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Country Commercial Guides for
Report prepared by U.S. Embassy Colombo, Sri Lanka, released July 1999 |
Chapter IIECONOMIC TRENDS AND OUTLOOK
Major Trends and Outlook
Sri Lanka began to shift away from a socialist orientation in 1977, but the pace of reform has been very uneven over the past twenty-one years. Socialist sentiments remain strong among certain groups, particularly in the workforce. In 1983, serious ethnic disputes slowed the process of liberalization and economic diversification. In 1988-90, a violent uprising of the Maoist-communist JVP organization--led by educated but unemployed youth--threatened the Government of Sri Lanka (GSL) and caused extensive upheavals and economic uncertainty. Increased privatization, reform, and an emphasis on export-oriented growth followed the successful quelling of the JVP revolt, taking GDP growth to 7 percent in 1993.
Divisive elections in 1994 slowed growth moderately, with GDP expanding by 5.5 percent in both 1994 and 1995. In 1996, growth slowed considerably--to 3.8 percent--due mainly to a prolonged drought and resulting power cuts, along with major terrorist attacks on civilian targets in the Colombo area. The economy recovered in 1997 registering a growth rate of 6.4 percent, investor confidence slowly began to recover, tourism picked up, exports rose and thermal power generating capacity was expanded. The Asian financial crisis took less of a toll on the economy of Sri Lanka in 1997, due in part to continued exchange controls on the capital account and relatively low exposure to short-term foreign debt.
Growth moderated in 1998 to 4.7 percent, in the midst of a global recession and domestic and regional economic/ political problems. A series of terrorist bombings in late 1997 and early 1998 in civilian areas, including Colombo's financial district, caused a decline in tourism and investor confidence in the first half of 1998. The situation was exacerbated by nuclear detonations by neighboring India and Pakistan in May 1998 which had a chilling effect on foreign commercial and investor interest in Sri Lanka, particularly in the stock market. Further, the Russian economic crisis in August 1998 caused a marked decline in tea exports and prices. Several other exports were hit hard due to declining demand and competition from cheaper sources in East Asia. On the positive side, both tea and rice output increased significantly in 1998 and garment exports and worker remittances remained strong. Tourism also recovered towards the latter part of the year.
For 1999, real GDP growth is expected to slow down to about 4 percent. The economy is faced with a series of challenges stemming from the slowdown in exports, especially tea and garments. On the positive side, increased private sector participation in the telecommunications service industry has yielded strong growth and development in this sector. More thermal power generating capacity is slowly being added, and with adequate rainfall for existing hydropower installations, the short-term power outlook is positive. Tourism is also likely to have a good year and worker remittances continue to grow.
In the longer term, prospects are uncertain. There are no imminent prospects for settling the ethnic conflict, and defense expenditures remain a significant drain on the economy. Implementation of major reforms in the civil service and education sectors, and more disciplined spending and improved revenue collection would help generate stronger economic growth. If privatization continues and export orientation strengthens, weaknesses in government will be somewhat less critical to growth. We expect to see growth continuing in the 5-6 percent range beyond 1999, still below Sri Lanka's potential. Growth prospects would improve with stronger leadership and more vigorous implementation of economic policy commitments.
Principal Growth Sectors
Growth in the three principle economic sectors moderated in 1998 when compared with 1997. Nonetheless, their performances are laudable in view of the difficult global and domestic economic environment prevailed during the year. The services sector, which accounts for 52.8 percent of GDP, increased by 5.2 percent. The manufacturing sector grew by 6.3. The manufacturing sector's share of GDP was 16.5 percent. The agricultural sector increased by 2.5 percent and accounted for 21.1 percent of GDP. The construction sector did well, growing by 7.1 percent.
The following table presents percentage changes in real sectoral output over the preceding year.
Contribution to 1998 GDP(a)% 1997(b) 1998(b) Manufacturing (17) 9.1 6.3 Services (53) 7.1 5.2 Agriculture (21) 3.0 2.5 Mining (02) 3.8 -5.4 Construction (07) 5.4 7.1 Real GDP Growth 6.3 4.7 (a) At current prices. (b) At constant prices
Agriculture: In recent decades, agriculture's contribution to the Sri Lankan economy has decreased. The agricultural sector's share of GDP has declined from 38.4 percent in 1978 to 26.3 percent in 1990 to 21.1 percent in 1998, as a result of the diversification of the economy and the consequent rise in manufacturing and services, lower prices for commodities such as coconut and rubber, and lower productivity. Despite its relatively small contribution to GDP, the agricultural sector still employs over 38 percent of the working population, and remains a major force in society and politics. Low productivity, especially in subsistence agriculture, including paddy cultivation, is a major concern to policy makers. Efforts are underway to increase productivity in plantation agriculture-- tea, rubber and coconuts --now under private sector management and ownership.
The agricultural sector posted mixed results in 1998. Both tea, the main agricultural export and rice, Sri Lanka's staple cereal did very well, but other agricultural products such as rubber and coconuts declined sharply.
-- The 1998 rice crop yielded a bumper harvest, increasing by a strong 20 percent to 2.7 million metric tons. This is the second highest level of production ever recorded, and only 4 percent lower than the peak production in 1995. Production increased due to good weather, increased area under cultivation and improvements in yield. However, production was sufficient to meet only about 83 percent of demand. To offset supply shortfalls, Sri Lanka imported 168,000 metric tons of rice during the year. A 35 percent import duty on rice was removed temporarily to facilitate the imports.
-- Tea production increased for the fifth consecutive year in 1998. Total production increased by 1.2 percent to 280.1 million kgs. The increase was entirely due to an increase in tea grown in low elevational areas. Low-grown tea, accounts for 54 percent of total production. Both high and medium grown tea production declined during this period. Tea production in the small holder sector continued to increase. The small holder's share in the national output increased to 61 percent. The yield levels in the recently privatized estate sector have been stagnant and are about half the yield level in the small holder sector.
-- Other major export crops, rubber and coconuts, declined in 1998. Rubber production, which has shown a declining trend since 1996, recorded a further decline of 9 percent in 1998. Production was affected by a decline in yield and by a drastic drop in prices. International natural rubber prices have declined due to the release of buffer stocks held by the United States and Thailand. The decline is also attributed to a loss of competitiveness as a result of currency depreciation of other rubber producing countries and a reduction in demand for motor vehicles following the East Asian recession. In order to overcome the crisis in the rubber sector, Sri Lankan rubber producers are increasingly shifting to the production of crepe rubber. Increased local consumption has also helped to stabilize prices somewhat. Sri Lanka exports 44 percent of its rubber output. The balance is consumed locally by the industrial sector. Recently, Sri Lanka decided to withdraw from the beleaguered International Natural Rubber Organization (INRO).
Major reform of the plantation sector (tea, rubber and coconut) began in 1992, when management (but not the land or assets) was privatized. In 1995 the GSL began privatizing regional holding companies. These holding companies obtained 50-year lease rights to the plantations. The GSL sold 20 plantation management companies in 1995-1997. Of these, 14 are listed on the Colombo Stock Exchange and account for about 4 percent of market capitalization. In February 1998, tea and rubber plantation workers obtained substantial wage increases after a nine-day long strike. The new wage agreement contains a formula for profit sharing which would afford the plantation companies the flexibility to weather downturns in prices.
The outlook for the agricultural sector in 1999 is not very encouraging. The paddy sector, which recorded a 20 percent increase in production in 1998, is unlikely to grow further in 1999. Paddy production in the main Maha season has fallen by about 2.5 percent. The smaller Yala crop, which grew by over 16 percent in 1998, is unlikely to record significant growth rates this year. To meet the shortfall, Sri Lanka plans to import at least 100,000 metric tons of rice. In the tea sector, while production is expected to improve further in 1999, prices have tumbled from the very high levels of early 1998. The average price of tea at the end of June 1999 was approximately Rs 100 per kg compared with an average price of Rs 134 per kg in 1998. Rubber production is up 5 percent in the first four months of 1999, but prices are still low. Coconut production has been flat. Tea and rubber account for 17.4 percent of total export earnings. The price drop in these crops, which sustain Sri Lanka's plantation sector, is of concern to policy makers and businessmen.
Industry: Manufacturing accounts for about 17 percent of GDP, about 44 percent of which is textiles, apparel and leather products. Growth in the manufacturing sector was 6.3 percent in 1998, compared with growth of 9.1 percent in 1997. Strong performance of domestic market oriented industries contributed heavily to growth in 1998. Performance in the export oriented manufacturing industries was mixed.
-- The textile, apparel, and leather products sector is the largest industrial sector and accounted for 44 percent of industrial output. This sector grew by 4.5 percent in 1998, a significant slowing down from the 18.7 percent growth in 1998. Garments, mainly exported to the U.S. and Western European markets, account for about 32 percent of manufacturing employment and 46 percent of total exports. There are 860 garment factories in operation. The exporters faced a shortage of U.S. quotas towards the end of the year. The unexpectedly high utilization of certain fast moving categories of U.S. textile quotas prompted the Sri Lankan Government to temporarily stop issuing textile visas for the affected categories of exports. The U.S. is the main export market for Sri Lanka's apparel exports, taking 60 percent of all apparel exports. Data indicate an increase in higher value added items to the U.S. About 77 percent of exports to the U.S. are under quotas. Sri Lanka's textile and apparel industry will need to invest heavily in technology and skills to face increased competition when quotas are fully phased out in 2005.
-- Growth in other major industrial sectors was mixed. The second largest industrial sector, food, beverages and tobacco, contributed 24 percent of industrial output and grew by 9.6 percent, compared with 3.4 percent growth in 1997. Two other major industrial sectors, chemicals, petroleum and rubber products sector and the nonmetallic mineral sector, grew by 13.1 percent and 5.1 percent, respectively.
-- The smaller fabricated metal products and machinery industry grew substantially, by 10.7 percent following a growth of 19 percent in 1997. This sector contributes 4 percent of GDP.
The Government is encouraging production of selected goods for which the country is believed to have a comparative advantage. A range of special incentives is now given for investments in these selected "thrust" industries:
--electronics and components for electronic assembling
--ceramics and glassware
--rubber-based industries
--light and heavy engineering
--cutting and polishing gems, diamonds and manufacture of jewelry.The 1999 outlook for manufacturing is not bright. Manufacturing sector growth has slowed to 3.3 percent in the first quarter of 1999 from 7.7 in 1998 due to a decline in demand for a range of Sri Lanka's exports including processed rubber, coconut, fiber and ceramic, leather and food and beverage exports. Textile and garment exports, which have grown rapidly in the past, have increased by just one percent in the first four months of 1999.
Services: Services, which account for 53 percent of GDP, grew by 5.3 percent in 1998. The communications sector, boosted by increased private sector participation, continued to grow strongly by a whopping 46 percent following a 33 percent growth in 1997. Electricity sub sector also grew sharply by about 10 percent in 1998. Increased thermal capacity following the addition of 51 megawatts of new thermal capacity to the national grid and increased hydropower generation were the main factors contributing to increased electric power generation. Growth slowed in banking and the insurance sector to 6.4 percent from 10.3 percent in 1997. The decline in external trade constrained the profitability of the banking sector. The stock market downturn also caused portfolio losses in the banking sector and eroded the profitability of stock brokering firms.
The communications and power sectors are expected to be buoyant in 1999, contributing markedly to service sector growth as a result of increased private sector participation. Growth in banking and finance will be under pressure in line with the general slowdown in the economy and slowing external trade. Port services declined in 1998 and the trend has continued into 1999 due to increased competition from regional and Middle Eastern ports. The recent transfer of transshipment traffic from Colombo to Port Raysut in Salalah, Oman by two of the main users of the port, Sea Land and Maersk Shipping Lines, is a major cause for concern. Tourist arrivals continue to recover from the heavy blows suffered in 1996-1997 from terrorist bombings in civilian areas. In 1998, arrivals increased 4 percent to 381,000, but remained below peak arrivals in 1994-1995. Tourist arrivals have remained buoyant in the first half of 1999. Industry sources expect arrivals to increase by at least 10 percent in 1999.
Government Role in the Economy
Historically, the public sector employed one quarter of the work force, but this proportion is decreasing as reforms continue and the private sector's role in the economy expands. In 1998, employees in government and quasi-governmental agencies made up 17.9 percent of the workforce. The International Monetary Fund (IMF) and the Asian Development Bank (ADB) have been actively pressing for stronger Government action on public sector reforms.
Since 1977, the GSL has been deregulating, privatizing and opening the economy to international competition. It has eliminated most price controls and quotas, liberalized import licenses, terminated export taxes, and sold over 50 state-owned companies. Tariff levels have been reduced on many items, though industry remains critical of high tariffs on a number of imported items and inputs. The Government actively promotes inward foreign investment and has eliminated most foreign exchange controls. In March 1994, it obtained Article VIII status in the IMF.
The state continues to control the price of bread, petroleum, bus and rail fares, telecom rates, and electricity. In addition, utilities and fertilizer are subsidized or have below-market prices. Aware of many of its shortcomings, the Government has been striving to eliminate subsidies and free-up prices, but finds it politically difficult. In 1998, the Government managed to fully phase out a subsidy on wheat flour, due to low world market prices for wheat. However, a move to increase rail fares failed. The Government is also moving to open the economy to more private sector participation and competition, albeit at a slower than desirable pace. Foreign shipping companies express concern that government-regulated fixed fee levels for a variety of port and related services are anti-competitive and make Sri Lanka's port less attractive in the long run. In May 1999, the Government announced a new film policy with plans to liberalize the import and distribution of motion films which is currently controlled by the state owned National Film Corporation.
Privatization: The state retains control over a great deal of infrastructure (ports, roads, rail and electricity). It owns the two largest commercial banks, two insurance companies, a national shipping line, and many other companies. The Government has taken steps to privatize some of the utilities and infrastructure sectors. In early 1998, the Government completed the sale of 40 percent of Air Lanka, the national airline, to Emirates of Dubai, UAE. Although the Government retains majority ownership, it ceded managerial control to the new owners. In August 1997, the Government sold 35 percent of Sri Lanka Telecom (SLT), the state-owned telecommunications entity, to Nippon Telephone and Telegraph (NTT) of Japan. The privatization deal also kept majority ownership for the Government but gave management control of SLT to NTT. In 1996, well ahead of SLT privatization, the Government effectively ended the state monopoly on telephone landlines when it approved the provision of 200,000 new lines, based on wireless local loop technology, by two private companies. In the power sector, the first medium scale BOO-BOT power project of 51 MW (megawatts) started operations in June 1998. Finalization of the contracts for this project took about four years of protracted negotiations.
Since December 1998, the Government has awarded tenders or issued Letters of Intent for three other medium to large-scale BOO-BOT power projects, the largest being a 150 MW combined cycle power plant awarded to Virginia-based AES Corporation. In the ports sector, after several years of negotiations, the GSL initialed primary project agreements with a private sector consortium including P&O Netherlands and local conglomerate John Keells Holdings to expand and operate the main port in Colombo. The agreements are expected to be finalized in late July and the QEQ handed over to SAGT in August 1999.
Following a competitive tender process, Caltex bought control of Lanka Lubricants in 1994, the Colombo (bottled) Gas Company was sold to Shell Oil in late 1995, and the Colombo Steel Corporation was bought by the Korean company Hanjung in December 1996. The Caltex-Lanka Lubricants venture has been extremely successful. However, both the gas and the steel companies were troubled by labor unrest in 1996 and 1997, but seem to have put those problems to rest since then. Government-owned plantations have been privatized under long-term lease arrangements, and some shares have been offered to the public, with good results. Many other ventures are also slated for privatization, though the GSL agency responsible for privatization, the Public Enterprise Reform Commission (PERC) is now proceeding carefully and slowly, and avoiding the most controversial entities. Further, given the depressed conditions of capital markets the privatization process slowed in 1998. As a result, there have been no major privatization sales during the past twelve-month period.
During the second half of 1999, a further 10 percent stake of SLT will be sold. The Government also hopes to sell several small livestock companies as well as minority stakes in several regional plantation companies and an insurance company, but some of them may be delayed. The Government also has plans to restructure several important government departments such as the Postal Department, Railways Department and Ceylon Electricity Board under government ownership. Privatization of the state banks is not considered feasible in the short term due to current political constraints. In a bid to overcome the problems at the state owned banks, the Government signed two agreements with the Bank of Ceylon and the People's Bank on July 16, 1998. These agreements aim at commercializing and consolidating operations. The Government is expected to sign fresh agreements with the two banks incorporating corporate plans in the near future. The future public sector reform program will largely depend on a study now being done by Arthur Andersen. This study will map out the reform strategies on privatization, capital and financial markets and labor markets, for the next 4-5 year period. The Asian Development Bank is expected to fund the reforms program.
Government procurement: While Government of Sri Lanka representatives at the highest levels have emphasized the importance of reform and transparency in policy announcements and publications on government procurement, unfortunately procedures for bidding on major government projects and supply contracts in practice are still not transparent or predictable, and lengthy unexplained delays (of years, rather than months) are common. Competitive bids are normally reviewed by a Technical Evaluation Committee, which makes recommendations to a Cabinet-Appointed Tender Board (CATB). The CATB then makes its recommendation to the relevant line ministry, which forwards a final recommendation to the Cabinet for approval. The deliberations and decisions of these different bodies are made "in secret," although information often "leaks" out.
The Cabinet has been known to reject recommendations and choose less competitive bidders on obscure or unsubstantiated grounds. Procuring agencies sometimes fail to follow up in making the contracted procurement. In addition, the Government has abruptly canceled tenders (or reneged on signed or implicit contracts that resulted from tender decisions) with no adequate explanation or compensation, causing significant financial hardship and inconvenience to the winning bidders. Military procurements are often made completely outside of normal tendering procedures, resulting in no transparency or accountability.
The Ministry of Finance and Planning in September 1996 issued "Guidelines on Government Tender Procedure" and reissued an expanded version of these guidelines in August 1997. The stated intent of the guidelines is to "reduce the time taken for the tendering process to six months, while keeping the whole process transparent and ensuring a level playing field to all tenderers." As of mid-1999, this intent has not yet been realized, based on the experience of numerous U.S. companies and their agents. For example, although the guidelines stipulate that appeals can be directed to a Tender Appeal Board, no such entity has yet been established. As a result, there is no functioning appeal mechanism in place.
Budgetary performance: The budget deficit in 1998 (excluding grants and privatization proceeds) at 9.2 percent of GDP, was much higher than the planned deficit of 6.5 percent. Government fiscal control faced a major setback in 1998 due to large expenditure overruns on defense, wages and pensions, and major shortfalls in revenue. The defense bill rose 13 percent to Rs 57.1 billion ($885 million, or 5.6 percent of GDP). Total revenue as a percentage of GDP declined for the third consecutive year, to 17.3 percent. Tax revenue was sluggish and increased only marginally by 3 percent in nominal terms. Consequently tax revenue at 14.5 percent of GDP fell short of a planned 18.4 percent target, and was the lowest recorded tax/GDP ratio since 1950. One of the major causes for the slackness in tax collections was the lower revenues generated from the Goods and Services tax (GST) introduced in April 1998 in place of the turnover tax. The GST is the most important tax source for the government. However, the current 12.5 percent GST rate is well below the revenue neutral tax rate of around 17 percent, which is a major cause for concern. Revenue from income tax and import duties was also lower than targeted due to various tax exemptions for investors, lower import tariff rates, and lower international prices for Sri Lanka's imports. Public investment was 6.7 percent of GDP, a significant improvement from the previous two years' spending level of around 5.9 percent, and was made possible due to higher utilization of foreign concessional loans. Public investment was concentrated on vital economic infrastructure such as power, ports, telecommunications, water supplies and roads development. The budget deficit was financed mainly through domestic borrowings (7 percent of GDP). Foreign borrowings were about 1 percent of GDP and foreign grants, 0.7 percent of GDP.
Total government debt rose to Rs 907 billion ($14 billion), or about 89.4 percent of GDP from 86 percent in 1997. Domestic debt was Rs 446 billion and foreign debt was Rs 460 billion ($7 billion). Despite the difficult fiscal environment, the government continued its policy of making the government debt program more market-oriented and reducing the stock of short-term debt. Interest payments declined to 5.4 percent of GDP from 6.2 percent in 1997. However, interest on Government debt continues to be a drag on expenditure, absorbing 20 percent of total government expenditure and 28 percent of government revenue. This interest on the public debt along with total expenditure on defense, public sector salaries, and pensions to retired public servants account for nearly 80 percent of total current expenditure. Therefore, the creation of a more balanced expenditure structure that effectively promotes long-term economic growth is a major challenge to the Government.
Sri Lanka looks set to overshoot the 1999 deficit target as well. The Government has revised budgetary targets and currently expects a deficit of around 7.8 percent of GDP, higher than the original target of 6 percent of GDP, or Rs 68 billion, announced when the budget was presented to Parliament in late 1998. The revision came in view of the slow down in the economy which has dampened tax revenue and due to an increase in debt service due to higher borrowings in 1998. The Government has vowed to keep defense expenditure at the budgeted level of Rs 47.3 billion through enhanced monitoring and control of expenditure. This is a major cutback from the Rs 57 billion spent in 1998. The revised budget estimates forecast total expenditures to rise 8 percent. Current expenditure is to rise just 3 percent and public investment is forecast to grow by 24 percent to 7.4 percent of GDP. GSL revenues are forecast to increase by 15 percent in 1999, much more than the expected inflation rate of around 10 percent. Priority in the capital investment program will be the development of economic infrastructure: transport, ports, telecommunications, power, and industrial infrastructure.
The budget for 1999 did not contain any major surprises or giveaways. However, the Government did not deviate from policy measures adopted in the past four years-- i.e. it did not propose major new subsidies, did not change open market policies, investment policies or macroeconomic policies. At the same time, the budget did not contain substantial measures to be taken in 1999 to address issues of critical importance in vital sectors such as public service, pensions, health, taxation, and public transport.
The following table presents Government fiscal operations as a percentage of GDP. 1998 figures are provisional and 1999 figures are projections:
Government Accounts (Percent of GDP)
1997 1998 1999 Revenue 18.5 17.3 17.7 Expenditure and net lending 26.4 26.4 25.5 Defense 5.1 5.6 4.1 Budget deficit before grants 7.9 9.2 7.8 Domestic finance 3.4 7.0 5.3 Privatization proceeds 2.5 0.4 0.7 Foreign grants and loans 1.9 1.7 1.8 Prices and Money: Money supply (M2) growth was 13.2 percent in 1998. Domestic credit expanded by 14.4 percent largely due to a hefty 42.8 percent increase in credit to the Government including a $100 million loan raised through the foreign currency banking units of commercial banks present in Sri Lanka. Private sector credit grew moderately by 11.8 percent due to slower economic growth and a slowdown in external trade. Despite the increase in government sector credit, the slow growth in private sector credit and a significant reduction in foreign inflows helped contain monetary expansion and inflation in 1998.
Inflation, as measured by the Colombo Consumer Price Index, was 9.4 percent in 1998, around the same level as in 1997. Inflation has slowed since then to around 6 percent as of June. Price reductions in major imports such as wheat, petroleum, and sugar have helped to keep inflationary pressures under control. M2 growth in the first four months of 1999 was 13 percent, indicating upward pressure on inflation in the next few months.
Monetary policy management was difficult in 1998 in view of the unstable external environment and the large government budget deficit. The Central Bank tightened monetary policy in the first half before relaxing it somewhat towards the end of the year. The Central Bank adopted open market policies with the Central Bank repurchase rate serving as the main signaling mechanism. The statutory reserve requirement for commercial banks remained unchanged at 12 percent. Commercial banks were allowed to include their Treasury bond holdings as part of their liquid assets. Despite increases in the Government fiscal deficit, interest rates were generally stable in 1998. As of July 1999, 3-month and 12-month Treasury bill interest rates were 11.85 and 12.69 percent, slightly higher than in 1998. Interest rates are expected to remain around current levels in the next few months, moving up slightly towards December. Average lending rates moved down slightly from 20.5 percent in 1997 to 19.56 percent in 1998. The weighted average prime lending rate was 14.9 percent and applied to prime customers of commercial banks. Throughout 1998, the Central Bank floated several long-term credit instruments including rupee loans and treasury bonds of varying maturity. Interest rate on these long-term loans averaged around 12 percent.
Balance of Payments
Sri Lanka's trade and current account deficits narrowed in 1998. Due to a slowdown in net capital inflows, however, the Balance of payments recorded a smaller $37 million surplus, compared with a surplus of $163 million in 1997.
Export growth slowed considerably to 2 percent compared with a growth of 13 percent in 1998. Despite a 12 percent increase in the import volume, import expenditure increased only marginally by less than 1 percent. Consequently, Sri Lanka's trade deficit narrowed in 1998, to $1,157 million, for the fourth consecutive year. The services account recorded a surplus of $143 million, down 10 percent from $159 million in 1997, due to a slow down in port services. Private transfers were up 18 percent to $848 million. Private transfers include $78 million received as compensation to Sri Lankans who lost employment in Kuwait in 1990 due to the Gulf War. In 1997, Sri Lanka received $63 million as compensation. Official transfers decreased by 11 percent to $120 million. The deficit in the current account declined from $393 million in 1997 to $289 million in 1998. The current account deficit has continuously declined in the past four years from a high of $860 million in 1994.
Private investment was low in 1998 when compared to 1997 due to a sharp drop in privatization receipts. Net long-term private capital inflows dropped to $200 million in 1998, from $477 million in 1997. Privatization receipts were $56 million, compared with $300 million in 1997. The privatization program slowed in 1998 due to uncertainty in the capital markets. However, foreign direct investment inflows were $150 million, compared with $133 million in 1997 and $100 million in 1996. Private investment was higher in telecommunications and power sectors. Foreign direct investment outflows were $13 million in 1998. Other net long term capital inflows were $7 million, compared with $47 million in 1997 mainly due to higher outflows for an advance payment of $48 million for six Airbus aircraft for Air Lanka which is held jointly by the Government and Emirates Airlines of UAE. Two large institutions, Development Finance Corporation of Ceylon and Sri Lanka Telecom, raised several foreign loans to the value of $108 million in 1998 to finance development projects. Portfolio investment through the Colombo Stock Exchange resulted in a net outflow of $24 million in 1998.
In 1998, Sri Lanka received $578 million from the donor community in grant aid and concessional assistance. The major donors were the Asian Development Bank, Japan and the International Development Association. U.S. assistance on a disbursement basis amounted to $11.75 million, $1.75 million of which constituted development assistance and $10 million, concessional agricultural loans for the sale of wheat. In addition to the concessional funding, the Government raised $100 million through the Foreign Currency Banking Units of Commercial Banks in Sri Lanka.
Sri Lanka's gross external assets of $2,907 million in December 1998 were sufficient to finance 5.9 months of imports of goods and services projected for 1998.
International Trade: Sri Lanka's trade deficit contracted by 5.5 percent to $1,157 million in 1998. Both export and import growth slowed. Exports were up by $68 million, to $4,735 million. Sri Lanka's two main exports, garments and tea, contributed strongly to this growth. Garment exports rose 8 percent ($186 million) to $2,460 million. Earnings from tea exports also rose 8 percent ($61 million) due to increases in prices and production. Two other important export sectors, footwear & leather products, and food & beverages also did well in 1998, increasing by 17 percent and 20 percent respectively. Several other exports decreased. In the agricultural export sector, earnings from rubber exports declined sharply by 45 percent on top of a 24 percent decline in 1997, due to lower prices and a decline in export volume. Earnings from coconut exports were down 20 percent. Thanks to increased prices, earnings from other agricultural exports were up 17 percent. A range of manufactured exports such as petroleum products, ceramic products, scrap metal, machinery and equipment, diamonds and jewelry declined. Some of these items such as ceramics, diamonds and jewelry have faltered in the face of decreased demand in recession-hit Japan and Thailand, and increased competition from cheaper sources in East Asia.
Despite a significant increase in the import volume, import expenditure increased by just $27 million to $5,891 million, reflecting lower prices for Sri Lanka's imports. Investment goods imports rose by 11 percent. Machinery imports rose by 6 percent. Building material imports increased 11 percent and transport equipment by 27 percent. In the intermediate goods category, imports fell 4 percent. The largest single import category, textiles for the garment export industry, grew by less than 1 percent despite a 10 percent increase in volume.
Consumer imports increased by 2.6 percent. The food import bill declined 7 percent to $723 million due to decreased imports and a reduction in food prices. Reflecting higher local production, rice imports declined by 42 percent to 168,000 metric tons in 1998 and cost $42 million. Wheat imports increased 11.5 percent to 880,000 metric tons in 1998 from 789,000 metric tons in 1997. However, lower world market prices caused the wheat import bill to decline from $139 million in 1997 to $127 million in 1998. Sugar imports also declined in 1998. Imports of non-food consumer goods increased by 20 percent in 1998.
The United States is Sri Lanka's largest export market and the destination for $1,890 million, or 40 percent of exports, predominantly garments. Sri Lanka's garment industry is heavily dependent on the U.S., with 60 percent of all garment exports bound for U.S. Japan edged into position as Sri Lanka's largest supplier with exports of $556 million in 1998. India, the largest source of Sri Lanka's imports in 1996 and 1997, was the second largest supplier in 1998. Other leading suppliers were South Korea, Hong Kong, Taiwan and Singapore. The United States remained the eighth largest supplier to Sri Lanka with a 4.8 percent market share. According to statistics compiled by the Central Bank of Sri Lanka, imports from the U.S. amounted to $230 million in 1998 compared to $187 million in 1997 and $198 million in 1996.
According to U.S. Customs' statistics, U.S. exports to Sri Lanka were $190 million in 1998 compared to $155 million in 1997 and $211 million in 1996. Wheat accounted for 28 percent of U.S. exports. For many years, U.S. exports to Sri Lanka were dominated by wheat. However, with the curtailment of concessionary funding programs, as well as increased trade in other areas, the U.S. export mix continues to evolve. Machinery and equipment (radio, navigation, television, telecommunication), computer equipment, textile fabrics, paper, aircraft parts, medical instruments, insecticides, synthetic rubber products, plastic, fruits, pharmaceuticals, books and cotton constituted the bulk of these exports. Sri Lanka's trade surplus with the U.S. in 1998 increased by 8 percent, exceeding $1.5 billion.
Exchange rate: The currency crisis in East Asia had little impact on the Sri Lankan rupee mainly due to existing capital account controls and small exposure to short term debt. The Central Bank also stepped up its surveillance on bank operations and used moral suasion to counteract excessive speculative forces. Another factor, which helped to maintain relative stability in Sri Lanka's financial markets, was the management of the exchange rate. The Sri Lankan rupee has a managed float. The Central Bank monitors the rupee's float closely against a basket of major currencies and intervenes to reduce excessive volatility of rates. The Sri Lankan rupee was allowed to depreciate 9.6 percent against the dollar in 1998 as against 7.5 percent in 1997. It depreciated 13.4 percent against the SDR. The higher depreciation against the SDR reflects the significant depreciation of the dollar against major currencies. The real effective exchange rate depreciated by 12 percent. In the first half of 1999, the rupee fell another 4.6 percent against the dollar.
Debt service: Debt service as a percentage of exports and services increased marginally from 13.3 percent in 1997 to 13.4 percent in 1998. Sri Lanka's external debt (both private and public) stood at $8,753 million at end of 1998. Total external debt was equivalent to 57 percent of GDP. Government or government-guaranteed debt accounted for 91 percent of total external debt.
The balance of payments outlook for 1999 is mixed. External trade has declined considerably in the first four months of 1998. Exports were down 13 percent and imports 17 percent. Sri Lanka's main exports, tea and garments, the star performers in 1998, have faltered during this period dragging down export earnings. According to the latest statistics, earnings from tea exports have declined 40 percent through May 1999. Tea prices which dropped markedly after the Russian economic crises in August 1998, are still hovering around Rs 100 per kg on average compared with an average of Rs 134 in 1998. Tea export volumes have dropped marginally by about 3 percent. Apparel exports have dropped by nearly 9 percent through April, but may pick up in the second half with high value winter clothing orders. A range of other exports such as rubber, coconut, diamonds, jewelry and gems are facing stiff competition due to a fall in demand and price declines due to higher currency depreciation in East Asia. In addition, freight rate increases from Colombo have also rendered exports like coconut fiber and ceramics noncompetitive. As a result, export growth is likely to be negative in 1999. Imports are expected to remain flat, and the trade deficit is likely to increase slightly.
The service balance is likely to be boosted by a strong growth in tourism. Revenues from port services, however, are under pressure due to a drop in transshipment traffic. Private transfers, another major source of foreign income, have risen 8 percent during the first quarter. Foreign direct investment inflows will increase in 1999, if major private sector infrastructure projects, now under negotiation with foreign joint venture companies in ports and power, get off the ground quickly. In addition, the sale of a 10 percent stake of Sri Lanka Telecom now being finalized is expected to generate substantial foreign capital inflows in the range of $100 million. Portfolio investment flows are likely to be negative in 1999 due to a lack of investor interest in the Colombo stock market. The stock exchange recorded a net outflow of about $14 million in the first half of 1999. The Government expects to receive $110 million in foreign grant aid and about $500 million in concessional and commercial loans in 1999 which could partly offset any gaps in FDI. In addition, the Government is planning to raise $200 million in international financial markets to boost much needed finances. However, it is not yet clear if proceeds could be realized in 1999. On the other hand, payments for nine airbus aircraft, for which orders have been placed in 1998 and 1999, will be a drain on the country's external finance.
Infrastructure Situation
Sri Lanka's infrastructure and its management are inadequate. Investment in transport (airports, ports, roads) and power has been marginal in the recent past, while demand continues to grow. Telecommunications infrastructure, while not completely adequate, is the one bright spot in infrastructure development, thanks to liberalized policies which have rapidly allowed significant private sector participation and considerable growth in the sector. Given budgetary constraints and the incapacity to absorb aid fully, the Government of Sri Lanka is promoting private infrastructure, particularly through build-own-operate (BOO) and build-own-transfer (BOT) schemes. The Bureau of Infrastructure Investment (BII) in the Board of Investment (BOI) is the primary authority for promoting and developing such projects. However, the BII has few successes to show for its efforts to date.
Sri Lanka is served by a fairly modern (by regional standards) international airport and three commercial ports, the largest being the port of Colombo. The Government of Sri Lanka has extensive plans for the development and expansion of the Colombo Port. Colombo has an annual capacity of 1.7 million TEU's. Plans are underway to expand the existing Queen Elizabeth Quay (QEQ) on a Build-Operate-Transfer (BOT) basis with private sector financing and to develop the North Pier with Japanese OECF financing. Up to now, the development work of the Port of Colombo has been largely financed by loans provided by the OECF. QEQ is to be developed by South Asia Gateways (SAGT), a joint venture between P&O Netherlands, P&O Nedlloyd and local conglomerate John Keells Holdings Ltd. Under the first phase of the project, the capacity of the QEQ will be increased by 750,000 twenty foot equivalents (TEU) at a cost of $240 million. The project will involve the construction of three container berths. The second and third stages of the expansion plan cover the construction of a new breakwater and development of outer harbor facilities.
The entire project is estimated to cost $850 million. The Government issued a letter of intent for the first phase of this project in February 1995, however, the project has experienced lengthy delays in part due to the port unions' vehement opposition to privatization. After several years of negotiations, the Government signed primary project agreements with SAGT in June 1998. Agreements are expected to be finalized in July 1999. Construction and operation work of the port development project is planned to commence in the fourth quarter of 1999. The new North Pier development program envisages developing the north pier area, which is currently serving as an oil jetty, into a multipurpose terminal with facilities to handle break-bulk, bulk and containerized cargo. The Government has pre-qualified contractors for this project. However, no further action has been taken.
The Government of Sri Lanka has been trying to develop the southern port of Galle since 1994. The Government issued tenders for the development of Galle port two times, and in 1996 issued a letter of intent to a Chinese-British consortium, which it cancelled in early 1998. In mid 1998 the Government commissioned a study for the phased development of a master plan for developing the port of Galle. Based on the study the Government has decided to develop a smaller area of the Galle port initially. The project will increase break bulk and container capacity of the port.
There are plans to expand the Bandaranaike International Airport (BIA) at Katunayake, on the outskirts of Colombo with Japanese OECF financing.
Inland transportation is dominated by road, but the system has hardly changed since independence, 50 years ago. Proposals to widen large sections of the existing trunk roads leading to key cities are slowly being implemented. These trunk roads presently are not wide enough for standard two-way traffic. A total of 345 kilometers of main roads and 47 bridges will be upgraded within a five year period with the assistance of the Asian Development Bank and the OECF. Total project cost is estimated to be $123 million. The ADB approved a $80 million loan for this purpose in December 1998. The Government is moving ahead with plans to develop two new highways; (a) A new 128 Kilometer highway from Colombo to the southern city of Matara will be funded by the OECF, Japan and the ADB. Construction is expected to begin in 2001. Total project cost is estimated at around $285 million. (b) A four-lane expressway linking capital Colombo to the international airport in Katunayake. The expressway will be approximately 25 kilometers in length, with four interchanges, several over-passes and underpasses and user fee levying facilities. The GSL has invited proposals from eight short-listed bidders for the design and civil construction of the expressway. In addition, several other inner and outer circular roads in Colombo are being upgraded.
Sri Lanka's energy policy has come under sharp criticism in recent years, as droughts underscored Sri Lanka's heavy reliance on hydropower and caused a severe power shortage in 1996. Hydropower was also affected by continued dry weather in the first half of 1997, but because the country retained some of the temporary--and costly--thermal capacity rented by the Ceylon Electricity Board (CEB) to handle the 1996 power crisis, there were no major difficulties during 1997. Many large industrial and commercial organizations now have standby generators which were imported during the power crisis in 1996 under a concessional government funding program.
As of July 1, 1999, Sri Lanka's installed electrical capacity of 1,636 MW consists of 1,139 MW of hydropower and 497 MW of thermal power. This 69:31 hydro to thermal ratio is a measurable improvement over the 81:19 ratio of 1996. In 1997, 178 MW of long-term thermal power was added to the national grid, and a 51 MW BOO-BOT thermal power project was commissioned in June 1998. A further 40 MW will be added to the national grid when a thermal power plant now under construction becomes operational in late 1999. There are plans to boost electrical power capacity further in the next few years. In February 1999, the Government signed an agreement for a 60 MW barge mounted power plant which is expected to be commissioned in late 2000. In addition, negotiations are in progress with Virginia based AES Corporation for a 165 MW combined cycle power BOO project. The Government has recently awarded a tender to build two smaller thermal power plants of 20 MW in two provincial towns under BOOT basis. Tendering is also in progress for another 150 MW combined cycle power plant and a 70 MW hydro power plant, to be funded by the OECF of Japan. The Government has recently received environmental approval for a 300 MW coal fired power project.
Sri Lanka will need to add 2500 MW of new generating capacity between 1999-2012; during the same period, the CEB hopes to achieve a hydro:thermal balance of 1:2. Environmental groups and nearby residents often object to and actively demonstrate against both hydro projects and thermal projects.
The telecommunications infrastructure has been expanded and modernized recently, due to increased private sector participation. As of January 1, 1999 there were 455,600 subscribers and another 224,400 on the waiting list of the state-owned Sri Lanka Telecom (SLT), which until 1996 had a monopoly over land line phones. In 1996, two private operators were authorized to provide land connections using wireless-loop technology. Each wireless loop service provider is expected to add 100,000 new lines by 2000. As of December 31, 1998, 68,000 subscribers were connected to these services. In addition, private companies provide 174,200 mobile phone connections, radio paging, data communication, Internet service and satellite link-ups, relieving some of the pressure. Private operators continue to expand and upgrade their services.
The August 1997 sale of a 35 percent stake in SLT to Nippon Telegraph and Telephone (NTT) of Japan created a "strategic partnership" which expected to lead to greater investment in and maintenance of lines, as well as improved efficiency and service. Since then, as expected, SLT has been vigorously pursuing an expansion plan with some of the projects being funded by the OECF, Japan. SLT also raised a $60 million syndicated loan facility locally in December 1998 to meet expansion costs. The privatization agreement included a provision to extend SLT's monopoly control over all the main international switches until 2002. This represents a backtracking by the Government on an earlier WTO commitment to eliminate the monopoly by 2000 and affects the competitiveness of other operators in the sector.
The semiautonomous Southern Development Authority (SDA), set up in 1996, put forward an ambitious development scheme for the south, including private sector construction of and financing for an airport and seaport near Hambantota, as well as major expressways and power projects. The SDA called for expressions of interest for these projects in May 1997, and in February 1998, eight investor groups were short listed. However, none of the projects got off the ground. The Government is now hoping to call fresh requests for proposals.
The government-sponsored Computer and Information Technology Council of Sri Lanka (CINTEC) has been tasked with helping to raise awareness and seek solutions for the Y2K problem. A National Y2K Task Force (NTF) set up under the supervision of the CINTEC continues to identify the readiness of vital economic sectors and utilities. It is moving into contingency planning stage from July 1999. NTF plans to have an operational room with connections to operations rooms of key sectors. The Government has obtained a loan of $29 million from the World Bank's International Development Association (IDA) to address Y2K issues in the banking sector and other critical government agencies. The Central Bank is working closely with banking and financial sector institutions to ensure Y2K readiness of the sector. All commercial banks are expected to be Y2K ready by September 30, 1999. Other vital sectors such as electricity, airport and civil aviation, sea ports, water, gas, petroleum, telecommunications and either already compliant or will be made compliant before September 30, 1999. Information about Sri Lanka's Y2K readiness is available in the NTF website http://www.cintec.lk/Y2K
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