94 in 1995 to 137 in 1996, linked to an increase in wage demands due to labor shortages, and delays in distributing equity shares promised to workers after privatization. In the nonplantation sector, the number of strikes declined slightly from 89 in 1995 to 87 in 1996. However, the impact of these strikes was much reduced as the number of workers involved and man days lost fell by 28 percent and 20 percent, respectively, from the levels in 1995.

B. Public Finances3

Central government finances

Budgetary developments in 1996

30. After two years of budget deficits above 10 percent of GDP, the overall deficit (excluding grants and privatization) in 1996 fell to 9½ percent of GDP, slightly lower than the 10½ percent envisaged in the budget.4 The deficit on current operations, however, amounted to 3.7 percent of GDP, higher than even the relatively unambitious target of 3.4 percent, and the highest current deficit in the 1990s. With evidence of substantial fiscal overruns by mid-1996—primarily because of military spending overruns and the expensive wheat flour subsidy, a number of corrective measures were taken in the second half of the year to keep the deficit within the target.

CHART II.3
CHART II.3

SRI LANKA: FISCAL DEVELOPMENTS, 1993–97

(In percent of GDP)

Citation: IMF Staff Country Reports 1997, 095; 10.5089/9781451823370.002.A002

Source: Data provided by the Sri Lanka authorities.
CHART II.4
CHART II.4

SRI LANKA: COMPOSITION OF EXPENDITURE, 1990–96

(In percent of current expenditure)

Citation: IMF Staff Country Reports 1997, 095; 10.5089/9781451823370.002.A002

Source: Data provided by the Sri Lanka authorities.
CHART II.5
CHART II.5

SRI LANKA: COMPOSITION OF REVENUE, 1990–96

(In percent of total revenue)

Citation: IMF Staff Country Reports 1997, 095; 10.5089/9781451823370.002.A002

Source: Data provided by the Sri Lanka authorities.
Revenues

31. Relative to GDP, the 1996 budget envisaged a small reduction in tax revenues and a larger reduction in total revenue from their 1995 levels, as the authorities recognized that the increase in revenues in 1995 was due to ad-hoc measures (especially levies on certain public enterprises) and was thus not sustainable. Total revenues turned out to be more or less in line with the budget as nontax revenue slightly exceeded its target, offsetting a small shortfall in tax revenue, an outcome which highlighted the lack of buoyancy in the tax system. The poor tax collections were mainly due to shortfalls in taxes on goods and services—including turnover taxes, excises (except those on cigarettes), import and stamp duties. While some of this shortfall is attributable to the weaker-than-anticipated levels of dutiable imports and economic activity in general, it also demonstrated the limitations of continued increases in indirect tax rates on just a few excise items as sources of additional revenue. In mid-year, in an effort to stem the fiscal deterioration, the authorities raised excise duties on liquor, cigarettes, kerosene, petrol and diesel. In addition, ad-hoc levies were imposed on two public enterprises with surpluses—the Ceylon Electricity Board and the Port Authority.

32. The shortfalls in taxes on goods and services were partly offset by higher collections of personal and corporate income taxes. The main factors boosting corporate tax receipts were the introduction of an audit system for the largest tax payers that succeeded in collecting back taxes and penalties of some Rs. 2 billion, the fact that tax holidays for several BOI registered companies had come to an end, and strong growth in the service sector. Personal income tax collections also rose, despite the increase in the exemption threshold, the widening of the tax bands, and the decrease in intermediate tax rates, owing primarily to an underestimation of the tax base.

Expenditure

33. The 1996 budget envisaged a decline in total expenditure and net lending by about 1 percent of GDP from 1995, entirely on account of reductions in current spending. In the final outcome, total expenditure fell by two percent of GDP, about evenly split between current spending and capital expenditure and net lending. Within current spending, the largest reduction came from military expenditure—although the reduction was considerably smaller than planned in the budget—as the large imports of military equipment in 1995 were not repeated. The reduction in other categories of current spending was due to the following factors:

  • Stricter controls on hiring together with the overestimation of the number of civil servants and military personnel eligible for wage increases contributed to a small decline in the wage bill.

  • Expenditure on goods and services (e.g., vehicles, fuel, office supplies, utilities and travel) fell as a result of tighter controls on imprest payments, combined with an effort to cut spending on vehicles, fuel, office supplies, utilities and travel.

  • Welfare payments under the Samurdhi program (which increase with the size of the household) turned out to be lower than expected because the average size of households proved smaller than originally estimated.

  • Pension payments were lower-than-expected owing to a smaller number of retirees than estimated.

34. These reductions were partly offset by the overrun in wheat flour subsidy, which would have been higher still had the authorities not raised prices in successive steps in the second half of the year. Combined with declining world wheat prices toward the end of the year, these price adjustments succeeded in reducing the subsidy to a relatively small amount by end-year.

35. Continuing the declining trend of recent years, capital spending and net lending fell by about 1 percent of GDP. In part, this trend is attributable to delays and weaknesses in project implementation, but a structural shift also appears to be under way away from large-scale capital projects towards smaller less expensive projects in the education and health sub-sectors. Furthermore, a larger share of physical infrastructure development is expected to be financed with private sector participation.

Financing and debt

36. Net external financing of the budget deficit amounted to only 1.4 percent of GDP instead of the 2.5 percent budgeted, mainly reflecting the above-mentioned weaknesses in project implementation. Net domestic financing was 7 percent of GDP, roughly in line with the budget target but much larger than the 1995 level of 5½ percent of GDP. The composition of domestic financing was, however, dramatically different from the budget plan, because only Rs. 4.7 billion of the Rs. 21 billion of expected privatization receipts was realized. As a consequence, the authorities were not able to adhere to their plan of not resorting to net bank financing, which amounted to Rs. 12.3 billion, equivalent to 5 percent of money supply at end-1995 and about 1½ percent of GDP—the highest level in the 1990’s. In addition, the statutory limit on outstanding treasury bills of Rs. 125 billion was reached in October 1995. The authorities decided not to raise this limit, as had been done in the past, but resorted instead to non-market “administrative borrowing” (equivalent to about 1 percent of GDP) from public enterprises with surpluses.

37. Total public debt rose to over Rs. 700 billion by end-1996, but fell as share of GDP to 92 percent from 97 percent of GDP in 1995. Domestic debt accounted for about 49 percent of total public debt outstanding. The decline in the debt ratio was on account of foreign debt, which rose only marginally as a result of weak project implementation and higher amortization payments. The movements of the yen-dollar exchange rate during the year resulted in a reduction in the value of the yen-denominated debt. Notwithstanding the fact that Sri Lanka continued to benefit from high levels of concessional foreign aid, interest payments on total public debt still represented a serious burden on the budget and absorbed approximately one-third of total tax revenues.

The 1997 budget

38. Building on the efforts to regain control over public finances in 1996, the 1997 budget targets a reduction in the overall deficit to 7.8 percent of GDP, and a reduction in the deficit on current budgetary operations to 1½ percent of GDP. As in the 1996 budget, a reduction in current spending is to account for virtually all of the decline in the deficit, as total revenue is budgeted to remain broadly unchanged at 19 percent of GDP and capital spending and net lending was projected to increase slightly.5 The lower deficit is envisaged to permit the elimination of bank financing, and privatization receipts above the conservatively budgeted amount of Rs. 5 billion will be used to retire public debt.

39. The main measures included in the budget plan are listed in Box II.1. In addition, the expenditure projection is predicated on the elimination of the wheat flour subsidy, implying a saving of 0.6 percent of GDP. Military expenditure is to be reduced by 1 percent of GDP as the build-up of arms of the previous two years is wound down. Transfers to public corporations are projected to fall by 0.7 percent of GDP as a result of tariff increases and related improvements in their financial performance, as well as the divestiture of several loss-making plantations.

40. As part of an exercise to correct distortions in pay relativities, civil service wages and allowances were raised by an average of 12 percent. To contain the budgetary impact of this wage increase, stricter controls on hiring, resulting in an employment freeze, are envisaged to continue. The budget also includes a further consolidation of social welfare programs, although the budgetary impact of this measure is expected to be small. Finally, the budget speech stated that the National Security Levy would be increased if military expenditure escalates beyond the budget level.

Public enterprises

41. Prior to the major reorientation of economic policies in Sri Lanka in 1977, the public enterprise sector is estimated to have accounted for the major part of GDP and about 20 percent of the country’s labor force. Following a series of reforms aimed at the gradual reduction in the public enterprise sector’s role in the economy, it is estimated that, in the early 1990s, the sector accounted for less than 20 percent of GDP. The public enterprise sector consists of between 200 and 250 entities, including 49 fully-owned government companies (in which the government is the sole owner), 38 subsidiary government companies (in which the government owns either a majority or a minority stake), 42 commercial corporations (which do not rely on the budget for financing), and 104 statutory boards (educational and research institutions, agricultural research and extension, and other agencies engaged in diverse activities).

Key Revenue and Expenditure Measures in the 1997 Budget

On the revenue side, several measures were implemented to secure the planned revenue-GDP ratio of 19 percent, of which the major ones are:

¶ A 1 percentage point increase in the 6 and 10 percent turnover tax rate bands as an interim step before implementation of the GST.

¶ The imposition of mandatory withholding of income taxes by employers.

¶ The inclusion of public sector employees, other than civil servants, in the income tax net.

¶ An unification of exemption thresholds for different types of income (previously at Rs. 100,000 and Rs. 144,000) at the higher level of Rs. 144,000 and a widening of the tax bands from Rs. 35,000 to Rs. 100,000 for personal income taxes.

¶ The closing of a number of corporate income tax loopholes.

¶ The replacement of several specific taxes and duties by ad-valorem taxes.

¶ The imposition of a minimum customs duty of 5 percent on a number of imports that were previously exempt

¶ The 1 percentage point increase in contribution rates for the Widows and Orphans Fund within the civil service pension scheme.

¶ The announcement of a contingency measure—an increase in the broad-based sales tax termed the national security levy, currently at 4½ percent—should military expenditure overshoot its target.

On the expenditure side, the important measures announced in the 1997 budget are:

¶ An exercise to correct distortions in pay relativities between civil service salary grades, which was estimated to result in an average increase in the wage bill of 12 percent in 1997 and 15 percent in 1998.

¶ An increase in pension payments by 5 percent.

¶ A 20 per cent across-the-board cut in expenditure estimates by all spending agencies, excluding funds allocated for health and national security.

¶ A freeze in the budget provisions for the purchase of motor vehicles together with stepped-up expenditure control and monitoring procedures.

¶ New expenditure programs include an enterprise credit scheme under the Samurdhi welfare program; community development projects; credits for self-employed youths; and the restructuring of renationalized or failed privatization companies.

Investment promotion measures include:

¶ Tax concessions, mainly through accelerate depreciation and the introduction of investment tax credits, envisaged to stimulate export-oriented investment.

¶ Fiscal incentives for advanced technology investment, including duty free imports for existing and new companies investing in advanced technology machinery and equipment.

¶ Reduction in the National Security Levy on machinery and equipment from 2 percent (compared to the standard rate of 4½ percent on non-capital goods) to ½ percent.

¶ Extension of tax holidays for investment and employment creation in backward areas.

42. In the first half of the 1990s, about 40 enterprises were privatized and a restructuring program was implemented to increase the managerial autonomy and efficiency of important public enterprises. For example, the Sri Lanka Telecommunications Department was converted into a corporation and the Sri Lanka Railways into a semi-autonomous authority.6 In March 1995, the new government established the Public Enterprise Reform Commission (PERC) to reformulate and accelerate the privatization program. Out of the total of 100–150 public enterprises, 47 were targeted for full or partial divestiture over a three-year period. In the first two years of the program, the program has fallen somewhat short of its goals, both in terms of the number of enterprises that have been privatized—23 of the 47—and in terms of receipts. This outcome is generally attributable to the unfavorable investment climate following the deteriorating security situation and the adverse supply shocks faced last year. Total receipts from the 23 privatized companies were Rs. 8.2 billion, well short of the target of over Rs. 40 billion. Almost half the receipts were accounted for by the three sales to foreign investors (Colombo Gas Company, Orient Lanka which runs the duty-free shops, and Ceylon Steel Corporation).

43. The program to divest the tree-crop plantation companies has perhaps been the best organized and the most successful part of the overall privatization exercise that started in 1995. It is expected that the divestiture program in this sector will be completed by end-1997. The modalities of the divestiture of plantations has been an initial all-or-nothing sale through the stock market of 51 percent of shares to a single investor, and distribution of another 10 percent free of charge to plantation workers. When the Government divests an additional 20 percent, the plantation can be listed on the stock exchange. The experience with the privatized plantations, albeit brief, has been positive, as more efficient management and favorable prices for tea and rubber have resulted in improved profitability.

44. The passage of the Rehabilitation of Public Enterprises Act in 1996 under which the government “renationalized” companies where the privatization process was deemed to have failed has been seen as a matter of some concern by the investment community. The definition of “failure” in this context related to behavior of privatized firms that was deemed not to be in the national interest, and included retrenchment of labor, nonpayment of workers in these companies, and other actions judged to be in violation of the rights of workers. In view of the concerns expressed by the investment community about the underlying commitment and basic philosophy of the government to turn over responsibility unequivocally and cease government intervention in privatized companies, the Government has stated that this legislation would apply in the first instance only to the 6 identified “failed privatizations” and that, in any event, these are to be offered for sale once they are rehabilitated.

C. Financial and Monetary Developments7

Financial system overview8

45. Sri Lanka’s financial system includes the Central Bank of Sri Lanka, 26 commercial banks (18 of which are branches of foreign banks), the National Savings Bank (NSB), three merchant banks, two development finance institutions, a state mortgage investment bank, and other nonbank financial institutions. The banking system is dominated by the two large state-owned commercial banks which together have a market share of about 60 percent. Long-term financial resources are mobilized mainly by the two large provident funds, the Employees’ Provident Fund and the Employees’ Trust Fund and five insurance companies. The main money markets are the increasingly active interbank call market and the primary market for Treasury bills; the secondary market for treasury bills is still concentrated in the Central Bank of Sri Lanka (CBSL). The major capital market is the Colombo Stock Exchange.9

46. Considerable progress has been made since the late 1980s in laying the foundation for a modern financial system, but many structural impediments remain. The bombing of the CBSL in January 1996 was a serious setback to ongoing reform efforts. Important recent reforms have been aimed at freeing up and deepening the market for government securities, notably by permitting the “captive sources”, i.e. the NSB and the provident funds, to purchase securities directly in the auctions, and by expanding the range of instruments and maturities offered. The CBSL has also strengthened the system of authorized primary dealers, introduced in 1992, in the hope of speeding up the development of a secondary market.

47. An important step was the NSB Amendment Act of 1995 which gave the NSB management the authority to set interest rates free from political interference. The NSB was further permitted to purchase government securities directly in the auctions, and the subsidy the NSB had been receiving to cover the difference between its savings rates and the interest on government securities was abolished in 1996. Before this change, due to its wide branch network (97 branches but also the services of 500 post offices and 3,500 post office agencies), the rates the NSB paid tended to place a floor under all deposit rates.

CHART II.6
CHART II.6

SRI LANKA: MONETARY AGGREGATES, 1994–97

Citation: IMF Staff Country Reports 1997, 095; 10.5089/9781451823370.002.A002

Source: Data provided by the Sri Lanka authorities.
CHART II.7
CHART II.7

SRI LANKA: INTEREST RATES, 1995–97

(In percent)

Citation: IMF Staff Country Reports 1997, 095; 10.5089/9781451823370.002.A002

Source: Data provided by the Sri Lanka authorities.1/ Weighted average.

48. In March 1997, the CBSL started auctions of two-year treasury bonds. These longer-term coupon instruments complement the treasury bills, which are discount instruments and have maturities up to one year. In May 1997, the auctions were expanded to include four year bonds. It is envisaged that treasury bonds will gradually displace the “rupee loans”, privately placed with captive sources, which are presently the most important debt instrument (at end-1996, 60 percent of domestic public debt consisted of rupee loans, 35 percent of treasury bills, and 5 percent of CBSL advances).

Monetary policy and developments

49. Over the course of 1996 and the beginning of 1997, there was a switch in the CBSL’s focus in conducting monetary policy. For much of 1996, its major concern was to restrain excessive monetary expansion, and to resist requests for liquidity support from the banks. Early in 1997, the CBSL eased the stance of monetary policy in order to stimulate the economic recovery. Economic activity had slowed in early 1996, due to the effects of the prolonged drought on agriculture and power generation, and the erosion of business confidence in the wake of a spate of acts of urban terrorism.

50. The main instrument of monetary policy is open-market type operations in treasury bills with which the CBSL influences reserve money growth in line with its desired monetary stance. Through May 1996, reserve money grew rapidly (the annual growth rate peaked at 24 percent in May), initially mostly due to the build-up in net foreign assets and later due to substantial increases in CBSL claims on government. In the second half of 1996, the decline in net foreign assets offset part of the increase in claims on government, and the growth in reserve money slowed sharply to 8.8 percent for the 12 months through December 1996. As a result, for most of the latter part of 1996, reserve money was well below the monthly targets that had been set by the CBSL. Concerned about the inflationary impact of the earlier expansion and the drought-induced food price increases, and uncertain about the budgetary out turn, the CBSL nonetheless decided not to relax its monetary stance.

51. Specifically, in the middle of 1996, the CBSL resisted requests from banks for relief with liquidity shortages they were experiencing due to a sudden increase in the amount of nonperforming loans. Instead, at regular monthly meetings with commercial bankers, the CBSL emphasized the importance of maintaining sound banking practices. This apparently changed banks’ behavior, as they became more cautious about lending and more vigorous about collection. This supply factor compounded the already weak demand for credit, and private sector credit growth was weak for the rest of 1996 (the annual growth rate was only 8.2 percent in December 1996, compared to 28.2 percent in December 1995).10

52. The growth of broad money closely reflected that of reserve money, peaking in March at 22.4 percent annual growth, before slowing to 10.8 percent by December 1996, and further to 9 percent by March 1997. Velocity throughout 1996 and early 1997 was broadly at the level of 1995.

53. Towards the end of 1996, the CBSL became convinced that the inflationary pressures had abated, partly because the 1996 budget out turn was better than expected and the growth of monetary aggregates had decelerated sharply.11 It therefore decided to support the economic recovery by sending a signal to banks that lower interest rates were in order, and for that purpose it lowered the statutory reserve requirements. In January, the requirements on rupee time and savings deposits were lowered from 15 to 14 percent, and in March further from 14 to 12 percent.12 The CBSL considered this move desirable for structural reasons, given that the requirements are quite high and are unremunerated, and given its commitment to rely more on open market operations in its conduct of monetary policy. Furthermore, non-BOI exporters were permitted (within an overall ceiling) to obtain foreign currency loans (BOI exporters already had that privilege).

54. The lowering of the reserve requirements had no immediate impact on the growth in monetary aggregates. For the most part, the banks invested the liquidity released in treasury bills through the CBSL repurchase facility, and in the secondary market for Treasury bills the CBSL operates. Furthermore, the steady decline in net foreign assets continued to drain liquidity from the banking system. By end-March 1997, annual growth in broad money was down to 9.0 percent, and in private sector credit to 6.3 percent.13 The cut in reserve requirements, amplified by moral suasion, did, however, have a direct impact on bank interest rates.

55. Short-term interest rates in Sri Lanka are heavily influenced by government cash management. The three-month treasury bill rate is the benchmark rate for most other short-term rates, including the official rates. Typically, in the first quarter of the year, when the government takes advantage of the increase in the limit of its overdraft facility with the CBSL (which is set at 10 percent of the previous year’s revenue), and when the CBSL transfers its profits, relatively few treasury bills are auctioned and their yield drops sharply. In 1996, the 3-month Treasury bill rate dropped from 19 percent at the beginning of the year, to 13 percent in May, before returning to 18 percent by year-end. A steadier, market determined rate, but one that is also influenced by risk factors, is the weighted average prime lending rate. This rate stayed in the 17 to 19 percent range throughout 1996.

56. When the CBSL first lowered reserve requirements in January 1997, it made it clear to the banks that it felt monetary conditions permitted a lower interest rate. The banks responded by lowering their prime lending rates immediately and, with a delay, their deposit rates; by March, lending rates had dropped about 2½ percentage points. The treasury bill rate’s seasonal drop was especially pronounced in early 1997, with rates decreasing from 18 percent end-December to 13 percent end-February, and further to 10½ percent by end-May 1997. By May, the CBSL judged the interest rate drop had gone too far and it started to push short-term rates upward by raising its repo rate.

Banking system soundness

57. There are increasing signs of fragility in Sri Lanka’s banking system. The Central Bank of Sri Lanka conducts off-site supervision on the basis of monthly returns, and on-site inspections at least once every two years. Banks are required to prepare their financial statements in line with CBSL guidelines for interest suspension, loan classification and provisioning, and must meet a risk-weighted capital adequacy ratio of 8 percent, defined in line with the Basle standards. The prudential guidelines are less stringent than accepted international norms: loans must be classified as nonperforming, and interest suspended, when they are 90 days past due, but provisioning is required only if the loans are past due more than 180 days, and then at only 20 percent.14

58. Financial statements based on these guidelines shows that the ratio of nonperforming loans to total advances is high for all banks, but especially so for the two state-owned commercial banks (despite the latest official support) (Table II.1). As government securities and statutory reserves comprise a high proportion of banks’ assets, the ratio of nonperforming loans to total assets is significantly lower. One of the SCB’s is below the Basle ratio of 8 percent for risk-weighted capital adequacy, and while most private banks meet the ratio, it should be noted that 8 percent is generally regarded a minimum, and that under more stringent rules for loan classification and provisioning the ratio would be reduced.15 Furthermore, some of the smaller private banks are significantly weaker than the five largest ones.

Table II.1.

Indicators of Bank Performance

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Source: Central Bank of Sri Lanka.
Table II.2.

State Commercial Banks—Performance Targets

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Source: Central Bank of Sri Lanka.

Provisional.

59. The available data on the composition of bank lending shows a concentration in short-term lending for commercial purposes. Lending for housing (which includes business premises and property development) grew by 26 percent in the 12 months to September 1996 but by December 1996 it had actually contracted. Industrial lending also contracted in the last quarter of 1996.

State commercial banks

60. Competition in the banking sector continues to be hampered by the dominance of the two largest banks, the Bank of Ceylon (BOC) and the People’s Bank (PB), which are state owned. The market share of these state-owned commercial banks (SCBs) has been remarkably stable, at about 60 percent of total banking system assets, despite the establishment of new banks and branches of foreign banks over the past decade. The SCBs are affected by a multitude of problems, several of them attributable to them being state-owned. The government frequently intervenes in their decision making, forcing them to make loans which are not commercially viable; salaries, especially for clerical and lower level staff, are excessively generous compared to the private sector; they are overstaffed; their incentive structure is not conducive to good performance by management and staff; and the branch networks are too wide.

61. The problems of the SCBs have an adverse impact on their financial condition and have necessitated two major official support operations in recent years. In 1993, the SCBs were recapitalized at a cost of Rs. 24.1 billion (3.4 percent of GDP) so that they could meet the 8 percent capital adequacy requirement. The operations of the banks was not fundamentally improved, and government-directed lending persisted. As a result, in 1996 the government was forced to issue bonds equivalent to Rs. 19.4 billion (1.8 percent of GDP) to cover the costs of loans it had guaranteed.16

62. The 1993 recapitalization prompted the establishment of performance agreements setting profitability and cost targets. The results of these agreements were mixed: it appears that the BOC has been meeting the profitability target (defined as the return on assets of the private domestic banks), while the PB has been substantially below;17 both banks complied with the requirement to enforce a hiring freeze for all except specified skill positions and to keep their total number of staff below December 1991 levels; both banks exceeded the employee-to-total-assets ratio of the private banks; and both banks failed to observe the limit on the number of branches as per December 1991.

63. Another initiative to improve the commercial orientation of the SCBs was the drafting of amendments to the BOC Ordinance and the PB Act which would enable the two banks to function as autonomous commercial banks by increasing the focus on profitability, leveling the playing field with the private banks, minimizing government intervention in credit decisions, increasing managerial autonomy, and increasing their authorized share capital. Because they were seen as precursors to privatization, these amendments met with stiff opposition in Parliament in 1996 and were subsequently withdrawn.

D. Balance of Payments and External Debt18

Overall developments

64. Sri Lanka’s overall balance of payments shifted into a small deficit in 1996 after several years of surplus. The shift from a surplus equal to 0.2 percent of GDP in 1995 to a deficit equal to 0.1 percent of GDP represents a continuation of a deterioration of the overall balance that has taken place since 1993, albeit at a slower rate.19 Underlying this movement is a shrinking current account deficit (from 6.4 percent to 5 percent of GDP between 1995 and 1996) that was more than offset by reductions in net capital inflows. Gross international reserves fell by SDR 37 million, dropping from a level equal to 4.8 months of imports to 4.3 months of imports.

65. The Central Bank of Sri Lanka pursued exchange rate policies in 1996 that may have contributed to the deterioration of the overall balance. The Central Bank, which sets its buying and selling rates against the U.S. dollar, held these rates steady in the early months of 1996, resulting in an increase in the real effective exchange rate. This was done in part as a signal to maintain confidence in financial markets following the disruption caused by the bombing of the Central Bank in January 1996. In mid-1996, the Central Bank allowed the exchange rate to resume its nominal depreciation against the dollar, but increases in the value of the dollar relative to other currencies (in particular the Japanese yen) resulted in a further appreciation of the real effective exchange rate. For the twelve months through December 1996, the nominal effective exchange rate depreciated by 1.2 percent while the real effective exchange rate appreciated by 12.4 percent. However, any assessment of the role of the exchange rate on the balance of payments is complicated by the need to disentangle its effect from the 1996 drought, the intensification of the ethnic conflict, and other shocks to the economy.

Current account transactions

66. The current account deficit fell from SDR 541 million in 1995 (6.4 percent of GDP) to SDR 484 million (5 percent of GDP) in 1996. The decrease in the current account deficit is composed of a decline in the trade deficit and an increase in the surplus on private transfers, partially offset by a shift into deficit on the services balance.

67. Sri Lanka’s trade deficit shrank from SDR 998 million in 1995 (11.7 percent of GDP) to SDR 909 million in 1996 (9.5 percent of GDP). The SDR value of exports and imports grew by 12.7 percent and 6.6 percent respectively, somewhat faster than in 1995 when exports grew by 12 percent and imports by 5.3 percent. These growth rates for exports and imports were much slower in both 1995 and 1996 than in 1992–94 period when both import and export volumes were growing at average rates well into the teens. The growth in export volume decelerated further to 3.9 percent in 1996 from 7.1 percent in 1995. This slowdown was partly offset by increases in the export value of tea, which experienced a 33 percent price increase. There was little change in either the value or volume of traditional exports other than tea (rubber, coconut products, and gems). The growth in the value of garment and other industrial exports also slowed to 9.5 percent in 1996, down from 12.6 percent in 1995.20

CHART II.8
CHART II.8

SRI LANKA: EXTERNAL SECTOR INDICATORS, 1992–96

Citation: IMF Staff Country Reports 1997, 095; 10.5089/9781451823370.002.A002

Source: Data provided by the Sri Lanka authorities.1/ Excluding official transfers.
CHART II.9
CHART II.9

SRI LANKA: EXCHANGE RATE INDICES, 1983–97

(January 1989=100)

Citation: IMF Staff Country Reports 1997, 095; 10.5089/9781451823370.002.A002

Source: IMF, International Financial Statistics, Information Notice System; and Bloomberg.

68. The reasons for the slowdown in the growth of exports are not entirely clear. As noted above, it is difficult to disentangle the effects of the real appreciation from those of the drought and other shocks. Growth in demand in major export markets remained steady and does not appear to have been a factor in the export slowdown. However, delays in trade liberalization and other structural reforms may have contributed to the slowdown of export growth, affecting import growth as well because of the high import content in Sri Lanka’s exports.

69. The volume of imports was largely unchanged in 1996, rising from 2.3 to 3.0 percent between 1995 and 1996. There was little change in the composition of broad categories of imports; the shares accounted for by food and fuel rose slightly, textile fabric and investment goods shares were largely unchanged, while shares of other intermediate and consumer goods fell slightly. At a more detailed level, the two most noteworthy changes were both attributable to the drought—there was a more than thirty-fold increase in rice imports to compensate for the poor harvest, and a sharp increase in machinery and equipment imports partly attributable to imports of generators used to replace hydroelectric power.

70. There was little change in the direction of trade between 1995 and 1996. Exports to the United States and the European Union continued to account for the bulk of Sri Lanka’s exports, although the share of exports to each of these markets dropped slightly to 34 percent and 30 percent respectively. The sources of Sri Lanka’s import continued to be widely diversified, with Asia (other than Japan) continuing to account for 50 percent of imports in 1996.

71. In contrast to the trade balance, the balance on services deteriorated in 1996, shifting from a surplus of SDR 9.8 million in 1995 to a deficit of SDR 67.8 million in 1996. The shift can be explained in almost equal measure by a decline in services receipts and an increase in services payments. The decline in services receipts from 1995 is attributable to a decline in travel and tourism receipts related to the intensification of the ethnic conflict, and a decline in interest receipts (primarily the interest income of the Central Bank). The most important factor behind the increase in services payments was an increase in interest payments largely attributable to the full year effect of increases in nonconcessional government related to military imports in 1995. Payments and receipts in other services categories registered little change between 1995 and 1996.

Capital account transactions

72. Net capital inflows into Sri Lanka, including transactions of Sri Lankan commercial banks, fell SDR from SDR 468 million in 1995 to SDR 324 million in 1996. This can be explained primarily by a decline in disbursements of medium and long-term loans to the Government of SDR 127 million in 1996, as large borrowing associated with military imports in 1995 was not repeated in 1996. Concessional disbursements to the Government were largely unchanged from 1995 and earlier years. The net foreign assets of commercial banks declined by SDR 50 million, as an increase in nonresident deposits was not matched by a corresponding increase in liquid balances held abroad. Other loan transactions showed little change from 1995; disbursements of loans to private borrowers as well as net private short-term capital inflows fell slightly, while amortization of both Government and private loans increased slightly.

73. Inflows of nonloan capital increased in 1996 by SDR 54 million to SDR 87 million, reversing much of the decline experienced in 1995. Within this inflow, privatization proceeds were largely unchanged, portfolio flows in the stock exchange shifted from a small outflow to a small inflow, and direct investment (primarily in services and the garment industry) rose from SDR 10 million in 1995 to SDR 60 million in 1996. Although this increase in direct investment is large in percentage terms relative to 1995, the net inflow in 1996 remains well below those of years in the early 1990s.

External debt

74. Sri Lanka’s external medium- and long-term debt, including debt to the Fund, grew by only 1 percent in nominal SDR terms in 1996. Relative to GDP, external debt declined from 66 percent to 59 percent. There was a similar decline in external debt relative to exports of goods and nonfactor services, which fell from 184 percent to 169 percent of GDP. In contrast, the ratio of debt service to goods and services exports rose from 13.9 percent in 1995 to 14.7 percent in 1996, reflecting debt service payments for military imports.

75. Several factors were behind the decline in debt relative to GDP. First, the slowdown in disbursements relative to a growing economy contributed to an acceleration in an already dropping level of debt relative to GDP. Second, the real appreciation of the Sri Lankan rupee resulted in an increase in Sri Lanka’s SDR-denominated GDP above the level that would result from Sri Lanka’s real GDP growth alone. Third and finally, the changes in the levels of partner currencies against the SDR in 1996 resulted in a reduction in the SDR value of existing debt. In the case of bilateral official debt to Japan, Sri Lanka’s largest bilateral creditor, the debt stock fell by SDR 79 million in spite of net disbursements from Japan equal to SDR 60 million.

Exchange and trade system

76. Sri Lanka’s exchange system was little changed in 1996. Sri Lanka accepted the obligations of Article VIII, Sections 2, 3, and 4 on March 15, 1994 and maintains an exchange system free of current restrictions. Capital inflows are largely unrestricted as are capital outflows of profits or repatriation of capital from investment in Sri Lanka. Other capital outflows are generally restricted unless related to economic activity in Sri Lanka (e.g., investments in sales promotion offices abroad). Detailed descriptions of the status and developments in the exchange system may be found in the Annual Report on Exchange Arrangements and Restrictions, 1996.

77. Sri Lanka’s trade policy regime was also little changed in 1996. The tariff system introduced in February 1995 with three non-zero rates of 35, 20, and 10 percent remained unchanged in 1996. Some products were shifted to lower bands and temporary duty waivers were introduced for rice and generators in response to the drought-induced decline in harvests and hydroelectric power shortages. A few products (other than the zero-rated items) remained outside the three-band system. The effective import duty collection rate fell from 10.1 percent to 8.8 percent between 1995 and 1996, reflecting these tariff reductions and waivers and the continued expansion of the export processing zone program. There are no export taxes in Sri Lanka, although exports of some agricultural and mineral items are subject to (mostly minor) royalties and other fees with some of the characteristics of user fees. For example, a 10 rupee (U.S. $0.18) royalty is charged by the Department of Wildlife on the export of an elephant and an export fee (cess) is charged on rubber for the benefit of the rubber replanting scheme.

78. Sri Lanka’s exports and imports remained largely free of licensing or other quantity controls apart from those import licensing requirements imposed for environmental, public health, phytosanitary, or public security reasons.21 The principal exceptions to this policy at the beginning of 1996 were import licensing requirements on potatoes, onions, and chilies (all three of which were removed in July 1996) and import licensing requirements on maize, wheat and wheat flour. The import licensing requirements on wheat, wheat flour, and maize relate to the Government’s contractual obligations to supply grain to a foreign-owned flour miller in Sri Lanka. Sri Lanka also maintains export quotas on textiles and apparel used to implement bilateral quotas under the Multi-Fiber Arrangement.

79. Sri Lanka is a participant in a number of regional trading arrangements, the most important of which is the South Asian Preferential Trading Arrangement (SAPTA). Under SAPTA, more than 1,700 items have been granted tariff concessions by all seven members (Bangladesh, Bhutan, India, the Maldives, Nepal, Pakistan, and Sri Lanka) on a most-favored nation basis. During 1996, Sri Lanka obtained new import tariff concessions from its SAPTA partners on a additional 67 items. The medium-term goal of SAPTA negotiations is to move toward the formation of a South Asian Free Trade Area (SAFTA). In May 1997, the target date for implementation of the SAFTA was moved up from 2005 to 2000.

1

See Appendix Tables 1 to 13, and Charts II.1 and 2.

2

The wage rates used for index calculation are minimum wages for different blue-collar trades fixed by the Wages Boards. As of 1996, there were 28 active wages boards.

3

See Appendix Tables 14 and 20, and Charts II.3 to II.5. The structure of the public sector is described in Sri Lanka: Selected Issues, SM/96/182.

4

The definition of the overall deficit in official budget documents treats privatization receipts as negative net lending rather than financing. By this definition, the 1996 budget deficit target was 7.8 percent of GDP.

5

Legislation for the introduction of a Goods and Services Tax (GST) was passed in October 1996. The 1997 budget plan did not explicitly include any revenue from the GST as preparations are still under way for its introduction.

6

A more detailed description of these developments during the first half of the 1990s was included in Sri Lanka: Selected Issues, SM/96/182.

7

See Appendix Tables 2 to 25, and Charts II.6 and II.7.

8

For a description of recent financial sector reforms, see Sri Lanka: Selected Issues, SM/96/182.

9

End-1996, it had 227 listings and a total capitalization of 15 percent of GDP (US$1.8 bln.), while turnover that year was equal to 1 percent of GDP.

10

These credit growth numbers are not strictly comparable because of the substitution of government bonds for bad loans in the SCBs in October of 1996 (see below). This operation had the effect of lowering “claims on private sector” and increasing “other assets (net)”. Without the bonds operation, annual private sector credit growth would have been 11.4 percent in December 1996.

11

The ceiling of Rs. 125 billion on outstanding treasury bills was reached by October, and no attempt was made to ask Parliament to raise it. The Government resorted instead to administrative borrowing, i.e. from government departments and agencies in the amount of Rs. 7.6 billion (about 1 percent of GDP). Nevertheless, there may have been some tightening in the government’s financing constraint, contributing to the better fiscal outturn.

12

Also, in January, the 5 percent reserve requirement on foreign currency deposits placed abroad was eliminated, and, in March, the requirements on foreign currency deposits lent domestically was reduced to 12 percent, to bring them in line with those on domestic currency deposits.

13

Without the effect of the October 1996 bonds issuance, the private sector credit growth in March 1997 would have been 12.5 percent.

14

An widely accepted rule internationally is at least a 20 percent provision for loans that are past due more than 90 days, and at least a 50 percent provision for those that are past due more than 180 days. See, for instance, Bank Supervision Guidelines, Financial Policy and Systems Division, World Bank, August 1992.

15

The 8 percent ratio was developed for internationally active banks in G10 countries. In practice, reputable banks in these countries maintain ratios of between 10 and 12 percent. See, “Non-G10 Countries and the Basle Capital Ratio: How Tough it is to Join the Basle Club” by C. Dziobek, O. Frecaut, and M. Nieto, International Monetary Fund, PPAA/95/5, March 1995.

16

Whereas the 1993 support operation was a straightforward recapitalization, involving the exchange of 30-year bonds for equity, the 1996 operation consisted of the issuance of 10-year bonds (at 14 percent interest p.a.) to cover capital and interest outstanding on government guaranteed non-performing loans. The banks remained responsible for the bad loans and are required to redeem the bonds as they collect on those loans. The government also issued Rs. 4.5 billion (0.4 percent of GDP) in bonds to the NSB, to compensate that bank for having to pay a higher rate on its deposits than it was earning on government securities.

17

It appears, however, that income is significantly overstated as it includes accrued interest on nonperforming loans.

18

See Appendix Tables 26 to 37 and Charts II.8 and II.9.

19

The discussion of the overall balance here reflects the Fund staff definition of the overall balance with changes commercial banks’ assets included above the line, rather than on the Central Bank of Sri Lanka’s definition which places this item below the line.

20

There are difficulties in measuring the volume and unit value of garment exports and other nontraditional exports with existing indices because of changes in the product mix within these categories.

21

There are four minor export licensing requirements on ivory, coral, certain wood and wood products, and passenger motor vehicles registered in Sri Lanka before 1945. Export of certain antique manuscripts is prohibited

Sri Lanka: Selected Issues
Author: International Monetary Fund