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Country Profile 2004

Sri LankaThis Country Profile is a reference work, analysing thecountry’s history, politics, infrastructure and economy. It isrevised and updated annually. The Economist IntelligenceUnit’s Country Reports analyse current trends and provide atwo-year forecast.

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Sri Lanka 1

© The Economist Intelligence Unit Limited 2004 www.eiu.com Country Profile 2004

Contents

Sri Lanka

3 Basic data

4 Politics4 Political background5 Recent political developments9 Constitution, institutions and administration10 Political forces12 International relations and defence

14 Resources and infrastructure14 Population15 Education16 Health16 Natural resources and the environment16 Transport, communications and the Internet18 Energy provision

20 The economy20 Economic structure21 Economic policy24 Economic performance27 Regional trends

27 Economic sectors27 Agriculture29 Mining and semi-processing29 Manufacturing31 Construction32 Financial services34 Other services

34 The external sector34 Trade in goods37 Invisibles and the current account38 Capital flows and foreign debt39 Foreign reserves and the exchange rate

41 Regional overview41 Membership of organisations

43 Appendices43 Sources of information43 Reference tables43 Population44 Labour force44 Transport statistics45 National energy statistics

2 Sri Lanka


45 Government finances45 Money supply and credit46 Interest rates46 Nominal gross domestic product by expenditure46 Real gross domestic product by expenditure47 Gross domestic product by sector48 Prices and earnings48 Agricultural production48 Mining & quarrying exports49 Manufacturing production49 Realised investments in Board of Investment projects49 Stockmarket indicators50 Tourism50 Exports50 Imports51 Main trading partners51 Balance of payments, IMF series52 Balance of payments, national series53 External debt, World Bank series53 Net receipts of foreign assistance53 Foreign reserves54 Foreign reserves-central bank data54 Exchange rates

.

Sri Lanka 3


Sri Lanka

Basic data

65,610 sq km

19.3m (2003 mid-year estimate)

Population in '000 (2001)

Colombo (capital) 2,266 Kandy 1,288Gampaha 2,077 Kalutara 1,069Kurunegala 1,461 Ratnapura 1,020

Tropical

Hottest month, May, 26-31°C (average daily minimum and maximum); coldestmonth, December, 22-29°C; driest month, February, 69 mm average rainfall;wettest month, May, 371 mm average rainfall

Sinhala, Tamil, English

The metric system is now predominant

Rupee (SLRs)=100 cents. Average exchange rate in 2003 SLRs96.52:US$1.Exchange rate on July 5th 2004: SLRs102.54:US$1

Five hours ahead of GMT

January-December

January 7th (Duruthu Full Moon Poya Day); January 15th (Tamil Thai PongalDay); February 1st (Hadji Festival Day); February 4th (National Day); February5th (Navam Full Moon); February 18th (Maha Sivaratri Day); March 6th (MedinFull Moon Poya Day); April 5th (Bak Full Moon Poya Day); April 9th (GoodFriday); April 13th-14th (Sinhala and Tamil New Year); May 1st (May Day);May 2nd (Holy Prophet’s Birthday); May 4th-5th (Vesak Full Moon Poya Day);June 2nd (Poson Full Moon Poya Day); July 31st (Esala Full Moon Poya Day);August 29th (Nikini Full Moon Poya Day); September 28th (Binara Full MoonPoya Day); October 27th (Vap Full Moon Poya Day); November 11th (Deepavali);November 14th (Ramazan); November 26th (Il Full Moon Poya Day);December 25th (Christmas); December 26th (Unduvap Full Moon Poya Day)

Land area

Population

Main towns

Weather in Colombo

Languages

Measures

Currency

Time

Fiscal year

Public holidays in 2004

Climate

4 Sri Lanka


Politics

Political background

The United People’s Freedom Alliance (UPFA) coalition, which is led by thepresident, Chandrika Kumaratunga, won the largest block of seats in the generalelection that took place in April 2004, but failed to gain a majority. The UPFA,which comprises Mrs Kumaratunga’s party, the People’s Alliance (PA), and theJanata Vimuthi Peramuna (JVP, the People’s Liberation Front), won a total ofonly 105 seats out of 225 in the parliament. As a result, the political scene isunstable and the government may collapse. The United National Front (UNF),led by Ranil Wickremasinghe, is the largest opposition party. Although the UPFAcame to power promising a hard line against Tamil secessionists, the prospectsfor a resumption of peace negotiations between the government and theLiberation Tigers of Tamil Eelam (LTTE, Tamil Tigers), which have remainedstalled since April 2003, have improved. The government has backtracked fromits hardline pre-election stance and has stated that it will engage the LTTE.

Sri Lanka was ruled by the Portuguese and the Dutch in the 16th and 17thcenturies respectively. British rule was established at the end of the 18thcentury. Pressure for independence built up in the first half of the 20th century.Sri Lanka (then known as Ceylon) became fully independent on February 4th1948, remaining a member of the Commonwealth.

For the past 20 years Sri Lanka has been caught up in a civil war in which over60,000 people have lost their lives. The immediate origins of the conflict lie inattempts by the 1956 Sinhalese-dominated government to reverse what wasseen as the disproportionate influence of the Tamils in Sri Lankan society. Thisprecipitated antagonism, which caused tensions between the Tamils and theSinhalese. In 1958 the first intercommunal riots occurred. Relations between thetwo groups deteriorated during the 1960s and 1970s: the Tamils sought a federalsystem of government and became alienated when this demand was rejected bysuccessive governments.

The failure of Tamil political parties to attain their aims by peaceful means ledto demands for an independent Tamil state, to be known as Eelam, and to theformation of terrorist groups dedicated to achieving this goal. Repressive actionby government troops only increased tension, culminating in a violent outburstof intercommunal rioting in 1983. The event led to a mass exodus of Tamilrefugees from Sri Lanka. By 1987 the Tamil Tigers, led by Velupillai Prabhakaran,emerged as the leading Tamil militant group, effectively controlling the northernpeninsula and the city of Jaffna.

In 1987 India, whose Tamil population in the adjacent state of Tamil Naduhad long tacitly aided the LTTE, intervened in Sri Lanka’s ethnic conflict. TheIndian Peace Keeping Force (IPKF), made up of divisions of the Indian Army,was deployed to oversee a peace accord, which provided for the formation ofprovincial governments to which limited powers would be devolved. Sri

History

The racial divide

An armed struggle began

Indian troops intervened

Sri Lanka 5


Lanka’s Northern and Eastern provinces, which correspond to the Tamils’desired state of Eelam, were provisionally merged. The LTTE, however, rejectedthe accord and resumed their offensive. The IPKF was then deployed againstthe Tigers and took their stronghold of Jaffna, relegating the LTTE to a guerrillarole.

The UNF, led by the former prime minister, Ranasinghe Premadasa, was electedin 1989. The new president, who was openly critical of the peace accord,ordered the IPKF to withdraw and embarked on direct negotiations with theTigers. As the IPKF withdrew in stages, finally leaving in March 1990, the Tigersreclaimed effective power in the Jaffna peninsula.

In 1989 Sri Lanka was paralysed by another serious wave of violence, inspiredthis time by the Marxist Sinhalese extremist party, the JVP. Aided by unofficialvigilante groups, the security forces responded ruthlessly with their own brandof terror. Thousands—mainly young men—lost their lives in extra-judicialkillings, committed either by the JVP or by the security forces. The campaignwas finally brought to an end in November 1989 by the capture and executionof most of the JVP’s leaders.

Recent political developments

Uneasy negotiations with the Tigers continued throughout the first half of 1990,but fighting broke out again in June. In May 1991 the former prime minister ofIndia, Rajiv Gandhi, was assassinated by an LTTE suicide bomber, allegedly inretaliation for IPKF excesses in the Jaffna area. In May 1993 Mr Premadasa wasalso killed by a Tamil Tiger suicide bomber. This marked a turning point in thepolitical fortunes of the United National Party (UNP), the main component ofthe UNF coalition, and in the profile and tactics (which had become bolder andmore ruthless) of the LTTE. After the assassinations of Mr Gandhi andMr Premadasa, the LTTE lost much international sympathy. Sri Lankans rejectedthe UNP’s conciliatory approach, and the UNP subsequently lost the 1994general election to the harder line PA. In November 1994 Mrs Kumaratunga waselected as president.

Shortly after coming to power, Mrs Kumaratunga’s government opened peacetalks with the LTTE. After a brief cessation of hostilities in January 1995, theTigers unilaterally called off the truce in April 1995, leaving the governmentwith little option but to step up its military effort. In December 1995 thesecurity forces took the former Tiger stronghold of Jaffna, dealing a majorpsychological blow to the militants. However, the fall of Jaffna was followed bya string of military reversals, blamed on faulty military strategy. In December1998 the government was forced to abandon an 18-month military campaignafter suffering heavy losses of manpower and equipment.

The Tigers retaliated against the increased military pressure from governmenttroops by stepping up terrorist attacks on economic and civilian targets on therest of the island. Since the 1996 bombing of the Central Bank of Sri Lanka,

Thousands died in a Marxistuprising

Peace negotiations collapsed

The People’s Alliance came topower

Terrorist attacks in Colombohave escalated

6 Sri Lanka


these targets have included hotels and office complexes in the financial districtof the capital, Colombo, power stations and a sacred Buddhist temple in Kandy.

After surviving an assassination attempt, Mrs Kumaratunga was re-elected for asecond term in the December 1999 presidential election, and in October 2000 ledthe PA coalition to a narrow victory in the parliamentary election.

In April 2000 fighting for control of land access to the northern Jaffnapeninsula intensified, as the LTTE stepped up efforts to secure more territoryahead of possible peace talks brokered by the Norwegian government. TheElephant Pass causeway, which links the northern peninsula to the rest of themainland, was captured by the Tamil Tigers, forcing an estimated 40,000government troops to retreat further into the Jaffna peninsula. With the supportof air force and military equipment purchased from Israel, and faced with fewalternatives, the army consolidated its position in the city of Jaffna itself.

The Tigers, presumably hoping to forestall a ban on its organisation andactivities in the UK under anti-terrorism laws, declared a unilateral ceasefire inDecember 2000. The government and the rebels held several rounds of talkswith Norway’s special envoy and designated peace broker, Erik Solheim. Thegovernment, however, refused to call a truce and the ceasefire was eventuallycalled off by the rebels in April 2001. On July 24th 2001 the Tigers launched adevastating attack on the international airport at Colombo, destroying 13commercial and military aircraft and inflicting damage estimated at more thanSLRs30bn (US$336m). The attack further undermined the credibility of thepresident, who suspended parliament in early July in an effort to prevent amotion of no confidence from being brought against her government, whichhad lost its parliamentary majority following the defection of the pro-government Sri Lanka Muslim Congress (SLMC) from the ruling coalition.

Decisive events in the last five years

1997-99

The Liberation Tigers of Tamil Eelam (LTTE, or Tamil Tigers) launch devastatingterrorist attacks on the capital, Colombo, in retaliation to a prolonged and expensivemilitary operation against their bases in the north. The People’s Alliance (PA)government bans the LTTE in 1998. Chandrika Kumaratunga is re-elected for a secondterm as president in December 1999 after narrowly escaping an assassination bid.

2000

More devastating terrorist attacks take place in Colombo. The Tigers capture the keyElephant Pass military camp on the Jaffna peninsula and march towards Jaffna city.The People’s Alliance (PA) narrowly wins a second term in office. The Tigers declarea unilateral ceasefire.

2001

The rebels call off their ceasefire. The UK bans the LTTE. The international airport atColombo is attacked, resulting in extensive damage to both commercial and militaryaircraft. The parliamentary election in December results in a victory for the UnitedNational Party (UNP). The LTTE declares a ceasefire in December.

Mrs Kumaratunga and the PAwon a second term

The war escalated further

The rebels declared afour-month ceasefire

Sri Lanka 7


2002

The government and the LTTE enter into a formal ceasefire agreement in February.The government lifts the ban on the LTTE ahead of the first round of peace talks inSeptember. A series of talks take place, with Norway as the mediator.

2003

The LTTE suspends peace talks in April, after their exclusion from a donor seminar inWashington, although it later stated that it remains committed to a political solution.

2004

Mrs Kumaratunga, concerned about being forced to continue to rule alongside theopposition-nominated prime minister, dismissed parliament and called a mid-termelection for April 2004. The United People’s Freedom Alliance (UPFA) coalition,supported by Mrs Kumaratunga, won 105 of the 225 seats in parliament, but fallsshort of a majority.

After failing to reach a compromise with the UNP, Mrs Kumaratunga negotiatedan agreement between the PA and the JVP, thereby regaining a majority inparliament, which was set to reconvene in early September 2001. However, theconditions laid down by the JVP were unacceptable to many in the ruling party,leading to defections from within the PA and leaving the president with littleoption but to call a fresh parliamentary election in December.

The UNP won 109 seats in the 225-seat legislature (parliament) in the December10th 2001 election, and held a majority through an alliance with the SLMC(comprising the UNF). Although the UNF alliance has suffered a series ofdisagreements, the UNP can also rely on the 15 seats controlled by the TamilNational Alliance (TNA). Mrs Kumaratunga’s PA suffered a sharp decline inpopularity; it won 77 seats, down from 107 in the previous election. MrWickremasinghe was appointed prime minister, but given the strong powers ofthe executive, and the personal animosity between Mrs Kumaratunga and MrWickremasinghe, the relationship between the government and the presidentremained uneasy.

The UNF government entered into a formal ceasefire agreement with the LTTEin February 2002, paving the way for a build-up to peace talks. The agreementcommitted the two sides to creating conditions that would enable civilian lifeto return to a state of relative normality. This included the unhindered transportof essential goods to the war-affected areas in the north and east, the removalof mines planted by government troops and the rebels, and the opening up ofthe A9 highway, the main land access route to the northern Jaffna peninsula, tounrestricted civilian traffic.

International involvement in the ceasefire (a team comprising representativesfrom Norway, Sweden and Finland was established to monitor the ceasefire),and interest from the US in particular, prompted the elusive leader of the LTTE,Mr Prabhakaran, to come out of hiding in April 2002 to address local andinternational media at a well-attended news conference in a rebel-controlledarea in the north. This was his first interaction with the media for more than 12years. For the rebels, the event was a major public relations exercise, designedto convince international observers that the organisation was committed to a

Another parliamentaryelection was called

The UNP came first in thevoting

The UNF and the LTTE haveagreed on a ceasefire

8 Sri Lanka


negotiated settlement. Mr Prabhakaran reiterated the group’s long-standingposition that any settlement would have to acknowledge the right of the Tamilsto their homeland, Tamil nationality and self-determination. The rebel leaderenvisaged a situation whereby the LTTE would be invited to set up and run aninterim administration in the Northern and Eastern regions.

The UNF government’s peace initiative was boosted by its sweeping victory inthe March 20th 2002 local council elections. Coming just three months after ittook office, the landslide win—the UNF took control of 217 of 222 councils inwhich elections were held—was interpreted as a renewed mandate for thegovernment’s efforts to engage the rebels in negotiations. The public offeredfurther support for the government’s peace efforts in municipal elections thattook place in May 2002, in which the UNF took 15 out of a possible 17 seats.

Concerned about being forced to rule alongside Mr Wickremasinghe andshaken by local council election results, Mrs Kumaratunga exacerbated a powerstruggle between the government and herself, and then called a mid-termelection for April 2004. The UPFA, which consists of the PA coalition togetherwith the JVP, became the single largest group with 105 of the 225 seats inparliament. Nevertheless, they fell short of a majority. The strength of the UNPwas reduced to 82 seats in parliament.

The result of the election could be interpreted as a resurgence of nationalism;the UNF government’s perceived excessive concessions to the LTTE and itsfailure to stem the escalating cost of living were major factors in its defeat. TheUNP’s re-election campaign relied heavily on its efforts while in government tonegotiate a peace with the LTTE—a message that failed to strike a chord amongthe vast majority of the electorate. The PA and the JVP had been critical of theUNF’s accommodation of the Tamil rebels and highlighted these reservations intheir election campaign, accusing the UNF of granting too many concessions tothe LTTE. Their approach struck a chord, leading to their victory.

The new coalition relies heavily upon the JVP, a hardline party that is opposedto a federal solution to the Tamil problem. Given that the UPFA alliance isreliant upon the JVP, things do not look promising. Nevertheless, in response tointernational pressure, the new government has steadily backtracked on itshardline stance and stated that it will negotiate with the LTTE.

Pressing for peace with the LTTE

The United National Front (UNF) government seemed to have thrown caution to thewind to make the latest peace initiative, signed in February 2002, work. Itdismantled many of the security checkpoints intended to protect cities and keyinstallations; lifted travel and transport restrictions to and from the war-affectedareas; permitted the Liberation Tigers of Tamil Eelam (LTTE, or Tamil Tigers) toengage openly in political work in areas under government control; facilitated theby-passing of airport procedures in order for the rebels’ chief negotiator, AntonBalasingham, to fly in and out of the country; and even promoted a majorinternational media conference hosted by the LTTE leader, Velupillai Prabhakaran. Arebel demand that the proscription on the group be lifted before preliminary talks,was met in September 2002 ahead of the first set of talks that were held in Thailand

The electorate supports thepeace process

The UPFA forms a minoritygovernment in April 2004

Sri Lanka 9


in the same month. A series of talks followed, with the Tigers making a majorconcession in December 2002, by agreeing to a solution based on a federal system ofgovernment and dropping their longstanding demand for a separate Tamil state.

Although the peace process has remained broadly on track, the LTTE has tested thepatience of the Sinhalese majority on a number of occasions. The group has violatedthe ceasefire several times, by smuggling arms and recruiting for the military. In orderto keep the process alive the former government overlooked some of theseindiscretions, but this provided its critics with ammunition. The LTTE’s actionsreinforced the criticism, when in April 2003 the group announced that it would notattend a donor conference in June. The reasons given included the government’sfailure to implement commitments made in previous talks, although the main reasoncited was that the group’s representatives were not allowed to attend an aid seminarthat took place in the US in April. (Their exclusion reflected a US law that prohibitsUS officials from meeting representatives of proscribed terrorist groups.) Followingcondemnation by the US for the group’s failure to live up to the spirit of the peaceprocess, the rebels announced that they would continue to pursue a politicalsettlement.

The election in 2004 of the United People’s Freedom Alliance (UPFA) has notimproved hopes of a resolution of the ethnic conflict. A failure to win a majoritymeans that a unified stance towards the LTTE will be difficult. The second-largestconstituent of the UPFA, the Janata Vimuthi Peramuna (JVP), strongly opposes afederal solution. The fact that the People’s Alliance (PA) is reliant on the JVP makesconcessions difficult. In addition, the president, Chandrika Kumaratunga, hascondemned the United National Party (UNP) for making too many concessions tothe Tamil rebels. Nevertheless, Mrs Kumaratunga has backtracked from her hardlinestance and has stated that she and her government will negotiate with the Tigers.

In early March 2004 the Tigers split. A Tiger leader, V Muralitharan, commonlyknown as Karuna, split from the main group and requested separate talks with thegovernment. The LTTE blames the Sri Lankan government for exacerbating the split.On July 7th 2004 an LTTE suicide bomber attempted to assassinate the new ministerof Hindu Cultural Affairs, and eventually blew herself up in a Colombo policestation (killing herself and four policemen). This was the first suicide attack sinceOctober 2001 and the incident does not bode well for the peace process.

Constitution, institutions and administration

Sri Lanka’s current constitution has been the subject of controversy ever since itwas promulgated in 1978. Its chief architect, Junius Richard Jayewardene(president in 1978-88), once quipped that the only thing that the constitution didnot empower him to do was to change a man into a woman. As the country’sfirst executive president under the new constitution, Mr Jayewardene perhapsenjoyed more power than any other leader of a democratic state at the time.The UNP that he led held a five-sixths majority in parliament, buttressing thepresidency still further.

However, the issue of unfettered power came to the fore in Mrs Kumaratunga’ssecond term as president. Technically, Mrs Kumaratunga wielded all the power

The constitution remainscontroversial

10 Sri Lanka


that Mr Jayewardene had, but she lacked his parliamentary support. For onlythe second time in 24 years, the country had a president from one party and agovernment from another. The first time that this had happened was whenMrs Kumaratunga led the PA coalition to victory in the parliamentary electionof 1994. It was her good fortune that the president at the time, D B Wijetunga,was content to play the role of a caretaker, having inherited the presidencyfollowing the assassination of Mr Premadasa, in 1993. The situation inMrs Kumaratunga’s second term was quite different. Her party, although inopposition, had adequate representation in the legislature to thwart the primeminister’s efforts. The prime minister failed to accommodate her views, andusing the president’s power to dissolve parliament, she called a new election.

Ironically, Mrs Kumaratunga has said on many occasions that she dislikes thepowers vested in the presidency, but she has never made a serious effort toeither reduce them or abolish the current system. This has in the past led thegovernment to consider legislation to prune away some of the president’spowers (including the power to dissolve parliament after it has sat in sessionfor one year).

The tensions between the executive and the legislature have made life harderfor institutions such as the judiciary, the police, the armed forces and the highlypoliticised bureaucracy. The credibility and independence of the judiciary hasoften been called into question in the past, especially since the presidentappoints judges to the Supreme Court. As head of state and head of thegovernment, the president presides over the cabinet, all members of which arefrom rival political parties. As commander-in-chief of the armed forces andpolice, she also presides over the National Security Council and maycountermand the orders of the Ministry of Defence. As head of thegovernment, she is entitled to instruct officials of the administration.Traditionally, the bureaucracy has been the plaything of the politicians inpower, with each party replacing the secretaries of government ministries andthe heads of government departments with loyalists, immediately after beingelected. In this environment, the hostility and suspicion between thegovernment and its head filters down through the bureaucracy, adding to itsinherent inefficiency and at times sowing confusion.

Political forces

The UNP draws much of its support from the more educated, affluent andwesternised urban areas and has the backing of many business leaders. TheUNP, the party responsible for opening up the economy in 1978, is decidedlyreform-friendly, as is clear from the acceleration in reform since it took office inDecember 2001. Part of this comes from the party’s historic bent towardsentrepreneurship. Much of this is driven by an urgent need to stimulate growthand improve business sentiment, both of which are essential if the party is togenerate popular support for efforts to end the ethnic conflict. The more left-of-centre parties, the socialists and the nationalists, have always been suspiciousof the UNP. This is not likely to change.

The UNP

State institutions have beenundermined

Sri Lanka 11


The PA, which ruled in 1994-2001, and is currently part of the ruling coalition,now also espouses the liberalisation of the economy, and carried out severalhigh-profile privatisations when it was last in office. However, it is not theconvincing advocate of the free market that the UNP is. The PA coalition alsoaccommodates several die-hard socialists and is closely allied with the JVP,making it something of a political chameleon. The JVP is a hardline Marxistparty that opposes any form of political devolution for the Tamils. In 1989 theparty was partly responsible for a wave of violence, leading the government atthe time to crack down and kill a number of JVP leaders. Over time the JVP hasbecome more mainstream. The PA also includes a new party, formed by theBuddhist clergy, the Jathika Hela Urumaya (JHU, or National HeritageParty),which won nine seats. The focus of its campaign was to criticise allegedcorruption in the main parties. It also takes a non-compromising stance towardsthe LTTE and opposes a political compromise with the Tigers. It has stated thatit will neither support the government in its negotiations with the LTTE, norwill it hinder them.

The UNF’s efforts to fast-track the peace negotiations with the LTTE provide theideal grist for the mills of the forces opposing it. In order to maintain theNorwegian-brokered ceasefire between the two sides, the former governmentaccommodated many of the demands of the rebels, heightening the concernsof the Buddhist clergy and nationalistic elements that oppose concessions tominorities. Similarly, attempts to reform the economy provided manyopportunities for the opposition to exploit the deep-seated fears of the poorerand less educated segments of society that the UNP’s policies were focusedonly on the rich. As a result, the government was not re-elected.

Main political figures

Chandrika Kumaratunga

The president of Sri Lanka is deeply sceptical about the bona fide credentials of theLiberation Tigers of Tamil Eelam (LTTE, or Tamil Tigers). Nevertheless, she issearching for a peaceful solution to the ethnic conflict. She is also constantlycountering attempts by hostile elements in the administration to bypass her inconducting the work of government.

Mahindra Rajapakse

The current prime minister is a staunch Kumaratunga loyalist. He is known to be amoderate politician who commands wide support within his Sri Lanka FreedomParty (SLFP) and beyond.

Ranil Wickremasinghe

The former prime minister gambled on the chance of ending two decades of conflictby staking his reputation on negotiations with the LTTE. The effort was undermined,and he has returned to the opposition.

Velupillai Prabhakaran

The leader of the LTTE, he was forced to commit himself to negotiations after theSeptember 11th 2001 terrorist attacks on the US changed world opinion. The LTTE

The former governmentsuffered severe criticism

The People’s Alliance coalition

12 Sri Lanka


leader is cleverly using every opportunity provided by the ceasefire to extend hisinfluence and strike a hard bargain with the government.

Buddhist clergy

Although by definition not “political” figures, the Maha Nayakes (chief priests) havehistorically had a say in political matters. They had voiced serious reservationsabout the previous government’s peace initiative and remain strongly against anyform of devolution of power to the LTTE.

International relations and defence

Sri Lanka’s relations with its main trading partners and geographicalneighbours have strengthened in recent years, following a relativeimprovement in its human rights record and efforts to end the conflict.Diplomatic efforts to mobilise international opinion against the Tamil rebelshave also borne fruit, a notable achievement being the bans on the rebelorganisation by the UK and the US. The US declared the LTTE a terroristorganisation in 1997, and major donor governments remain committed to theposition that any resolution to the ethnic conflict should not jeopardiseSri Lanka’s territorial integrity. Western countries, in particular the US,welcomed and supported the former UNP government’s commitment to peacetalks.

However, Western countries are unwilling to intervene in Sri Lanka’s civil warwithout involving the dominant regional power, India. India’s disastrousmilitary involvement in the civil war in the late 1980s has rendered it wary offurther military intervention. India, however, does not favour the annexation ofJaffna by the Tamil rebels, and could be forced to mediate in the conflict if theTigers were to declare a separate state. The LTTE’s cause has suffered asignificant setback following the terrorist attacks on the US in September 2001.Although the attacks have not directly changed the position of foreigngovernments with regard to the ethnic conflict in Sri Lanka, the use of armsand terror to meet political ends is now seen as far more objectionable than itwas before.

Sri Lanka’s armed forces are dominated by the army, which is 90,000-95,000strong. However, high levels of desertion reduce the army’s real operationalstrength. The air force and navy are both around 15,000 strong. The navy’smain role is to combat the LTTE’s Sea Tigers, and its main emphasis is oncoastal and inshore patrols. The International Institute for Strategic Studiesestimates the LTTE’s manpower at around 6,000, although other estimatesvary between 4,000 and 14,000.

Security risk

I. Armed conflict

The ethnic conflict involving the Liberation Tigers of Tamil Eelam (LTTE, or TamilTigers) and the government entered its 21st year in 2004. Hopes for a resolution havestrengthened since the signing of a Norwegian-brokered Memorandum ofUnderstanding between the government and the rebels in February 2002. Althoughthere have been occasional violations of the ceasefire, a fair degree of normality has

Sri Lanka has good relationswith its trading partners

Sri Lanka 13


been restored in the northern and eastern parts of the island. The economic embargoon these areas has been lifted, allowing for some resumption of economic activity.Direct talks between the government and the rebels started in September 2002.Although there is less threat of the rebels resuming their armed struggle (given thecurrent international stance against terrorism), based on the LTTE’s past record, aresumption of violence cannot be ruled out. The majority Sinhalese population alsoremains divided over how to resolve the crisis. The conflict has damaged theeconomy and reduced the country’s growth potential. Heavy defence costs havediverted resources away from infrastructure development. Consequently, powergeneration, road transport systems and port facilities are inadequate. As a result,operational costs are higher than would otherwise be the case. Expenses have alsobeen raised by the war-related costs of insurance, in sectors ranging from property totransport.

II. Terrorism

Private businesses have not been targeted by the Tigers, but suicide bombings havetaken place in areas where commercial businesses operate, including the central—andmost developed—parts of the capital, Colombo. As a result, people and property areat risk from terrorist bombings. Businesses in the city face additional security costs.The international airport was bombed in July 2001, as it was deemed a militarytarget—there is an air force base near the airport. However, the impact was felt moreby the tourist and airline industries than by the military. The internationalcondemnation of terrorism as a political solution, coupled with the LTTE’s desire togain legitimacy, has reduced the possibility of terrorist activity on the island, at leastwhile the ceasefire holds.

III. Civil unrest

Civil unrest is common in the periods preceding and following elections. In the run-up to the December 2001 parliamentary vote, more than 60 people were killed as aresult of factional violence. The 2004 elections were free of violence, although over250 complaints of intimidation and ballot stuffing were registered. Demonstrationsare also a common means of registering dissatisfaction with government policytowards the ethnic conflict. The timing of these demonstrations is difficult to predict,although they are typically less violent than those that occur during the campaigningfor elections. Private and foreign businesses are usually not targeted by protestors.Travel should be curtailed during these periods. Business activity and travel would inany case, be affected by curfews and road blocks, which usually follow any unrest.

IV. Violent crime

Violent crime unconnected with the civil war is an increasing concern. Desertersfrom the army are frequently armed, and as a result of the war, access to weaponshas become much easier. Local businesses have been attacked. Raids on largecommercial offices and manufacturing plants are rare, and attacks are unlikely in themore developed areas of the city.

V. Drug smuggling and organised crime

The LTTE is involved in drug smuggling to fund its operations and has adoptedtactics similar to those used by organised crime, such as extortion and peoplesmuggling. These activities, however, tend to occur outside Sri Lanka, among Tamilcommunities in other countries. There are signs that the rebels are adopting similar

14 Sri Lanka


tactics in areas that they hold in the north and east of the country. Again, it is theTamils that are being targeted (although the Muslim population in areas under LTTEcontrol also face similar problems).

Resources and infrastructure

Population

Sri Lanka has reached an advanced stage of demographic transition at arelatively low income level. Fertility has fallen below replacement levels; lifeexpectancy (close to 75 years) has improved and infant mortality rates havefallen. Sri Lanka’s total population stood at 19.3m in 2003. The onset of peacehas seen increased migration to the Northern and Eastern provinces.

Sri Lanka’s population is ageing rapidly. By 2010 Sri Lanka will have one ofthe oldest populations in Asia. The proportion of elderly (over 60 years of age)is forecast to increase from the current 8% to 13% by 2010 and to exceed 20%by 2025. Given the slowing growth rate in the labour force, this will doublethe old-age dependency ratio from 14% to 32% in less than three decades. Thisis a growing social concern since over 50% of the population is not covered byretirement benefits. The economic implications of providing pensions foraround 1.2m civil servants have prompted the government to initiate pensionreforms.

Years of civil strife have accentuated the polarisation of society along ethnicand religious lines. The creation of two separate streams of education, basedon language and ethnicity, has further accentuated the racial divide. Ethnictensions still persist among the four major communities—the predominantlyBuddhist Sinhalese (around 80% of the population), the Jaffna-based Tamils inthe north and east (around 7.1% of the population), the up-country or IndianTamils (5-6% of the population) who generally work on plantations and theTamil Muslims (around 7% of the population) who are mainly traders andpredominate in the Eastern province.

Sri Lanka has a low level of urbanisation, with over two-thirds of the populationliving in rural areas. Population distribution is rather uneven, with over half of thepopulation concentrated in the south-western and central zones (about 14% ofland area), where most of the land under cultivation is found. Only 10% of thepopulation lives in the dry zone, which comprises 40% of the land area.

According to a survey conducted in 2000 by the government and donoragencies, roughly one-third of the population is classified as poor, earning lessthan US$15 per month. Poverty is predominantly a rural phenomenon, owingto sluggish agricultural growth and the lack of physical infrastructure (roads,electricity, communications and irrigation), and has prevented the populationfrom benefiting from industrialisation. Government-financed povertyalleviation programmes, which cover nearly half the population, have not had

Impressive demographicachievements

The ageing population isa concern

Population distributionis uneven

Society is polarised alongethnic lines

One-third of the population ispoor

Sri Lanka 15


an impact because of poor targeting, with 44% of the benefits accruing to thetop three income quintiles.

Unemployment, on a declining trend since 1993, rose from 7.8% in 2001 to 9.2%in 2002. This recent trend is largely attributable to the downturn in themanufacturing and construction sectors since 2000. Anecdotal evidencesuggests that there is a high degree of underemployment, particularly in theagricultural and services sectors.

The profile of the jobless remains a major concern. About two-thirds are 24years of age or under, and over one-fifth have higher education qualifications.This is the product of an outdated education system that has created amismatch between academic training and employment opportunities.

Increased labour migration (204,000 left the country in 2002), primarily tothe Middle East, has helped to ease unemployment pressures in the face ofmodest economic growth. Over 65% of migrant workers are women, whomostly work as housemaids. Although their remittances are the third-highestforeign-exchange earner, the social cost is high, clear from increased incidenceof child abuse, alcoholism and low educational achievements in the familiesof these migrant workers.

Education

Sri Lanka’s policy of free education has paid off in terms of impressive literacy(90%) and enrolment rates, but high student drop-out (33%) and exam repetitionrates (50%) at the secondary level undermine these statistics. The quality andefficiency of the education system has deteriorated, primarily owing to thestate’s dominance (95% of schools are state-run). Expenditure on education fellto just 2.4% of GDP in 2002. Private-sector participation in education—particularly in vocational training institutes and English-medium schools—hasgrown in response to increasing demand. The government has launchededucational reforms, and the teaching of English and computer literacy are seenas high-priority areas, but the shortage of trained teachers is a constraint.

University education is severely restricted. The limited supply of universityplaces has resulted in a gross enrolment rate of only 2% of the eligiblepopulation, compared with an Asian average of 7-8%. The severe shortage ofuniversity places has resulted in large numbers of students opting to studyoverseas. (In 2002 outward remittances for education amounted to US$16m.)University courses are outdated and lack vocational orientation. This hasperpetuated a situation where large numbers of educated people areunemployed. Proposed reforms to university education include allowing theprivate sector to operate fee-levying universities and reorienting the curriculumtowards developing employable skills demanded by the job market.

A high degree ofunderemployment

Unemployment is highest foreducated young people

Labour migration has risensteadily

Quality of education hasdeteriorated

University educationis restricted

16 Sri Lanka


Health

Sri Lanka’s health indicators are the best in South Asia. The majority of thepopulation has access to a fairly extensive network of healthcare facilities,provided free of charge by the state. The quality and efficiency of healthcareservices has, however, deteriorated, owing to financial and human resourceconstraints. In 2002 Sri Lanka had just one doctor per 2,300 persons and 121nurses per 100,000 persons. In 2002 national health expenditure was 3.2% ofGNP, of which 48% was provided by the state and 46% by households.Employers accounted for just 3%, non-profit organisations contributed 2% andthe share of private insurance was a minuscule 1%.

Changing lifestyles and demographics have altered the demand profile forhealth services. Diseases associated with more affluent societies such as drugand alcohol addiction, and deterioration in mental health, as well as thoseassociated with an ageing population, are on the rise. The growing numbers ofwar-related wounded and disabled represent an additional burden onoverstretched health facilities. Less spending on preventive healthcare serviceshas led to a sharp increase in diseases such as malaria, dengue fever andencephalitis, which have reached epidemic proportions in recent years.

Private healthcare provision has grown, but, as it is expensive, its accessibility tothe wider population, who are not covered by health insurance, is limited. Theprivate sector provides around 50% of primary healthcare, whereas the bulk ofhospital care is still provided by state-run facilities. Health reforms aim toencourage increased private investment in curative health, thereby allowing thegovernment to focus more on preventive health.

Natural resources and the environment

Sri Lanka’s biodiversity has been affected by land degradation, coastal erosionand depletion of total forest cover, while industrial waste and sewage run-offare polluting its freshwater resources. The dumping of solid waste on openlands (owing to inadequate disposal facilities) is a growing health hazard.

Sri Lanka has a well-defined environmental policy (including mandatoryenvironmental impact assessments for all infrastructure and industrial projects),but weak enforcement has undermined its effectiveness. Private-sectorparticipation in services such as solid waste collection, waste-water and sewagetreatment and the management of industrial estates is being encouraged.Sri Lanka has ratified several international environmental treaties, including theKyoto Protocol in 2002.

Transport, communications and the Internet

The physical infrastructure in Sri Lanka is inadequate across all transport andutilities sectors. Budgetary constraints have led to a drop in public investment(3.3% of GDP in 2002) and the lack of rational pricing policies have deterred

Private investment in health isrising

Insufficient spending onhealth

The disease profile haschanged

Gradual degradation of theenvironment

Private-sector participation isencouraged

Infrastructure risk

Sri Lanka 17


private sector entry. The government is promoting private investment ininfrastructure, largely on a build-own-operate or build-own-transfer basis. Animportant step in 2002 was the establishment of a multi-sector regulatory bodyto overlook all utilities.

There is an extensive road network, but it consists largely of single-lane roads.Only one-third is paved and maintenance is poor. The situation is exacerbatedby a lack of spending on the rail network, which has resulted in the roadsystem becoming the dominant means of carrying cargo. Several projects arecurrently being undertaken to improve the rail system, but these will not havea significant impact. Traffic congestion will remain a problem until the ringroads and highways that are planned for the capital, Colombo, are built, butthese have a number of years left before completion.

Work on the expressway linking the airport with Colombo and the Southernhighway connecting the Southern province with the capital has commenced.The A9 highway leading to the Northern province was re-opened in 2002 andis being rehabilitated. Other road projects in the pipeline are the Colombo-Kandy expressway and an outer-circular highway in Colombo.

The decline in road conditions has been hastened by the sharp increase inusage—approximately 400,000 vehicles plied the roads in 2003. The opening in2002 of roads previously closed for security purposes has not significantlyeased the flow of traffic in Colombo. An unreliable and overcrowded bustransport system continues to undermine productivity and has encourageddemand for—and a proliferation in—substitutes such as vans, three-wheelertaxis and motorcycles. Transport policy is being revamped to encourage greaterinvestment in public transport. The government sold several of its 13 buscompanies to a UK-based operator, and the remainder are due to be divested.Fares were partly deregulated in 2002.

Years of inadequate investment and financial losses have relegated the railnetwork to the position of a minor player in the transport sector. Freighttransportation has been largely stagnant and the increase in passenger traffichas been negligible, although there were increases in 2001 and 2002. Railwayaccidents have increased sharply owing to poor maintenance.

The fleet of the national airline, Sri Lankan, was halved to six planes during arebel attack on the country’s international airport in July 2001. The airlinerecovered in 2002, when three new aircraft were added to the fleet and itstarted flying to several new destinations, including two in India. The ban ondomestic commercial flights was lifted in 2002 and three airlines commencedoperations between Colombo and Jaffna. An autonomous regulatory body, theCivil Aviation Authority, was established in 2002 to monitor and develop thecivil aviation industry. In 2004 India’s largest private airlines, Jet Airways andSahara India, began flying to Colombo. They are expected to increase thenumber of routes as well as the frequency out of Colombo in time.

Road traffic is a major problem

Three domestic airlines havebeen launched

Railways are run down andloss-making

New highways are beingconstructed

18 Sri Lanka


The main port of Colombo has two container terminals, the state-owned JayeContainer Terminal (JCT), operated by the Sri Lanka Ports Authority (SLPA)and the South Asia Gateway Terminal (SAGT), which is operated by P&O ofAustralia. The removal in 2002 of the war-risk insurance surcharge (imposed inJuly 2001 following the airport attack), boosted volumes to an unprecedented1.8m TEUs, of which one-fifth was generated by SAGT. Ongoing reforms to theSLPA (including the trimming of its workforce) has improved productivity. TheSLPA has also entered into exclusive service agreements with leading shippinglines, which have further boosted transshipment traffic. Further reforms thatare being considered include the construction of a new south harbour, and anew port in Hambantota in the south. In October 2004 a SLRs1bn single pointintegrated port service will begin operation at Orugodawatta. The governmentis also due to invest SLRs1.2bn to upgrade Galle Harbour port. The project willbegin in 2005.

The telecommunications sector has undoubtedly been the biggest success storyin recent years. Since its deregulation in 1996 and the partial privatisation ofSri Lanka Telecom (SLT) in 1997, the industry has grown at a spectacular pace.The number of fixed telephone lines grew by about 70% 1998 and 2002. Intensecompetition, improved supply and expanded coverage have fuelled growth inthe mobile phone industry—the number of users expanded by over 400%between 1998 and 2002 to reach 931,580. As a result, telephone density,including mobile phones, reached an estimated 9.6 per 100 persons in 2002.Internet connectivity has also grown, both in terms of the number of users(which grew by 269% in 1998-2002) and by the number of service providers,although it remains primarily an urban phenomenon. All leading governmentdepartments and companies operate websites and Internet banking has alsobeen introduced.

In 2002 SLT became a listed company on the stock exchange with a publicoffering of 12% of its share capital. The telecoms industry was liberalisedfurther with the lifting of SLT’s monopoly on the international network at end-2002. Since then, more than 30 new external gateway operators have beenissued. Licences and call rates have plummeted.

The reach of television extends to over 90% of the island and is the favouredmedium for advertising. In 2002, there were approximately 115 televisions per1000 inhabitants on the island. A high literacy rate means that newspapers arewidely read. However, a dominant state presence in all forms of media andcurbs on media freedom, which have stifled investigative journalism, havereduced their effectiveness as a watchdog.

Energy provision

In 2001 the country faced a severe power crisis—the second to occur since 1996.Power supplies were restored in May 2002, with the addition of 290 mw ofemergency power from the private sector. Although the failure of twomonsoons restricted the use of hydroelectric power, which accounts for 60% ofinstalled capacity, the crisis was attributable more to poor planning and delays

Port services have improvedvisibly

Telecommunications is themost dynamic sector

Press freedom is limited

The 2001 power crisis was theresult of poor planning

Sri Lanka 19


in awarding new power contracts. Between 1999 and 2001 barely 200 mw ofnew capacity was added, whereas demand grew rapidly, ironically owing to alow tariff policy (that encouraged increased usage) and expanded ruralelectrification.

Major new power projects—such as a badly needed 300-mw coal power plant,and a 150-mw hydroelectric plant—have yet to begin. Growing demand(estimated at 10% per year) requires at least 100 mw of new capacity addedeach year. However, only one power plant—the 70-mw Kukule Gangahydroelectric plant started generating in 2003.

The Ceylon Electricity Board (CEB) remains deeply mired in a financial crisis.Operating losses amounted to SLRs7.5bn (US$78.4m) in 2002, necessitatingSLRs15bn in bank borrowing, which raised its debt burden sharply. Costsmounted, owing to increased use of thermal power and purchases ofemergency power from private operators. Although tariffs were raised by 38%in 2002, the average cost of generating a unit of electricity at SLRs8.85(9.2 US cents) far exceeded the average tariff of SLRs7.21. Nevertheless,electricity tariffs are among the highest in South and South-east Asia. A newElectricity Reform Act passed in 2002 has paved the way for the restructuringof the CEB. Generation, transmission and distribution services will beunbundled by 2004. The various services will operate as separate commercialentities, with private-sector participation.

The deregulation of the petroleum industry

The importance of petroleum as a source of commercial energy has grown withincreased reliance on thermal power and growing demand from the transport sector.Annual crude oil imports rose to 2.28m tonnes in 2002 compared with 1.96m tonnesin 2001.• Several initiatives have been taken to deregulate and increase competition in the

petroleum industry, previously the monopoly of the government-owned CeylonPetroleum Corporation (CPC).

• In 2001 the monopoly in the liquefied natural gas (LNG) market held by Shell,the Anglo-Dutch energy exploration and production company, was lifted andcompetition has intensified with the entry of two new companies. Thegovernment is also in the process of divesting its 49% shareholding in Shell Gas,a 51% stake of which is held by the Shell Group.

• The marine fuel market was liberalised in 2002 with the sale of Lanka MarineServices (a subsidiary of the CPC), which previously held the monopoly onbunker fuel sales.

• In 2002 the retail (import, storage and distribution of petroleum) market wasderegulated. An agreement was signed with the Indian Oil Corporation (IOC),owned by the Indian government, to import and distribute petroleum products.Oil tanks in Trincomalee, in the east, were also leased to IOC for storagepurposes. There are plans to invite a third player to enhance competition in theretail market.

• Owing to the lack of storage and refining facilities, the CPC is considering thelease of its refining and storage facilities to private companies. The CPC itself isbeing restructured to face competition.

The CEB continues to face afinancial crisis

New projects are still pinnedto the drawing board

20 Sri Lanka


• Petroleum prices were freed in January 2001, with the adoption of a flexiblepricing policy that reflects movements in international oil prices. This enabledthe CPC to recoup part of the huge losses that it incurred in 2000 and by end-2002 it posted a SLRs5bn (US$52.2m) profit, which helped to reduce its banklending to SLRs16bn.

• The phasing out of the cross-subsidy between diesel and petrol reduced growthin diesel consumption to 5% in 2002, compared with an annual average growthof 12% in 1990-99 when diesel prices were heavily subsidised.

The economy

Economic structureMain economic indicators, 2003Real GDP growth (%) 5.9

Consumer price inflation (%) 6.3Current-account balance (US$ m) -101

Average exchange rate (SLRs:US$) 96.52Population (m) 19.3

Sources: Central Bank of Sri Lanka, Annual Report, 2003; Economist Intelligence Unit.

Sri Lanka’s economy is highly dependent on domestic trade. Wholesale and retailtrade is the largest single sector, accounting for 21% of GDP. The combined servicessector, which also includes transport, communications, financial services andtourism, generates more than 50% of GDP. Telecommunications is the mostdynamic subsector, recording double-digit growth in 1998-2003. Financial serviceshave seen healthy growth.

A downturn in manufactured exports reduced manufacturing’s share from17.4% in 2000 to 16.4% in 2003. Privately owned export-oriented factoriesproduce over 95% of manufacturing output. The manufacturing base isdominated by the garment industry, although the production of food andbeverages, as well as that of chemical and rubber-based goods, is alsoimportant.

Although its significance has declined in recent years, the agricultural sector isan important determinant of GDP, directly accounting for around one-fifth ofnational output and employing over one-third of the workforce. Indirectly, itsimportance is larger than these figures indicate because of links betweenagriculture, manufacturing and services.

Although privatisation has reduced the size of the public sector inmanufacturing, the state continues to dominate the financial sector and theutilities, and has a quasi-monopoly in health and education. It is also the largestlandlord, owning 90% of land. Sri Lanka has the highest number of publicemployees per head in Asia: 12% of the labour force are employed by thegovernment compared with 8% in Pakistan and 4.7% in India. Expenditure oncivil servants and a huge political establishment consumes around 10% of GDP.

The agricultural sector is thelargest employer

The services sector isdominated by trading

Manufacturing is the mostdynamic sector

The public sector is still large

Sri Lanka 21


Comparative economic indicators, 2003Sri Lanka India Pakistan Singapore Bangladesh

GDP (US$ bn) 18.6 592.0 69.0 91 51.9GDP per head (US$) 971 558 456 21,790 354

GDP per head (US$ at PPP) 3,346 2,690 1,970 27,860 1,270Consumer price inflation (av; %) 6.3 3.8 2.9 0.5 5.6

Current-account balance (US$ bn) -101 3.4 3.2 22.8 0.4Current-account balance (% of GDP) -0.6 0.6 4.7 24.9 0.7Exports of goods fob (US$ bn) 5.1 57.2 11.7 143.5 6.9

Imports of goods fob (US$ bn) -6.7 -74.4 -12.6 122.4 -9.3External debt (US$ bn) 10.7 104.4 33.6 15.1 18.1

Debt-service ratio, paid (%) 9.3 13.9 13.5 2.0 7.5

Source: Economist Intelligence Unit, CountryData.

Economic policy

Sri Lanka liberalised its economy in the late 1970s ahead of other developingcountries, but lost its competitive edge in subsequent decades, owing to thepatchy implementation of the reform agenda and the ethnic conflict. The paceof economic reform accelerated in 1989-92 under an IMF-sponsoredprogramme, but temporarily lost momentum after the People’s Alliance (PA)won power in 1994. After GDP growth slumped to 3.8% in 1996, the reformprocess was jump-started and significant progress was achieved in deregulatingand liberalising the economy. Several large privatisations including those ofplantations, Sri Lanka Telecom (SLT), a development bank and the nationalairline took place. The telecoms, power generation and port sectors wereopened to private participation, and foreign-equity limits in financial serviceswere relaxed. However, the pace of reform faltered in 1999-2001 as the civil warescalated, and presidential and parliamentary elections distracted thegovernment’s attention from the economy. In January 2001 the rupee wasfreed, ahead of the IMF’s provision of a US$253m balance-of-payments supportfacility. The facility, which was suspended in the second half of 2001 as thegovernment backtracked on several reforms, was renegotiated by the UnitedNational Front (UNF) government soon after it won the parliamentary electionin December 2001.

The pace of reform accelerated under the UNF. The 2002 budget introducedmajor reforms, including direct tax reforms and the replacement of the nationalsecurity levy and goods and services tax by a two-tiered value-added tax (VAT).The scope of VAT was extended further in the 2003 budget and exemptionsnarrowed. The 20% surcharge on corporate and personal taxes was lifted, themaximum rate of corporate tax was lowered from 35% to 30% in 2003, and thewide range of fiscal incentives was narrowed. Foreign investment in previouslyregulated sectors was completely liberalised. Administered prices, in particularthose of fuel and electricity, were freed.

The privatisation programme has gained momentum and has beenaccompanied by substantial deregulation. The insurance sector has reverted toprivate hands with the sale of the two state-owned insurance corporations. Thegovernment sold an additional 12% of its shares in SLT and liberalised the

The pace of reform has beenuneven

22 Sri Lanka


international telephone network at end-2002. Significant progress has also beenmade in deregulating the petroleum sector.

The government’s commitment to reform and the progress achieved in 2002has been viewed favourably by international lending agencies. In April 2003the IMF approved a US$567m loan package. In 2003 US$59m was disbursed.However, the IMF postponed its second tranche, worth US$80m due to bedisbursed in February 2004. Although satisfied by the progress made by thegovernment on the fiscal front, the IMF remained uncertain about thegovernment’s ability to push through some tough reforms, includingamendments to labour legislation. The World Bank is finalising an US$800mpackage to support deeper economic reforms in 2003-06. In early 2004 theBank approved a US$51m grant to reduce rural poverty.

The reform agenda in 2004-05

In April 2003 the IMF formally approved a US$567m aid package to Sri Lanka, underits poverty reduction and growth facility (PRGF) and an extended fund facility (EFF).The funds will be disbursed in eight equal tranches by end-February 2006. In itsMemorandum of Understanding signed with the IMF, the government has spelt outits structural reform agenda.

Financial sector reforms

In June 2003 legislation to pave the way for deeper financial sector reforms wasintroduced. This includes the Asset Management Company Law (which establishes acompany to take over the non-performing loans of commercial banks), andamendments to the Banking Law and Exchange Management Act, aimed atstrengthening the supervision powers of the Central Bank of Sri Lanka, facilitatingeasier entry and exit into the banking sector, and making the foreign-exchangeregime more market-oriented.

Trade reforms

The agenda for trade reform envisages a phasing out of the import surcharge byJanuary 2005. This will be accompanied by a move to a simplified three-tier tariffstructure by 2005.

Tax Reforms

The new government has backtracked on attempts to establish a single RevenueAuthority (incorporating the Inland Revenue Department, and the ExciseDepartment and Customs Authority) and instead aims to strengthen theadministration in each of the separate departments. Other tax reforms are theextension of the value-added tax (VAT) to the wholesale and retail sectors, andfurther rationalisation and streamlining of fiscal incentives.

Labour market reforms

Labour market reforms, implemented at end-2003, included a firm compensationformula for employees who are laid off and the setting of firm time limits for theresolution of industrial disputes.

Privatisation

The state-owned enterprises that are listed for privatisation include the retailbusiness of the giant state-owned trading corporation, the Co-operative Wholesale

Sri Lanka 23


Establishment, the Hilton Colombo hotel, the Ceylon Petroleum Corporation’s assetsand market network, and an additional 8.5% slice of Sri Lanka Telecom. Theprevious government also gave a firm undertaking that it would complete a fullevaluation of the assets and liabilities of a local state-owned commercial bank,People’s Bank, as well as initiating its commercialisation. However, the newgovernment has so far backtracked on privatisation.

Civil service and pension reforms

The freeze on civil service employment that started in 2002 continues. There will bea continued rationalisation of all state departments and agencies. In January 2003the pension system changed from being fully state funded into a contributoryscheme for newly recruited civil servants.

Successive governments have failed to effect a sustained decline in the budgetdeficit, which averaged 8.8% (excluding grants and privatisations) in 1999-2003.Although overruns on defence spending have been the primary cause of fiscalslippage, the lack of political commitment in curbing the size and cost of thecivil service, rationalising welfare payments and subsidies, and curbinggovernment borrowing have contributed to high deficits. Fiscal performancehas also been undermined by slowing revenue growth, as the proliferation oftax exemptions and concessions, import duty waivers and widespread taxevasion has eroded the revenue base.

In 2001 the fiscal deficit climbed to 10.5% of GDP. The massive increase inborrowing raised interest costs to one-third of expenditure and the debt stock toover 100% of GDP by 2002. Fiscal performance improved markedly in 2002,underpinned by improved financial management, a freeze on civil serviceemployment and wages, reduced transfers to loss-making state enterprises,more restrained government borrowing and lower defence expenditure—all ofwhich helped to reduce the budget deficit to 8.9%of GDP in 2002. In 2003 it fellfurther to 8% of GDP owing to a reining in of recurrent expenditure. Thereduction occurred despite a fall in tax receipts.

In 2002 the UNF government introduced the Financial Management(Responsibility) Act, primarily aimed at making successive governments moredisciplined, accountable and transparent in the conduct of fiscal operations.The act mandates specific and time-bound fiscal targets to be achieved in themedium term, and so far the new government has stated that it will adhere tothe new guidelines. The fiscal deficit is to be cut to 5% of GDP by 2006 andmaintained at that level thereafter. The limit for total government liabilities hasbeen set at 85% of GDP by 2006 and at 60% by 2013. To enhance transparencythe government is obliged to provide several reports, including a mid-year fiscalassessment, as well as a fiscal statement three weeks after a general election isannounced. The latter is aimed at discouraging pre-election handouts, whichare commonly used to gain political support.

The conduct of monetary policy is chiefly influenced by developments on thefiscal front and, to a lesser extent, by movements in the foreign-exchangemarket. Monetary policy was gradually relaxed in 1998-2000 in an attempt tostimulate further economic expansion, but tightened significantly in 2001 inorder to counter the inflationary impact of a sharp increase in government

Fiscal deficits underminemacroeconomic stability

Monetary policy has beengradually relaxed

24 Sri Lanka


borrowing. However, in the second half of 2001, as the economy slowedperceptibly, the Central Bank of Sri Lanka began relaxing monetary policy. Thekey indicative rate—the repurchase rate—was cut six times by 800 basis pointsto 12% by December 2001. There was further loosening in 2002, with therepurchase rate being cut by 225 basis points and this soft stance continued into2003. The prime lending rate fell from 21.5% in 2000 to 14.3% in 2001, and from12.2% in 2002 to 9% in 2003 and 2004. It is expected to fall even further.

Summary of government finances, 2003SLRs m % of GDP

Total revenue 276,516 15.7Tax revenue 231,648 13.2 Income taxes 39,397 2.2 Stamp duties 51.0 .. Value-added tax 97,230 5.5 Excise tax 50,972 2.9 Defence levy 79 .. Licence fees 641 .. Taxes on international trade 39,667 2.3Non-tax revenue 44,868 2.5

Expenditure & net lending 417,671 23.7Current expenditure 334,693 19.0 Wages, goods & services 138,661 7.9 Interest payments 125,126 7.1 Transfers & subsidies 70,906 4.0Capital and net lending 82,979 4.7 Public investment 87,409 5.0Budget balance (before grants &

privatisations) -141,155 -8.0

Note. Totals may not add owing to rounding.

Source: Central Bank of Sri Lanka, Annual Report, 2003.

Economic performance

Real GDP growth averaged 4% in 1999-2004, a reasonable performance giventhat it was achieved against the backdrop, for most of the period, of adevastating civil war. Sri Lanka has been unable to sustain growth rates of 6%or more, except in 1997 and 2000. Since 1994 the escalating civil war,heightened political and economic uncertainty and the slowdown in the paceof economic reform have kept Sri Lanka’s growth rates well below potential.Other factors that have constrained growth are a huge and inefficient publicsector, unsustainable fiscal deficits, and slow improvements in agriculturalproductivity, inefficiencies in the financial sector and inadequate infrastructurefacilities. External shocks have also had a significant impact on external trade.The lagged impact of the September 11th 2001 attacks on the US affectedtourism, and a global recession in 2001-2002 affected export demand. Anattack on the country’s international airport in July 2002 had an impact on thealready troubled tourism sector and port services. Indirectly, the impact of theattack was also pronounced in terms of the subsequent dip in investorconfidence and forgone potential investment.

The civil war has kept growthbelow potential

Sri Lanka 25


Economic gains of peace

Although the economy has still to experience the promised “peace dividend”, thereis no doubt that peace has brought tangible economic gains, including stimulateddomestic economic activity and improved market confidence. The removal of thewar-risk insurance surcharge has raised port output to unprecedented levels. Thecoverage of telecommunications and financial services has expanded with theopening of the north and east. The opening of the main highway to the north andeast has facilitated greater goods and factor mobility in response to increaseddemand from these previously deprived regions. The resumption of agriculturalactivities in these areas has also added to the supply of agricultural crops, whileextended fishing hours have resulted in an increase in fish production. Improvedinvestor confidence was clear from the increase in foreign direct investment (FDI),which rose to US$230m in 2002. One of the most quantifiable benefits was thereduction in defence spending, which fell from 4.8% of GDP in 2001 to 4% in 2002. Innominal terms defence spending was SLRs60bn (US$627m) compared with abudgeted SLRs100bn. In addition, reduced defence imports eased pressure on theexchange rate. Aid commitments also rose significantly as donors supported thepeace process.

Exports of goods and services have generally been the fastest-growingcomponent of GDP. Growth averaged a respectable 4.7% in 1999-2003, butexports contracted by 5.3% in 2001 in line with a downturn in world trade andtourist arrivals, before growing by 6.3% in 2002 as external demand staged arecovery. The export base remains narrow—Sri Lanka is still dependent on teaand garment exports to provide the impetus to economic growth. Subduedgrowth in rural, agricultural incomes and the erosion in real disposableincomes (owing to high indirect taxes and relatively high inflation) have limitedprivate consumption. Government consumption growth (mirrored by highfiscal deficits) was curbed in 2002 and 2003 as fiscal management wastightened. Investment as a proportion of GDP averaged 25.3% in 1999-2003. Alacklustre policy environment, political and security risks and high interest rateshave dampened private investment, whereas budgetary constraints have keptpublic investment below the desired norm.

Sri Lanka’s manufacturing sector, dominated by the private sector, grew at anaverage rate of 3.2% in 1999-2003, and is one of the principal drivers of economicgrowth. Growth in the services sector averaged 4.9% in 1999-2003, sustained bygrowing demand for utilities, communications and financial services. The heavyweighting of export and import trading makes services growth vulnerable todevelopments in the global market. The agricultural sector is the largest source ofemployment and still exerts a strong influence on the direction of GDP growth. Itssluggish growth, the product of low productivity and inadequate investment, hasremained a drag on overall economic performance in recent years.

Services growth outpacesmanufacturing

Exports are the most dynamiccomponent of GDP

26 Sri Lanka


Gross domestic product(% real change; factor cost at 1996 prices)

Annual average2003 1999-2003

Agriculture 1.5 1.4

Mining & quarrying 3.6 2.4Manufacturing 4.4 3.2

Construction 5.5 3.4Services 7.7 4.9GDP 5.9 3.7


In recent years consumer price inflation has been largely a cost-pushphenomenon. The sharp increase in international oil prices (necessitatingupward revisions to fuel, transport and electricity prices), an above averagedepreciation of the rupee, increases in war-related levies and importsurcharges, and drought-induced increases in food prices, all fuelled inflation in2001, which rose by 14.2% in that year compared with 6.2% in 2000. Inflationmoderated to 9.6% in 2002, underpinned by improved agricultural supplies andslower rupee depreciation, and then fell to 6.3% in 2003. Demand pressures,arising from high fiscal deficits, have been held in check by a prudentmonetary policy and slower growth in private credit.

However, attempts to keep inflation in the low single digits will present achallenge. Sri Lanka’s food prices are the highest in South Asia. Lowproductivity and inefficient marketing in domestic agriculture have prevented asustained decline in food prices, although increased competition from importshas helped slightly. Consumer resistance is weak and consumer protection lawsineffective. Given the high level of import dependence, domestic prices areextremely vulnerable to the depreciation of the rupee and imported inflation.Firmly entrenched inflationary expectations are an additional factor in theinflationary equation.

In late January 2001 the Central Bank abandoned its established practice ofannouncing a trading band for the rupee on a daily basis and floated the rupee.The decision was prompted by the sharp drop in foreign-exchange reserves andthe build-up of speculative pressure in the market in the second half of 2000.In 2000-01 the rupee depreciated by a cumulative 29.2%, falling fromSLRs72.12:US$ at end-1999 to SLRs93.16:US$ at end-2001, and at end-2003 itstood at SLRs96.52:US$1. A build-up of foreign reserves; increased inflows fromprivatisation and portfolio investment; subdued growth in import demand; andthe easing of speculative pressures have stabilised the rupee, which depreciatedby an annual average of 6.6% in 2002 and by less than 1% in 2003.

The rupee has gained stability

Inflation has weakened

Several factors militate againsta reduction in inflation

Sri Lanka 27


Prices(% change, annual average)

Annual average2003 1999-2003

Consumer prices 6.3 8.2

Wholesale prices 3.1 5.4

Sources: Central Bank of Sri Lanka, Annual Report, 2003; Economist Intelligence Unit.

Regional trends

Inadequate infrastructure development in rural areas, the concentration ofindustry and financial services close to the main ports and the airport, and thepoor performance of the agricultural sector have led to an unequal distributionof the benefits of economic growth between the regions. Given its proximity tothe port and airport, the Western province generates over 46% of GDP, 55% ofservices and 57% of total industrial output. The inhabitants of the Westernprovince have the highest income per head, followed by the North-western andSouthern provinces. The Northern and Eastern provinces are the poorest. TheSouthern, Central, North-western and Sabaragamuwa provinces, where theplantation, fisheries and other agricultural activities are concentrated, generate59% of agricultural output. Labour productivity in industry and services is alsohighest in the Western province.

Economic sectors

Agriculture

The plantation sector produces the three main export crops—tea, rubber andcoconut—of which only tea has the potential for any real increase in output. Teaplantations were privatised in 1995 and for the next five years production hitnew highs every year, surpassing 300m kg in 2000. The trend was reversed in2001, when a severe drought cut production by 3.5% to 295m kg, but recoveredin 2002 to a new record of 310m kg as weather conditions improved and in2003 it stood at a reasonable 303m kg. Low-grown teas (over 60% of output andproduced mainly by private smallholders) remain the most dynamic category,with yields at 2,212 kg/ha, nearly double those achieved by the larger plantationcompanies. The larger plantation companies are hampered by high productioncosts, primarily wage pressures from a unionised workforce.

Sri Lanka is the world’s leading tea exporter. With the exception of 1997 andwhen prospects of a US-led war in Iraq reduced Middle East demand in 2002,exported volumes have grown progressively. However, while rupee earningshave continued to grow, dollar-denominated earnings fell in 2001-02. Russiaand other members of the Commonwealth of Independent States (CIS) areSri Lanka’s largest buyers, followed by the UAE, Syria and Turkey.

Regional developmentis skewed

Tea has benefited fromprivatisation

Tea prices, exports andearnings have risen

28 Sri Lanka


Over two-thirds of rubber holdings and three-quarters of coconut cultivationare in the hands of smallholders and, as a consequence, suffer fromobsolescence and neglect because this group lacks economies of scale andfinds it harder to obtain funds for investment. Rubber production, on a long-term declining trend, slumped to 87.6m kg in 2000, the lowest level recordedfor 51 years and fell further to 86.2m kg in 2001. However, higher internationalprices encouraged increased tapping in 2002, raising production to 90.5m kg inthat year and then to 92m kg in 2003. Reduced fertiliser application haslowered yields, which are one-half those of other rubber-producing countries.In recent years, growing demand for rubberwood and land for commercialdevelopment has reduced the area under rubber cultivation and dissuadednew planting and replanting. Domestic consumption of rubber by the rubberproducts industry has continued to rise, causing exports of natural rubber tofall during much of the 1998-2003 period.

After a record harvest of 3.1bn nuts in 2000, a drought cut coconut productionto 2.8bn nuts in 2001, 2.4bn nuts in 2002 and 2.6bn nuts in 2003. The lack ofsupply of coconuts raised retail and wholesale prices sharply, and precipitated acrisis in the desiccated (dried) coconut mills industry. Sri Lanka is second onlyto the Philippines in the export of desiccated coconut and, in order to preventthe closure of several mills, the government attempted to divert more coconutsto the export-processing industry by lifting the surcharge on edible oil imports.High domestic consumption in the last few years—over two-thirds of totalproduction—has prevented a significant expansion in exports of coconuts.

Low productivity in the domestic agricultural sector is the product of a host ofproblems that successive governments have failed to resolve. Farmers havelimited access to credit, modern agricultural implements and high-quality seeds.Land holdings are small. Storage and transportation of produce are still fairlyprimitive, resulting in an estimated 40% post-harvest loss. Efforts to increaseprivate investment in domestic agriculture have not been successful, primarilyowing to inconsistent pricing and trade policies and heavy state interference inthe market.

Paddy (unmilled) rice dominates the non-plantation agricultural sector andaccounts for one-fifth of total agricultural output, rendering it an importantdeterminant of agricultural growth. Good weather conditions since 1997 haveenabled a progressive increase in paddy production, with output reaching 2.9mtonnes in 1999—the highest since 1995. The drought, however, reducedproduction to 2.7m tonnes in 2001, but production rose again to 2.9m tonnes in2002 and then to 3m tonnes in 2003. This partly reflected an increase in thelands under rice cultivation in the north and east, owing to reduced militaryactivity in the area. Although yields have improved continuously and are on apar with those achieved in Thailand and the Philippines, high production costsare a drawback.

The importance of rubber andcoconuts is falling

Domestic agricultureis inefficient

Rice production has risen

Sri Lanka 29


Output of principal agricultural crops, 2003Tea (m kg) 303Rubber (m kg) 92Coconut (m nuts) 2,562

Paddy ('000 tonnes) 3,071


Mining and semi-processing

Although mining accounts for less than 2% of GDP and generatesapproximately the same percentage of export earnings, its importance stemsfrom Sri Lanka’s international reputation for the quality of its precious andsemi-precious stones, in particular blue sapphires. The US was the largest buyerof gems in 2002. Japan, Hong Kong and Thailand are also big markets. TheAsian financial crisis reduced earnings from gem exports in 1998-99, but thiswas followed by an impressive recovery in 2000, when earnings climbed by52% in US dollar terms to US$93m. Earnings grew by 4% in dollar terms in 2002after a 12% decline in 2001, reflecting a general weakness in the economies ofSri Lanka’s major markets.

Sri Lanka also has mineral reserves (graphite, ilmenite, and mineral sand) thatare mined by private and state companies. Mining was opened to foreigninvestors in 1995, but resistance from environmental activists and local residentshas prevented any foreign mining projects from taking off.

Manufacturing

The resilience of the manufacturing sector derives from the growing dominanceof the private sector, whose share of total manufacturing grew to around 90%during the 1990s. The output of the public sector fluctuates, as the CeylonPetroleum Corporation (which generates 90% of public-sector output) is closedfor six weeks’ maintenance every two years.

Manufacturing is one of the fastest-growing sectors of the economy, recordingreal growth rates averaging 7.2% in 1997-2000. Investment in modern equipmentand advanced technological processes has raised production capacity, albeitmodestly, and facilitated an improvement in productivity. In 2001, however,manufacturing contracted for the first time in two decades, by 4.2%, as theglobal economic slowdown led to a sharp contraction in export-orientedindustries. This was followed by a weak recovery in 2002 (when output rose by2.2%), owing to a limited recovery in international demand and then by 4.4% in2003. In 2003 the garment sector’s performance, undergoing a consolidation inpreparation for the end of the Multi-Fibre Agreement in 2005, was lacklustre.

A principal weakness is the narrowness of the industrial base, which isdominated by textiles and clothing, food and beverages, and chemicals,petroleum and rubber products. Together, these three categories accounted for85% of production and 82% of growth in manufacturing in 2002. Anotherdrawback is the heavy import-dependence of the manufacturing sector(domestic value-added content is a little over one-third of total production),

Mining represents only a smallpart of the economy

The private sector dominatesmanufacturing

Manufacturing is import-dependent and narrow

30 Sri Lanka


making costs of production vulnerable to changes in international prices andthe exchange rate. Chemicals, petroleum and rubber products, the third-largestindustrial category, has the highest import content at nearly 80%. At 45%, value-added content is highest in food and beverages.

The garment industry: gearing up to meet future challenges

The development of the garment industry is Sri Lanka’s main success story. Thegarment industry today accounts for 35% of employment, more than 40% of outputin the manufacturing sector and generates over 50% of total exports. The biggestchallenge that the industry faces is the phasing out of the Multi-Fibre Agreement in2005, which will effectively end the quota-based regime, exposing the industry tomore intense international competition. Existing free-trade agreements (FTAs) andspecial concessions granted by the US to Mexico and some African and Caribbeancountries, together with increased supply from low-cost manufacturers in easternEurope and China, have already resulted in some loss of markets. Nevertheless,there are several developments that indicate that the industry is beginning torestructure to meet these challenges.

Positive factors:

• The industry’s dependence on quotas has been on a declining trend since themid-1990s). They are now lower than those of its South Asian competitors.

• The industry is decidedly not a “fly by night” one. Around 50 large garmentcompanies account for 50% of the country’s output, with the top 12% generating72% of exports and the top 28% accounting for 62% of total employment in theindustry. These manufacturers have established strong marketing links withbuyers, do not depend on quotas, and have moved into the niche market ofbranded and high value clothing.

• Sri Lanka’s labour standards and working conditions in factories (which arevalued highly by overseas buyers), are superior to those of some of itscompetitors, such as China and India. This gives the industry an edge.

• The government is also taking a more active stance to support the industry. Itlobbied for the EU’s removal of quota restrictions in 2001, and in 2002 initiateddiscussions for an FTA with the US.

• Finally, even if the smaller manufacturers, which account for the remaining 50%of the country’s output, face difficulties in the post quota era, most would eitheract as subcontractors to, or be absorbed by, the bigger players. The eventual lossis estimated at 20% of garment exports.

Challenges:

• The lack of a strong raw-material base. Approximately 85-90% of fabrics andaccessories are imported.

• Turnaround times are high. For example, it takes 90 days for goods to reach theUS market after an order is placed compared with 30 days from Mexico.

• Limited diversification in export markets. Over 90% of garment exports are tothe US and EU. Efforts to plumb the Japanese and other markets have not beensuccessful.

• Higher labour productivity and lower labour costs from competitors in EasternEurope, China and Asian countries such as Vietnam and Bangladesh haveeroded Sri Lanka’s competitive edge as a low-cost producer.

Sri Lanka 31


Outlook:

Ultimately, the performance of the industry beyond 2005 will critically depend onhow it markets its manufacturing capability and product quality—the key being toestablish itself firmly in high-value niche markets. Given the positive developmentsthere is a strong probability that the industry will weather the storm and performreasonably well in the face of increased competition.

Sri Lanka follows an export-oriented industrialisation strategy. A wide range ofincentives, including lower tax rates, tax holidays and duty-free imports of rawmaterials and capital goods are available for export industries. The progressiverationalisation of tariffs and the reduction in protection levels has affectedsome import-substituting industries, such as cement and textiles, althoughsome, such as processed foods, detergents and fabricated metal products haveproved equal to the challenge and compete effectively with imports.

With the exception of a few large investments in the garments sector,investment in manufacturing has slowed in recent years. Foreign investors havebeen deterred by the volatile political environment (owing to both the ethnicconflict and cross-party tensions in parliament), while the high cost of creditand an unpredictable interest-rate regime have also dampened domesticinvestment. The restrictive labour market, characterised by stringent labourlaws, has been cited as an additional deterrent to expanding production. Therising cost of infrastructure facilities (fuel, electricity, port and freight rates) hasrepresented an additional burden.

Industrial sector, 2003(1990 constant prices)

SLRs bn % of totalTotal output 220,050 100.0 Textiles, clothing & leather 86,247 39.2 Food, beverages & tobacco 50,656 23.0 Chemicals, rubber & plastic products 43,100 19.6

Total manufacturing exports 383,833 100.0 Textiles & clothing 248,572 64.8

Note. Export data is customs basis.


Construction

The construction industry has performed poorly. Real growth fell from 7.1% in1998 to an average of 4.8% in 1999-2000, and decelerated to 2.5% in 2001, andcontracted by 0.8% in 2002. This depressed performance reflects the downturnin public investment (in particular on large infrastructure projects) and subduedgrowth in private investment, which more than offset the increased demand forhousing, particularly in 2001-02. In 2003 it rebounded, growing by 5.5% owingto a rebound in private-sector demand.

There is an estimated shortage of 400,000 housing units in the country. Public-sector housing programmes cater primarily to low- and middle-income families,predominantly in rural areas. Private-sector housing programmes that focus on

Investment in manufacturinghas slowed

Industrial policy is export-oriented

Construction growth has beenweak

32 Sri Lanka


the middle- and higher-income categories have benefited from the increaseddemand for housing in urban areas. Tax incentives and the increasedavailability of housing finance have increased demand for housing, but landscarcity (primarily in urban areas), coupled with difficulties in obtaining cleartitle deeds, remain a constraint.

Financial services

Sri Lanka’s financial sector has grown rapidly in recent years, both in terms of thenumber of institutions and the scope of services offered. Several steps were takenin 2002 and early 2003 to liberalise and enhance the systemic stability of thesector. The foreign-equity limit in commercial banks, insurance services andstockbroking now stands at 100%. Insurance services have been fully privatisedfollowing the sale of a second state-owned insurance corporation. The risk-weighted capital adequacy of banks was raised to 10% in early 2003, and acredit rating for all deposit-taking institutions is now mandatory. (Several bankshave already acquired such ratings.)

In 2003 an Asset Management Company was created to take over the non-performing loans (NPLs) of banks. The “real time gross settlement system” forbanks was introduced. Debt recovery will also be made easier, with thestrengthening of existing laws.

The banking sector dominates financial markets, accounting for 57% of thefinancial sector’s assets compared with 35% in India. High NPL ratios andinterest spreads in commercial banks are a weakness. Although the soundnessof Sri Lanka’s banking system has improved, the average NPLs/total assets ratioremains high at 17%. However, private domestic and foreign banks have lowerratios of 16% and 13% respectively, compared with 19% for state banks. Sri Lankaalso has one of the highest levels of intermediation costs in the region, whichhas limited the decline in lending rates. This has been addressed by theremoval of the lower limit of 10% on the statutory reserve ratios (SRR) ofcommercial banks. By reducing the SRR, the Central Bank of Sri Lanka canlower the cost of funds to commercial banks, thereby reducing interest rates.

Banking density has improved with an expansion in the branch network ofcommercial banks. Intense competition among banks has also led to rapidgrowth in value-added services such as automatic teller machines (ATMs),credit cards, telebanking and Internet banking, and encouraged increasedfinancial intermediation. The banking sector is also undergoing structuralchanges. Mergers, acquisitions and strategic alliances, both among commercialbanks and other financial services, are becoming more common, blurring thedistinction between commercial, development and other specialised bankingservices. Development banks have diversified into insurance and fundmanagement, for example, and have increased their lending capacity byacquiring strategic stakes in commercial banks. Commercial banks, whose mainsource of business is trade financing, are financing development projects(through loan syndication) and moving increasingly into consumer credit andhousing finance.

Financial sector reforms havegained momentum

The banking sector dominatesfinancial markets

Increased competition inbanking has added value

Sri Lanka 33


A major weakness in the financial sector is the domination of the sector by thestate. The state accounts for 50% of the banking sector through its ownership ofthe two largest commercial banks, the Bank of Ceylon and People’s Bank. It hasa virtual monopoly on the management and use of long-term savings (throughtwo pension funds, insurance companies and the largest savings bank), andconsumes over 50% of domestic financial resources. The pre-empting of long-term savings funds by the state is one of the reasons that growth in the privatedebt market has been constrained.

These weaknesses are being actively addressed. In April 2003 the governmentcompletely withdrew from insurance services after selling its second insurancecorporation. Furthermore, the restructuring of the two state-owned banks andless political interference in their operations, has resulted in a turnaround inperformance. In 2002 the People’s Bank reported a net operating profit ofSLRs1.05bn (US$11m)—the first profit to be recorded in decades. The profit runcontinued in 2003 with the bank recording a spectacular profit of SLRs1.6bn.This was achieved after providing for a massive SLRs2.3bn in bad debts. Asignificant portion of the increase in profits was owing to treasury options. Thestate also plans to relinquish its monopoly on pension funds.

Sri Lanka’s capital markets are relatively underdeveloped and growth in theequity market continues to be constrained by low liquidity. The declining trendin the stockmarket since 1998 was reversed by the election of the coalitiongovernment led by the United National Party (UNP) in December 2001. In 2002the Colombo stockmarket became one of the best performing markets in theworld, with the All-Share Price Index (ASPI) rising by 31% to close at 815 pointsand the sensitive price index surging by 33% to 1,375 points at end-2002. Arevival in the primary market was underpinned by several new initial publicofferings (IPOs), including a 12% equity of SLT. For the first time, sectors such aspower and energy, healthcare and telecoms were introduced. Another highlightwas the net purchases of stocks worth US$25m by foreigners in 2002.

In 2003 the stockmarket continued to rise, boosted by a spate of acquisitions.The market’s daily turnover spiralled to SLRs4.8bn, the highest in the history ofthe stockmarket. Market capitalisation also nearly doubled, rising fromSLRs169bn at the beginning of the year to over SLRs300bn by the end of theyear.

In 2004 the Colombo Stock Exchange continued to fluctuate in response to thepolitical uncertainty. In the days leading up to the April 2nd election,speculation regarding a possible United National Front (UNF) victory saw sharprises in the exchange’s index but as news of a United People’s Freedom Alliance(UPFA) victory trickled in, it crashed, wiping SLRs21bn off the market betweenApril 1st and April 8th 2004.

Although there is an active market for government securities, the private debtsecurities market is small. The establishment of a credit rating agency, FitchRatings, has nevertheless encouraged more companies to move into bonds anddebentures, as well as encouraging more companies to seek credit ratings inpreparation for listing on the stockmarket.

The private debt market is stillsmall

The state is reducing its role inthe financial sector

34 Sri Lanka


Other services

Sri Lanka’s tourist industry—the biggest casualty of the civil war—has been theprincipal beneficiary of peace. Arrivals fell to 400,414 in 2000 when thecountry was put on a “war footing” and dropped by 16% in 2001, following theattack on the country’s international airport in July 2001. One year of peace in2002 saw arrivals rise by 17% to 393,171. Tourism continued to remain on astrong upward trend in 2003, with a record 500,650 tourists visiting.

In the past Sri Lanka has been unable to add value to its inherent advantages asa tourist destination, owing to its security risk, and the country still attractsmainly budget tourists. Nevertheless, the focus is now changing and thepackages offered are being diversified, including, for example, eco-tourism andadventure holidays, to attract more upmarket customers. In 1998 the UKovertook Germany to become the leading tourism market, but was displaced byIndia in 2002, owing to a highly successful marketing campaign. In 2003 the UKedged out India to regain the top slot with 93,300 visitors compared withIndia’s 90,700. As well as India, new markets such as Pakistan and China arebeing actively targeted. Tourism receipts are the leading source of invisibleinflows. Nearly 90,000 people are directly or indirectly employed in the sector,making it the third-largest employer in the country.

The external sector

Trade in goods

Foreign trade, 2003(SLRs m)

Exports fob 495,426 Textiles & garments 248,572 Tea 65,937 Machinery &equipment 27,951

Imports cif 643,749 Textiles 132,415 Petroleum 80,807 Food & drink 67,713 Machinery & equipment 67,330Trade balance -148,324


Sri Lanka has the most liberal trade environment in South Asia. Export andimport licences exist only for a handful of items, where they have been retainedfor security or environmental purposes. The tariff regime was rationalised to atwo-tier structure in 2000 (with the maximum tariff capped at 25%), but thiswas reversed in 2002 as several duty-exempt items (nearly 1,500) were broughtwithin a 2-10% duty rate, primarily for revenue purposes. There has been asharp reduction in duty waivers, which fell to 453 items in 2002 compared with2,536 items in 2001. The 40% import surcharge, imposed in 2001, was halved to20% in the 2002 budget. Import licences on rice were removed in 2002, butagricultural imports continue to be protected by a higher tariff.

The civil war hasaffected tourism

There is a liberal tradeenvironment

Sri Lanka 35


On a national-accounts (nominal basis) the heavy trade orientation of SriLanka’s economy is reflected in the high share of exports and imports as apercentage of GDP, at approximately 35% and 42% respectively. Althoughexports have traditionally grown at a faster rate than imports, the high importpropensity has resulted in a persistent trade deficit, averaging 7.1% of GDP (on abalance-of-payments basis) in 1999-2003, according to the Central Bank of SriLanka. The trade deficit, which narrowed in 1997-98, as import pricesweakened, fell again in 2001 owing to a sharp drop in imports, but expandedby 22% in US dollar terms in 2002 as imports grew by 2.2%, but exportscontracted by 2.4%.

In 2003 Sri Lanka’s merchandise trade deficit stood at 8.3% of GDP—US$1.5bn—a9.5% increase on the US$1.4bn deficit recorded in 2002. Export earnings rose by9.2% to US$5.1bn, whereas imports grew slightly faster, by 9.3% to US$6.7bn.

An inherent weakness in the external sector is the country’s narrow exportbase. Garments and tea account for nearly two-thirds of total exports. Garmentsgenerate over one-half of total export earnings and are the leading net foreign-exchange earner. The overwhelming dependence on garments has made thecountry vulnerable to shifts in international demand. In 2001-02, for example,the contraction in garment exports, owing to weak OECD demand, wasprimarily responsible for the sharp deceleration in export earnings growth.

There has been some limited diversification in industrial exports. Exports ofmachinery and equipment have grown progressively (to 5.7% of total exportsand to 7.3% of manufactured exports in 2002), to become the second leadingindustrial export category. Diamonds and jewellery and leather goods havealso shown promise. Sri Lanka is the world’s leading exporter of certain typesof tyres, but despite its natural advantage as a rubber producer, exports ofrubber products have remained subdued, partly owing to the limitedavailability of raw materials because rubber production has weakened inrecent years.

Approximately 80% of the incremental growth in exports in 2003 wasgenerated by industrial exports, which grew by an annual rate of 10%. Earningsfrom textiles and garments—the leading export category—rose by 6.3% year onyear to US$2.6bn, owing to a 3% increase in both unit prices and volumes. Withthe exception of petroleum products, where earnings contracted by 11%,revenue from all other principal categories of industrial exports recordedgrowth. Earnings from machinery, mechanical and electrical equipmentexports—the second-largest export category—grew by 9%; diamonds andjewellery exports rose by 14% and rubber products expanded by an impressive27%. A sharp increase in exports of prawns and other shellfish (20.1%) and freshfish (15%) helped to raise combined earnings from food exports by 17.8% yearon year.

The share of agricultural exports, which accounted for one-fifth of exportearnings, declined in 2002, pulled down by slow growth in rubber and coconutexports. Earnings have been propped up primarily by tea, which has retained

The narrow export base is aweakness

Exports of machinery andequipment are rising

Tea exports have propped upagricultural earnings

Trade is a key componentof GDP

Industrial goods drive an 80%increase in export earnings

36 Sri Lanka


its pre-eminence as the second-largest export category. With the exception of1999, when tea prices declined in rupee terms, both exported volume andrupee earnings have continued to hit record highs, allowing Sri Lanka tomaintain its position as the world’s leading tea exporter. Minor export crops,primarily spices (Sri Lanka is the world’s largest exporter of cinnamon), havealso performed well. Their value now exceeds the combined earnings fromcoconut and rubber exports.

Record earnings from tea, combined with price-induced increases in earningsfrom rubber exports, facilitated a 2.9% increase in earnings from agriculturalexports in 2003. Earnings from tea exports, which began recovering in May(after the end of the Iraq war), rose to US$683m—the net result of a 2.1%increase in exported volumes and a 1.3% rise in US-dollar prices. The sharp 49%increase in the international price of rubber more than offset the 5.4% drop inexported volumes, to generate US$39m in export revenue. The value of coconutexports rose by 17% in 2003, owing to increased export volumes. Together thethree export crops contributed over 80% of incremental growth in exportrevenue from agricultural products.

Sri Lanka’s manufacturing sector remains heavily dependent on importedcapital goods and industrial inputs, which together account for three-quartersof total imports. Increased usage of thermal power has boosted imported oilvolumes since 2000, raising the country’s oil bill to 13% of total imports in 2002from 12% in 2000. The growing dependence on thermal power will thus renderthe country more vulnerable to increases in oil prices.

The US dollar value of intermediate goods imports rose by 0.9% year on year in2003. In line with export performance, the leading import subcategory wasimports of textiles and garments, which increased by 3.9% to US$1.4bn. Crudeoil imports rose year on year by 7.7% in the same period, whereas the value ofother petroleum products rose by 9.3%. All principal intermediate goodsimports recorded increases in line with improved industrial activity. Imports ofchemical products rose by 9.5% year on year, those of paper products increasedby 10.9% and those of dyeing products rose by 15.2%.

Consumer goods account for approximately one-fifth of imports. The value offood imports, at 9% of total imports in 2001, fluctuates, depending on the sizeof domestic harvests and movements in international prices. Rice, sugar, wheatand milk powder dominate food imports. Passenger cars and householdappliances are the principal consumer durable imports.

The overwhelming reliance on a few export markets is another weakness inSri Lanka’s external trade. The US and the EU together take over two-thirds ofvisible exports and over 90% of garment exports. The EU is also the principalsource of tourism. Japan is a major market for fish products, machineryaccessories and gems. The Middle East is a leading tea market, the main source ofoil supplies and the leading employer of migrant workers, accounting for over 60%of total remittances from Sri Lankans employed abroad.

Textiles and oil dominateintermediate imports

The value of imports has fallen

The US and the EU areSri Lanka’s largest markets

Tea exports boom in 2003

Intermediate imports rise inline with economic growth

Sri Lanka 37


Asian countries including Japan supply over one-half of Sri Lanka’s imports. Abilateral free-trade agreement (FTA) with India became operational in 2000, butthe benefits in terms of increased exports have been negligible, as clear fromthe huge trade deficit with India, which rose by over 35% to SLRs6.4bn(US$66.9m) in 2002 compared with SLRs4.7bn in 2001. Food is the principalimport from India. Sri Lanka is pursuing similar agreements with Pakistan andEgypt in a bid to increase tea exports to these areas. Hong Kong (for fabrics andgarment accessories) and Singapore (for petroleum, telecommunications anddata processing equipment) are the second and third leading suppliers to SriLanka respectively, whereas South Korea is a leading foreign investor.

Main trading partners, 2003Exports to: % of total Imports from: % of totalUS 34.6 India 25.4EU 29.0 Hong Kong 8.4Asia 12.0 Singapore 7.8

Middle East 9.0 Japan 6.7CIS 3.6 China 4.9


Invisibles and the current account

The downturn in tourism and subdued growth in port services hit the servicesaccount in recent years. However, according to the Central Bank of Sri Lanka, in2002 there was a marked improvement as a result of the peace process.Increased earnings from tourism and port services boosted net services receiptsby 55% to US$271m. Net travel receipts, which rose by US$1bn compared with aUS$38m contraction in 2001, were boosted by US$115m, which was spent byoverseas Sri Lankans who visited the country in the wake of the peace process.

Balance of payments, national series(SLRs m)

1999 2000 2001 2002 a 2003Merchandise exports fob 325,170 420,114 430,372 449,855 495,426

Merchandise imports cif -421,873 -554,290 -532,964 -584,561 643,750Trade balance -96,702 -134,176 -102,592 -134,706 -148,324Net services 10,342 2,907 14,692 28,224 38,152Net incomeb -17,831 -23,009 -23,842 -24,174 -18,540Net private transfers 62,472 73,620 87,837 104,980 116,321

Current-account balance -39,903 -78,857 -21,980 -22,693 -9,608Capital & financial account (net) 30,473 31,827 49,077 40,634 67,851Overall balance -14,184 -30,939 29,765 36,051 48,610

a Provisional. b Since 1994 foreign currency banking units (FCBUs) have been treated as part of the domestic banking system in the compilationof balance-of-payments statistics. Transactions involving FCBUs and non-residents are included in the balance of payments, whereas thosebetween FCBUs and residents are excluded.


The FTA with India began in2000

The invisibles surplus rosein 2002

38 Sri Lanka


The deficit on the income account almost doubled between 1997 and 2000 inUS dollar terms as growth in interest payments on foreign debt, remittances ofprofits and dividends on foreign investment continued to outstrip growth inincome from foreign assets. In 2001 and 2002 this trend was reversed as thefall in global interest rates led interest outflows to fall more sharply thaninterest income. However, in 2003 rising interest rates increased the incomedeficit to US$316m.

Private transfers, which are primarily remittances from housemaids working inthe Middle East, are the second leading net foreign-exchange earner (aftergarments), and are an important balancing element in the current account,usually offsetting around 60% of the trade deficit. In 2002 net private transfers,which amounted to US$1,097m, were sufficient to finance 90% of thecombined deficit on the trade, services and income accounts. Official transfers,primarily food and commodity grants, halved from US$52m in 1998 to justUS$26m in 2002. In 2003 transfer receipts rose to US$1,371m as private transfersrose.

Capital flows and foreign debt

Two consecutive years of balance-of-payments deficits (in 1999-2000) werefollowed by three consecutive years of surpluses. The surpluses wereattributable to smaller financing requirements rather than to an improvementin the capital account, which has generally weakened in recent years. Increasesin private and government long-term capital inflows were primarily owing tolong-term credit, rather than in any real rise in new borrowing. An extremelylow rate of aid utilisation (estimated by the Asian Development Bank at 20-25%of concessional aid) has limited growth in these long-term aid disbursements.Private long-term borrowing has fallen, reflecting low investor confidence.However, a notable development in 2002 was the sharp increase in foreigndirect investment (FDI), which rose from US$82m in 2001 to US$242m in 2002according to the Central Bank.

Higher inflows from privatisation, increased utilisation of foreign aid by thegovernment, and continued FDI and portfolio investment led to animprovement in the capital and financial account, which expanded toUS$702m in 2003 from US$444m in 2002. Total direct investment grew by 8.6%to US$241.5m in 2003. Although FDI fell in absolute terms to US$171m in 2003from US$181m a year previously, this was offset by a 500% increase in inflowsfrom privatisation, which rose from US$5m in 2002 to US$30m in 2003. The netoutcome of these developments was an expansion in the overall surplus in2003 to US$502m from US$338m in 2002. This was the third consecutive yearof an overall surplus in the balance of payments.

The incomes deficit hasnarrowed

The balance of payments hasbeen in surplus since 2001

The balance of paymentsrecorded a surplus in 2003

Migrant transfers are a keycontributor

Sri Lanka 39


Foreign direct investment inflows

The declining trend in foreign aid inflows has increased reliance on foreign directinvestment (FDI) as a means of bridging the external financing gap. AlthoughSri Lanka has one of the most liberal and foreign-investor friendly regimes in Asia,FDI inflows have remained well below potential, primarily owing to the volatilesecurity climate. Annual FDI inflows averaged 0.8% of GDP in the 1980s, increasingto 1.2% of GDP in the 1990s. FDI peaked at US$430m in 1997 during the privatisationprogramme, but fell back in 1998-2001 as the privatisation programme stalled, andthe unstable political and security climate continued to deter foreign investors. FDIinflows staged a recovery in 2002, owing largely to the climate of improved securityand remained sound in 2003. In 2002 FDI stood at US$242m and fell marginally toUS$209m in 2003. FDI has been highly concentrated in the services and clothingsectors. In recent years investment in power, telecoms and ports has helped to shoreup FDI inflows.

According to the Central Bank, Sri Lanka’s external debt rose to US$9.3bn in2002 from US$8.5bn in 2001. The increase was largely attributable to increasedliabilities to the IMF (on account of borrowings under the stand-by facility), andincreased government concessional borrowing. Exchange-rate changesaccounted for an increase in debt stock. Medium- and long-term loans (94% ofwhich are government-owned or government-guaranteed) accounted for 92% ofthe total debt stock in 2002. Short-term debt (5% of the total debt stock)increased by 13% in 2001 as a partial recovery in imports increased private tradecredit. Short-term debt as a percentage of official reserves (a measure thatreflects the country’s external-sector vulnerability) fell further to 35% in 2002from 45% in 2001 (largely owing to a rise in foreign-exchange reserves). As mostdebt is on concessional terms, the impact of higher international interest rateson external debt-service payments is relatively small.

Sri Lanka has full current-account convertibility (the IMF’s Article VIII status),but capital inflows and outflows are restricted, although there has been somerelaxation in recent years. Exporters are allowed to borrow in foreign currencyfrom development banks; foreign-controlled companies can borrow fromdomestic banks; and Sri Lankan companies can borrow in international capitalmarkets, subject to approval by the Central Bank.

Foreign reserves and the exchange rate

Total foreign-exchange reserves, which fell by almost 50% between 1998 and2000, undermined by a drop in FDI and an overall balance-of-payments deficitin 1999-2000, improved markedly in 2001-03. Increased inflows in the form ofprivate remittances, FDI, public- and private-sector long-term borrowing and netportfolio investment, and significant purchases of foreign exchange by the CentralBank all helped to shore up reserves in 2002. As a consequence, the country’sgross external assets (Central Bank definition) rose to US$4.29bn at end-2002,equivalent to more than three months of imports, compared with 2.7 months in2001.

Concessional borrowingdominates foreign debt

Foreign reserves are buildingup gradually

40 Sri Lanka


The improved balance-of-payments position boosted the country's externalreserves to comfortable levels in 2003. Gross official reserves (those held by thegovernment and the Central Bank) grew by a spectacular 37% to US$2.3bn,equivalent to 4.2 months of imports. Purchases by the central bank (netpurchases were US$375m) were partly responsible for the increase in officialreserves. The country's total external assets (consisting of gross official reservesplus reserves held by commercial banks) grew by an equally impressive 28.9%to US$3.2bn, sufficient to finance 5.8 months of merchandise imports.

Foreign-exchange reserves, 2003(year-end)

Total Per head(US$ bn) (US$)

Sri Lanka 1.6 84.2Pakistan 8.1 54.8

India 67.0 64.1

Source: IMF, International Financial Statistics.

In late January 2001 the rupee was freed, ending a 23-year managed float. Themove to a free float, precipitated by a build-up of speculative pressure and aliquidity shortage in the foreign-exchange market, was also a precondition ofthe IMF’s approval of the US$253m balance-of-payments support facility. Therupee stabilised significantly in the second half of 2001, but a sharpdepreciation of the currency against the US dollar in the first half of 2001resulted in a 13.8% depreciation in 2001 for the year as a whole. In 2002 theforeign-exchange market was relatively stable as increased inflows boostedliquidity and a more market-oriented system limited speculation. The rupeedepreciated by just 6.6% in 2002 and by a mere 0.1% in 2003 (helped by the USdollar falling sharply against all other major currencies). The free float of therupee has anchored confidence and boosted forward market transactions,which accounted for 37% of transactions in 2002. Market stability has resultedin a sharp drop in forward market premia as well as increasing the length ofthe maturity period of forward contracts.

The rupee has gained stability

Foreign reserves remaincomfortable in 2003

Sri Lanka 41


Regional overview

Membership of organisations

The South Asian Association for Regional Co-operation (SAARC), whichcomprises India, Pakistan, Sri Lanka, Bangladesh, Nepal, the Maldives andBhutan, was established in 1985 at a meeting in Bangladesh. SAARC’s aimsinclude promoting welfare, accelerating economic growth, eradicating povertyand improving relations between member states.

Summit meetings are intended to be held annually and are complemented bytechnical committees, meetings of foreign ministers and a standing committee,which comprises the foreign secretaries (civil servants) of each country. Anunder-resourced secretariat, established in 1987 and based in Kathmandu,co-ordinates SAARC’s activities.

In the early years agreements were made to establish a food security reserve(an agreement that has never been implemented), to establish a meteorologicalcentre, to combat terrorism and to create various cultural exchanges betweenmember states. Along with micro-level issues, SAARC has also proposed thecreation of a South Asian Free-Trade Area (SAFTA). SAFTA, seen as areplacement for the South Asian Preferential Trading Arrangement, whichwas agreed in 1995 and which had, by 1996, identified more than 2,000products as eligible for preferential treatment, was initially to be put in place bythe ambitious target date of 2001. After the 1997 SAARC conference, an eminentpersons group was constituted to plot the way forward for the association. Thegroup argued that closer economic ties were the key to the future, andproposed that a free-trade area be in place by 2008 (2010 for the leastdeveloped member states), a customs union by 2015 and an economic union by2020. Political factors weigh against even this prolonged timetable.

India’s refusal to participate in the SAARC summit of 1999, in protest at themilitary coup in Pakistan, led to the cancellation of summits in 1999 and 2000,although a summit did take place in early 2002. The 2002 summit wasovershadowed by a meeting between the leaders of India and Pakistan. Tensionsbetween India and Pakistan have continually hampered SAARC’s progress onwider issues, although it has been relatively effective in providing a forum formeetings of non-governmental organisations and professional groupings. There ispressure on SAARC from the smaller countries for the association to deal withbilateral issues—much of this pressure stems from the problematic relationshipbetween India and Pakistan. There is a growing feeling that this problem preventsmultilateral progress, thus leading to a growing emphasis on bilateral tradingrelationships. India has signed bilateral free-trade agreements, effectivelybypassing SAARC, with Sri Lanka (2000) and Nepal (1996). Bhutan and India alsohave a free-trade agreement. Much of SAARC’s work is also likely to besuperseded by World Trade Organisation (WTO) regulations.

SAARC’s ability to reposition itself as the preferred conduit for bilateralrelationships within South Asia is likely to determine the success, or otherwise,of the organisation. SAARC’s success in arranging greater civil society linkages

The South Asian Associationfor Regional Co-operation

42 Sri Lanka


within South Asia contrasts strongly with its failure to boost government-levelties. As the largest members of SAARC, India and Pakistan, are engaged inpersistent low-level warfare, it is perhaps unsurprising that SAARC hasperformed poorly on this front.

Sri Lanka 43


Appendices

Sources of information

Central Bank of Sri Lanka, Annual Report

Central Bank of Sri Lanka, Selected Economic Indicators (weekly)

Department of Census and Statistics, Sri Lanka Labour Force Survey (quarterly)

Department of Census and Statistics, Statistical Abstract (annual)

IMF, International Financial Statistics (monthly)

International Institute for Strategic Studies, The Strategic Balance 2000-2001

World Bank, World Development Report (annual)

Central Bank of Sri Lanka, Economic Progress of Independent Sri Lanka

IMF, Sri Lanka: Recent Economic Developments, 1998

UNDP, National Human Development Report: Sri Lanka

World Bank, Recapturing Lost Opportunities, 1999

Board of Investment (BOI) site with general information on opportunities andregulations: www.boisrilanka.org

Central Bank of Sri Lanka: www.lanka.net/centralbank

Department of Information (general news and news links), useful for updatesgiving the official line on the ethnic conflict: www.news.lk

General government information and news links: www.gov.lk

IMF: www.imf.org

World Bank: www.worldbank.org

Reference tables

These reference tables provide the most up-to-date statistics available at the time ofpublication.

Population(m unless otherwise indicated; mid-year)

1999 2000 2001 2002 2003Total 18.2 18.57 18.7 19 19.3 % change year on year 1.5 1.4 1.4 1.5 1.3

Note. The increase in 2003 reflects increased migration to the north and east because of peacefulconditions.


International statistical sources

Select bibliography andwebsites

National statistical sources

44 Sri Lanka


Labour force(% unless otherwise indicated)

1999 2000 2001 2002 2003Labour force ('000) 6,673 6,827 6,773 7,145 7,609a

Employed 6,082 6,310 6,236 6,519 6,973 Unemployed 591 517 537 626 636Labour force participation rate 50.7 50.3 48.8 50.3 48.6

Share of employmentPublic sector 14.4 13.4 13.8 13.4 13.2Private sector 43.1 42.9 44.8 44.5 44.1Self-employed 28.3 28.4 28.5 28.6 29.2Unpaid family workers 12.2 13.0 10.6 10.7 10.8Unemployment rate 9.1 8.2 8.2 8.6 8.0

a End of 3rd quarter, 2003; includes Eastern but excludes Northern province.


Transport statistics1999 2000 2001 2002 2003

RoadNew vehicle registrations Private transport Motorcycles 42,497 39,987 34,119 54,762 86,877 Cars & jeeps 29,678 29,403 20,836 28,332 45,458 Public transport Buses & coaches 2,611 2,298 1,310 1,429 1,949 Three-wheelers 14,706 11,656 10,274 20,876 36,204 Goods transport 13,361 8,585 6,013 7,952 11,014Total incl others 102,853 91,929 72,634 113,351 181,502RailPassenger traffic ('000 passenger-km) 3,104 3,208 3,979 4,079 4,258Freight traffic (m tonne-km) 103 88 109 131 129

SeaVessel arrivals (no.) 4,339 4,232 4,014 4,062 4,032 Colombo 3,968 3,832 3,570 3,787 3,838 Trincomalee 274 303 327 199 121 Galle 97 97 117 76 73Total container volume ('000 TEUs) 1,704 1,733 1,727 1,765 1,959Transshipment container volume ('000 TEUs) 1,153 1,181 1,195 1,218 1,370


Sri Lanka 45


National energy statistics1999 2000 2001 2002 2003

ElectricityAvailable capacity (mw) 1,691 1,837 1,999 2,230 2,483 Hydro 1,143 1,149 1,161 1,171 1,247 Thermal 545 627 737 756 973 Hired power 0 58 98 300 260Units generated (gwh) 6,184 6,844 6,627 6,951 7,612 Hydro 4,170 3,197 3,110 2,692 3,310 Thermal 1,903 3,122 3,066 3,201 3,904Hired power - 364 341 913 394Self generation 108 158 105 141 n/aTotal sales (gwh) 4,809 5,259 5,238 5,502 6,208

Systems lossa 22.2 23.2 21.8 21.5 19.1Petroleum productsImports ('000 tonnes) 3,256 3,730 3,500 3,761 3,530 Crude oil 1,826 2,330 1,955 2,280 1,995 Refined products 1,303 1,266 1,419 1,344 1,394 Liquefied petroleum gas 127 134 126 137 141

a Using the ratio of total sales to total generation.


Government finances(SLRs m unless otherwise indicated)

1999 2000 2001 2002 2003Total revenue & grants 202,666 216,427 239,796 268,966 285,516 Tax revenue 166,028 182,392 205,840 221,837 231,648 Non-tax revenue 29,877 28,890 28,456 40,050 44,868 Grants 6,761 5,145 5,500 7,079 9,000Total expenditure & net lending 279,159 335,823 386,518 402,989 417,671 Current expenditure 207,271 254,279 303,362 330,847 334,693 Capital expenditure & lending 71,888 81,544 83,156 72,142 82,979Budget balance(before grants) -83,255 -124,541 -152,222 -141,102 -141,155 % of GDP -7.5 -9.9 -10.5 -8.9 -8.0


Money supply and credit(SLRs m; year-end)

1999 2000 2001 2002 2003Money (M1) 108,554 118,477 122,211 139,361 161,635 % change, year on year 12.8 9.1 3.2 14.0 16.0

Quasi-money 316,993 361,687 426,954 484,134 556,220Money (M2) 425,547 480,164 549,165 622,495 717,855 % change, year on year 12.6 12.8 14.4 13.4 15.3Domestic credit 441,945 557,706 646,904 680,396 731,872

Sources: IMF, International Financial Statistics; Central Bank of Sri Lanka, Annual Report, 2003.

46 Sri Lanka


Interest rates(%; year-end)

1999 2000 2001 2002 2003Interbank call loan rate (range) 9.8-14.3 20.1-32.0 12.3-13.5 10.1-11.3 7.4-8.3Prime lending rate (weighted average) 15.2 21.5 14.3 12.2 9.0

Treasury-bill rate 3-month 11.8 17.8 12.9 9.9 7.4 12-month 12.8 18.2 13.7 9.9 7.3Repurchase rate 9.3 17.0 12.0 9.8 7.0


Nominal gross domestic product by expenditure(SLRs m at current prices; % of total in brackets)

1999 2000 2001 2002 2003Private consumption 790,379 906,186 1,041,041 1,214,117 1,343,896

(71.5) (72.1) (74.1) (75.1) (76.3)Government consumption 99,851 132,189 141,441 139,311 139,268

(9.0) (10.5) (10.2) (9.1) (7.9)Gross fixed investment 301,728 352,632 309,684 337,782 392,940

(27.3) (28.0) (22.3) (22.5) (22.3)Stockbuilding 95 40 40 44 4,523

(0.0) (0.0) (0.0) (0.0) n/aExports of goods & services 392,437 490,676 525,398 570,995 629,696

(35.5) (39.0) (37.2) (35.9) (35.3)Imports of goods & services 478,526 624,048 613,167 679,550 745,520

(43.3) (49.6) (43.8) (42.6) (41.8)

GDP 1,105,964 1,257,675 1,407,398 1,582,655 1,760,280


Real gross domestic product by expenditure(SLRs m at constant 1996 prices; % change year on year in brackets)

1999 2000 2001 2002 2003Private consumption 689,480 723,032 725,709 792,440 850,445

(5.1) (4.9) (0.4) (9.1) (7.3)Government consumption 95,725 101,728 100,843 88,049 84,110

(6.8) (6.3) (-0.9) (-12.6) (-5.4)

Gross fixed investment 236,597 260,153 214,702 226,037 267,945(6.4) (10.0) (-17.5) (5.3) (17.9)

Stockbuilding 79 33 29 3,057 1,517(0.0)a (0.0)a (0.0)a (0.3) (0.2)

Exports of goods & services 314,969 371,663 352,064 374,223 392,148(4.0) (18.0) (-5.3) (6.3) (4.8)

Imports of goods & services 444,354 510,563 461,917 515,448 569,121(7.0) (14.9) (-9.5) (11.6) (10.4)

GDP 892,496 946,046 931,430 968,358 1,025,527(4.3) (6.0) (-1.5) (4.0) (5.9)

a Change as a percentage of GDP in the previous year.


Sri Lanka 47


Gross domestic product by sector(SLRs m unless otherwise indicated; constant 1996 prices)

1999 2000 2001 2002 2003Agriculture, forestry & fishing 172,238 175,317 169,377 173,623 176,209 % change 4.5 1.8 -3.4 2.5 1.5 % of GDP 21.3 20.5 20.1 19.8 19.0Mining & quarrying 14,238 14,921 15,019 14,858 15,396 % change 4.1 4.8 0.7 -1.1 3.6 % of GDP 1.8 1.7 1.8 1.7 1.7Manufacturing 136,498 149,115 142,909 145,864 152,274 % change 4.4 9.2 -4.2 2.1 4.4 % of GDP 16.9 17.4 16.9 16.7 16.4

Construction 57,075 59,815 61,292 60,796 64,115 % change 4.8 4.8 2.5 -0.8 5.5 % of GDP 7.1 7.0 7.3 6.9 6.9Electricity, gas & water 11,958 12,496 12,130 12,044 14,661 % change 9.5 4.5 -2.9 -0.7 21.7 % of GDP 1.4 1.5 1.4 1.4 1.6Transport & communications 93,444 100,706 104,510 112,472 123,900 % change 8.1 7.8 3.8 7.6 10.2 % of GDP 11.6 11.8 12.4 12.8 13.3Wholesale & retail trade 174,160 189,366 176,762 186,637 200,267 % change 1.0 8.7 -6.7 5.6 7.3 % of GDP 21.6 22.1 20.9 21.3 21.6Banking, insurance & real estate 60,926 64,810 69,949 77,695 85,931 % change 4.6 6.4 7.9 11.1 10.6 % of GDP 7.5 7.6 8.3 8.9 9.2

Ownership of dwellings 14,767 15,018 15,228 15,457 15,658 % change 1.2 1.7 1.4 1.5 1.3 % of GDP 1.8 1.8 1.8 1.8 1.7

Public administration & defence 39,773 41,443 41,857 41,869 42,185 % change 4.2 4.2 1.0 0.0 0.6 % of GDP 4.9 4.8 5.0 4.8 4.5

Other services 33,263 34,028 34,761 35,932 38,502 % change 9.8 2.3 2.2 3.4 7.2 % of GDP 4.1 4.1 4.1 4.1 4.1

GDP 808,340 857,035 843,794 877,248 929,348 % change 4.3 6.0 -1.5 4.0 5.9


48 Sri Lanka


Prices and earnings1999 2000 2001 2002 2003

Price indices (1952=100)Colombo consumer price index (av) 2,392.1 2,539.8 2,899.4 3,176.4 3,377.0 % change 4.7 6.2 14.2 9.6 6.3Wholesale price index (1974=100) 1,295.3 1,317.2 1,471.2 1,629.0 1,679.1 % change -0.3 1.7 11.7 10.7 3.1

Wages indices (1978=100)Agriculture 1,116.0 1,142.7 1,176.4 1,269.6 1,382.2 % change 1.7 2.3 2.9 7.9 8.9Industry & commerce 829.2 857.2 919.7 986.5 1,009.4 % change 2.7 3.4 7.3 7.3 2.3Services 559.7 559.7 657.6 678.0 678.0 % change 10.5 0.0 17.5 3.1 0.0


Agricultural production1999 2000 2001 2002 2003

Value (SLRs m; current factor cost) 163,481 177,396 199,584 232,853 237,411Paddy 30,197 32,063 34,731 41,767 40,906Tea 12,295 15,551 15,884 17,315 16,883Coconut 17,675 13,249 13,250 20,183 19,108Rubber 2,253 2,506 2,487 3,244 4,994Others 101,061 114,027 133,232 150,344 155,519VolumePaddy ('000 tonnes) 2,868 2,860 2,695 2,859 3,071Tea (m kg) 283.7 305.8 295.1 310.0 303.2Coconut (m nuts) 2,828 3,096 2,796 2,392 2,562Rubber (m kg) 96.6 87.6 86.2 90.5 92.0


Mining & quarrying exports(SLRs m)

1999 2000 2001 2002 2003Precious & semi-precious stones 4,327 7,091 7,275 8,173 7,601Natural graphite 132 191 225 212 243.0Metallic ores & iron pyrites 4 29 112 187 78.0

Ilmenite 21 - 5 - -Others 56 42 49 56 147.0

Total 4,540 7,352 7,666 8,628 8,069

Note. Totals may not sum owing to rounding.


Sri Lanka 49


Manufacturing production(SLRs m unless otherwise indicated; current prices)

1999 2000 2001 2002 2003Total manufacturing 397,873 462,720 498,230 548,431 604,199 Textiles, clothing & leatherwear 178,444 215,686 224,898 240,712 261,990 % of total 44.8 46.6 45.1 43.9 43.4 Food, beverages & tobacco 94,687 105,671 120,539 136,173 151,870 % of total 23.8 22.8 24.2 24.8 25.1 Chemicals, rubber & plastics products 62,590 74,670 78,553 90,250 100,113 % of total 15.7 16.1 15.8 16.5 16.6 Non-metallic mineral products 26,830 28,198 31,892 35,108 38,413 % of total 6.7 6.1 6.4 6.4 6.4 Fabricated metal products 14,305 15,678 17,638 19,358 21,872 % of total 3.6 3.4 3.5 3.5 3.6 Paper & paper products 5,854 6,516 7,369 7,528 8,293 % of total 1.5 1.4 1.5 1.4 1.4Private-sector industrial production index

(1990=100) 259 286 276 282 297 % change 5.3 10.5 -3.7 2.5 5.2


Realised investments in Board of Investment projects(cumulative, year-end)

1999 2000 2001 2002 2003No. of enterprises 1,399 1,503 1,561 1,643 1,766

Total investment potential (SLRs m) 176,020 194,727 208,079 241,470 277,480Foreign investment (SLRs m) 116,972 131,815 141,290 164,894 186,782


Stockmarket indicators1999 2000 2001 2002 2003

CSE all-share price index (year-end; 1985=100) 572.5 447.6 621.0 815.1 1,062.1Milanka sensitive index (year-end; 1998=1000,

index not backdated) 937.5 698.5 1,031.0 1,374.6 1,897.8Market capitalisation (SLRs bn) 112.8 88.8 124.0 162.6 263.0

Turnover (SLRs m) 14,293 10,624 13,906 30,184 73,629Net foreign purchases (SLRs m) -902 -3,365 -1,027 2,444 211


50 Sri Lanka


Tourism1999 2000 2001 2002 2003

Total visitor arrivals 436,440 400,414 336,794 393,171 500,642 Europe 282,000 267,664 211,049 208,374 265,802 Asia 114,375 91,521 89,732 143,064 177,351 North America 18,477 17,319 15,983 19,866 25,110 Australasia 15,159 18,228 13,105 13,209 22,965

Gross tourism receipts (SLRs m) 19,288 19,095 19,034 23,724 31,209No. of hotel roomsa 12,918 13,311 13,626 13,818 14,137Average occupancy rate (%) 57.6 52.3 42.1 43.1 53.2

a In graded hotels only.


Exports(SLRs m; fob)

1999 2000 2001 2002 2003Agricultural exports 66,750 76,270 83,253 89,682 93,069 Tea 43,728 53,133 61,602 63,105 65,937 Coconut products 9,119 9,174 7,348 8,009 8,926 Rubber 2,305 2,179 2,129 2,552 3,718Manufactured exports 250,516 325,931 331,687 347,657 383,833 Textiles & garments 171,068 226,930 227,360 232,027 248,572 Machinery & equipment 14,155 18,594 21,895 25,509 27,951 Rubber products 11,350 14,924 15,417 15,441 22,299 Diamonds & jewellery 12,064 14,546 16,495 19,634 22,506 Leather & footwear 14,140 13,392 13,401 8,045 5,583Gems 4,326 7,091 7,276 8,173 7,601Total incl others 325,171 420,114 430,372 449,850 495,426


Imports(SLRs m; cif)

1999 2000 2001 2002 2003Consumer goods 87,505 105,403 110,059 126,181 142,911 Food & drink 46,562 52,584 58,466 66,540 67,713 Consumer durables 40,943 52,819 51,593 59,641 75,198Intermediate goods 215,658 287,196 296,522 334,357 367,676 Textiles 93,105 111,386 117,993 126,438 132,415 Petroleum 35,344 68,381 65,190 75,627 80,807 Chemicals 9,590 11,152 12,647 14,792 16,363 Fertilisers 4,690 6,059 6,047 7,259 8,457Investment goods 110,599 130,889 96,185 112,046 127,363 Machinery & equipment 47,736 59,538 54,287 61,296 67,330 Building materials 18,296 23,087 22,144 26,013 31,667 Transport equipment 37,191 39,489 11,469 14,449 19,869Unclassified imports (military) 8,126 30,802 30,198 11,907 5,799

Total incl others 421,888 554,290 532,964 584,491 643,749


Sri Lanka 51


Main trading partners(% of total)

1999 2000 2001 2002 2003Exports to:US 38.9 39.5 40.0 37.5 35.6UK 13.1 13.3 11.9 12.6 12.5Middle East 7.9 7.9 9.0 8.1 9.0Germany 4.7 4.2 4.1 4.2 4.5Japan 3.5 4.1 3.9 3.0 3.2Imports from:India 8.7 8.2 10.1 15.0 16.1Hong Kong 7.8 7.1 7.8 8.0 8.4Singapore 7.4 6.8 6.9 7.1 7.8Japan 9.5 8.8 5.6 5.8 6.7South Korea 6.5 5.4 5.6 5.0 4.2


Balance of payments, IMF series(US$ m)

1998 1999 2000 2001 2002Goods: exports fob 4,808.0 4,596.2 5,439.6 4,816.1 4,699.2

Goods: imports fob -5,313.4 -5,365.5 -6,483.6 -5,374.6 -6,105.6Trade balance -505.4 -769.3 -1,044.0 -553.5 -1,406.5Services: credit 916.6 964.3 938.7 1,365.9 1,268.3Services: debit -1,361.6 -1,413.7 -1,621.5 -1,755.6 -997.0

Income: credit 214.2 166.7 149.0 93.4 75.3Income: debit -394.5 -419.3 -448.9 -373.9 -326.7Current transfers: credit 1,054.5 1,078.1 1,165.7 1,145.7 1,287.1

Current transfers: debit -151.3 -168.2 -182.7 -186.8 -190.2Current-account balance -227.5 -561.4 -1,043.7 -264.8 -289.7Direct investment in Sri Lanka 193.4 176.4 173.0 171.7 241.5Direct investment abroad 0.0 -5.0 -8.0 -9.2 -11.5Inward portfolio investment

(incl bonds) -162.9 -84.6 -63.4 -34.7 -

Outward portfolio investment -88.9 -71.8 -19.1 -23.6 -Other investment assets 75.9 23.2 -243.7 183.0 104.4

Other investment liabilities 99.7 226.7 562.3 -480.0 -560.0Financial balance 117.2 264.9 401.1 104.2 -Capital account nie credit 84.6 85.2 55.0 55.2 61.3

Capital account nie debit -4.7 -5.2 -5.7 -5.3 -5.9Capital account nie balance 79.9 80.0 49.4 49.9 55.4Net errors & omissions 26.3 -27.3 186.2 92.6 103.0Overall balance 223.6 -95.2 -360.8 -258.5 -331.5Financing (–indicates inflow)Movement of reserves -141.0 194.8 446.5 -290.7 -394.4Use of IMF credit & loans 82.6 99.7 85.7 59.8 74.0


52 Sri Lanka


Balance of payments, national series(SLRs m)

1999 2000 2001 2002 a 2003Merchandise exports fob 325,170 420,114 430,372 449,855 495,426Merchandise imports cif -421,873 -554,290 -532,964 -584,561 -643,750

Trade balance -96,702 -134,176 -102,592 -134,706 -148,324Net services 10,342 2,907 14,692 28,224 38,152

Net incomeb -17,831 -23,009 -23,843 -24,174 -18,540Net private transfers 62,472 73,620 87,837 104,980 116,321

Net public transfers 1,816 1,801 1,925 2,982 2,785Current-account balance -39,903 -78,857 -21,981 -22,693 -9,608Net capital transfers 5,650 3,795 17,766 6,219 5,927

Direct investment 12,449 13,319 15,271 17,716 19,450 Foreign direct investment (net) 12,449 13,119 7,310 17,281 16,557 Privatisation proceeds 0 200 7,961 435 2,893Net private long-termb 14,086 5,622 -22,907 -2,044 -3,215Net government long-term 4,451 3,653 21,984 13,233 52,920

Net short-term -6,162 5,438 16,974 5,509 -7,231 Portfolio investment -886 -3,355 -1,025 2,443 209 Net private short-termb -667 7,569 -3,798 6,548 1,790 Net commercial bank assets 1,766 -18,736 -2,867 6,893 -9,090 Commercial banks’ liabilitiesb -6,375 19,960 18,929 -10,735 -141 Net government short-termb 0 0 0 0 -

Capital & financial account (net) 30,473 31,827 49,088 45,589 67,851Valuation adjustments 2,103 5,189 22,245 8,900 -

Errors & omissions -6,857 10,902 -19,587 9,209 -9,634Overall balance -14,184 -30,939 29,765 36,051 48,610

a Provisional. b Since 1994 foreign currency banking units (FCBUs) have been treated as part of the domestic banking system in compilation ofbalance-of-payments statistics. Transactions involving FCBUs and non-residents are included in the balance of payments, whereas thosebetween FCBUs and residents are excluded.


Sri Lanka 53


External debt, World Bank series(US$ m unless otherwise indicated; debt stocks as at year-end)

1998 1999 2000 2001 2002Public medium- & long-term 7,948 8,413 7,942 7,603 8,455Private medium- & long-term 196 213 368 389 351

Total medium- & long-term debt 8,259 8,625 8,310 7,992 8,805 Official creditors 7,000 7,432 7,026 6,650 7,467 Bilateral 3,778 3,824 3,620 3,417 3,720 Multilateral 3,222 3,607 3,406 3,233 3,747 Private creditors 1,260 1,194 1,284 1,342 1,342

Short-term debt 433 944 696 453 496 Interest arrears 137 154 123 96 99Use of IMF credit 367 258 160 214 310.0

Total external debt 8,944 9,732 9,019 8,529 9,612Principal repayments 415 521 532 493 495.5

Interest payments 185 217 2465 223 220.4 Short-term debt 19 29 34 17 6.7Total debt service 600 738 777 716 716

Ratios (%)Total external debt/GDP 56.7 62.2 55.2 55.2 58.0Debt-service ratio, paida 8.6 10.9 10.1 9.7 9.9

Note. Long-term debt is defined as having original maturity of more than one year. a Debt serviceas a percentage of earnings from exports of goods and services.

Source: World Bank, Global Development Finance, 2002.

Net receipts of foreign assistance(SLRs m)

1999 2000 2001 2002 2003Loans 8,604 10,070 19,936 10,113 53,213 Japan 4,927 7,353 10,011 6,309 21,655 Asian Development Bank (ADB) 5,645 4,343 5,295 11,878 17,237 International Development Agency (IDA) 2,542 2,236 677 5,663 15,950

Grants 6,761 5,145 5,500 7,079 7,956 Japan 3380 2,826 2,135 2,287 1,643Total 15,365 15,215 25,436 17,192 61,169


Foreign reserves(US$ m; end-period)

1999 2000 2001 2002 2003Total reserves incl gold 1,640 1,043 1,290 1,705 2,273Total international reserves

excl gold 1,636 1,039 1,287 1,631 2,195Gold, national valuation 4 4 3 74 78


54 Sri Lanka


Foreign reserves-central bank data(US$ m; end-period)

1999 2000 2001 2002 2003Gross official reserves 1,639 1,049 1,338 1,700 2,329Total external assets 2,582 2,131 2,238 2,495 3,218

Total assets–in months ofmerchandise imports 3.3 1.7 2.7 3.3 4.2


Exchange rates(SLRs per unit of currency unless otherwise indicated; annual averages)

1999 2000 2001 2002 2003US$ 70.6 77.0 89.4 95.7 96.5

£ 114.3 116.5 128.7 143.4 157.7Euro 75.1 69.9 80.1 90.4 109.2

HK$ 9.1 9.9 11.5 12.3 12.5Rmb 8.5 9.3 10.8 11.6 11.7¥ 0.6 0.7 0.7 0.8 0.8

Sources: IMF, International Financial Statistics; Economist Intelligence Unit.

Editors: Ravi Bhatia (editor); Graham Richardson (consulting editor)Editorial closing date: July 5th 2004

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected]

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