Sri Lanka
Recent Economic Developments

This paper reviews economic developments in Sri Lanka during 1996–98. After slowing to 4 percent in 1996, economic growth recovered to 6½ percent in 1997. The slowdown in 1996 had been mainly owing to a severe drought that affected the agricultural sector and disrupted the power supply. The recovery in 1997 was strongest in agriculture and manufacturing, supplemented by continued good performance in the services sector, including a rebound in tourism. In addition, significant accomplishments were achieved in economic restructuring, including several successful privatizations and an initial step toward fiscal adjustment.


This paper reviews economic developments in Sri Lanka during 1996–98. After slowing to 4 percent in 1996, economic growth recovered to 6½ percent in 1997. The slowdown in 1996 had been mainly owing to a severe drought that affected the agricultural sector and disrupted the power supply. The recovery in 1997 was strongest in agriculture and manufacturing, supplemented by continued good performance in the services sector, including a rebound in tourism. In addition, significant accomplishments were achieved in economic restructuring, including several successful privatizations and an initial step toward fiscal adjustment.

I. Introduction

1. Over the last two decades, Sri Lanka’s economy has grown at an average of about 4 percent per year, with erratic performance from year to year. While progress has been made in increasing the outward orientation of the economy since steps toward market liberalization were initiated in 1977, several significant macroeconomic and structural constraints continue to hamper economic performance. These include low rates of savings and investment—with limited domestic resources absorbed by persistently high fiscal deficits—and rigidities in the labor market. Fiscal consolidation has, in turn, been slowed by delays in addressing the need for fundamental structural reforms in the areas of civil service and pensions. Finally, inefficiencies in the banking system have also been a drain on public finances (in order to recapitalize state banks), and have reduced the overall effectiveness of financial intermediation.

2. The on-going civil conflict continues to absorb the attention of policy makers and to affect economic performance. Meanwhile some progress has been achieved in re-establishing normal life in the North and the government continues to focus on forging a domestic political consensus on the greater devolution of authority as a means of resolving ethnic tensions.

3. After slowing to 4 percent in 1996, economic growth recovered to 6½ percent in 1997. The slowdown in 1996 had been mainly due to a severe drought which affected the agricultural sector and disrupted the power supply, affecting manufacturing and other economic activity. A deterioration in the security situation had also reduced business confidence and tourism, though manufacturing exports had continued to grow. The recovery in 1997 was strongest in agriculture and manufacturing, supplemented by continued good performance in the services sector, including a rebound in tourism. In addition, significant accomplishments were achieved in economic restructuring, including several successful privatizations and an initial step toward fiscal adjustment.

4. This paper provides background information on economic developments and key policy issues. The main economic developments in 1997 and the first quarter of 1998 are discussed in Chapter II. Sri Lanka’s recent experience in trying to sustain its history of strong performance with respect to social issues is discussed in Chapter III. Background information on key policy issues facing the authorities are elaborated on throughout the paper in the form of text boxes and more detailed annexes. These topics include labor market reform, the pension system, the size of the public sector, the privatization program, and banking system soundness.

II. Recent Economic Developments

A. Real Sector1

Growth, saving, and investment

5. Sri Lanka’s economic growth rebounded to 6.4 percent in 1997, from 3.8 percent in 1996, spurred by a strong recovery in the output of some traditional agricultural products (tea and paddy production); higher output and exports of manufacturing products (textiles and garments), and continued good performance in the services sector (electricity, telecommunications, and tourism). Preliminary indications suggest that the real economy grew by 5.8 percent in the first quarter of 1998, reflecting broad based growth across most sectors of the economy, especially services and manufacturing.

6. Gross domestic savings increased to 17.3 percent of GDP in 1997, from 15.3 percent in 1996, as a result of increased private transfers from abroad, faster growth in real incomes, and higher corporate savings, as well as less negative public savings, following reductions in current expenditures. With respect to capital formation, the share of gross fixed investment in GDP remained at about 24 percent of GDP. While private investment increased from 18 percent of GDP to 19 percent of GDP, because of higher imports of investment goods and a recovery in the stock market, this was offset by a decline in public investment, reflecting binding capacity constraints and the slow rate of implementation of the development budget.

7. As a result of these developments, the savings-investment gap narrowed from 5 percent of GDP in 1996 to 3 percent of GDP in 1997. Reliance on foreign savings was halved to 3 percent of GDP, on account of strong export performance, higher transport and travel receipts, and lower interest payments.

Sectoral developments


8. Agricultural output, which accounts for over 20 percent of GDP, increased by 3 percent in 1997, mainly reflecting increased production of tea, a recovery in paddy production, and a rebound in fish catch. The increase in coconut production was modest, while rubber production fell in response to lower prices.

9. The output of tea rose sharply during the year on account of continued increases in prices and a favorable supply response to the recent privatization of several tea plantations. The average Colombo auction price rose by a further 15 percent in 1997, following a 44 percent increase in 1996, while the average export price rose by 6 percent in U.S. dollar terms, partly owing to a drought in Kenya. As a result of these higher prices, and a slower increase in the cost of production following efficiency improvements, overall tea production increased by 7 percent over the previous year’s peak output.

Source: Information provided by the Sri Lanka authorities.

(In percent)

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

10. Though yields did not recover to the high pre-1995 levels, paddy production rose sharply (9 percent) on account of increased fertilizer use and favorable weather conditions during the two harvesting seasons.2 Fish catch increased during the year on account of the partial reopening of sea fishing areas in the North and East, and an expansion of inland fisheries. Coconut production recovered slowly from the impact of the drought in 1996, and increased by only 3 percent over the year as a tight supply situation in the first few months of the year was offset by higher production in the second and third quarters. Rubber production declined by 6 percent, owing to the combination of a decline in prices, which affected the profitability of the sector, labor shortages-as producers were unable to pay competitive wages-and heavy rains toward the end of the year, which prevented tapping.

11. The production of other agricultural crops was mixed. Output of peppers, cloves, cinnamon, and citronella all increased, while production of subsidiary food crops, such as chillies and potatoes declined, as the removal of licensing restrictions on these items in 1996 led to higher imports during the year.

Mining and quarrying

12. Production of quarrying products (bricks and tiles) increased by a modest 3 percent in 1997, despite the rebound in construction activity. However, exports of gems and semi-precious stones slowed sharply in the second half of the year, in response to the drop in demand from Japan and other countries in the wake of the East Asian financial turmoil.


13. Manufacturing output increased by 9 percent during 1997. This reflected, for the most part, continued expansion of the textile and garments sector, which grew by 19 percent in 1997. The industry raised its share in GDP to 5 percent from 4½ percent in 1996, following better quota utilization (to the U.S.A.) and continued increase in demand for Sri Lanka apparel and textiles from countries outside the quota system. In addition, the production of many other industrial items, such as plastics, paints, milk products, processed tea, beverages, sweets, meat products, electrical items, batteries and rubber products also showed high growth rates. Finally, manufacturing production was also boosted by a 44 percent increase in financing from the National Development Bank (NDB) and the Development Finance Corporation of Ceylon (DFCC), and, in part, in response to an increase in the number of companies eligible for investment incentives, mainly in the form of income tax and import duty concessions.


14. The services sector continued to grow steadily during the year, spurred by higher output in the electricity, telecommunication, and tourism sectors, along with increased activity in port services.

15. In the power sector, the addition of thermal power capacity raised the overall power-generating capacity of the national grid by 13 percent in 1997, and reduced its reliance on hydro power from 81 to 71 percent, thereby improving the availability of supply. The telecommunication sector continued to expand rapidly—by 33 percent—through improved performance by Sri Lanka Telecom Ltd, following the sale of a 35 percent share of Sri Lanka Telecom to Nippon Telegraph and Telephone Corp. (NTT) of Japan for $225 million, and increased private sector participation. In particular, the number of new telephone connections surged during the year, to more than 70,000; the largest increase in any single year, and equivalent to 23 percent of total existing land telephone lines in the country.

16. The tourism sector recovered during the year as tourist arrivals increased by 21 percent over 1996, reaching 366,000. As a result, the average room occupancy rate in graded hotels rose from 39 percent to 48 percent, and gross earnings from tourism increased by 26 percent to US$ 209 million. Preliminary figures on tourist arrivals indicate a small annual increase in the first four months of 1998. Port services continued to expand in 1997, although container handling facilities, especially in the Port of Colombo, reached full capacity. In particular, transshipment container handling, which accounts for about 75 percent of total container handling, rose by a further 26 percent in 1997, following a 40 percent increase in 1996. In response, the government formulated a National Ports and Shipping Policy during the year, which seeks to elevate Sri Lanka to the position of the premier shipping center in South Asia, with Colombo operating as the hub port. The main initiatives under this new policy include the development of container handling capacity at the Port of Colombo; infrastructure development of secondary ports; and greater involvement of the private sector in providing ancillary port services to enhance efficiency and productivity.

Prices, wages, and employment


17. All four main aggregate price indicators, as measured on an annual average basis, indicate that inflation declined in 1997, mainly as a result of improved supply conditions. The Colombo Consumer Price Index (CCPI), which is compiled by the Department of Census and Statistics (DCS) and which acts as the official measure of inflation, increased by 10 percent in 1997, down from 16 percent in 1996,3 while the Greater Colombo Consumer Price Index (GCPI), also compiled by the DCS and which has a wider coverage than CCPI, increased by only 7 percent in 1997, less than half the increase of the previous year. The higher inflation rate indicated by the CCPI could be attributable to the different weighting structure of the two indices, as administered prices and items such as vegetables, both of which registered sharp price increases during the year, have relatively higher weights in the CCPI. The two indicators compiled by the Central Bank of Sri Lanka (CBSL) also show inflation declining in 1997. The Wholesale Price Index (WPI) increased by 7 percent in 1997, sharply down from 21 percent recorded in 1996, reflecting lower increases in the price of tea and declines in the prices of rubber and coconut, all of which have high weights in the index. The GDP deflator indicates an inflation rate of 9 percent in 1997, down from 12 percent in 1996, partly reflecting a continued improvement in the terms of trade.

18. As indicated by the CCPI, the decline in average inflation relative to 1996 was attributable to sharply lower increases in the prices of fuel and food items, mainly due, respectively, to the decline in imported prices and an improvement in the domestic supply situation. In particular, prices of major subsidiary food crops, such as chillies, onions, and potatoes, declined during the year following the removal of licensing requirements in 1996. However, on an end-of-period basis, the decline in inflation was uneven, as the sharp decline of inflation in the first half of 1997 was partially offset by the resurgence of inflationary pressures in the second half of 1997, following the relaxation of monetary policy at the beginning of the year; increases in the administered prices of wheat flour, electricity, and cigarettes towards mid-year; and heavy rains in the last two months of the year which affected the supply of rice and vegetables.

19. As a result of some monetary tightening toward the end of 1997 and improved supply conditions, average inflation continued to decline in the first four months of 1998. The CCPI index declined to 8.9 percent in April, but rose to 10.1 percent by June, owing, in part, to continued excess liquidity in the banking system and to some effects from the introduction of the Goods and Services Tax (GST) on April 1. On a twelve-month basis, CCPI-measured inflation reached 14 percent by end-June.

20. The DCS is working to finalize, by end-1998, a new consumer price index based on the consumption patterns in the Greater Colombo Area, as recorded in the latest Labor Force and Socio-Economic Survey of 1995/96. In the meantime, the CBSL intends to revise the WPI and is also preparing, for publication by end-1998, a new CPI index which uses the consumption pattern of a sample group taken from the lowest 40 percent of households ranked by income. The new index aims to measure underlying inflation. It assigns a lower weight to food items than the CCPI (60 percent versus 72 percent), and uses more recent base weights (average of October-December 1996). However, it excludes the effects of the changes in administered prices, including those of wheat flour, bread, kerosene, electricity, transport fares, cigarettes and liquor, which together account for a significant share of the consumption basket.


21. In 1997, the government took the first step in a major overhaul of public sector salaries by accepting the recommendations of the Salaries Review Committee. The new salary scales recommended by the committee were consolidated, incorporating all allowances paid hitherto to each service post or grade. In the first phase, 40 percent of the proposed increase subject to a minimum of Rs 325 was paid with effect from January 1, 1997. The balance of the payment was effected on January 1, 1998 for employees at the low end of the pay scale, with the others deferred until July 1998.

22. As a result of these developments, wages of public sector employees increased by 11 percent in 1997. Given an inflation rate of 10 percent, this increase represents a real wage improvement of around 1 percent, compared to 3 percent in 1996. In the organized private sector, minimum wages applicable to several wages boards were revised upwards by 6 percent in 1997 compared to 8 percent in 1996. In the unorganized sector, nominal wages increased significantly, by 9-19 percent, for most activities, including building construction, paddy, tea and coconut cultivation.

Labor and employment

23. The unemployment rate4 declined to 10 percent in 1997 from 12 percent in 1996. The Sri Lanka economy generated about 75,000 additional employment opportunities, mainly from increased activities in the private sector fields of computer, electronic media, and financial services. As in previous years, Board of Investment (BOI) companies contributed to a major share of new employment creation during the year. Continuation of high migration for foreign employment also appeared to be a major contributory factor to the slow growth of the labor force and decline in unemployment (over 1 million Sri Lankans work abroad).

24. Total public sector employment is estimated to be 1.1 million in 1997, indicating a decline of 8 percent over 1996. This was solely due to a decline of 24 percent in the employment of quasi-governmental institutions. The transfer of 22 plantation companies in 1997 to the private sector under long-term lease agreements, coupled with the public sector reform policies, led to the decline. However, employment in the government sector, which includes the central government, provincial councils and local authorities, registered a 1 percent increase in 1997—largely among clerical, administrative and managerial workers.

25. As regards the domestic labor market, 1.2 million people are unemployed and seeking jobs. Most of them are highly educated, but they do not have the appropriate skills for employment in the business sector, and need more technical education. The Ministry of Vocational Training was set up to provide such services.

26. Existing labor laws and the apparatus for dispute resolution in Sri Lanka are not well-adapted for a modem, market economy.5 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 (with 15 or more workmen working for five years or more) must seek prior permission from the Labor Commissioner before terminating employment. Compensation is often costly and the arbitration procedure conducted by the Ministry of Labor is fraught with long delays and high administrative costs. As a result, 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 to get the government involved in resolving the differences. In 1997, a total of 156 strikes were recorded both in the plantations and other parts of the private sector, which was, however, a decrease from 224 in 1996.

B. Public Finances6

Structure of the public sector

27. The public sector in Sri Lanka comprises the government, public enterprises, and a wide range of public institutions. The relative size of the public sector in Sri Lanka has historically been large, dating back to the large-scale nationalization of many industries in the 1970s. In recent years, there has been a moderate decline in the size of the public sector owing primarily to recent successful divestitures of public enterprises.7 The central government includes the presidential secretariat, the parliament, the judiciary, and 28 line ministries. In addition, several other departments and agencies are covered by the central government budget. Provincial councils form the next level of government, which are district, municipal, urban, and village councils. The lower levels of government provide financial, technical, and other services, and oversee the implementation of social development projects. A major focus of the government’s efforts on constitutional reform will involve the devolution of significant responsibilities to the provincial councils. To ensure the overall efficiency and accountability of fiscal operations, this exercise will require improvements in the administration of the budgetary process and increased transparency in the relationship between the central government and lower levels of government, including through the presentation of sufficient detail on the revenue and expenditure of lower levels of government.

Overall direction of fiscal policy and adjustment

28. Persistently large budget deficits, often exceeding 10 percent of GDP, have been a major problem in macroeconomic management in Sri Lanka for more than two decades. Despite several attempts, sustainable progress has not yet been achieved. The adjustment that was achieved during earlier efforts was often at the expense of development spending while large current account deficits persisted. Factors that contributed to the past failures at fiscal adjustment include: (i) spending pressures created by the on-going civil conflict; (ii) reliance on short-term once—and-for-all adjustments to limit the deficit at the expense of longer-term improvements in the structure of the budget; (iii) adoption of off-budget spending units, public enterprises, and government guarantees to carry out quasi-budgetary operations; and (iv) lack of expenditure control and proper management of government expenditure programs.

29. The most recent effort to address these long-standing fiscal issues was initiated in late 1994 with a new government. The underlying philosophy was contained in the President’s policy statement of 1994, which concentrated on improving the efficiency of the public sector, reducing the fiscal deficit on a sustainable basis, and also contained a firm commitment that the government would retreat from the production and distribution of marketable goods and services. While much of the job remains to be done, this renewed effort has succeeded in reducing the overall deficit from 10½ percent of GDP in 1994 to 8 percent of GDP in 1997 (6½ percent of GDP budgeted for 1998) with a firm commitment to further reduce the deficit to 4 percent of GDP by 2000. The deficit excluding defense expenditure declined from 6 percent of GDP in 1994 to 3 percent in 1997.

30. The main policy measures associated with this effort have included:

a. Measures to improve the structure and buoyancy of the tax system. These included a widening of the tax base by bringing public corporation employees and other entities that were previously outside the tax system under income taxation; rationalization of excise taxation on key commodities; introduction of a motor vehicle tax; application of a standard National Security Levy on the basis of turnover and imports (with a concessionary rate on capital goods); periodic revisions on administrative fees and charges in line with inflation; conversion of stamp duty on trade documents to an ad valorem rate; increased social security contributions on an ad valorem basis; measures to improve the recovery of interest and loan repayments and increase profit dividends from public enterprises; and the introduction in April 1998 of a single rate goods and services tax (GST) on a value added basis to replace the business turnover tax (see Box 1). At the same time, customs tariffs and income tax rates have been simplified and lowered in order to give a boost to private sector development. Several specific industrial incentives for priority sectors have also been introduced.

Sri Lanka: Goods and Services Tax (GST)

Sri Lanka introduced a Goods and Services Tax (GST) on April 1, 1998, replacing the Turnover Tax (TT). As a transitional measure, some remnants of the TT continue in order to maintain the revenue yield (e.g., in the financial services sector). The GST is a derivative of a Value Added Tax and applies to all imports, manufacturing and service sectors. Wholesale and retail trading is in theory excluded from the scope of the tax but if such trading is combined with import or manufacture, registration is mandatory. Registered taxpayers may opt to pay GST on wholesale and retail sales but they must also pay Turnover Tax, normally 1 percent, to the Provincial Council. As a result of this option, the base of the GST may cover 60 percent of trade down to the retail level.

The GST was introduced with a single rate of 12.5 percent and a registration threshold of 1.8 million rupees per annum. Zero-rating applies to exports of goods and a narrow range of services, including international transportation of goods and passengers. Exemptions are wide ranging and apply to health care; education; public transport; the financial services sector; the primary produce of agriculture,1 horticulture, fisheries, animal husbandry and poultry; certain specified foodstuffs; and a number of major commodities (e.g., sugar, cement, gold, and precious stones).

The performance of the GST and the ability to generate revenue will be affected by the wide-ranging scope of the exemptions. Where a zero-rating, at export, overrides the exemption, it could lead to vertical integration in supply chains and distortions to competition. Moreover, some exemptions occur in the beginning or the middle of supply-chains and not at final consumption—as a consequence some cascading or non-recoverable tax will occur. The structure of the GST is not ideal but could be improved if exemptions were reduced and the GST extended to a full VAT.2

While some products such as oil, petrol, diesel and LPG are exempt from GST, they are subject to excises and price control. Although liability to GST would be preferable from a structure of the tax point of view this would decrease revenue receipts through increased input tax credits to GST registered businesses.3 On the other hand, removing the exemptions from forestry, timber, cement and precious stones would generate revenue and increase the base of the tax. The exemption of cement increases costs for the construction industry and fails to raise significant revenue on domestic consumption. Exemption from GST on precious stones and precious metals removed an opportunity to police a largely non-compliant sector. This already gives rise to misdescription of type of supply and disaggregation of business activities in order to avoid GST.

Commercial transactions are somewhat complex because the GST exists alongside the National Security Levy, Stamp Duty and in some cases Provincial Council Tax. The National Security Levy was intended to be a temporary tax but the likelihood is that the revenue will be required for some years to come. Stamp Duty, on the other hand, is an anachronism which produces unnecessary bureaucracy and places substantial burdens on business in comparison with the revenue raised.

The Department of Inland Revenue administers the GST in Sri Lanka. The Provincial Councils collect Turnover Tax on wholesale and retail activity. There is, therefore, duplication of administration, producing unnecessarily high collection costs. The number of registered GST taxpayers is expected to exceed 10,000. In fact, the registration threshold may have to be increased so that the burden on the Department of Inland Revenue does not exceed their administrative capacity. In the future, more resources will also have to be devoted to audit systems and procedures.

1 All processed foodstuffs are subject to GST.2 Extending the GST down to the retail level would require constitutional reform and revenue sharing with Provincial Councils.3 Taxing petrol and similar products would reduce the cost to industry but would tax consumption.

b. Rationalization of government expenditure. To control the growth in public emoluments (5 percent of GDP) the following measures have been implemented: introduction of a consolidated salary structure in order to monitor and control overtime and other allowances; a freeze on employment recruitment in government services; and increased scrutiny of the management of the cadre with a view to both current and future obligations (by way of pension). In addition, expenditure on non-priority items has been curtailed by adopting strict financial controls and improved management practices. For example, the use of unspent provisions and savings to accommodate other expenditure programs has been restricted to improve financial discipline in spending departments. Spending on welfare programs has been rationalized and brought under one overall program, and adjustments in the wheat flour price have eliminated a large subsidy element in the budget.

c. Improvements in debt management. Interest payments on domestic debt have become a major component of recurrent expenditure, representing 28 percent of total recurrent expenditure (6½ percent of GDP) during 1994-96. Reductions in the overall deficit, together with increasing receipts from the privatization program, allowed for a significant drop in domestic debt relative to GDP and have already reduced interest costs. In addition, steps have been taken to improve overall debt management through the retirement of short term debt and the issuance of medium term bonds, improved cash management, and restraints on short-term borrowing.

d. Efforts to improve fiscal transparency. Recent efforts to improve the conduct of fiscal policy have also included a cleaning of public accounts, rationalization of off-budget transactions; and the implementation of a new tender procedure to limit corruption and strengthen financial controls and accountability.

Budgetary developments in 1997

31. The 1997 budget sought to contain overall expenditure, improve fiscal management, reduce the overall fiscal deficit to 8 percent of GDP from 9½ percent of GDP in 1996, continue the privatization program, and limit budget financing to noninflationary sources.8 These overall objectives were largely achieved, but only at the expense of lower-than-budgeted development expenditure that more than offset a revenue shortfall. As a result, the current account deficit was only reduced from 4 percent of GDP in 1996 to 2¼ percent of GDP in 1997 compared to the budget target of 1½ percent of GDP. Higher-than-expected receipts from the privatization program (treated as financing) allowed government debt with the banking system to be marginally reduced, including a large repayment of Rs 10 billion to the Central Bank of Sri Lanka (CBSL).


(In percent of GDP)

Source: Data provided by the Sri Lanka authorities.

(In percent of current expenditure)

Source: Data provided by the Sri Lanka authorities.

(In percent of total revenue)

Source: Data provided by the Sri Lanka authorities.

32. Total domestic revenues amounted to 18/4 percent of GDP reflecting an erosion in revenue performance from the 20 percent of GDP recorded in 1995, and also less than the 19 percent of GDP envisaged in the 1997 budget. This shortfall was more than accounted for by tax revenue which fell to 16¼ percent of GDP in 1997. Foreign grants have been declining and amounted to only less than 1 percent of GDP in 1997.

33. The shortfall in tax revenue relative to budget estimates was largely on account of taxes on goods and services and, more especially customs duties. Income tax collections were as expected, declining in terms of GDP because of the increase in tax thresholds and a widening of the tax bands introduced in the 1997 budget. Indirect taxes now account for 86 percent of tax revenue as many sectors have been completely exempted from income taxes. Taxes on goods and services had been budgeted to increase to 10¾ percent of GDP, but declined to 9¾ percent of GDP. Despite increases in excise tax rates, excise taxes on liquor were lower than expected (and lower than in 1996) because of a drop in production and sales. However, the primary shortfall was recorded in customs duties. These had been budgeted to increase slightly relative to GDP because of the introduction of a minimum customs duty of 5 percent on a number of products. The shortfall occurred despite an increase in import values by 15 percent because of duty waivers granted during the year. In particular, the waiver granted on petroleum products in January 1997 to improve the liquidity position of the Ceylon Petroleum Corporation (CPC) is estimated to have cost the budget about Rs 2 billion (0.2 percent of GDP) in revenue. In line with the reduction in dutiable imports, as well as the lower rate applied to imports of machinery, the National Security Levy also fell short of budget estimates. In contrast, non-tax revenue exceeded budget estimates owing to improved collection of interest, levies, profits, and dividends from public enterprises (primarily the CEB, NDB, Telecom, the state-owned banks, and the Ports Authority), and an increase in the contribution rate for the Widows and Orphans Fund.


34. Total expenditure and net lending declined significantly during the last two years from 30½ percent of GDP in 1995 to 26½ percent of GDP in 1997. While there was some compression in capital expenditure and net lending, about three-fourths of this adjustment has been through lower current expenditure.

35. As had been budgeted, current expenditure in 1997 was reduced to 20½ percent of GDP from 22¾ percent of GDP in 1996. This reduction was primarily accounted for by lower defense expenditures, which declined in nominal terms, and lower subsidies and transfers. Defense, salaries, interest, and pensions now account for 80 percent of current expenditure. Additional compression of expenditure was achieved by imposing a 20 percent cut in nominal terms for other current expenditure on goods and services excluding those related to health and security. Items affected were expenditure for traveling, fuel and lubricants, office equipment, transport, communication and utilities, and other supplies.

36. The decline in subsidies and transfers primarily reflects the effective removal of the wheat subsidy following the adjustment in the wheat price in 1997, and better targeting of the fertilizer subsidy. The railway and the Postal Department continued to be the major public institutions incurring losses and requiring budgetary support. It was also noteworthy that domestic interest payments in 1997 declined to below 5 percent of GDP reflecting sharply lower recourse to debt financing in 1997 as well as improved debt management. Government salaries were kept in check at 5 percent of GDP, despite the acceptance of the recommendations of the salaries commission which were designed to correct distortions in pay relativities between civil service grades. The new salary scales were made effective, allowing for 40 percent of the increase to take place in 1997, The remaining increases took place in 1998.

37. The Samurdhi scheme was created in 1996 to consolidate several transfer programs (food and kerosene stamps and the Janasaviya program) into one program. In addition to Samurdhi, a few specifically targeted social transfers such as those related to the provision of school uniforms and textbooks have been retained.9 As a result of consolidating these programs, the actual cost of social programs (excluding pensions and refugees) declined slightly relative to GDP in 1997. Overall savings on social transfers in 1997 were offset, however, by the need for increased transfers to refugees from the civil conflict in the north and for drought victims. Government transfers to pensioners remained at 2 percent of GDP in 1997, but the current structure of the pension system has substantial longer-term implications for government expenditure that will need to be addressed in coming years (see Box 2).

38. With respect to the functional classification of expenditure and in line with the overall reduction in total expenditure, expenditure on general public service, social services, and economic services have all declined in recent years. Defense expenditure is still relatively high at 4 percent of GDP but has declined from the peak of 1995-96. Despite expenditure reductions relative to GDP in other areas, expenditure on education and health has also declined from 4½ percent of GDP in the early 1990s to 4 percent of GDP in 1997. However, owing to cuts in other areas, expenditure on health and education accounted for 46 percent of expenditure on social services compared to 43 percent in 1996. (For a more complete discussion of social issues see Chapter III).

39. Capital expenditure and net lending of 514 percent of GDP remained at about the same level as in 1996, but was short of the budget estimates of 6½ percent of GDP. This reflected lower on-lending to state enterprises. Capital expenditure, at 5 percent of GDP was also the same as in 1996, but below the budget estimates. The shortfall in development expenditure illustrated the significant underutilization of available foreign resources, which are mostly of a concessional nature. This was caused by delays in project implementation, particularly in port development, power, energy and telecommunication, owing to disputes at project implementing agencies and a lack of sufficient domestic funds to fully absorb foreign resources.

The Sri Lankan Pension System

The impact of demographic ageing in Sri Lanka will be substantial. It is projected that by 2025 Sri Lanka will have the third oldest population in Asia (after Japan and Korea). As a result of high life expectancy and a falling fertility rate, Sri Lanka may have already achieved below replacement fertility, and will be the only low- or middle-income country in the world to have an elderly population greater than 20 percent by 2025. (See Rannan-Eliya, et. AL, Institute of Policy Studies). Accordingly, the need to provide retirement income support will have serious consequences in the next two decades and beyond, and will become a growing social and economic issue.

The retirement income system consists of a pension scheme and provident funds. The only pension scheme is the Civil Service Pension Scheme (CSPS) which covers civil servants, the armed services, teachers, and provincial and local government employees. This is supplemented by a seperate program that provides pension payments for widows and orphans of the above-mentioned groups, partially financed by employee contributions of 4-7 percent of salary. Mandatory provident fund schemes exist for other employees in the formal sector. The Public Sector Provident Fund (PSPF) is mandatory for those public sector employees not covered by the CSPS, and it is mandatory that every non-government employee in the formal sector participate in the government administered Employees’ Trust Fund (ETF), the Employees’ Provident Fund (EPF) or another approved provident fund. The EPF and the ETF provide lump-sum benefits and do not contain a pension component. Outside the mandatory schemes, there are several government administered voluntary pension schemes that offer retirement benefits for farmers, fishermen, and the self-employed. These schemes require contributions of 3-6 percent of wages from members but a separate fund is not maintained. Both coverage and pension benefits offered by these schemes are marginal. New private pension or provident funds are banned pending the development of a new regulatory and supervisory framework.

Structural reform of the existing retirement income schemes to facilitate increased coverage and sustainable financing has become imperative. Less than half of the labor force is covered by the existing retirement income systems. The CSPS has relatively generous provisions and is largely unfunded. For the Provident funds have serious problems with administration and coverage.

While mandatory in principle, there has been large-scale evasion in terms of coverage of the EPF/ETF. The incentive to participate in these schemes has been limited by low returns. For example, it has been estimated that for the EPF, an employee that started work in 1960 and retired in 1995 would have received a negative real rate of return on their contributions (Rannan-Eliya et al.). Rules governing the different retirement income schemes also contribute to problems of labor mobility from the public sector to the private sector, affecting the ability of the government in effectively reducing the authorized cadre.

The generosity of the CSPS scheme derives from high life expectancy, the relatively young age at which workers can start collecting benefits, and political pressure for ad hoc increases in benefits to keep pace with wage and price inflation. In recent years the pension bill has been growing at about 15 percent per annum and stood at Rs. 18 billion (2 percent of GDP) in 1997. Pension benefits are in the form of monthly payments, a gratuity upon retirement, and disability insurance, and are not explicitly indexed to wages or inflation. The CSPS is funded by general tax revenues and makes payments which are calculated as 85-90 percent of the last drawn salary, after completing 30 years of service, with reduced benefits for years of service below 30, and a mandatory retirement age of 60. Based on the possibility of retirement from the public sector with full benefits as early as age 55, Sri Lanka has the second highest expected duration of retirement benefits in the world (22 years). A recent simulation model has estimated that if pension benefits are revised in line with government wages in the future as envisaged under current policy, costs will escalate to more than 5 percent of GDP purely as a result of population ageing.

Financing and debt

40. Net external financing of the budget amounted to only 1 percent of GDP, less than had been budgeted owing to the weaknesses in project implementation referred to above. Total domestic financing amounted to 6 percent of GDP; slightly more than the budget estimates. However, the composition of domestic financing was different than anticipated in the budget as receipts from the privatization program totaled Rs 22½ billion (2.5 percent of GDP), far exceeding the budget estimates. This allowed the government to make repayments on its outstanding debt to the banking system of about Rs 1 billion, including a Rs 14 billion repayment to the central bank.

41. Total central government debt increased to Rs 759 billion at end-1997, but continued its declining trend relative to GDP falling to 85 percent, compared to a peak of 97 percent in 1993. Outstanding debt is split almost equally between domestic and foreign debt, with most of the latter consisting of project loans on concessional terms. Foreign debt also reflects a small amount of commercial borrowing and suppliers credits, including money raised through a US$50 million floating rate note issued in 1997. Three-fourths of domestic debt is held by the nonbank sector, mostly by provident funds, insurance companies, and other savings institutions. This proportion has increased in the last two years as the government has been able to reduce its reliance on financing from the banking system.

42. The government’s objectives in the management of domestic debt have been to retire high-cost debt, move into medium and long-term borrowing, and rely more on market-based instruments. The reduction in the overall deficit, together with the existence of privatization proceeds, substantially reduced the domestic borrowing requirement in the last two years and enabled the government to repay some of its highest cost debt. The government has also started issuing treasury bonds with a maturity of 2-4 years to extend the maturity structure and eventually to act as a market-based instrument to replace the use of rupee loans with captive sources.10 Despite these efforts, the placement of rupee loans with the Employees Provident Fund (EPF) and other captive sources continues to be the main source of domestic financing. The rupee loans issued in 1997 were at maturities of 2-8 years with an administratively set interest rate that generally moves in line with market developments and stood at 11-11½ percent at the end of the year. More treasury bonds are planned to be issued in 1998.

The 1998 budget

43. The 1998 budget was formulated in the context of the improved macroeconomic performance in 1997 and sought to consolidate these gains and help pave the way for accelerated growth in order to provide more employment opportunities for youth in the growing sectors of the economy. The budget is based on a further reduction in the overall fiscal deficit to 6½ percent of GDP to reduce inflationary pressures and contain the build-up in domestic debt. The budgetary strategy was also based on the targeting of priority sectors for incentives in order to encourage additional job generation. Key measures introduced with the budget are summarized in Box 3.

44. Revenue is projected at 18½ percent of GDP; about the same as that recorded in 1997 and ½ percent of GDP below the 1997 budget. The key structural measure on the revenue side was the introduction of the GST on April 1, 1998 at a standard rate of 12½ percent. Although it had been previously estimated that the revenue-neutral rate was 15-16 percent, the budget assumed no overall revenue loss would result from the GST because it would lead to improved compliance for other taxes.

45. Current expenditure was budgeted to fall by 2½ percent of GDP. The bulk of this adjustment was to be achieved by a relative decline in military spending (1 percent of GDP), a reduction in interest payments (½ percent of GDP), and lower subsidies and transfers (½ percent of GDP). The civilian wage bill was expected to remain at about 3 percent of GDP owing to a partial delay in the implementation of previously agreed salary increases until mid-year. Capital expenditure was budgeted to increase to ½ percent of GDP.

Public enterprises

46. The approximately 150 public institutions in Sri Lanka encompass a broad range of organizational forms, including commercial enterprises, boards, bureaus, authorities, corporations, agencies, and institutes. In 1997, the central government made budgetary transfers to about 75 enterprises, down from more than 100 in 1995. Total current transfers in 1997 amounted to Rs 5.4 billion (½ percent of GDP), compared to more than Rs 10 billion (1½ percent of GDP) in 1995 and 1996, while capital transfers were Rs 17 billion (2 percent of GDP). The largest recipients of current transfers were the Cooperative Wholesale Establishment (CWE), and the CEB. The largest recipients of capital transfers were the Road Development Authority, the Mahaweli Authority, the National Water Supply and Drainage Board, and the Sri Lanka Land Reclamation and Development Corporation.

47. The operations of a large number of public enterprises have been a major burden on the budget. Annual transfers to these enterprises have been large, and, as a whole, public enterprises have made inadequate contributions to government revenue. Despite the successes achieved by the privatization program (see Annex III), a large number of entities still engage in commercial activities in almost all sectors of the economy—the government presence is especially significant in the services sector (including banking). Weaknesses include a lack of modern commercial and management practices, inflexible pricing and procurement policies, and inadequate capital investments. Efforts to reform enterprises and minimize government transfers to enterprises have involved adjustment of tariffs on electricity, postal services, water, telecommunication, and petroleum. On-going reforms include strategies to further improve efficiency through divestiture, corporatization of vital enterprises, and imposition of budgetary ceilings on transfers and prescribed limits on other borrowing to impose a harder budget constraint. Participation of the private sector in infrastructure development in areas such as telecommunication, power and ports are also being encouraged. For example, private investment in these areas over the medium term is projected to be around $1 billion.

Sri Lanka: Key Measures Introduced in the 1998 Budget

Revenue measures:
  • Reduction in the corporate income tax to 15 percent for agriculture, fisheries, livestock, and tourism with effect from April 1, 1998;

  • Introduction of a value added based goods and services tax (GST) at a rate of 12.5 percent with effect from April 1, 1998;

  • Adjustment of selected turnover tax rates to ease the transition to the GST;

  • Increased excise taxes on some products (cigarettes and liquor) to compensate for effective reduction of turnover tax rate with the introduction of the GST;

  • Contingency to increases the National Security Levy (currently 4.5 percent) if defense expenditure exceeds Rs 45 billion;

  • Extension of the Investment Tax Allowance for another 2 years (it had been set to expire at end-March 1998);

  • Extension of fiscal incentives for advanced technology industries for another 2 years; and

  • The import tariff structure was maintained but exemptions were announced for a number of products and industries.

Expenditure measures:
  • 10 percent cut on recurrent expenditures other than salaries, pensions, and household transfers, applicable to all spending agencies, including public corporations, state banks and statutory agencies (except for the Ministries of Health, Education, and Defense);

  • Enforce specific borrowing limits on public enterprises; and

  • The approved increase in public sector salaries beginning in January 1, 1998 to be limited to those earning less than Rs 7,500 per month with the other increases granted on July 1, 1998.

Debt management:
  • Reduce the authorized borrowing limit on treasury bills from Rs 125 billion to Rs 115 billion; and

  • Replace Rs 16 billion in high cost rupee securities (issued in 1994 at 15-16 percent interest) with new treasury bonds at prevailing rates.

Investment incentives:
  • 100 percent foreign-owned international reputable companies and franchises allowed into retail and wholesale trading with a minimum initial investment of $150,000;

  • Foreign participation in non-deposit-taking financial institutions allowed subject to approval by the central bank; and

  • Various incentive programs were introduced for priority sectors (textiles, tourism).

48. Despite some attempts at deregulation, monopolistic influences by government enterprises continue in many infrastructural services and commodity marketing, although some progress has been made recently. Imports of wheat grain and the internal distribution of wheat flour and several agricultural products remain under the monopoly of the CWE. The CPC remains the exclusive importing and marketing agency for petroleum and petroleum products. A deregulation program in 1994 eliminated commodity subsidies for wheat flour, fertilizers, and kerosene and introduced flexible pricing policies. However, subsidies were then reintroduced later that year. Adjustment in administered wheat prices in 1997, together with a decline in international prices, have eliminated the costly budgetary subsidy for wheat flour, although a flexible pricing policy has not yet been put in place. Declines in international petroleum prices have also eliminated subsidies for petroleum products (although a cross subsidy for diesel and kerosene remains). While no formal subsidy to the CPC was paid in 1997, concerns over its cash flow position led to the introduction of duty waivers for petroleum products, an implicit subsidy to CPC. Initial, but limited, steps to liberalize trade monopolies of major enterprises have been taken as the operations of the Paddy Marketing Board (PMB) have been discontinued, imports of wheat flour for industrial users are now permitted, and CPC has not expanded its network of retail outlets since 1994 with all new stations owned by the private sector.

49. The Public Enterprise Reform Program generated Rs 22½ billion in 1997, which substantially reduced the government’s borrowing requirement. Most of the amount raised (Rs 13 billion) was from the sale of a 35 percent stake in Sri Lanka Telecom Limited. Other major divestitures in 1997 included the sale of convertible debentures of the National Development Bank (Rs 4½ billion)—the largest single public offering made through the Colombo Stock Exchange. Other revenues derived from the divestiture of 51 percent shares in each of seven plantations companies, further divestiture of minority shares in several other plantations, two salt companies and a ceramics company. Further divestitures are planned for 1998 (see Annex III).

C. Monetary Developments and Banking System Soundness11

Monetary policy and developments, 1997-98

Monetary policy

50. The objectives of monetary policy are to promote price stability, stabilize the external value of the rupee, and promote economic growth. Monetary policy is conducted through the CBSL, which is governed by a three-person Monetary Control Board (MCB) comprising the Governor, the Secretary to the Minister of Finance, and a third member appointed by the President. In addition to conducting monetary policy, the CBSL is also responsible for regulating the exchange rate, maintaining international official reserves, advising the Treasury on public debt management, and regulating and supervising commercial banks, finance companies, and specialized banks. While the CBSL operates with a considerable degree of independence from government, the representative from the Ministry of Finance retains, in certain cases, veto power over MCB monetary policy decisions, and government influence remains pervasive throughout the financial sector (see Box 4).

51. Over the last year or so, the CBSL has continued its gradual move toward indirect instruments of monetary control. In addition to formulating (though not publicly announcing) indicative monthly programs for reserve and broad money, from early 1997 the CBSL began to pay greater attention to other indicators, such as the overnight interbank interest rate and developments in the foreign exchange market. At present, the CBSL uses reserve money and short-term interest rates as its operational targets and conducts monetary policy principally through open-market type operations in domestic government securities (treasury bills with maturities of 3, 6 and 12 months and, since March 1997, treasury bonds, with maturities ranging between 2-4 years) in a bid to influence interbank interest rates and broad money growth in line with the desired monetary stance (see Box 5 for a brief description of available instruments). In practice, the CBSL creates a large demand for reserves through its relatively high statutory reserve requirements (SRR), and affects the level of reserve money through the amount of treasury bills it takes into its own portfolio at the weekly auctions, and the conditions it sets on transactions through the secondary window.

52. After focusing in the first three quarters of 1997 on supporting economic recovery, following the drought of the previous year, monetary policy was tightened in late 1997, following pressure on the exchange rate from events in neighboring Asian countries. Thus, in the first quarter of 1997, there was an orderly reduction in interest rates to help boost credit to the private sector and support economic recovery, which was reversed toward the end of the year, to preserve stability in the domestic financial market amidst external uncertainty in the wake of the East Asia currency crisis.

Sri Lanka: Overview of Financial System and Pervasiveness of Government Influence

The financial system of Sri Lanka is made up of the following five types of institutions:

  • Banking institutions, comprising the Central Bank, 25 commercial banks (including foreign currency banking units (FCBUs)), of which 2 are state-owned banks, 6 are private domestic banks, and 19 are branches of foreign banks;

  • Deposit institutions, comprising the National Savings Bank (NSB), 25 finance companies, and 8 Regional Development Banks (encompassing 17 Regional Rural Development Banks);

  • Long-term lending institutions, comprising several development finance institutions, including the Development Finance Corporation of Ceylon (DFCC) and the National Development Bank (NDB), and 3 housing finance institutions (the State Mortgage and Investment Bank (SMIB), the National Housing Development Authority (NHDA), and the Housing Development Finance Authority (HDFA));

  • Contractual savings institutions, comprising 6 insurance companies (IC), 2 government-sponsored provident funds for private sector employees (the Employees’ Provident Fund (EPF) and the Employees’ Trust Fund (ETF)), and private provident funds; and

  • Specialized financial institutions, comprising 5 leasing companies, 10 merchant banks, 7 venture capital companies, and a few unit trusts.

While considerable progress has been made over the years in laying the foundation for a modem financial system, the government continues to exert excessive influence over it, thereby impeding the country’s growth potential. In particular:

The government continues to dominate the banking sector, despite the introduction over the years of new banks and branches of foreign banks. The 2 state-owned banks, which account for about 2/3 of banking system assets and liabilities, still do not operate on a fully commercial basis despite two recent recapitalizations. As a result, the quality of their loan portfolios has deteriorated and interest rate spreads remain large (see Section C). Moreover, the government continues to repress a market determination of savings rates by administering the deposit rates of the NSB, effectively setting a floor on deposit rates for the entire banking system.

The government requires some nonbank financial institutions to hold a specified amount of treasury securities in meeting their liquid asset requirements (almost 2/3 of total government debt is sold directly to such captive investors, including the NSB, insurance companies, and the two government-sponsored pension funds). While these fixed-rate, non-marketable securities (‘Rupee loans’) keep the government’s cost of borrowing artificially low, they distort the allocation of savings to finance investment, and prevent the development of a secondary market in government debt. In addition, the recent decision to allow treasury bonds to be discountable (at a non-penal interest rate) and freely usable to meet the liquid asset requirement, could prevent the determination of a market-determined yield curve, which would provide a benchmark for the issuance of private debt securities.

Sri Lanka: Instruments of Monetary Policy

The Monetary Law Act provides the Central Bank of Sri Lanka (CBSL) with an array of instruments to influence the money supply, the availability of credit, and interest rates. In the last few years, the CBSL has continued its gradual move toward more indirect instruments of monetary control.

1. Statutory reserve requirements

Statutory reserve requirements (SRR) for commercial banks are uniform at 12 percent for rupee demand deposits, time and savings deposits, and foreign currency deposits not invested outside Sri Lanka (no currency matching requirement is applied). Foreign currency deposits held outside the country are not subject to SRR. Not less than 2 nor more than 4 percent of total deposits can be held in the form of vault cash, and holdings of treasury bills cannot be included in SRR. SRR are calculated weekly, must be maintained on a daily basis, and are not remunerated.

2. Credit operations with banks, quantitative restrictions, and interest rates

In the last few years, the CBSL has moved away from direct controls on credit or interest rates. In particular, while the CBSL can still provide credit to commercial banks through its lender-of-last-resort facility, its refinance facility has been gradually phased out, and all credit ceilings were removed in 1992. In addition, commercial banks are free to set their deposit and loan rates.

3. Open market operations
  • Repurchase facilities:

    Repurchase agreements or repos (selling treasury bills to absorb liquidity with the simultaneous agreement to repurchase them) were introduced in October 1993 in order to stabilize the lower end of the call market. Access is at the discretion of the banks but limited by the size of the CBSL’s portfolio of treasury bills; the CBSL cannot for legal reasons do repos in its own securities. Repos are currently available with maturities up to 91 days, but in practice are mostly overnight. Reverse repos (purchasing treasury bills to inject liquidity with the agreement to resell) have been used in the past (e.g. November 1995), although such advances are subject to pre-specified limits.

  • CBSL secondary window:

    The CBSL stands ready to sell (“discount”) and buy (“rediscount”) treasury bills through its secondary window. Transactions are at a penalty interest rates, which are usually set once a week in reference to the relevant rates in the primary market. The CBSL increases (decreases) the spread depending on whether it wants to discourage (encourage) transactions.

  • Primary market:

    The CBSL organizes weekly auctions of treasury bills (and, since 1997, treasury bonds) on behalf of the government, mainly for government debt management purposes. Treasury bills have maturities of 3, 6, and 12 months, and are offered solely to 23 “accredited primary dealers,” after first having satisfied the requests from the provident funds and the National Savings Bank on a noncompetitive basis. Treasury bonds have maturities ranging from 2 to 4 years. On occasion (e.g. 1997), the CBSL has also issued its own securities with maturities ranging from 7 to 28 days.

Monetary developments

53. In a move designed to provide a boost to the economy, the CBSL eased its monetary stance in early 1997. In January, the SRR on rupee deposit liabilities of commercial banks was lowered to 14 percent from 15 percent, and the SRR of foreign currency deposits placed abroad was abolished (previously 5 percent). In addition, commercial banks were granted permission to extend foreign currency loans to non-Board of Investment (BOI) exporters from either their domestic banking units (DBUs) or their foreign currency banking units (FCBUs).12 In March, the SRR on all deposit liabilities was further reduced to 12 percent, including on foreign currency deposits lent domestically (from 15 percent). The lowering of the SRR was expected to increase bank credit to the private sector by about Rs 20-25 billion, through the multiplier effect and lower bank lending rates.

54. In the event, credit expansion remained slower than expected in the first half of 1997 as both lenders and borrowers remained cautious—the former because of concerns over rising nonperforming loans (see section below). As a consequence, there was no immediate impact on the growth of monetary aggregates as the funds released were initially invested in treasury bills from the CBSL’s secondary window. In the second half of the year, a sufge in capital inflows from privatization receipts, disbursement of foreign funds destined for the development finance institutions, and the inflow of compensation payments to the victims of the Gulf War, led to an additional increase in banking system liquidity, and a new wave of sterilization operations by the CBSL in a bid to ensure an orderly reduction in interest rates. By September, the CBSL had exhausted its holdings of treasury bills, and had to issue some of its own short-term securities—the first time since 1994—with maturities of 7 and 28 days, in an effort to stabilize the lower end of short-term interest rates (interbank rates). During this time, the implementation of monetary policy was assisted by improved fiscal management, and some of the monetary expansion was also offset by a build-up of government deposits with the CBSL and the retirement of Rs.10 billion of treasury bills held by the CBSL. Toward the end of the year, despite some moderate tightening of monetary policy to ease exchange rate pressure, through increases in the repo rate and in the spread vis-à-vis the discount rate, commercial banks continued to find themselves in a position of excess liquidity during the first quarter of 1998, and they opted to roll over their excess funds in the CBSL’s overnight repurchase facility rather than through its discount facility to take advantage of the former’s higher returns.

55. After declining by 13 percent in the year to end-March 1997, in response to the lowering of the SRR, the annual growth of reserve money remained negative for the remainder of the year, hovering around minus 2 percent (Table 32). The rise in international official reserves, which contributed significantly to reserve money growth, was more than offset by a concomitant negative contribution of net domestic assets in the third and fourth quarters of 1997, following the reduction in net credit to government from the CBSL from the retirement of government debt, as well as government receipt of substantial privatization proceeds (Chart 6). Reserve money growth picked up sharply in the first quarter of 1998, fueled by a further increase in net foreign assets of the monetary authorities. In contrast to 1996 when it remained stable throughout the year, the money multiplier surged to 4.1 in the first quarter of 1997, before settling in the 3.8-4.1 range during the remainder of the year and the first quarter of 1998 (Table 35).

Source: Data provided by the Sri Lanka authorities.1/ Broad money includes foreign currency banking units (FBCUs).

56. Including FCBUs, broad money grew by 14.6 percent in the year to end-1997 (excluding FCBUs, broad money growth was 13.8 percent, less than the CBSL’s indicative target of 14.5 percent).13 Just under two thirds of the increase in broad money mirrored the sharp improvement in the balance of payments, reflecting the combination of a $162 million build-up in international official reserves and a sharp rise in net foreign asset position of commercial banks in response to declining domestic interest rates and concerns about the East Asia currency crisis. Net claims on government declined by 2 percent, stemming from a contraction in the fiscal deficit as well as an increase in nonbank financing, including privatization receipts. Total claims on public corporations declined by over 5 percent, although loans and advances to both the Ceylon Petroleum Corporation (CPC) and the Cooperative Wholesale Establishment (CWE) rose sharply during the year (by an average of just under 50 percent) because of liquidity problems of the former, and to cover operational losses and reduced budgetary support of the latter. Credit to the private sector increased by 13.8 percent. While commercial banks proved cautious in increasing the amount of credit extended by their domestic banking units (11.4 percent), and some borrowers postponed some large scale investments, credit extended by FCBUs to BOI enterprises surged by 28 percent, and more than offset the decline in credit extended to other (non-BOI) approved enterprises (minus 13 percent). In addition, although not captured in the monetary survey, loans granted by long-term credit institutions more than doubled during the year to Rs 21 billion (equivalent to 8 percent of private sector credit), of which half went to industrial enterprises.

57. In the first quarter of 1998, annual broad money growth (including FCBUs) accelerated to 15.7 percent, despite moderate tightening in the last quarter of 1997, driven mostly by the continued build-up in the net foreign asset position of commercial banks and net official international reserves of the monetary authorities. Net domestic assets grew by a modest annual rate of 6 percent as public sector credit declined, owing to a renewed build-up of government deposits and sharply lower credit to public corporations. Private sector credit increased at an annual rate of 13 percent, driven by the continued surge in credit extended by FCBUs since mid-1997 (averaging 30 percent on an annual basis).

Sri Lanka: Foreign Currency Banking Units, Non-Resident Foreign Currency Balances, and the Monetary Survey

This Box reviews the evolution of foreign currency banking unit (FCBU) transactions; the reasons for the recent reclassification of non-resident foreign currency (NRFC) balances; and the impact of both on the monetary survey. A numerical example, based on end-1996 data, is given in the attached table.

Foreign Currency Banking Units

FCBUs were established in mid-1979 to develop non-resident offshore banking activities and facilitate operations of companies in the Export Processing Zones. In the past, transactions of FCBUs were treated as foreign assets and liabilities in the balance sheets of domestic banking units (DBUs), and included under net foreign assets in the monetary survey. Until a few years ago, the size of FCBU transactions, and their corresponding impact on the monetary survey, remained limited. However, in recent years, FCBUs have become an important source of credit to resident Board of Investment (BOI) enterprises. Moreover, the decision taken towards end-1996 to permit non-BOI exporters to obtain foreign currency loans from FCBUs has increased the level of FCBU transactions with residents.

Non-Resident Foreign Currency Balances

In the past, NRFC deposits were treated as foreign liabilities of DBUs, while investments of these deposits by the DBUs in the FCBUs were treated as foreign assets of DBUs. In fact, about 50 percent of NRFC deposits are held by residents, mainly returnee migrants, and these deposits should therefore be treated as domestic deposits denominated in foreign currencies, rather than as foreign liabilities. Moreover, since FCBUs are in fact mostly domestic entities, the investments of foreign currency deposits by the DBUs in FCBUs should be treated as domestic assets denominated in foreign currencies rather than as foreign assets. Only the final investments made by the FCBUs with non-residents should be treated as foreign assets.

Impact on the Monetary Survey

The changes described above have the following implications for the compilation of the monetary survey:

  • Net domestic assets rise because of the inclusion of credit extended by FCBUs to both the private and public sectors;

  • Net foreign assets change as foreign liabilities decline because of the reclassification of foreign currency deposits as domestic deposits denominated in foreign currencies, and foreign assets decline following reclassification of DBUs’ investments in FCBUs; and

  • Broad money rises owing to the reclassification of foreign currency deposits as domestic deposits denominated in foreign currencies.

Table 1.

Sri Lanka: Bridging Table Between Unadjusted and Adjusted Monetary Surveys, December 1996

(In millions of Sri Lankan Rupees)

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Source: Central Bank of Sri Lanka.

Interest rates

58. While interest rates are now generally free of direct controls, the government retains some influence on the interest rate structure by transacting government securities in primary and secondary markets, and through its dominance in the banking sector (Box 4). Reflecting declining inflationary expectations and excess liquidity in the market in 1997, interest rates generally declined steadily during most of the year, except from a brief period in mid-year, before firming slightly from the end of the year and into 1998 on mounting regional concerns from the East Asia crisis (Table 37 and Chart 7). However, real interest rates remained negative in the first half of the year, and turned positive only around mid-year as average inflation dipped. In late 1997-early 1998, as inflation turned upwards again, real interest rates were barely positive.


(In percent)

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

59. At the short end of the market, the CBSL’s repo rate was reduced from 12.8 percent to 7 percent in the first quarter of 1997, raised again to 9 percent by the fourth quarter; while the discount rate on 3-month treasury bills in the secondary market fell from 17.2 percent to 9.7 percent by end-October, 1997. Beginning in the last quarter, in response to the combination of higher than anticipated inflation, uncertainty in the foreign exchange market, and the attendant downward pressure on the rupee, short-term interest rates rose as the CBSL increased the margin between the discount and rediscount rates for treasury bills toward end-1997 and again in early 1998, and raised the repo rate from 9 percent to 11 percent in December, and further to 12 percent in January 1998.

60. As a consequence of their excess liquidity position throughout most of the year, commercial banks reduced the range of interest rates on short-term interbank call loans as well as the average lending rate offered to prime customers steadily throughout the first three quarters of 1997, from 13-31 percent to 7-12 percent, and from 18.4 percent to 13.9 percent, respectively. In the last quarter, both sets of interest rates were raised, to 9-20 percent and 15.2 percent, respectively, as the CBSL raised key rates under its control. However, banks’ average lending rates, weighted by the shares of all their customers, declined by only 0.9 percentage points to 20.1 percent during the year (and remained significantly positive in real terms). For the most part, this reflected the oligopolistic banking practices of the two state-owned banks, which account for over half of total private sector credit, and which continued to be burdened by large nonperforming loans and high intermediation costs (see C.2 below). Moreover, the average weighted deposit rate of commercial banks declined more gradually throughout the year, from 12.3 percent to 10 percent—exceeding the decline in the average weighted lending rate—and fell further to 9.8 percent during the first quarter of 1998.

61. Long-term interest rates, which include yields on nontradable rupee loans and on newly introduced tradeable treasury bonds, as well as lending rates of specialized banks and other long-term credit institutions, also showed a declining trend in 1997. In particular, yields on 5-7 year rupee loans, which are administratively set, were reduced from 14 percent to a range of 11.25-12.25 percent; while the yield on 12-month fixed deposits of the NSB was reduced from 15 percent at end-1996 to 11 percent in November. However, except for the lending rate of the DFC, the decline in long-term lending rates over the year was less pronounced.

Banking system soundness

62. The role of financial sector weaknesses in the unfolding of the recent currency crises in Asia have added urgency to the CBSL’s efforts to strengthen the country’s banking system. Struggling with the consequences of a large volume of nonperforming loans, the state of the banking system, already fragile, appears to have deteriorated in 1997. The CBSL has concentrated on issuing and implementing regulations that make the financial condition of the banks more transparent.

Regulation and supervision

63. The 1995 amendments to the Banking Act strengthened the CBSL’s regulatory powers and extended its mandate beyond commercial banks to specialized banks, foreign currency banking units, and rural development banks (see Box 7). The Bank made considerable progress in issuing directives so that, by and large, core regulations are now up to international standards. In 1997, the Bank issued directives, replacing mere guidelines, with respect to: capital adequacy; loan classification, suspension of interest and provisioning; limits on investments in equity; limits on the acquisition of immovable property; and single borrower limits. In particular, loans must now be classified as non-performing when they are more than 90 days past due, and at that time, interest must be suspended. Provisioning is required only once the loans are past due more than 180 days, although at only 20 percent. Furthermore, the CBSL introduced additional periodic returns for commercial banks as of April 1998 to be able to monitor compliance. For the near future, the Bank has announced a raise in the Basle-standard weighted capital adequacy ratio from 4 to 5 percent for core capital and from 8 to 10 percent overall.

64. In May 1998, the CBSL issued guidelines for external auditors. It also introduced a short list of auditors from which banks henceforth have to choose, and announced removal from the short list in case of noncompliance with the guidelines. The purpose of the guidelines is to assist the auditors and enlist their support with the CBSL’s prudential supervision. Audits must conform with Sri Lanka Accounting Standards (SLAS), which aside from some variations to accommodate local circumstances, are based on International Accounting Standards. Banks listed on the Colombo Stock Exchange are already required to maintain their accounts according to SLAS. Other banks have been directed by the CBSL to do so as of 1998. Once the SLAS have been translated into Sinhalese and Tamil and subsequently gazetted, they will become mandatory for all companies.

65. The CBSL has made progress in effectively extending its supervision to the specialized banks. A comprehensive set of directives and return forms was issued and on-site inspections have started. However, the CBSL has yet to implement its new mandate with respect to the foreign currency banking units (FCBUs) of the commercial banks. Since the FCBUs lend mostly to the export industries, the expectation is that their loan portfolios will be in better shape than those of the banks’ domestic units. The CBSL will also issue limits on foreign exchange exposure. In an attempt to strengthen market discipline, the CBSL is considering a proposal that will require banks to publicly disclose a broad range of financial information. It is also preparing amendments to the Banking Act to strengthen its hand in dealing with errant institutions.

Financial condition of the banks

66. Pending the implementation of the new offsite inspection system, bank monitoring is done on the basis of quarterly reports.14 The financial indicators include the volume of non-performing loans and its impact on capital adequacy and liquidity. In Table 2, this information is presented in aggregate form for the three distinct categories of banks, namely the two state banks, the six private domestic banks, and the 19 foreign bank branches.

Table 2.

Sri Lanka-Indicators of Banking System Soundness, 1996Q1-1998Q1

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Source: Central Bank of Sri Lanka; based on quarterly bank reporting.

Weighted by total advances.

Net nonperforming loans are defined as nonperforming loans less provisions and accrued interest.

Specific provisions plus accrued interest over total non-performing loans.

67. Since the beginning of 1996, the ratio of non-performing loans to total advances has increased for all three categories of banks. For banks as a whole, the ratio has reached the high level of 17 percent, mostly on account of the state banks whose average is 21 percent. Deducting specific provisions against expected loan losses and interest in suspense, the volume of net-non-performing loans is much smaller but has also been rising in relation to total advances. Net-non-performing assets amount to 2.2 percent of GDP. The fact that state and domestic private banks have not raised additional capital to offset their loan losses is reflected in a steep increase in the ratio of net-non-performing loans to capital, to 150 percent and 77 percent, respectively. For the same reason, the risk-weighted capital adequacy ratios are slowly decreasing for all except the foreign banks. On average, the overall capital adequacy ratio of the state banks is just below, and that for the domestic banks is just above, the announced new limit of 10 percent. Finally, the liquidity ratio of private domestic banks has deteriorated, although it is still above the 20 percent limit.

68. There are several qualifications to be made to these bank soundness data. On the one hand, the situation may be better than indicated by the data. Banks have become more careful in accounting and provisioning for non-performing loans, encouraged by more vigorous enforcement by the CBSL of loan classification and provisioning regulations. That may explain a part of the observed deterioration of loan portfolios. Banks in Sri Lanka are, also, reluctant to write off loans as long as there is even the most remote chance of collection. This inflates the non-performing loan ratios (a breakdown of non-performing loans into substandard, doubtful, and loss is presently not available from the offsite monitoring database), although this would not affect the net-non-performing loan ratios.

69. On the other hand, there are several reasons why the actual situation may be less favorable than it seems:

  • Off-site supervision is still in an embryonic stage, and on-site inspections occur only once every two years so that one cannot be confident of the degree of compliance with prudential regulations;

  • Overdraft loans, which account for some 30 percent of lending, may not be classified properly;

  • Provisioning is less stringent than international best practice;15

  • Lending by the private domestic banks is growing at a brisk pace of twice the average rate for all banks (an annual growth rate of 23 percent as of March 1998). This has the temporary effect of improving the non-performing loan ratio but in the medium term may lead to a sharp deterioration depending on the quality of the loan decisions;

  • In the absence of data on the sectoral concentration of (non-performing) loans, lending to related parties, and observance of single borrower limits, it is difficult to judge the riskiness of the loan portfolios; and

  • The individual bank data underlying these aggregate ratios are quite heterogeneous, so that in each category one or several banks are considerably worse than the average.

70. Spurred on by the CBSL, banks are trying in various ways to improve their financial situation. The state banks have slowed their lending and are particularly careful when approving large loans. All banks have stepped up loan recovery but find the legal environment not conducive. Even the option of parate execution of real estate collateral, i.e. outside the court system, is often frustrated by borrowers who still manage to take their case to court. Mid-1998, several banks announced plans to place subordinated debt in order to raise their tier two capital, while others are looking to revalue their assets (permitted once every seven years) in an attempt to achieve the same.

State commercial banks

71. Despite the recent loss in market share to the private domestic banks, the two state commercial banks, the Bank of Ceylon (BOC) and the People’s Bank (PB), still dominate banking. Together they account for 55 percent of total assets and total advances. It is also clear that they are considerably weaker financially than the banking system on average. Many of their problems can be attributed to the government interference to which they are susceptible given their state-owned nature: politically and socially motivated loans; excessively generous salaries, especially for lower level staff; poor incentive structures, especially for management; overstaffing; and over-branching for social reasons.

Financial Sector Regulation and Supervision in Sri Lanka

Sri Lanka’s banking system is regulated and supervised by the Central Bank of Sri Lanka (CBSL). It does so within a legal framework consisting of the Monetary Law Act and the Banking Act (both amended in 1995). The main objective is to safeguard the interest of depositors. The CBSL is empowered to issue detailed regulations in the form of directives. The CBSL’s mandate covers the country’s commercial banks (two state banks; six private domestic banks; and nineteen foreign banks, all branch offices), and since 1995 also the specialized banks (savings bank and long-term lending institutions), the Foreign Currency Banking Units (FCBUs), and the Regional Rural Development Banks (RRDBs). With its staff of about 75, the CBSL Bank Supervision Department conducts both on-site and off-site supervision. On-site inspections must take place at least once every two years. The off-site supervision is done on the basis of periodic returns for which a computerized system is about to be put in operation.

Insurance companies are presently regulated by the Controller of the Insurance, who heads a department in the Ministry of Finance. Upon passage of the pending Regulation of Insurance Industry Act, an Insurance Board will take over the regulation and supervision. The Colombo Stock Exchange and companies listed on it are regulated and supervised by the Securities and Exchange Commission, The location of the new regulator and supervisor for pension funds still has to be decided as a new law is under preparation. At present, the CBSL manages the Employees’ Provident Fund, the country’s largest fund, while private pension funds must be registered with the Commissioner of Labor.

72. The state banks have benefited from major official support operations twice in recent years. In 1993, they were recapitalized at a cost of 3.4 percent of GDP in order to meet the then new eight percent capital adequacy ratio requirement. Unfortunately, lending did not improve and, in 1994, there was an upsurge in politically motivated lending, with and without explicit government guarantee. As the guaranteed lending turned non-performing, the government was forced in 1996 to place bonds in the state banks equivalent to 1.8 percent of GDP. Since then, the financial position of the PB has weakened again, and that of the BOC did not improve convincingly. In the case of the PB, the overall risk-weighted capital adequacy ratio dropped below the eight percent minimum towards the end of 1996.16

73. At the time of the 1993 recapitalization, the state banks were subjected to performance agreements setting profitability and cost targets. These have not been successful in improving their financial position fundamentally. In light of this experience, the government and CBSL have been drafting new agreements, Memoranda of Understandings (MOUs), that would impose performance targets in return for explicit protection against political interference with the lending process. The CBSL is also undertaking portfolio audits of the two banks.

D. Balance of Payments and External Debt17

Overall developments

74. In the unfavorable regional environment of 1997, Sri Lanka’s overall balance of payments improved, shifting back into surplus after a deficit year in 1996.18 This development is mainly a result of the continuing decline in the current account deficit (from 5 percent of GDP in 1996 to 3 percent of GDP in 1997), accompanied by a slight improvement in the capital and financial accounts. Gross international reserves recovered almost to 1995 levels in absolute terms (to $2 billion at end-1997), and remained at slightly above four months of import cover.

75. For the first half of 1997, the Central Bank of Sri Lanka pursued an exchange rate policy which kept the value of the Sri Lankan rupee roughly constant in real effective terms, thus maintaining the 12.4 percent real appreciation which occurred in 1996. After the onset of the Asian crisis, as there were no strong market pressures on the rupee, the Central Bank kept the same rate of nominal depreciation of the exchange rate during the second half of the year as it had for the first half. Over the year as a whole, the rupee depreciated by 7.2 percent against the dollar, which, given the developments in Sri Lanka’s trading partners, translated into a nominal effective appreciation of 6.1 percent and a real effective appreciation of 14.8 percent. This appreciation in the real effective exchange rate reached a peak in January 1998 (at 18.1 percent from January 1997), and has since begun to subside.

Current account transactions

76. The current account deficit was reduced from $730 million in 1996 to $430 million in 1997, due to continuing improvements in the trade balance, high growth in port services, and compensation payments in the form of private transfers to migrant workers employed in Kuwait for losses incurred during the Gulf War.

77. In 1997 the trade deficit shrank from $1.3 billion (10 percent of GDP) to $1.2 billion (8 percent of GDP). Export growth continued to outpace import growth in value terms, spurred by strong performance in textiles, garments, and tea. Non-traditional exports (industrial exports, minor agricultural products, gems and other miscellaneous categories) have consistently grown at double-digit rates over the past 5 years, and now account for 80 percent of exports. Traditional exports have performed more unevenly due to weather and global supply conditions. Sri Lanka’s tea industry received a boost in 1997, as its major competitor Kenya suffered from drought. Prices increased by a further 6 percent in 1997, after an increase of 26 percent in 1996. At the same time, a bumper crop allowed Sri Lanka to reap full advantage of the price gains.

78. The Asian crisis has not had a large effect on Sri Lankan exports so far; textiles and garments, the largest export sector, has performed well. Possible competition from the troubled countries seems to have been limited due to various factors, such as difficulties of exporters in obtaining credit in crisis countries, and the Sri Lanka garment industry’s own efforts at producing higher value-added products. However, smaller sectors have been adversely affected, including rubber, and gems and jewelry. While rubber prices had been weak even before the onset of the crisis, since then their continued decline has wreaked havoc on the industry, with a decline of 24 percent in export value, following a smaller decline of 7 percent in 1996. The value of gem exports declined by 14 percent, due to jewelry company closures in Japan as well as effects from the Asian crisis.

79. While import volume growth was over 10 percent, declining world prices for many of Sri Lanka’s imported products limited the growth of import values to 7.6 percent. Most of the import growth in 1997 can be attributed to increased intermediate and investment goods imports. Consumer goods imports remained largely unchanged in 1997; rice and wheat, which had been substantial in 1996, declined in 1997 because of the good harvest and were replaced by imports of sugar and other consumer goods. Imports associated with the textiles industry grew in line with exports; in other areas, investment imports for the telecommunications industry also increased as the sector upgraded and expanded its services.

80. Sri Lanka’s trade patterns remain largely unchanged, with the European Union and the United States accounting for almost 70 percent of exports. Countries of the former Soviet Union are growing customers for Sri Lankan tea, but their combined share of exports remain below 5 percent. Import trade still originates mainly from Asia (including Japan), accounting for close to 60 percent of the total.

81. The change to reporting balance of payments data in the Balance of Payments Manual 5th edition format has highlighted some features of Sri Lankan services and income accounts. The service account has been in surplus of over $150 million over the past five years, except for 1996 when it fell to $105 million. All categories within the services account have generally been in surplus except for other business services and government expenditure (n.i.e.), which have been jointly recording a deficit of $30-$40 million since 1993. In 1997 transportation services registered healthy growth (15 percent) due to increases in port services, reflecting Sri Lanka’s position as a shipping gateway to the region and improved management of the port. The ports have been handling increased trans-shipment trade, and there are major expansion plans over the next five years.

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

(January 1990=100)

Sources: IMF, International Financial Statistics, Information Notice System; and staff estimates.

82. Income accounts have consistently been in deficit since 1993, reflecting the interest payments and dividend and profit remittances made which exceed such income from abroad. The deficit was reduced from $200 million in 1996 to $170 million in 1997, mainly as a result of high central bank securities and foreign exchange trading profits for the year.

83. Private transfers in 1997 were boosted by inflows of United Nations compensation payments to migrant workers employed in Kuwait for losses incurred during the Gulf War. These payments amounted to $65 million for the year.

Capital and financial account transactions

84. Capital transfers, which mostly consist of official capital transfers, fell over the past two years, with an inflow of $90 million in 1997. The decline is a result of lower utilization of concessional assistance.

85. The financial account improved slightly (by almost $50 million) to $480 million in 1997, reflecting a surge in foreign direct investment ($130 million) and privatization proceeds from the sale of Sri Lanka Telecom ($300 million). The higher-than-expected inflows were offset by accumulation of foreign assets by the commercial banks (of $200 million) and a continued decline in official disbursements (from $670 in 1995, to $460 in 1996, and $420 in 1997). Private net inflows increased due to a decline in amortization payments following extraordinary repayments made in 1996 on outstanding loans for hotel projects and Air Lanka.

86. While foreign investors had been withdrawing some of their portfolio investment in the Colombo Stock Exchange during the second half of the year in response to regional turmoil, there was still a net inflow of $13 million for 1997 as a whole.

External debt

87. Sri Lanka’s external debt position improved, with total external debt outstanding falling from 68 percent of GDP in 1996 to 61 percent of GDP in 1997. Medium and long-term debt (including the IMF) also fell from 56 to 50 percent of GDP during this period. In terms of exports of goods and services, MLT debt declined from 161 to 136 percent, and debt service declined from 14 percent to 12 percent.

88. Much of the decline in these ratios is a result of exchange rate movements during the year; 65 percent of Sri Lanka’s debt is denominated in SDR or Yen, both of which lost ground against the U.S. dollar in 1997. In addition, the worsening utilization rate of foreign concessional loans for public capital expenditures has also kept public debt levels from increasing. However, non-concessional loans to the public sector increased as the government issued a $50 million floating rate note (at 1.5 percent over LIBOR) during the year. Private debt increased slightly owing to Sri Lanka Telecom borrowing for expansion projects, and a floating rate note issued by the National Development Bank (guaranteed by the AsDB).

89. Short-term debt relative to GDP was stable at 11 percent; in absolute terms it increased slightly owing to more trade-related financing during the year and increased commercial bank foreign currency liabilities.

Exchange and trade system

90. In 1997 no major changes were introduced in Sri Lanka’s exchange system. 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 (although limits on foreign ownership exist in certain industries, and all applications must be channeled through the Board of Investment), as are capital outflows of profits or repatriation of capital from investment in Sri Lanka. Other capital outflows are generally restricted (decided on a case-by-case basis) unless they will provide positive benefits to the country. In recent years, a few overseas investment projects have been deemed to satisfy this criterion and were approved19.

91. The Central Bank does not participate in forward market activities. Commercial banks are allowed to transact in forward markets for foreign exchange, and mainly engage in 6-month contracts for trade-related purposes. No other derivative operations are permitted in Sri Lanka.

92. There were few permanent changes in the trade policy regime in Sri Lanka in 1997. The three-band system of 10, 20, and 35 percent remained in effect, along with the few items which incur non-standard duty rates. However, duty exemptions or remissions were granted on several products, such as petroleum, sugar, and wheat. The effective import duty collection rate continued to fall from 8.5 percent in 1996 to 7.4 percent in 1997, reflecting decreases in dutiable imports in relation to total imports, particularly in intermediate goods.

93. Sri Lanka’s trade reforms in the 1990s have been substantial20. The Fund’s restrictiveness of trade index for Sri Lanka declined from 7 in 1990 to 4 in 1993 and has remained at that level since21. During this period maximum tariff rates were substantially reduced (in steps from 60 percent to 45 percent in 1993, to the current 35 percent since 1995), while most of the remaining export taxes and import licensing requirements were removed. The current government has announced its intention to continue this process.

94. Licensing requirements on imports and exports have not been changed in 1997; trade is generally unrestricted, with controls imposed on certain items due to environmental, public health, phytosanitary, or public security reasons. The licensing requirement on wheat grain remains, due to the contractual obligation by the government to supply grain to a particular flour miller until 2004. Sri Lanka also maintains export quotas on textiles and apparel used to implement bilateral quotas under the Multi-Fiber Arrangement.

95. In February 1997, Sri Lanka submitted its commitments to the WTO in the telecommunications sector. In December 1997 it submitted its draft conditional offers on insurance, banking, and other financial services. In some cases liberalized policies already in place were given as offers. New offers included the waiver of the restriction on the number of branches that foreign-incorporated commercial banks can open in Sri Lanka (the former limit was 10 branches). Also, whereas before, non-nationals were only permitted to hold up to 49 percent equity of a commercial bank incorporated in Sri Lanka, they can now also hold up to 49 percent of share capital of any institution providing financial services.

96. 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). Concessions received in 1996 were made effective from 15 July 1997 by a Gazette notification. In May 1997, member countries agreed to advance the South Asia Free Trade Area (SAFTA) to the year 2001. However, there remain a number of obstacles to overcome, the most difficult of which is the reluctance to abolish non-tariff barriers on the part of many member countries.

III. Social Issues22

97. In general, Sri Lanka adopted policies since the 1940s which fostered greatly improved social sector indicators over the course of the years. Decisions were made which have borne fruit in the form of a relatively healthy, well-educated population, with no destitute poverty. However, as the country’s economic development continued and more open-market policies were adopted, some of these policies have proved unsustainable and are in need of fundamental reform in order for the gains to be consolidated and further improved upon.

The health sector

98. Sri Lanka has lifted the health standards of its population by emphasizing preventive care, supporting this with well-developed primary health care as well as hospital systems, and providing free health care to all citizens. Most of the indicators in this sector compare well to countries at similar income levels (see Table 3). However, in recent years the improvement rate has slowed; Sri Lanka has had to tackle both health problems associated with a less-developed country while also encountering emerging problems more symptomatic of a higher-income country. For example, malnutrition, malaria, and iron deficiency anemia among pregnant women have remained problem areas, while the new challenges come from a population which has come through the full cycle of demographic transition23 while the country remains at a relatively low level of income. By 2010, Sri Lanka have the oldest population in Asia after Japan and Singapore. In addition, emerging threats such as a high incidence of tuberculosis, STDs and AIDS will also impose demands on scarce resources.

Table 3.

Sri Lanka: Social and Demographic Indicators

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Sources; World Bank, World Development Indicators, 1997. Sri Lanka. Social Services: A Review of Recent Trends and Issues, 1998.

In 1988.

Ratio of dependents (total number of individuals aged less than 15 yrs and greater than 64 years) to working age population (number of individuals ages between 15 and 64 years).

Low and middle income.

Fifteen years old or older.

99. Some of the current problems in the public health care system include management weaknesses and inadequate financing. Administrative policies have resulted in a system in which the budget is non-transparent, there is a lack of clear responsibility and accountability, as well as lack of management capacity. Also, donor financing which concentrated more on providing physical infrastructure in tertiary care has skewed the allocation of health expenditures towards tertiary care at the expense of primary and secondary care24.

100. Private health care service has acted as an important safety valve in Sri Lanka; institutions operate on a two-tier basis, in which fee-based emergency health care helps to subsidize free health for the poor. The provision of these services guarantees eligibility for other incentives (tax concessions and duty waivers) which have encouraged the development of private financing of health care in Sri Lanka, such that in 1997 it accounted for 40 percent of overall national health expenditures.

101. Some of the key issues for reform in the health sector include preparing the system for handling the problems of an aging population, determining the future role of the public health care system, and quality control for private health care. As the population ages, different and more highly specialized skills will be required than those needed in caring for the current population. A rethink of health policy needs to be conducted to search for ways to improve resource mobilization and expenditure allocation, as well as to determine the future role of the public health care system and its sustainable financing. The mix and interrelations between the public and private sector provision of health care need to be redefined and some incentives changed so as to prevent the current over reliance on the public sector for expensive treatments. In addition, quality control in the private sector needs to be addressed; currently there is no appropriate regulatory framework.

102. In 1997 a Presidential Task Force on Health Reforms was established to review and make recommendations. Since then, the Health Sector Reforms Implementation Unit was established to oversee the implementation of the changes. Some of the recommendations include measures to strengthen administration and management of the system, further development of infrastructure and services, and strengthening the link between the private and public health sectors, as well as encouraging further development of private health care provision. The development of private health insurance is also being explored. The plans have been evaluated as going in the right direction, but do not fully address the fundamental problems in the sector in a comprehensive and sustainable way; in particular, at the secondary and tertiary health care levels. Also lacking is a sound implementation plan which is both politically feasible and economically affordable.


103. While the education system in Sri Lanka also enjoyed priority status for many years, with resources dedicated to free delivery, wide coverage of primary and secondary schools throughout the country as well as development of post-secondary education, in recent years problems have beset the system that perhaps stem from the government’s virtual control of the entire educational system in the country. This has manifested itself in problems of low quality of instruction, politicization of the teacher recruitment process, and an unsatisfied demand for university education.

104. With the increased unsatisfied demand for higher education, there has been an expansion in the number of vocational/technical institutions in the country. However, these have not greatly eased the situation, as they provide poor quality training with little relevance to labor market needs, and underutilized facilities.

105. A radical reform of the educational system is needed; a National Education Commission was appointed in 1992 to identify reform issues in general, higher, vocational and technical education. In early 1997 a Presidential Task Force was established to recommend reforms and to begin to implement them in 1998. Some of the recommendations include allowing for unit-expenditure-based financing of general education, private sector provision of vocation training, and a contract system for new university lecturers (vs. the current tenure system.) There are also a host of other more detailed suggestions aimed at improving quality and relevance of the curriculum, evaluation procedures, as well as administrative procedures.

106. The reform effort will have to address the following challenges more directly: an outdated education system which churns out graduates with few marketable skills (as evidenced by high unemployment rates among the educated young), a restricted and weak university system, insufficient financing (relative to GDP), and the education system’s contribution to social and ethnic cohesion (the segregated schools for Sinhala and Tamil students).

Poverty and social welfare

107. Sri Lanka provides a wide-ranging program of assistance to its population. While this has virtually eliminated destitute poverty, such that under the international poverty line of $1 a day Sri Lanka’s poverty rate is only 4 percent, under more reliable measures based on local poverty lines and nutritional needs almost 25 percent of the population lives below the poverty line.

108. There are three remaining large programs of assistance: Samurdhi, emergency relief, and the Integrated Rural Development Plan (IRDP), which is mostly donor-funded and is currently being revamped in order to better achieve its objectives and reduce its overlap with other poverty programs. Samurdhi covers 1.8 million families (over 50 percent of the population), and provides assistance through two components; direct income support in the form of food coupons, and training, credit and savings schemes to promote self-reliance and rural entrepreneurship. The emergency relief program provides food for refugees displaced by the civil conflict.

109. While the achievements of the social welfare programs are impressive in many respects, it is disturbing that the poverty rate in the country remains high, and that the major achievements in health and education policies above have not been matched by those in poverty reduction policies. The virtual elimination of starvation and destitute poverty were achieved by the provision of subsidies or direct handouts by the government, but the programs to promote self-reliance and entrepreneurship have not been successful, such that the poor cannot lift themselves out of poverty after having been given a boost by the government. Some reasons for this problem are as follows. Insufficient adaptation of the human resource base - with the adoption of more open, market-oriented policies, the provision of education has not followed, such that the educated young at this point are not equipped with the skills to take advantage of the new opportunities. Insufficient emphasis on broad-based economic growth - Sri Lanka’s average annual growth rate of under 5 percent over the past-15 years has not been sufficient to lift substantial portions of the population out of poverty. Structural reforms necessary for improved growth performance were not implemented, for example in agriculture and public enterprises. Finally, the social welfare programs themselves were weak and poorly implemented. They were not well-targeted, lacked the coordination and flexibility to respond to local conditions and needs, became politicized (leading to a large administrative bureaucracy), and also were unsustainable and myopic in that their design did not incorporate the incentives for the recipients to eventually lift themselves out of poverty. In fact, they may have encouraged dependency.

110. Sri Lanka is in need of better information on poverty, in order to be able to formulate a comprehensive and consistent plan for long-term poverty alleviation. The government has asked for assistance from donors in this matter, and analytic work is being undertaken in order to analyze the progress made in poverty reduction and assess the country’s poverty profile. Armed with this knowledge, the government can then set about planning a strategy for poverty alleviation which will require coordinated policies in other sectors of the economy in order to promote strong and broad-based economic growth. Some of these policies should include investment in rural infrastructure, removal of distortions in land and labor markets, and strong macroeconomic management. At the same time however some features of the social safety net will temporarily remain in order to provide a cushion for those disadvantaged by the ongoing reforms.


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ANNEX I The Need For Labor Market Reform

The case for labor market reform

111. Since abandoning the closed, controlled economy in favor of an open and liberalized one in 1977, Sri Lanka has undertaken many far reaching reforms: trade liberalization; a shift from pegged to floating exchange rate; interest rate deregulation and foreign competition in banking; the lifting of price controls; and the privatization of many state enterprises. However, little headway has been made in reforming the labor market to meet the demands of the new economic model. Indeed, the failure to reform the labor market may well have forestalled some of the benefits from the other structural reforms. Sri Lanka’s core labor laws date from before independence and acquired a distinct pro-labor orientation during the country’s socialist period. Programs for labor market reforms, unveiled on tow occasions (1997 and 1989), were unsuccessful because of successive governments’ commitment to social development and equity, and the strength of organized labor. Because of many piecemeal changes, a most unwieldy body of law has emerged, and enforcement is haphazard. The present government has taken some legislative initiatives, but mainly to strengthen the enforcement of the existing body of labor laws.

112. There are several compelling arguments for labor market reform. One is that unemployment and underemployment are serious problems in Sri Lanka, in an economic sense and from a social and political point of view, given the high incidence of long-term unemployment among educated youth (World Bank, 1996).1 Flexible labor markets tend to be better at generating employment. There is also the widespread conviction that the labor laws are dampening productivity and thereby retarding industrial progress (IPS, December 1996).2 Moreover, the current obstacles to laying off redundant labor make it difficult to proceed with dismantling the protection of the sizeable import-substituting industries that remain.

Main controversies 3

113. Surveying various possible labor market distortions, Rama (1994) concluded that in Sri Lanka the main problem is with the laws that provide job security;4 in particular, the Termination of Employment of Workmen Act (TEW A). The TEWA prevents any termination on non-disciplinary grounds, including enterprise restructuring or liquidation, in private sector firms with more than 15 employees without the written consent of the affected workers and that of the Commissioner of Labor. In practice, the major problem is the uncertainty regarding the duration of the review process—during which firms must continue to pay salaries—and regarding the amount of compensation they must ultimately pay—ranging from one to nine months’ salary for each year of service. The implicit costs to laying off labor dampen labor demand and stifle job generation. Moreover, the job security the TEWA provides may have a negative impact on work ethic and productivity, and, firms seem to prefer overtime, subcontracting and casual or contract labor over hiring more permanent staff. Proposals include repeal of the TEWA or amending it so as to place upper limits on both the length of the review and amount of compensation.

114. Settlement of industrial disputes in Sri Lanka relies heavily on conciliation and arbitration. Collective agreements are not popular, principally because unions often fail to honor their obligations under them while the employers have no effective legal recourse. Both employers and trade unions complain about the availability of conciliation and arbitration services by the Department of Labor. The Labor Commissioner is empowered by the Industrial Disputes Act to help settle a dispute through conciliation or voluntary arbitration. In addition, the Minister can refer a dispute for mandatory arbitration. In practice, parties are not eager to seek arbitration voluntarily, and the Minister has become reluctant to refer cases for mandatory arbitration, so that the large majority of cases is conciliated. Even though conciliation is less labor intensive than arbitration, the staff resources of the Ministry of Labor are inadequate to deal properly and speedily with the great number of cases every year, which is well in excess of 10,000.5 The proposals for improvement are threefold. The Industrial Disputes Act should be amended to streamline the procedures for conciliation and arbitration. The Ministry of Labor should have more and better trained staff. In addition, voluntary collective bargaining should be promoted by spelling out the responsibilities of unions and employers in facilitating the process.6

115. A great impediment to unions in collective bargaining is that there is no legal requirement for union recognition.7 Employers deal with unions when they consider it in their interest, and often they do not, particularly employers in the Export Processing Zones (EPZ). Given this legal vacuum it is not surprising that some three quarters of all strikes deal with the issue of recognition. However, amending the Trade Union Ordinance to provide for union recognition without at the same time permitting de-recognition would leave employers exposed to irresponsible behavior by unions. One proposed solution is therefore to list in either the Industrial Disputes Act or the Trade Union Ordinance “unfair labor practices” for employers as well as for employees or their unions.8 Other proposals call for making unions more responsive to their members, for instance, by insisting that they account properly for their finances and hold secret ballots in advance of every strike action. These proposals may also be helpful in ending the dominance of political patronage in industrial relations in Sri Lanka.

116. Another problem is the complexity of labor legislation. Since independence, the number of laws dealing with labor issues has grown from 7 to 49; moreover, there are innumerable amendments. There is only one case of a law ever having been repealed (Amarasinghe, 1998). Even if one accepts the argument that only 10 of those laws are of real importance, the overlap and inconsistencies between them leave plenty of scope for confusion. A project is underway, with support from the International Labor Organization, to prepare an index that would make it easier to navigate the labor laws. The more fundamental approach is to combine a radical overhaul of the labor legislation, consolidating it into one piece of industrial relations law.

117. Aside from the deficiencies in the labor laws, their implementation suffers from weaknesses in the institutional infrastructure. The staffing problems of the Ministry of Labor in carrying out its role in dispute settlement have already been noted. Another weakness are the Labor Tribunals conceived to deal speedily with cases of unjustified dismissal on disciplinary grounds. In practice they satisfy neither workers nor employers. The inquiries that the Tribunals conduct to determine whether a worker must be reinstated or deserves a compensation are beset with procedural complexities which either party can exploit to delay settlement of the case.9 In the end, the Tribunal has no powers to enforce its judgment and the complainant ends up in the congested appellate court system. Given the long delays in obtaining redress, workers often resort to industrial action.

Recent legislative initiatives

118. The legislative initiatives taken so far by the present government were primarily motivated by a desire to put a stop to the widespread evasion of labor laws and the often violent repression of trade union activities. To that end, the government promulgated in September 1995 a National Workers’ Charter that for the most part reaffirmed rights already provided for under existing legislation.10 Even though the Charter was formulated in consultation with employers, business representatives and unions, it was seen as a pro-labor policy statement by the government. In the Charter the government promised to prepare and bring into force a Code of Industrial Harmony of mutual obligations of employers and workers. To provide legal basis to the Charter where necessary, the Government undertook to draft an Employment and Industrial Relations Act (EIRA).

119. For the most part, taken by themselves, the clauses in the Charter are not controversial. For instance, the Government pledges to provide workers with adequate transportation and accommodation close to work, to ensure adequate labor inspection services, and to strengthen conciliation and arbitration. More controversial is the Government announcement that it will guarantee and protect the rights of workers to form and join trade unions, and to organize and bargain collectively. The Charter also states that anti-union discrimination by employers will be made an unfair labor practice. All of these rights were already supported by laws or ILO conventions and were included only because of their widespread evasion.11 Nonetheless, given the strong pro-labor credentials of the parties making up the PA coalition, these clauses have aroused the suspicion of the business community.

120. Most controversial is that in the Charter the Government undertakes to ensure that employers recognize trade unions and deal with them on matters pertaining to their members. Even though this does not entail compulsory recognition, resistance and even hostility by employer groups to this clause is widespread. At a minimum it is argued this should have been accompanied with provisions for de-recognition in cases of unfair labor practices.

121. Two other clauses of the Charter proved controversial. The first is the plan to regularize certain forms of employment because they are being used to circumvent the restrictions of the TEWA, such as apprentices and trainees, and casual labor. The other is the decision to grant to workers employed by contractors full protection under existing labor laws, creating potentially serious financial liabilities for firms using subcontractors.

The state of the debate

122. The work on the drafting of the EIRA continues, mostly within the Ministry of Labor and with little involvement of the tripartite National Labor Advisory Council (NLAC) as was announced in the Charter. A draft published in 1996 met severe criticism from the business community for not addressing the concerns expressed with regard to the Charter. Notably, it obliged employers to deal with unions representing at least 40 percent of the workforce in the establishment without placing any obligations on unions to act responsibly. The liability with respect to subcontractors was extended beyond wages to the contributions to the Employees’ Provident Fund and Employees’ Trust Fund, and to compensation in case of termination of employment. The draft act also gave responsibility to the Commissioner of Labor for determining what constituted temporary work, adding to his already excessive burden. The draft was also criticised for not covering the 700,000 government employees.

123. In view of these criticisms, the President appointed a tri-partite Task Force on Employment. It had a mandate to look at the issues of investment, job creation and union rights and proposed considerable changes to the draft act, including with respect to union recognition. Subsequent to the Task Force’s report, the Ministry issued a new draft early 1998. Disappointed that this latest draft had taken on board few of the Task Force’s proposals, the employers boycotted the NLAC where the consultative process was to continue. Likewise, the discussions on the Code of Industrial Harmony appear in a stalemate. Employers prefer that the mutual obligations for employers and unions be incorporated in the EIRA rather than in the Code since, like the Charter, the Code has no legal powers but is merely an enunciation of principles.

  • Amarasinghe, E.F.G, “Chapter 24: Labor and Employment 1948-1997,” in Fifty Years of Sri Lanka’s Independence-A Socio Economic Review, A.D.V. de S. Indraratna (ed.), Sri Lanka Institute of Social and Economic Studies, Colombo (1998).

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  • Athukorala, Premachandra, Labor Productivity in the Manufacturing Sector in Sri Lanka, Study for the Department of National Planning, Ministry of Finance and Planning, Colombo (June 1997).

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  • Institute of Policy Studies, Sri Lanka: State of the Economy 1996, Colombo (September 1996).

  • Institute of Policy Studies, Sri Lanka: State of the Economy 1997, Colombo (December 1997).

  • Institute of Policy Studies, Study on the Impact of Labor Legislation on Labor Demand in Sri Lanka, IPS Studies No. 99, Colombo (December 1996).

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  • Rama, Martin, Flexibility in Sri Lanka’s Labor Market, World Bank Policy Research Working Paper 1262 (March 1994).

  • World Bank, Sri Lanka in the Year 2000: An Agenda for Action—A Joint Sri Lanka-World Bank Study, Washington (1996).

ANNEX II Relative Size of the Public Sector, 1992-971

124. Summary measures point to some decline in the size of the public sector in Sri Lanka relative to the development of the overall economy during the past five years (see Tables 4-8 and Chart 10). The most significant declines were recorded in employment and the value of industrial production accounted for by public enterprises. In contrast, public sector purchases of goods and services have declined by a smaller amount, and value added of the public sector relative to gross national expenditure has actually increased since 1992. Changes in all of these measures are influenced by trends in defense expenditure which increased significantly in 1994-95.

Table 4:

Sri Lanka: Employment in the Public Sector, 1992-97

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Sources: Table 23, CBSL Annual Report; Appendix Tables 11 and 12; and data provided by the Sri Lanka authorities.

1997 data are based on the third quarter position.

Includes employees of government ministries, school teachers, and defense personel, as well as employees of provincial councils and local governments, but excludes employees in the Northern and Eastern province.

Includes universities, public corporations, boards, and state-owned banks.

Table 5.

Sri Lanka: Public Sector Capital Spending, 1992-97

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Sources: CBSL Annual Report (1997), Table 59, and data provided by the Department of Public Enterprises.

Central government capital expenditure less transfers to public corporations and public institutions plus capital expenditure of government entities. Captial transfers from the central government are used as a proxy for actual capital expenditure for local governments and provincial councils.

Consists of statutory boards, commercial corporations, fully-owned government companies and subsidiary government companies.

Table 6.

Sri Lanka: Public Sector Purchases of Final Goods and Services, 1992-97

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Sources: CBSL Annual Report (1997), Table 59; and Appendix Table 15.

Transfers from the central government are used as a proxy for actual expenditure for local governments and provincial councils.

Excluding changes in Treasury deposits and expenditure under provision

Consists of statutory boards, commercial corporations, fully-owned government companies and subsidiary government companies.

Table 7.

Sri Lanka: Value Added of Public Sector to Gross National Expenditure, 1992-97

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Source: CBSL Annual Report (1997), Table 5.

Transfers from the central government are used as a proxy for actual expenditure for local governments and provincial councils.

Table 8.

Sri Lanka: Value of Industrial Production of Public Sector Industries, 1992-97

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Sources: CBSL Annual Report (1997), Tables 16 and 19.


Source: Data provided by the Sri Lanka authorities.

125. The data cover the central government (including government ministries, school teachers, and defense personnel) and quasi-governmental institutions (including universities, public corporations, boards and state-owned banks). Transfers from the central government are used as a proxy for spending by provincial councils and local governments, and actual spending by these entities may be higher to the extent that they finance operations from their own sources of revenue. However, total spending by these entities is small relative to the overall size of the public sector and this does not seriously bias the analysis of overall trends.

Public sector employment

126. Table 4 highlights relevant data available for total employment and total public sector employment. The latter is broken down into two main categories—central government and quasi-governmental institutions. While the absolute number of employees has dropped since 1994, this decline reflects primarily the privatization of government plantations. In contrast, central government employment has increased, in part because of the build-up in defense personnel during 1994-95. As a percent of total employment, public sector employment declined from 27 percent in 1992 to 19 percent in 1997, with all of this decline accounted for by quasi-governmental institutions. Central government employment remained constant at about 13½ percent of total formal sector employment.

Capital spending by the public sector

127. Table 5 provides estimates for Government capital expenditures plus investment outlays of state enterprises. Comprehensive data on capital spending of the central government (adjusted for transfers to public corporations and institutions) are combined with data on investment outlays for statutory boards, commercial corporations, fully owned government companies, and subsidiary government companies. This measure reveals that capital spending has declined moderately in relation to GDP, particularly when compared to the peak years of 1993 and 1994. The high level of investment in these years was primarily due to the Mahaweli project.

Government spending on final goods and services

128. Government spending on goods and services as reported in the fiscal accounts, together with the data on investment outlays of other government entities are used to estimate total government spending (Table 6). Total government spending on final goods and services peaked in 1994 (because of investment spending) and 1995 (because of defense spending). Since then, estimated total spending has declined to 19 percent of GDP.

Value added of public sector to gross national expenditure

129. National accounts data provide sufficient breakdown to identify the contribution of spending by the public sector to total gross national expenditure. This breakdown, shown in Table 7, includes public consumption of goods and services and spending on gross fixed capital formation. This measure shows that the public sector’s share of national spending has increased (but declined since 1995), mainly due to the rise in the public consumption of goods and services.

Value of industrial production by the public sector

130. Public enterprises continue to be strongly represented in the services sector, and dominate in banking and insurance. However, the share of industrial production accounted for by public enterprises has declined dramatically from 12 percent in 1992 to 6 percent in 1997 (Table 8) reflecting sharp reductions in government involvement in several key industries—namely basic metal products; non-metallic mineral production; chemical, petroleum, and rubber products; and paper and paper products.

ANNEX III Sri Lanka: Privatization Program and Public Enterprise Reform

131. Government policies supporting nationalization and widespread protectionist measures during the late-1950s through the mid-1970s led to the creation of a large public enterprise sector. By 1977, there were 107 public enterprises (not counting statutory boards) that accounted for nearly 24 percent of GDP, 30 percent of investment, and 40 percent of formal sector employment. While a market-oriented liberalization program was implemented in 1977, government support to state-owned enterprises did not decline.1 Privatization was not formally adopted as a government policy until 1987 when the Presidential Commission on Privatization (PCP) was created and two legislative enactments were passed. The implementation of the privatization program did not actually begin until 1989 and has been carried out in two phases, 1989-94 and 1995-97.2 The activities of privatized enterprises are generally governed by existing commercial legislation and enforced by the Fair Trading Commission (FTC). The Plantation Restructuring Unit (1992-94) was in operation for two years to overlook and regulate the activities of the plantation sector and the National Transport Commission (NTC) came into operation in 1991 to regulate the bus transport sector.

132. A total of 77 enterprises have been privatized, 42 enterprises from 1989-94 and 35 more from 1994-97. The bulk of the privatizations were in the manufacturing sector followed by some in the services sector. However, there are still 151 enterprises and statutory boards in the public sector (Table 9) with 181,000 employees (3V4 percent of total employment), a book value of Rs 295 billion, and estimated annual turnover of Rs 167 billion.3 Enterprises are spread throughout the economy with the largest numbers in agriculture, construction, the financial sector, manufacturing, and other services. In terms of employment, only six have more than 10,000 employees (Janatha Estates Development Board, Sri Lanka State Plantations Corp., Ceylon Electricity Board (CEB), Bank of Ceylon, People’s Bank, and the Sri Lanka Ports Authority). In terms of book value of assets the largest are the Mahaweli Authority, CEB, and the Ports Authority, and with reference to annual turnover the largest are the Cooperative Wholesale Establishment (CWE), the Ceylon Petroleum Corporation (CPC), CEB, and the two state banks.

Table 9:

Sri Lanka: Public Enterprises and Statutory Boards 1/

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Source: Data provided by the Sri Lanka authorities.

List comprises 100 percent government owned entities, except People’s Bank which is 92 percent government owned excluding those listed in the 1998 program (Table 1.2). Statutory Boards do not include universities and post-graduate institutions.

The operations of the Paddy Marketing Board were suspended at the end of 1997.