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SRI LANKA

State of the Economy

2009

INSTITUTE OF POLICY STUDIES 99, St. Michael’s Road, Colombo 3, Sri Lanka

SRI LANKAState of the Economy

2009

INSTITUTE OF POLICY STUDIES99, St. Michael’s Road, Colombo 3, Sri Lanka

Copyright C September 2009Institute of Policy Studies, Sri Lanka

ISBN 978-955-8708-59-0

National Library of Sri Lanka-Cataloguing-In-Publication Data

Sri Lanka State of the Economy -- 2009 / Colombo : Institute

of Policy Studies of Sri Lanka, 2009 . --- 238 ; 21cm

ISBN 978-955-8708-59-0 Price Rs.

i. 330.95493 DDC 21 ii. Title

1. Economics - Sri Lanka

Please address orders to:Institute of Policy Studies of Sri Lanka99 St Michael’s Road, Colombo 3, Sri LankaTel: +94 11 2431 368, 2431 378 Fax: +94 11 2431 395Email: [email protected]: www.ips.lk

This report was prepared by a team led by Dushni Weerakoon, with the guidance of Saman Kelegama,

Executive Director, IPS. Contributing authors are Nisha Arunatilake, G.D. Dayaratne, Deshal de Mel,

Ayodya Galappatige, Asha Gunawardena, Dilani Hirimuthugodage, Suwendrani Jayaratne, Ruwan Jayathilaka,Priyanka Jayawardena, Tilani Jayawardhana, Roshini Jayaweera, Haren Kodagoda, Malathy Knight-John,

Sunimalee Madurawela, Wimal Nanayakkara, Nethmini Perera, Dharshani Premaratne, Parakrama

Samarathunga, Athula Senaratne, Manoj Thibbotuwawa, Dushni Weerakoon, and Kanchana Wickremasinghe.Editorial support from Charmaine Wijesinghe and D.D.M Waidyasekera, and formatting support from

Asuntha Paul is gratefully acknowledged.

Contents

The Global Economic Crisis: Issues, Impacts

and Outlook

1. Policy Perspectives 1

2. The Global Economic Crisis: Issues, Impacts and Outlook 82.1 Overview 82.2 Evolution of the Crisis 82.3 Spread to the Real Sector and Emerging Economies 112.4 Current Global Economic Climate 122.5 Sri Lanka's Channels of Exposure 15

2.5.1 Garment Sector 162.5.2 Tea 182.5.3 Rubber 182.5.4 Gems and Jewellery 202.5.5 Remittances 212.5.6 Tourism 222.5.7 Ports and Aviation 23

2.6 Impacts on External Finances 242.7 Sri Lanka's Response to the Crisis Thus Far 252.8 Prospects and Policy Options 26

3. The Global Economic Crisis and Sri Lanka's Economic Outlook 293.1 Introduction 293.2 Output, Employment and Investment 29

3.2.1 Sectoral Growth Performance 313.2.2 Employment Trends 323.2.3 Savings and Investment 34

3.3 Initial Conditions: Fiscal and Monetary Policy Weaknesses 353.3.1 Fiscal Policy 353.3.2 Monetary Policy 36

3.4 External Sector Developments and Impact of the Global Crisis 383.4.1 Policy Response: Exchange Rate Management 40

3.5 Macroeconomic Response to the Global Economic Crisis 423.5.1 Is there a Role for Fiscal Policy? 423.5.2 Room for a Monetary Policy Stimulus 43

3.6 Constraints on 'Policy Space' 44

The Global Economic Crisis and Implicationsfor Sri Lanka

4. How Will the Sri Lankan Labour Market Withstand the GlobalEconomic Crisis? 474.1 Introduction 474.2 International Policy Responses 49

4.2.1 Developed Countries 494.2.2 Developing Countries 494.2.3 Lessons from Past Crises 50

4.3 The Effects of the Crisis on the Sri Lankan Labour Market 524.3.1 Performance and Structure of the Labour Market 524.3.2 Effects of the Crisis on the Labour Market 54

4.3.3 Effects of the Crisis on Migrant Trends 544.3.4 Effects of the Crisis on Wage Trends 55

4.4 Social Safety Nets and their Coverage 564.4.1 Retirement Schemes 564.4.2 Separation Related Compensation 564.4.3 Health Insurance 574.4.4 Insurance of Migrant Workers 584.4.5 Samurdhi and Public Welfare Assistance Allowance 58

4.5 Government Response, Effectiveness and Gaps 584.5.1 The Stimulus Package 584.5.2 Temporary Active Labour Market Programmes and

Assistance to the Self-employed 594.5.3 Extending Social Safety Nets 594.5.4 Programmes for Re-training and Labour Market Flexibility 604.5.5 Improving Domestic Labour Market Conditions 60

4.6 Conclusions and Policy Implications 60

5. Global Economic Crisis and Agriculture Sector in Sri Lanka 625.1 Introduction 625.2 Foodflation to Weakening Commodity Prices 625.3 Status of Food Security of Sri Lanka 655.4 Impacts on the Non-plantation Sector 66

5.4.1 Rice: The Staple Food 685.5 Impact on the Plantation Sector 69

5.5.1 Tea Sub-sector 695.5.2 Rubber Sub-sector 725.5.3 Coconut Sub-sector 745.5.4 Minor Export Crops 74

5.6 Policy Responses Adopted 765.7 Conclusion and Policy Recommendations 77

6. Economic Crises and Poverty: Special Focus on Sri Lanka's Estate Sector 796.1 Introduction 796.2 Poverty in Sri Lanka 80

6.2.1 Explaining Poverty in the Estate Sector 826.3 The Estate Sector in the Sri Lankan Economy 85

6.3.1 Role of Plantation Crops in the Economy 866.4 Impact of the Economic Downturn on the Estate Sector 88

6.4.1 Impact of the Economic Downturn on Estate Worker Welfare 896.5 Conclusion 92

7. Global Economic Crisis and Energy Dependence of Sri Lanka 937.1 Introduction 937.2 Overview of the Energy Sector in Sri Lanka 937.3 Energy Dependence of Sri Lanka 967.4 The Global Economic Crisis and Energy Markets 101

7.4.1 Supply Uncertainty in Global Energy Resources 1027.4.2 Growing Demand from Emerging Economic Powers 1027.4.3 Concerns over Global Warming and Climate Change 1027.4.4 Technological Advancements in the Energy Front 1027.4.5 Emerging Structural Changes in Energy Markets 103

7.5 Future Energy Security 1037.5.1 Oil Exploration in the Mannar Basin 1037.5.2 Other Alternatives 104

7.6 Conclusions and Policy Implications 106

8. Global Financial Crisis: Regulatory and Policy Challenges for Sri Lanka 1088.1 Background 1088.2 Contextualizing the Global Financial Crisis 1098.3 Impacts of the Global Financial Crisis on Sri Lanka's

Financial Sector 1158.4 Financial Sector Regulation: Policy Challenges 119

8.4.1 Speed of Financial Deregulation 1198.4.2 Paradox of Under and Over-regulation 1208.4.3 Corporate Governance: Issues of Trust, Corruption

and Self-regulation 121

Policy Briefs

9. The Global Economic Crisis and Possible Impact on Sri Lanka'sHealth Sector 1239.1 Introduction 1239.2 Sri Lanka's Health Sector 1239.3 Impact on the Health Sector 124

9.3.1 Health Financing 1249.3.2 Donor Funding 1259.3.3 Household Out-of-pocket Expenditure 1269.3.4 Cost of Medicines 1279.3.5 Primary Health Care 1289.3.6 Private Health Care 129

9.4 Conclusions and Policy Recommendations 129

10. Crises and Vulnerability: Improving the Nutritional Levels of Children 13210.1 Introduction 13210.2 Nutritional Status of Sri Lanka 13210.3 Main Factors Contributing to Malnutrition 13410.4 Experiences from Other Countries 13510.5 Measures Adopted in Sri Lanka 13510.6 Conclusions and Policy Recommendations 137

11. Impact of the Global Economic Crisis on Migration and Remittances 13911.1 Background 13911.2 Role of Migration and Remittances in the Sri Lankan Economy 13911.3 Impact of the Crisis on Remittances 14111.4 Impact on Sri Lanka 14211.5 Conclusion 144

12. Global Financial Crisis and Microfinance in Sri Lanka 14512.1 Introduction 14512.2 Impact of a Financial Crisis on MFIs 145

12.2.1 Availability of Resources 14612.2.2 Outreach and Loan Portfolio 14812.2.3 Operations and Sustainability 15012.2.4 Interest Rates 150

12.3 Strategies Utilized by MFIs to Adapt to the Current Environment 15112.4 Conclusions and Policy Implications 152

13. Impact of the Global Economic Crisis on Sri Lanka's Fishery Industry 15413.1 Introduction 15413.2 Offshore/Deep Sea Fishing 154

13.2.1 Impact of the Economic Downturn on the OffshoreFishery Sector 156

13.3 Coastal Fishery Sector 15813.3.1 Impact of the Economic Downturn on the Coastal

Fishery Sector 15913.4 Inland Fisheries and Aquaculture 15913.5 Conclusions and Policy Implications 161

14. Economic Crises and Sustainable Resource Management: CommunityForestry in Sri Lanka 16214.1 Introduction 16214.2 Issues of Deforestation in Sri Lanka 16214.3 Importance of CF in Sri Lanka 16314.4 Challenges for CF in Sri Lanka 16514.5 Institutional and Policy Issues 16614.6 Policy Implications and Recommendations 166

15. SAARC Food Bank: Dealing with Food Insecurity during Crises 16815.1 Introduction 16815.2 What is a Food Bank? 16815.3 The SAARC Food Bank 170

15.3.1 Evolution 17015.3.2 Objectives and Operation 170

15.4 Opportunities and Challenges of the SAARC Food Bank 17215.5 Conclusion 175

16. The Global Economic Crisis and ICT 17616.1 Introduction 17616.2 Global Economic Downturn and the ICT Sector 17616.3 IT-BPO Sector 17816.4 ICT Employment and Education 17916.5 Remedial Measures 180

16.5.1 ICT as an Enabler 18016.5.2 Mobile and Telecommunication 18016.5.3 Role of FOSS 182

16.6 Conclusion 182

Prospects17. Prospects 183

Appendices

Appendix A: Macroeconomic Indicators i

Appendix B: Capital Market xxvi

LIST OF FIGURESFigure 2.1 : US External Sector Imbalances 9Figure 2.2 : Loose Monetary Policy in the US 9Figure 2.3 : US Housing Values 10Figure 2.4 : GDP Growth in the US and the EU 13Figure 2.5 : Unemployment Rates in the US and the EU 14Figure 2.6 : Changing Patterns of Consumption in the US 15Figure 2.7 : US Monthly Imports 16Figure 2.8 : Textile and Garment Exports 17Figure 2.9 : US Clothing Retail Sales 18Figure 2.10 : Monthly Tea Export Earnings 19Figure 2.11 : Sri Lanka Rubber Export Prices 19Figure 2.12 : Sri Lanka Natural Rubber Export Earnings 20Figure 2.13 : Trends in Gem Exports 21Figure 2.14 : Monthly Private Remittances 22Figure 2.15 : Cargo Handling 24Figure 3.1 : Quarterly GDP Growth 30Figure 3.2 : Key Industrial Sector Growth 32Figure 3.3 : Trends in Policy Interest Rates and Inflation 37Figure 3.4 : Lending by Licensed Commercial Banks 38Figure 3.5 : External Current Account 39Figure 3.6 : Nominal and Real Exchange Rate Movements 41Figure 3.7 : Gross Official Reserves 42Figure 3.8 : Trends in Inflation Rates 43Figure 3.9 : Trends in Interest Rates 44Figure 4.1 : Employment by Economic Activity 53Figure 5.1 : Fluctuations in FAO Food Price Index 63Figure 5.2 : Food Commodity Price Indices 63Figure 5.3 : World Market Prices of Rice and Wheat 64Figure 5.4 : Retail Price Fluctuations of Select Commodities 67Figure 5.5 : Cultivated Extent, Production and Average Yield of Select

Food Crops 67Figure 5.6 : Price of Rice and Wheat Flour in the Colombo Market 68Figure 5.7 : Extent, Production and Average Yield of Paddy 69Figure 5.8 : Value of Tea Exports 69Figure 5.9 : Trends in Crude Oil and Tea Prices 70Figure 5.10 : Tea Production 71Figure 5.11 : Cost of Production of Tea, Rubber and Coconout 71Figure 5.12 : Monthly Fertilizer Use and Tea Production 72Figure 5.13 : Rubber Production 72Figure 5.14 : Price of Rubber 73Figure 5.15 : Export Values of Rubber 73Figure 5.16 : Coconut Production 74Figure 5.17 : Prices of Coconut Products 75Figure 5.18 : Export Volumes of Select Minor Export Crops 75Figure 6.1 : Value of Exports of Tea, Rubber and Coconut 86Figure 6.2 : GDP Contribution of the Plantation Crops 86Figure 6.3 : Total Labour Force in the Estate Sector 88Figure 6.4 : Total Daily Wage Rates for Males and Females in Tea and Rubber 90Figure 7.1 : Overview of Energy Supply in Sri Lanka 95Figure 7.2 : Sri Lanka’s Dependence on Petroleum Products 96

Figure 7.3 : Volatility of Global and Local Petroleum Product Prices 98Figure 7.4 : Energy Dependence by Sector 100Figure 7.5 : Oil Exploration Blocks on Offer 105Figure 13.1 : Fish Production by Sub-sector 155Figure 13.2 : National Fish Production by Sub-sector 156Figure 13.3 : Quantity of Fish and Fishery Product Exports 157Figure 13.4 : Prawn Production and Exports 158Figure 13.5 : Export Value of Fish and Fishery Products 160Figure 14.1 : Percentage Change in Natural Forest Cover by District 163Figure 15.1 : Features of a Food Bank and a Food Pantry 169Figure 16.1 : Export Earnings from Computer and Information Services 178Figure 17.1 : Trends in Trade Flows 185Figure 17.2 : Changes in Inflation and Policy Rates 186

LIST OF TABLESTable 2.1 : Projected World Output 12Table 2.2 : Percentage Change in Tourist Arrivals 22Table 2.3 : Tourist Arrivals by Country of Residence 23Table 3.1 : Output Growth 30Table 3.2 : GDP: Sectoral Performance 31Table 3.3 : Key Statistics of Labour Force 33Table 3.4 : Selected Indicators of Investment and Savings 34Table 3.5 : Fiscal Policy Indicators 36Table 3.6 : Exposure to Short-term Foreign Currency Borrowing 39Table 3.7 : Deficit Financing 45Table 4.1 : Labour Market Indicators and the Structure of the Labour Force 52Table 4.2 : Departures for Foreign Employment 55Table 5.1 : Annual Average Food Availability in Sri Lanka by Major

Food Commodity Groups 65Table 6.1 : Poverty Trends in Sri Lanka 80Table 6.2 : Inequality: Gini Co-efficient of Per Capita Expenditure 81Table 6.3 : Household Income and Expenditure Patterns by Secor 82Table 6.4 : Average Monthly Household Real Income by Sector 83Table 6.5 : Wealth Quintiles by Sector 83Table 6.6 : Early Childhood Mortality Rates 84Table 6.7 : Problems in Accessing Health Care 84Table 6.8 : Housing and Related Characteristics 85Table 7.1 : Supply and Demand Structure of the Energy Sector in

Sri Lanka 94Table 7.2 : Total Value of Petroleum Imports 97

Table 7.3 : Growth of Vehicle Fleet in Sri Lanka 99Table 10.1 : Child Malnutrition 133

Table 11.1 : Outlook for Remittance Flows to Developing Countries 140Table 11.2 : Rising Immigration Controls Worldwide 142Table 12.1 : Income Sources of Selected MFIs 147Table 12.2 : Expansion of Operational Areas by MFIs 148

Table 12.3 : New Products Introduced by Selected MFIs 149

Table 12.4 : Changes in Interest Rates on Loans and Savings 151Table 14.1 : Community Forestry Pilot Activities Undertaken through

SLANRMP 165Table 15.1 : Assessed Share of Food Grains for the Reserve 171Table 17.1 : Key Fiscal Developments 184

LIST OF BOXESBox 8.1 : Evolution of and Responses to the Global Financial Crisis 110Box 8.2 : The Tale of Lehman Brothers and AIG 113Box 8.3 : Sri Lanka’s Financial Sector: Structural Features 116Box 8.4 : Financial Sector Regulation: Key Legislation 116Box 8.5 : Corruption and the Global Financial Crisis: A Few Documented

Examples 121Box 10.1 : Nutritional Interventions for IDPs 136

Box 14.1 : International Experience of CF 164Box 15.1 : SAARC Food Security Reserve and Reasons for its Failure 172Box 15.2 : The SAARC Food Bank 173Box 16.1 : Government ICT Initiatives 181

1

1. Policy Perspectives

Under normal circumstances, Sri Lankawould have joined the ranks of manycountries across the world gripped byeconomic uncertainty in the wake of theworst global economic crisis in 60 years tobe forecast for 2009. For Sri Lanka, however,2009 will represent a remarkable turnaroundin the political arena and possibly in theeconomic sphere as well. The military victoryover an armed separatist conflict spanningthree decades has brought the prospect oflong term peace and stability a step closer.In the economic sphere, despite the near termeconomic gloom, it has brightened theprospects significantly for sustained socio-economic development of the country in thelonger run.

The renewed sense of economic optimism -captured most visibly by an immediateupturn in the Colombo Stock Exchangefollowing the formal announcement of thedefeat of the Liberation Tigers of Tamil Eelam(LTTE) on 18 May, 2009 - is not misplaced.The economic benefits of peace will bemanifold, ranging from a halt to thedestruction of the country's human and socialcapital, its infrastructure, and confidence inits economy. It will also help in openingmarkets and reintegrating economicactivities. The end of armed conflict willalso allow the rehabilitation andreconstruction of the Northern and EasternProvinces of the country to commence, withspill-over effects to invigorate economicgrowth across the country.

While peace and stability hold out thepromise of creating the conditions for longterm sustained development, there are nearterm challenges to be overcome, not leastthe adverse impacts of the global economic

crisis as it coalesces with domestic policyconstraints. Even before the full magnitudeof the global economic crisis began toemerge, it was clear that the Sri Lankaneconomy was already set to face a numberof challenges. What was also clear was thatthe economy was not on the soundest ofplatforms to face a global economic crisisof the magnitude that was sweeping acrossboth developed and developing economies.

To a great extent, initial domestic economicconditions determine the possible policyresponses to mitigate the downside effectsof the global economic recession. Sri Lanka'sinitial conditions were poor: relatively weakpublic finances, a ballooning deficit on theexternal current account, significantinflationary pressure, and a misalignedexchange rate. Domestic macroeconomicpolicy miscalculations added to bring homethe sharp reality of the global economic crisisto the forefront by end 2008 that, in theend, compelled the country to seek assistancefrom the International Monetary Fund (IMF).

For Sri Lanka, policy concerns for much of2008 was not so much about a possibleslowdown in GDP growth, but concerns overregaining macroeconomic stability andmaintaining a lid on a growing externalresource gap. GDP growth for the first threequarters of 2008 had continued at a relativelyhealthy 6.5 per cent. However, theinflationary spiral of recent years increasedunabated to peak at 28.2 per cent on a point-to-point basis in June 2008, before reversingin response to the tight monetary policymeasures adopted in early 2007. At the sametime, the annualized rate of inflation peakedat 23.4 per cent in October 2008. Priceinstability was accompanied by a significant

State of the Economy 2009

2

widening of the external current accountdeficit - of a magnitude last experienced bythe country in 1982. The deficit for theperiod January-September 2008 haddeteriorated sharply to US$ 2990 millionfrom US$ 980 million in the comparableperiod in 2007.

A sustained deterioration in the externalcurrent account suggests, in principle, theneed for a depreciation of the exchange rate.Indeed, Sri Lanka has been experiencing asustained weakening of its current accountfrom 2006 as a result of the external supply-side shock of rising international oil prices.The policy flexibility to allow the exchangerate to mirror developments in theunderlying fundamentals, however, wasseverely constrained. Rapidly spirallinginflation, growing external debt servicingobligations and a need to attract foreigninvestors into the government debt securitiesmarket, all combined to make a stableexchange rate regime an attractive option.In that climate, a devaluing currency wouldfurther raise inflation, endanger fiscalconsolidation, and generate expectations offurther devaluations to add to investor risks.The Sri Lankan rupee in effect saw a nominaldepreciation of only 0.9 per cent against theUS dollar in 2007. From December 2007 toSeptember 2008, the rupee for all intentsand purposes was 'pegged' unofficially atRs.108 to the US dollar. This was despitemounting evidence of a sharp appreciationof the real exchange rate. The real effectiveexchange rate (REER) estimated by the CentralBank of Sri Lanka (CBSL) indicates a realappreciation of the currency by 25 per centin the twelve months leading up toSeptember 2008.

Thus, well before the global financial crisiswas to manifest, the Sri Lankan economywas set to face severe challenges of its own.GDP growth was showing signs of aslowdown, inevitable in view of the tight

monetary policy stance that had pushed upinterest rates to near 20 per cent. GDPgrowth of 6.3 per cent in the third quarter of2008 was well below the 7 per cent achievedin the comparable period in 2007 (or eventhe 7 per cent growth achieved in the secondquarter of 2008). Notably, growth in bothindustry and services sectors had slowed inthe first three quarters of 2008. Industry andservices grew at 6.2 and 6.3 per cent,respectively, as compared to rates of 7.3 and7.0 per cent achieved in the comparableperiod in 2007. It was the sharply improvedcontribution from agriculture - recording agrowth of 8.6 per cent in the first threequarters of 2008 compared to a rate of 2.7per cent in the comparable period in 2007 -that kept overall economic growth fairlybuoyant.

Export earnings growth during January-September 2008 had already slowed to 9.9per cent compared to a growth rate of 12.6per cent over the same period in 2007.Tellingly, much of the export earnings growthin the first nine months of 2008 was drivenby agricultural products. Industrial exportswere performing extremely poorly. Exportearnings growth from textiles and garments,for instance, was down to 2.8 per cent duringJanuary-September 2008 compared to agrowth rate of 10.4 per cent achieved in 2007over the same period. Other industrialproducts fared no better; during the first ninemonths of 2008, they grew by only 2.6 percent, relative to a growth rate of 16.5 percent achieved in 2007 over the same period.A misaligned currency that reports a sharpreal appreciation against trading partnercurrencies obviously would not have helpedSri Lanka's exporters to compete effectivelyin international markets.

The knock-on policy distortions were notconfined to the real sector of the economy.A very modest monetary policy response toevidence of high domestic inflationary

Policy Perspectives

3

pressures not only failed to curb risinginflationary expectations, but instead fuelleda credit boom during 2005-07. At its peakin mid-2007, credit growth to the privatesector was at 26 per cent. The outcomeinevitably was that the CBSL was requiredto tighten monetary policy much moresharply from 2007 onwards, abandoningadjustments to policy rates and adoptingexplicit quantitative targeting. Reservemoney growth, for instance, dropped froma high of 21.2 per cent in 2006 to a mere1.5 per cent by end 2008.

Monetary tightening measures saw interestrates on average spike to over 20 per cent -the high cost of borrowing deterred not onlyprivate investment, but imposed a liquiditycrunch on financial institutions, and costlyloan repayment obligations on borrowers. Itis an acknowledged pattern that credit boomscreate an environment of riskier behaviouron the part of both borrowers and lendersalike. This has been a truism in the currentglobal banking crises and subsequentfinancial meltdown. Sri Lanka's experienceis no exception. The domestic financialsystem has been coming increasingly understress in 2008 - an increase in the ratio ofnon-performing loans of the commercialbanking sector, financial collapses, and theexposure of financial frauds run along "Ponsi"schemes have been on the rise. Risks to SriLanka's financial system stability, however,have little or nothing to do with the globalfinancial crisis.

The true impact of the global economic crisison Sri Lanka began to emerge only in thefourth quarter of 2008. The impact camefrom the most vulnerable point of exposureof the economy - i.e., on the external accountposition. Export earnings began to be dealta double blow. In addition to the gradualloss in competitiveness as a result ofdomestic policy distortions, viz., a sharpappreciation of the real exchange rate, the

export sector also began to face a rapidlyshrinking export market. The overwhelmingdominance of developed country markets -particularly the US and EU - as destinationsfor Sri Lanka's industrial exports has been akey source of concern with regard to thecontours of the global economic crisis.Another has been the sharp decline incommodity prices that have impacted heavilyon Sri Lanka's key plantation exports. Totalexport earnings growth in the fourth quarterof 2008 contracted by 5 per cent ascompared to a growth of 12 per cent recordedover the same period in 2007. A positiveimpact of the decline in commodity priceshas been the rapid fall in oil prices. Growthin import expenditure in the fourth quarterof 2008 remained unchanged, assistingsomewhat in containing the overall tradebalance.

However, access to all forms of foreigncapital became scarce with the onset of theglobal financial crisis. A governmentinvitation for proposals to raise a syndicatedloan of US$ 300 million issued in October2008 had to be abandoned. At the sametime, Sri Lanka also began to see outflowsfrom the capital account as a direct result ofthe global credit crunch. Having partiallyopened up the capital account from 2007 -permitting foreigners to invest up to 10 percent of the government debt securitiesmarket - the global credit crunch saw foreigninvestors cashing in their investments fromSeptember 2008. Sri Lanka experienced arapid outflow of an estimated US$ 400million of foreign investments in Treasurybills and bond holdings from a total inflowat the time of US$ 650 million.

The policy response to these developmentson the external front - vis-à-vis the exchangerate - was ill advised. In effect, the policythrust was to 'lean against the wind' anddefend the currency through a run-down ofofficial reserves. As Sri Lanka's gross official


4

reserves dipped alarmingly as a result - fromUS$ 3.4 billion in August 2008 (sufficientfor 3 months of imports) to US$ 1.7 billionby December 2008 (sufficient for 1.5 monthsof imports) - the focus shifted to ensuringan adequate re-building of reserves.Notwithstanding attempts to do so throughthe issuance of 'diaspora' bonds andarranging currency swaps through othercentral banks, Sri Lanka was compelled toapproach the IMF for a Stand-ByArrangement of US$ 1.9 billion for balanceof payments (BOP) support in February2009.

Developing countries are generally perceivedto approach the IMF when they have runout of all other options owing to thedemanding conditions that it attaches toloans. Despite an announcement in March2009 that the IMF is overhauling its lendingframework, along with the conditionsattached to its loans, not much appears tohave changed. However, the imposition ofconditions is also more likely if weak policyresponses are perceived to have led thecountry to seek assistance. While the Letterof Intent between the Government of SriLanka (GOSL) and the IMF is providing anenhanced facility of US$ 2.6 billion underthe Stand-By Arrangement - equivalent to400 per cent of Sri Lanka's quota - it willalso place the country on a tightmacroeconomic stabilization path.

The IMF facility alone will not solve SriLanka's efforts to bridge its foreign resourcegap. The country still has to meet its foreigncurrency denominated debt serviceobligations and repayments in 2009. Theseinclude funds raised via Sri LankaDevelopment Bonds (SLDB), bilateral linesof credit, payments associated with oil pricehedging, etc. By end 2008, the externalcurrent account deficit as a percentage ofGDP had risen to 9.3 per cent of GDP - justshort of the previous high of 11.9 per cent

of GDP recorded in 1982. However, thecircumstances are vastly different. In the early1980s, Sri Lanka was in the midst of a capitalimport-intensive hydro-energy developmentprogramme that was almost entirely donorfunded. In the current context, Sri Lanka'saccess to external resources is more difficultto come by. Bridging the external resourcegap requires more fundamental reforms, theroot of which lies in the country's weakpublic finances.

The constraints that weak public financesimpose on the ability of governments torespond with appropriate policy flexibilityto external shocks - such as the current globaleconomic downturn - is clear from SriLanka's experience. The potential impact ofthe global recessionary conditions on SriLanka's own growth performance becameclear from the fourth quarter of 2008. GDPgrowth dropped sharply to 4.3 per cent forthe fourth quarter of 2008 and further to 1.5per cent in the first quarter of 2009. Theemerging evidence of the downside risks toGDP growth prompted the CBSL to revisethe forecast for 2009 to an 'optimistic'assessment of 4.5-5.0 per cent and a'pessimistic' assessment of 2.5-3.5 per centin April 2009.

Many countries across the world - bothdeveloped and developing - have respondedwith substantive fiscal stimulus packages tomitigate the downside effects of fallingaggregate demand. Sri Lanka's weak publicfinances allow little leeway for a similarcourse of action if macroeconomic stabilityis not to be further weakened. In January2009, the government was able to offer onlya Rs. 16 billion 'stimulus' package -amounting to around 0.3 per cent of GDP,or a 2 percentage point increase in budgetedcurrent spending for the year. Some of thatis to be raised from cuts in other areas ofspending which to a degree will dilute theexpected stimulus to aggregate demand.

Policy Perspectives

5

The reversal in the build-up of inflationarypressures from mid-2008 has allowed thegovernment some breathing space to offer amonetary policy stimulus. These includeefforts to inject liquidity into the market aswell as effecting reductions to interest rates.However, the pass-through effects have beenslow to trickle down to lenders andborrowers despite repeated calls from theCBSL to pass on interest rate reductions toclients. The ability of monetary authoritiesto sustain moves to lower interest rates willonce again depend critically ondevelopments on the fiscal front.

A positive feature of fiscal performance in2008 was that the deficit was contained to7.7 per cent of GDP. However, domesticborrowing to bridge the deficit increasedsharply to 7 per cent in 2008 from thebudgeted estimate of 3.7 per cent. A similaroutcome for 2009 appears likely as SriLanka's ability to raise foreign financing tobridge the deficit - despite a budgetedestimate of 2.9 per cent of GDP - faces risingconstraints in the current global economicenvironment. Indeed, the fiscal deficit hadalready crept up to 4 per cent of GDP in thefirst four months of 2009, relative to the 2.1per cent achieved in the comparable periodof 2008. The entirety of the deficit has beenfinanced through domestic sources duringJanuary-April 2009.

The extent to which monetary authoritiescan accommodate domestic publicborrowing without putting upward pressureon interest rates - or alternatively fuellinginflationary pressures - will depend onaggregate demand conditions in theeconomy, and by association, private sectorappetite to undertake investment. If domesticconsumption declines and/or demand for SriLanka's exports drop sharply, domesticborrowing to bridge the deficit can beaccommodated without necessarily leadingto macroeconomic instability. The danger,

however, is that the fiscal deficit appearsset to increase, as spending pressures mountand government revenues decline. In thiscontext, achieving the revised fiscal deficittarget of 7 per cent of GDP for 2009, setunder the Letter of Intent with the IMF, willbe difficult.

A decline in revenues in times of aneconomic downturn is to be expected.However, Sri Lanka's expenditure needs aremounting rapidly; rehabilitation andreconstruction needs related to the Northernand Eastern Provinces of the country cannotbe ignored, job lay-offs and threats tolivelihoods are on the increase, criticalindustries such as tea - which absorbs a bulkof the most vulnerable sections of thepopulation - are in need of urgent assistance.

Unemployment is on the rise globally.Indeed, recent figures of job market lossesspanning the globe suggest that the worldeconomy is set to undergo one of the biggestincreases in unemployment for decades. Thefull magnitude of jobless rates is yet toemerge given that the changes inunemployment come with a lag as outputcontracts. The channels through which thecurrent global economic crisis is impactingon employment prospects are varied. Oneof the key channels is faltering demand thatis exacerbated by tight credit conditions inmost markets. Cash-strapped firms are thuscompelled to cut costs, including job-layoffsthrough voluntary schemes and/ortermination of employment.

Precise estimates of job losses in Sri Lankaare not available. Reliable data is difficultto obtain, for instance, owing to the greatershare of employment in the informal sector.Nonetheless, reports of job losses are on therise, with the rate of unemploymentestimated to have increased marginally to5.3 per cent in the first quarter of 2009 froma year end rate of 5.2 per cent in 2008. The


6

government may be compelled to step inwith assistance - providing some form ofsafety-nets, etc., that can in turn sustaindemand. In the more medium term,however, the focus has to fall squarely onmaking Sri Lanka's labour market moreflexible through appropriate regulatoryreforms.

The current global economic environmentalso threatens the progress towards povertyalleviation efforts, particularly amongst someof the most vulnerable segments of thepopulation. For developing countries suchas Sri Lanka, the adverse impacts onparticular channels with linkages to povertyreduction - remittances, foreign investment,trade, etc. - can have direct impacts onpushing people back into poverty. As anagricultural exporter, changes in worlddemand and prices affect the country'splantation sector. Such heavy exportdependent sectors such tea - as well asgarments in the industrial export sector -employ large numbers of the economicallydisadvantaged. Similarly, the majority of SriLanka's estimated stock of 1.8 millionmigrants comes from poor socio-economicbackgrounds.

The expected declines in officialdevelopment assistance (ODA) as developedeconomies go into recession will impact onaid to developing countries for key socio-economic sectors such as health. Domesticfiscal constraints - particularly as governmentrevenues decrease - may compel budget cutsthat impacts adversely on health and socialprogrammes targeting the poor. Impacts onthe nutrition and health of young childrenin poor families are of special concern inthis context.

Access to credit for the poor in support oflivelihoods may also be affected by the creditcrisis. While some may considermicrofinance, for instance, to be insulated

from the current financial compulsions - inview of the relatively small sums of moneyinvolved - many microfinance institutions(MFIs) today are funded internationally,through aid budgets and privateorganizations. Moreover, there may beinstances where microfinance loans actuallyfinance consumption and where borrowersaccess more than one MFI to pay off loansof another. A credit squeeze can indeedimpact adversely on loan repayments ratesif such practices are common.

The global financial crisis has also broughtthe role of regulation in financial systemsback to the centre stage. Indeed, the rootcause of the financial crises is itself subjectto some debate. There are those whoadvocate the 'global imbalances' argument- large current account surpluses/deficits runby countries like China and the US,respectively - and those that identifyinadequate regulation as the more directcontributory factor. The former is argued tohave infused liquidity into the US, allowinga credit-fuelled boom to work its way toasset prices such as real estate. However, itcould well be argued that it was ultimatelya highly deregulated environment thatpermitted new and riskier financialinstruments to flourish, and which in theend unravelled the highly interconnectednetwork of investment banks, mortgageentities, hedge funds, etc. Sri Lanka too hasbeen grappling with mounting risks to thestability of the financial system. Currentregulatory oversight of the CBSL providesloopholes for unregistered front companiesthat rake in deposits. The exposure of scamsand the collapse of such front companiescall for changes to the enforcement ofprudential requirements and the regulatoryregime.

The fall-out from the global economic crisison all of the above mentioned issues are ofdirect policy relevance to Sri Lanka, and are

Policy Perspectives

7

examined in some detail in the rest of thereport. Sri Lanka has to grapple with theproblems of responding to not only thecurrent economic downturn, but also theneeds of a sustained post-conflict recoveryprogramme. While the fall in oil prices haseased the build up of foreign exchangepressures, there are worrying signs that pricescould creep up once more as the globaleconomic contraction bottoms out. Theimmediate task is to restore macroeconomicstability, and thus provide a sound platformfrom which a reconstruction programme forthe Northern and Eastern Provinces can belaunched. However, such expenditure drivenprogrammes hold the potential fordestabilizing macroeconomic consequencesas well, whether they are funded throughgovernment borrowing or donor assistance.They can induce inflationary pressures,impact on the exchange rate through a formof 'Dutch desease' effect, etc.

Thus, a coordinated and prudent approachto macroeconomic policy management inthe coming months will be essential. Publicinstitutions need to be strengthened byreducing corruption and wastage to ensurethat the greater part of the reconstructioneffort is mobilized through domesticresources. Sri Lanka has learnt first hand overthe last few years that its traditional sourcesof donor assistance increasingly comes tied

to conditions that go beyond the scope ofeconomic assessments. The questionableattempts to delay the granting of the IMFfacility, for instance, is a reminder that thecountry should resolve to manage itseconomy without falling into a financial trapof being forced to seek external assistance.

In the first instance, it requires thatpolicymakers exercise prudent andappropriate policy responses to mitigatemacroeconomic instability. In the secondinstance, Sri Lanka should now pay greaterattention to the many reforms that are needed- restructuring of public sector/publicenterprises to allow fiscal consolidation,labour market reforms to improve flexibilityto respond to market needs, reforms toeducation policy to improve marketableskills, etc. - to sustain higher growth overthe longer term. A reconstruction relatedeconomic boom can lift Sri Lanka'seconomic growth in the medium term. But,if it is not accompanied by efforts to improveoverall efficiency in the economy - thatretains the confidence of investors - theboom can be relatively short-lived, and leavebehind macroeconomic instability in itswake. What is required is to ensure that areconstruction related economic impetus isallowed to transform into a sustained longterm growth path through an appropriateeconomic reform process.

2. The Global Economic Crisis: Issues, Impacts and Outlook

2.1 OverviewThe year 2009 is projected to see the firstglobal economic contraction since the Sec-ond World War. The financial crisis thatplagued markets in developed economiesthrough most of 2007 and 2008 cascadedinto a full blown global economic crisis inthe fourth quarter of 2008. The crisis ini-tially affected major financial institutions inthe US and the EU before spreading to thereal sector, with construction and the auto-mobile industries being the first to be di-rectly affected. As access to credit wassqueezed, consumption declined, reducingdemand for imports. The constrained demandfor exports and the decline, or indeed rever-sal, in financial flows in developing marketsresulted in the crisis spreading beyond theUS and EU to economies where financialmarkets were largely unexposed to toxic fi-nancial instruments.

The impacts of the global economic crisisbegan to be felt in Sri Lanka in the fourthquarter of 2008. But there remains uncer-tainty regarding the depth and duration ofthe global crisis, and thus the eventual trueimpact on the Sri Lankan economy. The situ-ation is also made particularly complex giventhe merger of external and internal crises inthe Sri Lankan economy. This Chapter willexplore the evolution of the global economiccrisis, the impacts that have been visible inSri Lanka, the remedial measures that havebeen undertaken by the government of SriLanka and, finally, the steps that need to betaken to address concerns in the short termand long term in order to overcome theadverse conditions the economy is facing.

8

2.2 Evolution of the CrisisThe global economy had grown at above trendrates for five years before the first signs ofstress in financial markets began to appearin mid-2007. Several factors combined tocontribute to this boom period, and the un-winding of many of these factors resulted inthe severe downturn that took hold inSeptember 2008.

i) Global imbalances: A fundamental prob-lem in the global economy that has beenvisible since the 1990s, and became pro-nounced at the turn of the century, wasthe persistence of large current accountdeficits in the US and equally large cur-rent account surpluses in East Asia, andmore recently in the Middle East. In theaftermath of the Asian financial crisis of1997/98, many East Asian economiesbuilt up large foreign asset reserves anddomestic savings as a buffer against fu-ture crises. At the same time, consump-tion of imports by the US in particularwas increasing, resulting in a large andincreasing flow of goods from Asia tothe US. The result was a widening cur-rent account deficit in the US economywhich was financed by increasing flowsof capital from Asian and Middle East-ern economies to the US. Between 2000and 2007, US$ 5.7 trillion worth of capi-tal flowed into the US economy, equiva-lent to 40 per cent of US gross domesticproduct (GDP) in 2007.1

The constant flow of funds into the USeconomy resulted in high levels of

1 US Bureau of Economic Analysis.

The Global Economic Crisis: Issues, Impacts and Outlook

9

liquidity, contributing to an abundanceof cheap credit that could be invested invarious assets. A similar situation wasexperienced in the UK, Spain, Ireland andsome Eastern European countries. Thelarge consumption of foreign imports bythe US economy contributed to growthacross the global economy.

ii) Loose monetary policy in the US: Whenthe dot.com bubble burst in 2000, theUS Federal Reserve reduced interest ratesto stimulate economic activity. As is evi-dent from Figure 2.2, between 2002 and2005, monetary policy was very lax with

Figure 2.1US External Sector Imbalances (2001-07)

interest rates being negative or zero. Theresult of such a monetary policy stancewas increased access to cheap credit andsubstantial incentives for borrowing in theUS market. The US economy grewstrongly in this period as credit basedconsumption and investment increasedrapidly.

iii) Deregulation and financial innovation:The rapid increase in credit availabilityat a low price and financial deregulationencouraged financial institutions tocreate innovative financial productswhich enabled increased lending to

Figure 2.2Loose Monetary Policy in the US

Source: Federal Reserve and US Bureau of Economic Analysis data.

Source: US Bureau of Economic Analysis data.


10

borrowers with limited credit worthiness,particularly in the housing market.Collateralized Debt Obligations (CDOs),for instance, were often sub-prime as-set backed securities which were sold to(mainly) investment banks, which thensliced up these assets and re-packagedthem into AAA rated investment prod-ucts which were then sold off to inves-tors across the globe. The initial mort-gage seller faced none of the risk and hadevery incentive to make as many loans aspossible, and then sell the resultingassets to investment banks which in turnpass on the risk to an investor at a fee.This detachment between borrower andlender resulted in a substantial under-pric-ing of risk, and an increasing volume oflending to sub-prime borrowers. Themispricing of risk was exacerbated by thevery stable macroeconomic conditionsthat prevailed until 2007, and the abun-dance of cheap credit available in themarket. Furthermore, the deregulation offinancial markets enabled many suchinvestment products to be kept off the

Figure 2.3US Housing Values (2000-08)

balance sheets of the financial institu-tions that dealt in them.

The confluence of the three major factorsmentioned above resulted in massive creditcreation in the US, much of which was in-vested in the housing market, and to a lesserextent in equity markets. House prices in theUS increased rapidly between 2002 and2007, and the resulting positive wealth ef-fects further boosted economic activity.

It was in this context that the downturn be-gan in mid-2007. As inflation pressures gath-ered pace around 2005, the US Federal Re-serve eventually increased interest rates andbegan to tighten monetary policy. As inter-est rates increased, it became increasinglydifficult for sub-prime borrowers to repayadjustable rate mortgages, and housing de-faults began to emerge, forcing a rise in fi-nancial market write-downs. Pressure on theUS financial sector continued through thesecond half of 2007 and into the first half of2008, with institutions such as Bear Stearns,Freddie Mac and Fannie Mae being either

Source: Standards and Poors' data.


11

taken over by the US government or by otherbanks. However, on 15th September 2008,the credit squeeze became an economic cri-sis as Lehman Brother's announced bankruptcyand two days later the US government took a79.9 per cent stake in the insurance giantAIG. The stability of even the strongest fi-nancial institutions came into question asthere was a great deal of uncertainty regard-ing the extent of exposure to toxic assets,particularly CDOs and Credit Default Swaps(CDS) which were not reflected in standardbalance sheets. Long standing financial in-stitutions such as Washington Mutual andWachovia became victims of the crisis. Asliquidity declined sharply, the credit drivenasset bubble in the US (both housing andequity markets) crashed, driven by increas-ing defaults in the sub-prime mortgage mar-kets and the flight of capital from equitymarkets to the relative safety of governmentassets. The write-downs also spread to Euro-pean financial institutions which had in-vested in what became toxic assets. HBOS(the British Building Society) and Fortis (theBenelux bank), were taken over by Britishbank Lloyds TSB and French bank BNPParisbas, respectively, and Iceland's threelargest banks were nationalized. Investorssought safety, and avoided the slightest per-ceived risk resulting in the freezing of inter-bank lending as financial institutions priori-tized the consolidation of their own balancesheets over lending between one another.

2.3 Spread to the Real Sector andEmerging EconomiesThe spread of the emerging crisis to the realsector was heightened in the fourth quarterof 2008 as reduced credit availability resultedin a slowdown in consumption and invest-ment as the ability to borrow declined. Con-sumption was further dented by falling assetprices through the wealth effect and reduced

ability to finance borrowing. As consump-tion and demand declined, firms cut backon production and investment, resulting inlarge scale lay-offs and unemployment, fur-ther hurting consumption. As a result, USreal GDP contracted in the fourth quarter of2008, with similar results in the EU and Ja-pan as well.

Prior to September 2008, developing coun-tries were largely insulated from the finan-cial turmoil since the kind of sophisticatedfinancial instruments that were affected bythe crisis were prevalent primarily in the fi-nancial markets of America and Europe. Infact, there was optimism that the domesticconsumption of emerging economies suchas India, China and Brazil was sufficientlystrong for these and other developing econo-mies to have 'de-coupled' from the fortunesof developed markets. However, as the crisisbegan to spread to the real sector, the chancesof developing nations remaining immunediminished sharply. Global trade was ad-versely affected, as were capital flows be-tween the developed and developing econo-mies. Export oriented countries such asSingapore (3.7 per cent fourth quarter GDPcontraction in 2008), South Korea (5.6 percent fourth quarter contraction from the thirdquarter 2008), Japan (4.3 per cent contrac-tion in GDP in the fourth quarter, 2008),and ASEAN-5 (2.1 per cent growth in thefourth quarter of 2008) suffered substantialGDP losses due largely to a contraction inexport demand.2

Developing economies that are reliant oncommodity exports have also faced a down-turn due to the crash in commodity prices -the Middle East is projected to grow at asubstantially slower pace, while Russia isexpected to contract by 6.5 per cent in 2009according to the International Monetary Fund

2 IMF, World Economic Outlook, July 2009 (updates on April Issue).


12

(IMF) projections (see Table 2.1). Otheremerging economies which are heavilyreliant on external financing have alsosuffered due to the freezing up of credit flows.Central and Eastern Europe, for instance,which grew at a respectable 5.4 per cent in2007, slowed down to 3 per cent in 2008and is expected to contract by 5 per cent in2009 according to the IMF.3 Emergingeconomies with larger domestic markets areexpected to have some degree of cushion tomitigate external demand shortfalls. Chinaand India, for instance, will continue to grow,but at a moderated pace in 2009.Furthermore, economies that entered thecrisis with substantial external reserves andstrong budgetary and balance of payments(BOP) positions are likely to have more spacefor supporting their respective economies bystimulating demand.

2.4 Current Global Economic ClimateGiven the tumultuous end to 2008, it wasclear that 2009 was going to be a very toughyear for the global economy. World outputis projected to contract by 1.4 per cent in2009, although a slow recovery is expectedfrom 2010, backed by government monetaryand fiscal stimulus measures (see Table 2.1).

Advanced economies are experiencing thedeepest recession since World War II with aslowdown of 7.5 per cent in the last quarterof 2008, and GDP expected to contract by3.8 per cent in 2009. The US - at the centreof the crisis - is expected to contract by 2.6per cent in 2009, with financial strains andthe collapse of the housing market chokingthe economy. It is, nevertheless, expected torecover from mid-2010 with the support of afiscal stimulus amounting to 2 per cent of

Projections

2007 2008 2009 2010World Output 5.1 3.1 -1.4 2.5Advanced Economies 2.7 0.8 -3.8 0.6US 2.0 1.1 -2.6 0.8UK 2.6 0.7 -4.2 0.2Euro Area 2.7 0.8 -4.8 -0.3Japan 2.3 -0.7 -6.0 1.7Canada 2.5 0.4 -2.3 1.6Emerging & Developing Economies 8.3 6.0 1.5 4.7India 9.4 7.3 5.4 6.5China 13.0 9.0 7.5 8.5Russia 8.1 5.6 -6.5 1.5Brazil 5.7 5.1 -1.3 2.5Middle East 6.3 5.2 2.0 3.7ASEAN-5 6.3 4.8 -0.3 3.7Africa 6.2 5.2 1.8 4.1

Table 2.1Projected World Output (2009-10)

Source: IMF, World Economic Outlook, July 2009.

3 Ibid.


13

its GDP and other counteractive measuresto boost economic activity.4 Western Eu-rope - like advanced Asian countries - hasbeen affected mainly through the trade chan-nel. The UK and the EU, suffering from lowertrade and financial constraints are expectedto contract by 4.2 per cent and 4.8 per cent,respectively, in 2009, with the EU expectedto record a negative growth rate in 2010 aswell. As evident from Figure 2.4, the outputof the US and the EU has contracted sharplyfrom the third quarter of 2008. East Asiancountries such as Japan, which are highlydependent on manufacturing exports, havealso been significantly affected. Japan hasexperienced a 49.4 per cent decline in itsexports compared to the previous year, withits exports to the US shrinking by 58 per centand to the EU by 55 per cent.5

Likewise, growth in emerging and develop-ing countries is expected to decline to 1.5

4 IMF (2009), Update on Fiscal Stimulus and Financial Sector Measures, (April 26, 2009).5 IMF, World Economic Outlook, April 2009.6 World Bank (2009), "Swimming Against the Tide: How Developing Countries are Coping with the Global Crisis", Background Paper

prepared by World Bank Staff for the G20 Finance Ministers and Central Banks. Governors Meeting, Horsham, UK, March 13-14, 2009.

per cent in 2009 (a sharp fall from the 8.3per cent growth rate in 2007) after sufferinga contraction of 4 per cent in the last quarterof 2008. The World Bank estimates thatdeveloping economies would be the hardesthit with severe long-term implications: 94out of 116 developing countries have experi-enced a slowdown in economic growth.6

Lower export demand, lower commodityprices and lower capital inflows are expectedto drag down the growth rates of economicgiants like India and China, although theirgrowth rates are expected to remain positive,buoyed by domestic demand and more im-portantly government stimulus measures.Whilst China is projected to grow by 7.5 percent, India is expected to grow by just 5.4per cent (Table 2.1). It is encouraging to notethat China's economic performance remainspositive (GDP growth in the second quarterof 2009 was 7.9 per cent) despite a prolongeddecline in exports. China's exports have

Figure 2.4GDP Growth in the US and the EU

Note: Percentage change from previous quarter.

Source: EuroStat and US Bureau of Economic Analysis data.


14

declined for eight successive months withexports down by 19.7 per cent in the firstquarter of 2009,7 and falling by 21.4 percent in June 2009. Whilst export declinesare unlikely to end soon, there has been somemoderation in the rate of contraction ofexports. The Middle East - which is impor-tant to Sri Lanka in terms of worker remit-tances - is expected to record a slower butpositive output growth with the support oftheir large financial reserves cushioning theextreme impacts of sharply declining oil rev-enues and the construction sector. Growthin the region in 2009 is expected to reduceto 2 per cent compared to growth of 6.3 percent and 5.2 per cent in 2007 and 2008,respectively.

The slowdown of the global economy isclearly reflected in global economic activityindicators such as unemployment andconsumption levels. The IMF expects glo-

bal unemployment levels to increase by about2.5 percentage points which is expected tobe larger than in previous recessions.8

Consumption is also expected to contract by1.1 per cent, a rate higher than in any previ-ous recession. Given the importance of theUS and the EU in terms of Sri Lanka's exportdestinations, consumption and unemploy-ment provide an indicator of short tomedium term prospects for Sri Lankan exports.

Labour markets in the US and the EU havebeen weakening rapidly as seen from Figure2.5. Since December 2007, the number ofunemployed persons has increased by 7.2million, with 3.3 million job cuts taking placebetween November 2008 and April 2009across many industries in the US. As a result,the total number of unemployed has increasedto 14.7 million as of June 2009 with the un-employment rate reaching 9.5 per cent. Thesituation is similar in the EU with the total

Figure 2.5Unemployment Rates in the US and the EU

7 National Bureau of Statistics of China.8 IMF, World Economic Outlook, April 2009.

Source: US Bureau of Labour Statistics, and Eurostat data.


15

number of unemployed in the region increas-ing to 21.4 million, with a current unem-ployment rate of 9 per cent.

Constrained credit markets and growing un-employment levels have reduced personalincome in important export markets for SriLanka like the US, dragging down consump-tion levels with it. The performance in theUS market substantially affects economicperformance in Sri Lanka's other major ex-port markets as well. As evident from Figure2.6, US consumption in the fourth quartercontracted by 4.3 per cent, with consump-tion of non-durables falling by 9.4 per centfrom the previous quarter. Encouragingly,consumption levels have increased in the firstquarter of 2009, with the consumption ofnon-durables increasing by 1.3 per cent, com-pared to consumption in the previous quar-ter. However, consumption levels in the firstquarter of 2009 have fallen substantially com-pared to consumption in the first quarter of2008. Consumption contracted by 1.2 percent and consumption of non-durables con-tracted by 3 per cent in the first quarter of2009. The fall in the consumption of non-durables is of particular concern to Sri Lanka

Figure 2.6Changing Patterns of Consumption in the US

Note: Percentage change from previous quarter.


given that a majority of Sri Lankan exports tothe US are non-durables such as garments.In the Euro area too, final consumption ex-penditure fell by 1.3 per cent in the finalquarter of 2008 compared to the previousquarter.

Along with the declines in consumption andoutput in the US, imports - which in thepast have been a major source of global de-mand - have also been falling rapidly sinceJuly 2008. However, encouragingly, the rateof the slowdown of imports has declinedsince January 2009, but yet remains at a lowerlevel than in 2007.

2.5 Sri Lanka's Channels of ExposureSri Lanka lacks a sophisticated financial mar-ket, thus direct exposure to the sophisticatedfinancial instruments which were contami-nated by the financial crisis was limited.Capital market liberalization remains at anascent stage and, therefore, the major trans-mission channel of the negative impacts ofthe global economic crisis to Sri Lanka is viatrade - both merchandise trade and trade inservices.

% c

hang

e in

exp

endi

ture


16

Sri Lanka is a highly trade dependent countrywith a poorly diversified export basket andexport market. An overwhelming majority of60 per cent of exports from the country go tothe US and EU (over 37 per cent to the EUand 23 per cent to the US). This is of par-ticular concern since the global economiccrisis has most significantly affected theeconomies of the US and the EU. With theunfolding of the crisis, Sri Lankan exportslike tea, rubber, cinnamon, coconut, gar-ments, gems and a number of other com-modities are facing declining demand in in-ternational markets, resulting in reduced earn-ings - a turn of events which can eventuallyleading to reduced output and employmentin the country.

2.5.1 Garment Sector

The impact on the garment sector has been afocal point of discussion as 43 per cent ofSri Lanka's total export earnings are gener-ated through textiles and garment exports.Furthermore, 94 per cent of total garment

Figure 2.7US Monthly Imports (June 2007-May 2009)


exports from Sri Lanka go to the EU and theUS. After an initial decline in garmentexports from Sri Lanka in December 2008,there was a positive growth in exports in thefirst three months of 2009 (see Figure 2.8).Despite the resilience shown by the garmentsector in the first quarter of 2009, the laggedeffects of the crisis have resulted in garmentexports declining consecutively in April andMay by 10.1 per cent and 22.7 per cent, re-spectively.

The growth in garment exports from Sri Lankain the first quarter of 2009 was driven byexports to the EU. Industry sources are ofthe opinion that this can be attributed tothe Generalized System of Preferences (GSP-plus) concessions which have helped to keepprices at a competitive level relative to theexport prices of other non GSP-plus recipi-ent country garment exporters. Although SriLanka initially benefited as an alternativemarket to China for garment imports by theUS,9 exports to the US declined by 4.5 per

9 Due to anticipated protection measures against China in the wake of the economic crisis and general trade tensions between China andthe US over issues such as currency manipulation, US importers began to search for alternative markets. Sri Lanka is one of the countriesthat benefited from this although countries such as Bangladesh were able to capture a greater share of the market.


17

cent in March 2009. The industry has alsoattributed the overall growth to theconfidence raised by the government'sannouncement of the Export DevelopmentReward Scheme allowing Sri Lankancompanies to offer competitive prices.10

There remains some degree of uncertainty withregard to the near term performance of thesector as the ability to secure orders throughthe rest of 2009 and early 2010 is notguaranteed, and anecdotal evidence suggestsdownsizing in the sector and closure of somesmaller firms due to diminished demand.According to the Joint Apparels AssociationForum (JAAF) more than 50 factories havealready been shut down, with largecompanies such as Sinotex closing down dueto the shortage of orders from the US. WhilstUS clothing retail sales have declinedsubstantially since mid-2008, there has beenrecent stability as seen in Figure 2.9. Thissuggests that Sri Lanka's garments exports tothe US may stabilize at a lower level towards

Figure 2.8Textile and Garment Exports (January 2008-April 2009)

Note: Percentage change in month from previous year.

Source: CBSL, Selected Monthly Economic Indicators, various issues.

10 More details on the Export Development Reward Scheme are given in Section 2.7.11 IMF, World Economic Outlook, April 2009.

the end of 2009 if the current retail trendscontinue.

The medium term sustainability of Sri Lanka'sgarment exports to the EU remains in doubtgiven the uncertainty with regard to the con-tinuance of the GSP-plus provision to SriLanka. The EU is projected to face a moresevere and long lasting downturn than theUS, and remedial efforts thus far in the EUhave been relatively limited.11 Furthermore,as unemployment continues to increase, therecovery of demand is likely to be protracted.As the lagged impacts of declining consump-tion affect Sri Lanka, the sector could facefurther challenges towards the latter part of2009. Given that the garment sector providesdirect employment to over 270,000 peopleand is a major source of foreign exchange tothe country, declining demand for garmentscould have substantial macroeconomic im-plications on the country. However, from alonger term perspective, the global economiccrisis may have a silver lining as many of the


18

larger Sri Lankan garment exporters have suc-cessfully undertaken substantial productionstreamlining in order to cut costs. Such mea-sures augur well for the longer term competi-tiveness of the industry in Sri Lanka.

2.5.2 Tea

Tea is Sri Lanka's second largest export sectorand accounted for 13 per cent of total exportearnings in 2008. Sri Lanka's tea sector expe-rienced a substantial boom in the first half of2008, buoyed by a wide ranging global com-modity boom. In July 2008, global tea pricessoared and Sri Lankan tea fetched US$ 3.20per kg. Demand for Sri Lankan tea was largelydriven by increases in demand in the MiddleEast and Russia, which were experiencing anincome boom due to the spike in global oilprices. However, with the increased severityof the global downturn, oil prices and gen-eral commodity prices began to fall in thesecond half of 2008. Sri Lanka was particu-larly affected due to sharp falls in demand inthe Middle East and Russia which accountfor 78 per cent of Sri Lankan tea exports. Fur-thermore, the Russian ruble depreciated

Figure 2.9US Clothing Retail Sales (June 2008-June 2009)

Source: US Census Bureau, Advance Monthly Sales for Retail and Food Services.

sharply during this time, putting furtherdownward pressure on demand for SriLankan tea. As a result of such global devel-opments, prices of Sri Lankan tea collapsedin the fourth quarter of 2008 to an averageof US$ 2.12 per kg. compared to US$ 2.88per kg. in the corresponding period in 2007.

In the first quarter of 2009, the tea sectortook a further hit with adverse weather con-ditions undermining supply, and compound-ing the impacts of external developments.Sri Lanka's tea prices and export earningsare to an extent influenced by oil prices sincethis affects demand in the major markets ofthe Middle East and Russia. Given the ex-pectations of a prolonged depression of glo-bal demand, oil prices are expected to re-main moderate through 2009 and some partof 2010. Therefore, the prospects for the teasector will remain muted during this period.

2.5.3 Rubber

The rubber sector is an important export sec-tor for the country. Sri Lanka is the eighthlargest rubber exporter in the world. Like tea,rubber prices boomed in 2007 and through


19

Figure 2.10Monthly Tea Export Earnings (2007-09)

Source: Sri Lanka Tea Board.

the first half of 2008, driven by increaseddemand in China and rising demand for natu-ral rubber due to the higher cost of synthetic

rubber which requires petroleum as an in-put. As a result, prices of Sri Lankan rubberexports peaked in mid-2008.

Figure 2.11Sri Lanka Rubber Export Prices (2008-09)

Source: Rubber Research Institute.


20

However, with the worsening of the globaleconomic crisis, rubber prices and exportearnings began to decline in the second halfof 2008, particularly in the fourth quarter of2008.

Natural rubber exports from Sri Lanka in2008 amounted to Rs. 13.5 billion, whilstexports of rubber products amounted to Rs.58.7 billion, largely composed of rubber tyresand surgical gloves. Growth of exports of bothrubber tyres and surgical gloves slowed downin 2008. The bulk (73 per cent) of Sri Lanka'srubber tyre exports are to the EU and the US.The demand for rubber tyres (and natural rub-ber) is likely to be adversely affected by thecollapse of the automobile industry in thesecountries - particularly in the US, and to alesser extent in the European automobile sec-tor. Given weak credit availability, increasedunemployment and pessimism in consumermarkets, the prospects for the automobilesector in these countries remain weak overthe next two years. The moderate price ofpetroleum will also make synthetic rubber

Figure 2.12Sri Lanka Natural Rubber Export Earnings (2007-09)

Source: Central Bank of Sri Lanka, Selected Monthly Economic Indicators, various issues.

and related products relatively competitiveand will adversely impact demand for natu-ral rubber and its related products. There-fore, the prospects for rubber and rubber prod-uct exports from Sri Lanka are likely to bebleak in 2009 and 2010.

2.5.4 Gems and Jewellery

The export of diamonds and gems has plum-meted with the adverse impacts of the crisison demand for luxury items. Although dia-mond exports earnings have grown by 20.2per cent in 2008, driven to an extent by thespecial incentives provided from the govern-ment,12 the fourth quarter of 2008 saw a de-cline in exports as demand collapsed (Figure2.13). Gem exports in the period January-April 2009 have fallen by almost 51 per centcompared to the same period in 2008. Thisfall in exports has been largely due to thedownturn in demand in the US and the EU.The industry is now looking to penetrate newmarkets such as China, India, Russia, Turkeyand the Middle East.

12 Promotion of value addition in the gem industry by giving tax exemptions, charging a lower income tax, etc.


21

Figure 2.13Trends in Gem Exports


Source: CBSL, Monthly Economic Indicators, various issues

2.5.5 Remittances

Remittances play a major role in the SriLankan economy, particularly in terms ofbridging the external current account deficitin the country. Worker remittances remainedbuoyant in 2008 growing from US$ 2.5 bil-lion in 2007 to US$ 2.9 billion in 2008.However, with the onset of the global eco-nomic crisis in the fourth quarter of 2008,the sustainability of continued growth in re-mittance inflows was called into question.Although remittances are usually a stablesource of external financing, and are oftencounter-cyclical in downturns, it may not beso this time due to the widespread nature ofthe global economic crisis.

The majority of temporary migrants from SriLanka work in the Middle East and more than50 per cent of Sri Lanka's remittances origi-nate from the region. Given the decline inoil prices in 2008 and the likelihood of de-pressed prices continuing through 2009 andmuch of 2010, demand in the Middle East is

likely to remain deflated. As previously dis-cussed, IMF estimates suggest that growth inthe Middle East will drop to 2 per cent in2009 and remain subdued at 3.7 per cent in2010. As a result, there will most probablybe some slowdown in remittances during2009-10. A fall in remittances was recordedin Sri Lanka in the first two months of 2009with remittances in January contracting by6.6 per cent and by a further 3.8 per cent inFebruary compared to the previous year. Asa result, remittances in the first quarter of2009 contracted by 1.7 per cent in contrastto the 23.5 per cent growth during the samequarter in 2008. However, encouragingly,remittances have grown by 2.9 per cent inthe first five months of 2009 compared tothe same period in 2008 and recorded agrowth of 22.4 per cent in May despite theglobal economic downturn and stiffcompetition from other remittance receivingeconomies.13 Nevertheless, compared to the16 per cent growth in private remittances in2008 where it grew by over 20 per cent right

13 This increase may be due to the increases in remittances flowing into the country with the ending of the war in May 2009.


22

Figure 2.14Monthly Private Remittances (2008-09)

Source: CBSL, Monthly Economic Indicators, various issues.

through the first 9 months,14 the growth of2.9 per cent in the first five months of theyear is considerably low.

2.5.6 Tourism

Another channel through which the SriLankan economy is exposed to the globalcrisis is tourism. In the first five months of2009, total tourist arrivals fell by almost 20per cent, compared to the same period in2008. Heightened security conditions in the

country stemming from the final phase ofthe war, and also the global economic down-turn are the most likely reasons for thedecline in tourist arrivals into the country(Table 2.2). Nevertheless, in June 2009, amere one month after the end of the war,there has been an increase in tourist arrivalsby 8.1 per cent.15

The drop in tourist arrivals in the first fivemonths may have been partly due to fallingincomes and weakening currencies in keyWestern European and South Asian markets:the number of tourists from Western Europefell by 15.4 per cent in the first five monthsof 2009 compared to the same period in2008. Arrivals from four of the top five sourcemarkets in 2008 - India, UK, Germany andthe Maldives - have contracted in the firstfive months of 2009, with the exception ofarrivals from Australia. Tourist arrival figuresfrom a few selected countries are shown inTable 2.3. There have been significantdeclines in tourist arrivals by key South Asiancountries like India (41.2 per cent) and Paki-stan (39.6 per cent) in the first quarter of

15 It has been noted that the growth may look exaggerated as June arrivals in 2008 were the lowest since June 2002.

Month Percentage change

January -32.4

February -15.7

March -10.5

April -12.4

May -20.6

June 8.1

Source: Sri Lanka Tourism Development Authority.

Table 2.2Percentage Change in Tourist Arrivals

(2008/09)

14 CBSL, Annual Report 2008.


23

2009. Given the price sensitivity of tourism,another factor that may have contributed tothe decline in tourism was the appreciationof the Sri Lankan rupee with respect to cur-rencies of major tourism source markets. TheSri Lankan rupee was soft pegged to the USdollar resulting in appreciations against thesterling pound (23 per cent), the euro (8.7per cent) and the Indian rupee (15.9 per cent)between March 2008 and March 2009. It islikely that the decline in tourism will con-tinue with arrivals from Western countriesreducing significantly as a result of the glo-bal economic crisis causing increased unem-ployment and lower incomes in this sectorthrough 2009 and 2010.16

The tourism sector has substantial multiplierimpacts on the Sri Lankan economy throughforeign exchange earnings (US$ 384 million),direct employment (60,516) and indirectemployment (84,723), and derived demandfor many goods and services ranging fromtransport to the supply of agricultural prod-ucts for consumption. Therefore, the down-turn in the tourism sector will have wideranging impacts on the Sri Lankan economy.

2.5.7 Ports and Aviation

The impact of the crisis as reflected in termsof cargo handling in the port services is il-

Table 2.3Tourist Arrivals by Country of Residence

Country of Residence January to May % Change 2008 2009

India 42,126 24,778 -41.2UK 34,077 30,265 -11.2Germany 16,023 11,234 -29.9USA 5,736 4,813 -16.1France 4,755 6,707 41.1Australia 6,402 7,205 12.5

Source: Data from Sri Lanka Tourism Development Authority.

lustrated in Figure 2.15. Total cargo handlingwhich saw an increase during October-November 2008 declined significantly inDecember 2008. Furthermore, in the periodJanuary-April 2009, it had reduced by 13.6per cent compared to the same period theprevious year. Given that a majority of cargohandling in Sri Lanka is transshipments toand from India, the numbers to an extentreflect the slowdown in trade in the regionas a whole. The general slowdown inbusiness activity is also underlined by cut-backs in flights between India and Sri Lanka.

In terms of air travel, Sri Lankan Airlinesflights to India has been slashed by half (from100 flights per week to 51), with flights toCochin, Calicut, Coimbatore and Hyderabadbeing halted as part of a cost-cuttingstrategy. These routes primarily carried traf-fic between the Middle East and the Far East,thereby suggesting reduced traffic on theseroutes. The case of the aviation sectorillustrates a dilemma between short term andlong term objectives. A long term objectiveof the Sri Lankan aviation sector is toposition itself as a hub for air services toIndia by maximizing connectivity to theIndian sub-continent. However, short termcost objectives clash with this long termobjective. Nonetheless, it is important to

16 The global economic crisis has also resulted in detrimental impacts on government finances in terms of revenue collection as the import pricesof certain commodities have declined, reducing the revenue margin.


24

Figure 2.15Cargo Handling



strike the appropriate balance between thesetwo objectives.

2.6 Impacts on External FinancesSince capital account liberalization in SriLanka is at a nascent stage, the main impactof the global economic crisis on externalfinances is through the government sector.In recent years, the government of Sri Lankahas increased its reliance on foreigncommercial borrowing to finance governmentexpenditure. Government current expenditurehas consistently exceeded current revenue,and capital expenditure has relied entirelyon borrowed financing. Given the pressurethat is exerted on domestic interest rates as aresult of increased domestic borrowing,foreign borrowing will be required in thenear term to finance substantial budget defi-cits. In the context of the global economiccrisis creating investor risk aversion anduncertainty with regard to Sri Lanka'sexternal financial position, access toexternal commercial finance has beendiminishing. The government's ability to rollover debt will be under strain, particularlyin the context of the upcoming re-paymentsdue in 2009 and 2010.

Thus far, there has been no major impact onforeign direct investment (FDI) as net FDI in2008 saw a growth of 26 per cent to US$691 million, led largely by the services sec-tor. Portfolio investment, though relativelysmall, showed signs of decline in 2008,largely due to foreign investors withdrawinginvestments from relatively risky marketsseeking to shore up their balance sheets. Netforeign portfolio investment in 2008 was US$60 million, with withdrawals of US$ 488million.

One area of the capital account that was lib-eralized was with regards to the governmentdebt securities market, permitting foreigninvestors to hold up to 10 per cent of thegovernment Treasury bill and bonds market.This market attracted substantial investor in-terest, and by September 2008 an estimatedUS$ 650 million had been invested by for-eigners. However, in the fourth quarter of2008, as the global financial crisis took ongreater proportions, investors sought safermarkets and withdrew money from the SriLankan government debt securities. The esti-mated foreign investment in this sector haddeclined to just US$ 19 million by April2009.


25

A combination of the factors discussed aboveled to a widening trade deficit and a sharpdeterioration of the current account of thebalance of payments (BOP). Even as the ad-verse impacts of withdrawal of capital fromgovernment securities on the country's ex-ternal account was being felt, the CentralBank of Sri Lanka (CBSL) attempted to de-fend the value of the rupee against the USdollar, undermining export competitivenessand adding to the problems of declining glo-bal demand faced by the export sector. Thecurrencies of competing countries have de-preciated against the US dollar throughout2008. Between January 2008 and January2009, for instance, many countries under-took to depreciate their currencies by signifi-cant margins, including Brazil (by 35 percent), India (21 per cent), Mexico (29 percent), South Africa (24 per cent), Malaysia(12 per cent), Thailand (11 per cent) and abasket of major currencies calculated by theUS Federal Reserve depreciated by 15.2 percent.17 During this same period, the SriLankan rupee depreciated by only 5.6 percent.

2.7 Sri Lanka's Response to the CrisisThus FarThe immediate short term response to theglobal economic crisis is the need to extendsupport to exporters who face disruptions dueto demand shortfalls in export markets. Thisis particularly important at a time when creditmarkets remain tight and there are difficul-ties in accessing traditional credit channels.Medium term credit lines to tide over thedifficulties being faced by exporters will beimportant.

In January 2009, the government announceda Rs. 16 billion "economic stimulus" pack-age to help exporters adversely affected bythe global economic downturn. The package

amounts to just 0.3 per cent of GDP, high-lighting the limited fiscal space that the gov-ernment has to provide for an adequate stimu-lus package. Under this system, incentivesfor producers in terms of a rebate scheme aswell as energy price reductions are offered.A 5 per cent rebate scheme is offered to allindustrial exporters subject to certain condi-tions. Under this system, exporters can ei-ther apply for cash outright, or can set offthe rebate against their taxes. Exporters whohave been trading continuously since Janu-ary 1, 2006 are eligible to apply for benefitsunder this Export Development RewardScheme (EDRS) if they meet the followingcriteria:

i) An Export Development Reward (EDR)of 5 per cent of export earnings will begiven in the 1st quarter of 2009 to thoseexporters who maintain a minimum of80 per cent of exports effected in 1stquarter of 2008. For the next 3 quartersof 2009, the exporter should be able tomaintain export earnings equal or moreto the export earnings recorded in thecorresponding quarter of the previousyear.

ii) If export proceeds in the first quarter ofthe current year are equal to 80 per centor more but less than 90 per cent of ex-port earnings recorded in the correspond-ing quarter of the previous year, and ifexport earnings are equal to 90 per centor more but less than 100 per cent ofthe export earnings recorded in the cor-responding quarter of the previous yearin the other quarters, a reward of 3 percent of the export value will be paid.

iii) Maintenance of employment levels asdeclared by the Employees' ProvidentFund (EPF) and Employees' Trust Fund(ETF) returns as at the third quarter of2008 must be maintained as well.

17 US Federal Reserve data.


26

Furthermore, under the stimulus package, a15 per cent surcharge on electricity is liftedfrom tourism, apparel, leather and rubberindustries. A cess on manufactured rubberexporters would be lifted, with tea produc-ers supported through state-purchases whenthe prices are low, through subsidies of fer-tilizer (at Rs. 1000 per 50 kg. bag until thegreen leaf prices are Rs. 45) and, by suspend-ing the repayments on loans given to mod-ernize tea factories for one year. One month'sworking capital is also to be given to teafactories through commercial banks on therecommendations made by the Sri Lanka TeaBoard.

According to the government, the stimuluspackage will not be financed by extra bor-rowings, but rather through savings on oilprice reductions, cutting down on govern-ment expenditure, increases in taxes on im-ported commodities, and also by budgetaryallocations to the Export Development Board(EDB) for export promotion. In that sense,the reward scheme is more a redistributionof budgetary expenditure rather than a stimu-lus of extra funds released to the economy.The practicality of meeting the qualifyingcriteria set out by the government has beencalled into question by industrialists. Export-ers have emphasized the difficulty in meet-ing the export values as prices of commodi-ties such as tea and rubber have fallen as aresult of lower demand. In response, the gov-ernment agreed to some flexibility in termsof the revenue criteria, and exporters havebegun to apply for the concessions offeredfor the first quarter of 2009. There has alsobeen some discussion with regards to thepossibility of allowing some flexibility inlabour market regulations based on negotia-tions between employers, trade unions andthe government, enabling a shorter workingweek.

2.8 Prospects and Policy OptionsThe initial global response to the economiccrisis was characterized by uncertainty andcaution. However, with the serious deterio-ration of the global economic situation inthe fourth quarter of 2008, there was a greatercollective effort by key governments to for-mulate a coordinated response to the crisis.Key areas that have received attention are fi-nancial markets, monetary policy and fiscalpolicy.

Measures to address financial markets remainuncertain. Whilst many measures have beenadopted particularly in the US (TARP, PPIPamong others),18 it remains to be seenwhether these will be completely effective.One problem is the continued difficulty inassessing the actual extent of losses in thefinancial markets, and political challengesin financially supporting banks and other fi-nancial institutions have forced governmentsto err on the side of caution.

The priority of global monetary policy hasshifted from preventing inflation to prevent-ing deflation. In this context, the importanceof communication by Central Banks becomesparamount. Central Banks need to collec-tively display a commitment to preventingdeflation in the short term, but also a com-mitment to curtailing long term inflation.Conventional monetary policy measures areundermined by the zero interest rate floorand short term imperfections in credit mar-kets which affect monetary transmission. TheUS Federal Reserve, for instance, has engagedin unconventional quantitative and crediteasing, buying US long term governmentsecurities, infusing the economy with freshlycreated money, etc. with the aim of reduc-ing credit costs. Other key economies haveslashed interest rates and engaged in expan-sionary monetary policy. The key challengeis to gauge when to halt the monetary easing

18 Troubled Asset Relief Programme (TARP) and Public Private Investment Programme (PPIP).


27

that is currently going on in many countries- an abrupt halt could disrupt recovery, whilsta protracted loose monetary policy stancewill be inflationary in the medium term.

Like monetary policy, fiscal policy is facedwith a similar dilemma of balancing shortterm expansion with medium term price anddebt stability. Major expansionary fiscalmeasures amounting to close to 2 per centof global GDP were announced by G-20countries such as the US, Europe, Japan andsome of the emerging economies in responseto falling domestic demand. Current eco-nomic indicators suggest that there is a needto continue with expansionary policy during2010 as well. This indicates substantial me-dium term pressure on debt positions. Theimpacts of expansionary fiscal policy willbe felt in the real sectors of the economiestowards the second half of 2009.

Despite the substantive measures beingadopted by governments across the world, itis unlikely that the above-trend global growthrates in the first half of the decade will bereplicated any time soon. Nonetheless, therehave been some positive developments asthe rate of economic contraction appears tobe slowing down; there has been some re-covery in financial markets, with major fi-nancial institutions buoyed by governmentsupport. House prices in the US have stabi-lized somewhat in the first quarter of 2009.Household consumption in the first quarterof 2009 has also improved on the previousquarter, but continues to be weighed downby a weak labour market and low asset prices.The health of the US financial sector remainsthe major concern as recovery efforts with-out well functioning credit markets are likelyto be of limited efficacy. Whilst second quar-ter earnings in major financial institutionssuch as Goldman Sachs, JP Morgan and Bankof America were strong - having taken ad-vantage of federal assistance and the marketopportunities that emerged as competitors

folded - there remain concerns about overallfinancial market health. Credit card defaultsremain high and mortgage delinquencies areyet to fully stabilize as high unemploymentundermines repayments. It also remains tobe seen how well the sector will performwhen government assistance draws to a close.As such, it is as yet too early to be able toconclude that the financial crisis has com-pletely bottomed out.

For countries such as Sri Lanka, the immedi-ate short term response to the global eco-nomic crisis is the need to extend support toexporters who face disruptions due to de-mand shortfalls in export markets. This isparticularly important at a time when localcredit markets remain tight and there are dif-ficulties in accessing traditional credit chan-nels. Medium term credit lines to tide overthe difficulties being faced by exporters willbe important. Some measures have alreadybeen extended to exporters in Sri Lanka asdetailed in the discussion. However, someof the criteria have been unrealistic, andwhilst it is encouraging to note that the gov-ernment is willing to grant some flexibilityin this process, it is more advisable to have atransparent and predictable process ratherthan an ad hoc, case-by-case criteria for sup-port. At the same time, there will be caseswhere smaller firms will not be competitivein such circumstances and the governmentmay have a role in acting as an intermediaryin takeovers by larger firms to provide thebest chance for the resources to be utilizedin a productive manner. The export sectordownturn is also a prime example of the needfor temporary unemployment benefits forretrenched employees.

In the medium term, policy implications aremainly in terms of monetary and fiscal policy.High government expenditure resulting infiscal deficits has forced the government torely heavily on short term foreign commer-cial borrowing, creating vulnerability in ex-


28

ternal finances, particularly in times of glo-bal financial crises. Fiscal rationalization willalso provide more policy space to deal withcrises of this nature - both in terms of acounter-cyclical stabilizing role of fiscalpolicy and in terms of providing a direct eco-nomic stimulus. Fiscal rationalization willalso allow monetary policy to focus on itskey role - i.e., the maintenance of price sta-bility in the economy.

Longer term policy measures need to takeinto account the fundamental changes in theglobal economy that could result from thecurrent global economic crisis. The above-trend global economic growth since 2002has largely been driven by credit fuelledconsumption in the US (the ratio ofliabilities to disposable income in the USreached 138 per cent in 2007 and consump-tion accounted for 77 per cent of US realGDP growth between 2000 and 2007, whichin turn accounted for a third of globalprivate consumption growth).19 Given likelyreforms in the US financial markets, boththrough formal regulation and through amoderated appetite for risk in terms oflending and financial instruments, the samelevels of credit driven consumption areunlikely to materialize in the foreseeablefuture. In this context, it becomes importantfor Sri Lankan exporters to seek alternativemarkets, particularly in Asia, wheredomestic consumption is likely to beencouraged to a greater extent to offsetglobal imbalances of recent years. Otherlonger term policy measures include reformsin the labour market to enhance flexibilityin responding to external economic crises ofthis nature, and in energy markets to ensuregreater competitiveness of Sri Lankan export-

ers whose competitiveness is undermined bySri Lanka having the region's most expensiveenergy costs. Finally, it is important for policymakers to recognize the fact that Sri Lanka -with a small domestic market of approxi-mately US$ 35 billion - will be reliant onexports to external markets to spur economicgrowth, taking advantage of economies ofscale. In this context, recent global trends inprotectionism need to be considered with agreat deal of caution. Whilst encouragingdomestic production in the country isimportant, it should not be undertakenthrough excessive protection, which risksretaliation by trading partners that undermineexport market access.

A sharp drop in Sri Lanka's GDP growth inthe fourth quarter of 2008 to just 4.3 percent, followed by a further fall in the firstquarter of 2009 to 1.5 per cent, heralded anindication of the likely impact on near termoutput growth for the country. The mostnotable downturn was in the services sector- accounting for nearly 60 per cent of GDP -recording a growth rate of just 3.8 per centin the fourth quarter 2008 and 1 per cent inthe first quarter of 2009. The sharp slow-down in services - a sector which is largelyunexposed to the channels through whichSri Lanka is most likely to be impacted bythe global economic crisis - suggests that thereare other factors at work affecting Sri Lanka'srecent economic performance. The exposureto the global economic crisis has been dis-cussed, but what is even more pertinent isthe impact of domestic policies. The detailsof Sri Lanka's domestic macroeconomicpolicy management and response to theemerging global economic crisis will bediscussed next in Chapter 3.

19 McKinsey Global Institute (2009), "Will US Consumer Debt Reduction Cripple the Economy?", March 2009.

29

3. The Global Economic Crisis and Sri Lanka's Economic Outlook

3.1 Introduction

Amidst the turmoil of an unfolding globaleconomic crisis in 2008, Sri Lanka posted acreditable GDP growth rate of 6 per cent.With world output estimated to contract forthe first time since in 60 years - with growthin global export volumes forecast to plum-met by 10 per cent after 30 years of uninter-rupted growth - the near-term outlook formost economies appear grim. Sri Lanka, too,will not escape unscathed. The sharp dropin GDP growth in the fourth quarter of 2008to 4.3 per cent, and a further decline to 1.5per cent in the first quarter of 2009, are in-dicative of the potential downside effects tothe country's economic outlook for 2009.

However, the global downturn cannot befaulted for all of Sri Lanka's economic chal-lenges ahead. Despite maintaining a robustGDP growth of 6.5 per cent in the first ninemonths of 2008, Sri Lanka was facing mount-ing pressure on its external accounts posi-tion. The rapid increase in international oilprices up to mid-2008 was largely to blamefor a ballooning current account deficit - tri-pling to nearly US$ 3 billion in the ninemonths to September 2008 from the compa-rable position in 2007. Despite evidence ofa severe deterioration in the current account- on a scale last witnessed by the country inthe early 1980s - Sri Lanka had failed to main-tain sufficient policy flexibility to respondappropriately.

Policy flexibility was constrained by a seriesof developments. During 2005-07, high GDPgrowth - averaging just under 7 per cent perannum - was maintained at the cost of aweakening macroeconomic environment. Theeconomy was prone to overheat as a result

29

of an expansionary fiscal policy thrust that,in turn, was accompanied by an accommo-dative monetary policy stance. The gradualbuild-up of inflationary pressures from 2004took off from mid-2006, with the rate of in-flation reaching over 20 per cent on a point-to-point basis in early 2008. As domesticborrowing sources dried up and interest ratesbegan to climb in response to monetary tight-ening from 2007, Sri Lanka resorted increas-ingly to short term foreign currency denomi-nated borrowing and allowed a partial open-ing up of the government debt securitiesmarket to foreign investors from 2007.

The build-up of inflationary pressure, greaterexposure to short-term foreign borrowing, andattempts to attract foreign investors into thedomestic debt market made a stable exchangerate regime an attractive proposition. Thus,despite a worsening external current accountposition from 2006 onwards, Sri Lanka's cur-rency was held steady for the most part, not-withstanding the means by which the deficitwas being financed. The nature of capitalflows financing a current account deficitmatters to the extent that an economy andits currency may struggle if foreign capitalinflows suddenly dry up. In the event, allthese developments combined to raise thedownside risks of an external shock to theeconomy such as the current globalrecessionary conditions.

3.2 Output, Employment and Invest-mentSri Lanka's annual average GDP growthslowed to 6 per cent in 2008 from a high of7.7 per cent achieved in 2006. Despite theslowdown in GDP growth, it was nonethe-


30

less a creditable achievement in the midst ofsignificant domestic constraints, and a rap-idly evolving global economic crisis in thelatter part of the year. Sri Lanka also suc-ceeded in crossing the US$ 2000 per capitaincome threshold in 2008 (Table 3.1).

The Sri Lankan economy was already gearedto experience a slowdown of its near 7 percent average annual growth achieved during2005-07 on the back of expansionary fiscaland monetary policies. The steady overheat-ing of the economy was evident in the spi-ralling rates of inflation that the country be-

Table 3.1Output Growth (2003-08)

2003 2004 2005 2006 2007 2008GDP 5.9 5.4 6.2 7.7 6.8 6.0 Agriculture 1.7 0 1.8 6.3 3.4 7.5 Industry 4.7 5.4 8.0 8.1 7.6 5.9 Services 7.6 6.7 6.4 7.7 7.1 5.6

Per capita GDP(US$ mn.) 981 1,062 1,241 1,421 1,634 2,014

gan to witness over the same period. A tight-ening of monetary policy from early 2007was intended to curb demand-pull pressuresand rein in aggregate demand in the economy.The most visible impacts of such measures -rising interest rates - was felt most in theindustry and services sectors.

Domestic policy measures that would haveinevitably decelerated economic activity co-incided with the contractionary effects of theglobal economic crisis in the fourth quarterof 2008. GDP growth slowed sharply to 4.3per cent (Figure 3.1). The services and indus-

Source: CBSL, Annual Report, various issues.

Figure 3.1Quarterly GDP Growth (2007-09)


0

2

4

6

8

10

12

14

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

2007 2008 2009

%

Agriculture Industry Services GDP

The Global Economic Crisis and Sri Lanka’s Economic Outlook

31

try sectors saw output growth decline by 3.6and 3.3 percentage points, respectively, rela-tive to fourth quarter performance in 2007.Whilst all three sectors are likely to be ad-versely affected by the global economiccrisis - from contracting world demand anddepressed commodity prices - Sri Lanka'sservices and industry sectors have beenvulnerable to the added pressures arising fromdomestic macroeconomic management thathas largely spared the agriculture sector.

3.2.1 Sectoral Growth Performance

Much of the growth momentum in 2008 wasdriven by a resurgent agriculture sector per-formance. Its contribution to GDP growthincreased to over 15 per cent in 2008 rela-tive to just 6 per cent in the previous year,with a share of 12 per cent of GDP. The keyfactors in the improved performance werethe recovery in tea production, along with asignificantly higher production of paddyowing to a renewed harvest from the Eastern

Province during the Yala season.1 The Yalaseason output grew by 51 per cent to yield1.8 million metric tonnes - a result largelyof a 62 per cent increase in the extent ofland cultivated when compared to theprevious Yala season. The increase in landunder cultivation came primarily in thedistricts of Ampara, Batticaloa andTrincomalee - contributing 23 per cent ofthe total Yala season paddy production in2008.

The increase in rice production was alsopartly a result of the higher prices of cereals,including wheat, in the world market, espe-cially during the first two quarters of 2008.Moreover, with the relaxation of securitymeasures in the Eastern Province, other areasof agricultural activity - e.g., milk and fishproduction, etc. - benefited. Annual fish pro-duction rose by 10 per cent in 2008 - dueboth to favourable weather conditions andrenewal of fishing in the Eastern Province.

1 Rice cultivation in Sri Lanka has two main seasons: Yala season between May-September, and Maha season between December-February.

Table 3.2GDP: Sectoral Performance

Annual Average (%) Annual (%)

2002-04 2005-08 2007 2008

GDP 5.1 6.6 6.8 6.0Agriculture 1.3 4.8 3.4 7.5 Tea 1.5 0.8 2.2 4.3

Rubber 2.9 7.5 -2.0 10.3 Coconut -2.1 3.6 5.1 5.2 Paddy -0.8 11.0 -6.4 22.9Industry 3.9 7.5 7.6 5.9

Manufacturing 3.8 5.7 6.4 4.9 Construction 3.8 8.7 9.0 7.8Services 7.2 6.7 7.1 5.6 Wholesale and retail trade 6.4 5.2 6.1 4.7

Post and telecom 24.8 22.5 21.5 22.3



32

Tea production increased by 17.5 per centduring the first half of 2008 on account offavourable weather conditions and buoyantexternal prices. The sector, however, beganto feel the adverse impact of the decline incommodity prices in the second half of theyear, and contracting demand from key ex-port markets. By year end, tea productionhad declined to 4.3 per cent relative to agrowth rate of 13.3 per cent in 2007. By con-trast, rubber production has held steady, grow-ing by 9.9 per cent in 2008 compared to agrowth in production of 11.7 per cent in theprevious year.

The industry sector grew by 5.9 per cent in2008, with the largest sub-sector of manu-facturing expanding by 4.9 per cent. The keyindustrial sectors - food and beverages whichaccounts for nearly 50 per cent of industrialvalue added, and the textile and garmentssector that accounts for a further 25 per centof value added - saw a decline in 2008. Anunfavourable domestic economic environ-ment - high interest rates, rising cost of liv-ing, and a misaligned exchange rate - con-

Figure 3.2Key Industrial Sector Growth


tributed to a less than profitable setting inwhich to operate. The adverse impacts ofdeclining global demand in the fourth quar-ter of 2008 only added to the existing chal-lenges facing the industrial sector.

The services sector which has been a keydriver of growth in the Sri Lankan economy -accounting for nearly 60 per cent of GDP -has recorded a slowdown in 2008, mainlyowing to the decline in export trade, trans-port, and financial services activities. Again,domestic compulsion weighed heavilyagainst continued expansion of the servicesrelated industries before the onset of the glo-bal economic meltdown. The latter onlyserved to exacerbate the situation further. Thewholesale and retail trade sector, and postand telecommunication sectors - which arethe primary contributors to the services sec-tor - have experienced a decline in growth in2008.

3.2.2 Employment Trends

According to available official statistics, therate of unemployment in Sri Lanka has been


33

declining steadily in recent years to reachthe lowest recorded rate of 5.2 per cent in2008. Total employment in the country roseby 133,000 in 2008.

During 2000-08, the labour force grew by12 per cent. However, yearly labour forcegrowth rates show that the labour force isgrowing at a declining rate. The decrease inthe labour force, despite an increase in theworking age (15 and over) population ismainly due to the decrease in the labour forceparticipation rates. In addition, thedepartures for foreign employment have beenincreasing over the last couple of decades.More than 200,000 persons are estimated todepart for temporary employment abroad eachyear. According to the Sri Lanka Bureau ofForeign Employment (SLBFE), the stock ofoverseas contract workers at present is around1.8 million, which is equivalent to 20 percent of the workforce in domesticemployment.2

Table 3.3Key Statistics of Labour Force

2000 2002 2004 2006 2008Labour force (‘000 persons) 6,827 7,145 8,061 7,599 7,650Labour force participation rate (%) 50.3 50.3 48.6 51.2 50.3 Male 67.2 67.9 66.7 68.1 67.6 Female 33.9 33.6 31.5 35.7 35.0Employment status (%) Public sector 13.4 13.4 13.0 13.4 14.9 Private sector 42.9 44.5 46.4 42.1 41.1 Employers 2.3 2.8 2.9 3.1 3.0 Self-employed 28.4 28.6 28.3 30.8 30.2 Unpaid family workers 13.0 10.7 9.4 10.5 10.8Composition by economic activity Agriculture (% of total) 36.0 34.5 33.5 32.2 32.7 Industry (% of total) 23.6 20.9 22.8 26.6 26.3 Services (% of total) 40.3 44.7 43.7 41.2 41.0Unemployment rate (% of labour force) 7.6 8.8 8.3 6.5 5.2 Male 5.8 6.6 6.0 4.7 3.6 Female 11.1 12.9 12.8 9.7 8.0

Notes: a: Data excludes Northern and Eastern Provinces.


By employment status, the largest increaseduring 2008 is seen in the proportion of thoseemployed by the public sector. By sector ofemployment, there has not been any discern-ible change: the services sector employed thelargest proportion (41 per cent) in 2008, fol-lowed by the agriculture (33 per cent) andindustry (26 per cent) sectors.

At a first glance, the labour market statisticslook promising in view of declining unem-ployment rates. However, unemploymentremains high for females (9 per cent), foryouth (22 per cent for 15-19 year olds, and15 per cent for 20-29 year olds) and for theeducated (12 per cent for those qualified inA Levels). In addition, a large proportion ofthe employment that has been created in thelast decade has been in the informal sector,particularly as self-employed. At present,informal sector employment accounts forclose to 70 per cent of the total employed.

2 These figures are not adjusted for arrival of temporary workers after completing their work contracts.


34

These developments suggest that Sri Lanka'sworkforce remains vulnerable to socio-eco-nomic stress in the event of job lay-offs. Inthe context of the current global economicdownturn that is seeing unemployment esti-mated to rise sharply across the world, theabsence of social security/safety nets for thevast majority of Sri Lanka's working popula-tion is a cause of immense concern. An Un-employment Insurance Benefit Scheme hasbeen proposed and discussed, but fiscal con-straints have prevented it from being imple-mented.

3.2.3 Savings and Investment

The improvement in the domestic savingsratio - domestic savings as a percentage ofGDP - witnessed over the 2005-07 periodreversed sharply in 2008. The domestic sav-ings ratio declined quite markedly to 14.1per cent in 2008 from 17.6 per cent achievedin the previous year. Sustained cost of livingpressures undoubtedly have led to householdssaving less than earlier. In addition, finan-cial turmoil in the country - the collapse ofwell recognized organizations and severalfinancial scams that came to light in 2008 -would also have impacted adversely ondepositor confidence.

These factors also explain the drop innational savings to 18.2 per cent in 2008.

Despite the continued healthy growth intotal private remittance inflows to thecountry, net factor income as a percentageof GDP dropped from 5.8 per cent in 2007to 4.1 per cent in 2008.

Despite the 5.1 percentage drop in nationalsavings, Sri Lanka was able to maintain arelatively stable rate of investment. Totalinvestment as a percentage of GDP droppedonly marginally to 27.5 per cent from a ratioof 28 per cent achieved in 2007. Theinvestment rate was held primarily due tothe steady increase in public investment since2004. Over that period, governmentinvestment as a percentage of GDP has grownprogressively from 2.7 per cent in 2004 to6.5 per cent by 2008.

The continued decline in private investment- from a high of 23.9 per cent in 2006 to21.1 per cent in 2008 - is worrying, althoughnot unexpected. The high interest rate envi-ronment has been a key factor. Underlyingthis has also been a general decline in inves-tor confidence, largely as a result of the weak-ening of macroeconomic stability that theeconomy has experienced since 2006.

Some of the government investment activi-ties will lift Sri Lanka's long-term growthpotential and is, therefore, to be welcomed.

Table 3.4Selected Indicators of Investment and Savings

% of GDP 2002-04 2005-2008 2007 2008Investment 22.8 27.5 28.0 27.5 Private 19.5 22.4 22.6 21.1 Government 2.5 5.1 5.4 6.5Domestic savings 15.6 16.5 17.6 14.1National savings 21.0 21.8 23.3 18.2

FDI (US$ mn.) 190 481 548 691FDI (% of GDP) 1.0 1.5 1.7 1.7



35

These include projects initiated to improveinfrastructure facilities such as the port de-velopment activities at Colombo andHambantota, together with the expansion inroad development and power generationprojects. Other initiatives includeprogrammes directed specifically towardsarea-based development of the Eastern Prov-ince. The Negenahira Navodaya programmeunder the Board of Investment (BOI) and theNegenahira Udanaya special developmentprogramme under the Ministry of IndustrialDevelopment are some of the key initiatives.

Despite the weakening of the macroeconomicenvironment in Sri Lanka, the inflow of for-eign direct investment (FDI) has held steady.The total net inflow of FDI in 2008 amountedto US$ 691 million, remaining stable at 1.7per cent of GDP. Telecommunication, manu-facturing, and power generation sectors havecontinued to be the main areas of attractionfor foreign investors. While Sri Lanka is atrisk of seeing a reversal of the steady increasein FDI inflows of recent years as a result ofthe global economic crisis, the ending of theconflict is likely to restore long term inves-tor confidence in the economy.

Clearly, investment by the government bynecessity will be a central feature of SriLanka's post-conflict rehabilitation and re-construction process. It holds both advan-tages and risks in the context of the currentglobal economic downturn. A proactive fis-cal policy stance by the government for re-construction purposes will mitigate thedownside effects of a slowdown in privateinvestment and consumption in the economy.However, the risks are many. Sri Lanka's fis-cal situation remains fragile. The expectedslowdown in output growth will inevitably

take its toll on government revenue sources.As the country grapples with the mountingtask of raising sufficient financial resources -to continue with ongoing development ef-forts, and initiate new area-based develop-ment programmes in the Northern and East-ern Provinces - fiscal management will bethe entry point of ensuring a sustainable eco-nomic recovery in the medium term, and onethat will eventually translate into a soundlong term socio-economic development pro-cess.

3.3 Initial Conditions: Fiscal andMonetary Policy Weaknesses3.3.1 Fiscal Policy

For Sri Lanka, fiscal policy management haslong been the bane of underlying weaknessesin the macroeconomic environment. Recentexperience has not been very different.

The pressures on budgetary expenditures havebeen rising on multiple fronts. The post-tsu-nami reconstruction effort during 2005-06took a toll on government finances as costescalations and donor funding gaps betweencommitted and disbursed funds emerged.3

Military spending aimed at ending the 30year long conflict that had taken a heavy tollon the economy rose sharply from 2006.4

Despite these pressures, government capitalinvestment on infrastructure related devel-opment too has seen a notable increase - from4.2 per cent of GDP in 2004 to 6.4 per centby 2007. Clearly, the government was at-tempting to ensure that its 'development'drive was not neglected while it pursued itspolitical aim of ending terrorism in the coun-try.

A first glance at Sri Lanka's fiscal policy in-dicators does provide evidence of some wel-

3 GOSL (2006), "Post-tsunami Recovery and Reconstruction", Ministry of Finance and Planning and Reconstruction and DevelopmentAgency (RADA).

4 Relevant Appropriation Bills presented to Parliament indicate increases in allocated defence spending from Rs. 96 billion in 2006, Rs. 139billion in 2007, Rs. 166 billion in 2008, and Rs. 177 billion in 2009.


36

come developments. Current expenditure asa percentage of GDP has declined progres-sively from 2005 to stand at 16.9 per cent in2008. Capital expenditure has held steadyfor the most part over the same period. Im-portantly, the fiscal deficit - although stillhigh at 7.7 per cent of GDP in 2008 - hasbeen contained.

The weaknesses in fiscal policy managementthat have percolated through other key mac-roeconomic indicators have arisen largely dueto the means through which the deficit hasbeen financed. Domestic financing of thedeficit in 2006, for instance, included a heavyreliance on borrowing from the monetaryauthorities. The significant inflationary pres-sures that the economy witnessed, particu-larly from 2006 onwards, was in large partattributable to domestic financing issues. Asdomestic financing channels began to getexhausted, Sri Lanka turned increasingly toforeign financing, and in particular to for-eign currency denominated borrowing oncommercial terms. The latter, although cost-

Table 3.5Fiscal Policy Indicators

2005 2006 2007 2008 2009a

% of GDP

Total revenue 15.5 16.3 15.8 14.9 16.4Tax revenue 13.7 14.6 14.2 13.3 14.9Total expenditure 23.8 24.3 23.5 22.6 22.8Current 18.1 18.6 17.4 16.9 15.8Capital 5.8 5.6 6.1 5.7 7.1Deficit -8.4 -8.0 -7.7 -7.7 -6.5

Foreign financing 3.3 2.5 3.7 0.6 2.9Domestic financing 5.1 5.5 4.0 7.0 3.5

Government debt 90.6 87.9 85.0 81.1 77.1 Foreign 39.0 37.5 37.1 32.8 31.5 Domestic 51.6 50.3 47.9 48.3 45.6

Note: a: Estimate.


lier, could be accessed fairly speedily, andmost critically, came free of 'conditions' tiedto disbursement.

Many of these developments - monetizationof the fiscal deficit, recourse to highervolumes of short-term foreign currency bor-rowing, etc. - held serious implications formonetary policy and exchange rate manage-ment if the Sri Lankan economy was toescape a progressive weakening of its macro-economic environment. The policy responseson many fronts failed to respond adequatelyto unfolding signs of economic instability.

3.3.2 Monetary Policy

Inflationary pressures in the Sri Lankaneconomy were present from 2005 - arisingprimarily from the combined effects of theinflationary impacts of the post-tsunamireconstruction expenditure drive as well as asteady rise in international oil prices. It calledfor greater vigilance with regard to inflation,5

including a watch on the external currentaccount developments when setting monetarypolicy.

5 See IPS, Sri Lanka: State of the Economy 2005.


37

The initial monetary policy response wasmoderate. Indeed, even as the domestic bor-rowing requirement to bridge the fiscal defi-cit peaked in 2006, the accommodativemonetary policy stance added to the infla-tionary pressures that had been building upin the economy from mid-2004. While vari-ous measures such as Open Market Opera-tions (OMO) were used, adjustments topolicy rates was the main instrument (at leastuntil 2006), but this was used only very spar-ingly (Figure 3.3). At times, real interest rateswere negative as a result during this period.

The culture of 'cheap credit' led to a rapidexpansion in credit growth. Credit growth tothe private sector, for instance, peaked at about26 per cent in mid-2007 compared to anannual average of around 17 per cent during2002-04. Such trends - where prices losetouch with the fundamentals in the midst ofa credit boom - in turn can cause other down-side risks to emerge in the economy. Accessto cheap credit typically lends itself towardsrisk taking in financial markets on the part of

Figure 3.3Trends in Policy Interest Rates and Inflation (2004-07)

02468

101214161820

2004 2005 2006 2007

%

CCPI REPO


both borrowers and lenders. Not surprisingly,much of the credit boom saw lending rise toriskier areas of activity such as lending forcommercial purposes, consumption, andhousing/real estate during 2005-07 as evi-dent from Figure 3.4. Despite the absence ofcomparative data for 2008, available infor-mation suggests that the trend was similar.Against a total growth in loans and advancesof Licensed Commercial Banks (LCBs) of 6.4per cent in 2008, credit for consumption grewsharply by 29.5 per cent.6

Such developments pose risks to the healthof the country's financial system stability.The global financial crisis in part was theresult of similar trends - credit driven hous-ing and consumption booms - in developedcountries. As credit dries up and interest ratesbegin to climb, lenders become unable torepay loans. Indeed, the situation exacerbatesas the liquidity squeeze begins to hit eco-nomic activity in general. Sri Lanka's experi-ence has been that sharply rising interest ratesfollowing the credit boom has raised the risks

6 CBSL, Annual Report 2008.


38

for financial sector stability. The gross non-performing loans (NPL) ratio for the LCBs,for instance, increased from 5 per cent atend 2007 to 6 per cent by 2008 and is ex-pected to rise further in the near term.

The exposure of large financial scams and/ormismanagement - such as Sakvithi finance,Golden Key Credit Card Company, etc. - inthe course of 2008/09 have added to drain-ing some confidence in the stability of thefinancial system in the country. Some of theseillegally operated activities were run on thelines of "Ponsi" (pyramid) schemes that in-variably run into difficulties during times ofa liquidity squeeze. The inability to keep onattracting fresh deposits can quickly lead toan unravelling of such schemes. As the con-tagion effects spread to banks (e.g., SeylanBank) and finance companies (e.g., The Fi-nance and Asian Finance) the CBSL wasforced to step in, in its role of regulator.

What is clearly important to note is that thestresses facing Sri Lanka's financial sectorhave not been due to linkages with the un-folding global financial crisis. The country'sfinancial system was to a very great extentshielded from the turmoil of the global fi-

nancial crisis due to the very limited natureof liberalization in the sector vis-à-vis inter-national capital markets. Sri Lankan banksare allowed only limited exposure to foreignborrowing. Financial institutions in the coun-try were also not permitted to trade in themany sophisticated financial instruments thatwere at the very heart of the global financialmeltdown.

3.4 External Sector Developments andImpact of the Global Crisis

Greater reliance on external sources of financ-ing to bridge Sri Lanka's fiscal deficit openedup another front on which the country's vul-nerability to the emerging global economiccrisis increased. From 2006, as domesticborrowing peaked and interest rates began torise as a result, Sri Lanka began to look toshort term foreign currency denominatedborrowing at commercial rates of interest.These have taken the form of Sri Lanka De-velopment Bonds (SLDBs), sovereign bonds,and syndicated loans. As a further move toattract foreign capital, investment in govern-ment securities of up to 10 per cent of themarket was opened to foreigners incremen-tally from 2007.

Figure 3.4Lending by Licensed Commercial Banks (2004-07)



39

Short term foreign currency borrowings wereused to plug a deteriorating external paymentsposition that the country was facing. SriLanka's trade balance weakened sharply asexpenditures on oil imports ballooned, andwhile remittances increased steadily to plugsome of that deficit, the external currentaccount position has been weakeningprogressively (Figure 3.5). During 2006-07,

the current account deficit increased to anaverage of 4.5 per cent of GDP. In 2008, itdeteriorated sharply to 9.3 per cent of GDP.The external current account reflects the bal-ance of investment and savings in theeconomy. A current account deficit is notnecessarily bad: an economy may be bor-rowing from abroad to finance investmentthat will lift future growth. Nevertheless, a

Table 3.6Exposure to Short-term Foreign Currency Borrowing

Date Type Amount ($) Maturity Due2006 June SLDB 250 mn 2 yr2006 June SLDB 50 mn 3 yr 2009 June2006 August SLDB 175 mn 3 yr 2009 August2006 September SLDB 70 mn 2 yr2006 September SLDB 35 mn 3 yr 2009 September2006 December Syndicated loan 100 mn 3 yr 2009 December2007 March SLDB 215 mn 2 yr 2009 March2007 October Sovereign bond 500 mn 5 yr2008 June Syndicated loan 150 mn 3 yr2008 June SLDB 230 mn 2 yr2008 September SLDB 60 mn 2 yr

Source: Compiled from www.cbsl.gov.lk

Figure 3.5External Current Account


-16. 0

-14. 0

-12. 0

-10. 0

-8. 0

-6. 0

-4. 0

-2. 0

0. 0

2004 2005 2006 2007 2008

% o

f G

DP

0

500

1000

1500

2000

2500

3000

3500

US

$ m

n.

Remittances Trade balance Current account balance


40

large deficit does mean that an economy andits currency may struggle if foreign capitalinflows suddenly dry up. Thus, the nature ofcapital flows financing the deficit also mat-ters.

For Sri Lanka, the immediate impact of theglobal economic crisis was felt at its mostvulnerable point of exposure - i.e., a weakexternal payments position. An estimatedinflow of US$ 650 million of foreign invest-ment into Sri Lanka's Treasury bills and bondholdings reduced sharply from September2008 with the onset of the global financialcrisis. The general liquidity squeeze in de-veloped markets and investors aversion torisks in emerging economies contributed tothis outflow. By end December 2008, capi-tal inflows in the Treasury bill and bondsmarket in Sri Lanka had shrunk to a mereUS$ 212 million.

In addition, export earnings in the fourthquarter of 2008 fell to US$ 1,987 million(from US$ 2,089 over the same period in2007) while import expenditure remained flatat US$ 3,245 million. Efforts by the CBSL toraise US$ 300 million in October 2008 wereabandoned due to the inhospitable globalfinancial environment, and Sri Lanka's bal-ance of payments (BOP) deteriorated accord-ingly. The overall BOP shrank from a sur-plus of US$ 516 million in July 2008 to US$173 million in September 2008, to end theyear with a deficit of US$ 1,225 million(compared to a surplus of US$ 531 millionat end 2007).

3.4.1 Policy Response: Exchange RateManagement

At a fundamental level, a persistent and ris-ing external current account deficit requiresappropriate policy adjustments. The deterio-ration in Sri Lanka's current account wasdriven largely by an external supply-sideshock to the economy in the form of an es-calation in international oil prices. Given the

duration of the price escalation and the like-lihood that oil prices would settle at a higheraverage level than that prevailing prior to theonset of the price hike, the external supplyside shock could hardly be deemed 'tempo-rary'. The persistent weakening of the cur-rent account deficit suggests that it requiredan appropriate adjustment in exchange ratepolicy management. For instance, a gradualdepreciation of the currency in such circum-stances would allow the relative prices of SriLankan goods and services to be pulled down,making them more attractive in internationalmarkets and thus boost exports.

Building pressure on the current account wereto an extent offset by foreign capital inflowsin the form of short term borrowing, inflowsinto the Treasury bill and bonds market, etc.Such inflows also have an impact on ex-change rate movements: inflows can lead toupward pressure (appreciation) of the ex-change rate. Critically, such exchange ratemovements do not reflect a change in theaggregate demand for Sri Lanka's goods andservices. They will, nonetheless, have theusual effect on relative prices, dampeningnet exports.

A combination of the above factors was atwork to keep Sri Lanka's exchange rate re-markably steady over time (Figure 3.6). Therupee saw a nominal depreciation of just 4per cent between September 2006 and Sep-tember 2007, and even that gradual depre-ciation reversed in October 2007 with theinflows of foreign capital - US$ 500 millionsovereign bond and other short term flows.Efforts were made thereafter to keep the ex-change rate at an 'unofficial' peg of Rs. 108to the US dollar.

A steady exchange rate was attractive for threekey reasons. In the first instance, the spiral-ling inflationary pressures in the economywould have worsened in the context of adepreciating currency. A 'suppressed' ex-


41

Figure 3.6Nominal and Real Exchange Rate Movements


change rate dampens net exports, and thusaggregate demand in the economy. In effect,it has deflationary consequences and supportsmonetary tightening measures. A secondimportant reason to promote a stable ex-change rate was with regard to fiscal con-solidation. Sri Lanka's rising exposure to shortterm foreign borrowing meant that a depre-ciating currency raises the costs of debt ser-vicing and repayment of the principal. A thirdfactor was the drive to attract foreign invest-ment into the government debt securitiesmarket. A depreciating currency, or expecta-tions of future depreciation, raises the risksfor investors and could deter such capitalinflows from coming into the country.

A misalignment in the exchange rate - at oddswith the fundamentals of the economy - hasa cost. Clearly, when there is a sharp infla-tion rate differential between Sri Lanka andher competitor countries, and nominal ex-change rate movements do not reflect thefundamental imbalances that exist in theexternal current account, there will be anappreciation of the real exchange rate thatleads to loss of competitiveness of exports

in international markets. The real effectiveexchange rate (REER) of the rupee as mea-sured against a basket of 24 currenciesappreciated sharply by nearly 28 per cent dur-ing the 12 months of October 2007 to Octo-ber 2008. Thus, Sri Lanka's export sectorfound itself attempting to compete in a rap-idly shrinking global export market on theback of a weakening in competitiveness as aresult of exchange rate policy management.

However, the more costlier policy responseto exchange rate management was perhapsthe decision to defend the currency using upthe country's foreign reserves in the latter partof 2008. As external finance pressuresmounted, exacerbated by the outflow of shortterm foreign capital inflows, the CBSL inter-vened heavily in the foreign exchange mar-ket. Gross official reserves declined from US$2.7 billion in July 2008 to US$ 1.7 billionin December 2008, or from 3.2 months ofimports to 1.5 months of imports. Pruden-tial rules of thumb suggest that reservesshould be sufficient to cover at least threemonths of imports.


42

Figure 3.7Gross Official Reserves


As import coverage declined sharply, theCBSL launched measures to re-build foreignreserves by attempting to encourage SriLankan non-residents to subscribe to'diaspora' bonds and to negotiate with otherCentral Banks to arrange currency swaps.These measures had very limited success, andSri Lanka was compelled to approach theInternational Monetary Fund (IMF) for aStand-By Arrangement of US$ 1.9 billion forBOP support in February 2009.

3.5 Macroeconomic Response to theGlobal Economic CrisisMany economies experiencing, or expectedto experience, falling aggregate demand areemploying fiscal policy as a key instrument -by raising expenditures or cutting taxes - tostimulate economic activity. For many de-veloped countries, fiscal policy will likelyhave a more immediate impact given thatthe margin to reduce already low interest ratesand thus provide a monetary policy stimulusis limited.

3.5.1 Is there a Role for Fiscal Policy?

With a relatively high fiscal deficit of 7.7per cent of GDP in 2008, the options to pro-vide a fiscal stimulus in Sri Lanka is verylimited. Nonetheless, in January 2009, thegovernment announced that it would offer aRs. 16 billion "stimulus package" directedto mitigate the adverse impacts of the globaleconomic downturn on the most severelyaffected sectors. In reality, the package trans-lates to only around 0.3 per cent of thecountry's GDP, and in view of a decision tofinance the package from cuts in other areasof expenditures, the impact of the fiscalstimulus is likely to be even more limited inraising aggregate demand.

It could well be argued that Sri Lanka doesnot require any additional fiscal stimulus tomitigate any deflationary trends in theeconomy. Indeed, the ending of a three de-cade conflict has brought the needs of reha-bilitation and reconstruction of the North-ern and Eastern Provinces to the forefront ofpolicy discussion. Even if large scale infra-


43

structure investment does not get off theground in 2009, substantial expenditures willhave to made to meet the immediate needsof nearly 250,000 internally displaced per-sons (IDPs) in the Northern Province alone.As the country begins the challenging task ofa medium to long term rebuilding effort, thepressures will be on how resource gaps canbe filled, and how fiscal policy can be man-aged without spurring macroeconomic vola-tility. Thus, Sri Lanka's domestic compul-sions override the need to subscribe to stan-dard policy prescriptions followed in othercountries in regard to the provision of a fis-cal stimulus package to deal with a down-turn in the global economy during 2009-10.

3.5.2 Room for a Monetary PolicyStimulus

The most promising development on themacroeconomic front in 2008 was evidenceof a sharp reduction in inflation from thefourth quarter of 2008 (Figure 3.8). Thelagged effect of the tighter monetary stanceadopted since early 2007 - where reservemoney growth which peaked at 21.2 per cent

in 2006 had dropped markedly to a mere 1.5per cent by end 2008 - is the key driver ofthe current deflationary environment.

The point-to-point rate of inflation droppedsteadily from a peak of 28.2 per cent in June2008 to 0.9 per cent by June 2009. The an-nualized rate of inflation peaked at 23.4 percent in October 2008 before beginning a pro-gressive reduction to 12.5 per cent by June2009.

As price inflation dropped, it allowed agradual easing of interest rates. The 3-monthTreasury bill rate which peaked at 21.3 percent by end 2007 dropped gradually toaround 17 per cent by end 2008. In early2009, the CBSL signalled its intentions toease monetary tightening measures adoptedsince early 2007. The Statutory Reserve Re-quirement (SRR) on commercial banks wasrelaxed. In February 2009, policy rates werereduced for the first time since abandoningpolicy rate adjustments in February 2007.Interest rates on 3-month Treasury bills haddropped to 12 per cent by May 2009.

Figure 3.8Trends in Inflation Ratess



44

The impact of a monetary policy stimulus iscritically dependent on the effectiveness ofthe transmission mechanism in the financialsystem. Lending rates have been slow to re-spond to easing of liquidity constraints. TheAverage Weighted Prime Lending Rate(AWPR), for instance, dropped only margin-ally to begin with (Figure 3.9). The past creditexcesses that have led to a mismatch of theasset and liabilities portfolios of banks havehindered a speedier adjustment of interestrates. Indeed, the ability of the CBSL to sus-tain the easing of monetary policy itself isdebatable.

3.6 Constraints on 'Policy Space'Restoring and sustaining macroeconomic sta-bility while keeping Sri Lanka's growth mo-mentum buoyant will be the key challengein the medium term. In the immediate shortterm, fiscal pressures will mount. The slow-down in economic activity will inevitablyeat into government revenue collection. TheMid-Year Fiscal Position Report prepared bythe Ministry of Finance and Planning sug-gests that in the period January-May 2009,

government revenue had contracted by 8 percent, with the sharpest falls in key revenuesources such as VAT collections whichdeclined by 24.3 per cent.

Other programmes - such as 'MathataThitha',7 BOI concessions, duty waivers onessential food items, duty free car importsfor public servants, etc., - have also eateninto government revenue collection. Effortsto bridge revenue shortfalls has seen the in-troduction of less welcome ad hoc adjust-ments such as the scaling up of cess rates, anexcise duty on gas, a Nation Building Tax,specific duties on selected imports, etc. Thus,collections from cess rates, import duties andother taxes grew by 11.1 per cent, 7.5 percent and 39.5 per cent, respectively duringthe period January-May 2009. However, thesetaxes account for only around 20 per cent oftotal revenue to the government and morecomprehensive reforms are required to sus-tain revenue growth in the medium to longerterm. Indeed, acknowledging the need, thegovernment has appointed a PresidentialTaxation Commission to look at ways andmeans of raising government revenue to a

Figure 3.9Trends in Interest Rates


7 The scaling up of tobacco and liquor excise duty as a part of the government's programme to discourage consumption.


45

developing country average of 20 per cent ofGDP by 2011.

In the midst of revenue constraints for thegovernment, expenditure is set to mount, notleast due to the rehabilitation needs of theIDPs in the Northern Province. According tothe Mid-Year Fiscal Position Report, expen-ditures have already risen by 28 per cent dur-ing January-April 2009 from the correspond-ing period for 2008. Even if the targeted defi-cit for 2009 is contained to the budgeted 6.5per cent of GDP, the anticipated means offinancing it is questionable (Table 3.7). Itappears to rely quite heavily on foreignfinancing, which in the more recent past,has translated into foreign borrowing ratherthan loans on concessional terms. Foreignborrowing in the current global economicenvironment will not be very attractive. Onthe other hand, even if donor funding for theNorthern and Eastern Province reconstructionprocess is sought, there is typically a oneyear gap or so between pledges/commitmentstranslating into disbursements. Thus, thereis every likelihood that the government willhave to resort to a higher level of domesticborrowing than anticipated in the budgetaryproposals. In such an event, the policy spaceto sustain a reduction in interest rates willbe limited, particularly in view of the factthat Sri Lanka's annual rate of inflation stillremains fairly high at 12.5 per cent bymid-2009.

Table 3.7Deficit Financing

% of GDP 2006 2007 2008 2009a

Total financing 8.4 7.7 7.7 6.5Foreign financing 2.5 3.7 0.6 2.9

Loans 1.4 2.8 -0.1 2.4Grants 1.0 0.9 0.7 0.6

Domestic Financing 5.6 4.0 7.0 3.5

Market borrowing 5.6 3.6 7.0 3.5

Notes: a: Estimate.


Developments on the external sector will alsohave a critical bearing on policymanoeuverability. Sri Lanka can expect to seea narrowing of its trade deficit in 2009 asthe drop in import expenditure exceeds anyreduction in export earnings. The trade defi-cit for the first quarter of 2009 had droppedto US$ 645 million as against US$ 1,401million recorded over the same period in2008. The growth in remittance inflows hasalso remained healthy, reaching US$ 774million in the first quarter of 2009 as againstan inflow of US$ 787 million over the sameperiod in 2008. Thus, Sri Lanka will likelysee an improvement in its current accountdeficit in 2009. However, it is still likely tobe relatively high given that any improve-ment is from a severe weakening of 9.3 percent of GDP in 2008.

A welcome development has been evidencethat the exchange rate is being allowed torespond to market signals. The rupee depre-ciated sharply to Rs. 120.7 to the US dollarin March 2009 in the wake of depleting offi-cial reserves. It has since stabilized at Rs.114-115 per US dollar in the face of weak-ening import demand, and anticipated buildup of foreign capital with the application tothe IMF as well as investor confidence onthe back of the long awaited end to militaryoperations in the Northern Province. Pledgesof foreign loans/grants - e.g., US$ 500 mil-lion loan pledged by Libya - have also helpedto steady the exchange rate.


46

However, Sri Lanka is not out of the woodsin terms of its vulnerability to external fi-nancing constraints. The country's gross of-ficial reserves which slipped further to US$1,272 million by March 2009 - sufficient foronly 1.2 months of imports - improved toUS$ 1,436 million by May 2009 (or 1.4months of imports). This was largely due tothe absorption by the CBSL of foreign ex-change from the market. Despite the limitedbuild up of reserves, questionable attemptsto delay the approval of the Stand-By Arrange-ment and/or attach 'political' conditions tosuch a loan have kept a degree of economicuncertainty alive.

Sri Lanka's experience with regard to its re-quest for BOP support in the midst of a glo-bal economic crisis underlines the nature ofgeo-political pressures that developing coun-tries can face. In such a context, it becomesall the more important that prudent policyresponses are adopted in managing thecountry's economy. An inappropriate policyturn weakens the economy to a point that ithas no other viable option but to approachthe lender of last resort - i.e., the IMF - andaccede to 'conditionalities' that can rangefrom exchange policy management to fiscalconsolidation. At this particular juncture, SriLanka needs to retain some degree of fiscal

flexibility to respond appropriately to theoverwhelming rehabilitation and reconstruc-tion needs of the Northern and Eastern Prov-inces.

This calls for domestic responsibility to ra-tionalize public expenditures - to eliminatewasteful expenditures in the delivery of pub-lic services. Rationalization will allow thereconstruction needs to be met in part byredirecting existing resources, and withoutrelying unduly on borrowed funds or on do-nor support. With the end of the three de-cade long conflict, the country's longer termdevelopment potential looks promising. Itshould not be derailed by imprudent han-dling of macroeconomic management in theinterim. Reconstruction related expenditureswill have inflationary consequences, muchas they did during the post-tsunami recon-struction effort. A much more appropriatecoordinated response - between fiscal andmonetary policy - than seen in the more re-cent past will be needed to address macro-economic imbalances that are likely toemerge.

The near term outlook for the Sri Lankaneconomy in the context of the current globaldownturn and domestic imperatives will bediscussed in Chapter 17.

4. How Will the Sri Lankan Labour Market Withstand the GlobalEconomic Crisis?

4.1 IntroductionThe global economic crisis has made inroadsinto the labour markets of countries acrossthe world. A report on Global Employment

Trends by the International LabourOrganization (ILO) in January 2009 predictsthat the global economic crisis will result inthe number of unemployed increasing fromits 2007 level of 18 million to 30 millionpersons under present conditions. Theglobal unemployment rate is estimated torise to 6.1 per cent, compared to the 2007rate of 5.7 per cent. In a worst case scenario,this rate is expected to increase further to7.1 per cent, resulting in an estimated 50million unemployed across the globe. Thenumber of working poor in the world - thoseearning less than US$ 2 a day per person - isestimated to rise up to 1.4 billion, or 45 percent of the employed population of theworld. The report also predicts that theproportion of people in vulnerableemployment can rise to 53 per cent of theemployed population.1 Although advancedeconomies are predicted to be more affectedby unemployment, the socio-economiceffect of unemployment is likely to be moresevere in sub-Saharan Africa and South Asiaas these regions have poor labour marketconditions - characterized by high unemploy-ment, low employment creation, low levelsof social protection, low wages, and theword's largest share of working poor.2

47

How the ongoing crisis will affect the labourmarket differs from country to country. Thesedifferences are only partly explained by thedownturn in economic activities in differentcountries. The structure of the labour marketin a country and the policy environment thatgoverns it also play a large role in the expla-nation. For example, job losses relating tothe present crisis are highest in the US, whichhas one of the most flexible labour markets.The job losses in the US amounted to 4.4million from December 2007 to March2009, resulting in an unemployment rate of8.1 per cent in February 2009, the highestrecorded rate in 25 years.3 By contrast, inEurope, where labour markets are more rigid,the unemployment rates are below that inthe US. In Japan, although output is reduc-ing at a faster rate, unemployment is low.This is partly due to a 'dual labour market',where regular workers receive higher benefitsand have more secure jobs relative totemporary workers. As a result, job losses inJapan are becoming more apparent amongsttemporary workers. Similar outcomes are alsoapparent in countries with similarly 'dual'labour markets, such as Spain.4

The impact of the global economic crisis onthe labour markets of the developingcountries will also depend on the structureof their labour markets and their exposure tothe world markets. Unlike for the developed

1 Vulnerable employment comprises workers who are either self-employed or are contributing family workers. They are least likely to becovered by safety nets that guard workers against income loss during economic downturns.

2 ILO (January 2009), “Global Employment Trends”, International Labour Organization. Available at: http://www.ilocarib.org.tt/portal/images/stories/contenido/pdf/LabourMarketInformation/get09.pdf [accessed 13th May 2009].

3 The Economist, March 14th-20th, 2009, Vol. 390, No. 8622.4 The Economist, March 14th-20th, 2009, Vol. 390, No. 8622.


48

economies, the consequences of the globaleconomic crisis on the labour markets in thedeveloping world are less known due to lackof information on these markets. Availableinformation suggests that the developingcountries have also been severely affected bythe crisis, particularly those sectors that aremore exposed to the global market.5

However, with decreasing household incomesand slowing consumer demand, othersectors are also being affected by the crisis.For example, according to a rapid assessmentof the impact of the global economic crisison Indonesia,6 by December 2008, 17,300workers were already laid off and there wereplans to lay off a further 24,100. Accordingto the same study, the sectors most affectedby the crisis in Indonesia were the manufac-turing industries such as textiles andgarments, wood industry, metal and steelindustry, and the pulp and paper industry.Many workers also left plantation compa-nies due to the scaling down of labour forcesby companies affected by falling commod-ity prices. In addition, the food and bever-ages, electronics and construction industriesalso experienced job losses due to slowdemand. Further, like in many other labourexporting countries, Indonesia's 5.8 millionmigrant workers were also vulnerable to joblosses due to the crisis. Some estimatessuggest that 250,000 Indonesian migrantworkers have returned home, many from theexport agricultural sectors in Malaysia.

The ILO (2009) predicts that as the employ-ment in the formal economy shrinks,workers will move to the informal economyand to rural areas, driving down wages inthese sectors and pushing households towards

poverty.7 The crisis will increase poverty intwo ways. The first is through the employ-ment effect, as individuals lose jobs, house-hold incomes will reduce. The second isthrough the income effect, where reductionin wages and profits caused by excess supplyof labour and reduced demand for goods willerode family incomes. The World Bank esti-mates that some 53 million people will fallbelow the level of extreme poverty due tothe crisis.8

The exact extent of the crisis on the labourmarket in Sri Lanka can only be tentativelyevaluated due to the lack of timely data avail-ability. As described later, already there isevidence that the more exposed economicsectors - such as the garments, export-ori-ented agriculture and tourism sectors, as wellas the construction sector have been affectedby the crisis. This Chapter will examine someof these issues. Section 4.2 will discuss theinternational policy responses - by bothdeveloped and developing countries - to thelabour market issues brought on by thecurrent economic crisis and the experiencefrom past responses to similar economicdownturns. Section 4.3 will describe thestatus of the Sri Lankan labour market at theonset of the crisis, and how it has beenaffected by the crisis thus far. Section 4.4will describe the social safety nets and theircoverage in the country, and their usefulnessin providing social support during the presentcrisis. Section 4.5 will examine thegovernment's response to the crisis and itslikely outcomes. Lastly, the Chapter will dis-cuss changes that need to take place to bet-ter prepare the labour market to face futuresuch shocks.

5 Ibid.

6 Djaja, Komara (2009), "Impact of the Global Financial and Economic Crisis on Indonesia - A Rapid Assessment", ILO.7 ILO (January 2009), "Global Employment Trends", International Labour Organization. Available at: http://www.ilocarib.org.tt/portal/

images/stories/contenido/pdf/LabourMarketInformation/get09.pdf [accessed 13th May 2009].8 The Economist, March 14th-20th, 2009, Vol. 390, No. 8622.

49

How Will the Sri Lankan Labour Market Withstand the Global Economic Crisis?

4.2 International Policy Responses4.2.1 Developed Countries

Across the globe, governments haveresponded to the job losses and decliningincomes in a variety of ways. In the US,which has low social safety nets comparedto other developed countries, the governmentis expanding unemployment safety nets byincreasing coverage, improving benefits, andlengthening the maximum duration forreceiving benefits. In Japan, the governmentis giving social assistance to non-regularworkers, a group that has been sidelined bylabour market policies in that country. Inother countries, governments are providingfinancial incentives to companies to keepworkers. For example, in Austria, Denmark,France, Germany, Hungary, Italy and Spain,governments are encouraging firms to shortenwork weeks, rather than laying off workers.The difference of the shorter work week ispaid by the government. Other countries arerelaxing the requirement of companies to paysocial insurance contributions for affectedworkers in the short term. The UK hasdeviated from this general practice bypaying firms to hire and train workers whohave been unemployed for more than sixmonths, thus allowing the labour market toadjust to the structural changes that aretaking place.9 Japan has tried a combinationof policies to assist the jobless. In its earlierless successful attempts, Japan tried toencourage firms to hire temporary workersas regular workers and to send the unem-ployed to the rural areas to work in farms.These attempts were less successful, as cashstrapped firms were unwilling to broadentheir shares of the formal sector work force.In more recent times, the government hasconsidered relaxing the requirements for re-ceiving unemployment benefits and provid-ing newly laid-off workers with short term

loans for housing and living expenses. It isalso subsidizing the pay of workers on man-datory leave, and giving incentives to firmsto re-hire laid-off staff. The government isalso giving incentives to start up new busi-nesses.

Measures such as subsidizing firms to keepworkers and providing incentives for firmsto re-hire fired workers cannot be sustainedover a long period. In the long run, what isneeded is to create productive new jobs andto train workers to match the skill require-ments of those jobs. However, until the con-fidence in the financial markets return andthe liquidity situation improves, the scopefor new investments will be muted.

4.2.2 Developing Countries

The policy measures adopted by developingcountries are somewhat different. Most ofthese countries do not have unemploymentinsurance programmes that cover a majorityof the workers. As such, governments needto come up with alternative mechanisms tocreate jobs, and support household income.

The main means adopted by governments ofdeveloping economies to support the labourmarket is by investing in infrastructureprojects that create jobs, and by providingdirect financial assistance to the poorest. BothChina and India are injecting money forinfrastructure development projects. Somecountries are allowing workers to borrow fromtheir pre-funded retirement schemes as atemporary measure of financial assistance.Countries like Chile and Colombia alreadyhave unemployment insurance schemes,where workers pay into individualunemployment accounts from which theycan withdraw money during periods ofunemployment.10

9 The Economist, March 14th-20th, 2009, Vol. 390, No. 8622.10 The Economist, March 14th-20th, 2009, Vol. 390, No. 8622.


50

The effectiveness of these different measuresin providing relief to those affected by in-come and job losses depends largely on theability of the planners and the implementers.A particular challenge for interventions thatseek to assist through provision of jobs orincome assistance is targeting. Unlessproperly targeted, the interventions will dolittle to improve the living standards of thosewho are most affected by the crisis.Especially in developing countries, whereadministrative capacity and governance isweak, ensuring effective coverage is difficult.A concern with regard to the introduction oflarge scale infrastructure projects is the tim-ing. Developing countries are well knownfor delays in the commencement of suchprojects due to procedural bottlenecks suchas inefficiencies in awarding tenders andacquiring land needed for such projects. Forcountries which do not have their ownfinancial resources, raising funds for infra-structure projects will also be a problem.Hence, unless there are already projects inthe pipeline, the ability of governments toinitiate and start new projects in the shortterm, when jobs are needed, is unlikely tohappen. Governments may have a betterchance of implementing simple projects thatrequire less administrative capacity - such asclearing public parks, etc. In this regard,allowing the affected to rely on legislatedsaving schemes, such as unemployment in-surance schemes - such as those in Chile andColombia - and pre-funded retirementschemes are better in terms of targeting.However, in some countries this would notbe a feasible option when these funds havelimited liquidity, and when relevant govern-ments are unable to provide credit to theseschemes for such relief measures.

4.2.3 Lessons from Past Crises

Lessons from previous economic crises, suchas the Asian financial crises of the late 1990shighlight the importance of ensuring that thepolicy measures taken by governments aretargeted, timely and temporary. If not, theinterventions will not result in the desiredoutcomes. Worse, they may result in longterm imbalances that are difficult to correct.The experience of public works programmesin Indonesia as a means of increasing labourdemand during the time of the Asian finan-cial crises highlights the need for proper tar-geting. During this crisis, the Indonesiangovernment introduced public worksprogrammes with wages set at the minimumwage levels in Jakarta. However, as the mini-mum wage levels varied across regions, andas the minimum wages in Jakarta were thehighest, the programme attracted a broaderband of workers than the targeted.11

The need for temporary solutions for solvingtemporary problems is well illustrated by theconsequences of the labour market policychanges by European governments subse-quent to the 1970s oil shocks. These govern-ments introduced early retirement schemesto encourage workers to leave the labourmarket voluntarily as a means of easing theunemployment problem at the time. How-ever, these policies resulted in an increase inthe dependency ratio, as people used this asa means of leaving the labour market early,years after the markets recovered from theshock. Once established, these types of policymeasures are difficult to reverse due to po-litical pressure.

In the past, during economic crises, govern-ments have intervened in the labour markets

11 Manning, Chris (2001), "Globalization, Economic Crisis and Labour Market Policy: Lessons from East Asia", No.23, East-West CenterWorking Papers, East, West Center, Hawaii, USA.

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in a variety of ways. These can be broadlycategorized into two: active or passive poli-cies. Active labour market programmes(ALMP) include, a) programmes for improv-ing the quality of labour supply, b)programmes for raising labour demand, andc) programmes that aim to facilitate jobmatching.

The first type of programmes aims to re-trainworkers to either start their own businessesor to fit into new sectors of the economy.The success of these programmes largely de-pend on the success of the planners to matchthe skill training to the skill demand in themarket. The second type of programmes aimsto increase demand for labour by investingin projects that create employment. The mainchallenge in these programmes is to ensureproper targeting. For example, if the unem-ployed are mostly laid-off garment sector fe-male workers, infrastructure projects that pro-vide employment for male construction work-ers will not result in the desired outcomes.Finally, the third type of programmes helpsto match job seekers to employers. However,the success of these programmes depend onthe incentives given to job seekers and toemployers to register with the prorgamme.In some countries, the unemployed are re-quired to register with job search centres inorder to receive benefits. In such instances,a larger pool of job seekers register with thesecentres, and employers are also attracted bythe large skill pool, and willingly registeravailable vacancies.12

The passive labour market policies adoptedby countries as social safety nets include, a)provident funds covering pensions, disabil-ity and worker health, 2) severance payments,3) minimum wage policies, and 4) unem-

ployment insurance schemes. However, theability of these to protect workers duringtimes of crisis will depend on their coverageand their effectiveness. In many countries,only the formal sector workers are coveredby these policies. When the informal sectoris large relative to the formal sector, the abil-ity of these policies to safeguard workers willbe less.

The policies are also ineffective when theexisting policies are not properly imple-mented. Proper implementation of policiesis especially difficult during times of crisis.For example, during the Asian financial cri-ses, minimum wage regulations were noteffective in maintaining wages. The averagereal wages were lower than the stipulated inmany affected countries.13 Studies have alsofound that many firms that face financialhardships fail to pay severance payments todisplaced workers. Further, as most severancepay amounts are linked to salaries and ten-ure at work, different workers receive differ-ent payments. This has led to managementproblems.

Unemployment insurance schemes may notbe effective in protecting workers duringtimes of crises. First, these schemes may alsonot cover the whole labour force. In manycountries, including some developed coun-tries, part time workers and contractual work-ers are not covered by unemployment insur-ance programmes. Also, when the numberof unemployed is large, as usually is the caseduring times of economic downturns, theprogramme costs can be large, making themunsustainable. Lastly, implementing theprogrammes can be difficult in countrieswhere institutions are not strong and lackcapacity.14

12 Ibid.

13 Ibid.

14 Ibid.


52

4.3 The Effects of the Crisis on the SriLankan Labour Market4.3.1 Performance and Structure of theLabour Market

According to the Labour Force Survey of Sri

Lanka, in 2008, 7.6 million individuals wereeconomically active in the country. Thisrepresents a labour force participation rate -the proportion of individuals in theemployable age who are active in the labourmarket of 50.2 per cent.15 Of those in thelabour force, roughly 7.2 million were em-

ployed, while the rest (0.39 million) wereunemployed. In addition to the workers em-ployed domestically, some 1.8 million SriLankans are estimated to be working abroad.Of this, around 62 per cent are estimated tobe female workers who are mainly workingas house maids in the Middle East.16

Sri Lanka's unemployment rate has comedown steadily since the early 1990s. Atpresent, it is around 5 per cent. However,unemployment remains high for females (9per cent), for youth (22 per cent for 15-19

Table 4.1Labour Market Indicators and the Structure of the Labour Forcea

2006 2007 2008

Household populationb (‘000) 14,834 15,048 15,079Labour force (‘000) 7,599 7,489 7,569Employed (‘000) 7,105 7,042 7,175Unemployed (‘000) 493 447 394Labour force participation rate 51.2 49.8 50.2Unemployment rate 6.5 6.0 5.2Employment-to-population ratio 47.9 46.8 47.6

Employment by sector (%) 100.0 100.0 100.0Agriculture 32.2 31.3 32.7Industry 26.6 26.6 26.3Manufacturing 19.2 18.9 18.9Constructionc 7.4 7.7 7.4Services 41.2 42.1 41.0Trade and hotels, etc. 15.3 14.9 14.3Transport, storage and communication 6.1 6.5 5.9Finance, insurance and real estate 3.1 3.1 3.3Personal services and other 16.8 17.7 17.5

Emploment by status (%) 100.0 100.0 100.0Public 13.4 13.8 14.9Private 42.1 42.7 41.1Employers 3.1 2.8 3.0Self-employed 30.8 30.4 30.2Unpaid family workers 10.5 10.3 10.8

Notes: a: Data exclude both Northern and Eastern Provinces, b: Aged 10 years and above, c: Mining and

quarrying, electricity, gas and water categorized under construction.

Source: CBSL, Annual Report 2008.

15 Central Bank of Sri Lanka, Annual Report 2008.16 Ibid.

53


year olds, and 15 per cent for 20-29 yearolds) and for the educated (12 per cent forthose qualified in A Levels). Compared toregional averages of unemployment, youthunemployment rates are high in the country.The lowering unemployment rates are mainlyexplained by a dwindling youth labour forcedue to demographic changes, labour emigra-tion, and increased participation in highereducation.17

While the employment-to-population ratio -an indicator largely regarded as a broadmeasure of the ability of the economy to cre-ate employment - has improved over the pastdecades, it is still low in Sri Lanka comparedto regional averages, indicating low jobcreation in the country.18 A large proportion

of the employment that has been created inthe last decade has been in the informalsector, particularly as self-employed. Atpresent, close to 70 per cent of the employedare in the informal sector. In terms of mainindustrial sectors, the services sector em-ployed the largest proportion (41 per cent)in 2008, followed by the agriculture (32.7per cent) and industry (26.3 per cent) sec-tors. These proportions have remained moreor less the same in the last three years (seeTable 4.1). Of the total employed, the sharein agriculture has decreased over time.However, there is no corresponding expan-sion in wage and salaried employment.Overall, since 1992, most of the gain in em-ployment has been in 'self-employment' atthe expense of workers in the public and pri-

Figure 4.1Employment by Economic Activity

Source: Calculations based on CBSL, Annual Report, various issues.

17 Arunatilake, N. and P. Jayawardena (2008), 'Labour Market Trends and Outcomes in Sri Lanka', Institute of Policy Studies of Sri Lanka,mimeo.

18 For example, around 2005, the youth (15 to 24 year olds) employment-to-population ratio in Sri Lanka was 33.8 per cent, when thecorresponding statistics for South Asia and East Asia were, 42.5 per cent and 62.1 per cent, respectively. Ibid.

0

500

1000

1500

2000

2500

3000

1 2 3 4 5 6 7 8

quarters (2007 to 2008)

'000 Persons

Agriculture Manufacturing

Construction Trade and hotels, etc.

Transport, storage and communication Finance, insurance and real estate

Personal services and other


54

vate sectors.19 These statistics suggest that alarge proportion of workers (around 40 percent) in the market fall into the category ofvulnerable workers - defined to be workerswho are either self-employed or are unpaidfamily workers. The ILO (2009) indicates theneed to track the size of these vulnerableworkers as they are the least likely to be cov-ered by social safety nets.20

4.3.2 Effects of the Crisis on the LabourMarket

Since the present crisis started in developedcountries around September 2008, the effectsof the crisis on the fourth quarter of 2008labour force data are of interest. Comparedto the last quarter of 2007, the employmentlevels in the last quarter of 2008 shows asharp decline in the trade and hotels sub-sector coming under services, and in themanufacturing sub-sector under industry.However, employment in agriculture, theconstruction sub-sector of industry, and allsub-sectors of the services sector (other thanthe trade and hotels sub- sector) shows anincrease in employment levels. According tothe latest available data, the overall employ-ment level has increased by 129,000 fromthe first quarter 2008 to the first quarter 2009.The gain in employment is mainly due toimprovements in employment in agriculture(of 203,000) and services (of 21,000) sec-tors. Employment in the industry sector isestimated to have contracted by 95,000.21

In the absence of more detailed information,it is difficult to attribute these trends in em-ployment to the present global crisis. How-ever, anecdotal evidence suggests that em-

ployment in the trade and hotel sector andin manufacturing is affected by the economiccrisis.

Further, there is firm level evidence thatconfirms that the manufacturing sector hasbeen affected by the global crisis. In the lastyear, 40,000 garment sector workers wereestimated to have been laid off with theclosure of several garment factories.22

According to the Board of Investment (BOI),11 firms in the Export Processing Zones (EPZs)have closed down during the periodSeptember 2008-March 2009 where 3,198workers lost their jobs. In comparison, onlyone firm closed between September 2007 toMarch 2008.23 According to informationfrom District Labour Offices of theDepartment of Labour, the majority of theclosures were due to lack or reduction of or-ders and low demand.24 These developmentsare likely to continue in 2009 with the pre-dicted deepening of the economic downturnin developed countries. Usually, there is alag between an economic downturn and theworsening of employment conditions as firmstake time to adjust. Given this, the employ-ment conditions can be expected to worsenin the coming months.

4.3.3 Effects of the Crisis on MigrantTrends

As indicated earlier, foreign employmentprovides a significant source of employment(and foreign financing) to the country. Theinternational literature on migration relatedissues suggests that over-dependence on for-eign employment could make a country more

19 Ibid.

20 ILO (January 2009), "Global Employment Trends", International Labour Organization. Available at: http://www.ilocarib.org.tt/portal/images/stories/contenido/pdf/LabourMarketInformation/get09.pdf [accessed 13th May 2009].

21 Department of Census and Statistics (2009), Bulletin of Labour Force Statistics of Sri Lanka.

22 The Sunday Times, 'Global Crisis Rips Garment Industry', 1st March, 2009.23 Gunatilake, Ramani (2009), "Rapid Assessment of the Impact of the Global Economic Crisis on Employment and Industrial Relations in Sri

Lanka", ILO. 24 Information from District Labour Offices relate to BOI as well as non-BOI firms. Ibid.

55


vulnerable to external shocks.25 This is dueto the fact that employment protection poli-cies and lay-offs in destination countriescould increase labour market pressures in thecountries of origin. Table 4.2 provides thelatest available figures on departures for for-eign employment from Sri Lanka. These in-dicate that the effect of the global crisis hasnot affected foreign job placements in 2008.In fact, the trends in foreign job placementsshow a higher growth rate from 2007 to 2008,compared to the earlier year (see Table 4.2).It is of further interest to note that the totalgrowth in foreign job placements have in-creased, particularly due to the increase inthe placement of skilled and other workers(including professionals). This is the groupthat is most likely to be affected by theglobal economic crisis, due to such factorsas cut-backs in construction and servicesectors in the labour receiving countries.However, as in the domestic market, theeffect of the global crisis on foreign job place-ments could be felt more in 2009. There arealready some indications that job orderscoming from the Middle Eastern countries -a major destination for migrant workers - aredeclining.26

26 http://southasia.oneworld.net/todaysheadlines/sri-lanka-uncertain-labour-markets-forecast-bleak-economy. [Accessed: 29th April, 2009].27 Arunatilake, N. and P. Jayawardena. (2008). 'Labour Market Trends and Outcomes in Sri Lanka', IPS, mimeo.

Table 4.2Departures for Foreign Employment

% increase2006 2007 2008 2006/07 2007/08

Total placements 201,948 218,459 252,021 8.2 15.4By manpower categoryHousemaid 99,659 102,349 108,709 2.7 6.2Other

Skilled labour 45,063 53,462 65,124 18.6 21.8Unskilled labour 40,705 52,182 59,427 28.2 13.9Other 16,521 10,466 18,761 -36.7 79.3


4.3.4 Effects of the Crisis on WageTrends

Over the decade 1996-2006, wage trends inSri Lanka have tended to deteriorate. Onaverage, real earnings grew faster over the1996 to 2000 period compared to the 2000to 2006 period. From 1996 to 2000, realearnings grew at 3.8 per cent on average an-nually, but the corresponding rate for the2000 to 2006 period was only 0.7 per cent.27

This decline in real earnings growth is simi-lar for males and females and for private sec-tor workers. However, real earnings in thepublic sector have grown at a higher rate inthe latter period. The above trends are largelyexplained by the poor performance of thegarment and tourist sectors due to the poorexternal environment and increased compe-tition. At the same time, high inflationand interest rates over the 2000 to 2006 pe-riod has crowded out private investments.The ability of the country to attract foreigninvestment in the post-2000 period has alsobeen low, except in the post-tsunami period,due to the unstable macroeconomic environ-ment in the country. Thus, income levels inthe country were already low at the start ofthe crisis in the country.

25 World Bank (2006), "Global Economic Prospects: Economic Implications of Remittances and Migration", World Bank.


56

In 2007 and 2008, formal private sectorwages - measured by the minimum wage rateindices of workers administered by regula-tions under the Wages Board Trades - showsan increase in real wages (as well as innominal wages). Although workers in theinformal sector also experienced an increasein wages nominally, the real wages have de-clined for workers in the construction sectorand for workers in the tea industry. Althoughthere was a decrease in real wages in 2007,the decline in 2008 is more marked.28 Incontrast, the informal sector workers inrubber and coconut industries, and malepaddy workers, have experienced a real wagegain in 2008. The decline in real wages inthe tea industry may have been affected bydemand shortages in the external market dueto the present crisis. Government interven-tions to stabilize tea and rubber prices mayhave helped to keep the nominal informalsector wages in the export agriculture sectorindustries from slipping. However, with thedeepening of the economic downturn indeveloping countries, export markets willfurther tighten, which will adversely affectwage levels in 2009.

4.4 Social Safety Nets and theirCoverageAt present, there are several schemes for pro-viding social security for workers in Sri Lanka.These include various retirement benefitschemes, severance pay schemes, and gratu-ity payments. This section discusses how thesemay serve as a safety net to workers affectedby the crisis.

4.4.1 Retirement Schemes

There are two main retirement scheme in thecountry. The Public Service Pension Scheme(PSPS) is provided to former permanent civil

servants at retirement. The Employees' Provi-dent Fund (EPF) is available for formalprivate sector workers.29 This scheme covers63 per cent of the formal private sector work-ers. In addition, there are retirement schemesfor farmers (28 per cent coverage), fishermen(78 per cent coverage), self-employedpersons (7.7 per cent coverage), and avariety of other workers in the informalsector. Together, all the programmes coveronly a little more than a quarter of the work-ing age population in the country.30

The retirement schemes are not useful safetynets at a time of crisis such as this given thata person needs to be of a certain age to ben-efit from these schemes. The earliest a fullpension can be obtained is at age 55 for menand age 50 for females, under both the PSPSscheme and the EPF scheme. For workers inthe public sector this is not a concern as theirjobs are highly protected. Older eligibleworkers in the private sector who arecovered by these programmes can receivesome benefit from these schemes in case ofretrenchment due to the economic crisis.31

Some countries are allowing workers toborrow against mandatory retirement schemes- such as the EPF scheme - as a temporaryincome assistance measure. If Sri Lanka toointroduces such a scheme, retrenched work-ers can get some income support from theirretirement savings.

4.4.2 Separation Related Compensation

Sri Lanka does not have a formal unemploy-ment insurance scheme. However, labourlegislation in the country has clauses thatprevent employers from terminating workerswithout reason and without compensation.The Termination of Employment of Work-men (Special Provisions) Act of 1971 (TEWA)

28 CBSL, Annual Report 2008.29 In addition, some formal private sector workers are covered by approved private provident funds and other private pension funds.30 World Bank (2006), "Sri Lanka: Strengthening Social Protection", World Bank.31 Ibid.

57


specifies strict procedures for employers tofollow before terminating workers. Employ-ers, in firms with more than 14 workers, arerequired to obtain written permission fromthe Commissioner of Labour before termi-nating any workers. The Act also stipulatesthat a response be given within three months.However, TEWA does not specify the levelof compensation to be paid to the workers.This was at the discretion of the Commis-sioner. A special Act, Industrial Disputes(Hearing and Determination of Proceedings)(Special Provisions) Act, No. 13 of 2003,was passed in 2003 to speed up the legalprocess involved under TEWA. Since itsenactment, workers are compensated accord-ing to a formula that is based on the numberof years of service, age at the time of termi-nation, and the salary at the time of termina-tion. This formula was revised in March 2005.The revised formula is based on the years ofservice. Under this, workers with 1-4 year'sof service receive 2.5 times their monthlysalary per year of service. The total benefitsincrease with the years of service but arelimited to 48 monthly salaries per worker.32

This formula is very generous according tointernational standards. For example,workers with 20 years of experience receivethe equivalent of 39 months of salary, whilethe corresponding compensation received byworkers in other Asian countries is about16.3 months of salary.33

In addition to this, workers who have servedmore than five years in a firm are in generaleligible to receive a gratuity payment equiva-lent to half a month's salary for each year ofwork completed under the Payment of Gra-tuity Act, No. 12 of 1983 (PGA). This in-cludes workers in firms employing more than

15 workers, and employees hired for work inmost agricultural or estate land.

The unemployment benefits under the TEWAcover 37 per cent of the labour force in theformal sector. Most workers who are cov-ered by the TEWA are also covered by thePGA and can expect some relief if termi-nated due to the crisis. However, past expe-riences indicate that implementation of theTEWA is weak. The number of applicationsfor TEWA cases received and disposed arelow - less than 100 a year - partly becausefirms prefer to use voluntary retirementschemes to lay-off workers to avoid cumber-some procedures and delays. Further, firmswhich face financial difficulties and areforced to downsize may not have the liquid-ity to compensate large numbers of workersin the short term. In these instances, eligibleworkers may have to wait a long period tobe compensated, and may not receive ben-efits when they need them the most.

4.4.3 Health Insurance

In Sri Lanka, health insurance is not required,as government health services do not chargeuser fees. However, some treatmentprocedures are not available in the publicsector. Health insurance is available for somein the formal private sector. These provideinsurance against treatment that persons mayseek from private sector facilities. The cover-age of these insurance schemes is estimatedto be 25 per cent of the formal privatesector.34 Since many of these benefits arelinked to employment, separation from workwill make an employee ineligible to partici-pate in the health insurance, thereby increas-ing their vulnerability to health shocks.

32 Ibid.33 Ibid.34 Arunatilake, Nisha, et al. (2006), "Social Insurance and Social Assistance Post Tsunami", Institute of Policy Studies of Sri Lanka, August 2006,

mimeo.


58

4.4.4 Insurance of Migrant Workers

The Sri Lanka Bureau of Foreign Employment(SLBFE) has introduced the 'Sahana' healthinsurance scheme maintained by the Sri LankaInsurance Corporation (SLIC) for migrantworkers who are registered with them. In2007, the 'Sesatha' voluntary retirement ben-efit scheme was introduced by the SLBFE andthe Sri Lanka Social Security Board for mi-grant workers. However, enrolment in thisprogramme is believed to be small.35 Theafore-mentioned insurance programmes onlycover benefits for accidents or harassment-related return to the country, benefits todependents in case of death, or benefits onretirement.36 There is no scheme that coversearly return to the country due to termina-tion of work contract. As such, the availableinsurance schemes for migrant workers willnot provide relief to workers in case they areforced to return due to termination of con-tracts. This is particularly of concern forworkers who have taken loans to finance theinitial costs associated with foreign employ-ment.

4.4.5 Samurdhi and Public WelfareAssistance Allowance

Under the government's Public Welfare As-sistance Allowance (PAMA) programme,households selected on the basis of their levelof income are provided income support.There has been considerable controversy onthe criteria used to select eligible householdsfor PAMA. The Samurdhi Development Of-fices (Niyamakas) select beneficiaries basedon a survey carried out in 1995. These offic-ers are also advised to use their discretion inselecting households based on householdcharacteristics and assets. These selectionsare subjected to the influence of local politi-

cians as well as the biases of the officers. Afurther problem with the scheme is that thereare no clear entry and exit criteria. As such,households falling into poverty due to anexternal shock, such as the present economiccrisis, cannot expect to benefit from thisprogramme.37

4.5 Government Response, Effective-ness and Gaps4.5.1 The Stimulus Package

In Sri Lanka, the main sectors affected by theglobal economic crisis are the export- ori-ented agriculture and manufacturing, andtourism. Exports that enjoyed a 9.6 per centgrowth in the first three quarters of 2008,experienced a 2.7 per cent decline in the lastquarter of the year. Exports showed a 19 percent decline from January to May 2009, whencompared to the corresponding period in2009. Increased international competitionin the face of lower demand and high pro-duction costs reduced the competitivenessof Sri Lanka's exports. Tea, rubber, coconutand cinnamon industries were adversely af-fected by falling international prices due tolow demand. Recessions in Western Europe,the largest regional source of tourism for SriLanka, resulted in reducing tourist arrivals tothe country.

These effects on the real economy were re-flected in the labour market. Several garmentfactories were closed down and othersstopped hiring new workers. As mentionedearlier, workers have been laid off from theapparel industry. Other export-orientedmanufacturing industries such as the ceramicindustry were also looking to cut jobs in theface of reduced demand. The incomes of theinformal rubber and tea sector workers

35 Help Age (2008), "Tackling Poverty in Old Age: A Universal Pension for Sri Lanka", Health Age International.36 Arunatilake, Nisha, et al. (2006), "Social Insurance and Social Assistance Post Tsunami", Institute of Policy Studies of Sri Lanka, August 2006,

mimeo.37 World Bank (2006),"Sri Lanka: Strengthening Social Protection", World Bank.

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dropped due to unavailability of work in teaand rubber plantations, and low profit mar-gins due to low prices on green leaf tea andrubber latex. Another group that is affectedby the crisis are the foreign employed work-ers. High skilled migrant workers and thosewho are working in the Eastern Pacific Rim,Europe, and the US remain vulnerable to jobcuts. The construction and the real estatesectors in the Middle East have been affectedby the global economic crisis, where thou-sands of Sri Lankan workers are employed.38

Many of the interventions of the "stimuluspackage" introduced by the government inJanuary 2009 were to safeguard productionrather than to directly safeguard employmentand incomes. The limited incentives givento companies to maintain work forces werenot sufficient. Many firms in the manufac-turing sector were not hopeful of benefitingfrom the government's stimulus package, asthe package was available only to those whocould maintain revenue and employmentlevels. In the face of declining demand, manywere unable to afford the costs of presentlevels of production.39

4.5.2 Temporary Active Labour MarketProgrammes and Assistance to theSelf-employed

The workers who are most likely to beaffected by the crisis would be temporaryand contractual workers, return migrantworkers, and workers in the informal sector.These workers have none or very limitedsocial safety nets. The majority of thoseaffected are likely to be females and youth.This is likely to increase the already highunemployment levels amongst these groups.At the same time, the crisis is likely to

increase the number of households inpoverty. Although the Samurdhi programmeprovides some assistance to those inpoverty, it is unlikely to be beneficial to thenewly poor, given poor and inflexible target-ing of the poor by the programme.Programmes such as the minimum price forpurchasing latex from growers can be ben-eficial in providing some relief to the infor-mal sector workers. However, such measuresare unsustainable unless rubber manufactur-ers are given financial incentives to buylatex at stipulated minimum prices.40 Thishighlights the need for temporary policies toprovide employment such as public worksprogrammes aimed at improving demand inthe market.

A large proportion of Sri Lankan workers areengaged in self-employment. As describedearlier, these workers will be severely affectedby lowering demand and reduced liquidityin the market. They are also likely to facehigher competition as more and more un-employed workers become self-employed. Asurged by the ILO, it is prudent to providethese workers with financial support throughemergency assistance programmes to preventthem from falling into poverty.

4.5.3 Extending Social Safety Nets

Although in recent years, the levels of socialsecurity awarded to return migrants haveimproved, their coverage is still low. Fur-ther, there are no products to safeguard re-turn migrants from external shocks that af-fect termination of their work contracts.Given that the government is increasinglyseeking to promote foreign employment, itis important to introduce safety nets for theseworkers. One means of doing this would be

38 http://southasia.oneworld.net/todaysheadlines/sri-lanka-uncertain-labour-markets-forecast-bleak-economy. Down loaded on 29th April,2009.

39 http://www.lankabusinessonline.com/fullstory.php?nid=1277882506. Down loaded on 29th April, 2009.40 For instance, in the face of declining prices, rubber manufacturers may not be able to pay the stipulated prices for latex.


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an insurance scheme to provide workers withsome protection during economic downturnssuch as the present one.

Workers in the public sector have high lev-els of job and income security and are un-likely to be affected by the crisis. Workers inthe formal private sector, especially thosecovered by TEWA, are also well protected.Even if these workers are to lose their jobs,they will be well compensated in most in-stances. Workers with more than five yearsof service and those who are eligible to re-tire will also benefit from legislated gratuitypayments and retirement benefits.41

4.5.4 Programmes for Re-training andLabour Market Flexibility

Although existing legislation will protectworkers from the adverse effects of thecrisis, the inability of firms to adjust to thechanging global economy will adverselyaffect the long term economic growth of thecountry. The post-crisis economy is likely tobe different from the present one. Thesectors which experienced high growth maynot sustain similar growth patterns, whilenew sectors will gain momentum. Given this,it is important to allow mobility in themarkets, such that workers can learn new skillsto cater to the new demands in the market.42

Thus, it is important to introduce flexibilityinto the labour markets to re-adjust. It isalso important to introduce programmes tore-train workers in order that they can ben-efit from emerging trends in the new eco-nomic landscape.

4.5.5 Improving Domestic LabourMarket Conditions

Successive governments in the recent pasthave relied on foreign markets as a source ofemployment. Job creation has been severely

limited domestically. Even the jobs that werecreated were in the informal sector. As dis-cussed earlier, over-reliance on foreign em-ployment can increase a country's vulnerabil-ity to economic shocks. As such, there is aneed to improve the investment climate andpromote job creation in the formal privatesector. This will help cushion the economyin three ways. First, a larger proportion willbenefit from the social safety nets which arecurrently enjoyed by formal sector workers.Second, the labour market of the country willbe less vulnerable to economic downturnsand related contractions in the labour mar-kets in labour importing countries. Third, thiswill help to increase domestic demand forgoods and services, lessening the dependenceon foreign markets.

4.6 Conclusions and PolicyImplicationsThe global financial crisis that started in theUS has now spread to all parts of the globeand made inroads into the real economy. TheILO predicts that these developments will inturn increase the global unemployment rateto 6.1 per cent, and reduce incomes of thosewho keep their jobs, especially those in theinformal sector. The impact of the crisis onthe labour markets in developing countrieswill largely depend on their exposure to theworld economy, the structure of the labourmarkets, and the level of social protectionavailable to workers. In Sri Lanka, for in-stance, export-oriented agriculture and manu-facturing sectors, and the hotel sector in par-ticular, are predicted to be hit hardest by thecrisis. Especially in developing countries,where social protection to the unemployedare low, workers laid off from the formalsector and return overseas workers will mostlikely join the informal economy, therebyreducing incomes in that sector.

41 However, it must be mentioned that these are lump sum payments and thus are likely to be beneficial in the short term.42 The Economist, March 14th-20th, 2009, Vol. 390, No. 8622.

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Governments across the world have inter-vened in labour markets to extend and in-crease assistance given to the unemployed,to provide assistance to firms to retain work-ers, and to assist workers to get re-trained fornew jobs. In developing countries, govern-ments have resorted to improving the de-mand for jobs by increasing investments ininfrastructure, and providing income assis-tance through measures such as allowingworkers to borrow from their legislated sav-ings schemes.

At the onset of the crisis, Sri Lanka's labourmarket was in a weak position to face theconsequences of the crisis. The structure ofthe labour market and the design of socialsafety nets in the country are such that onlya limited proportion of workers are coveredby social safety nets. The vast majority (closeto 70 per cent) of workers in the country arein the informal sector - a sector that is leastprotected by social safety nets. Of the totalemployed, a little more than 40 per cent areeither unpaid family workers or self-employed- those termed as vulnerable workers by theILO. The stimulus package introduced by thegovernment mainly seeks to protect produc-tion. There are no direct relief interventionsto safeguard the living standards of informalsector workers.

The public sector workers and formal privatesector workers are in a better position to facethe crisis due to the protection provided tothem through legislation. However, theseprotectionist measures in the market alsoconstrains the ability of the firms to re-ad-just to the changing economic structure ofthe world economy. This in turn, will lowerproductivity of the firms and affect the longterm growth of the country. The crisis high-lights the need to improve the country's in-vestment climate and to expand formal em-ployment opportunities, and to provide flex-ibility to the labour market so that Sri Lankais able to adapt to the changing dynamics inthe global economy.

Overseas employment is seen as an easymeans of sourcing employment and earningforeign exchange by successive governments.An estimated 20 per cent of the Sri Lankanlabour force is working abroad. At least, somepercentage of these is likely to be affected byeconomic stagnation in destination countries,and is likely to return to the country. Over-reliance on foreign markets will increase thevulnerability of the country to global eco-nomic shocks. Although overseas employ-ment can be looked on as a temporary solu-tion for low job creation in the economy, inthe long term, Sri Lanka will need to im-prove the investment climate to encouragejob growth locally.

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5. Global Economic Crisis and Agriculture Sector in Sri Lanka

5.1 Introduction

Sri Lanka's agricultural sector is dualistic innature, comprising of a well developed ex-port oriented plantation sector and a lessdeveloped food crop production sector thatis only partially market oriented. The formerproduces tea, rubber and coconut in mediumto large estates, while the latter accounts forpaddy, subsidiary food crops, vegetables andfruits in predominantly small holdings.

The importance of the agricultural sector tothe economy in generating income and em-ployment is evident from its notable contri-bution to GDP and the labour force. Althoughthe agricultural sector share in GDP has beendeclining over time, it still contributes around12 per cent from both the plantation andnon-plantation sectors.1 Its contribution toemployment is more significant. Despite adecline in the employment share - with theexpansion of the industrial and services sec-tors in recent years - agricultural sector em-ployment absorbs nearly 32 per cent of thetotal labour force, with significant employ-ment generation from paddy and tea - thetwo dominant players of the non-plantationand plantation sectors, respectively.

Until more recently, the productivity of mostagricultural crops had been declining or stag-nating over the last few decades. However,recent developments have contributed toimprove the volume of production of mostdomestic agricultural crops, resulting in adecrease in their imports, and a boost to ex-ports of plantation crops. The more recentpositive developments have been due largely

to technological advances. Productivity im-provements can be advantageous in meetingnot only domestic shocks, but also globaleconomic shocks to the agricultural sector.The linkages between global economicshocks and impacts on Sri Lanka's agricul-ture sector differ depending on the sector -i.e., whether it is the export oriented planta-tion sector or the more domestic orientedfood crop production sector. As a net foodimporter, changes in world supply and pricesof food impacts on Sri Lanka's domestic foodcrop production sector. As an agriculturalexporter, changes in world demand and pricesaffect the country's export oriented planta-tion sector.

The current global economic crisis followsthe food crisis of mid-2007 to mid-2008.The underlying causes of the two crises arefundamentally different in nature and theirimpacts on Sri Lanka's agricultural sector alsodiffer. The impact from the downturn in theglobally economy can be significant, andunevenly distributed amongst different stake-holder groups. Thus, the main aim of thisChapter is to examine the impact of the glo-bal economic crisis on both the non-planta-tion and plantation agricultural sectors, es-pecially on farmer incomes as well as on theoverall food security situation for the coun-try.

5.2 Foodflation to Weakening Commod-ity PricesBefore proceeding directly to examine theimpact of the global economic crisis on the

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1 The GDP and labour force share in the agricultural sector has declined from 20 to 12 per cent and from 36 to 32 per cent, respectively,over the period 2000-08.

Global Economic Crisis and Agriculture Sector in Sri Lanka

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agricultural sector, assessing the transforma-tion from 'foodflation' to weakening com-modity prices is in order. The prices of mostcommodities rose sharply from mid-2007,continuing a multi-year upward trend thatbegan in 2002 (Figure 5.1). The surge inprices was led primarily by dairy and grains,but prices of other commodities - with theexception of sugar - also rose significantly(see Figure 5.3). These price increases werelargely driven by financial factors, as well asshifts in the balance between supply anddemand. Oil prices also soared by about 50

Figure 5.1Fluctuations in FAO Food Price Index

Source: Food and Agriculture Organization (FAO) statistics.

per cent in the first half of 2007 contributingto the food price hike to some extent.

There was a complete reversal of the so-calledfoodflation from mid-2008 to date (Figure5.1). Oil prices plummeted by more than 60per cent from their peak levels of July-No-vember 2008. The prices of other commodi-ties have also declined significantly. Themajor contributory factors for the fall in thefood price index were once again dairy, ce-reals and oils and fats, while sugar pricesshowed an upward trend and meat pricesrecorded a late decline (Figure 5.2).

Figure 5.2Food Commodity Price Indices

Source: FAO statistics.


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Prices of grains started to decrease from mid-2008 owing to various factors, of which theemerging financial crisis was also onefactor. Speculators started to move away fromcommodity markets to recover asset positionsin the financial system. The more recentappreciation of the US dollar and falling oilprices contributed to the drop in internationalgrain prices. An upward shift in grain sup-ply, caused partially by better weather con-ditions, and a downward shift in demandfor grains with the worldwide economic slow-down have also pushed prices downwards.The prices of rice and wheat - the mostconsumed grains of importance to Sri Lanka- did not continue to fall in early 2009 asexpected. Prices have stabilized, or haveshown a tendency to increase marginally (Fig-ure 5.3).

The sharp decrease in the price of oil is likelyto have weakened incentives to furtherincrease bio-fuel production, which had beenan important factor in pushing up thedemand for grains in recent time. Most ofthese prices are expected to stabilize, ordecline further, along with the moderationin global demand. However, this will also

depend to an extent on oil price trends overtimes. The observed high price volatility ofgrains is, however, detrimental to long terminvestment in the production of grains andcould affect food security, unless remedialmeasures are taken.

A high degree of price uncertainty and weak-ened international dairy product markets wereobserved in dairy prices. A decline in dairyproduct prices since late 2007 was due largelyto an increase in milk production - assistedby a return of favourable weather conditions- appreciation of the US dollar, and the glo-bal economic downturn. Even though it isnot strictly apparent, the health scare relatedto the melamine contamination of dairy prod-ucts in China may also have caused a dropin demand to some extent, contributing tothe price decline. However, in 2009, somedegree of stability in the dairy market ap-pears to have been established (Figure 5.2).

The above discussion shows that even thoughimport demand in most economies was ex-pected to reduce further with the global eco-nomic crisis, leading to a decline in pricesof food commodities gradually, it had not as

Figure 5.3World Market Prices of Rice and Wheat

Source: FAO statistics.


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yet materialized in the first quarter of 2009.The implications of falling real prices of foodin the world vary depending on whether acountry is a net importer or a net exporter offood, the composition of the food commod-ity bundle being traded, and the magnitudeof price reductions of different commodities.Similarly, at the micro level, the implica-tions of these depend on whether an indi-vidual is a net food consumer or a net foodproducer. Net food consumers gain at timesof falling food prices. Thus, the followingsection will discuss the food security situa-tion of Sri Lanka in order to assess the impli-cations on the plantation and non-plantationagriculture.

5.3 Status of Food Security of Sri LankaIn terms of food consumption, the impact ofthe global economic downturn on Sri Lankadepends basically on the macro and microlevel food security situation of the country.Sri Lanka has been a net food importer since

the time of British colonial rule, and conse-quently has been affected by developmentsin the global food market ever since, bothfavourably and unfavourably. Efforts to breakfree of this dependence through increasedproduction, mainly of the major staple food(rice) have been only partially successfulchiefly due to population growth. In themeantime, changes in demographic structure,increased urbanization along with the 'dem-onstration effect' from developed countrieshave led to increased consumption of someother food items which are largely imported.2

It is clear from Table 5.1 that even thoughSri Lanka has historically been a net foodimporter, more than three-fourths (77 percent) of the food commodities are produceddomestically, while slightly less than one-fourth (24 per cent) is imported. The amountof food exports from total domestic food pro-duction is very insignificant at just over 1per cent. Also, food imports into Sri Lanka

Table 5.1Annual Average Food Availability in Sri Lanka by Major

Food Commodity Groups (2000-07)Commodity Gross Productions Exports ImportsGroups Availability Qty % of Qty % of Qty % of

(000 Mt) (000 Mt) Availability (000 Mt) Availability (000 Mt) Availability

Rice 3,079.8 2,979.1 96.7 3.9 0.1 104.7 3.4

Wheat flour 703.1 0.0 0.0 703.1 100.0

Other cereals 163.8 42.5 26.0 121.3 74.1

Roots, tubers & 404.0 346.7 85.8 57.3 14.2

other starchy food

Sugar 559.4 52.7 9.4 506.7 90.3

Pulses & nuts 144.6 33.4 23.1 111.2 76.9

Vegetables 960.5 841.8 87.6 6.1 0.6 124.8 13.0

Fruits 320.7 282.8 88.2 4.3 1.4 42.3 13.2

Meat 119.8 117.7 98.3 0.1 0.1 2.1 1.8

Eggs 51.4 51.4 100.0

Fish 356.4 294.9 82.8 15.2 4.3 76.7 21.5

Milk 272.4 215.2 79.0 57.2 21.0

Oil & fats 977.6 1,022.6 104.6 61.9 6.3 16.9 1.7

Total 8,113.4 6,280.7 77.4 91.6 1.1 1,924.2 23.7

Source: Department of Census and Statistics, Food Balance Sheet, various years.

2 Local populations may be influenced by the 'demonstration' of different food habits and modern life styles, especially from developedcountries through advertising.


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have accounted for only 7-8 per cent of SriLanka's total imports in recent years. At in-dividual commodity level, local productionof all major food items except wheat flour,other cereals, sugar, and pulses and nutswhich are imported in bulk quantities, ex-ceed 75 per cent of total availability. Fish,milk, fruits, onions, and potato are the othermajor items that are imported in significantquantities, while coconut and fish are thetwo major food commodities exported, butin small proportions - i.e., 6 per cent and 4per cent of gross availability, respectively.Hence, the impact of the global economiccrisis on domestic producers is minimal ex-cept for a few individual commodities thatSri Lanka imports in larger quantities as thecountry is not heavily dependent on theworld food market at the macro level.

At the micro level, the importance of foodin the consumers' consumption basket is thekey determinant in deciding the impact ofprice changes on individuals. Food accountsfor a significant share of total consumer ex-penditure, having a share of 48 per cent atthe aggregate level while it exceeds 60 percent in the lower two income deciles. There-fore, the global economic downturn, and theresulting changes in supply and prices ofmajor food commodities of importance toSri Lanka, has some impact on domestic con-sumers at the micro level.

The following section will evaluate the lossesand gains of changing food prices to the coun-try as a whole, and to the individual pro-ducer and consumer. More importantly, itwill assess how far the Sri Lankan food mar-ket follows changes in the world market.

5.4 Impacts on the Non-plantationSectorRising prices of world food commoditiessuch as wheat, milk powder, dhal, etc., ex-erted significant pressure on Sri Lanka's im-port bill and added to cost-of-living pressures

until mid-2008. Food price increases - someof it contributed through higher import prices- are likely to have eroded the already con-strained purchasing power of consumers, es-pecially the urban and the estate poor. Aconstraint on household food consumptioncan have other downside adverse effects. Itcan encourage a shift in consumption to evenless balanced diets, worsening the dietaryhabits of the poor.

On the other hand, food price increases arelikely to have contributed positively to liftthe income of agricultural sector employees,particularly the rural poor, whose livelihoodsare predominantly in agriculture. Further,price increases of imported food items mayalso have encouraged more competitivebehaviour amongst local producers. To someextent, it created opportunities for local pro-ducers to popularize domestic substitutessuch as fresh milk for milk powder. How-ever, short run measures taken by the gov-ernment to bring down escalating food prices- such as imposing price ceilings on rice andmilk powder, and reducing the import dutyon edible oils - were effective in stabilizingprice levels to some extent.

Commodity price declines in the interna-tional market during the latter part of 2008caused by the contraction in world demandfor most commodities, including crude oil,resulted in a decline in the international pricesof food items like milk powder, sugar, dhal,etc., which are of import interest to Sri Lanka.

As Figure 5.4 shows, Sri Lanka's food pricesfollowed world price declines for the mostpart, not only in major imported food com-modities but also items which are importedin lesser quantities. A slight reduction, ornear stability, in the prices of most of thecommodities is seen since early 2009 fol-lowing the trend in world price declines.Price reductions would have thus benefiteddomestic consumers to a certain extent. How-


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ever, since the drop is not comparable to thelevels that existed in the same period priorto the price increases in 2007, the benefit toconsumers would depend largely on increasesto their real income.

Domestic farmers too are unlikely to havebeen adversely affected by the world pricedeclines, as the bulk of the volume of mostfood commodities are domestically produced

Figure 5.4Retail Price Fluctuations of Select Commodities

Source: CBSL and HARTI.

as explained in the preceding section on thestatus of food security in Sri Lanka. Even incommodities having a bulk import share, thenegative impacts on farmers are minimalsince the price drop started from the peaksreached in early 2008, and the magnitude ofthe decline is less.

In terms of the production of non-plantationcrops, there is no significant change in the

Figure 5.5Cultivated Extent, Production and Average Yield of Select Food Crops

Source: CBSL and Department of Census and Statistics.


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extent of production, volume, and yield inrecent years, except for a few isolated casessuch as big onions (Figures 5.5). Since mostof these crops are used only for domesticconsumption, or are exported in minor quan-tities, and the import content is also verylow, the impact of the global economicdownturn on the production of these com-modities is negligible.

5.4.1: Rice: The Staple Food

Speculative behaviour of oligopolist rice trad-ers/millers resulting from the internationalprice hike caused a sharp increase of pricesof all varieties of rice during mid-2007 tomid-2008 (Figure 5.6). Unfavourable weatherconditions that damaged a part of the 2007Maha harvest, and the substitution effect dueto increased price of wheat flour also con-tributed to this price shift. Since this exceededthe seasonal price fluctuation in the ricemarket during the same period, the govern-ment intervened in the rice market by relax-ing the specific duty on rice imports and set-ting a maximum retail price. Even thoughthis stabilized the retail price of rice at acertain level, it also prevented the normalbehaviour of the rice market.

Figure 5.6Price of Rice and Wheat Flour in the Colombo Market

Source: CBSL and HARTI.

As a result, though a sharp increase of the2008 Yala harvest - resulting largely from theincreased cultivated extent - would have oth-erwise exerted downward pressure on prices,the price of rice did not decline below 60Rs./kg (Figures 5.6 and 5.7). This was wellabove the prices that prevailed during thesame period in 2007 (Figure 5.6). Increasedproduction can be attributed to more favor-able weather, and increased extent of landbrought under cultivation in the Eastern Prov-ince and other areas under the government's"Api Wawamu-Rata Nagamu" campaign.Nonetheless, the yield decline from 2007 to2008 indicates that the level of productionhas not increased in proportion to the extentof cultivation.

Even though the world price hike in rice wasreflected in prices charged by local traders,the recent world price decline due to thecontraction in world demand has not beentransmitted to domestic consumers on ac-count of government intervention. If Figures5.3 and 5.6 are compared, it is evident thatthe world rice price decline in early 2008 ismuch sharper than that seen in Sri Lanka.This is the case in wheat flour too. Even if


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no government intervention was in place, itis questionable whether the presentoligopolistic market structure operating in SriLanka would allow for any such price de-cline. The impact of the world price declineon paddy farmers is, therefore, minimal asthe private millers buy paddy above the stateguaranteed price which is adequate to coverthe costs of milling, transport, storage, orretailing margins at the existing retail price.

5.5 Impact on the Plantation SectorAlthough falling prices have a beneficial ef-fect on reducing inflationary pressure in the

economy, the loss of export revenues willhave a negative impact on the income ofbusinesses and the government (especiallythrough taxes and state exports). This comesprimarily through the plantation sector -dominated by tea, rubber, coconut, and mi-nor export crops (MECs) - which is an im-portant sector in terms of the contribution toGDP, export revenue, and employment gen-eration.

5.5.1 Tea Sub-sectorTea is comparatively price inelastic due tothe habit forming property of caffeine con-

Figure 5.7Extent, Production and Average Yield of Paddy

Source: CBSL and Department of Census and Statistics.

Figure 5.8Value of Tea Exports (2007-08)



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taining beverages. Further, tea has gainedpopularity in recent times due to its healthrelated benefits. Along with the food pricehike, tea exports from Sri Lanka increasedsubstantially from April 2007 to a peak levelin July 2008 (Figure 5.8).

The export increase is attributed at the do-mestic level to increases in production dueto favourable weather conditions, undisturbedfactory operations, etc. The rise in global teaprices along with the general commodityprice boom acted as an external factor in en-couraging higher production. The demand fortea was strong in economies that benefitedfrom the international oil price boom, andare of particular export interest to Sri Lanka.As evident from Figure 5.9, tea prices followthe same pattern as oil prices for the mostpart. Since oil exporting nations from theMiddle East, North Africa, Russia and someCIS countries together absorb more than 75per cent of Sri Lankan tea exports, Sri Lanka'stea sector was in a much better position to

Figure 5.9Trends in Crude Oil and Tea Prices

Source: Sri Lanka Tea Board, CBSL, and US Energy Information Administration.

gain from the global economic conditionsthan many other countries.

However, with the onset of the global eco-nomic downturn, commodity prices beganto ease from mid-2008. For instance, globaloil prices began to decline from July 2008.Tea prices too began to decline from Sep-tember 2008 as demand for tea began to con-tract, spurred by both depressed demand aswell as the emerging global liquidity con-straints impacting major trading companies.The price decline effect was reflected in SriLanka's export revenue from tea in the fourthquarter of 2008. Although total exports oftea in 2008 surpassed that of 2007, the per-formance in the fourth quarter of 2008 isindicative of the consequences of globalmarket conditions. A domestic supply shockresulting from unfavourable weather condi-tions, in combination with the decline inauction prices, caused a further fall in teasupply in the first quarter of 2009 (Figure5.10).


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Source: Sri Lanka Tea Board and CBSL.

Figure 5.10Tea Production (2007-09)

The current developments have serious im-plications for the future of the tea industry,particularly in the context of rising costs ofproduction. Production costs have been in-creasing, especially in the last few years, dueto higher labour costs - constituting about60 per cent of total costs - and higher input

prices such as on fertilizer (Figure 5.11).Nitrogen fertilizer, such as urea application,is very important for tea production as it isbased on the harvesting of young leaves whichrequires nitrogen for its growth (Figure 5.12).Thus, the increase in urea prices has a majorimpact on tea production.

Figure 5.11Cost of Production of Tea, Rubber and Coconut (1994-2008)

Source: Department of Census and Statistics.


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Figure 5.12Monthly Fertilizer Use and Tea Production (2007-08)

Source: CBSL.

5.5.2 Rubber Sub-sector

Despite an escalation in the cost of produc-tion of rubber as evident from Figure 5.11,rubber production recorded a substantial in-crease in 2008 - though production was ini-tially subject to the adverse affects of highrainfall in the first half the year (Figure 5.13).

The increase in rubber production was drivenmainly by higher international oil priceswhich has a bearing on the demand for syn-thetic rubber. The price of synthetic rubberescalates with oil price hikes, increasing thedemand for natural rubber. Rubber produc-tion continued to show positive trends eveninto the first half of 2009.

Figure 5.13Rubber Production

Source: CBSL.


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The prices of thick pale crepe (TPC), ribbedsmoked sheets (RSS), and brown crepeincreased continuously to peak in June 2008- the highest ever price recorded at theColombo Rubber Auctions in RSS (Figure5.14). However, the global economic melt-down has caused rubber prices to decline

since. The major causal factor for this wasthe shift in demand from natural rubbertowards synthetic rubber with the decline inoil prices. The most recent data suggests thatprices have stabilized, and even picked upmarginally.

Figure 5.14Price of Rubber (2007-09)

Source: Colombo Rubber Traders Association.

Figure 5.15Export Values of Rubber (2007-08)



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Despite the drop in rubber prices, produc-tion levels have not been affected thus far aspreviously discussed. Nonetheless, the pricedecline has resulted in a drop in export valuein the fourth quarter of 2008 (Figure 5.15).More recently, rubber prices have shown somesigns of a reversal in prices in mid-2009, rais-ing the possibility of increasing export rev-enues. Much will depend on the behavior ofoil prices in the near future.

5.5.3 Coconut Sub-sector

Coconut production recorded a marginalgrowth in 2008, mainly due to the improvedperformance in the second half of the year asa result of improved weather conditions. Thefirst half of 2008 saw the coconut sector suf-fering from the adverse effects of a droughtin the previous year, and production lossesdue to diseases. However, production levelsin late 2008 and early 2009 were quite satis-factory (Figure 5.16).

The prices of coconut and coconut-basedproducts, including coconut oil and desic-cated coconuts (DC) at the Colombo Auc-tion, increased substantially during the first

half of 2008 - continuing from price increasesexperienced from 2007. However, pricesbegan to decline in the second half of 2008(Figure 5.17). The higher price for coconutand coconut-based products in the first halfof 2008 can be attributed to high domesticand international demand along with supplyshortages, and the increase in world demandfor coconut oil for bio-fuel production.

However, higher production of coconuts inthe latter part of 2008, together with thedecline of petroleum prices - that reduceddemand for bio-fuel - and changes introducedto the duty structure of imported edible oils,contributed to pull down the price of coco-nuts and coconut-based products towards theend of 2008.

5.5.4 Minor Export Crops

The production and exports of minor exportcrops have shown mixed performances in2008. The production and exports of clovesand cocoa increased in 2008 compared tothe previous year. On the other hand, carda-mom, pepper, and cinnamon saw a declinein production (Figure 5.18). However, pro-duction and exports of these products in the

Figure 5.16Coconut Production (2007-09)



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Figure 5.17Prices of Coconut Products (2007-08)


fourth quarter of 2008 were badly affectedby the decline of world demand due to theglobal economic crisis. Accordingly, pricesof these products also dropped, especially

the price of cinnamon. Apart from reducedexport demand, the production of certaincrops like pepper has been affected by heavyand continuous rainfall in major pepper grow-

Figure 5.18Export Volumes of Select Minor Export Crops



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ing areas, and the imposition of certain traderestrictions under the India-Sri Lanka Bilat-eral Free Trade Agreement (ISBFTA) that hascurtailed growing pepper exports to India.

5.6 Policy Responses AdoptedSri Lanka dealt with the problem of high foodprices in different ways - i.e., with directcontrols and indirect support for the devel-opment of the agriculture sector. For example,in the first half of 2008, a single compositelevy was introduced - instead of customs dutyand other applicable taxes - on eleven essen-tial food items. Moreover, duties applicableon some items such as potatoes, big onions,green gram, etc. were reduced to provide re-lief to consumers. With the aim of control-ling the rapid increase of rice prices in thelocal market, the government specified maxi-mum retail prices for different grades of ricein April 2008, and also raised the customsduty on rice imports in August 2008. In ad-dition, the government continued to providea fertilizer subsidy for paddy farmers amount-ing to Rs. 26 billion in 2008, even in themidst of soaring international fertilizer prices.

Without limiting initiatives to direct pricecontrols alone, the government has takenseveral measures to improve the productiv-ity of the domestic agricultural sector to miti-gate the impacts of price fluctuations. Thesemeasures include the implementation of the"Api Wawamu-Rata Nagamu" programme toimprove domestic agriculture production,revitalizing co-operatives, 'Lak Sathosa' out-lets, etc. to distribute essential commoditiesto consumers at concessionary prices, andthe introduction of new cess rates on theimportation of some food items which canbe grown domestically such as grains andfruits.

Making the domestic dairy industry competi-tive in the face of increasing world milkprices has also received policy attention. Toharness opportunities for dairy development,a special credit package, namely the Agro-Livestock Development Loan (ALDL) schemewas introduced for the dairy sector in 2008.Under this scheme, Rs. 5000 million is tobe disbursed for small dairy projects and formilk and crop processing industries at con-cessionary interest rates.

Relevant authorities have also taken actionto control the supply of tea in order to miti-gate the impacts of a demand drop and re-sultant price decline. These include mini-mizing the tea supply at the Colombo TeaAuction (CTA), restricting plucking only totop quality leaves, and the introduction ofpruning in order to induce the vegetativegrowth of the plant as a future investmentduring the period of low prices. Further, de-cisions have been taken to provide loans ofone month's working capital to tea facto-ries, suspend the reform of loans extendedfor tea factory modernization under a plan-tation development programme for a periodof one year, establish a tea trading institu-tion to intervene in tea auctions, maintain acess on tea imports, and provide a fertilizersubsidy for tea small holders.

A fiscal stimulus package was introduced torevitalize the rubber industry and mitigatethe downside risks arising from the globaleconomic crisis. The measures include theimplementation of a support price schemefor the purchase of rubber latex, and an in-crease in the cess to enhance demand fordomestic rubber latex.3 Further, measureswere taken to reduce the cost of productionby suspending the export cess collected fromthe domestic rubber manufacturing industries

3 Rs. 150 per kg support price was introduced for rubber latex, while a cess on imported natural rubber latex and imported synthetic rubberwas increased to Rs. 25 and Rs. 35 per kg., respectively.


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for a period of one year, suspend the dutysurcharge on electricity, and reduce the priceof furnace oil. A scheme for providing finan-cial assistance to encourage local manufac-turing of tyres which are imported was alsointroduced by the government. Productivityimprovement programmes such as traininglatex harvesters and bud grafters, cost cut-ting programmes such as introducing newcover crops to reduce nitrogen fertilizer re-quirement, and the application of paddy strawto reduce potassium fertilizer cost have alsobeen introduced at the producer level.

The government has taken several short termand long term measures to improve the per-formance of the coconut industry. A dutywaiver granted on the importation of palmoil and coconut oil was reduced in mid-2008,and was later removed.4 The Coconut Re-search Institute (CRI) has been encouragedto continue its research activities to improvethe productivity, crop conservation, and theintroduction of new coconut-based valueadded products.

The government announced several measuresto address the problems faced by cinnamonproducers. These include measures such asgranting of loans to fulfill working capitalrequirements of growers at competitive rates,and the introduction of a special incentivescheme under the Export Development Board(EDB) for cinnamon exporters who purchasecinnamon at guaranteed prices from cinna-mon cultivators.

5.7 Conclusion and Policy Recommen-dationsThe impact of the global economic crisis onthe domestic non-plantation crops and plan-tation sector are different both in terms of

the magnitude and the stage of the valuechain. In terms of the magnitude, the plan-tation sector has been more severely affectedthan the domestic oriented agriculture sec-tor. In spite of falling international commod-ity prices in recent months, in the domesticsector, the food price crisis still continues toan extent. Food price levels remain high, andmay do so at least in the short term. This isprimarily due to the fact that even as priceshave declined, the fact that they started froma peak level means that the rate of declinehas been lower compared to the increase.

Even though Sri Lanka benefits from reducedimport costs as a result, the price impact onoverall food consumption to vulnerablegroups of the population is still high. Thepresent food crisis which started in early2008 was triggered by rapidly rising interna-tional prices of certain food items, and wasdriven by a series of short term factors. Ad-dressing only short term causal factors - thathave reduced food prices to some extent inrecent times - is not sufficient. Long termcausal factors too need to be addressed. Shortterm solutions like price controls should beviewed only as temporary measures to pro-vide relief to consumers. Price controls areunattractive options in the long term as thereis a tendency for them to become a perma-nent feature as has happened in the rice re-tail market. However, many underlyinglonger term factors have been looming in themarket for some time. These include the longstanding problem of stagnating productivityin domestic crops, a decline in real invest-ment in the sector, low value addition, andinadequate technological development.

The latterly seen reversal of commodity priceincreases has not affected domestic produc-

4 With effect from July 2008, the duty waiver granted on importation of palm oil and coconut oil was reduced from 23 per cent to 13 percent. With effect from December 2008, the duty waiver on palm oil and coconut oil was removed, thereby applying a 28 per cent duty onimportation of palm oil and coconut oil (CBSL, Annual Report 2008).


78

ers to any great extent. However, since thecost of production has been rising continu-ously in the absence of significant improve-ments in productivity, price controls willabsorb profit margins of farmers, making themvulnerable to future shocks. Hence, it is ofthe utmost importance that the governmentsreviews the current price controls in order toensure the development of a sustainable ag-ricultural sector in the country. In view ofadverse impacts arising from the current glo-bal economic crisis, state support may beconsidered favourably in the short and me-dium term only.

Thus, while implementing short term mea-sures to safeguard the livelihoods of vulner-able people from the adverse effects of pricebubbles, it is important to adopt long termmeasures. Productivity and quality improve-ments through technological progress, whichis more or less absent at present, appears tobe the most viable solution for the agricul-ture sector to cope with future shocks. Fur-ther, without limiting measures to only in-crease production, more attention is alsoneeded on marketing, extension, and researchand development aspects as well. Such mea-sures will improve competitiveness and miti-gate future downside risks.

The plantation sub-sector consisting of tea,rubber, and coconut all face a common setof problems. Inadequate productivity growthis the major factor of which the primarysource is the slow progress made in technol-ogy development. The flow of cess funds tobe utilized for the development of the in-dustry is critical. Supply of improved plant-ing materials, increased inter-cropping prac-tices, and more usage of trained skilled labourare important factors for plantation manage-ment. The government should seriously studythe key recommendations of the D.E.W.Gunasekara and Piyadigama Reports on theplantation sector and consider implement-ing some of these which are crucial for im-proving productivity of the sector.

On the production side, the major problemis the adherence to bulk primary product ex-ports. Bulk black tea, smoked sheet rubber,and desiccated coconut are the major exportsof the three industries, despite growing op-portunities to diversify the product base byadding value, and thereby increasing revenuesas well. Securing the participation of the pri-vate sector can be one way of circumventingthis problem. Further, market diversificationby seeking untapped foreign markets shouldalso be pursued vigorously.

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6. Economic Crises and Poverty: Special Focus on Sri Lanka's Estate Sector

6.1 IntroductionThe current world economic crisis threatensto hamper global poverty alleviation efforts,and indeed reverse some of the gains thathave been made in recent years. Most devel-oping countries are experiencing reductionsin export earnings and GDP growth, whichinevitably will have adverse effects on em-ployment and earnings, and thus on povertyand social welfare. The World Bank, for in-stance, estimates that 90 million more peopleacross the world can be trapped in povertyas global economic growth slows down in2009 - on top of an estimated 130-155 mil-lion people already pushed into poverty in2008 due to soaring food and fuel prices.1 Itfurther projects that more than 1 billionpeople could go chronically hungry in 2009.The past experiences of crises shows that itmay harm human development in four ways:by increasing poverty, worsening nutrition,reducing the quality and supply of educa-tion and health services, and wiping out themeagre savings and wages of poor people.This scenario would set back the fight againstpoverty. Indeed, the World Bank estimatesthat a one percentage point reduction in GDPgrowth could trap 20 million more peopleinto poverty.2

Sri Lanka too is likely to face significant ad-verse effects in its drive to alleviate povertyacross the country. The negative impacts ofthe economic downturn on poverty can of-ten get overlooked as the impacts are feltindirectly. However, the consequences canbe quite severe, particularly for sections of

the population that are already vulnerable andmarginalized in terms of their socio-eco-nomic development.

Declining demand in industrialized countriesfor key exports such as garments and tea willaffect a large number of workers in these sec-tors and their families. Remittances frommigrant workers may also decline due to thecrisis, which will affect not only the fami-lies of the migrant workers in Sri Lanka, butalso hold wider economy-wide implications.Impacts on employment are on the rise.While employment losses may be felt mostlyin the urban sector, the consequent effect onthe rural economy and income levels of therural households cannot be underestimated.

In this regard, the estate sector of the countryis likely to be hit far harder than many othersectors, with declining incomes from tea ex-ports being a key channel of transmission.Disaggregated poverty statistics for Sri Lankaindicate an increasing trend in estate sectorpoverty, while poverty levels for the rest ofthe country and other sectors have been onthe decline. Thus, examining the extent andthe ways in which the current global eco-nomic crisis and general slowdown in eco-nomic activity in Sri Lanka will affect pov-erty and welfare of estate sector workers istimely.

The Chapter initially provides an overall pic-ture of the state of poverty in Sri Lanka andthen goes on to focus on the present poverty

1 http://www.worldbank.org/html/extdr/financialcrisis/bankinitiatives.htm2 http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTPOVERTY.


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situation that exists in the country's planta-tion estate sector. Thereafter, the discussionanalyses the role played by the estate sectorin the economy and how the economic per-formance of the sector is being affected bythe current economic downturn. Finally, thechannels of transmission of the economicshock to the estate workers are explored toassess the degree to which the welfare of es-tate sector workers is likely to be impacted.

6.2 Poverty in Sri LankaAlthough Sri Lanka is a developing country,most of the human development indicatorsfor health and education in Sri Lanka are nowalmost on par with the developed world. SriLanka has already achieved - or is well ontrack to achieve - the Millennium Develop-ment Goals (MDGs) of most of the healthand education indicators. However, improve-ments in the MDG indicators related to eq-uity in education and health do not show

Table 6.1Poverty Trends in Sri Lanka (1990-2006/07)

Sector 1990/91 1995/96 2002 2006/07PHC

Sri Lanka 26.1 28.8 22.7 15.2Urban 16.3 14.0 7.9 6.7Rural 29.4 30.9 24.7 15.7Estate 20.5 38.4 30.0 32.0

PGISri Lanka 5.6 6.6 5.1 3.1Urban 3.7 2.9 1.7 1.3Rural 6.3 7.2 5.6 3.2Estate 3.3 7.9 6.0 6.2

SPGISri Lanka 1.8 2.2 1.6 0.9Urban 1.3 0.9 0.5 0.4Rural 2.0 2.5 1.8 1.0Estate 0.9 2.5 1.8 1.8

Notes: PHC = Poverty Head Count; PGI = Poverty Gap Index; SPGI = Squared Poverty Gap Index.Source: Department of Census and Statistics, Household Income and Expenditure Survey (HIES) for

1990/91, 1995/06, 2000, and 2006/07.

3 It should be noted that the Household Income and Expenditure Survey (HIES) conducted by the Department of Census and Statistics (DCS)did not cover the Northern and Eastern Provinces in 1990/91, 1995/96 and 2000, while the 2006/07 survey covered the Eastern Province.

4 However, the more recent price increases of most consumer items may have increased the poverty headcount which may get reflected inthe next HIES, expected to be conducted in 2012 after the next Census of Population in 2011.

5 The Poverty Gap Index ((PGI) is a measure indicating the depth of poverty. This is simply the sum of all the poverty gaps in the population,which can be used as an indicator of the minimum cost of eliminating poverty using perfectly targeted transfers. The Squared Poverty GapIndex ((SPGI) indicates the severity or inequality of poverty and gives more weight to the poorest of the poor.

similar improvements. Thus, a key concernremains the continued existence of signifi-cant variations between sectors and regions.

The national poverty headcount - the per-centage of the population below the pov-erty line - computed by the Department ofCensus and Statistics (DCS) for Sri Lankadeclined from 26.2 per cent in 1990/91 to15.2 per cent in 2006/07.3 During the pe-riod from 1990/91 to 1995/96, the povertyheadcount increased by 2.7 percentagepoints, while during the period from 1995/06 to 2000, the headcount actually decreasedby 6.1 percentage points. The period from2000 to 2006/07 shows a decline of 7.2percentage points, which is remarkable.4

Other measures of poverty show similartrends,5 resulting in a decline in the PovertyGap Index (PGI) from 5.6 in 1990/91 to 3.1in 2006/07 at the national level. In the

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Economic Crises and Poverty: Special Focus on Sri Lanka’s Estate Sector

urban sector,6 the PGI has declined by nearlytwo-thirds (from 3.7 in 1990/91 to 1.3 in2006/07). In the rural sector,7 the PGI hasdeclined from 6.3 in 1990/91 to 3.2 in 2006/07. In the estate sector,8 it has increased from3.3 to 6.2 during the same period. TheSquared Poverty Gap Index (SPGI) has alsoincreased from 0.9 to 1.8 in the estate sectorduring the same period, indicating that theseverity of poverty also has increased in thissector between 1990/91 and 2006/07.

The urban sector reported the lowest SPGIand the highest Gini co-efficient among thesectors.9 The SPGI measures inequalityamong the poor, while the Gini co-efficientmeasures overall inequality, when both poorand non-poor are considered together. Thisshows that inequality among the poor is lowin the urban sector, although overall inequal-ity is high. The situation in the estate sectoris exactly the opposite, except in 1990/91when both the SPGI and the Gini co-effi-cient were lowest in the estate sector.

The SPGI for the estate sector shows that in-equality among poor who stay below thepoverty line is highest in the estate sectorcompared to the other two sectors. On theother hand, a low Gini co-efficient for the

Table 6.2Inequality: Gini Co-efficient of Per Capita Expenditure

Sector 1990/01 1995/96 2000 2006/07Sri Lanka 0.32 0.35 0.40 0.41Urban 0.37 0.38 0.42 0.46Rural 0.29 0.33 0.39 0.39

Estate 0.22 0.20 0.26 0.23

Source: DCS, HIES for 1990/91, 1995/96, 2000 and 2006/07.

estate sector shows that even the non-poorare also not much far above the poverty line.Most of them could be clustered just abovethe poverty line. As such, they could slipeasily into poverty due to any economicshock. These could take the form of priceincreases, low demand for plantation exports,adverse weather conditions, etc. Even in theother two sectors, people clustered just abovethe poverty line are vulnerable to economicshocks.

The urban sector shows a continuous reduc-tion in poverty from 16.3 per cent in 1990/91 to 6.7 per cent in 2006/07, already pass-ing the expected MDG target of 8.1 per centto have been achieved by 2015. The ruralsector, accounting for nearly 80 per cent ofthe population, is the main contributor tothe reduction of poverty at the national level.The poverty headcount for this sector hasfallen from 29.4 per cent in 1990/91 to 15.7per cent in 2006/07, nearing the expectedMDG target of 14.7 per cent to be reachedin 2015. If the present trend continues, thetarget could be achieved before 2015. Thisremarkable improvement can be attributedto various rural development programmes thatare being implemented to improveurban-rural connectivity, access to basic

6 Areas under Municipal Councils (MCs) and Urban Councils (UCs).7 Comprises all areas other than the MC areas, UC areas and the estate sector.8 Consists of all plantations which are 20 acres or more in extent, and with 10 or more resident labourers.9 The Gini co-efficient which ranges from zero to one explains the total inequality of a distribution. The higher the Gini co-efficient, the greater

the income or expenditure inequality.


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needs such as health, education, marketing,banking, etc.

The incidence of poverty in the estate sec-tor, accounting for around 5.5 per cent ofthe total population has increased from 20.5per cent in 1990/91 to 38.4 per cent in 1995/96. Despite an improvement thereafter - witha decline in the headcount to 30 per cent in2002 - poverty levels in the estate sector con-tinue to remain high compared to the othersectors. The poverty headcount in this sec-tor increased further in 2006/07 to 32 percent, while the other two sectors experienceda decline (Table 6.1).

6.2.1 Explaining Poverty in the EstateSector

Despite the fact that the estate sector ac-counts for only 11.3 per cent of total pov-erty in Sri Lanka in 2006/07, the incidenceof intra-sector poverty is highest in this sec-tor (32 per cent) as previously discussed. Allpoverty indicators - PHC, PGI, SPGI, Gini-coefficient, etc. - show that the majority ofthe poor in the estate sector are clusteredaround the poverty line and, therefore, arehighly vulnerable to economic shocks. A

number of other indicators also show thatinadequate infrastructure facilities, poor ser-vice delivery mechanisms, etc., are still af-fecting the quality of life of the people livingin the estate sector. There are some gradualimprovements. For instance, some plantationcompanies provide better welfare facilitiesrelative to some others owned by private in-dividuals.

Table 6.3 clearly indicates that key indica-tors - mean household income, per capitaincome, income receiver's mean income,mean household expenditure, etc. - do poorlyin the estate sector compared to the othertwo sectors. While all previous surveys alsoshowed a similar pattern, the differences be-tween the mean household incomes of ruraland estate sectors were not high in earlierperiods (Table 6.4).

The food ratio - proportion of expenditure onfood and drink to total expenditure - is anindirect indicator of development and livingconditions. It is presumed that the lower thefood ratio, the better are living conditions. Inthe estate sector, the food ratio in 2006/07was 52.7 per cent which is much higher than

Table 6.3Household Income and Expenditure Patterns by Sector (2006/07)

Sri Lanka Urban Rural Estate

IncomeMean HH income per month (Rs.) 25,414 42,878 22,979 15,724Per capita income per month (Rs.) 6,235 9,989 5,713 3,637Income receiver’s mean income per month (Rs.) 13,705 21,842 12,686 7,290

Average HH size 4.1 4.3 4.0 4.3No. of income receivers 1.8 1.9 1.8 2.1ExpenditureMean HH expenditure per month (Rs.) 22,671 37,978 20,620 12,879

Food ratioa 35.8 27.9 37.6 52.7

Gini co-efficient of HH expenditure 0.42 0.45 0.40 0.25

Note: a: The proportion of expenditure on food and drink to the total expenditure.

Source: DCS, HIES of 2006/07.

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the other two sectors. A low Ginico-efficient of household expenditure (0.25)in the estate sector indicates a homogeneoushousehold expenditure pattern.

The Wealth Index is a socio-economicindicator that is used as a proxy for long termliving standard of a household. It is basedon data relating to ownership of consumergoods, dwelling characteristics, drinkingwater sources, toilet facilities, and othercharacteristics related to the socio-economicstatus of a household. Table 6.5 gives thedistribution of household population intofive wealth quintiles by sector. The dataillustrate that almost half the population inthe urban sector (49.2 per cent) is in thehighest wealth quintile. In the estate sector,nearly two-thirds (64 per cent) is in thelowest quintile and only 1.3 per cent in thehighest quintile. Moreover, 90.4 per cent isin the lowest and second quintiles combined.This further confirms that living conditionsin the estate sector are still very poor,

Table 6.4Average Monthly Household Real Income by Sectorsa

Survey Year All Sectors Urban Rural Estate1980/81 881 1,274 795 7531990/91 1,125 2,151 864 7611995/96 1,177 2,044 1,064 7382002 1,362 2,386 1,246 777

2006/07 1,838 3,101 1,662 1,137

Note: a: At 1980/81 constant prices.

Source: HIES, 1980/81 to 2006/07.

although there is a gradual improvement. Inthe rural sector, the population is found tobe more evenly distributed.

The data in Table 6.6 on early childhoodmortality rates show that most indicators aremuch higher in the estate sector comparedto the other two sectors. As such, allindicators related to nutritional status ofchildren and early childhood mortality rates(especially infant mortality and under-fivemortality) are significantly higher in the caseof the estate sector. It has been observed thatthe mother's education is highly correlatedto the nutritional status of their children, aswell as early childhood mortality.According to the Demographic and Health

Survey (DHS) of 2006/07, 19.9 per cent ofwomen in the estate sector have had noeducation, and another 29 per cent have notcompleted their primary education. Thus,nearly 50 per cent of women in this sectorhave a very poor level of education.

Table 6.5Wealth Quintiles by Sector

Wealth Quintile Total Urban Rural EstateLowest 20.0 8.3 19.2 64.0Second 20.0 9.9 21.3 26.4Middle 20.0 12.4 22.0 5.8Fourth 20.0 20.1 21.0 2.5Highest 20.0 49.2 16.5 1.3

Total 100.0 100.0 100.0 100.0

Source: DCS, Demographic and Health Survey of 2006/07.


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A mother's health and nutrition are directlylinked to the health and nutritional status oftheir children. But, accessing health care isanother major problem that women in theestate sector face. Various factors can pre-vent women from getting medical advice ortreatment as indicated in Table 6.7. Accord-ingly, nearly 77.4 per cent of the women inthe estate sector have at least one major prob-lem in accessing health care. Out of the dif-ferent type of problems, 'distance to healthfacility' is the main problem for more than50 per cent of them. Two other reasons fornot seeking medical advice or treatment are'getting money for treatment' (49.2 per cent)and 'having to take transport' (47.4 per cent).

Table 6.6Early Childhood Mortality Rates (2006/07)a

Type of Mortality All Sectorsb Urban Rural EstateNeonatal mortality 11 6 15 18

Post- neonatal mortality 5 3 4 11

Infant mortality 15 10 19 29

Child mortality 5 9 3 5

Under-five mortality 21 19 23 33

Note: a: For the ten year period preceding the survey; b: For the year preceding thesurvey year of 2006/07.

Source: DCS, DHS of 2006/07.

This clearly shows that the lack of suitablehealth care facilities in close proximity isone of the major problems that prevent manywomen from seeking medical care.

Nutrition is one of the most vital require-ments for child survival and early childhooddevelopment.10 Damage in early childhoodcan have serious long term effects on anindividual's well-being and that of the nextgeneration. When children's cognitive devel-opment is impaired, particularly before twoyears of age, the effects may be irreversible.Under-nourished girls face higher risk ofmaternal and child mortality. They also havea greater probability of low birth weight and

Source: DCS, DHS of 2006/07.

Type of Problem All Sectors Urban Rural EstateGetting permission to go for treatment 3.0 3.8 2.3 14.4Getting money for treatment 22.3 19.2 21.2 49.2Distance to health facility 19.5 9.9 19.2 50.6Having to take transport 19.3 10.1 19.1 47.4Not wanting to go alone 21.6 24.9 20.5 30.8Concern no female provider available 7.5 9.9 6.4 20.2Concern no provider available 8.2 9.4 6.8 29.0Concern no drugs available 9.4 10.4 8.1 28.5At least one of the problems of 47.3 44.5 45.9 77.4accessing health care

Table 6.7Problems in Accessing Health Care (2006/07)

10 See discussion on "Crises and Vulnerability: Improving the Nutritional Levels of Children" in Policy Brief 10 of this report.

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stunting of their own children - problemsthat are often compounded by an early startto childbearing among poor women. Accord-ing to the DHS of 2006/07, 9.6 per cent ofwomen aged 15-19 years in the estate sectorhave begun childbearing, compared to 6.4per cent and 6.2 per cent in the urban andrural sectors, respectively.

Table 6.8 gives some of the housing charac-teristics that can be used to compare the liv-ing conditions of people in the three sectors.All the characteristics appear to indicate thatthe living conditions of the people in theestate sector are still at a lower level thanthose in the other two sectors.

6.3 The Estate Sector in the Sri LankanEconomyAs discussed previously, all indicators onpoverty, nutrition, health, housing, etc. in-dicate that the socio-economic conditionsin the estate sector are still relatively weak.Indeed, the estate sector related poverty fig-ures show a worrisome picture, showing nosigns of improvement while the other sec-tors of the economy show positive trends. In

Table 6.8Housing and Related Characteristics (2006/07)

Percentage of Households (HHs) Sri Lanka Urban Rural EstateWithout exclusive bedrooms 2.6 3.9 2.1 6.1

With only one bedroom 23.2 26.8 21.1 44.4

With safe drinking water 85.7 97.2 85.9 50.6

With semi-permanent wall 11.6 7.8 12.1 14.3

Floor 13.1 3.2 14.4 19.5

Roof 17.7 12.9 14.9 72.9

With floor area less than 100 sq.ft. 4.9 2.1 4.9 11.9

With toilet (for exclusive use of HH) 90.0 87.2 91.5 73.0

Using electricity for lighting 80.4 94.2 78.8 67.0

Using firewood as cooking fuel 80.0 38.3 86.2 98.1

Using gas as cooking fuel 16.2 48.5 11.6 0.5

Source: DCS, HIES of 2006/07.

addition to some of the factors underlyingthese developments, some part of the prob-lem lies in the roots of the formation of theestate sector, the significant role it has playedin the economy in the past, and the chang-ing role of the estates in the economy atpresent.

The Sri Lankan economy had a long historyof heavy dependence on a few primary com-modities, primarily tea, rubber and coconut.Despite emerging evidence of unfavourableterms of trade for primary commodities, SriLanka failed to diversify away from a planta-tion agricultural export base until the open-ing up of the economy in the late 1970s.Nationalization of the plantation sector inthe 1970s - with management vested in theJanatha Estate Development Board (JEDB)and State Plantation Corporation (SPC) - wasaccompanied for the most part by poor per-formance. The privatization of plantationsbegan actively in the early 1990s. In 1992,out of a total of 502 estates, 449 estates wereformed into 23 Regional Plantation Compa-nies (RPCs) and their management handedover to 23 private sector companies, initially


86

for five years. In 1995, the management wasleased and vested in 21 RPCs for 99 yearsinitially, which was later reduced to 53 years.

6.3.1 Role of Plantation Crops in theEconomy

With the liberalization of the economy andmanufactured export thrust, the role of theplantation crops in the economy also

changed. Plantation crops which accountedfor about 95 per cent of total exports in the1950s saw its share decline to about 75 percent in the 1970s. Tea exports played a keyrole, accounting for close to half of totalexports by the late 1970s. By the 1990s,industrial products had come to dominateexports, although agriculture continued toaccount for about 35 per cent of exports,

Table 6.1Value of Exports of Tea, Rubber and Coconut

Note: As a percentage of total exports.Source: CBSL, Annual Report, various issues.

Table 6.2GDP Contribution of the Plantation Crops


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while the contribution of the tea sector hadreduced by half to 25 per cent.11 In morerecent years, the shares have fallen further -with agriculture accounting for less than 20per cent of total exports and the share of teaexports declining to around 12 per cent (Fig-ure 6.1).

As mentioned already, the plantation sectorhas undergone various stages of transforma-tion, including its role in the economy. Al-though it has been well over a decade sincerestructuring of the sector began under pri-vate management, significant improvementsin the corporate plantation sector as a wholecannot be witnessed. Currently, the sector isfaced with problems of low productivity,high cost of production, lack of quality im-provement and marketing practices, low prof-itability and an inability to generate suffi-cient surpluses to maintain its long-termsustainability. Inconsistencies in policy for-mulation towards the sector and externaldemand factors have also been a burden attimes.

Another key area of concern is the continuedexistence of deep rooted problems on thelabour front. This applies mainly to tea, butalso to rubber to an extent, where workersreside in an enclosed structure of estates,separated from the rest of the economy to agreat extent. The roots of plantation labourgo back to the colonial regime, whereby thetransfer of labour from South India to workin the plantations commenced around 1867.Though the labour supply was initially on acontract basis, over time, the workers beganto migrate with families to specific estates.After Sri Lanka achieved independence, theywere classified as temporary immigrants.

Discussions between India and Sri Lanka withregard to future citizenship of such workerssaw the enactment of the Sirima-Shastri Pactin 1964, under which an agreement wasreached to repatriate 600,000 plantationworkers of Indian Tamil origin back to In-dia. A further 375,000 was to be accepted asfranchised citizens of Sri Lanka. The presentestate population is derived from the lattergroup who are now wage employees of theestates.

The total labour force of the plantation es-tate sector was about 550,000 in the 1980s(with State Plantation Companies). Withprivatization in 1992 and the formation of23 RPCs, the management of the labour forcedid change inevitably, without an option forthe employees of the estates. Over the years,the labour force has contracted gradually,declining to about a half of the total labourforce numbers that prevailed 25 years ago.In total, the 23 RPCs and the state planta-tions (JEDB and the SLSPC) had 13,645 asstaff and 244,681 as labourers by 2006(Figure 6.3).12

The long term commercial viability of theplantation sector is threatened by reducedavailability and low productivity of the es-tate labour force. Skilled labour migrationhas become a challenge for plantation es-tates, as skilled operations in harvesting tech-nology plays a key role in determining pro-duction, productivity and quality standardsin tea. One of the prominent causes for thereduction in the workforce, which was abun-dant in the early years, is worker out-migra-tion. It is estimated that a 2 per cent out-migration of labour would be a major con-straint for the management companies in

11 See CBSL, Annual Report, various issues.12 Out of the total land extent of tea, rubber and coconut (146,469 Ha), 93 per cent of the land is with RPCs. For all three types of plantation

crops, over 90 per cent representation is with RPCs.


88

estate development unless innovative partialmechanization measures are introduced.13

Migrating overseas or to other localities fordifferent types of occupations are consideredas less strenuous, better paying and moreprestigious, and is indicative of thechanging long term aspirations of the youngergeneration towards upward social mobility.In addition to the lack of social acceptance,low standards of living and poor infrastruc-ture at the estates are some of the other mainfactors which cause labour out-migration.14

6.4 Impact of the Economic Downturnon the Estate SectorIn examining the potential impact paths ofthe current global economic crisis on theestate sector, the discussion will be confinedto the tea and rubber sectors as only thesetwo sectors have a majority of its labour forceas resident workers. As already discussed inChapter 2, the global economic downturn

Table 6.3Total Labour Force in the Estate Sector

Notes: Total labour force in all estates under 23 management companies and state managementcompanies. The total labour includes, staff, regular employees and casual employees.

Source: Ministry of Plantation Industries, Plantation Sector Statistical Pocket Book 2007.

has a direct impact on the demand and pricesof export crops. Both tea and rubber exportsectors have been impacted. Tea productionand exports have been on the decline sincemid-2008. In the case of the rubber sector,the impact of the global downturn has beenmore muted.

While the present discussion does not ex-tend to the level of small holdings, limitingthe discussion only to the plantations estates,the likelihood of very differing impacts can-not be ignored. The small holders often lacktechnical know-how, accumulated savings,collateral for alternative financing to diver-sify, and are also less organized. The impacton the labour force operating in the planta-tion companies and small holdings will alsobe different.

In the case of the tea sector, for instance, theimpact of the downturn will be more severe

13 Ministry of Plantation Industries (2008), The Report of the Committee to make recommendations on Development and Management ofEstates Leased out to RPCs.

14 Ibid.

89


on the small holders than the corporateestate sector. The tea small holders occupyabout 65-75 per cent of the tea extent in thecountry and contribute about 65 per cent oftea output. In contrast to the estate sector,the small holders perform better. The yieldof tea small holdings is much higher thanthat of the estates. Much of the growth intea demand in recent years can be attributedto the attraction consumers of countries likeMiddle-East had to inherent qualities in lowgrown tea. This explains the vulnerability oftea small holders, as often the small holdersare concentrated in the low-country andproduce low-grown tea. As large quantitiesof tea remain unsold at auctions, the smallholders find it difficult to carry out their dailyoperations, unlike the plantation estates. Theadverse impact on the tea sector will not onlyaffect the private estates (small holdings), butalso the small holders and employees of bothtypes too, as it provides livelihood for over 1million family members and over 100,000workers. In the last quarter of 2008, it wasestimated that about 400,000 tea smallholders would be affected by the downturnin the global economy.

6.4.1 Impact of the EconomicDownturn on Estate Worker Welfare

As previously discussed, the importance ofthe estate sector in the economy cannot beignored, particularly in terms of foreignexchange income earnings and employmentprovision. These factors in themselves makethe estate sector vulnerable to the global eco-nomic crisis. The estate sector accounts fora sizable percentage of the population - onemillion in absolute terms or 5.4 per cent ofthe total population. Even more critically, itis the already poor welfare status of theestate sector relative to the rest of thecountry that makes it vulnerability to the

adverse effects of the current economic down-turn more serious.

The economic crisis can affect estate workerwelfare in direct and indirect ways. Theo-retically, the indirect impact would arise ifthe contraction of world demand results in areduction of export earnings that in turnwould require rationalization/restructuringmeasures to be adopted by the companies.In such circumstances, it would not be sur-prising if strategic management decisionsinvolved measures to cut down on produc-tion as a means of surviving the financialstresses. Such measures, however, will havea bearing on the earnings of the estate labour.Reduced earnings can fuel poverty, and thewelfare of the estate population may dete-riorate even further. However, whether theadverse impacts of the global economic melt-down will trickle down in the same extentto the worker level - to result in a sharp dropin welfare - is debatable when the context inwhich the labour force operates in the es-tates is considered.

The indirect impacts of the economic crisiscan affect the wage rates of the workers. Fig-ure 6.4 illustrates how the total daily wagerates of tea and rubber estate workers havefluctuated over the years since 1980.15 Innominal terms, wage rates have been increas-ing and the earning potential of workers haveincreased with a wage hike after 2005, forboth tea and rubber. This is mainly because,in addition to the increasing daily wage rate,they can earn a price share and an incentivewhich together decides the total daily wageearned. Accordingly, by 2007, the total dailywage of a worker was Rs.290 for tea andRs.260 for rubber. However, even with theprice share and incentive, the real wage rateshave remained relatively constant, with onlyslight fluctuations.

15 On top of the daily wage, workers were provided with a price share and an incentive. The total daily wage includes all these threecomponents. This provision started from 2005 for both tea and rubber.


90

Table 6.4Total Daily Wage Rates for Males and Females in Tea and Rubber

Note: The real wage rates are calculated by using CCPI (1952=100) at 1980 constant prices.Source: Ministry of Plantation Industries, Plantation Sector Statistical Pocket Book, various issues, and

CBSL, Annual Report, various issues.

However, what is interesting to note is themethod of wage determination. The wagesof estate workers are decided through acollective agreement with the labour unions,which is reviewed every two years. Due tovarious political-economy reasons, thebargaining power of the labour unions are sohigh that labour wages are not tied toproductivity or output. In recent years,political pressure has even led to theviolation of a collective agreement betweenthe Plantation Unions and the Employers'Federation of Ceylon.16 The RPCs are hop-ing to come to an agreement on wages, whichwill tie up the wages with productivity/out-put in order to ensure economic efficiency.As a statutory requirement mandated by leg-islation, the estate management is bound toprovide not only the wage rates determinedthrough a collective agreement, but also thenumber of fixed pre-determined days of workto the workers.

In a situation where tea stocks wereaccumulating due to the drop in prices,

managers of estates were left with the onlyrational strategic option of cutting downproduction so as not to let the stocksaccumulate. As by legislation, the estate man-agement is obliged to provide 300 days ofwork per year - without deviation - most ofthe estate management have taken steps toadvance pruning. Even the advice of the SriLanka Tea Board to growers and producersduring the last quarter of 2008 was to 'goslow'. The Tea Research Institute (TRI) hasrecommended 'selective plucking' of tealeaves and advancing the pruning of teaplants, lowering fertilizer usage to ensurelow production of tea leaves, and makinguse of this interim period for the develop-ment of tea estates. Such measures are ex-pected to allow growers and producers toprovide the obliged number of days of work,and at the same time to reduce productionlevels.

This reinforces the arguments that workerwelfare may not be adversely affected in in-direct ways as a result of the current eco-

16 Ministry of Plantations Industries (2008), Report of the Committee to make recommendations on Development and Management of EstatesLeased out to RPCs.

91


nomic crisis, unless other factors impinge inthe longer run. In the long run, if the estatesare able to negotiate a wage rate determina-tion that is tied to productivity, or the estatecompanies make substantive losses and be-come incapable of paying wages, or start lay-ing off labour, etc., the impacts on workerwelfare will be different. As it stands atpresent, companies have to absorb the shocksof an external economic crisis with limitedtrickle down effects on the welfare of work-ers through wages effects.

Nonetheless, there could be an indirect im-pact on income if workers are unable to earnthrough price shares and incentives. Thesedepend on the extra volumes of plucking andthe number of days worked. Though suchearnings are relatively marginal, it could havean impact on worker welfare, particularly inthe longer term. Cumulatively, a drop in earn-ings will pull down non-poor estate house-holds into poverty. The possibilities existgiven the fact that non-poor estate house-holds are often just above the poverty line.

The second effect of the global economiccrisis on worker welfare is quite direct. Aspecial characteristic of the estate sector liesin the structure of its formation in the colo-nial era. As workers were brought down fromSouth India, they were absorbed into an en-clave structure of the estates and sidelinedfrom the rest of the economy. As a conse-quence, the estate population became com-pletely dependent on the management, notonly for their work but also for the servicesof their day-to-day life. The estates performa quasi government role. Within the enclavestructure, the estates provide almost all thewelfare services to the workers. There is ahigh possibility that with the reduction ofprofits of the estates, the management maydivert attention from provision/improvementof welfare services. However, a counter ar-gument is also possible as most of the wel-fare services provided are fixed, or cannot be

reduced. Welfare benefits such as gratuitywould continue to exist unharmed by theeconomic downturn. However, there is al-ready pressure to amend the Payment of Gra-tuity Act, No. 12 of 1983 which ties up theentitlement to gratuity with a prescribedminimum number of days of working.

It is as yet not possible to arrive at any firmconclusions, particularly due to the lack ofinformation. Nevertheless, it is possible thatthe initial steps taken to meet financial con-straints might be related to gradual reduc-tions in welfare service provision during thedownturn. Though this would not be visibleinitially as fixed welfare services cannot bereduced, it may manifest in the provision ofminor services (e.g., whitewashing of houses,cleaning of environment, etc.). In the shortrun, though the welfare of workers will notbe affected to the same extent as the magni-tude of the global crisis on the profits of es-tate companies, it will still have a negativeimpact.

In addition to the welfare services providedby the estates directly, an independent orga-nization has been formed to overlook thewelfare services of the estates called the Plan-tation Human Development Trust (PHDT).The organization started its operations fol-lowing the change of estate management in1992. It is a tripartite organization whichfosters close inter-dependent relationshipsbetween the employers of the estates, theworkers and the government.

The PHDT comes under the mandate of theMinistry of Youth Empowerment and Socio-Economic Development. The line ministriesare the Ministry of Plantation Industries,Ministry of Nation Building and Estate Infra-structure Development, and the Ministry ofHealthcare and Nutrition. The recurring costsof the PHDT are borne by the RPCs. ThePHDT also has several international and lo-cal non-government organizations (NGOs)


92

as partners. The PHDT exists to ensure andintegrate the social responsibility of the part-ners towards the plantation community,channelling the work of several entities of-ten in partnership with the community, es-tate management, trade unions and otherorganizations.17

Accordingly, most of the welfare services ofthe estates are streamlined through the PHDT,which acts as the central body for receivingfunds from the government, local or interna-tional NGOs. In turn, it allocates funds forthe welfare services of the estates of RPCs,JEDB and SLPC, based on needs. The keyareas are sanitation, housing, health and earlychildhood care and development. As the re-current costs of the PHDT are borne by theRPCs - which they cannot waive off - thewelfare services provided by the PHDT canbe assumed to be fixed. However, the extentto which they can extend services dependson the amount of funding the PHDT receivesthrough channels of government or local/in-ternational NGOs. In the long run, with theglobal economic meltdown and constraintson donor funding, it is likely that workerwelfare can get affected in the future.

6.5 ConclusionThe plantation sector remains a vital sectorof the Sri Lankan economy. It is likely tocontinue to play an important role in viewof its still significant contribution to overallgrowth, employment, foreign exchange earn-ings, etc. Globalization has offered unlim-

ited opportunities as well as challenges forthe plantation sector. As detailed in the dis-cussion above, though the impact of the glo-bal economic crisis could impair the rolethat the estates play in the economy, thetrickle down adverse effects on the workersare likely to be somewhat muted as it cas-cades, particularly in the short run. How-ever, it must be noted that should the globalrecession turn out to be of a longer durationthan anticipated at present, it could havemore serious repercussions. Companies op-erating in the sector might be compelled totrim welfare service provisions, as they arenot allowed to reduce wages or cut the num-ber of working days under current mandatedprovisions. Companies have to adopt inno-vative practices for long term sustainabilityand attempt to mitigate the impact by diver-sifying and developing the estates in otherways during the downturn. These kinds ofactivities may have to be encouraged by thegovernment by way of loans and subsidies.

Even a subtle change in welfare provisionscould have a sizable impact in view of therelatively poor socio-economic standing ofthe estate sector population - in particular,the existing high levels of poverty and thefact that many households are aggregatedaround the poverty line. In this context, theattention of policy makers should remainfocused on developments that could impingeon the welfare status of the estate workers toensure that overall efforts to address povertyreduction in the country are not undermined.

17 PHDT, Annual Report 2007.

Global Economic Crisis and Energy Dependence of Sri Lanka

93

7. Global Economic Crisis and Energy Dependence of Sri Lanka

7.1 Introduction

One of the key sectors that link the Sri Lankaneconomy to the global economy is the en-ergy sector. Even before the emergence of thecurrent economic crisis, the vulnerability ofthe Sri Lankan economy to volatile changesin global energy markets has been fairly ob-vious. The shock waves of oil price changeshave had ripple effects throughout theeconomy. This has been a familiar experi-ence during the last few decades, and mostrecently during 2004-08. It seems that suchtrends could easily outlast the current globaleconomic crisis or any of its short-term re-percussions.

This Chapter attempts to examine the natureof global energy market issues with a viewto identifying major policy implications tomitigate downside impacts on Sri Lanka. Inessence, the identified problem is one ofgrowing dependence of Sri Lanka's economyon global energy markets to fulfill its energyneeds. Such dependence on global energymarkets is on the rise, mainly due to highdemand for petroleum-based energy fromcertain sectors of the economy. A commonperception on this issue is that if Sri Lankacan find its own petroleum resources, theproblem can be easily overcome. However,in the discussion to follow, it is argued thatthe situation is somewhat more complex and,therefore, a more broad-based solution isnecessary for the country.

7.2 Overview of the Energy Sector inSri Lanka

In discussing the energy sector issues in SriLanka, energy dependence is defined as theexternal dependence of Sri Lanka in fulfill-

ing its energy needs. Modern economies relyheavily on energy resources to ensure sus-tainable development. However, the avail-able energy resources are not evenly distrib-uted across the globe geographically, andcertain regions are more richly endowed thanothers. Among others, fossil-based energysources such as petroleum and coal havebecome the major sources of energy for mod-ern industrialized economies. Therefore, theuneven distribution of these resources is amajor cause of concern for countries whichlack such resources. Sri Lanka, being a coun-try which is yet to confirm possession of anytype of petroleum or coal resources, there-fore has to face the reality of rising depen-dence on global markets to fulfill its energyneeds in the foreseeable future.

The first step towards understanding the prob-lem of energy dependence is to examine thesupply and demand for energy in Sri Lanka.The demand for various energy sources arederived from five major sectors of theeconomy, namely: residential, commercial,industry, transport, and agriculture. As evi-dent from Table 7.1 and Figure 7.1, the resi-dential sector is the largest energy user, wherebio-mass plays a prominent role. The trans-port sector is the second largest user of en-ergy in the economy, followed closely bythe industrial sector. Compared with thesemajor sectors, commercial and agriculturesectors consume relatively low amounts ofenergy. An important point to be noted hereis that the composition of the energy mixused by different sectors varies substantiallyamongst each other. For instance, energyconsumption of the household sector is domi-


94

Tab

le 7

.1Su

pply

and D

eman

d S

truct

ure

of th

e En

ergy

Sec

tor

in S

ri L

anka

En

d U

sers

Cate

go

ryD

em

an

dSu

pp

ly (

‘00

0 T

OE)

Rem

ark

sT

yp

es

of

Majo

rT

yp

es

of

En

erg

yP

etr

ole

um

Bio

-mass

Ele

ctr

icit

yU

ses/

Ap

pli

cati

on

s/Scale

sSo

urc

es

(Majo

r)P

rod

ucts

Hou

seho

lds

Coo

king

Fire

woo

d (r

ural

)1

22

3803

22

592

per

cen

t of e

nerg

yLP

G, K

eros

ene

(urb

an)

need

s ar

e m

et b

y bi

o-m

ass

Ligh

ting

Elec

tric

ity (a

ll ur

ban

& ru

ral)

prod

ucts

, w

here

pet

role

umK

eros

ene

(un-

elec

trifi

ed a

reas

usag

e is

ver

y m

inim

al.

& r

ural

poo

r)

Dom

estic

app

lianc

esEl

ectr

icity

(urb

an &

rur

al u

pper

)

Oth

er h

ome

ener

gy n

eeds

Mis

cella

neou

s (s

olar

, etc

.)

Com

mer

cial

Pow

er a

nd e

nerg

y ne

eds

ofEl

ectr

icity

58

15

42

17

Elec

tric

ity fu

lfills

hal

f of t

heda

y-to

-day

run

ning

of t

heen

ergy

req

uire

men

t.co

mm

erci

al e

stab

lishm

ents

Petr

oleu

m c

ontr

ibut

ion

isar

ound

15

per

cent

.

Ind

ustr

yLa

rge

indu

stri

es(b

oile

rs,

Elec

tric

ity3

43

1169

22

5M

ajor

con

trib

utio

n by

bio

-fu

rnac

es, k

ilns,

dri

ers,

etc

.)Pe

trol

eum

-bas

ed fu

els

(die

sel,

mas

s. P

etro

leum

heav

y fu

el o

il, k

eros

ene,

etc

.)de

pend

ence

is v

ery

low

.

Smal

l & m

ediu

m in

dust

ries

Elec

tric

ity(b

oile

rs, f

urna

ces,

kiln

s,dr

iers

, etc

.)B

io-m

ass

(fire

woo

d)

Tra

nspo

rtA

ll ty

pes

of p

ublic

& p

riva

tePe

trol

eum

-bas

ed f

uels

(di

esel

1931

00

100

per

cen

t pet

role

umve

hicl

es&

pet

rol)

depe

nden

t.

Agr

icul

ture

Wat

er p

umpi

ngPe

trol

eum

-bas

ed f

uels

(di

esel

80

0En

ergy

req

uire

men

t is

& k

eros

ene)

com

para

tivel

y ve

rym

inim

um, y

et p

urel

yEl

ectr

icity

petr

oleu

m d

epen

dent

.

Sour

ce: E

stim

ated

bas

ed o

n in

form

atio

n fr

om "

Sri L

anka

Ene

rgy

Bal

ance

200

7" a

nd In

tern

atio

nal E

nerg

y A

genc

y.


95

nated by bio-mass, whereas nearly all theenergy needs of the transport sector are metthrough petroleum (Table 7.1).

Figure 7.1 helps to understand certain aspectsrelating to the supply of energy in Sri Lanka.From the supply side, a major share of SriLanka's energy continues to come fromrenewable, indigenous sources, namely,bio-mass and hydro. Accordingly, 47 per centof primary supply comes from bio-masssources, whereas petroleum and hydro ac-count for 43 per cent and 9.5 per cent, re-spectively. The contribution of non-conven-tional sources such as wind and solar poweris still at an insignificant level. Fuel wood isthe major type of bio-mass widely used inhouseholds, especially in rural areas, for

domestic cooking, heating of water, etc.Besides, a large number of small to mediumrural industries also use bio-mass forthermal energy in boilers, driers and kilns,etc. In addition to fuel wood, coconut shells,baggase, and paddy husk, etc. also act asbio-mass energy sources on a limited scale.The hydro option is mainly used forgeneration of electricity (a type of secondaryenergy). Electricity fulfills the energy needsof households, commercial establishments,as well as industrial establishments to acertain extent. Electricity provides energy forlighting and various appliances used inhouseholds and commercial establishments.Industrial establishments also use electricityfor operating various machinery.

Figure 7.1Overview of Energy Supply in Sri Lanka

Source: Sri Lanka Energy Balance 2007.

Primar y Ene rgy Supply in 2007 ('000 TOE)

B io m a ss

47%

P et ro leu m

4 3%

H ydro

10%

N o n-co n vent i o nal

0 %

Se ctor al Energy Us e in 2007 ('000 TOE)

Household ,

commerc i al and

o t hers

48 %

T ransp ort

2 6%

Indus try

26 %

A g ricult ural

0 %


96

Petroleum fulfills almost all the energy needsof the transport sector. In addition, differentfuel oils provide thermal energy for furnaces,boilers, generators, etc., usually in large in-dustrial establishments. From the mid-1990sonwards, thermal electricity generation basedon petroleum fuels has become the mainsource of electricity generation, surpassinghydro-electricity generation.

7.3 Energy Dependence of Sri LankaDependence on the energy sector is mainlydetermined by the origin of different sourcesof energy in the energy mix. Accordingly, ofthe three major sources of primary energy,

bio-mass and hydro are totally indigenoussources. Therefore, they do not contributetowards dependence on global energy mar-kets. The key link that determines global de-pendence of the energy sector is petroleum.Over the course of the last century, petro-leum has become the major source of en-ergy for modern economies. This has createda global scale dependence of non-oil pro-ducing countries on oil-producing countries.As Sri Lanka is yet to find its own petroleumresources, with gradual modernization anddevelopment of the economy, the countryhas become more and more dependent onglobal petroleum markets.

Figure 7.2Sri Lanka's Dependence on Petroleum Products (1987-2007)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

Petrole um Product Impo rts , 1987 - 2007

Other

Refined

Crude O il

To tal Im por t V al ue of Pe tr o le u m Pr od uc ts

0

20 0 0 0

40 0 0 0

60 0 0 0

80 0 0 0

100 0 0 0

120 0 0 0

140 0 0 0

160 0 0 0

19 8 7 19 8 9 19 9 1 19 9 3 19 9 5 19 9 7 19 9 9 2 0 0 1 2 0 03 2 0 05 2 0 07

Cr ud e O il

Re f ine d

P ro d uct s

Expe nditur e on Petrole um Imports as a Perce ntage of GDP

(1987 - 2007)

0

1

2

3

4

5

6

7

8

9

1987 1989 1991 1993 1995 19 97 199 9 2001 2003 2005 200 7

( %)

Source: Sri Lanka Energy Balance 2007; and CBSL, Annual Report, various issues.


97

Sri Lanka's growing dependence on petroleummarkets has two major dimensions, namely;growth of volume of imports (quantity), andrising prices (value). Quantity implies thetotal amount of petroleum imported by thecountry annually. A non-oil producing coun-try such as Sri Lanka can import petroleumin two major forms - i.e., either as crude oilor refined products. Petroleum imported ascrude oil has to be refined locally. A countryshould have crude oil storage facilities, re-fineries, refined oil storage, and distributionfacilities to achieve this.

Sri Lanka imports petroleum in both theseforms. Figure 7.2 gives the trends in petro-leum imports during the period 1987-2007.As far as import volume is concerned, it hasnearly doubled during the last two decades,indicating growing demand for petroleum.In terms of the composition of imports, itappears that the locally refined quantity ofpetroleum has remained more or less stableover the years. It is the share of refined prod-ucts that has increased steadily over the yearsto double the total volume of imports by2007. This indicates that refinery capacityhas remained the same over the last two de-cades without significant improvement. Atpresent, the government is trying to enhancethis by increasing the capacity of the exist-

ing refinery at Sapugaskanda with the finan-cial support of Iran. Plans are also underwayto establish a new refinery in Hambantotaalong with the new harbour project. In termsof the value of imports, expenditure on re-fined products has exceeded the expenditureon crude oil from around 2004.

Overall, the expenditure on petroleum im-ports has increased in absolute as well asrelative terms, increasing from Rs. 0.8 bil-lion in 1980 to Rs. 27.6 billion by 2007 inabsolute value (Table 7.2). What is moreindicative is the relative increase in terms ofGDP. While undergoing frequent fluctua-tions, the share of petroleum expenditure hasgradually risen from 3-4 per cent of GDPduring 1985-2000 to 7-8 per cent in 2007.This can be considered to be a relatively sharpincrease as far as the overall economy is con-cerned. The government's immediate re-sponse to such price instability has been pri-marily by way of short term measures suchas removal of the duty waiver on petrol tocross subsidize the use of diesel, and enter-ing into a hedging deal to mitigate the ef-fects of adverse price fluctuations. However,such measures cannot be expected to pro-vide a solution to deal with the rising bur-den of energy dependence over the long run.

Table 7.2Total Value of Petroleum Imports (1980 -2007)

Petroleum 1980 1990 1995 2000 2005 2006 2007 Imports (Rs. mn.)

Crude Oil 7,309 12,425 12,360 39,343 77,686 107,160 114,150 Refined products 932 1,150 4,812 24,452 88,767 114,822 151,141

LPG - 210 1,121 4,172 7,573 9,426 11,462

Total 8,241 13,785 18,293 67,967 174,026 231,408 276,753

GDP 66,527 321,784 667,772 1,257,636 2,452,782 2,938,656 3,578,386



98

As already mentioned, the overall burden ofpetroleum imports is a result of both in-creases in volume as well as price hikes. Fig-ure 7.3 shows that during the last two de-cades, crude oil prices have increased nearlyfour times. Although the price level had re-mained relatively stable from mid-1980 toaround 2000, it started to rise steadily from2003 onwards. The current global downturnin demand appears to have stabilized pricesto a certain degree, although this could wellbe a temporary phenomenon. Figure 7.3 alsoindicates that the local price of petroleumproducts mirrors the variations in crude oilprices in the international markets.

As the energy mix of key sectors is different,sectoral dependence on global energy mar-

kets also vary. The transport sector remainsthe most dependent, given that the entiresector depends totally on petroleum whilethe vehicle fleet in the country has been ex-panding rapidly. As a result, the transportsector is also the most vulnerable to fluctua-tions in oil prices. As seen from Table 7.3,the vehicle fleet has increased nearly four-fold over the period 1990-2007, recordingan average rate of 9 per cent growth per an-num. A majority of new additions to the fleetare petrol vehicles, whereas diesel vehiclesaccount for around one-fourth of the growth.Given the important role of the transport sec-tor in the economy - moving people as wellas cargo - its dependence and vulnerabilityhas the potential to adversely affect all prod-ucts and service sectors.

Figure 7.3Volatility of Global and Local Petroleum Product Prices

Source: Sri Lanka Energy Balance 2007; and CBSL, Annual Report, various issues.

Cr ude Oil Im po rt Pr ice V ar ia tio ns

0

10 0

2 0 0

3 0 0

4 0 0

50 0

6 0 0

Lo cal Pr ice Var iatio ns o f Petro leu m Pro du ct s

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

Pet rol (90 Oc tane) Auto D iesel Kerosene LPG (Shel l) per Kg


99

In addition to the transport sector, the nextmost dependent sector on global energy isthe power generation sector. Prior to the1990s, Sri Lanka had made reasonableprogress in utilizing the country's significantpotential for hydro electricity generation.Until then, except during some short peri-ods under severe drought conditions, nearlyall power generation was derived from a net-work of hydro-electric power plants locatedmainly along two major rivers, Mahaweli andKelani. However, the country graduallyreached the limits of hydro potential in themid-1990s.

As shown in Figure 7.4, consumption anddemand for electricity has been increasingsteadily over the years. Owing to uncertaintyover other options (a prolonged debate over

coal power plants), energy planners opted torely on thermal power plants that are drivenon petroleum-based fuels. As a result, dur-ing the last decade, the share of thermal gen-eration has increased to over 60 per cent oftotal annual generation and continues togrow even further (Figure 7.4). According tothe power supply projections by the CeylonElectricity Board (CEB) in 2006, petroleum-based thermal generation capacity is to risein the near future until the anticipated in-crease in the share of power generation fromcoal takes over gradually. However, from theperspective of energy dependence, the policyof shifting towards coal will not free the coun-try from the burden of energy dependence asSri Lanka will also have to import coal fromforeign markets.

Table 7.3Growth of Vehicle Fleet in Sri Lanka

Year No. of Registered Growth (%) Vehicles Total Petrol Diesel

1990 819,943 14.9 13.1 1.7

1991 904,373 10.3 7.8 2.5

1992 1,003,047 10.9 8.0 2.9

1993 1,086,821 8.4 5.9 2.4

1994 1,162,313 6.9 4.3 2.5

1995 1,244,653 7.1 4.4 2.5

1996 1,325,384 6.4 3.9 2.3

1997 1,407,437 6.2 3.7 2.4

1998 1,511,197 7.4 4.4 2.9

1999 1,614,050 6.8 4.2 2.5

2000 1,706,077 5.7 3.7 2.0

2001 1,778,711 4.3 3.0 1.2

2002 1,892,367 6.4 4.9 1.4

2003 2,073,869 9.6 7.8 1.7

2004 2,297,711 10.8 9.3 1.4

2005 2,527,380 10.0 8.4 1.5

2006 2,827,902 11.9 10.1 1.8

2007 3,125,794 10.5 8.9 1.6

Source: Department of Census and Statistics, Statistical Abstracts, various issues.


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Figure 7.4Energy Dependence by Sector

Source: Sri Lanka Energy Balance 2007.

Sri Lanka is still unable to find significantalternatives to fulfill the rising demand forpower generation from indigenous sources.Therefore, it seems that there is a high likeli-hood that rising demand for electricity willbecome a major factor that increases thecountry's energy dependence in the future.

Overall, Sri Lanka's situation of energydependence can be summarized as follows:

• Dependence on global energy marketsis rising steadily, both in terms of vol-ume of imports as well as expenditureon petroleum. Dependence measured

0

500

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1987 1997 2007 1987 1997 2007 1987 1997 2007

Industr y Transport Househo ld ,

Commerc ial &S ect o r

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B iomass

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Elect ricit y

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Sources o f Ele ctr icity Generation over 1970 - 2007

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in terms of the share of expenditure onpetroleum to GDP has nearly doubled.

• Level of dependence varies among dif-ferent economic sectors. Among oth-ers, the transport sector is the most de-pendent sector on petroleum. Rapiddemand for transport services from anexpanding economy and the resultantincrease in the vehicle fleet are themajor causes. The vulnerability of thetransport sector to global oil price hikescreates economy-wide repercussions.

• Gradual exhaustion of hydro poweroptions for electricity generation hasfurther complicated the situation byincreasing the dependence on fossil fuelpower generation as well.

• As a result, the Sri Lankan economyoverall has become more and more vul-nerable to shocks in global petroleumprices.

• Given the fundamental importance oftransport and power generation sectorsfor the growth of the economy, the ris-ing dependence of these sectors on glo-bal energy markets can impede theentire process of economic growth.

• Sri Lanka seems to be less prepared toface the repercussions of this problem.This can be observed by the fact thatthe country has not taken timely mea-sures to expand refinery capacity andexplore sustainable alternatives forpower generation. The option of coalpower generation cannot be expectedto reduce energy dependence as coalitself has to be imported.

7.4 The Global Economic Crisis andEnergy Markets

To assess the possible impacts of the currentglobal economic crisis on Sri Lanka's grow-ing energy dependence, an understanding ofthe linkages between energy markets and the

global economy is needed. Sudden hikes inpetroleum prices can result in economic un-certainty at the global level. Net oil import-ers quite often find themselves facing bal-ance of payments (BOP) difficulties, infla-tionary pressures, etc. At the aggregate, glo-bal economic output can falter as evidencedduring previous oil price hikes in 1973-74,1979-80, 1990-91 and 2008. In the samevein, economic crises on a global or regionalscale are not necessarily linked to oil pricehikes, as evidenced by the current globaldownturn.

The observed movement of oil prices duringthe course of events leading up to the presenteconomic crisis offers some insights. Oilprices were on a rising trend from 2003 on-wards. However, the most severe oil priceincrease was from early 2007 to the secondquarter of 2008 when the acute signs of theglobal economic crisis began to appear. Infact, the sharp escalation in prices during thisperiod caused the most distress to net oilimporters such as Sri Lanka. Thereafter, withthe global downturn, decreasing demand hadled to a relatively sharp drop in oil prices bylate 2008. Falling oil prices provided somerelief to economies like Sri Lanka, easing theburden of import expenditures. Indeed, thishelped the economy to absorb the adverseimpact of a decline in export earnings withthe onset of the economic downturn in keydeveloped country markets.

Thus, focusing on the current global eco-nomic crisis alone cannot provide usefulpolicy insights on how best to face prob-lems created by rising energy dependence.Instead, it may be necessary to focus moreon certain characteristics of global energymarkets that affect short to long term hori-zons. There are certain long term factors thatcan transform the global energy markets.These should be taken into considerationwhen domestic policy is adjusted to face


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identified challenges. Amongst the moreimportant forces that influence these changesare:

• Supply uncertainty of global energyresources

• Growing demand from emerging eco-nomic powers

• Technological changes in the energysector

• Growing concerns over global warm-ing and climate change

• Emerging structural changes in energymarkets and institutions

7.4.1 Supply Uncertainty in GlobalEnergy Resources

All fossil-based energy resources are exhaust-ible over the long run. Current estimatesindicate that proven reserves of petroleumwill last for another 40 years only.1

However, significant uncertainties prevailover such estimates. Even though the priceof petroleum has been rising gradually overthe years, this cannot be considered as areliable indicator of growing scarcity due toa number of reasons. Petroleum is geographi-cally concentrated in certain areas of theworld, and the industry is controlled by afew major national and multinationalcompanies that enjoy strong market power.Hence, an oligopoly market structure, ratherthan a competitive market structure, prevailsin the oil industry. In addition, the function-ing of oil markets is significantly influencedby the governments of major oil producingcountries. This situation is further compli-cated by the behaviour of speculators.Besides, global geo-politics play a major rolein energy markets. Therefore, the existingmarket structure can hardly be expected toyield reliable and un-distorted price signalsof growing scarcity.

7.4.2 Growing Demand fromEmerging Economic Powers

A rapid rise in demand for petroleum hasbeen reported from fast growing developingeconomies such as China, India, and Brazilduring the recent past. Pressure on globalenergy resources from these economic growthcentres are identified as a major reason forthe recent escalation of world energy prices.This has led to a situation where lesspowerful players, such as non energy-richdeveloping nations, are being increasinglymarginalized. These countries will have tobear a heavy burden of rising oil import costsin the future.

7.4.3 Concerns over Global Warmingand Climate Change

In recent years, the threat posed by globalwarming and climate change has graduallyassumed the status of a major world issue.The growing concentration of green housegasses (GHG) in the atmosphere due toburning of fossil-fuel is considered to be themajor cause for this global problem. It hasbeen predicted that the entire worldcommunity will have to face seriousrepercussions, unless immediate actions aretaken to reduce the rate of GHG emissions.Scientists have expressed the necessity ofchanging the established pattern of energyuse by reducing the global dependence onfossil-based fuels such as petroleum and coal.Overall, it can be expected that pressure toswitch to a low-carbon economy will leadto major changes in the global energy scene.

7.4.4 Technological Advancements inthe Energy Front

Increasing fuel prices and concern over cli-mate change have provided incentives tosearch for alternative sources of energy andtechnologies. This has already triggered sig-

1 British Petroleum (BP) Statistical Review of World Energy 2008 estimates the reserves-to-production ratio (R/P) to be 41 - an indicator ofthe length of time that the remaining reserves will last if production were to continue at that level.


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nificant investments on alternative energyapplications such as solar, wind, bio-fuel,geo-thermal, wave energy, etc. There are alsoefforts to improve the energy efficiency ofexisting systems by reducing wastage ofenergy. However, to date many such invest-ments have been confined to developedcountries. Developing countries need care-fully designed strategies to absorb thebenefits of such technological improvementsin the power and energy sectors.

7.4.5 Emerging Structural Changes inEnergy Markets

Traditionally, energy markets have beendominated the world over by large oligopo-lies or state monopolies. Technologies nor-mally involved in petroleum and related in-dustries, and associated economies of scale,justified these market arrangements to a cer-tain extent. New energy technologies haveopened the way for more competitive andflexible market structures that can respondto changing realities more speedily. For in-stance, alternative energy industries such assolar, wind, and bio-fuel appear to be domi-nated by relatively small, dynamic, tech-savvyfirms which are highly competitive. As a re-sult, they have become the fastest growingbusinesses, amply supported by venture capi-tal funds.

The above discussed issues are the more longterm factors that govern changes in the glo-bal energy sector. They determine long termrealities that have to be dealt with when fac-ing problems of growing energy dependence.In addition, the petroleum market is fre-quently affected by short term fluctuationsthat are caused by the following:

• Uncertainties due to speculativebehaviour of certain agents, and

• Disturbances caused by variouspolitical issues in major supply regions.

The behaviour of petroleum prices can usu-ally be considered to be an overall outcomeof the interaction between these long termand short term factors. For instance, whilethere is a long term trend of rising oil pricesthat can be considered as indicative of risingscarcity due to gradual depletion of exhaust-ible resources, short term factors such as re-gional political upheavals, behaviour ofspeculators, etc. also cause significant fluc-tuations. Understanding the reality of SriLanka's vulnerability to such long term aswell short term upheavals in the global pe-troleum market is an essential step in facingthe problems of energy dependence.

7.5 Future Energy Security

7.5.1 Oil Exploration in the MannarBasin

Against the backdrop of energy dependence,it appears that there are many optimists whopredict a successful exploration of petroleumresources in the Mannar Basin, offshore ofthe western and north-western coast of SriLanka. However, according to availableinformation, this can at best be consideredto be an uncertain prospect. The governmentis slowly but steadily taking the necessarysteps to explore this option. According tothe opinion of experts engaged in this sectorof activity,2 the data acquired so far can beinterpreted to indicate about a 60 per centprobability of successful oil exploration inthe Mannar Basin. Depending on theacquisition of new data as explorationprogresses, the probability of success couldchange. Therefore, it is not possible to drawany firm policy implications at this juncture.

2 Information cited in this section is based on discussions with the Director General, Petroleum Resources Development Secretariat (PRDS).


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However, it is worthwhile to examine somekey implications of current developments.The government has taken steps to create thenecessary institutional setting by establish-ing the Petroleum Resources DevelopmentSecretariat (PRDS) under the Petroleum Re-sources Development Act of 2003. So far, ithas acquired 6000 km of 2D data in theMannar Basin with the technical support ofTGS-NOPEC, a Norwegian geo-physicalcompany (Figure 7.5). The government calledfor worldwide bids from technically quali-fied firms to undertake further exploration ofoil prospects in three selected blocks in 2008.Based on the bids, the government decidedto enter into a Petroleum Resources Agree-ment (PRA) for only one block. The success-ful bidder was Cairn India Ltd., a subsidiaryof a British oil firm known as Cairn. In July2008, the government entered into a PRAwith Cairn Lanka (Pvt.) Ltd., a subsidiary ofCairn India. Cairn Lanka has already startedpetroleum operations in the Mannar Basin.Based on even the most optimistic timeframe, it would take five more years (by 2014)to produce the first barrel of crude oil forsale.

Expert opinion suggests that current data avail-ability does not justify the provision of anyreliable estimate on the quantity of economicoil deposits lying underneath the MannarBasin. However, similar offshore basins thathave been successfully explored elsewhereseem to have several billion barrels. This can,therefore, be considered as a reasonable guesswith regard to Sri Lanka's situation at thisjuncture too. According to currently avail-able information, it is expected that depos-its could contain both oil and gas.

From the perspective of overcoming the prob-lem of rising energy dependence, the signifi-cance of a successful exploration of petro-leum in the Mannar Basin cannot be over-emphasized. It would provide a significant

boost to the Sri Lankan economy. Firstly, itwill help to reduce the burden of rising oilimport bills, thereby lessening budgetary andinflationary pressures on the economy.Secondly, it can provide significant opportu-nities for earning foreign exchange by export-ing surplus production. Essentially, it has thepotential to provide substantive benefits tothe Sri Lankan economy on the assumptionthat the potential wealth from the oil ismanaged and invested in an effectivemanner to uphold the long term goals andnational interests of the country.

7.5.2 Other Alternatives

Despite the potential relief that can be pro-vided by successful exploration of oil pros-pects, policy makers cannot consider it asthe single most important pillar of a longterm energy security strategy due to the fol-lowing reasons. Firstly, petroleum is an ex-haustible resource and the country cannotbe expected to rely on the deposits over anindefinite period. Secondly, rising concernsover global climate change due to fossil-fuelemissions have seriously undermined theposition of petroleum as an energy source ofthe future. Many scientists are advocating thenecessity of a low carbon energy future - aproposition that cannot be overlooked bypolicy makers. As a result, it may be that asuccessful oil industry in Sri Lanka has a moreimportant role to play in the short and me-dium term horizons than in the long run.Given these facts, it is imperative for thecountry to maximize the potential gains fromprospective oil wealth, which also requiresspeedy action from policy makers.

There is thus much room for other alterna-tives to play important roles in a nationalenergy security strategy to help overcome theproblem of energy dependence. A few es-sential strategies for national energy securityare diversifying energy mix and supplysources, introducing efficiency improvements


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to the existing system, and reaping the ben-efits of global carbon trade by improving theenvironmental outcome of the energy sys-tem.

a) Diversifying Energy Mix and SupplySources

It is necessary to explore the opportunitiesavailable in upcoming sustainable energyalternatives such as solar, wind, and bio-mass energy. Rising concerns over climate

change and volatile petroleum prices haverecently boosted the prospects of such greenenergy alternatives, attracting significant in-vestment for research and development. Boththe rising price of oil and technological in-novations seem to be gradually decreasingthe economic gap between petroleum andgreen energy alternatives. As a result, certainenergy sources that were non-economic inthe past compared to petroleum are gradu-ally becoming economically viable options.Sri Lanka has already made a preliminary as-

Figure 7.5Oil Exploration Blocks on Offer

Source: Petroleum Resources Development Secretariat.


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sessment of its wind and solar energy poten-tial, and some efforts to promote bio-massenergy are already underway. A few essen-tial steps needed to achieve this objectiveare:

• Enhancement of national research anddevelopment capacity on indigenousalternative energy resources;

• Selective introduction of suitable tech-nological improvements from successstories in other countries, while un-dertaking adaptive research to makethem locally successful, and;

• Creating an enabling environment forsuccessful adoption of new technolo-gies through appropriate policy andinstitutional changes.

The government has initiated action in thisdirection by enacting the Sustainable EnergyAct of 2007, and establishing the Sustain-able Energy Authority (SEA) under this pieceof legislation. It is too early to assess theeffectiveness of this measure as all activitiesinitiated by the SEA are still at the initialstage of implementation.

b) Efficiency Improvements in the ExistingSystem

It has generally been accepted that Sri Lanka'spresent strategy of energy use is not the mostefficient, and various improvements are nec-essary. This includes minimizing the wasteof energy by consumers through improvedpractices, improving the energy efficiency incurrent industrial processes, and cutting downlosses in transmission and distributionsystems, etc. Besides, given that thetransport sector is the key contributorysector to growing energy dependence,strategic decisions to improve energy usagein this sector is quite imperative. Forinstance, enhancing the role of the rail net-work and other public transport to handlepassenger and cargo transportation can be

expected to improve the efficiency of energyuse in the transport sector significantly thanat present. Another important aspect of effi-ciency improvements is institutional reforms.This is an area where strong political sensi-tivities are involved, as has been particularlyevident in the power sector. Recently, theSri Lanka Electricity Act of 2009 was intro-duced under the regulatory framework en-abled through the Public Utilities Commis-sions of Sri Lanka (PUCSL) to regulate eco-nomic, safety, and technical aspects of thegeneration, transmission, distribution, sup-ply, and use of electricity.

c) Reaping the Benefits of Global CarbonTrade

International efforts on climate change miti-gation have led to the establishment of a re-ward system for sustainable energy strategiesthrough a Clean Development Mechanism(CDM). Accordingly, developing countriescan contribute to climate change mitigationby adopting sustainable energy sources whilebeing rewarded through CDM by earningcarbon credits. There are also opportunitiesto attract green investments to help localeconomies too. Sri Lanka has scarcely madeany progress on this front. It is essential tolink any activity relating to the country's questfor sustainable energy to carbon markets sothat maximum benefits will be reaped forthe economy as well as the environment.

7.6 Conclusions and PolicyImplications

Sri Lanka's energy dependence is mainly amatter of the growing share of petroleumenergy in the overall energy mix, thereby sub-jecting the economy to the impacts of vola-tile fluctuations in global petroleum markets.Given that Sri Lanka has not fully exploredany fossil-based energy resources so far, thisoutcome of dependence is inevitable to acertain degree. The outcome is further aggra-vated by deep structural weaknesses in the


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energy sector caused by lack of preparednessto face such problems. Volatile price hikesin the petroleum market is a result of longterm structural factors as well as short termoperational factors related to global petro-leum markets, which has indirect rather thandirect linkages to the major causes of thecurrent global economic crisis. As a result ofthe downturn, petroleum prices have stabi-lized to a certain degree during recent months,providing some relief for economies severelyaffected by the global economic/financialcrises. However, as experienced during sev-eral years before the current economic crisis,the structural long term factors and short termoperational factors that govern the petroleummarket have the potential to precipitate hard-ships once the demand for petroleum beginsto rise again. Therefore, policy preparednessto face the consequences of growing energydependence is a matter linked to a long termenergy security strategy, rather than any shortterm survival strategy for weathering the glo-bal economic crisis.

Key options to face the above mentionedchallenges include the diversification of theenergy mix by promoting indigenous alter-natives, increasing the energy efficiency ofcurrent systems, and reaping the benefits of-fered by carbon trade. Harnessing as yet un-certain oil prospects in the Mannar Basincould be a positive factor that could help totransform the energy sector over the short tomedium term if managed effectively. How-ever, the future status of petroleum is gradu-ally being undermined by global concernsover climate change. Over the long run, SriLanka should take this as an opportunity -while extracting the benefits of potential oilwealth if explorations are successful - to ex-tend its long term national energy interests.To achieve this, the country should be onthe alert to absorb suitable technical andmarket opportunities that emerge in indig-enous green energy alternatives such as so-lar, wind, and bio-mass which are being rap-idly identified as dominant options in a lowcarbon economy in the future.


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8. Global Financial Crisis: Regulatory and Policy Challenges for Sri Lanka

8.1 Background

The immediate causes of the current globalfinancial meltdown have been discussedalready in this report. These factors combinedwith an overly accommodative financialregulatory environment in the US thatallowed for practices such as speculativeborrowing in residential real estate, high-risk mortgage loans, securitization ofsub-prime loans that fostered problems ofmoral hazard, complex and non-transparentfinancial instruments, and inaccurate creditratings resulted in a global economic andfinancial crisis that is widely perceived asbeing the most pernicious since the GreatDepression of 1929. To cite from the"Declaration of the Summit on FinancialMarkets and the World Economy", by theleaders of the G-20 on November 15 2008:1

"During a period of strong global growth,growing capital flows, and prolongedstability earlier this decade, marketparticipants sought higher yields withoutan adequate appreciation of the risks andfailed to exercise proper due diligence.At the same time, weak underwritingstandards, unsound risk managementpractices, increasingly complex andopaque financial products, andconsequent excessive leverage combinedto create vulnerabilities in the system.Policy makers, regulators, supervisors, insome advanced countries, did notadequately appreciate and address therisks building up in financial markets,keep pace with financial innovation, or

take into account the systemic ramifica-

tions of domestic regulatory action."

The rapid spread of the crisis that began inthe US - particularly with the loss of confi-dence in financial institutions following thecollapse of Lehman Brothers in September2008 - renders theories of de-coupling ofeconomies a myth, exposes the fragility andvolatility of financial markets driven by per-ceptions, and emphasizes the imminent needfor prudent financial regulatory systems bothat the domestic and at the internationallevel.

Analyses of international macroeconomicimbalances, and of the consequences of loosemonetary policies with respect to the globalfinancial turmoil, have been the subject ofdiscussion earlier in this report. As such,the objective of this Chapter is to addressthe regulatory and policy lessons gained, andchallenges posed by the crisis for Sri Lanka.This is important, particularly in view of twofactors: a) that robust regulation and policycredibility are essential for investor confi-dence in a climate where international anddomestic economic and financial marketsare in turmoil; and b) that tightening of creditby financial institutions in response to thecrisis - a typical problem of informationalasymmetry and moral hazard - could havesignificant impacts on vulnerable sectorssuch as small and medium enterprises (SMEs)and microfinance, which would in turn have

1 See http://www.g20.utoronto.ca/2008-leaders-declaration-081115.html for the full text of the Declaration.

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Global Financial Crisis: Regulatory and Policy Challenges for Sri Lanka

a negative spill over effects on employment,livelihoods, and poverty levels. The fact thatthe Sri Lankan economy has now entered apost-conflict phase further compounds theneed for sustainable financial flows for de-velopment.

Section 8.2 of this Chapter sets out a briefsequential snapshot of the current globalfinancial crisis together with some examplesof international policy responses. Thissection also provides some background onthe global financial regulatory structure, andthe nature of financial instruments used inthe advanced economies and selected emerg-ing and developing economies, in order toget a better comparative picture of thefinancial sector in Sri Lanka. The discussionalso analyzes policy questions and debatesarising from the crisis - such as re-drawinglines between markets and government,global cooperation and the benefits andlimits of policy transfer relating to financialsector reform, etc. Section 8.3 looks at theimpacts of the global financial crisis on SriLanka's financial sector. The key questionthat underpins the analysis is the 'home-grown' vis-à-vis 'imported' nature of thecrisis - i.e., to what extent is Sri Lankaimmune to or exposed to the 'contagion'effects of the crisis, and what are the funda-mental factors that create instability in SriLanka's financial markets and institutions.The concluding section of this Chapter fo-cuses on key regulatory and policy challengesrelating to Sri Lanka's financial sector, suchas the speed of financial deregulation andarriving at an appropriate balance between

over and under-regulation, regulatory gover-nance - in particular regulatory independence- and corporate governance - includingissues of trust, corruption, and self-regulation.

8.2 Contextualizing the GlobalFinancial Crisis

Databases developed to track trends in thestructure and development of financialinstitutions and markets across countriesindicate that the financial sector has deep-ened over time, particularly in advancedeconomies.2 While the deepening has beenless significant in the case of financialinstitutions such as banks, the globalizationof financial services and theinterconnectedness of financial markets arebecoming more pronounced. Studies alsopoint to the fact that financial sectordevelopment has a greater impact on growthin low and middle-income economiesrelative to high-income economies.3 Suchfindings, which underscore the vulnerabil-ity of developing countries to volatility andimbalances in global financial markets,reiterate the need to unpack the nature andscope of the current global financialmeltdown in order to get to sustainablepolicy solutions, both at the internationaland at the domestic country level. Box 8.1sets out key episodes - including declara-tions of bankruptcies, country-level bail outschemes and policy responses by interna-tional entities and groups such as the IMFand the G-20 - that marked the globalfinancial crisis from March 2007 to April2009.

2 See Beck, T., A. Demirguc-Kunt and R. Levine (2009), "Financial Institutions and Markets Across Countries and over Time", Policy ResearchWorking Paper No. 4943, May, World Bank.

3 See A., Philippe, P. Howitt and D. Mayer-Foulkes (2005), "The Effect of Financial Development on Convergence: Theory and Evidence",Quarterly Journal of Economics, 120, 177-222.


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Box 8.1

Evolution of and Responses to the Global Financial Crisis: 2007-2009

• March/April 2007: IMF warns of risk to global financial markets due to weakened US homemortgage market

• February 17, 2008: UK government temporarily nationalizes housing lender Northern Rock

• March 2008: US Federal Reserve prevents Bear Stearns bankruptcy by taking on US$ 30billion in liabilities and selling off the entity to JPMorgan Chase for a sumconsidered less than the value of Bear’s Manhattan office building

• May 4, 2008: Finance Ministers of 13 Asian countries agree to set up a foreign exchangepool of about US$ 80 billion in the event of a regional financial crisis;China, Japan and South Korea pledge to provide 80 per cent of the monieswith the balance to come from members of the ASEAN

• September 7, 2008: US Treasury announces the take-over of Fannie Mae and Freddie Mac,government-sponsored entities that bought securitized mortgage debt

• September 15, 2008: Lehman Brothers declares bankruptcy at US$ 639 billion – the largest in thehistory of the US

• September 16, 2008: US Federal Reserve bails out American International Group (AIG), theinternational insurance giant – in a US$ 85 billion deal, which was laterincreased to US$ 150 billion in November 2008 – given its exposure tocredit default swaps

• September 17, 2008: US Treasury announces a US$ 700 billion economic stabilization packageto enable the government to buy toxic assets from the country’s biggestbanks – a policy move aimed at restoring confidence in the financial system

• October 8, 2008: US Federal Reserve, European Central Bank, Bank of England and the CentralBanks of Canada and Sweden reduce primary lending rates by a halfpercentage point in a coordinated effort

• October 12-13, 2008: Germany, France, Italy, Austria, Netherlands, Portugal, Spain and Norwayannounce domestic rescue plans worth around US$ 2.7 trillion; the plansfollowed the British model of recapitalization, state ownership, governmentdebt guarantees, and better regulations

• October 13, 2008: UK government takes over a stake of 60 per cent and 40 per cent, respectively,in Royal Bank of Scotland and Lloyds TSB and HBOS for US$ 60 billion

• October 14, 2008: US Treasury, Federal Reserve, and Federal Deposit Insurance Corporation,in coordination with European monetary authorities, announce a plan toinvest up to US$ 250 billion in preferred securities of nine U.S. banks –including Citigroup, Bank of America, Wells Fargo, Goldman Sachs, and JPMorgan Chase

• October 18, 2008: President Bush, French President Nicholas Sarkozy and the President of theEuropean Union (EU) issue a joint statement proposing an internationalsummit to be held after the US Presidential elections; whilst the Europeanshad been pushing for a meeting of the G-8, President Bush called for abroader global meeting that would include countries such as China andIndia

• October 19, 2008: South Korea announces a) foreign debt guarantees of up to US$ 100 billionto its banks; b) pumping in funds of US$ 30 billion into the banking sector

• October 22, 2008: Pakistan seeks help from the IMF to meet balance of payments difficultiesand to stave off a possible economic crisis given decreasing foreigninvestment and high fuel prices; November 24, 2008 - IMF approves a 23month Stand-By Arrangement of US$ 7.6 billion to Pakistan

• October 19, 2008: IMF approves the creation of a Short-Term Liquidity Facility to supportcountries with strong policies that face temporary liquidity problems

• November 2, 2008: India's Central Bank cuts its short-term lending rate by 50 basis points to 7.5per cent, and reduces its cash reserve ratio by 100 basis points to 5.5 percent

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• November 9, 2008: China announces a US$ 587 billion stimulus package aimed primarily atinfrastructure, housing, agriculture, health care, and social welfare spending

• November 11, 2008: IMF defers decision to approve a US$ 2.1 billion loan to Iceland - the thirdtime that the IMF scheduled and then failed to discuss the Iceland proposal.The tentative Iceland package requires the country to implement economicstabilization; November 19, 2008 - IMF finally approves the loan to Iceland,following which Denmark, Finland, Norway and Sweden agree to pumpin an additional US$ 2.5 billion in loans to Iceland

• November 15, 2008: Japan announces a contribution of US$ 100 billion from its reserves to theIMF to help emerging economies

• November 24, 2008: UK announces a fiscal stimulus package of US$ 20.2 billion to deal withthe looming recession in the country

• December 11, 2008: EU leaders approve a US$ 269 billion economic stimulus package

• December 23, 2008: Central People's Bank of China lowers interest rates for the fifth time infour months

• January, 2009: Sri Lanka announces a Rs.16 billion bail out package (0.3 per cent of GDP)

• January 22, 2009: Singapore announces a US$ 13.7 billion stimulus package

• January 28, 2009: US House of Representatives pass the American Recovery and ReinvestmentAct of 2009 (with the cost of the bill estimated at US$ 819 billion)

• January 29, 2009: Thailand's Parliament announces a US$ 3.5 billion stimulus package

• February 5, 2009: Bank of England reduces its key interest rate by 50 basis points from 1.50 to1.00 per cent - the lowest level since the founding of the Bank in 1694

• February 14, 2009: G-7 pledges to prevent a resurgence of protectionism, urging all membersto fight recession without distorting free trade

• February 17, 2009: General Motors and Chrysler submit recovery plans to the US governmentrequesting US$ 21.6 billion more in loans; December 19, 2008 - PresidentBush announced a US$ 13.4 billion three year rescue plan for the twocompanies with several attached conditionalities

• February 17, 2009: President Obama signs a US$ 787 billion economic stimulus bill - whichincludes US$ 575 billion in government spending and US$ 212 billion intax cuts

• March 10, 2009: Malaysia's Finance Minister announces a fiscal stimulus package of US$16.3 billion

• March 14, 2009: G-20 Finance Ministers and Central Bank Governors agree to take steps tohelp emerging and developing economies cope with capital flow reversals,and also on the need to boost the resources of the IMF

• March 24, 2009: IMF approves a major re-haul of its lending framework in an attempt toincrease the flexibility of its lending policies and to streamline conditionality;measures include the creation of a new Flexible Credit Line, enhancing theflexibility of its traditional Stand-By Arrangement, and simplifying cost andmaturity structures

• April 2, 2009: G-2O London Summit sees the leaders of the world's largest economiesagreeing to deal with the global financial crisis with measures amounting toabout US$ 1.1 trillion - including US$ 750 billion for the IMF, US$ 250billion to boost international trade, and US$ 100 billion for multilateraldevelopment banks. The Summit also saw pledges to establish a newFinancial Stability Board that would work closely with the IMF to ensurecross-border cooperation; tighter regulation of banks, hedge funds andcredit rating agencies; and, a crackdown on tax havens. Commitments toresist protectionism were reiterated by the leaders at the Summit

Contd............Box 8.1


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The extent and depth of the global financialcrisis are clearly reflected in the domino typefailures, widespread rescue operations, andcrisis management strategies set out in Box8.1. A comprehensive understanding of thenature and scope of the global meltdown,however, also requires some knowledge ofthe much disputed financial tool set used inthe US - the epicentre of the crisis - and ini-tial/pre-crisis conditions in the financial sec-tors of advanced economies such as the UKand selected emerging and developing econo-mies. Unpacking the initial conditions thatunderpinned the recent crisis also requiresan understanding of the institutional archi-tecture that governs international finance, inorder to address policy issues on the re-shap-ing of global financial regulation.

The evolution of the securitized credit modelfrom its simpler formulations - for example,corporate bonds - to more complex incarna-tions in the form of derivatives such as CreditDefault Swaps (CDSs) and CollateralizedDebt Obligations (CDOs) is widely perceivedto be one of the principal causes of the fi-nancial crisis. The structure of these instru-ments enabled investors and traders to hedgeunderlying credit exposures, use securitizedcredit taken off a particular bank's balancesheet as collateral to raise short term liquid-ity, and engage in highly complex and opaquere-securitization practices. The complex de-sign of the transformed securitized creditmodel permits issuers to re-package theseinstruments into varied slices of risk andmaturity. The danger with this model is thatit can, if not used properly, create principal-agent problems between investors and man-

agers of these funds - a phenomenon illus-trated in the case studies on Lehman Broth-ers and AIG (Box 8.2). The pre-crisis yearsalso saw a rapid growth in highly leveraged,off-balance sheet tools such as StructuredInvestment Vehicles (SIVs), a form of'shadow banking' - not on the books of regu-lated banks - that manage maturity transfor-mation. These financial innovations grew tomeet investors' demand for high yieldinginstruments in a climate of low risk aver-sion, with the demand for yield uplifts inturn being driven by global macroeconomicimbalances.

Whilst the financial sectors of some emerg-ing and developing economies have beenaffected by the global crisis, studies indicatethat these countries have, for the most part,been shielded from the credit crisis due tonegligible exposure to the 'toxic assets' thathave devastated financial institutions andmarkets in the more advanced economies -in particular, the US and the UK.4

Research on the history of financial crisesindicates that such episodes occur oftenenough so as to be considered a part of thesystem of finance capitalism.5 As such, fi-nancial crises can be considered within thebroader genre of market failures - which inturn, links to public policy questions on thenature and scope of regulation. The apogeeof international financial regulation, as at thetime of the current global meltdown, is theBasel process - enshrined in the Basel Ac-cord I created in 1988 and in the Basel Ac-cord II published in 2004. The Basel initia-tive was a response to a spate of interna-

4 See Mohan, Rakesh (2009), "Global Financial Crisis - Causes, Impact, Policy Responses and Lessons", speech delivered at the 7th AnnualIndia Business Forum Conference, London Business School, London, 23 April 2009 - for an analysis of the impact of the crisis on India.

See Gruenwald, Paul and Ivy Tan (2009), "Lessons from the Crisis for Asian Banks", Asian Journal of Public Affairs, Vol. 2, No. 2, Lee KuanYew School of Public Policy, National University of Singapore - for an analysis of the impact of crisis on Asian banks.

See "Economic Focus: Domino Theory", The Economist, February 28, 2009 - for a general analysis of the impact of the crisis on emergingmarkets.

5 See for instance, Fratianni, Michele (2008), "Financial Crises, Safety Nets and Regulation". Available at: http://ssrn.com/abstract=1286903.

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Box 8.2The Tale of Lehman Brothers and AIG

Why did Lehman Brothers collapse?

Lehman Brothers filed for bankruptcy on September 15, 2008 – the largest bankruptcy filing in US history– with the entity’s assets of US$ 639 billion far surpassing those of bankrupt giants such as Enron andWorldcom. Lehman Brothers, which was founded in 1850, survived the railroad bankruptcies of the1800s, the Great Depression of the 1930s, and two World Wars; and yet, the sub-prime crisis proved tobe too much for this entity. What was different this time around?

• In 2003-04, in the years of the housing bubble in the US, Lehman bought over five mortgagelenders. As the credit crisis heightened in 2007, the company continued to underwrite hugeamounts of mortgage-backed securities amounting to a portfolio of US$ 85 billion. Lehman’sstocks fell by 48 per cent in March 2008, as hedge fund managers began to question thevaluation of the company’s mortgage portfolio in the midst of a sub-prime crisis, and followingthe near collapse of Bear Stearns – the second largest underwriter of mortgage-backed securitiesin the US. The value of the entity’s shares continued to drop despite overtures made byLehman to several potential partners, and on September 15 2008, the company declaredbankruptcy with the value of its stock plunging by 93 per cent from its previous close onSeptember 11, 2008.

• The collapse of Lehman is also perceived as an episode that posed an enormous liability toplayers in the CDSs market. The declaration of bankruptcy by Lehman led to a transfer of largesums of credit in the CDSs market in order to insure buyers of Lehman credit default riskprotection. The sellers of CDSs were obligated to pay the full investment in these bonds backto the insured parties/buyers. The mathematics worked out to the sellers of Lehman CDSshaving to pay the insured counterparties 91.375 per cent of the face value of the bonds –which was extremely worrisome given Lehman’s legacy of hundreds of billions of dollars inoutstanding debt.

Why did the government step in to bail out AIG?

AIG is a financial conglomerate which engages in activities including insurance and investment. Thedifficulties encountered by this entity are a prime example of contagion, not from core business activities,but from an unregulated part of the group taking on risk via non-regulated products – in this instance,CDSs.

Why would a robust and large company such as AIG take on the gamble of entering into new and riskyfinancial product markets? The lure of money – given that the CDSs market averages around US$ 70trillion annually – may well have been a factor. Moreover, the traditional insurance and investment linesof AIG’s business remained strong, perhaps creating a sense of over-confidence amongst AIG’s management.However, on September 16 2008, the US government intervened to bail out AIG, primarily because ofthe fact that its size and exposure to the CDSs market would have had a devastating domino effect in theglobal insurance industry, given the extensive presence of AIG’s insurance banks in several countries.

tional bank failures in the 1980s, and was aresult of a meeting of the central banks andsupervisory authorities of ten countries - theBasel Committee on Banking Supervision -in Switzerland in 1987. The objective of theBasel I Accord was to: a) strengthen the sta-bility of the international banking system;and, b) to set up a fair and consistent inter-national banking system to reduce competi-tive inequality among international banks.However, this first agreement is seen asflawed for the following reasons: a) limited

differentiation of credit risk; b) static mea-sure of default risk; c) no recognition of term-structure of credit risk; d) simplified calcula-tion of potential future counterparty risk; and,e) lack of recognition of portfolio diversifi-cation effects.

Given these criticisms, it is clear that Basel Iwould not have been sufficient in the face ofthe current financial crises. In response tothe criticisms of Basel I, the Basel Commit-tee on Banking Supervision set out a second


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accord which aims at: a) ensuring thatcapital allocation is more risk sensitive; b)separating operational risk from credit risk,and quantifying both; and, c) attempting toalign economic and regulatory capital moreclosely to reduce the scope for regulatoryarbitrage. In order to achieve these objec-tives, Basel II uses a 'three pillars' approach:1) minimum capital requirements, address-ing risk; 2) supervisory review; and 3)market discipline to bring about stability inthe financial system.

However, the question still remains as towhether the Basel process is sufficient to ad-dress serious regulatory lapses in the interna-tional financial system. Discussions on thisissue take the position that the Basel processis an inadequate and ineffective regulatoryinstrument,6 where empirical evidenceindicates that Basel I encouraged high-risk,short term borrowing. The emphasis of BaselII on credit ratings, and its dependence onbanks to produce risk weights for capitalrequirements, would also be rather futile ina situation such as the current financialmarket imbroglio.

Discussions and statements in the interna-tional policy arena in relation to the globalfiscal crisis, the need to re-haul global finan-cial regulation and to 'fix' global finance infora such as the G-20 and by key policymakers have one thing in common: a call fora global system of financial regulation ofsome sort. Clearly, such policy solutions arenot rooted in reality. Real politick andissues of national sovereignty render thenotion of a global super regulator unfeasibleand a non-starter. More important in this

debate are the questions of policy transfer,and the inapplicability of generalized,homogenous financial regulation to a diversespectrum of economies with vastly differentdomestic financial markets and institutions.A more pragmatic solution would be tocreate a new financial order with a minimalset of international best practices - togetherwith the restructuring of Bretton Woods in-stitutions such as the International MonetaryFund (IMF) to ensure a more democratic pro-cess of country representation and enhancedresources.

Another key policy concern coming out ofthe global financial crisis is the recurring de-bate over states versus markets; in this in-stance, more specifically, nationalization offinancial institutions versus maintaining thestatus quo in terms of private financial enti-ties; and of the extent of re-regulation of thefinancial sector.

As indicated in Box 8.1, the policy responsesto the financial crisis in some countriesincluded the take-over of private banks bythe state, in what is best described asmeasures of crisis management. The morerelevant question, however, is what liesbeyond the phase of crisis management. It isunlikely that nationalization strategies wouldrectify the core issues of bad financial insti-tutional practices, which triggered theglobal crisis. The vast literature on the ben-efits of state-ownership vis-à-vis privatizationsuggests that state entities are not immuneto the principal-agent problems faced by theprivate sector.7 Moreover, in countries thathave a poor record of governance in general,

6 See Dani Rodrik's argument for national, as opposed to global regulation, in "Economic Focus: A Plan B for Global Finance" in TheEconomist, March 14, 2009.

7 See Kelegama, S. (1997), 'Privatization: An Overview of the Process and Issues' in W.D.Lakshman (ed), Dilemmas of Development: FiftyYears of Economic Change in Sri Lanka, Colombo: Sri Lanka Association of Economists.Megginson, W. and J.M. Netter (2001), "From State to Market: A Survey of Empirical Studies on Privatization." Journal of EconomicLiterature, 39, 321-389Willner, J. and D. Parker (2002), Relative Performance of Public and Private Enterprise under Conditions of Active and Passive Ownership,Manchester: Centre on Regulation and Competition, University of Manchester.Knight-John, M. and P.P.A.W. Athukorala (2005), "Rethinking Privatization in Sri Lanka: Distribution and Governance" in J. Nellis, and,N. Birdsall (eds.), Reality Check: The Distributional Impact of Privatization in Developing Countries, Washington D.C: Center for GlobalDevelopment.

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nepotism and political capture tend to un-dermine any positive efficiency impacts ofstate-ownership. The question of re-regula-tion will be addressed in detail in the con-cluding section of this Chapter. However, atthis juncture, it is useful to point out thefact that the main causes of the global melt-down were the flawed regulatory practicesin place in the US. Clearly, a more targetedregulatory structure that has the capacity toaddress problems of informational asymme-try - moral hazard and adverse selection -that are rampant in financial markets is es-sential. It is highly debatable, however, ifthis translates into more regulation or re-regu-lation. What it implies rather is a more sim-plified scheme of regulation that would en-courage, rather than deter, competitive mar-ket forces.

8.3 Impacts of the Global FinancialCrisis on Sri Lanka's Financial Sector

As previously mentioned, Sri Lanka's finan-cial sector does not face the same degree ofvulnerability as those other countries listedin Box 8.1. As in the case of countries suchas India and other Asian economies - withthe exception of South Korea - Sri Lanka hasnot been exposed to the 'toxic assets' thatcreated havoc in the balance sheets of banksand other financial institutions in advancedeconomies and some emerging and develop-ing economies in Central and Eastern Europeand in Latin America. The level of capitalmarket liberalization - with Sri Lanka main-taining a partially closed capital account -has also contributed to staving off contagioneffects of the global crisis.

This does not imply, however, that Sri Lankanpolicy makers can be entirely complacent.Whilst the country's financial sector has beenshielded from the short term direct impactsof the global financial meltdown, the inevi-table tightening of credit flows on the partof the advanced economies that have takenthe biggest hit will have medium termimpacts on Sri Lanka in terms of access andcost of international finance. According tothe IMF, countries such as Sri Lanka andGhana that have begun to access internationalcapital markets are at medium term risk fromthe global credit crunch.8 This is reiteratedby Sri Lanka's experience in the latter monthsof 2008, which indicates that the govern-ment securities market that was recentlyopened out to foreign investors, subject tolimits, recorded a significant reversal ofcapital flows. Moreover, as will be detailedlater on, Sri Lanka's financial sector has facedserious 'home-grown' regulatory issues in thepast years. As such, regulatory governanceissues remain a significant challenge for SriLanka - although this is not a phenomenonthat is exclusive to the financial sector, butrather one that is relevant for regulation perse in the country.

Sensible and workable regulatory and policysolutions necessitate a thorough understand-ing of the initial conditions - defined for thispurpose as the structure of Sri Lanka's finan-cial market, and the regulatory and legalframework governing the sector. Boxes 8.3.and 8.4 provide a brief overview of keyfeatures of Sri Lanka's financial market, andof the existing legislation pertaining to thefinancial industry, relevant for the purposeof the analysis set out in this Chapter.

8 IMF (2009). "The Implications of the Global Financial Crisis for Low-Income Countries", March 2009. Available at: http://imf.org/external/pubs/ft/books/2009/globalfin/globalfin.pdf.


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Box 8.3Sri Lanka's Financial Sector: Structural Features (as at 2007)

• The banking sector dominates the financial system – the CBSL holds approximately 13 percent of the total assets of major financial institutions, while the rest of the banking sectoraccounts for 58.1 per cent.

• Sri Lanka’s banking sector is highly concentrated, and as at 2006, had the highest marketconcentration level in the region.

• Contractual savings institutions (including insurance companies and employees’ providentand trust funds) account for around 20.6 per cent of total financial sector assets.

• Credit rating agencies, venture capital companies, and unit trusts are negligible in terms offinancial sector assets.

• The bond market is dominated by government debt securities; the corporate bond marketis relatively underdeveloped, with the corporate sector relying on bank credit.

• The Colombo Stock Exchange (CSE) has modern infrastructure and a main and secondboard for listing; however, the linkages between market fundamentals and activities on theCSE are very weak.

• Securitization remains at an extremely early stage of development in Sri Lanka

Box 8.4Financial Sector Regulation: Key Legislation

A. Banking Sector

Banking Act No. 30 of 1988 (and Amendments to this Act, specifically Banking [Amendment]Act No. 2 of 2005

The Act of 1988 provides for the introduction and operation of a procedure to licensepersons carrying out banking business, and the business of accepting deposits and investingsuch money. The law sets out guidelines for the regulation of the banking sector and giveswide supervisory powers to the Monetary Board of the Central Bank of Sri Lanka (CBSL).

The 2005 Amendment further expands and strengthens the regulatory powers of the MonetaryBoard of the CBSL; for instance, Section 83 C (1) of this piece refers to ‘pyramid schemes’ –

“No person shall directly or indirectly initiate, offer, promote, advertise, conduct, finance,manage or direct a Scheme where a participant is required to contribute or pay money ormonetary value and the benefits earned by the participant are largely dependent on:(a) increase in the number of participants in the Scheme; or(b) increase in the contributions made by the participants in the Scheme”

B. Non-banking Sector

(1) Securities MarketSecurities Council Act No. 36 of 1987 (and Amendments No. 26 of 1991; No. 18 of 2003)

These Acts provide regulatory powers to the Securities and Exchange Commission of SriLanka (SEC) over all aspects of the listed securities market outside of government debt; the1991 Amendment provides for the licensing of unit trusts; the 2003 Amendment extends thejurisdiction of the SEC to market intermediaries such as underwriters, clearing houses, marginproviders, investment managers, and credit rating agencies – and also gives the SEC thepowers to summon and investigate.

(2) Insurance Market

Insurance Act No. 43 of 2000

This legislation which facilitated the setting up of an insurance regulator – the InsuranceBoard of Sri Lanka (IBSL) – ensures that the insurance business is carried out with integrity in

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order to safeguard the interests of policy holders and potential policy holders; and, registerspersons carrying on insurance business in the country.

(3) Auditors

Accounting and Auditing Standards Act No. 15 of 1995

The Sri Lanka Accounting and Auditing Standards Monitoring Board (SLAASMB) was establishedunder this legislation to regulate the accounting and auditing practices of “specified businessenterprises” (e.g. companies with a turnover in excess of Rs. 500 million, staff in excess of 100employees, etc.) The regulatory ambit of the SLAASMB is broader than that of the SEC (withjurisdiction limited to quoted companies) extending to financial institutions, banks, and family-owned entities.

(4) Finance Companies

The Finance Companies Act No. 78 of 1988 (and its subsequent Amendments)The Act sets out the Monetary Board of the CBSL as the regulator of "finance companies" -entities defined in the Companies Act No. 17 of 1982 as registered to carry out "financebusiness". The Finance Companies Act No. 78 of 1988 defines "finance business" as the"business of acceptance of money by way of deposit the payment of interest thereon and a)the lending of money on interest; or, b) the investment of money in any manner whatsoever;or, c) the lending of money on interest and the investment of money in any manner whatsoever.

Citing relevant text from Section 10 of the Finance Companies Act of 1978:Section 10 (1):

"where the Board on a report made by the Director is of the opinion that a finance company-(i) is following unsound or improper financial practices, detrimental to the interests of its

depositors;(ii) is likely to be carrying on its business in a manner detrimental to the interests of its

depositors;(iii) has contravened or failed to comply with any provisions of this Act, or any direction

issued thereunder,the Board may direct such Company-

(a) to cease following any such practice or desist from any such contravention; or(b) to comply with the provisions of this Act; or,(c) to take necessary action to correct the conditions resulting from such practice or

contravention; or(d) secure the reduction of the number of shares held in the company by any person.

Sections 11 and 12 of the Act provide the CBSL with the necessary powers to examine therecords and books of finance companies.

(5) Finance Leasing Business

The Finance Leasing Act No. 56 of 2000

The Act provides the Head of the Department of the CBSL to which the subject of financialleasing is assigned by the Monetary Board with regulatory powers over this area. The Act setsout strict criteria for registration as a finance leasing business in Section 3:

"A person shall not be eligible to be registered under this Act unless such person-(a) is a licensed commercial bank or a licensed specialized bank within the meaning of

the Banking Act No. 30 of 1988;(b) a finance company within the meaning of the Finance Companies Act No. 78 of

1988; or(c) a public company incorporated under the Companies Act No. 17 of 1982 having

such minimum issued and paid up capital as may be prescribed.


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Sri Lanka’s financial industry is governed byseveral pieces of legislation,9 with clear cutregulatory jurisdiction with respect to thevarious financial markets as indicated in Box8.4. In general, with a few exceptions (suchas the fact that unlisted companies thatpublicly offer debt securities do not comeunder the jurisdiction of the SEC), thelegislation governing Sri Lanka’s financialsector is sound – at least on paper. However,the regulatory challenges lie in theimplementation of the law largely due topolitical-economy factors stemming fromweak governance practices. For instance,relevant questions that need to be raised are:to what extent and how effectively did theregulator utilize the provisions granted underSection 10(1) and Sections 11 and 12 of theFinance Companies Act to deal with theproblems that emerged with regard to financecompanies. Similarly, what were theobstacles faced by the regulator with respectto using Section 83 C(1) of the Banking Actof 1988 to effectively deal with theproliferation of pyramid schemes in thecountry.

Another area which has not receivedadequate attention in Sri Lanka, and whichis now of increased concern due to the globalfinancial crisis as well as the 'home-grown'problems that afflict the country's financialmarkets - as will be discussed below - isthat of corporate governance and of riskmanagement. The SEC together with theInstitute of Chartered Accountants of SriLanka (ICASL) put out a voluntary code ofcorporate governance in 2002. In addition,the Colombo Stock Exchange (CSE)introduced corporate governance standardsfor listed companies in 2007. These codesof conduct include the minimum numberof non-executive and independent directors,criteria for determining independence,

disclosure requirements, remuneration, andaudit committees. However, only a fewcompanies have adopted these standardsgiven that they are voluntary.

As mentioned earlier on, the recent turmoilin Sri Lanka's domestic financial market doesnot bear the hallmark of events in the globalfinancial arena. Instead, the crises relatingto 'pyramid schemes', and the problems atfinancial institutions, such as The FinanceCompany and stresses on banks such asPramuka and Seylan Bank, point to country-specific factors. As per the Banking Actof1988, the core objective of the CentralBank of Sri Lanka (CBSL) is to maintainfinancial system stability - i.e., to regulatethe entire financial system. It is, therefore,pertinent to question what went wrong. TheCBSL did step in post-crisis, to rescuefinancial entities that were affected by thefailure of unregulated and illegal financialfirms, and to restore public confidence andsystemic stability. For instance, in December2008, the state-owned Bank of Ceylon wasappointed as managing agent to Seylan Bank,and liquidity in the form of collateralizedborrowings was pumped into Seylan Bank.In addition, in February 2009, thegovernment announced a special supportpackage to help finance and leasingcompanies that face liquidity problems dueto a crisis of confidence on the part ofdepositors; and, the CBSL has continuouslyengaged in public awareness campaigns -ranging from issuing newspaper notices inall three languages to programmes for schoolchildren at the regional level - aimed ateducating the public on high risk, unregulatedfinancial investments.

The crisis in Sri Lanka's financial sector raisesa crucial question as to the role of theregulator - which in accordance with

9 In addition to these legislative enactments, the industry has a Financial Ombudman to deal with issses relating to dispute settlement .

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international best practice is to a) addressinformational asymmetries - in this instance,make information on high risk investmentsavailable to the public; which the CBSL didand continues to do effectively; b) havecredible powers of prosecution. In line withthis argument, the regulator cannot be heldresponsible for the risk-taking behaviour (callit "greed") on the part of the thousands ofinvestors that were attracted by the undulyhigh interest rates offered by unregulatedfinancial entities.

A recent statement by the chairman of theSEC suggests that there are still over 2,000unauthorized finance companies in SriLanka.10 Currently, the CBSL is in the processof implementing new measures to increasetransparency, provide for better coordinationamongst the various entities that regulate thefinancial industry, and to enhance the powersof prosecution. All finance companies arenow mandated to list on the CSE in the nexttwo years in order to broad base ownership,and to enhance accountability via disclosurerequirements. A consolidated supervisionframework is in the process of beinginstitutionalized with the SEC, Sri LankaAccounting and Auditing StandardsMonitoring Board (SLAASMB), the ICASL,and the CSE working together. The FinanceCompanies Act of 1988 is to be replaced bynew legislation that aims to place morerestrictions on unauthorized financialinstitutions and enhance prosecutory powers(including penalties and duration ofimprisonment).

Looking to the future - and to the possibilityof further capital market liberalization - andthe adoption of innovative financialinstruments by financial institutions in SriLanka, the challenge to address regulatory

loopholes and enhance domestic financialregulatory capacity becomes greater.

8.4. Financial Sector Regulation: PolicyChallenges

This concluding section of the Chapteraddresses three key policy challenges thathave been the subject of debate in financialpolicy circles following the globalmeltdown. The aim of the discussion in thissection is not to arrive at conclusive policymeasures for Sri Lanka, but rather to raisethe antenna on these issues so as to stimulatemore debate amongst local stakeholders inthe financial policy space - with the finalobjective of getting to consensus-basedpolicy solutions.

8.4.1 Speed of Financial Deregulation

The speed and sequencing of financial marketliberalization has been at the centre of muchcontroversy, in contrast to trade liberalizationfor instance, in academic and policy circlesinternationally and locally. Given theinformational asymmetries that characterizefinancial market products and flows, thepossibility of miscalculations, speculativebubbles, and capital outflows/capitalreversals are greater in the financial sector,as opposed to the real sector. Empiricalevidence on financial liberalization alsosuggests that the relationship between capitalaccount openness and growth is weaker thanthat between current account openness andgrowth.11

In emerging and developing economies, theproblems of informational asymmetries arecompounded by the lack of supportinginfrastructure - such as for example, strongfinancial regulatory institutions and robustmacroeconomic frameworks. As such, speedy

10 "Sri Lankans Still at Risk from Unregulated Financial Firms", Lanka Business Online, June 16 2009. Available at: http://www.lbo.lk/print.php?nid=86402222.

11 Soebbeke, Eva (2008), "Do Financial Regulation and Deregulation Work Symmetrically?". Available at http://ssrn.com/abstract=1343825.


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and ad hoc deregulation of capital accountscan easily destabilize these economies andsend them into a downward spiral. The idealpolicy prescription, therefore, would be tomaintain some degree of capital controls untildomestic financial regulatory structures haveevolved to a stage where they can handlethe complexity and inter-connectedness ofglobal financial flows.

Capital market liberalization has been thetopic of much debate and discussion in SriLanka over the last two decades. Asmentioned earlier on, however, Sri Lanka'spolicy on capital account openness -maintaining partial controls - was significantin lowering the level of exposure to theglobal financial crisis. In what may beperceived as a rather surprising and yet boldmove, two of the highest ranking officialsof the CBSL called for capital accountconvertibility on the grounds that this wouldenhance the prospects of capital inflows, andincreased investment into the country. Whilstthis is by no means an invalid argument,what is relevant in this context is the timingof such a move. Capital accountliberalization yields its best results whenstrong macroeconomic and regulatoryfundamentals are in place. As portrayed inthe events described in the precedingsections, financial regulation is still at arudimentary stage in Sri Lanka - certainly nota very conducive environment for unpluggingcapital controls.

8.4.2 Paradox of Under and Over-regulation

The regulation of financial markets tends todraw two starkly contrasting views,particularly in policy and academic circles:extreme libertarians that oppose any type ofregulation, and interventionists that focuson widespread market failures and call for

heavy-handed regulation. There is, however,a more balanced and pragmatic middle-ground that is less bent on ideology and morefocused on strategic regulatory actions -based on the principle of regulation forcompetition. That is, regulation not as anend in itself, but as a means to enhancecompetition and contestability, and toimprove consumer and producer welfare.What this also means is that every instanceof market failure does not necessitateregulatory action. Instead, sensible and well-informed regulators need to weigh the costsand benefits of any regulatory action priorto instituting it.

Linked to this debate on balanced regulationis a conundrum faced by policy makers inthe event of financial crises: labelled the'paradox of under-and over-regulation'.12 Themain thesis here is that the success of aprudential regulator, or a sustained periodof economic stability, may well lead tocomplacency, reducing the demand for theregulator's services and bringing about under-regulation - which in turn could result in afinancial crisis. At the other end of thespectrum lies the phenomenon of over-regulation, where a crisis that imposes costsgreater than anticipated, prompts apendulum shift from under to over-regulation.

At the centre of this paradox is the problemof asymmetric information betweenstakeholders affected by the regulations andthe regulator, with the following policymeasures being recommended to address thisissue: a) improve information disclosure -the regulator must be kept aware of anyexposure by financial institutions to systemicrisks; b) increase the independence of theregulator vis-à-vis the political process andlobby groups - given principal-agent

12 See analysis by Aizenman, Joshua (2009), "Financial Crisis and the Paradox of Under-and Over-Regulation", Working Paper 15018,National Bureau of Economic Research.

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problems, regulator independence isessential to institute information disclosurerequirements; and, c) centralize theregulatory process - fractured regulationmakes the process less transparent, and alsoprovides space for arbitrage between diversefinancial regulatory agencies.

8.4.3 Corporate Governance: Issues ofTrust, Corruption and Self-regulation

The current global financial crisis negatesperceptions that corruption is a phenomenonunique to developing countries. Concreteexamples of capture in the course of theglobal financial crisis are set out in Box 8.5.Corruption and capture are also intrinsicallylinked to the notion of trust,13 defined as:

"…epiphenomenal to the more basic

concept of social capital….social capital

consists of norms or values, instantiated

in an actual relationship among two or

more people that promotes cooperation

between them….a group of people

embedding such norms will tend to trust

one another more than those who do not,

or will at least have better grounds for

coming to a decision on whether to trust.

To understand where trust comes from,

one has to understand how the shared

norms arise and how they become

embedded in actual social groups."

It could be argued that corruption and captureare less pervasive in high-trust societies, orsmaller social or professional groups, thatare governed by similar norms and values.These concepts also have a strong bearingon practices of self-regulation, the bed-rockof corporate governance.

The need for sound corporate governancepractices has been underscored by theepisodes that contributed to the global

Box 8.5Corruption and the Global Financial Crisis: A Few Documented Examples

• Freddie Mac and Fannie Mae spent millions of dollars lobbying influential members ofCongress in exchange for lax capital reserve requirements

• AIG’s “small” derivatives unit in London, obscured its accounts, was governed by laxregulatory oversight, and took extraordinary risks

• Countrywide Financial, a giant mortgage lender, switched regulators in order to comeunder the lax oversight of the Office of Thrift Supervision, funded by fees paid byregulated banks, and which also co-incidentally supervised AIG’s derivatives unit

• In April 2004, the largest investment banks in the US persuaded the Securities andExchange Commission (SEC), at a 55 minute-long meeting, to relax its regulatory stanceand enable them to take on larger amounts of debt

• Madoff’s giant Ponzi scheme, through system-wide irregularities, points to subtle formsof corruption and capture; although the SEC was aware of Madoff’s multiple violationswhen he served on the Commission’s Advisory Committee, the SEC failed to unmask thePonzi scheme

Source: Kaufmann, Daniel (2009), “Corruption and the Global Financial Crisis”, January27, 2009. Available at: http://www.forbes.com/2009/01/27/corruption-financial -crisis-business.html

13 Fukuyama, Francis (2001), "Differing Disciplinary Perspectives on the Origins of Trust", Boston University Law Review, 81, 479-494.


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financial meltdown. Closer to home, thespate of financial institution failures in SriLanka further emphasize the need for aworkable code of corporate governance,which would create incentives to promoterobust self-regulation. Much like the nexusbetween trust and shared norms, self-regulation functions best when the followingfactors are in place: a) proximity – self-regulators need to be close to the industrybeing regulated in order to have hands-onknowledge of the industry, and to identifyand respond to potential problems in a timelymanner. Ironically, however, proximity canalso be a disadvantage due to conflicts ofinterest; b) collective interests of industry –this can also increase the self-regulator’spowers to ensure compliance.

Finally, policy makers have to come to termswith broader and pervasive issues ofregulatory governance, including the needfor accountability, transparency, andoperational and financial independence ofthe regulator. Whilst financial markets haveparticular characteristics that distinguishthem from other product markets – such asthe volatility of capital flows, for instance –the core features of sound regulatorygovernance remain the same. Sri Lanka’sfinancial sector has, at least up to now, beenshielded from the domino impact of theglobal turmoil. However, issues ofgovernance in general and of regulatorygovernance in particular remain a challenge.

The Global Economic Crisis and Possible Impact on Sri Lanka’s Health Sector

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9. The Global Economic Crisis and Possible Impact on Sri Lanka's HealthSector

9.1 IntroductionAn important characteristic of the global eco-nomic crisis has been the speed with whichit evolved, and the consequent uncertaintyfacing policy makers across the world. In thisregard, the developing world is likely to behanded a particularly raw deal in a crisis thatis not of its own making. A key challengefacing the world at large - and developingcountries in particular - is to prevent the eco-nomic crisis from becoming a social and ahealth crisis.

An examination of past recessions and theireffect on health care provides some indica-tions of the likely impact on socio-economicconditions arising from the current globaleconomic downturn. Given that the dura-tion and magnitude of the downturn is asyet unclear, as is the likely medium termoutlook for low-income and emerging econo-mies, conclusions can only be tentative atthis stage. Nonetheless, there are significantrisks arising from the prospect of cuts in so-cial spending such as on health, education,and social protection. Poorer populations arelikely to be the first and hardest hit by anydownturn. Over the last three decades, mostpoor households in developing economieshave benefited from the growth of exportoriented industries and inward remittancesfrom abroad. As demand declines in devel-oped economies, job losses, and lower re-mittances from migrant workers are likely toadd to the adverse consequences for familyincome, and the ability to pay for health care.

The objective of this policy brief is to dis-cuss the probable channels through which

an economic crisis of this nature can affectSri Lanka's health sector. In particular, itattempts to make the case for sustaininginvestments in health, and to identify actionsthat can help to mitigate the negativeimpact of the economic crisis. The discus-sion will examine the overall impact of theeconomic downturn on key health sectorareas such as health financing, donor fund-ing, household out-of-pocket expenditure,cost of medicines, primary health care, andprivate health care. The concluding sectionwill address some policy options to mitigatethe adverse impacts on the country's healthsector.

9.2 Sri Lanka's Health SectorSri Lanka has continued the practice of pro-viding health care services free of charge atall government health institutions, togetherwith the provision of services in close prox-imity to households. Over the years, this hasled to the establishment of a network of 954government health institutions in 276 Medi-cal Officers of Health (MOH) areas, with ahealth workforce of nearly 50,000 spreadwidely throughout the country. This has en-sured that at present, Sri Lanka has on aver-age a total of 49 medical officers, 87 nurses,and 25 public health midwives per 100,000population.

Government hospitals and dispensariesspread throughout the island are able to treataround 43 million out-patient visits andaround 4.5 million in-patients annually.1 Theprovision of high standard health care facili-ties has become a challenging task over the

1 Ministry of HealthCare and Nutrition, Annual Health Bulletin 2004/2005, Medical Statistics Unit.


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years due to budgetary constraints. Privatesector provision of alternative sources ofallopathic and indigenous treatment hashelped reduce the public health care burdento some extent. Despite the many challenges,Sri Lanka is on track to achieve its Millen-nium Development Goals (MDG) targets interms of the relevant health indicators. Theunder-five year mortality rate has declinedby half over the period from 1990 to 2005,and is on track to be reduced by two-thirdsby 2015. The infant mortality rate has de-clined from 19.3 per 1000 live births in 1990to 12.0 in 2005, and is on its way to achievethe target of 5.9 per 1000 live births in 2015.The proportion of one year old childrenimmunized against measles has reached 98per cent. Maternal mortality has declined bytwo-thirds since 1990, and is on its way toachieve a three-quarter reduction by 2015.The proportion of births attended to by skilledhealth personnel has reached 98.7 per cent.

Over the years, a steady growth in privatehealthcare services has been a significantdevelopment in Sri Lanka's health sector.Nonetheless, the state health services havecontinued to focus on pro-poor delivery ofown health facilities. This has been impor-tant in the context of other socio-economictrends in the country. Although the propor-tion of people living in extreme poverty - oron less than US$ 1 a day - has fallen since2000 to stand at 15 per cent of the total popu-lation, the gap between the rich and poorappears to have grown since. For example,the share of national consumption of thepoorest quintile of Sri Lanka's population isestimated to have fallen from 46 per cent to39 per cent between 1990 and 2004.2 Evenmore worryingly, wealth remains a keydeterminant of access to health care.

9.3 Impact on the Health Sector9.3.1 Health Financing

Sri Lanka's two tier health system - comprisedof a heavily subsidized public sector and auser charged private sector - has produced aprogressive health financing system. The con-ventional categorizations of finance sourcesfor Sri Lanka's health care are taxation,private health insurance, out-of-pocketpayments, and donor assistance. Governmentfinances for health care flows from generaltaxation, and from donor assistance at a lesserrate.

General government expenditure on healthreached Rs. 71 billion in 2007 from Rs. 11billion in 1995. Total health expenditure inSri Lanka which accounted for 3.4 per centof GDP in 1990 increased at a slow pace to4.1 per cent of GDP in 2007. The govern-ment health expenditure to GDP ratio hasbeen fluctuating between 1.7 per cent and1.9 per cent over the period 1990- 2004, andhas remained at a little over 2 per cent since2005 -reflecting the constraints of financialprovisions in budgetary allocation involvedin normal years, even in the absence of asharp economic downturn.

Evidence from past economic crises, espe-cially in the South Asian region, gives a rea-sonable prediction about what is likely tohappen over the next year or so. In a worstcase scenario, if the flow of income to statecoffers are subject to contraction, governmentexpenditures - inclusive of expenses on health- will be squeezed and is likely fall, contrib-uting to poorer health outcomes.

In Sri Lanka, governments have tended toprotect health spending, even to the extentof increasing it over the years. But an eco-

2 Central Bank of Sri Lanka, Consumer Finance Survey 2004.


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nomic recession makes the task of defendinghealth budgets more difficult. Financial un-certainty may set one health programmeagainst another in a frantic competition forfunds. Likewise, reductions in total expendi-ture will have an impact on the compositionof health spending.

Sri Lanka's health care system has been im-proving over the years, and as such, a higherstandard of health status has been achievedwith the relatively limited resources avail-able to the health sector. Historically, healthauthorities have made significant efforts to-wards identifying what factors are associatedwith better performance, and how publicdelivery can be strengthened. This has beenimportant due to the fact that the state healthsector has not always been capable of pro-viding more and better services to lowincome populations, and to reach the poorin urban slums, remote rural areas, andgeographically marginalized areas such as theestate sector. These efforts have beenhampered due to lack of adequate funds. Ifthere is a further contraction of budgetaryprovisions, efforts to address such criticalissues will not receive the same level ofattention, widening the existing disparitiesin service delivery beyond acceptable levels.

At provincial level, the devolved system ofprovincial governance has failed to promotethe expected service delivery of health topeople of the province. They continue to beheavily dependent on funds from the centralgovernment. The financial stresses on thelatter are likely to tighten further as a resultof the current economic downturn. In theface of an economic crisis, the underlyingsystem of distribution of financial resourcesfrom the centre to provincial governmentcould become fractious, paralyzing the ex-isting health care delivery system at the pro-vincial level.

The shortage of allocated financing will havea major impact on infrastructure spending inthe secondary and peripheral level healthfacilities which is critical for sustainableservice delivery in the health sector. Main-taining, constructing, or rehabilitating themuch needed infrastructure in public healthfacilities - together with access to roads, watersupply, sewerage systems, drainage systems,etc. - could be seriously affected.

Investments in private sector health care fa-cility infrastructure projects could be post-poned or put on hold, since private sectorinvestment depends largely on bank borrow-ing. Delaying capital spending is a commonshort term response of the private health careindustry when faced with budget cuts. Whileit may be a logical response in the short term,it can, however, lead to longer term prob-lems if the downturn is sustained. Reduc-tions in maintenance, medicines, or otheroperating costs related to surveillance or su-pervision are likely to have a more damagingand immediate effect on service delivery.

9.3.2 Donor Funding

A country like Sri Lanka requires financialinflows from the rest of the world to facili-tate and accelerate economic growth, trade,and development. These flows which includeofficial development assistance (ODA) arevery likely to be negatively affected duringthe current crisis. The volume of ODA in-flows also indicates the strength and valueof donor financing to the health sector. In1995, Sri Lanka's government health sectorutilized Rs. 180 million in ODA assistance.In 2007, it had reached Rs 2,533 million.3

In the face of a global recession, fiscal pres-sures in affluent countries may prompt cutsin their ODA budgets. When analyzing thebehaviour of donors during previous reces-

3 Ministry of Finance, Government Budget Estimates, various issues.


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sions, it is clear that ODA for the healthsector too can decline. For example, this wasevident during three previous episodes of glo-bal economic distress in 1990-93, 1997-99,and 2000-01. During the 1990-93 crisis, to-tal ODA commitments fell, but commit-ments towards health continued to rise. How-ever, during the 1997-99 and 2000-01 cri-ses, both total ODA and ODA commitmentsto health declined.4

The present scenario with regards to ODA isthat OECD and EU countries have given anundertaking not to cut aid, but some donorshave indicated possible reductions in aidspending. Even before the present financialcrisis, in 2005, ODA spending by the G-8countries forecasted a shortfall of US$ 34,000million in 2010. In the last round of budget-ing, in December 2008, ODA was reducedby 10 per cent, from US$ 3.1 billion to US$2.8 billion, although all programme requestswere approved. Recipients were asked toachieve the same goals with reduced fund-ing through changes like cuts in overheadcosts or finding lower cost options forpharmaceuticals.5

Foreign aid plays a key role in providing aboost to the health sector that a country couldnot manage on its finances alone. The mobi-lization of foreign aid in Sri Lanka was chan-nelled to island-wide national services suchas prevention of HIV/Aids, controlling tu-berculosis (TB), eradication of malaria, im-proving existing primary care facilities, andconstructing new health institutions.

To some extent, aid ensured that spending isgenuinely pro-poor where possible, sinceODA for health is earmarked along suchlines. Moreover, infrastructure investments

and opportunities for safeguarding lives couldbe identified as important advantages reapedfrom the utilization of ODA funds. In thiscontext, greater predictability of external fi-nancing is vital, especially to facilitate plan-ning, and to obtain better value for money.This has been particularly so in cases whereODA has been earmarked for healthprogrammes such as those aimed at fightingHIV/Aids, TB, and malaria. In general, SriLanka has generated good results from ODAfunds in these areas in the past, and therebymade significant progress towards achievingits health related MDG goals. The danger isthat ODA cuts will stall the process, andleave these programmes unprotected whenthey most need it.

If donors do not cut back on expenditure formedicines or on technical assistance, but yetreduce the overall volume of funds neededfor service delivery, medicines may not getto those who need them. Such a situationrisks exacerbating the tensions between HIV/Aids treatment and other forms of healthspending.6

9.3.3 Household Out-of-pocket Expen-diture

One component of household health expen-diture is that of direct out-of-pocket (OOP)health spending by households on medicalgoods and services. These OOP health ex-penditures in Sri Lanka include user fees paidfor utilizing i) private medical and dentalservices, ii) private hospital services and treat-ment, and over-the-counter (OTC) paymentsto purchases, iii) medical and pharmaceuti-cal products, or iv) therapeutic appliancesand equipment. Private facilities influencethe user fees paid by households. Addition-ally, the pharmaceutical market offers a wide

4 Parry, J. and G. Humphreys (2009), "Health Amid a Financial Crisis: A Complex Diagnosis", Bulletin of the World Health Organization,Vol. 87, No. 1.

5 BBC, "Health News Hour", 30 January, 2009.6 WHO (2009), "High Level Consultation on the Financial and Economic Crisis and Global Health", 19 January 2009. http://www.who.int/

mediacentre/events/meetings/financial_crisis_20090113/en/index.html.


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range of medical goods which determine theOTC payments. These variations in house-hold health expenditure, in turn, are some-what reflected by households' Ability to Pay(ATP). When the household ATP falls, pa-tients will switch from the private sector tothe public sector, often putting an unbear-able burden on government funded freehealth services.

In contrast to public spending, private OOPexpenditure usually tends to decline in a re-cession, particularly if the service delivery ischaracterized by equity or fairness, and pro-vided at free of cost in the public sector.

In general, poor households are likely to bethe first and hardest hit by any downturn.With possible job losses, decreasing remit-tances from abroad, etc., there could be aserious drop in household income to pay forhealth. Although free health services are pro-vided by government health institutions, anaverage of 46 per cent of total health expen-diture is incurred as OOP payments by indi-vidual households.7

In many countries, social safety nets providedby the state prevent individuals from fallinginto poverty beyond a certain level. In SriLanka, successive governments implementedvarious income support programmes aimedat reducing poverty - such as food subsidyschemes, food stamp schemes, Janasaviyaprogramme, Samurdhi programme, etc. - inaddition to uninterrupted free health careservices. This approach to poverty reductionmeans unconditional cash transfers from thestate to the households, placing a heavyburden on the government budget. Once thebudgetary provisions for these services aresubjected to contraction, there can besignificant stress on socio-economic condi-

tions at the household level. This situationis likely to cause increased mental healthproblems, and can even lead to higher ratesof suicide as people struggle to cope withpoverty and unemployment. In addition tomental problems such as depression and bi-polar disorders, the current economic down-turn could exacerbate feelings of despairamong people vulnerable to such illnesses.About 75 per cent of suicides in Sri Lankaare in rural households,8 especially amongfarmer communities, mainly due to the factthat these communities have high levels ofstress because they live at subsistence level,many without even the barest necessities oflife.

9.3.4 Cost of Medicines

The rising cost of medicines has been of majorconcern to consumers and health groupsworldwide in recent years. The high and ris-ing prices have made medicines much lessaccessible to patients, thus hindering the treat-ment for the needy.

In Sri Lanka, dispensing medicine in the pub-lic sector has become more rational, espe-cially in primary and secondary level facili-ties. Public sector hospitals are expected toprovide drugs free of charge to patients. How-ever, the reality is also that most patientstend to purchase more expensive drugs fromprivate pharmacies which are generally un-available in state hospitals faced with inter-mittent shortages in drugs supply. This con-straint has forced households to spend fromout-of-pocket to seek patient treatment fromprivate hospitals and practitioners.

In the current economic downturn, the costof medicines will probably increase for acountry such as Sri Lanka. The economicdownturn is likely to be accompanied by a

7 IPS (2004), Sri Lanka National Health Accounts 2004.8 Daily Mirror, "Suicides in Sri Lanka: Still a Cause for Concern", September 12, 2007.


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depreciating currency where the prices ofimported medicines, raw materials, andmedical equipment will increase. In 2005,Sri Lanka paid out-of pocket a staggering Rs.24 billion to purchase medicine for out-patient care in the private sector. The expen-diture for medicine in the public sector forout-patients was Rs. 590 million.9 If costincreases are not absorbed, the impact willbe reflected in shortages or increased costsof care. If the government cuts back onexpenditure for medicines, or reduces theoverall volume of funds needed for servicedelivery, medicines may not get to those whoneed them. On the other hand, the govern-ment is also accountable for shortages of anyessential drugs in the country.

At present, there is no price control orregulation of prices of pharmaceuticals in theprivate sector. The results of a study carriedout on the prices of the innovator andgeneric equivalent of 28 drugs showed thatthe price of generic drugs in Sri Lanka waslower than that of international prices. How-ever, for the innovator products, there hadbeen an increase in prices of up to 400 percent more than international referenceprices.10

In an economic downturn, prices of importedmedicinal drugs can be increased to unethi-cal levels as there are no price controls inplace. It has been observed that the prices ofpharmaceuticals are increased at times with-out obvious reasons. The pharmaceuticalcompanies often quote the fluctuation in theUS dollar as the reason for increasing prices.Adding to the crisis is the reality that thou-sands of pharmacies in Sri Lanka are beingrun illegally, without a qualified pharmacistto dispense drugs.

9.3.5 Primary Health Care

It is to be noted that during the Asian finan-cial crises of 1997/98, the Indonesian gov-ernment paid a heavy price for dispropor-tionately cutting health spending over othersectors of the economy. A 25 per cent bud-get cut for primary health care resulted in asimilar decline in childhood immunizationcoverage, a drop in the use of clinics, and areversal of previous falls in infantmortality.11

Primary health care needs a high priority ap-proach in policy at a time of financial crisis.The World Bank, for instance, is advisingcountries to focus spending on specificprogrammes, such as nutrition for pregnantwomen or child immunization, as fears arethat women and children will bear the bruntof downside effects - rising infant mortality,and worsening nutrition in a worst case sce-nario.

Although Sri Lanka has made significantimprovements in its primary health careduring the recent past, there has been littlechange in maternal and newborn mortality,especially in the plantation sector and in afew other poverty stricken areas where nutri-tion has been relatively neglected, and prob-lems of low birth weight babies and lownutritional status of children and mothersexist. In these areas, about 50 per cent ofpregnant women suffer from anaemia.Children are not much better off. About 32per cent are malnourished, and one in threeis under weight. In most of these geographi-cal areas, around 20 per cent of babies bornare of low weight (< 2.5 kg).12 The eco-nomic consequences of the global financialcrisis put them at greater risk, and without

9 IPS/HPP, National Health Account data base.10 See Prof. G. Fernando, "The Ills of too Many Pills”, Daily Mirror, 28 March, 2007 and "Quality Drugs at Affordable Prices", Daily Mirror,

8 February, 2008.11 WHO (2009), "The Financial Crisis and Global Health", WHO: Geneva.12 DCS, Annual Health Bulletin 2004/2005, Demographic and Health Survey 2006/07, and Special MDG Survey 2007.


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an adequate social safety net this would likelylead to a serious deterioration in their socio-economic status.

9.3.6 Private Health Care

Experiences in other Asian countries haveshown that spending by the private sectortends to decline in an economic downturn,as patients either defer care completely orturn from the private to the public sector, ifcare is available at free cost. Unless publicsector services are ensured adequate finan-cial support in these circumstances, the qual-ity of care is likely to deteriorate.

According to available data,13 health servicesin the private sector are 15 times more ex-pensive compared to the public sector healthservices. On average, the public sector in-curs a cost of Rs. 850 for an average in-pa-tient per day, while the private sector treatsa patient at a cost of Rs. 12,500. If cost in-creases are not arrested, the impact will bereflected in shortages, or in increased cost ofcare. With possible job losses in the privatehealth care sector, especially among para-medic personnel, a contraction of the pri-vate sector as a service provider due to lowerdemand for private health care could be ex-pected. Also infusing capital for infrastruc-ture development and introduction of hi-techmedical care will be put on hold, mainlydue to possible low demand. After the Asianfinancial crises of 1997/98, in Thailand, theprivate sector health services suffered due tosignificant demand reductions, and a num-ber of private sector doctors applied toreturn to the government sector.14

From the delivery side, the growing burdenof non-communicable diseases, the demandfor insulin, cardiovascular medicines and

asthma inhalers, for example, is increasingrapidly. Although people can borrow to payfor private care treatment of acute illnessepisodes, those dependent on long term treat-ment risk progressive impoverishment.

9.4 Conclusions and Policy Recommen-dationsThe most critical factor affecting Sri Lanka'shealth care provision has been the inadequacyof resources in general, and that of financialresources in particular.

Many of the key campaigns to combat dis-eases and to keep global public health ob-jectives on track to achieve the MDG targetsare heavily dependent on international co-operation and support. Cutting back on fund-ing would jeopardize ongoing treatment ofpeople affected by diseases such as HIV/Aids,tuberculosis, and malaria. Though societiesin wealthier countries have been hard hit bythe current global financial crisis, the worldcannot afford a reduction in commitmentsto social expenditure.

For a tropical country like Sri Lanka, mos-quito borne diseases are a common occur-rence. Diseases such as dengue fever havebecome endemic in the country. The mostrecent outbreak is estimated to have led tomore than 200 known deaths and over 10,000clinically/laboratory confirmed cases. Thereis no specific drug treatment for dengueunlike for malaria, but early management/treatment of the condition could reducemortality. A core issue related to dengue isthe reduction of vector densities. At present,most of the activities are concentrated oneliminating temporary mosquito breedingplaces connected to garbage and waste dis-posal. The major responsibility for such ac-

13 Data from the IPS Health Policy Programme (IPS/HPP) Data base.14 Parry, J. and G. Humphreys (2009), "Health Amid a Financial Crisis: A Complex Diagnosis", Bulletin of the World Health Organization,

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tivities lies with local government bodies,with limited financial resources at their dis-posal.

Financial crises can and do act as contribu-tory factors in slowing down progress toeradicate such diseases. A workableprogramme put forward by the Epidemiol-ogy Unit of the Ministry of Healthcare andNutrition called the National Plan of Action

for Prevention and Control of Dengue Fever:

2005-09 pruned down its activities due tobudgetary constraints experienced in the lat-ter stages of the programme. The absence ofearmarked global funding for the eradicationof dengue, as compared to programmes deal-ing with HIV/Aids and malaria preventionhas also not helped.

As far as the prices of medicinal drugs andpharmaceuticals are concerned, there isevidence that the rise in the cost of care topatients can be controlled, particularlythrough generic substitution. According tothe Drug Regulatory Authority (DRA) thereare around 7,000 varieties of drugs that havebeen registered, including non-essential andhighly expensive drugs under a confusingmultiplicity of brand names. For instance,some 130 varieties of the generic paracetamolhave been registered, while the antibioticamoxicillin is registered under more than 70brand names. In addition to governmentexpenditure on essential medicine forgovernment hospitals and dispensaries,private out-of-pocket expenditure onpharmaceuticals in 2006 has been a stagger-ing Rs. 23 billion.15 In 2006, an 18 memberNational Standing Committee appointed towork out legislation of the National Medici-nal Drugs Policy was expected to slash the7,000 varieties of drugs to less than 1,000,taking into consideration five factors for theregistration of drugs - i.e., quality, efficacy,

safety, cost, and need - through an indepen-dent Drug Regulatory Authority.

If the proposed National Medicinal DrugPolicy is implemented, Sri Lanka would needto import only around 1,000 essential drugs,with significant savings on foreign exchange.It is also necessary to promote the rationaluse of drugs that requires patients to receivemedications appropriate to their clinicalneeds, in correct doses, for an adequate pe-riod of time, and at the lowest cost to them.

With regard to household out-of-pocket ex-penditure, it may be argued that it is an op-portune time for policy makers to implementa comprehensive social safety net programmewhich should include both unconditionaland conditional cash transfers to poor house-holds.

During an economic downturn, it may alsobe appropriate for medical experts to launchalternative strategies such as initiatives topromote preventive care, healthy habits, andalternative medicine - combining prevention,treatment, rehabilitation, and recovery efforts,while also promoting wellness of alternativemedicine such as meditation, massage, acu-puncture, and herbal treatments. Manychronic illnesses such as heart disease, dia-betes, and some types of cancer can be pre-vented through such simple steps as a betterdiet and more physical activity. Heart dis-ease and cancer are the top two killers in thecountry.

Those providing health care services -government and private stakeholders - mustensure that efforts to safeguard and sustainthe performance of the health system aremaintained. The Ministry of Healthcare andNutrition, for instance, can focus on financ-ing specific essential services for vulnerable

15 IPS, Sri Lanka National Health Account Estimates 2006.


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populations in times of economic crisis. Theemphasis should be on access to defined ser-vices, rather than on an overall figure for gov-ernment health expenditure. This requiresthat the Ministry identifies key services, thosetargeted, necessary strategies, etc. It alsomeans having access to better data and moni-

toring mechanisms. Although short termmeasures to mitigate the negative conse-quences of the economic downturn are ur-gent, there is a need to take a longer termperspective that will have the effect of mak-ing the health sector more resilient in thefuture.


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10. Crises and Vulnerability: Improving the Nutritional Levels of Children

10.1 Introduction

Sri Lanka's overall health indicators are ontrack to achieve the 2015 Millennium De-velopment Goals (MDGs). Compared toother developing countries, infant and ma-ternal mortality rates are markedly low inSri Lanka. Almost all are vaccinated at theright time. However, malnutrition in chil-dren continues to be a serious health con-cern in Sri Lanka. Recently published gov-ernment statistics show that malnutritionaffects hundreds of thousands of children,despite countless initiatives to alleviate mal-nutrition over the years. In particular, suchconditions are entrenched in traditionallypoor and conflict-hit regions. Of childrenunder five years of age, almost one out offive are reported to be underweight, risingas high as one-third of pre-school childrenin some deprived districts.1 The impacts onthe nutrition and health of young childrenin poor families are of special concern dur-ing times of economic crises. Reductions ingovernment expenditures, cut-backs in do-nor assistance, etc., can disproportionatelyraise the risks to already vulnerable groupsin society.

Childhood health and nutritional status havesignificant implications in terms of educa-tional achievements. Good health andnutrition are vital during the process of rapidmental and physical growth that occurs frombirth through adolescence.2 For instance,improved nutrition leads to better develop-mental levels in infancy, readiness for school,better enrolment rates, learning capacity, and

educational attainment.3 Further, malnutri-tion during childhood has serious and longlasting consequences. Malnutrition raises thelife time risk of poor physical health,constrains intellectual growth, and leads tomore chronic illnesses and disability inadulthood. It is also a multifaceted problem.Girls who are born with low birth weightgrow into women of short stature, who them-selves are more likely to have low birthweight babies, especially if they have theirbabies whilst they themselves are too young.Unless the vicious cycle of malnutrition isbroken at some stage, this situation will con-tinue over many generations resulting in aninter-generational cycle of malnutrition.

Apart from such problems, the impacts ofmalnutrition can have adverse implicationson the economy, through their effects oneducation, productivity, growth, and healthcare expenditure. Therefore, in the long run,poor nutrition and health can result in apoorly educated and unhealthy populationwhich will act as a drag on economic growthand development. Nutrition indices need toimprove considerably for Sri Lanka to achievethe nutrition MDG of halving the propor-tion of people who suffer from malnutritionby 2015. This policy brief discusses currentconditions and possible policies to moveforward.

10.2 Nutritional Status of Sri Lanka

According to the findings of the recentDemographic and Health Survey 2006/2007,

1 Department of Census and Statistics and Ministry of Healthcare and Nutrition (2008), Demographic and Health Survey 2006/2007-Preliminary Report. Available from http://www.statistics.gov.lk .

2 http://www.neahin.org/programs/physical/schoolchildren.htm (Accessed on 07/04/2009).3 World Health Organization (1996), The Status of School Health, Geneva: WHO.

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among pre-school children, 22 per cent ofchildren are underweight, 18 per cent are tooshort (stunted), and 15 per cent are too thin(wasted) as measured by weight-for-height.4

Further, the data reveal that the prevalenceof malnutrition varies by socio-economic aswell as geographical groups of the country.

For example, districts in the western andnorth-western parts of the island show fewercases of under-nutrition, while children inconflict-affected and estate areas suffer fromalarming levels of malnutrition. At the topof the categories, 41 per cent of children inNuwara-Eliya district were stunted, while 32

Table10.1Child Malnutritiona

Height-for-Age Weight-for-Age

2000 2006 2000 2006 Age in months <6 5.2 9.7 10.0 12.1 6-8 6.0 9.5 12.4 12.0 9-11 10.9 15.6 18.4 15.6 12-17 19.4 18.6 18.7 18.5 18-23 24.2 22.7 19.8 22.9 24-35 21.7 21.9 25.7 23.4 36-47 17.4 19.8 25.2 24.9 48-59 22.7 15.7 30.2 25.3 Sex Male 17.0 18.7 22.1 22.3 Female 20.1 17.2 23.9 20.8 Residence Urban 10.2 13.7 15.8 16.6 Rural 18.2 16.7 23.9 21.7 Estate 43.7 42.2 34.7 29.7 Mother’s education No education 47.4 42.0 41.2 34.9 Primary 31.7 29.8 34.8 33.7 Secondary 19.2 18.8 24.9 22.7 Passed G.C.E (O/L) 13.7 13.8 19.9 17.6 Higher 7.6 10.0 8.9 13.8 Total 18.5 18.0 23.0 21.6

Notes: a: Percentage of children under five years are classified as malnourished according to anthropometricindices. The indices are expressed as standardized scores (z-scores) or standard deviation units fromthe median for an international reference population that was recently developed by the WHO(2006). These indices are not comparable to indices based on the previously used CHS/CDC/WHOChild Growth standards. Children who fall more than two standard deviations below the referencemedian are regarded as undernourished.

Sources: Data for 2006 from DCS, Demographic and Health Survey 2006/2007 preliminary report; and datafor 2000 calculated from Demographic and Health Survey 2000, WHO Global Database on ChildGrowth and Malnutrition, 2006.

4 In children, the three most commonly used anthropometric indices to assess their growth status are weight-for-height, height-for-age andweight-for-age. (https://www.who.int/nutgrowthdb/about/introduction/en/)

These anthropometric indices are defined as follows:weight-for-age: underweight reflects low body mass relative to chronological age;weight-for-height: wasting or thinness indicates in most cases a recent and severe process of weight loss;height-for-age: stunted growth reflects a process of failure to reach linear growth.


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per cent of children were found to be under-weight in the Badulla district.5 Moreover,the percentage of underweight children in-creases steadily with the child's age, whileit decreases as the level of education of themother rises.

The condition of being underweight is foundto be far higher for estate children than forchildren in urban and rural areas. As of 2006estimates, almost 30 per cent of estate sec-tor children are underweight, while rural andurban sector estimates are 22 per cent and17 per cent, respectively. Similarly, morethan 42 per cent of children are found to bestunted in the estate sector. Stunting levelsin estate sector children are three times higherthan that of urban sector children (Table10.1). When compared with estimates ofunderweight children in 2000, the more re-cent estimates suggest a marginal improve-ment in the estate sector. By comparison, inurban areas, the percentage of children whoare underweight has been increasing since2000.

Alternatively, micronutrient deficiencies(most common deficiencies are iodine, ironand vitamin A) which affect healthy childgrowth and development are less obviousforms of under-nutrition, but constitute ma-jor public health problems in Sri Lanka. One-third of pre-school aged children are affectedby Vitamin A deficiency and a half of chil-dren of 5-10 years of age are affected by irondeficiency. Although iodine deficiency is themost common preventable causes of physi-cal and mental retardation, one out of everyfive children suffers from iodine deficiencydisorders.6

10.3 Main Factors Contributing toMalnutrition

Malnutrition in children is the consequenceof a range of factors that are often related toinadequate dietary intake and poor health sta-tus. These factors themselves are interdepen-dent and closely linked to overall standardsof living - i.e., whether a population can meetits basic needs such as access to food, hous-ing, health care, etc. Moreover, malnutritionis frequently a part of a vicious cycle thatincludes poverty and disease. Socio-economicchanges that improve health, nutritional, andoverall standards of living can break thiscycle.7 On the other hand, in many develop-ing countries, especially in urban populations,there has been a trend in affluent classes to-wards increased consumption of energy-densenutrient poor foods - i.e., high in fats andsugars, and not enough nutrients. Even forlow-income families, these foods may bemore affordable and accessible than morenutritious foods such as fruits and vegetables.8

The immediate determinants and underlyingcauses of childhood malnutrition in Sri Lankarange from inadequate dietary intake and se-vere and infectious diseases to socio-eco-nomic, knowledge, and cultural factors thatinfluence the utilization of health services andavailable food. Poverty plays a key role here.It affects malnutrition through household foodsecurity, inadequate basic infrastructure, andhealth services. Although poverty is an im-portant basic determinant of child malnutri-tion - where 15.2 per cent of Sri Lanka's popu-lation is considered to be poor - it does notsolely explain the high rates of child malnu-trition prevailing in the country. Inappropri-ate feeding practices, poor sanitation and

5 Department of Census and Statistics and Ministry of Healthcare and Nutrition (2008), Demographic and Health Survey 2006/2007-Preliminary Report. Available from http://www.statistics.gov.lk

6 http://www.unicef.org/srilanka/activities_1667.htm (Accessed on 07/04/2009).7 https://www.who.int/nutgrowthdb/about/introduction/en/ (Accessed on 15/02/2009).8 http://www.who.int/childgrowth/4_double_burden.pdf (Accessed on 07/04/2009).


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drinking water, and diseases (diarrhoea andacute respiratory infection) are the othermajor determinants of malnutrition.

Appropriate food must be offered to the childwith correct timing and frequency. Whenchildren move into complementary feeding,the growth of children might be hamperedby wrong kinds of food or a shortage of food.On the other hand, one of the reasons fordiseases such as diarrhoea is poor access tosafe drinking water and sanitation. In SriLanka's estate sector, for instance, around ahalf of all households have no access to safedrinking water.9

10.4 Experiences from Other Countries

Schools are ideal settings for nutritionprogrammes and services. This is so givenclose links between nutrition and education- dietary, hygienic, and exercise habits thataffect nutritional status are formed during theschool-age years. The World Health Organi-zation (WHO) and the Food and AgricultureOrganization (FAO) are collaborating inpromoting school-based nutrition interven-tions in developing countries. The WHO,for instance, launched its Global SchoolHealth initiative to promote the developmentof Health Promoting Schools (HPSs) in1995.10

In 1999, the WHO and the FAO assisted inthe development of HPS in China with thefocus on nutrition. Selected pilot schoolssupplemented their nutrition educationactivities (healthy nutrition and the impor-tance of a balanced diet, nutritional deficien-cies and their effects, and good hygienicpractices) with improvements in health-related school policies and the overall envi-

ronment, including renovations to schoolfacilities (clean water supplies, hygienicpractices in cafeteria) and grounds. Theresults achieved by the project were quiteimpressive.11

School lunch programmes can also be animportant initiative in alleviating childmalnutrition. There is evidence to suggestthat school lunch programmes can lead tobetter school attendance and academicachievement in developing countries - i.e.,children receiving lunches have more energyto focus on their education. One such initia-tive was community programmes connect-ing nutrition to schools that was started inPanama. Selected Panamanian communitiesfocused on improving food security ofchildren, and teaching them how to growand eat nutritious foods. The studentsstudied nutrition education, food processing,and forestry and worked on maintainingschool gardens. Eventually, the project spreadinto the wider community (involvingteachers, farmers, and parents) and accom-plished significant changes - underweightchildren dropped by almost 50 per cent.12

Similarly, adequate safe drinking water andsanitary facilities are considered as essentialelements of a health-promoting school. InChina, for instance, a de-worming projectwas implemented through schools in 1996with the support of the WHO to ensure areduction in helminth infection.13

10.5 Measures Adopted in Sri Lanka

Successive governments have implementedvarious programmes to improve the nutri-tional status in the country. Child growthmonitoring, antenatal care, and nutritioneducation have been established strategies

9 Ibid.10 World Health Organization (1996), The Status of School Health, Geneva: WHO.11 ftp://ftp.fao.org/docrep/fao/006/j0243m/j0243m04.pdf (Accessed on 07/04/2009). 12 FAO (2003), The State of Food Insecurity in the World, Rome: FAO.13 http://heapro.oxfordjournals.org/cgi/content/short/15/3/197 (Accessed on 07/04/2009).


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encompassing the whole country for the lastseveral decades. Several new strategies arealso being planned as interventions with bet-ter targeting. These include supplementaryfeeding programmes such as a glass of milkfor school children, a food basket for preg-nant and lactating mothers, etc. Some of theprogrammes to address problems of malnu-trition in Sri Lanka include:

• Care for pregnant mothers: promotingprenatal nutrition services, includingiron and folate supplementation, de-worming, monitoring the nutritionalstatus of expecting mothers, and nutri-tion counselling.

• Promotion of appropriate infant andyoung child feeding (e.g., breastfeeding,weaning practices, and introducingsupplementary food).

• Growth monitoring and promotion:empowering caregivers to understandthe growth patterns of their children andto take appropriate action, including

funding for child development records.

• Control of micronutrient deficiencies:an island-wide vitamin A supplemen-tation programme, and universal saltiodization.

With the end of the war in May 2009, around300,000 Internally Displaced Persons (IDPs)fled from the conflict zone and are now ac-commodated in camps in the Vavuniya,Mannar, Trincomalee, and Jaffna districts.The enormous IDP influx has become a newchallenge and has placed an enormous bur-den on already stretched resources. Nutritionis a critical issue for IDPs, especially for chil-dren under five years of age, and lactatingmothers who are at risk after months of lim-ited access to food of high nutritional value.The government is attempting to ensure thebest possible health care services to the IDPswith the assistance of many national andinternational agencies (see Box 10.1).In 2003, as the world's largest provider of

Box 10.1Nutritional Interventions for IDPs

Nutritional interventions have been employed to provide additional fortified food to allchildren under the age of five years, and for pregnant and lactating women. Acutelymalnourished children, pregnant and lactating women suffering from underweight arefurther assisted with the provision of multiple micronutrient supplements (sprinkles andvitamin A mega doses) through therapeutic feeding and supplementary feeding. Improvedinfant and young child feeding practices and breastfeeding are being promoted amongthe IDP population. Moreover, to control parasites, the distribution of de-worming tabletsfor all children under five years, and pregnant and lactating women have been initiated.Many national and international agencies (UNICEF, WFP, World Vision, etc.) haveprovided assistance for these programmes.

Further, the government has made efforts to ensure that several other hygiene relatedissues – especially water and sanitation – which directly affect the health and nutritionalstatus of IDPs are addressed. Timely provision of safe water, sanitary facilities, garbagedisposal, fly control, and drainage of surface water, etc., are essential to prevent anyoutbreak of diseases. The provision of such services within the domain of governmentagencies are being addressed with short term, medium term and long term plans.


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nutritious meals to poor school children, theWorld Food Programme (WFP) launched ameals-in-school programme in Sri Lanka for33,000 children in the conflict-affectedzones. The programme targets children whohave been most affected as a result ofdisplacement, poverty, and food deficits. TheWFP school meals programme is aimed atmotivating daily attendance of schoolchildren, and thus enhancing their ability tolearn. The WFP is working with parent groupsto manage the cooking and provision ofmeals. Such partnerships are expected tofurther foster social cohesion and commu-nity integration among people.14 Inaddition, the WFP has been giving schoolmeals for children of some Catch-up Educa-tion (CUE) programmes in conflict-affectedareas when they attend "catch-up classes".15

Furthermore, in order to meet the needs ofrecently displaced IDPs, the WFP has boostedfood stocks and supply of nutritionally-richfood for women and children.

In recognition of the need to strengthencoverage and quality of nutrition interven-tion programmes, the Ministry of Healthcareand Nutrition has recently developed aNational Nutrition Policy. As the causes ofmalnutrition are multi-factorial, the focus ison integrating nutrition with other sectoralactivities, including health, agriculture,education, economic reform, and ruraldevelopment. Another strategy that has beenadopted to improve the information base isthe establishment and implementation of aNational Nutrition Surveillance System. Thisis expected to help better targeting ofinterventions by giving timely data on aregular basis on nutritional status and itsdeterminants at divisional, district,provincial, and central levels. Such data avail-ability can enhance the planning and man-

agement of interventions, and thus their over-all effectiveness.

10.6 Conclusions and Policy Recom-mendationsSri Lanka has many decades of experiencewith programmes to improve nutrition. How-ever, malnutrition continues to remain a chal-lenging problem. Wide disparities that pre-vail across regions and districts add to thecomplexities in dealing with malnutrition.Lack of proper targeting of food subsidies andnutritional interventions has resulted in in-effective programmes. Sustainable nutritionalinterventions should be aimed at enhancingfood security, dietary quality, and access tosafe water and sanitation at the householdand community levels as well as at schoollevels. Some policy recommendations in thisregard are discussed below.

A successful fight against hunger must in-volve a community-centred approach to mal-nutrition. To promote long term changes, theindividual causes of malnutrition within thecommunity (especially among the poor inthe estate sector and in rural areas) must berecognized and removed. It is important toidentify food shortages, inadequate feedingpractices, and diversities in diet that exist. Acommunity approach to nutrition demandsthat the community answers these questionswith the help of trained individuals, anddevelops long term solutions to their malnu-trition problems.

A safe living environment needs to be en-couraged by providing basic facilities, includ-ing safe drinking water, sanitary facilities,drainage, and waste management. To pro-vide safe drinking water and proper sanita-tion, the most appropriate type of water sup-

14 http://one.wfp.org/english/?ModuleID=137&Key=711 (Accessed on 07/04/2009). 15 Arunatilake, N. et al. (forthcoming), "Catch-up Education in Sri Lanka", IPS: Colombo.


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ply and sanitation technology should be cho-sen. Some identified needs include:

• Pipe borne water to be provided tourban and rapidly expanding areas.

• Safe drinking water and sanitation toestate and rural districts to be providedthrough community based water andsanitation systems.

• Proper drainage and waste managementsystems to be provided in urban areas.

In many other countries, linking healthprogramme delivery into the school systemthrough a multi-sectoral approach (education,health and nutrition) has proven to be costeffective. Some options for school healthprogrammes include:

• Target areas identified as being foodinsecure, with poor school attendanceand/or with identified malnutritionproblems in school aged children.

• Provision of safe water and sanitationin schools - latrine/toilet, handwashing and drinking water facilities.

• Develop community participation inschool feeding programmes to assuretheir sustainability and possibleinfluence on home feeding.

• Supplement the school feedingprogramme with nutritional and healtheducation, micronutrient enhancement,and de-worming.

Impact of the Global Economic Crisis on Migration and Remittances

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11. Impact of the Global Economic Crisis on Migration and Remittances

11.1 Background

According to the World Migration Report

2008 published by the International Organi-zation for Migration (IOM),1 human mobil-ity makes economies more dynamic and moreefficient. It argues further that migration haspositive features in alleviating variousdevelopmental implications of economicdownturns, and in particular, an ability tocushion some of the adverse shocks ofeconomic crises. Despite such observations,many destination countries have imposedrestrictive laws on migrant labour in responseto depressed economic conditions in theirown countries. Such developments canarguably result in economic and socialinstability in poorer countries that dependon remittances. This policy brief will look atpossible implications of the global economiccrisis on migration and remittances. Morespecifically, it will look at global shifts inmigration, rising unemployment amongmigrants, the impact on migrant remittances,and the implications of a possible rise inreturning migrants. The discussion willattempt to draw relevant lessons and policyimplications for Sri Lanka.

11.2 Role of Migration and Remit-tances in the Sri Lankan EconomyMigration has become an important elementin socio-economic life of many developingcountries, including Sri Lanka. The Sri LankaBureau of Foreign Employment (SLBFE)estimates the current total stock of out mi-grants from Sri Lanka on employment abroadto be 1.8 million. However, given the dearthof information with regard to those who seek

employment through unregistered jobagencies or find employment directly, anddata on return migrants, the numbers haveto be interpreted with some caution. Out-migration for temporary contract work for lowskilled jobs by Sri Lankans targeting theMiddle Eastern countries began in themid-1970s. Prior to this, professional andtechnical personnel migrating to developedcountries dominated the foreign employmentmarket. After employment channels to theoil rich Gulf countries emerged, temporarylabour migration has been increasing rapidlyover the last three decades with an estimated250,000 persons migrating annually in searchof employment.

In 2008, foreign employment placementsreported a 15.4 per cent increase against theprevious year's growth of about 8.2 per cent.According to the SLBFE, the total number ofdepartures for foreign employment in 2008was 252,021 compared to 218,459 during2007. This increase was reflected in all cat-egories of manpower such as housemaids,skilled, unskilled, and professional migrants.

Remittance inflows - the most tangiblebenefit of migration - contributed US$ 2.9billion to the Sri Lankan economy in 2008,an increase of 16.6 per cent against theprevious year. Despite this healthy growthin 2008, there are concerns that the overallgrowth in remittances will not be asbuoyant in 2009 due to the slowdown in theglobal economy. Indeed, private remittanceinflows decreased by 1.7 per cent to US$

1 IOM (2008), "World Migration 2008: Managing Labour Mobility in the Evolving Global Economy", Volume 4, IOM World MigrationReport Series.


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774 million during January-March 2009 ascompared to the corresponding period of2008. However, by May 2009, the cumula-tive inflow of private remittances hadincreased by 2.9 per cent to US$ 1,308million during the first five months of theyear.2

The impact of the global downturn onremittance flows is of concern given itsimportant role in the Sri Lankan economy.Inflows accounted for 35.6 per cent of totalexport earnings and were sufficient to financeover 75 per cent of Sri Lanka's trade deficit

in 2008. The remittance contribution fromthe Middle East constituted 57 per cent ofthe total inflows to the country.3 In the re-cent past, remittances have played a multi-dimensional role in the Sri Lankan economy.Accounting for nearly 7 per cent of GDP,remittances have not only helped to supportthe country's savings and investment rates,but they have also been an important sourceof income to migrant households. It is inthis backdrop that the rest of the discussionfocuses on the impact of the current globaleconomic crisis on migrant workers andremittance flows in the medium term.

Table 11.1Outlook for Remittance Flows to Developing Countries (2009-10)

Base Case Forecast Low Case Forecast

2008e 2009f 2010f 2011f 2009f 2010f 2011fUS$ billion

Developing countries 305 290 299 317 280 280 289(as share of GDP, %) (1.9) (1.8) (1.7) (1.6) (1.8) (1.6) (1.4)East Asia and Pacific 70 67 68 72 64 64 65Europe and Central Asia 53 48 50 53 46 47 50Latin America and Caribbean 63 60 62 65 58 58 59Middle-East and North Africa 34 33 34 36 32 32 32South Asia 66 63 65 70 61 62 64Sub-Saharan Africa 20 19 20 21 18 18 19Low-income countries 45 43 45 48 41 42 44Middle-income countries 260 247 254 269 239 238 245Growth rate (%)

Developing countries 8.8 - 5.0 2.9 6.3 - 8.2 - 0.2 3.2East Asia and Pacific 6.6 - 4.2 1.9 5.6 - 7.5 - 1.3 2.1Europe and Central Asia 5.4 -10.1 4.2 7.5 -12.7 -1.6 5.1Latin America and Caribbean 0.2 - 4.4 2.3 5.6 - 7.7 - 1.0 2.5Middle-East and North Africa 7.6 - 1.4 2.9 5.6 - 5.2 - 0.9 2.1South Asia 26.7 - 4.2 3.4 6.8 - 7.3 0.5 4.2Sub-Saharan Africa 6.3 - 4.4 3.5 6.7 - 7.9 0.0 3.5Low-income countries 13.0 -5.4 4.4 7.5 - 8.2 1.6 4.9Middle-income countries 8.1 - 4.9 2.7 6.0 - 8.1 - 0.5 2.9

Notes: e = estimate; f = forecast.Source: World Bank (2009), Migration and Development Brief 09.

2 Central Bank of Sri Lanka, "External Sector Performance - May 2009", Press Release.3 The Middle Eastern region continued to dominate the foreign employment market with over 90 per cent of the total migrants from Sri Lanka

being concentrated in the region, with a majority consisting of housemaids.


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11.3 Impact of the Crisis onRemittancesAlongside the many revised forecasts for theglobal economy in 2009, remittance flowsto developing countries are expected to showa sharper decline of 5-8 per cent in 2009(Table 11.1). Having witnessed a buoyantgrowth in remittance flows globally - record-ing double digit annual growth in the pastfew years - the expected downturn in 2009will have many social and economic impli-cations for poorer countries.

The downturn in economic activity acrossthe world will impact migrant labour throughdifferent channels. The impact will also dif-fer depending on the skills profile of themigrant. For instance, the sharp drop in de-mand for exports being experienced by manyadvanced and emerging economies - and re-lated inflows of foreign direct investment(FDI) - is one obvious channel. Most of theseindustrial centres and commercial produc-tion sites tend to employ more migrantlabour. These trends can create significantshifts in the structure of the global labourmarket, in turn affecting labour exportingcountries like Sri Lanka.

As unemployment in advanced economiesrises, there will be a decline in the demandfor migrant labour from many countries.Recent trends suggest that many low andsemi-skilled workers who already reside inadvanced economies are at risk of losing theirjobs, while new entrants may be unable tosecure employment. Thus, advanced econo-mies can be expected to reduce the numbersof migrant workers permitted to seek workin their countries. In the UK, for instance,immigration from Poland for workers seek-

ing summer employment in 2008 was at itslowest level since 2004, down by 36 per centfrom 2007.4

Developing countries are also being affectedby the global economic crisis. Many are ex-periencing a decline in demand for their ex-ports, while all forms of capital flows arealso expected to be constrained. Declines inFDI, official development assistance (ODA)and a possible downturn in private transfersare some of the key features. For many ofthese countries, the impacts are more sig-nificant on internal migrant patterns. For in-stance, as China's export sector has been hithard, with an estimated 10 million workerslosing their jobs in the final months of 2008,there are rising implications for its internalmigrant population. Export processing zonesin India have also been affected by the sig-nificant drop in demand for their productswhere large job losses were experienced.5

Inevitably, as employment opportunities formigrant workers shrink, they and theirdependents will be called on to bear theadverse impacts. A study conducted by thePew Hispanic Center in the US,6 for instance,has found that 70 per cent of migrantssurveyed had sent less money home in 2008compared to 2007 - a trend which could havesignificant consequences for families backhome who are dependent on these funds.

As seen from Table 11.2, many governmentsin both developed and developing econo-mies - have adopted more restrictive immi-gration policies in order to protect the locallabour market and to reduce the intake offoreign labour. It could be envisaged that thenumbers with regard to regular migration

4 Development Research Centre on Migration, "Globalization and Poverty", Briefing, February 2009.5 IOM (2009), "The Impact of the Global Economic Crisis on Migrants and Migration" IOM Policy Brief, March 2009.6 Lopez, M.H., G. Livingston and R. Kochhar (2009), "Hispanics and the Economic Downturn: Housing Woes and Remittance Cuts", Pew

Hispanic Center Report, January 2009. Available online: http://pewhispanic.org/files/reports/100.pdf.


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flows have also declined as potentialmigrants choose to stay back in the homecountry, adopting a 'wait-and-see' approachto the evolving situation.

11.4 Impact on Sri LankaAs previously mentioned, Sri Lanka has sig-nificant numbers of its labour force engagedin temporary employment abroad. The SriLankan economy too has been shedding somejobs in sectors such as garments as the im-pact of the global economic downturn is feltin key export industries. However, the depthand scope of the effect on remittances andmigration is yet to be seen in full. The growthof remittance flows has slowed in the periodJanuary-May 2009 to 2.9 per cent as noted

Table 11.2Rising Immigration Controls Worldwide

Country Immigration Control during 2008/09

UK • Has introduced a point-based system that favours high-skilledmigrants over unskilled migrants

• It has most recently raised the minimum educational andfinancial qualifications for high-skilled migrants

Australia • Will reduce the intake of skilled migrants by 14 per cent

US • A provision of the stimulus package makes it moredifficult for beneficiary firms to hire high-skilled foreign workers

Spain • Has introduced a “voluntary return” programme for migrants

Italy • Plans to introduce tougher requirements for residencypermits, requiring doctors to report undocumented patients andauthorizing citizens’ patrols to pick up illegal immigrants

Malaysia • Has instituted a freeze on the issue of work permits to foreignworkers in the manufacturing and services sectors (attempting torestrict the entry of new and returning workers)

• Cancelled work visas for 55,000 Bangladeshi workers in earlyMarch 2009

Russia • Announced in December 2008 that it would reduce workpermits by half in 2009 from 4 million to 2 million

Thailand • Announced that it would not issue new work permits or renewthe work permits of about half a million foreign workers

• The planned 2009 registration of irregular migrants in Thailandhas been postponed

Kazakhstan • Has imposed a moratorium on the admission of less-skilledworkers from April 2009

Source: Compiled using World Bank (2009), Migration and Development Brief 09.

earlier, against a robust growth in the lastfew years. The immediate implications of aslowdown in remittance flows will be onthe balance of payments (BOP) at the macrolevel, on household income at the microlevel, etc. However, another worrying fea-ture that could emerge is that of returningmigrants, adding to the stresses on employ-ment generation.

Evidence of past economic downturns showthat migrant workers are often the most vul-nerable category of workers, in terms of joblosses and treatment in the host country. Thisis mainly due to the common perception thatthe presence of migrant workers tend toreduce employment opportunities for the


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locals. However, migration has also to beviewed as contributing to productiveeconomic activity in the host countries,particularly when efforts are under way tostimulate an economic recovery.

The bulk of Sri Lanka's migrant workers - com-prising of housemaids that account for 47per cent of Sri Lanka's temporary workers - isless likely to be immediately affected by theglobal economic downturn. This is particu-larly so due to the type of occupation wherelocals are reluctant to engage in similar work.Such jobs are not taken up by many localsfor both social and economic reasons. Inaddition, the housemaid category tends toremit about 85 per cent of their income tohis/her dependents back at home.7 To someextent, this will also safeguard the volumeof remittances that Sri Lanka receives in anygiven year.

The unskilled category of workers - compris-ing 24 per cent of total migrants from SriLanka - is the most vulnerable to suffer joblosses in the near term. There have beenreports that migrants in Dubai, for instance,are being affected due to the slowdown inthe construction and services sectors.Unskilled migrant workers engaged in theconstruction industry, therefore, may see joblay-offs which can also impact some propor-tion of workers from Sri Lanka in this area ofactivity.

However, the situation in Dubai, forinstance, cannot be generalized to allmigrant workers in the Middle East. Dubaiis more dependent on trade and financialservices, and real estate than many of theother Gulf countries which depend prima-rily on oil revenues. The recent decline in

oil prices may also not have a major impacton remittance flows. There is evidence tosuggest that in recent years, remittance out-flows from Saudi Arabia, for example, havebeen uncorrelated with oil prices.8 ManyGulf Cooperation Council (GCC) countries(especially Saudi Arabia) are following longerterm strategies for infrastructure developmentfor which funding has been planned on along term basis. Therefore, it is unlikely thatmigrant workers engaged in these sectors willlose jobs on a large scale as there may not bea significant drop in the level of investmentfor existing projects. In addition, in certainlabour market sectors in destinationcountries, there is likely to be a continuedneed for migrant workers. Recent studies sug-gest that in certain sectors - such as healthcare, household/domestic employment, andcare work (as well as in certain agriculturalwork) - where demand for workers isstructural, loss of employment opportunitieswill be minimal.9

In terms of skilled and professional migrantworkers, the impact of the global economicdownturn on Sri Lanka will be muted.Although most developed countries haveimposed restrictive migrant policies that aremainly applicable to professional categoriesof migrant workers, such developments willlikely hold only minimum implications forSri Lanka. Sri Lanka's professional categoryof migrants makes up only about 1 per centof total migrants from the country. Of course,new entrants to this category can drop sig-nificantly in 2009 due to host country re-strictions.

Overall, Sri Lanka's migrant population isunlikely to be significantly affected in termsof loss of employment. However, there is

7 De Silva, A., W.D.Lakshman and N.D. Samarawickrama (1995), "Employment and Investment Opportunities for Women Migrants in SriLanka", (ILO-ARTEP).

8 Ratha, D. and S. Mohapatra (2009), "Revised Outlook for Remittance Flows 2009-2001: Remittances Expected to Fall by 5-8 per cent in2009", Migration and Development Brief, No. 09, World Bank.

9 IOM (2009), "The Impact of Global Economic Crisis on Migrants and Migration", IOM Policy Brief, March 2009.


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also emerging evidence of reduction in wagesor non-payment of wages, reduction in thenumber of working days, and limited oppor-tunities for overtime work, poor work condi-tions, etc. in some destination countries.Typically, migrants have weak bargainingpowers, especially irregular and temporarycontractual workers. According to the Inter-national Organization for Migration (IOM),some countries have implemented policiesto speed up the deportation of irregular mi-grants. The common tendency of migrantsthat lose jobs is to seek opportunities in theinformal economy, thus increasing the stockof irregular migrant workers. Such develop-ments pose risks to the well-being of SriLanka's migrant population as well, andneeds to be watched carefully.

In anticipation of a possible reduction inremittance flows, Sri Lanka launched aprogramme to attract inflows via "Diaspora"bonds. In February 2009, Sri Lanka announcedan initiative to sell US$ 500 million ofgovernment securities to the Sri Lankandiaspora community with road shows andpromotional campaigns in 11 countries.10 Al-though the government was optimistic ofraising the targeted amount, the expectationswere not met. The economic slowdown indeveloped countries, currency risks etc., mayhave acted as deterrents. Moreover, the fi-nancial ability of the Sri Lankan diaspora com-munity to subscribe large sums is also ques-tionable. The bulk of the migrant commu-nity are housemaids and low skilled workersas previously mentioned.

In addition to the above measures, in June2009, the government also decided to pay a20 per cent bonus interest on ResidentForeign Currency (RFC) and Non ResidentForeign Currency (NRFC) accounts. A supple-

mentary estimate of Rs. 1.5 billion wasapproved by the Parliament to meet the ex-penditure for the payment of this bonus in-terest. The CBSL has further proposed to paya 50-100 per cent premium for those whoinvest funds in the newly introduced Eco-nomic Resurgence Certificates which alsotargets Sri Lankans living abroad.11

11.5 ConclusionDespite the emerging evidence that there willbe a sharp decline in global remittance flows,Sri Lanka appears not be at significant risk ofexperiencing a sharp downturn in inflows inthe near term. The bulk of migrant workersfrom Sri Lanka are in the GCC region,engaged in low skilled jobs and as house-maids. This category of workers typicallytends to save less in the host country whichensures that a high proportion of their in-come is remitted back home to support theirdependents. This scenario can be expectedto continue in the current environment of aneconomic slowdown, as most migrant work-ers are supporting the basic needs of theirdependents back home. In addition, it hasto be noted that remittances are sent by ac-cumulated flows of migrants over the years,and not only by new migrants of the lastyear or so. This can make remittances morestable over time.

Sri Lanka may also not face the additionalstress of significant numbers of returningmigrants due to job lay-offs. Job losses todate are seen mainly in employment sectorsthat are more sensitive to economic cyclessuch as private construction work, manufac-turing, financial services, retail and trade/tourism related services, and thus affectingmigrants in these particular sectors. The num-bers of Sri Lankan migrants in these sectorsare not particularly significant.

10 "Sri Lanka Targets US$ 500 from Diaspora: CB Governor", Lanka Business Online, 2 February 2009, available at http://www.lankabusinessonline.com/fullstory.php?nid=435672348.

11 "Sri Lanka to Pay Bonus for NRFC and RFC", Colombo Page, Wed, Jun 24, 2009. Available at http://www.colombopage.com/archive_091/Jun1245849648RA.html.

Global Financial Crisis and Microfinance in Sri Lanka

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12. Global Financial Crisis and Microfinance in Sri Lanka

12.1 Introduction

During the currency crises in East Asia andthe banking crises in Latin America in the1990s, institutions serving poor customersgenerally performed better financially thanmainstream banks.1 However, the currentglobal financial crisis is more complex,deeper, and difficult to predict, particularlysince it has since evolved into a global eco-nomic recession. What is clear, however, isthat the current economic turmoil will havea number of potential implications for fi-nancial service providers across many coun-tries. One such potential sector ismicrofinance institutions (MFIs). As in thecase of other financial services providers, MFIswill also face the challenges of a fall in capi-tal availability as a direct consequence ofthe global financial turmoil. In addition, itcan have a significant impact on microfinanceclients' spending habits which change thesavings and debt profiles of MFIs. MicroRate,2

for instance, expects that microfinance willbe more affected by economic cycles than ithas been in the past.3 This is due to twomain reasons; MFIs are more strongly inte-grated into financial sectors compared to thepast, and secondly, the definition of'microcredit' has taken many forms of loanschemes than before.

Although it is still too early to fully evaluatethe effects of the global financial crisis onthe microfinance sector in Sri Lanka, poten-tial channels of impact need to be kept inmind. The MFIs serve a particularly vulner-

able segment of the population - the poorand informal sector workers - that stand moreexposed to the downside risks of economicand financial instability. In examining thechannels of exposure, it must also be noted,however, that Sri Lanka's financial systemstability is under stress at present due largelyto domestic policy imperatives. There hashardly been any contagion effect from theglobal financial crisis, although the countrywill be impacted by the world economic re-cession as explained in previous chapters.

The discussion will set out an initial explo-ration of issues related to the linkages be-tween the economic downturn and implica-tions for the microfinance sector. It will alsoattempt to provide some tentative recommen-dations for MFIs to deal with the currentadverse environment, based on informationderived from a sample of eight selected MFIsin Sri Lanka.

12.2 Impact of a Financial Crisis onMFIsMFIs in Sri Lanka can be categorized intothree broad groups. They are formal institu-tions, semi-formal institutions, and informalinstitutions. State owned banks, private com-mercial banks, and development banks areincluded in the formal group. The semi-for-mal group consists of non-governmental or-ganizations (NGOs), community based or-ganizations (CBOs), cooperative societies,

1 Littlefield, E. and C. Kneiding (2009). 'The Global Financial Crisis and Its Impact on Microfinance', Focus Note, 52, CGAP.2 It is the rating agency for microfinance which provides microfinance information services.3 MicroRate, (2009), "The Impact of the Global Financial Crisis on Latin American and Caribbean Microfinance Institutions", MicroRate, Inc.

Arlington.


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and banking societies. Rotating Savings andCredit Associations (ROSCAS) and moneylenders are included in the third microfinancegroup. Nevertheless, MFIs are defined toinclude only the institutional sources, i.e.,formal and semi-formal institutions provid-ing microfinance services as the major (oran important) part of their business.4

The regulation of MFIs is important as it en-sures their financial soundness and helps tobuild the confidence of donors, funders,members, and depositors. The regulation andsupervision structure of MFIs in Sri Lanka iscomplicated. For example, the regulatorystructure with regard to the non-bank MFIsis different from the regulatory framework ofgovernment sponsored MFIs and banks thatprovide microfinance. NGOs are not permit-ted to accept savings, while cooperative so-cieties are permitted to mobilize savings andto lend only to members. All the bankswhich are dealing with microfinance activi-ties are supervised by the Central Bank of SriLanka (CBSL).4

As most of the empirical evidence suggests,MFIs in developing countries remain stableduring a financial crisis because microfinancefocuses on micro-entrepreneurs. Most ofthese microfinance clients are living in rela-tively less affected environments where thereis less of an impact arising from internationaltrade, capital flows, and exchange rate ex-posure. Moreover, mainstream financial in-stitutions are likely to follow rigid creditrules during a crisis which pre-empts thepoor from borrowing from these commer-cial institutions, and MFIs will, therefore,continue to be more attractive. However, dueto the likelihood of high inflation during afinancial crisis - prompting people to allo-

cate more on consumption and less on sav-ings - clients may be unable to repay theirloans on time. This phenomenon can directlyaffect the portfolio quality of MFIs. There-fore, the impacts of a global financial crisiscan be broadly divided into four groups:availability of resources, outreach and loanportfolio, operations and sustainability, andinterest rates.

12.2.1 Availability of Resources

Microfinance Investment Vehicles (MIVs) -comprising of two main players, internationalfinancial institutions (IFIs) and private invest-ment funds - are the most recent source offunds for MFIs. Thus, the global financial/economic crisis can directly impact on themicrofinance sector through a slowdown inportfolio growth. MFIs will be affected bythe sharply curtailed funding from domesticand international lenders, investors, and de-positors. Therefore, money will becomescarcer, and refinancing risk is likely to be-come a serious concern for some institutions.

It is important to look at the main sources offunds of selected MFIs in Sri Lanka beforeanalyzing the extent to which the availabil-ity of resources has been affected by the cur-rent financial crisis. Table 12.1 shows theincome source of selected MFIs.

As can be seen from Table 12.1, almost allthe selected MFIs are partially dependent ondonor funds, where most of such donor fundsare foreign funds. Therefore, the global fi-nancial crisis has an effect on the availabil-ity of resources for MFIs. Every institutionexpressed the opinion that donor funding isbecoming more limited, or that they are con-ditional. As a result, the cost of funding hasbeen increasing during the financial crisis.

4 A Draft MFI Act was prepared in 2005, but is yet to be approved. Microfinance business is defined by this Act as "acceptance of depositsor receiving and/or obtaining external funds and providing financial accommodation in any form and other financial services, particularlyto low income persons and to small and micro-enterprises". The MFI Act will prevent carrying out microfinance activities without a licence.The minimum capital requirement for operating at a national level is Rs. 50 million. Responsibility of supervision of licensed MFIs is assignedto the Department of Supervision of Non-Bank Financial Institutions of the CBSL.


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Savings are increasingly becoming a more at-tractive funding source as capital marketstighten. However, it is not always a feasibleor better option due to two reasons. The firstis due to changes in savings habits - i.e.,lack of savings and high withdrawals. Thesechanges are again due to two main reasons.The first is that fewer savings are raised onaccount of higher cost of living anduncertainty in the midst of an economicdownturn. The second reason is due to SriLanka's domestic financial situation. Forexample, there have been many recent finan-cial scams (e.g., 'Danduwam finance,''Sakvithi finance', Golden Key, etc.) thathave drained some amount of confidence inthe financial system. These scams are alsolikely to discourage the poor from saving atMFIs. Not unexpectedly, most of the selectedMFIs have experienced a decrease in savings

Table 12.1Income Sources of Selected MFIs

MFI Sources of Funds Change during 2007-08Agro Portfolio interest and donor funds DecreasedMicrofinance

Arthancharya Portfolio interest, credits and grants DecreasedFoundation

Hatton National Portfolio interest and donor funds Cost of funding has increasedBank

Samurdhi Portfolio interest and government funds Decreased

SanasaDevelopment Bank Portfolio interest and donor funds No change

SEEDS Portfolio interest, donor funds,Business Development Services (BDS)earnings, capacity building develop- Limitedment earning, investments such astreasury bills and bonds.

Sewa Finance Portfolio interest and donor funds Decreased. Donors ask for20 per cent of money inthe bank as a guaranteewhich was necessary at theinitial stage.

Women’s Bank Portfolio interest and no donor funds Decreased

Source: Based on primary information.

during the current downturn. In addition,some of the MFIs operating in Sri Lanka arenot permitted to mobilize savings depositsas mentioned previously.

Thus, capital flows that were flowing intothe MFIs have begun to shrink in the currentfinancial and economic climate. The reduc-tion in available resources currently beingexperienced by MFIs in Sri Lanka can be ar-gued to be a result of the combined impactsof both global and domestic financial sectordevelopments, and holds implications for themicrofinance sector.

In particular, limited and more expensivefunds have an adverse effect on the expan-sion targets of MFIs, meeting clients'demands, and covering operational costs.5

Expansion or growth of the microfinance

5 A few MFIs also show large increases in commercial borrowing which leads to higher lending rates at MFIs.


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sector is set by demand and institutionalcapacity. Demand for microfinance servicesin Sri Lanka remains high. This is in part dueto the fact that mainstream financial institu-tions are credit constrained and are charginghigh interest rates which are not affordablefor poor micro entrepreneurs. Manymicrofinance providers further contend thatclients continue to turn to MFIs as many areaffiliated to reputed CBOs. For example,SEEDS is affiliated to the 'Sarvodaya Move-ment' and Sewa Finance is affiliated to 'SewaLanka Foundation'. Thus, select institutionsare handling microfinance activities whiletheir mother organizations are dealing withother social activities. These social activitiesprovided by their mother organizations areable to tie their members to MFIs.

Some of the MFIs are already beginning toindicate signs of their inability to meet cli-ent demand with a shrinking portfolio. Mostof the MFIs which are at initial stages of de-velopment do not have loan reserves. The

inability to meet demand has created somefrustration in the microfinance sector. Themanagement of MFIs interviewed identifiedthe inability to meet demand as a black markagainst their reputation amongst clients. Infact, one of the newly established MFIs, forinstance, is finding it difficult to even coverits maintenance costs. While cost cuttingstrategies such as moving to smaller premisesare being followed up, the survey of MFIs inSri Lanka suggests that most of the institu-tions are trying to increase their savings as apreferred option.

12.2.2 Outreach and Loan Portfolio

According to the management of select MFIsin Sri Lanka, continued high demand formicrofinance services despite the current eco-nomic downturn is an important feature.Strong demand is one of the determining fac-tors of the growth of the microfinance sectorin a country, as mentioned previously. Theexpansion targets of MFIs and their revenuesare likely to be adversely affected by the glo-

Table 12.2Expansion of Operational Areas by MFIs (2007-08)

MFI New Operational Areas Problems Facedduring the Expansion

Agro Microfinance New branches were opened within existing Nonedistricts

Arthancharya Expansion of operations to Puttlam district Lack of fundsFoundationHatton National Bank Two new branches NoneSamurdhi By 2006, Samurdhi Banks were well estab-

lished in each village in the country with nonecessity of further expansion. None

Sanasa Development 16 new Development Centres in Northern NoneBank and Eastern ProvincesSEEDS 38 sub-branches (after March 2008) Lack of capacity of

existing staffSewa Finance Plans to open branches in another three Not enough capital

districts: Kurunegala, Anuradhapura andAmpara.

Women’s Bank One branch in Matale was opened in 2008. Competition fromother MFIs



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bal financial crisis and the domestic finan-cial situation. The expansion targets are two-fold: expansion of the operational areas, andexpansion of the products. Table 12.2 showsthe new areas where MFIs expanded theiroperations during 2007-08.

It would appear that the expansion targets ofmost of the selected, well established MFIsin Sri Lanka are unaffected. They do not ap-pear to have faced any problem during theexpansion process. However, newly estab-lished MFIs in Sri Lanka have faced financialdifficulties during expansion over the last twoyears. For example, Sewa Finance - one ofthe newly established MFIs - had planned toexpand their operations into three other dis-tricts - namely, Kurunegala, Anuradhapuraand Ampara. According to the management

of Sewa Finance, they have not been able toachieve this target due to the lack of funds.

The second expansion target is the introduc-tion or development of new microfinanceproducts into the market. In the case of theSri Lankan microfinance sector, the financialstress and economic downturn does not ap-pear to hold major adverse impacts on theexpansion of microfinance products. Thereis also no difference between well estab-lished institutions and newer organizations.Table 12.3 shows the new products intro-duced, and the development of existing prod-ucts done by selected MFIs during 2007-08.

As can be seen from Table 12.3, almost ev-ery selected MFI has introduced at least onenew microfinance product into the market

Figure 12.3New Products Introduced by Selected MFIs (2007-08)

MFI New ProductsAgro Microfinance Three loan products were introduced – Shakthi, Unnathi, and

Pragathi – for income generation activitiesCompulsory loan scheme (2008)Loan Security Fund (2007)

Arthancharya No new productsFoundation

Hatton National Bank Joined the poverty alleviation microfinance programme funded bythe Japan Bank for International Cooperation (JEBIC) conducted byCBSL

Samurdhi Introduced three loan schemes: cultivation loan scheme, Mihi Jayaloan scheme to start businesses, and a housing loan scheme forSamurdhi beneficiariesIntroduced two savings schemes: Diriya Matha women’s savingscheme and Sisurata children’s savings scheme.

Sanasa Development Introduced small scale loan scheme for low income earnersBank ‘Pilisaru’ savings scheme for school children was introduced

SEEDS New lottery systemInvestment certificateChildren’s saving scheme

Sewa Finance No new products were introduced

Women’s Bank New welfare scheme named ‘Subani III’ and new insurancescheme named ‘Sarani’ was introduced.a

Notes: a: Sarani is a micro-insurance scheme. The annual premium is Rs. 360 and the scheme wasformed to secure children's education after member's death.



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during the reference period. Therefore, it canbe concluded that the global financial crisisand domestic financial sector developmentsto date have had no effect on service expan-sion of the microfinance sector in Sri Lanka.

12.2.3 Operations and Sustainability

Due to the higher cost of living experiencedin Sri Lanka recently, the ability to save hasdeclined, affecting the ability to repay loansas well. Simultaneously, purchasing powerhas also declined, whereby micro entrepre-neurs find it more difficult to sell their prod-ucts in the market. As a result, they earn alesser income which is not sufficient torepay their loans on time. The borrowers -largely the relatively poor - have been find-ing it difficult to meet loan obligation dueto rising costs of borrowing from MFIs, inpart related to the high interest rate regimein the domestic financial sector.

Default in loan repayment is the majorconcern of selected MFIs in Sri Lanka atpresent. Most of the selected MFIs are facinga problem of lower repayment rates. Thosenot currently facing such problems are none-theless anticipating future lower repaymentrates. In addition, most of the MFIs facingproblems of lower repayment are of the opin-ion that it is very significant in sectors whereclients are dependent on plantation and tour-ism activities. These are two areas that havebeen adversely affected by the global eco-nomic crisis. However, the MFI arm of thegovernment's poverty alleviation programme(Samurdhi) appears not to be facing a prob-lem of low loan repayment. An effectivemonitoring system is viewed by the manage-ment team as the basis for its relative

success.6 Samurdhi has been successful inmaintaining a repayment ratio of more than95 per cent.7

Defaults in loan repayments can lead to manyother problems in the microfinance sectorsuch as lower quality of portfolio, an increasein non-performing loans, lower capital stock,and reduction in total assets. Except for thegovernment microfinance programme, almostall the selected MFIs have faced a deteriora-tion in their portfolio quality. There is nodifference in respect to whether the institu-tion started recently or has been in operationover a long period. Some of the officers inthe selected MFIs declared that their Portfo-lio-at-Risk (PAR) increased up to 20 per cent,and as a result, they could not receive donorfunds. This may be one of the reasons for thereduction in available resources to the MFIs.As a result, some of the selected MFIs havehad to turn to commercial borrowing at ahigher cost.

12.2.4 Interest Rates

Increased financing costs lead to higher lend-ing rates during a financial crisis. It seemsthat this phenomenon is common to the SriLankan microfinance sector as well. WhenMFIs seek their funds through commercialborrowing, the cost of finance is higher,which in turn leads to higher lending rates.Both domestic and global developments havehad a bearing on interest costs incurred byMFIs. The global financial crisis reduced thevolume of foreign funds available to MFIsthrough MIVs, forcing MFIs to turn to thedomestic market. The generally high interestrate regime in Sri Lanka's financial markets -the result of domestic policy scenarios - has

6 This is the only microfinance programme in Sri Lanka in which there is a field officer (Samurdhi animators) in each and every village acrossthe country.

7 People may repay Samurdhi loans, though they do not repay the loans from other institutions as a result of a good monitoring system andbeing a government programme. On the other hand, the Samurdhi programme has the highest outreach and, therefore, the percentage ofmembers from plantation and tourism sectors may be smaller compared to the other select MFIs which operate within a few districts. As aresult, the loan default of members from these two sectors might be a small segment out of the total loan default.


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meant that MFIs have had to pay higher fi-nancing costs as a result. Table 12.4 showsthe interest rates on loans and savings chargedby MFIs during 2007-08.

As can be seen from Table 12.4, the govern-ment microfinance programme (Samurdhi)from the selected MFIs appears to be the leastaffected by the crisis. It has decreased its in-terest rate for loans, while three other insti-tutions increased their interest rate for theirmicro credits. However, some of the MFIshave not changed their interest rates for loansduring the reference period.

During a financial crisis, people save less asdescribed earlier. The global financial crisis,together with the domestic financial stressesdescribed earlier, has meant lower savings atmost of the MFIs in Sri Lanka. In addition,some of the MFIs pointed out that they recordhigher amounts of savings withdrawals. It isespecially valid for MFIs which are based onportfolio interest. Higher interest rates onsavings are a motivating factor to encouragesavings and, therefore, it is important tomotivate people to save more as a stablesource of funds. However, despite the gener-ally high interest rate regime that prevailed

Table 12.4Changes in Interest Rates on Loans and Savings

MFI Interest Rate Interest Rate on Savingson Loans

Agro Microfinance No change Savings are not mobilized by this MFIa

Arthancharya Foundation No change Reduced

Hatton National Bank Increased No change

Samurdhi Reduced No change

Sanasa Development Bank Increased No changes in the normal savings accounts.But interest rate on fixed deposits wasincreased

SEEDS Increased Increased

Sewa Finance No change Savings are not mobilized by this MFI

Women’s Bank No change No change

Note: a: Existing regulations do not permit NGOs to mobilize savings.


in Sri Lanka during the reference period, onlytwo institutions have increased their interestrate on savings (Table 12.4). It seems thatother institutions have still not taken thenecessary steps to encourage people to in-crease their savings. However, as was seenin the Table 12.3, most of the selected MFIshave introduced new savings schemes as asavings stimulating strategy.

12.3 Strategies Utilized by MFIs toAdapt to the Current EnvironmentIt is difficult to separate out the effects di-rectly related to the global financial crisisfrom those caused by the food crisis, anddomestic financial stresses. Most of the MFIsinterviewed do not consider the currentdownturn in the microfinance sector to be aresult of the global financial crisis. However,some of the institutions have taken steps toadapt to the current situation in Sri Lanka.These include savings mobilization, interestrate adjustment, and tightening of collateralpolicies and monitoring systems. It seemsthat liquidity risk is one of the major prob-lems that the Sri Lankan MFIs are experienc-ing as a result of both the global financialcrisis and domestic financial sector develop-ments. Savings mobilization may be an al-


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ternative to this problem. Therefore, almostall the MFIs which are permitted to mobi-lize savings have introduced new savingsschemes to the market. In addition, some ofthe MFIs have adjusted their interest rate forsavings so that it can attract more savings.

On the other hand, credit risk and default inrepayment are major concerns faced by MFIsat present, where collateral is viewed as themeans of mitigating risks. Prior to the crisis,most of the MFIs issued loans without physi-cal collateral, or social collateral like groupguarantees. Most of the MFIs mentioned thatthey have since tightened the collateralrequirements by way of a personal guaranteeof government officers or bank statements.In addition, Sewa Finance is followinganother strategy to reduce the defaults in loanrepayments. The management team of thisinstitution makes field visits to investigatethe reasons for lower repayments in anattempt to decrease outstanding loanbalances. The Women's Bank is also in theprocess of computerizing their systems inorder to improve the monitoring ofborrowers.

12.4 Conclusions and PolicyImplicationsMFIs operating in a developing country likeSri Lanka are bound to face some impact as aresult of the current global financial crisis,although it is still too early to evaluate thefull impact on the Sri Lankan microfinancesector. In addition, separating the impactsresulting from the global financial crisis andimpacts resulting from domestic financialdevelopments is difficult. For the most part,they are inter-linked.

Nonetheless, according to the experience ofselect MFIs, there are different types of risksin regard to the microfinance sector in SriLanka at present. These are liquidity risk, in-terest rate risk, reputation risk, credit risk,and guarantee risk.

Liquidity risk is one of the key negativeimpacts of the global financial crisis on theSri Lankan microfinance sector. Most of theexternal funding agencies have trimmed theamounts of funds, and are requesting guar-antees. Prior to the onset of the crisis, mostof the loans obtained by the MFIs wereacquired at subsidized rates of interest. Morerecently, however, these subsidies have beencut, and most funds increasingly tied to vari-ous conditions. One of the major reasonsfor the decrease in funding is also related tohigher Portfolio-at-Risk (PAR), resulting fromdomestic financial stresses as mentionedearlier.

Some institutions have turned to localcommercial loans at higher interest rates.Changes in interest rates can affect the op-erations of MFIs. Interest rate increases - duelargely to domestic financial developments -raise the cost of financing from local lend-ing points or external funds. This high costis non transmittable to the loans as borrow-ers are unable to repay loans at high interestrates. However, some MFIs have transferredthe higher cost of financing to borrowers.Such developments run the risk of harmingthe reputation of MFIs, and can lead to asense of frustration amongst the clients. Inaddition, due to inadequacy of capital, someMFIs are also unable to fulfill their clients'needs - adding to loss of reputation of theaffected MFIs.

The Sri Lankan microfinance sector has alsofaced the problem of credit risk as a result ofrecent developments. Delays or non-paymentof loan obligations is a significant feature,and is due to two major reasons: the highercost of loans, and the higher cost of livingwhich leads to lower savings. This is an is-sue of great concern to MFIs as it leads tothe risk of portfolio losses. However, com-pared to the mainstream financial institutions,credit risk might be lower for MFIs as loanamounts tend to be smaller. Lack of collat-


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eral may undermine the willingness to repayloans. Most MFIs, therefore, have decidedto tighten collateral requirements. However,in this regard as well, MFIs are better offcompared to the mainstream financial insti-tutions as most of the collateral required bymainstream financial institutions are basedon listed securities or real estate that tend tolose value during economic downturns.

Capital inadequacy is one of the mostimportant adverse impacts of the globalfinancial crisis experienced by the Sri Lankanmicrofinance sector. The results of the nega-tive impact can be masked by diversificationof funding sources of MFIs. Donor diversifi-cation is important among funding sourcediversification strategies. MFIs shouldexplore more funding agencies rather thandepending on a few agencies. In addition,MFIs can minimize dependence on foreignfunds and increase more local money throughlocal funding agencies and savings promo-tions. Savings promotions can be done byoffering attractive interest rates and by theintroduction of new savings schemes. Locallyraised funds will also mitigate currency risk.In addition, MFIs can maintain revolvingfunds.8 For example, Etimos Lanka PrivateLimited has provided loans to ArthacharyaFoundation, whereby the latter is able tomaintain a revolving fund using that money.Such arrangements can assist in overcomingtighter government rules during a crisis thatmay lead to a shrinking of external funds forMFIs.

Credit risk is another potential adverse im-pact of the global financial crisis on SriLanka's microfinance sector. This impact canbe reduced with a transparent monitoringsystem. In addition, loan risk funds mightbe a partial solution to mitigate lower repay-ment rates. A loan risk fund is a form of

credit insurance. An insurance premium canbe deducted from the loan at the time theloan is issued, and it can be deposited in aloan risk fund. During a crisis, MFIs shoulddecrease loan sizes. Small sized loans mightreduce credit risk. Monthly or weeklyinstalments are lower and, therefore, borrow-ers are in a better position to repay the smalleramounts. On the other hand, risk to the MFIsis also less as the amounts are small and canbe covered partially through a loan risk fund.In addition, institutions can also considertightening up the collateral conditions forloans so that clients are motivated to repaytheir loans and discharge the collateral.

Microfinance clients should be motivated todiversify their income sources. Income di-versification will help them to cope betterduring a financial crisis, and they can aim toearn sufficient money to repay loaninstalments. In addition, they can also savesome amount of money from diversified in-come sources. On the other hand, clientsshould be informed about potential changesto consumption patterns during recessionaryconditions. Savings withdrawals due to mis-conceptions can be reduced if clients are bet-ter informed.

Domestic financial sector stresses can createmistrust of MFIs as well. Government inter-vention may be necessary in this context.Regulation and supervision of MFIs by thegovernment or a relevant authority is impor-tant. Such regulation will help to build con-fidence between MFIs and their client base.In addition, during times of crisis, govern-ments may need to consider subsidizing themost severely affected entrepreneurs and in-come generating activities so that poor cli-ents can continue their microfinance activi-ties unhindered.

8 A revolving fund is a fund whose income remains available to finance its continuing cycle of operations. This can be established for a specificpurpose such as making loans, with the stipulation that repayments to the fund may be used anew for the same purpose.


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13. Impact of the Global Economic Crisis on Sri Lanka's Fishery Industry

13.1 Introduction

The fishery sector plays an important role inthe Sri Lankan economy in terms of provid-ing employment for many people, ensuringfood security, and earning foreign exchangethrough exports. The sector is a direct sourceof livelihood for about 150,000 fishermen,and provides indirect employment foranother 100,000 persons.1 Its contributionto food security is also valuable as 60-70 percent of the country's animal protein require-ment is supplied by local fish production.2

Over the last decade, the sector has emergedas an important source of foreign exchangethrough the export of fish and fishery prod-ucts such as fresh, chilled or frozen fish(tuna, sword fish, sear, shark, etc.), crusta-ceans (shrimp, prawns, lobster, crabs, etc.),sea cucumber, and shark fins. Apart from foodfish exports which are dominant, a steadygrowth in ornamental fish exports is anotable feature due to its high potential forfurther exploitation. The total fish exportsrepresent around 2 per cent of the country'stotal exports.3

The total national fish production consistsof three main sub-sectors, namely: offshore/deep sea fishing (35 per cent), coastal (52per cent), and inland fisheries (13 per cent).4

Different sub-sectors employ different meth-ods of fishing, have varying potential, andface diverse challenges. How these sub-sec-tors face the current global economic crisiswill also differ. Apart from differences in each

sub-sector, the work force engaged in thefishery sector cannot be differentiated intoparticular sub-sectors. Resource mobilizationin the fishery sector by fishermen is notable.For example, during off seasons, most of theyoung coastal fishermen work as crew/labourers in multi-day boats which are usedfor offshore fishing. The Fibreglass ReinforcedPlastic (FRP) boats/one-day boats owned bythese coastal fishers are hired by small boatowners. Therefore, the direct impact on onesub-sector due to any external factor hasindirect implication on other sectors, and onthe overall fishery sector.

The following sections examine briefly thecontext of the three main sub-sectors of thefishery industry, and the impact of thecurrent global economic downturn in termsof changes in fishery exports, credit andinsurance facilities, and new investments ineach sector. The final section presents someconclusions and suggestions on how best toface critical challenges, and remain as a com-petitive industry.

13.2 Offshore/Deep Sea FishingOffshore/deep sea fishing using multi-dayboats which takes place outside the conti-nental shelf and beyond, extending to theedge of the Exclusive Economic Zone (EEZ)has been the fastest growing sector with highpotential. Currently, there are about 2,600registered multi-day boats operating in Sri

1 Nevil N. B. (2005), "Trash Fish Production and National Fish Feed Requirement in Sri Lanka", a paper presented at the Regional Workshopon Low Value and Trash Fish in the Asia-Pacific Region, Vietnam.

2 Department of Census and Statistics, Food Balance Sheet.3 MFAR (2007), Ten Year Development Policy Framework of the Fisheries and Aquatic Resources Sector: 2007-2016, Ministry of Fisheries

and Aquatic Resources. 4 Figure 13.1 shows the contribution of each sub-sector to the total national fish production since 1990.

Impact of the Global Economic Crisis on Sri Lanka’s Fishery Industry

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Lankan waters. Offshore fishing is largely forthe export market, with about 25-30 fishexporters currently registered with the Boardof Investment (BOI). Most of these compa-nies are Sri Lankan, and one-third of themare either joint ventures or foreign compa-nies. Around one-third of such exportersengage in deep sea fishing, and another one-third engage in processing and exportingprawns.5 There has been strong demand fortuna fish caught by offshore fishing as manybuyers prefer tuna from the Indian ocean dueto low levels of heavy metals. Sri Lankan fishexports have benefited from the EU General-ized System of Preferences (GSP-plus) schemein further expanding trade as a result of freeaccess to European markets.

In 2008, the sub-sector's contribution to thetotal national fish production was 34 per cent(Figure 13.1). Fish production in thissub-sector has been growing since 1990despite a sharp drop in 2005 due to theDecember 2004 tsunami and has continuedto grow thereafter (Figure 13.2).

Figure 13.1Fish Production by Sub-sector (1980-2008)a

There have been various efforts to expandoffshore fishing given substantive potentialfor improvement. Recently, the Ministry ofFisheries and Aquatic Resources (MFAR)provided Rs. 100,000 worth of subsidy for55 people to buy new boats with advancetechnology.

Although there is significant potential toimprove trade, expanding this sector is some-what challenging in view of heavy initialinvestment required, which is not affordableto the average fisher folk. Not only is thecapital investment required to buy a multi-day boat very high, but the operating cost(fuel, labour, food, ice, and other costs) ofsuch boats at sea for one or more weeks isalso comparatively high. In addition, a ma-jority of existing multi-day boats are notequipped with advanced technology to en-sure high quality of fish captured, as well asefficient use of fuel. On-board systems suchas navigation, lighting, toiletry, etc., in manymulti-day boats are not well developed tofacilitate offshore fishing efficiently. Mod-

5 National Aquatic Resources and Research and Development Agency (NARA), Fisheries Yearbook 2007.

Notes: a. As a percentage of total national fish production.

Source: Ministry of Fisheries and Aquatic Resources.

0102030405060708090

100

Coastal Offshore Inland & Aquacultureaquaculture


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ernizing the available boats with high tech-nology - for example, fixing cold rooms (on-board cold storage systems instead of bring-ing tonnes of ice cubes) - needs more invest-ment, while at times improvements are notpossible with existing boats.

In the past, it was the case that most of theboats were not insured, although the risk inoffshore fishing is very high. In 2007/08, theMFAR made insurance compulsory for multi-day boats. Thereafter, most boat owners in-sured their boats when licensing or at thetime of renewing licences. The Sri Lanka In-surance Corporation (SLIC) and another twoprivate companies have been engaged in in-suring such boats. However, the situation issuch that most of the fishermen are reluctantto pay insurance as they claim that insur-ance companies are reluctant to pay dam-ages for the insured boats, follow cumber-some procedures that waste time, chargeadditional costs for boat owners (harbour feesand loss of revenue), and that they demandproof of damage for boats in the deep seawhich is sometimes difficult to provide.

13.2.1 Impact of the Economic Down-turn on the Offshore Fishery SectorThe impact of the current global economiccrisis on the offshore fishery sector is dis-cussed under the following themes: exportdemand, export related costs, access tocredit, new investments, and insurance fa-cilities.

a) Reduction of Export DemandSri Lanka's total fish exports have been onthe rise over the years. For instance, duringthe period 2000-07, exports have risen by10-15 per cent per annum (apart from 2004).However, a slight reduction of 3.7 per centof the total quantity of exports is observed in2008 compared to 2007. Nonetheless, it isinteresting to note that export earnings in thesame period have reduced by only 0.2 percent (see Figure 13.5).

Despite the reduction of tuna exports, theexport performance varies with different typesof fish.6 Tuna exports have been dominantin Sri Lankan fish exports over the last

6 For example, chank and shell fish exports also reduced in 2008, but earnings have increased by 33 per cent compared to the previous year.It is interesting to note that exports of other food fish have been increasing rapidly. This category includes frozen and fresh fish (herrings,swordfish, pacific salmon, trout, mackerel) excluding livers and roes, fresh or chilled fish fillets and other fish meat. The majority of these itemsare imported and re-exported to different countries. Crabs and lobsters and molluscs exports have been increasing over the last years andshown positive growth (see Figures 13.3 and 13.5).

Figure 13.2National Fish Production by Sub-sector (1980-2008)


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decade. There has been a steady increase oftuna exports from 2003 to 2007, before adecline was experienced in 2008 (Figure13.3). For instance, tuna exports increasedby 82 per cent in 2007, but fell by 13 percent in 2008, while earnings also fell by 4per cent (Figure 13.4). The major destina-tions for tuna exports from Sri Lanka are EUmembers such as the UK (41 per cent), France(17 per cent), the Netherlands (9 per cent),Italy (9 per cent), and Germany (6 per cent).It is likely that the reduction in fisheryexports is due to the reduction of demand byEU countries due to the global economicdownturn.

According to the major exporters, competi-tion in the world fish market is increasing,and there has been a slight reduction in prices.This has resulted in exporters receiving lowerprofit margins. However, most of the bigexporters have been able to secure their regu-lar shipments.

b) Access to Credit and Impact onInvestmentInadequate formal credit facilities and useof informal credit is very common in the SriLankan fishery sector. Fish exporters and pro-cessors make use of formal credit from stateand private banks. In addition to the slightreduction of demand for particular exports,many exporters face the problem of delaysin payments by foreign buyers. This has re-sulted in exporters borrowing money frombanks to meet their financial needs until pay-ments are realized. Sharp increases in inter-est rates on credit, and unwillingness of banksto lend more in the current economic envi-ronment has resulted in liquidity constraints.

Boat owners and other fishermen also facedifficulties in obtaining loans. Even to buymulti-day boats, it is difficult to obtain loansfrom banks unless the borrower owns a prop-erty to mortgage. In addition, no bank creditis provided to cover the operational cost.

Figure 13.3Quantity of Fish and Fishery Product Exports (2002-08)

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Note: a: 'Other' category includes fish maws, canned fish, shark fins, dried fish, Maldive fish, andsprats.



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Most of these financial needs are fulfilled bymerchants and businessmen in the fisherysector. Some of them are multi-day boatowners, wholesale fish traders, or commis-sion agents. In addition, some fishery coop-eratives are also helping fishermen to buyboats and nets.

Quality improvement and increasing produc-tivity are critical for the fishery sector to re-main as a competitive exporting industry. Asmentioned above, offshore fishing requiresinvestment in advanced technology in orderto get high quality fish and fishery products,reduce wastage, etc. in order to enable a re-duction in the overall cost of fishing and becompetitive in the export market in the fu-ture. The prevailing high interest rates andlack of innovative credit facilities to enhanceinvestment in this sector will have negativeimpacts in the long term.

c) New InvestmentsIn areas such as Negombo and Chilaw, re-mittances from foreign employment by lo-cals have been a source of investment fornew multi-day boats. Some of the migrants,particularly those in the construction sector,

have been adversely affected by the globaleconomic downturn. A decline in remittanceflows can have negative implications on newinvestments in newly advanced multi-dayboats.

d) Boat InsuranceAlthough a majority of multi-day and someone-day boats have already been insured,apart from the SLIC, the other two privateinsurance companies offering services to thefishery sector have been reluctant to providesuch services as they are also facing finan-cial constraints. Even the SLIC finds that thepremiums paid by the boat owners are notsufficient to compensate the damage claims.

13.3 Coastal Fishery SectorThe coastal fishery sub-sector has been themajor contributor to national fish produc-tion. It is still dominant, although its contri-bution has reduced gradually from 90 percent in 1980 to 52 per cent in 2008. The fishcatch received from coastal fishing goesmainly towards local consumption. It islargely a small scale industry, characterizedby multi-species and multi-gear fishing, tak-ing place within the continental shelf with

Figure 13.4Prawn Production and Exports (1990-2008)


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the use of fishing craft (small canoes, beachseine, traditional motorized, traditional non-motorized, FRP boats, and one-day boats)which are suited for one day or few hours offishing. The coastal fishery sector has beenfacing several challenges such as increasedcompetition among fishermen due to an in-crease in the number of craft, increases inoperational costs due to the rise in fuel prices(fuel prices are comparatively lower atpresent), poor access to credit facilities, in-ability to fish during the off season, lack ofalternative livelihood opportunities, pooraccess to infrastructure facilities (e.g., lackof anchoring places/harbours), poor suppliesof inputs (e.g., ice and fuel), etc.

13.3.1 Impact of the Economic Down-turn on the Coastal Fishery SectorFish production that comes from coastal fish-ing goes mainly towards local consumption.Therefore, it is difficult to find direct im-pacts of the global economic downturn onthis sector in terms of reduction in demand.Except in the Northern and Eastern Provinces,coastal fishermen are facing problems withthe increase in the number of fishing craft,with hardly any room to expand the sectorby increasing fishing effort. Due to the con-flict situation that prevailed in many areasof the Northern and Eastern Provinces, coastalfishing was limited, due both to the numberof fishermen who were operating as well asowing to security restrictions on fishing times.Efforts to reduce restrictions on fishing timehave already been announced. Expanding thecoastal fishing industry in these areas canlead to an increase in total fish production.Providing the necessary infrastructure facili-ties will be critical, including facilities suchas harbours, storage, transport, etc.

In addition, there is substantive room for thesector to improve its productivity by improv-ing the quality of fish. Quality improvementhas to be achieved by increasing training on

fish handling techniques, as well as provid-ing required infrastructure facilities. Althoughthere have been some government investmentin infrastructure, further investment in suchfacilities (storage, ice plants, etc.) is criticalto improve productivity. The sector will facenegative impacts in the long run if invest-ments by the government have to be reduceddue to the economic downturn.

There will be an indirect impact due to re-duction of export demand for Sri Lankan fishin terms of reduction of fish prices in thelocal market, and less availability of workfor young fishermen during off seasons.

13.4 Inland Fisheries and AquacultureInland fishery has been identified as a sub-sector with a potential for expansion in viewof the availability of inland water bodies inthe country. During 1980-1990, its contri-bution to total fish production had increasedfrom 10 per cent to 20 per cent. However,from 1995 there was a significant drop ininland fisheries production which reversedin 2001 with the sub-sector showing a steadyincremental growth. This has largely been inresponse to several attempts to promote andenhance aquaculture production. In 2008,its contribution to total fish production was14 per cent (see Figure 13.1).

In the late 1990s, fish exports from Sri Lankawere dominated by prawns and shrimps. In1998, for instance, prawn exports contrib-uted 1.4 per cent of total exports. However,from the late 1990s, prawn production andexports reduced drastically as Sri Lanka ex-perienced several disease outbreaks. Threemajor disease outbreaks were experienced in1988-1990, 1996, and 2003. The first out-break was due to White Spot Disease andresulted in a loss of production of 35-70 percent of the stocks. In the second outbreak,caused by White Spot Disease and YellowHead Virus, 85 per cent of the total farm


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area became non-functional. 7 The thirdmajor outbreak of disease (White Spot) alsoimpacted adversely on the production capac-ity and export earnings of the industry. Inaddition to these major disease outbreaks,there have also been frequent localized out-breaks in prawn farms due to bacterialinfections.

After the third outbreak of disease in prawnfarms, the National Aquaculture Develop-ment Authority (NAQDA) instituted mea-sures to regulate prawn farming. The NAQDAwith the Ministry of Fisheries of the NorthWestern Provincial Council launched a com-prehensive programme to control the situa-tion and to rehabilitate the collapsed indus-

try in 2003.8 The NAQDA took a furtherstep to introduce a zoning plan and a cropcalendar for farmers to reduce the risk of thedisease spreading. New prawn farms werenot allowed to be set up in the North West-ern Province. Due to these control measures,the number of farms in operation droppedfor 1-2 years. However, from 2006, prawnproduction has been showing a slow, butsteady growth (see Figure 13.4). There havebeen efforts by NAQDA to introduce newprawn farms in Batticaloa which can alsoresult in further increases in production.

Despite the steady increase in prawn pro-duction over the last few years, it is interest-ing to note that prawn exports are on a de-

8 Among several measures taken to eliminate the further spreading of such diseases, regularizing hatcheries which were producing highquality post larvae, screening existing brooder stock, training prawn farmers to use best management practices, and cleaning of Dutch canalwhich has been the main source of water for prawn farms were dominant.

Figure 13.5Export Value of Fish and Fishery Products (2002-08)

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7 Jayasinghe J.M.P.K. (1998), "Shrimp Culture in Sri Lanka: Key Issues in Sustainability and Research", National Aquatic Resources Researchand Development Agency, Sri Lanka.


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clining trend. This is basically due to the pref-erences by prawn farms to sell their productsin the local market to obtain higher profitswithin a comparatively shorter period of time.Input costs to grow prawns to export stan-dard size are comparatively high. Therefore,prawn farmers find catering to the local mar-ket to be a lucrative business where standardprawn sizes are not demanded.

Ornamental fish exports have been growingsteadily up to 2007. There has been a slightreduction in export quantity of 1 per cent in2008. Although the exported amount has re-duced, there was an increase in export earn-ings of 7.3 per cent compared to the exportvalue of 2007. Therefore, there is no signifi-cant evidence that the current global down-turn has had any impact on ornamental fishexports so far. However, as most of the orna-mental fish exporters are small and mediumscale, they face problems in terms of accessto credit as interest rates climb. This has hada negative impact on the profit margins ofthese exporters.

13.5 Conclusions and PolicyImplicationsIn recent years, Sri Lanka's fishery industryhas been facing several changes as a result ofthe tsunami impact, post-tsunami fishery live-lihood donations (boats and fishing equip-ment), and changes in fuel prices. Therefore,it is difficult to attribute changes in the fish-ery industry to effects brought on by the glo-bal economic crisis.

However, according to available information,it is clear that a segment of fishery exports(tuna) has been impacted negatively due tothe global downturn as a result of reducedexport demand by European buyers. Accord-ing to exporters, competition among export-

ers in the world market has been increasingas buyers are looking for cheaper markets.

Therefore, fish exporters and processors cumexporters have to make certain efforts to re-main competitive in the export market. Amonga few measures that can be taken to mitigatedownside risks include, reduction of operat-ing costs by optimum use of available re-sources, reduction of wastage, implementingmeasures to maintain high quality of fish(backward integration, improved fish handlingtechniques, packing techniques, etc.), anddeveloping a committed workforce as an es-sential short term measure. However, reduc-ing costs alone will not be sufficient to main-tain long term competitiveness of such in-dustries. Therefore, export companies willneed to take a more proactive approach byoffering better value for existing customers,finding new buyers for existing markets, andfinding new markets or niche markets.

In addition, offshore fishing needs new in-vestment in advanced technologies to remaincompetitive in export markets, to provide goodquality fish, and reduce wastage. However,inadequate innovative credit and insurancefacilities carry the threat of low investmentsthat can ultimately result in poor growth andcompetitiveness of the fish export industry inthe long run. Therefore, innovative credit andinsurance facilities are vital for the fisherysector to deal with financial barriers that hindernew investments, particularly at a time whenthe industry is facing a challenging exportenvironment. In addition, the BOI shouldencourage technology intensive investmentsthrough joint ventures to exploit the EEZ toobtain high quality fish. This can ensure thecontinuous supply of quality products to helpSri Lanka remain competitive in the worldmarket.


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14. Economic Crises and Sustainable Resource Management: CommunityForestry in Sri Lanka

As the unfolding impacts of the global eco-nomic crisis capture the immediate atten-tion of policy makers, other evolving globalconcerns - such as climate change - are indanger of being sidelined, at least for thetime being. However, the impacts of suchdevelopments could have more serious andlonger lasting consequences for the globaleconomy than the relatively more short-livedeconomic cycles of busts and booms. A keyconcern in this regard relates to sustainablemanagement of natural resources. Defores-tation - like the heavy consumption of fossilfuels that is primarily responsible for increasedgreen house gas (GHG) emissions - also actsas a factor that accelerates the process ofGHG emissions. Moreover, there are numer-ous forest goods and services that make apositive contribution to the economy andenvironment. Therefore, reducing deforesta-tion is important to face the threat ofclimate change, as well as to secure the over-all sustainability of economies around theworld. In this context, community forestry(CF) is viewed as an alternative strategy toreduce deforestation and support sustainabledevelopment.

14.2 Issues of Deforestation in SriLankaAlthough deforestation in Sri Lanka is oftenviewed as a consequence of locally drivenfactors, historically, it has had clear associa-tions with the global economy. The issue ofdeforestation first came up in Sri Lanka inthe latter part of the 19th century, due tolarge scale conversions of virgin wet zoneforests for export oriented plantation agricul-ture. For instance, establishment of tea, rub-

14.1 Introductionber, and coconut plantations in the low coun-try wet zone has resulted in significantreduction in natural forest cover. Also, theestablishment of cardamom crop in theKnuckles forest has caused severe deforesta-tion and degradation. Secondly, as currentlyexperienced, due to increased populationpressure, and consequent issues of land frag-mentation, farmers tend to cultivate com-mercial food crops by clearing the surround-ing natural forests in the dry and intermedi-ate zones. For example, rapid expansion ofhighland commercial agricultural crops hasbecome a main cause for deforestation inthe dry zone of the country today.

Figure 14.1 shows the decline of natural for-est cover between 1983 and 1992, where amajority of districts located in the dry andintermediate zones recorded a negativechange in their forest coverage. Agriculturalexpansion in the dry zone is primarily drivenby the motive of import substitution oflocally consumed food crops, and thus hasclear implications for deforestation. Whilethe implications of the global economiccrisis on natural forests may not be clearlyvisible at present, it might have indirect im-plications on natural resources, including for-ests. The implications primarily come in theform of conversion of forest lands to agri-culture, and not through trading of forestproducts as in the case of many other forest-owning countries.

Due to the fact that a majority of agricul-tural development and colonizationprogrammes from the mid-20th century wereconcentrated in dry zone areas, forests in the

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dry zone have become more fragmented re-cently. As a result, the management of frag-mented and isolated patches of dry zone for-est has become a challenge for the forestmanaging agencies. The Forest Department(FD) with its command and control orientedapproach to forest management, seems to beless effective in protecting such isolatedpatches of dry and intermediate zones dueto a number of reasons. The situation callsfor adopting a participatory approach to for-est management, where local communitieshave an important role to play as key stake-holders in forest management than at present.As per the international experience, CF isviewed as an alternative strategy to reducedeforestation and, thereby, to foster sustain-able forest management through meaningfulcommunity involvement (Box 14.1).

14.3 Importance of CF in Sri LankaManaging fragmented forest patches with theavailable limited human and financial re-sources poses a considerable challenge to theFD. On the other hand, the root cause of

Figure 14.1Percentage Change in Natural Forest Cover by District (1983-1992)

Source: Illustrated using data from Legg, C.,N. Jewell (1995), "A 1:50,000-scale Forest Map for SriLanka: The Basis for a National Forest Geographic Information System", The Sri Lanka Forester,Vol.10, Nos. 3 & 4.

deforestation in fragmented forest sites isupland cultivation and associated farmingactivities. Thus, direct and active commu-nity involvement is crucial to manage frag-mented forests effectively. Lessons from arecent pilot project on CF, Sri Lanka- Austra-lia Natural Resource Management Project(SLANRMP) - implemented by the FD withthe support of the Australian government -shows that active community involvementin forest management can generate favourableresults to control deforestation in certain lo-cal forests in the dry and intermediate zone.The experience of the project also providessuccessful examples for aforestation andreforestation initiatives, undertaken withactive community involvement in degradedforest areas.

In addition, CF may induce attitudinalchanges among communities towards con-servation. The introduction of CF is oftenassociated with awareness creation amongthe communities on the importance of for-est resources, and the role of communities


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to protect them. Favourable attitudes gener-ated by such programmes could lead to sig-nificant impacts in terms of wise use of for-est products and services by the communi-ties.

CF can result in a number of favourable di-rect and indirect environmental outcomes.The protection of catchments which containstributaries of major rivers in Sri Lanka is animportant outcome in this regard. This isparticularly important because agriculture inSri Lanka is largely dependent on irrigation

Box 14.1International Experience of CF

CF is increasingly being recognized as an alternative approach for managing natural forestresources. Based on the experience from CF implementing countries all over the world,Malla (2007) finds that community management of forest areas – including forests with highbio-diversity value – have generated favourable impacts. A significant amount of degradedforest lands in the world have been converted into improved watersheds and landscapesthrough which local communities are also benefited. Based on present evidence, it is foundthat CF has led to improved forest governance with community involvement in an inclusive,transparent, and accountable manner.

Communal management of forests is also seen as an important source of investment,particularly in developing countries where overall government spending on forest conservationis comparably low. However, governments have to respond positively to new and changingdemands of forest management, rather than continue to rely on the top-down, highlybureaucratic approaches in place. It requires a range of knowledge and skills in planningand implementing CF. As per the international experience, most of the successful CFprogrammes have been developed by government agencies in close collaboration withground level government officers, community level leaders, NGO representatives, researchers,and donor agencies, where every stakeholder has an important role to play. Also, outsidedonor funding is found to have been more effective where donors have encouragedcollaboration amongst relevant stakeholders. A few examples of such effective and longterm donor commitments are the Nepal Swiss CF Project, the Nepal-Australia CF Project, andthe Livelihood and Forestry Programme. Such projects have enabled local people to earn asignificant amount of cash income, and have enhanced rural development in turn. In spite ofthe positive impacts of CF, it involves key challenges such as scaling up of CF programmesbeyond pilot projects, equitable distribution of benefits, etc. which should be considered in

the planning and implementation process.

Source: Malla, Y. (2007), “Community-Based Forest (Natural) Resource Management: A Path toSustainable Environment and Development, Lessons from Three Decades of Experience andFuture Challenges”, in RECOFTC 1987–2007: The First Twenty Years, RECOFTC.

tanks which are supported by suchcatchments. The protection of catchments isagain important in the face of increasingwater scarcity due to the ongoing climatechange processes.

Available evidence shows that CF has a num-ber of subsidiary impacts on communities,in addition to its direct positive impacts inreducing deforestation and protection ofcatchments. The experience of the CF pilotprojects implemented in several districts ofSri Lanka shows that the formation of com-


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munity-based organizations (CBOs) and theiractive role in CF has not only led to thesuccess of the initiative, but also resulted incertain positive spill-over impacts on thecommunity. For instance, through varioustraining and capacity-building programmesand hands-on experience, the communitieshave been better able to link with outsideorganizations to mobilize their support forcommunity development.

Table 14.1 provides a summary of pilotactivities adopted by the SLANRMP indifferent local areas with community partici-pation.

14.4 Challenges for CF in Sri LankaThe relationship between forests and peopleis somewhat distinct in Sri Lanka when com-pared with other developing countries. Theforest peripheral communities in Sri Lanka

Table 14.1Community Forestry Pilot Activities Undertaken through SLANRMP

Category Activities undertaken RemarksForest-based activities Establishment of nurseries Undertaken to restore

Establishment of plantations degraded forest lands,Maintenance of plantations to afforest selectedEstablishment of fire line lands, and to minimizeMaintenance of fire line the impacts on forestCollection of non-timber forest products fires.

Micro-enterprise Home gardens development Aimed at providingactivities Dress making alternative income

Handicrafts sources for households,Paddy farming and thereby to upgradeLime drying well-being of poorSoap making communities, whichDairy would act as anOther livestock incentive to participateFood processing in CF activities.Shoe makingBee keeping

Community-based Tank rehabilitation Undertaken toactivities Village infrastructure improve infrastructural

Community halls/facilities and livelihoodCommunity-based aquaculture opportunities at theEco tourism community level.

Source: Sri Lanka-Australia Natural Resource Management Project, Annual Plan 2007-2008.

are comparatively less dependent on forestproducts as a source of income. Instead,they are dependent on forest land for theirupland agricultural activities which forms amajor part of household income. This issomewhat distinct from the observationsfrom other countries such as India, Nepal,and certain African countries where there ishigh dependence on forest products. Thenature of the forest-people relationship in SriLanka creates a challenge for sustainabilityof the forest resource. This is because beingdependent on forest lands (rather than onforest products) has direct implications ondeforestation, and thereby on thesustainability of the resource. Thus, the com-mon notion that 'high dependence on forestproducts could act as a powerful economicincentive for communities to protect naturalforests' may not be applicable to the SriLankan context.


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Thus, the introduction of CF in the currentsetting may lead to negative impacts on live-lihoods of the households who are depen-dent on forest lands for their farming activi-ties. Therefore, the creation of a properincentive mechanism for households for thosefarming income to be forgone, is of primeimportance. This is critical in terms of safe-guarding the livelihoods of people, as wellas in ensuring the sustainability of CF initia-tives.

Since the dependence on forest products islow in Sri Lanka, there is only limited spacefor promoting forest-based small industriesas a means of compensating forgoneeconomic benefits. In this backdrop, it isimportant to introduce alternative ways ofcompensating forgone benefits for commu-nities. However, livelihood related activitiesare beyond the scope and mandate of theFD. Therefore, at the ground level, it is achallenge to get the relevant agencies involvedin the process, and to properly coordinatethem to achieve the goals of CF. Givencurrent capacities and availability ofresources, it remains a challenging task forthe FD.

14.5 Institutional and Policy IssuesThe present system of forest management isbased on the provisions made by the ForestOrdinance. Accordingly, there is a commandand control approach to management, wherecommunity participation is not considered akey stakeholder involvement in forest man-agement activities. As such, the Ordinancedoes not have provisions for creating legalpartnerships with the communities and theprivate sector. Hence, there is limited roomfor active community involvement in forestmanagement in Sri Lanka. However, havingidentified the importance of partnering withthe communities and the private sector, theFD is in the process of introducing new formsof legal partnership agreements withcommunities.

The introduction of CF has to be necessarilycoupled with capacity building programmesat all levels of implementation. On the otherhand, physical and financial facilities requiredfor implementation of CF has also to beprovided. In the present set-up, the FD alone,with the limited amount of financial resourcesit receives from the Treasury, is not capableof financing such programmes. Whereassuch resource needs have been covered tosome extent with donor support in the pilotproject, it is necessary for the FD to exploreinnovative mechanisms of resource mobili-zation for CF in the future. The internationalexperience suggests that while donor fundsare important in the initiation and expan-sion of CF programmes, in the long run,alternative funding sources - for instance,community-private partnerships - will haveto be looked into.

14.6 Policy Implications and Recom-mendationsRecent pilot experiences have established CFas an alternative approach to forest manage-ment with the potential to generate numer-ous social, economic, and environmentalbenefits. In particular, it can be seen as auseful way of managing isolated patches offorest resources in the dry and intermediatezones of the country which are surroundedby agricultural communities. However, thepresent regulatory system of forest manage-ment does not create a conducive environ-ment for necessary cooperation betweenlocal communities and the FD for successfulCF. It is a positive sign that the FD is in theprocess of bringing necessary modificationsto allow for legal partnerships with localcommunities in forest management.

In order to perform facilitation and coordi-nation of CF activities, dedicated staff mem-bers of the FD are required. Essentially,capacity building of dedicated staff has tobe done in order to enable them to interactand collaborate with the communities effec-


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tively. Maintaining favourable relationshipsby ground level FD officers is a significantfactor that determines the success of CF.Thus, training has to be given to staff at alllevels of the implementation process. On theother hand, training and capacity buildingprogrammes should also aim at creating aright attitude towards active communityinvolvement in forest management.

Above all, in order to raise necessary resourcesfor implementation of CF, the FD has tomobilize additional resources than at present.This could partly be achieved by coordinat-ing with other relevant agencies that havedirect and indirect interests in CF. Suchorganizations include government organiza-tions, private organizations, non-governmen-tal organizations (NGOs), microfinance

institutions and CBOs. Development offunding facilities at the local, regional, andnational levels with such relevant organiza-tions is also very important to compensatecommunity members who are engaged in sup-portive CF activities.

Due to the comparatively low dependenceon forest resources of the local communi-ties, future CF initiatives should necessarilylook into avenues for creating incentives forcommunity participation. Past experiencesuggests that incentives can be brought aboutat household as well as at community levelthrough livelihood support activities andcommunity development activities. In thisregard, the FD should be the facilitator andthe coordinator of support extended by vari-ous agencies.


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1 It is estimated that 35 per cent of the people in Bangladesh, 25 per cent in Sri Lanka, 20 per cent in India and 20 per cent in Nepal areundernourished according to the “State of Food and Agriculture in Asia and Pacific Regions 2008”. Available at : ftp://ftp.fao.org/docrep/fao/010/ai411e/ai411e00.pdf

2 Adhikari. K. (2008), SAARC Seed Bank, Trade Insight,Vol.4, No.3.3 "Hunger on the Rise" available at: www.fao.org/newsroom/EN/news/2008/1000923/index.html

15. SAARC Food Bank: Dealing with Food Insecurity during Crises

15.1 IntroductionSouth Asian countries currently face threetypes of crises: namely; financial, food andfuel crises. While the region accounts for 23per cent of the world's population, it gener-ates only 2 per cent of global income. Theregion also has the highest concentration ofpoverty and hunger - accounting for 40 percent of the world's poor, and 35 per cent ofthe undernourished.1 While agriculture isthe main income source for the vast major-ity, agricultural productivity remains verylow. It is frequently argued that a South Asianhousehold on average suffers from food in-security.2 Indeed, on a wider scale, it is es-timated that the most recent food crisispushed nearly 41 million people in Asia andthe Pacific back into hunger and povertyduring 2007-08.3

The Food and Agricultural Organization(FAO) in its report Regional Strategies and

Programme for Food Security in the SAARC

Member States has identified four dimen-sions of food insecurity:

• Availability - measures the availabil-ity of resources for food productionand their productivity,

• Access - the level of income determinesaccess to food, especially where thefamily income reflects household foodsecurity,

• Utilization - whether the food iscooked or processed in a way that itcould be easily absorbed into the body,and

• Vulnerability - explained as the risksdue to environmental, market and en-titlement, nutrition and health factors.

The above four dimensions suggest that SouthAsian countries are at risk in terms of foodinsecurity at different levels - i.e., availabil-ity measures food insecurity at national lev-els, whereas access to food measures it atregional and household levels, and utiliza-tion and vulnerability measures food insecu-rity at household levels. While Individualcountries have adopted several strategies tomitigate the risks, it could be argued that itis also important to have collective strate-gies on a regional scale. One such approachproposed for the South Asian region is theestablishment of a SAARC Food Bank.

15.2 What is a Food Bank?

The poor we will always have among

us, but why the hunger?"

John van Hengel (founder of the food

bank)

A food bank is a non-profit organizationwhich distributes non-perishable goods andperishable food items to non-profit agenciesinvolved in local emergency foodprogrammes. Emergency food programmesprovide immediate hunger relief to individu-als and families who are unable to affordfood, and receive inadequate government

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financial assistance from initiatives such asa food stamp programme.4

The world's first food bank was the St. Mary'sFood Bank, started in 1967 in Arizona, US.Unwanted food items from hotels, cafete-rias, grocery stores, and farms were collectedfor distribution among the poor. From thisexperience, the concept of food banking wasstarted. Based on the idea of a 'bank', indi-viduals and companies who had the resourcescould make a 'deposit' of food and fundsthrough donations, and agencies could make'withdrawals'.

At present, many countries have food banks,most of which are non-profit organizationsor civil society organizations. For example,the US has the biggest food bank network;

the Second Harvest Bank represents more than200 food banks. Canada, Europe, and Aus-tralia are some of the other countries whichsuccessfully operate food banks. These foodbanks distribute food and grocery industrydonations to welfare agencies that in turnidentify the poor, and utilize those funds tofeed the hungry. Some of the countries haveopened food pantries in schools with the aimof eradicating hunger in school children.

However, there are some differences betweenfood banks and food pantries. A food bankis similar to the wholesale arm of the fooddistribution system for people living in pov-erty, while a food pantry is similar to theretail arm that serves people directly withemergency food. Some food pantries serveonly a few families each month, but there

Figure 15.1Features of a Food Bank and a Food Pantry

Is a food storing agency Is a food receiving agencyActs as a wholesale food distribution system Acts as a retail food distribution systemOperates on instruction of government Serves people directlyDistributes goods: canned and boxed Distributes food items (meals, fooddry groceries, fresh produce, frozen foods, etc. parcels)

Food Receiving Sources Donors: general public, Government Companies Super markets

Food Bank Food Pantry

4 Food stamps is typically a government programme, whereby households below a certain income threshold are provided monthly foodspending credits that can be redeemed at local food stores.


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are many that provide emergency food sup-port to hundreds of families every month.

15.3 The SAARC Food BankThe SAARC Food Bank is the world's firstregional food bank to be established in orderto address issues of regional food insecurity.5

The main purpose of the SAARC Food Bankis similar to other food banks - i.e., to oper-ate as a regional hunger relief agency. How-ever, it has several unique characteristics,such as limiting itself to only two main grains- rice and wheat - to be used only duringfood emergency or food shortage periods. Itcould be argued that it is similar to a 'bufferstock' or a 'safety stock' which is organizedto stabilize prices, and counter uncertaintiesin supply and demand.

15.3.1 Evolution

The SAARC Food Bank is an improved ver-sion of the SAARC Food Security Reserve sys-tem that was first conceptualized at the 3rdSAARC Summit in Kathmandu in 1987 (seeBox 15.1). The initial proposal to set up theSAARC Food Bank was adopted at theIslamabad Ministerial Conference of theSAARC in January 2004. In the same year,the Technical Committee of the Agricultureand Rural Development (SAARC-TCARD)discussed in detail a Concept Paper on theSAARC Food Bank. Most importantly, at the15th SAARC Summit held in Colombo in2008, the Heads of State of all governmentsin South Asia adopted the "Colombo Decla-ration of Food Security". This declaration (Co-lombo Statement) states that "we, the Headsof State or Governments, affirm our resolveto ensure region-wide food security and makeSouth Asia, once again, the granary of the

world". It has proposed several strategies toensure food security within the region. Onesuch strategy is to establish the SAARC FoodBank. The declarations also states, "we di-rect that the SAARC Food Bank be urgentlyoperationalized".

15.3.2 Objectives and Operation

In terms of the agreement signed to establishthe food bank, the objectives of the food bankcan be identified as follows:

• Act as a regional food security reservefor SAARC member countries duringnormal time food shortages and emer-gencies

• Provide regional support to nationalfood security efforts

• Foster inter-country partnerships and re-gional integration

• Solve regional food shortages throughcollective action

The SAARC Food Bank reserve covers onlytwo main grains in the region - i.e., rice andwheat, or a combination thereof. This actsas a reserve in addition to the already exist-ing national reserves, and will remain as theproperty of the respective member country.Member countries are responsible for assess-ing their share of the reserves, and informingthe SAARC Food Board on the quantity ofits reserves and its location (see Box 15.2).At the time of signing the SAARC Food Bankagreement, the SAARC Food Board assessedthe share of individual member countries,considering their production capacity, percapita consumption, food availability in thecountry, etc. The shares of member coun-tries are set out in Table 15.1.

5 The Common Market for Eastern and Southern Africa (COMESA) perhaps provides the closest example. A key objective of COMESA wasto expand regional trade in key food staples, and to improve national marketing systems. Agricultural programmes under COMESA havetwo objectives; sustainable regional food security and enhanced regional integration. To obtain food security, a strategy proposed in 2005was to establish a regional food security reserve. However, more up dated information on its progress is not readily available.


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Table 15.1Assessed Share of Food Grains for the Reserve (in MT)

Country MTAfghanistan 1,420a

Bangladesh 40,000

Bhutan 180

India 153,200

Maldives 200

Nepal 4,000

Pakistan 40,000

Sri Lanka 4,000

Note: a: This was decided at the first meeting of the SAARC FoodBoard.

Source: Agreement on Establishing the SAARC Food Bank.

The SAARC Food Bank agreement refers alsoto the quality of the reserves. It is compul-sory for member countries to provide adequatestorage facilities for the food grains, to in-spect the food grains periodically, to applyappropriate quality control measures, to in-clude turnover of the food grains, and toimmediately replace any food grains that donot satisfy the said standards. In addition,each member country agrees to undertakeevery effort to comply with any guidelineson storage methods or quality control mea-sures adopted by the SAARC Food Board.

Member countries can withdraw food grainin the event of a food emergency,6 and/orfood shortage.7 When there is a food emer-gency or a food shortage, the food requiringcountry needs to inform the other membercountries about its need. If the said countryneeds other members' help, it has also toinform the SAARC Food Board. During anemergency, a member country is allowed towithdraw food grains from its assessedreserve (within the own country) and/or fromits voluntary reserve (in other member coun-

tries) with immediate effect. During aperiod of food shortage, a member countryneeds to provide three months advance no-tice to the other member countries and theSAARC Food Board if withdrawals are fromits accessed reserve, or one month priornotice if the withdrawals are from voluntaryreserves.

The SAARC Food Board will decide theprices, terms and conditions of payments.There are three broad principles in the deter-mination of prices:

• Prices quoted shall be lower than pricesgenerally charged or quoted for coun-tries beyond the region

• Prices shall be representative of themarket, both domestic and interna-tional, and may be adjusted suitablyto reflect seasonal variations and pricemovements in the recent past

• A responding member country shall en-deavour to accord, as far as possible,national treatment in respect of calcu-lating the cost components such as the

6 A situation where the member country suffers a severe and unexpected natural or man-made calamity, or is unable to cope with a state ofcondition by using its national reserves.

7 A situation where the member country suffers from a production shortfall or storage shortfall, and where it is difficult to cope by usingavailable national reserves.


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costs related to storage, internal freight,interest, insurance and overheadcharges, margin of losses, etc., whilemaintaining its reserve and making re-leases.

A member country can decide on a suitableplace for a food bank in their country, and ifneeded, can appoint a member (may be pri-vate or government sector) to carry out foodbank transactions. The expenditure relatingto the functioning of the food bank will beborne by the member countries proportion-

Box 15.1SAARC Food Security Reserve and Reasons for its Failure

The establishment of a SAARC Food Security Reserve was proposed during the third SAARCSummit in Kathmandu in 1987, and came into effect on 12th August 1988. The reservecomprised of rice and wheat to meet 'emergencies' (i.e., a state or condition resulting fromhaving suffered a severe and unexpected natural or man-made calamity) in member countries.This reserve was maintained in addition to the national reserves of the respective membercountries. It was administered by the SAARC Food Security Reserve Board which comprisesrepresentatives from each member country. The main functions of the Board were to undertakea periodic review and assessment of the food situation and prospects in the region, includingfactors such as production, consumption, trade, prices, quality, and stocks of food grains. Themain condition to utilize the food from the reserve was to declare a national emergency by themember-state. However, no government of member countries was found to be willing todeclare emergencies to utilize it, even though there were food demands in the region, (e.g.,wheat crisis in Pakistan, floods and cyclone in Bangladesh, tsunami in Sri Lanka, etc.). Membercountries were also reluctant to utilize the reserves due to the complicated procedures in-volved in obtaining access, as the whereabouts of its location was not clear. Further, due to thenon-existence of a price advantage in drawing from reserves, member countries preferred toimport rather than draw from the reserves. The availability of food aid as grants from othersources, inability of the SAARC Food Reserve to compete with food aid given as grants, andpolitical tensions between member states discouraged member countries from using the foodreserve.

Due to the inactivity of the Food Security Reserve and having identified the importance ofregional collective efforts to address food insecurity, a second attempt was made by initiatingthe establishment of the SAARC Food Bank. It is an improved version of the SAARC FoodSecurity Reserve, where member countries can use the reserve during normal food shortagesand emergencies, price preferences are explained in both quantitative and qualitative terms,

procedures are more transparent through the SAARC Food Bank Board, etc.

ately, as part of the SAARC Secretariat bud-get. The first meeting of the SAARC FoodBank Board was held in November 2008 inNew Delhi.

15.4 Opportunities and Challenges ofthe SAARC Food BankThe collective attempt to establish a SAARCFood Bank is commendable as it is the firstever regional food bank, and demonstratesthe collective cooperation of the membercountries in addressing issues such as theglobal food crisis. Nonetheless, there are


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several opportunities as well as challengesahead in operationalizing the concept.

First of all, it offers several benefits to mem-ber countries. The agreement specifically fo-cuses on the determination of prices of thefood grains in an attempt to be fair by allmember countries. In particular, it providesfor exceptional situations, determining forinstance that "in the case of emergency, the

humanitarian aspects would be given due

importance while determining prices". Main-taining a food bank will be an added advan-tage to member countries, providing an ad-ditional source of reserves to their nationalreserves. Given that the food bank consistsof the two stable grains produced in the re-gion, it will also enable member countriesto easily consume these grains as they arewell accustomed to them. Costs relating totransport and distribution may also be lower

Box 15.2The SAARC Food Bank

The SAARC Food Bank Board comprises all member countries, and its functions are to under-take periodic reviews and assessments of the food situation, examine immediate short termand long term policy actions, review implementation of the provisions of the agreement,assess the demands for food grains, identify institutions and organizations in member coun-tries, and determine prices, etc.

The SAARC Food Bank is identified as a short term solution for food security. Thus, debates areongoing on whether to establish a SAARC Seed Bank. The operationalization of a seed bankwill create an effective long term mechanism of production, exchange, and use of communityand environmental friendly improved seeds that are in the domain of private and publicsectors as well as farmers. Different strategies have been identified to ensure and expandfarmers' access to high yielding seeds through a seed bank. These include the implementationof policy and institutional support measures, establishment and cooperation with regionalprivate seed companies and public sector agricultural research institutions, assistance frominternational seed banks and companies, etc. The SAARC Agricultural Ministerial Board is inthe process of preparing an action plan to establish the SAARC Seed Bank. Currently, theBoard deals with several issues relating to its implementation. These include identifying a clearmechanism to facilitate the process of access to seeds that deals with mutually agreed terms,Prior Informed Consent (PIC) procedures, seed development process, Intellectual Property

Rights (IPR) rules relating to seeds, bio-safety and bio-technology policies, etc.

when borrowing from the region as opposedto borrowing from outside.

However, there are several challenges formember countries in making the food banka success. The success of operating a foodbank will depend on how people are able toaccess the reserve and its distribution sys-tem, including the cost of distribution. Ingeneral, governments will select a nodal pointto establish the food bank. This location islikely to be close to the capital city withease of access to necessary infrastructural fa-cilities. However, in most cases of food short-ages at the household level, it is question-able whether the people who are in remoteareas and who do not have access to the re-serve will actually benefit from it. Further,most of the people in the South Asian regionhave low purchasing power, and are alreadyfacing a food deficit. Therefore, some doubts


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remain as to whether the neediest will actu-ally benefit from the food bank. As explainedbefore, in order to overcome this situation,world-wide food banks have identified theneedy people and areas with food shortagesbefore they establish these banks, thus mak-ing it possible to directly serve the needypeople. They have also established severalbranches in different areas where it provideseasy access to people.

It is also not clear as to how the SAARCFood Bank will react in an event of a re-gional disaster where several countries getaffected. In such a crisis, the food bank hasto prioritize the recipient countries accord-ing to their needs and requirements. Howsuch a system can be operationalized is notspelt out.

In addition, there may be some concern thatthe agreement provided for consumer prefer-ences when selecting the types of grains. Forexample, there are varieties of rice (raw rice,parboiled rice, etc.,) and preferences in thisregard vary from country to country, as wellas within different regions of the same coun-try. Therefore, it is important to identifywhether the selected varieties are compat-ible with the preference of consumers of themember countries. At least, it should substi-tute for consumer preference.

The SAARC Food Bank is an improved ver-sion of the SAARC Food Security Reserve.The latter, however, did not operate asplanned due to non-effective use of the re-serve by member countries as its locationwas not known to many member countries.As such, justifiable concerns remain as towhether the SAARC Food Bank would alsoface a similar plight.

The SAARC Food Bank is a short term solu-tion to face a food crisis. It is, therefore, im-portant that long term solutions are alsoidentified, with the overall objective of in-

creasing food production across the SouthAsian region. The SAARC Seed Bank is onesuch initiative aimed at providing facilitiesto exchange high yield seeds, exchange newtechnologies, provide know-how within theregion, etc. Similar initiatives should alsobe adopted to complement the concept of aregional food bank.

Individual SAARC member countries mayalso have their own specific challenges to beovercome. In the case of Sri Lanka, for in-stance, there are several issues that can af-fect the implementation of the food bank.Sri Lanka's monthly rice consumption is60,000 MT, whereas the SAARC Food Bankwould reserve only 4,000 MT, sufficient foronly two days of consumption. Before liber-alizing rice imports in 1996, Sri Lanka re-served three months of rice requirement inits buffer stocks. Therefore, it may be impor-tant to reconsider the food bank's assessedshare of reserves.

Prior to 1996, when Sri Lanka had bufferstocks, the storage costs were very high, thestocks were in danger of getting spoilt, andmonitoring facilities were not adequate, etc.Therefore, the government tried to stabilizethe rice market through imports by adjustingtariff rates from 1996. When consideringcosts, importing rice is cheaper than havinga reserve, due largely to the high storage costsinvolved in maintaining a reserve. However,there is an element of uncertainty when acountry depends on imports. Hence, it isnecessary to reassess the opportunity cost ofhaving a 4,000 MT reserve as against impor-tation of rice.

According to the SAARC Food Bank agree-ment, Sri Lanka has to stock rice in its ownreserves. However, it is a proven fact thatstoring paddy is less costly and less likely toget spoilt when compared to storage of ricewhich needs an extra formulation cost.


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It is also not clear as to how the reserve wouldoperate in different countries. In the SriLankan context, the question is whether it isthe government or the private sector that willoperate it. If it is a government body (e,g.,the Paddy Marketing Board) it would incur acost which the Treasury would have to bear.At present, there are well established privaterice producers in Sri Lanka (Nipuna, Araliya,etc.) who have the capacity to handle thereserve. For example, if ten rice producersare selected, they only have to provide 40MT each for the reserve. In such a situation,the government could act as the monitoringbody, and if needed, it could provide themwith storing facilities, subsidies, etc. As such,it is important to study available options,

and select the best feasible operationalmethod.

15.5 ConclusionIn light of the above discussion, it is clearthat having a regional food bank is a shortterm solution in the event of a regional or aglobal food crisis. However, there are spe-cific individual factors which are to be con-sidered by each of the member countries inthis regard. The success of the SAARC FoodBank in the region will depend on the opera-tion of the individual banks in member coun-tries, and its sensitiveness to catering to theneeds in the region. Simultaneously, as a re-gion, it is important to identify long termsolutions to tackle food crises in the future.


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16. The Global Economic Crisis and ICT

16.1 Introduction

Information and Communication Technolo-gies (ICT) are key pervasive technologies thatcan increase productivity and efficiency, anddrive economic growth. Indeed, the techindustry was regarded as a long term growthindustry that could withstand difficulteconomic times such as the dot.com burstof 2001-03. To a degree, this is based on thesupposition that demand for basic servicesis income-inelastic. However, more recentevidence suggests that the ICT sector isunlikely to remain unaffected by the currentglobal economic crisis. A recent reportprepared by the International Telecommuni-cation Union (ITU) argues that demand forICT can be adversely affected as consumerincomes are squeezed, and employment pros-pects come under threat as the globaleconomy contracts on a scale not witnessedfor well over 60 years.1 However, such stud-ies also note that the current economic down-turn may present opportunities for disrup-tive technologies,2 and new business mod-els to emerge. Such developments can occurwhere prices are falling and where technol-ogy is changing - for example, in marketsfacilitated by the availability of lower-priced,higher performance consumer broadband. Inthe longer term, therefore, there is optimismthat the ICT industry may emerge relativelyunscathed from the current global economiccrisis.

However, there are downside risks to the ICTsector which may be regional or country spe-cific. Funding in the current financial cli-

mate is likely to be a key issue for many.Private sector operators that invest in thenational backbone infrastructure, includingnext-generation-networks, can be expected tobe facing financial constraints. In turn, suchdevelopments will require governments tostep in to meet shortfalls in financing wherepossible. In the case of Sri Lanka, the generalconsensus appears to be that the direct im-pact of the global downturn might not affectthe ICT industry immediately, but that itsspin-off effects can create issues as regardsto opportunities for expansion and employ-ment in the sector. This policy brief is anexploratory attempt to investigate some ofthe possible impacts on Sri Lanka's ICT sec-tor, based largely on discussions held withrelevant stakeholders.

16.2 Global Economic Downturn andthe ICT SectorThe ICT sector at present is an important sec-tor in its own right, typically accounting forup to 7.5 per cent of GDP worldwide (de-pending on which sectors and services areincluded), in addition to its important fa-cilitating role in many other sectors.

Of the many areas of ICT activity, telecomservices are vital for consumers and busi-nesses alike. Studies project that the telecomservices market will be affected significantlyin 2009, generating US$ 1.4 trillion, at agrowth rate of only 1 per cent (compared tothe 10-11 per cent annual growth rates overrecent years).3 This is largely owing to the

1 Information and Communication Technologies (2009), "Confronting the Crisis: Its impact on the ICT Industry", February 2009.2 Aimed at improving a product or service in ways that the market does not expect, typically by being lower priced or designed for a different

set of consumers.3 Pyramid Research Report (2008), "Global Telecom Services Revenue Forecast 2008-2013: Emerging Market Opportunities", December

2008.

The Global Economic Crisis and ICT

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grim economic outlook and substantial cur-rency fluctuations resulting from the globaleconomic and financial crises. Moreover,voice services are expected to be the hardesthit in 2009, contracting by 3 per cent com-pared with a 6 per cent expansion in 2008.Meanwhile, business growth in non-voicemobile applications and broadband Internetaccess are expected to remain strong withthe data market (both fixed and mobile) reach-ing US$ 411 billion in 2009, up 12 per centfrom 2008. Many analysts also appear toagree that the true impact of the economicdownturn is yet to materialize across the ICTsector.4

Despite general concerns over the overallimpact of the downturn on the ICT sector, itis also likely that there will be variations inimpact across regions and countries. Studiesexamining the income elasticity of ICTservices suggest different patterns of responsein consumer demand for developing anddeveloped countries. In developing countries,mobile phones were considered a luxury goodfor the most part. On this basis, mobile phoneusage might be expected to fall with areduction in real income,5 as in the casewhere consumers' disposable incomes werehit recently by rises in food prices. How-ever, as mobile networks have continued togrow in developing countries beyond allexpectations, the argument that they are a'luxury good' is hard to defend and is beingincreasingly rejected. Thus, demand may stillcontinue to grow in developing economiesdespite falling incomes, as telecom networksare in the early stages and business use ishigh.6 By contrast, in the case of developed

countries, most research suggests that broad-band Internet access is inelastic,7 implyingthat a fall in income would lead consumersto give up their broadband subscriptions ordefer connection upgrades.

In respect of mobile communications, itcould, therefore, be argued that the globaleconomic crisis is unlikely to have a majoradverse impact on developing countries.There has been a remarkable growth in thepenetration of mobile phones in developingcountries, with every two persons estimatedto have a mobile phone by end 2008. In mostdeveloping countries with a mobile penetra-tion of less than ten, restrictive governmenttelecommunication policies are likely to havecaused more harm to the growth of the ICTsector than any economic crisis could. There-fore, a key challenge during the current eco-nomic crisis will be not only about provid-ing high quality services to current subscrib-ers, but also ensuring that infrastructure roll-out continues to pick up new subscribers.

The economic crisis could affect mobile sub-scribers in developing countries if consum-ers lose their jobs or see their incomes beingcut. However, once a user gets a mobilephone, it is difficult to give up, and in manycountries, mobiles have become a necessity.8

Mobiles have largely replaced fixed lines forvoice communications in many developingnations.9 Therefore, other ICT services arelikely to be dropped, with mobile only be-ing discontinued as a last resort.

Thus, by the end 2008, the economic crisishad yet to impact growth in mobile services

4 http://www.analysysmason.com/About-Us/News/Insight/Will-telecoms-escape-the-economic-downturn/7/11/085 Income elasticity of demand for mobiles is estimated roughly at +1.5 for an average developing country with 8 per cent penetration.6 http://www.lse.ac.uk/collections/media@lse/pdf/Wheatley%20paper%2003.02.2006.PDF7 For example, long-run income elasticity of demand for broadband in OECD countries is estimated at +0.78. See: www.itu.int/osg/spu/ni/

voice/meeting.phtml8 Frost and Sullivan (2006), "Social Impact of Mobile Telephony in Latin America", available at: http://www.gsmlaa.org/files/content/0/94/

Social%20Impact%20of%20Mobile%20Telephony%20in%20Latin%20America.pdf9 ITU (2008), "Asia-Pacific Telecommunication/ICT Indicators 2008", available from: http://www.itu.int/ITU-D/ict/


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in the largest developing country markets.The tightening of credit has threatened capexand investment in telecom networks, but thisimpact has so far been mainly confined todeveloped countries. It might spread to de-veloping countries, especially those relianton foreign direct investment (FDI) from de-veloped countries for financing network roll-out. This will be particularly so where mo-bile operators are controlled by European orNorth American carriers. However, as previ-ously mentioned, the impact so far has beenlimited, and demand for mobile services indeveloping countries is expected to be strong.

The rest of the discussion will examine theemerging issues of concern as a result of glo-bal developments with regard to the ICT in-dustry in Sri Lanka.

16.3 IT-BPO SectorInformation technology enabled services(ITES) include business process outsourcing(BPO), knowledge process outsourcing

(KPO), and other information technology (IT)related services. The IT-BPO sector holds animportant position in Sri Lanka's ICT sector.The Export Value Survey of 2007/08 by PriceWaterhouse Cooper (PWC) and the ExportDevelopment Board (EDB) suggests that theIT-BPO sector was the fifth largest exporterwith the potential to even surpass earningsfrom the tea export sector. Furthermore, it isclear that the momentum in export earningsgrowth in computer and information servicesin recent years has been relatively high (Fig-ure 16.1). While net export earnings havegrown steadily from US$ 50 million in 2002to US$ 230 million in 2008, its contribu-tion as a share of total merchandise exportsand services has also increased from 0.8 percent to 2.3 per cent over the same period.The ITES sector recorded strong growth inexcess of 31 per cent in 2008. However, it islikely to experience a slowdown in the com-ing years due to the economic downturn inthe top export markets, namely, the US andthe EU.

Figure 16.1Export Earnings from Computer and Information Services (2001-08)


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179

Given that most of the key clients for SriLanka's IT-BPO sector are based in devel-oped countries, there are some emerging con-cerns for the local industry. Many developedcountries, hit hard by the global downturn,are taking measures - such as cost cutting -to mitigate the impacts. The general down-turn in outsourcing as well as on embarkingon new projects has affected the IT-BPObusiness organizations in Sri Lanka, with theimmediate impact being a drop in revenueaccording to industrialists operating in thesector.

Accordingly, in response to the slowdownin incoming businesses, various measureshave been adopted by the local IT-BPOsector. Some leading organizations havetaken aggressive measures, especially sincethe fourth quarter of 2008 to reduce costs,adhere to best practices, as well as attemptsto increase market penetration. In this regard,many of the interviewed IT-BPO organiza-tions have also been investing in improvingsales and marketing, and looking at entirelynew market segments such as Asian andMiddle Eastern regions.

Recruitment has also been more tightly con-trolled. Indeed, in some instances, recruit-ment has been put on hold and there hasbeen a certain amount of job cuts in the localIT-BPO sector. As the IT-BPO sector providesa large number of job opportunities, espe-cially for new graduates in IT and relatedfields, this is likely to have some effects onthe employment opportunities in the ICTsector.

However, it was also noted that though therehas been a slowdown in outsourcing and newprojects coming in with the onset of the glo-bal economic crisis with clients taking mea-sures to reduce costs, the outlook in the fu-ture may nonetheless change. Beyond theinitial period of the crisis, it may prove ben-eficial for clients to outsource more towards

cheaper outsourcing destinations in thelonger run. Thus, a more optimistic scenarioalso exists that business will gradually beginto pick up towards the end of 2009. If thiswere to materialize, the global economiccrisis could indeed result in positive devel-opments for the local IT-BPO sector in thelong run.

Despite such optimism, many of those in-terviewed in the ICT industry have voicedconcerns over possible protectionist measureswhich may be taken by developed countriesthat could adversely affect the local ICT in-dustry, and especially the IT-BPO sector.

16.4 ICT Employment and EducationAccording to leading academics in the ICTsector, there are a growing number of gradu-ates in IT and related fields annually. Cur-rently, there seems to be a reduction of em-ployment opportunities in the ICT sector. Thisis expected to effect the newly passing outgraduates the most, as this group lacks in-dustrial experience. With lesser number ofemployment opportunities, the industry isalso becoming quite selective about the can-didates to whom it will offer the limitedamount of placements available. However,most individuals interviewed were of theopinion that this situation may be a tempo-rary one, which could change in about a year.It was also noted that the experience wassimilar during the 2001-03 dot.com collapse.

Some are also of the opinion that as statesector e-government projects and similar ITrelated initiatives are ongoing without anyhindrance or slowdown, it may present ICTemployment opportunities for at least a por-tion of the new and recent ICT graduates.This situation may also provide an opportu-nity for the government to attract some ofthe best passing out graduates, who usuallyprefer to seek private sector employmentunder normal circumstances.


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In order to ensure some degree of flexibilityin staff strength based on performance, rev-enue, and the general economic climate,some business organizations in the ICT sec-tor appear to be exploring the possibility ofhaving workforce flexibility in terms of re-cruitment of staff members through manpower consultancy companies rather thanresorting to direct employment.

In the meantime, the number of ICT person-nel who are enrolling on postgraduate ICTcourses has shown an increase, which mayindicate that the established individuals inthe ICT sector are taking the environmentcreated by the current downturn to enhanceand improve their qualifications. It is per-haps also a timely opportunity to further ex-pand education/training facilities in the ICTsector, particularly by encouraging privatesector participation.

Additionally, while job losses in the ICT sec-tor have been reported in many developedcountries, Sri Lanka could also experiencethe phenomenon of return migrant workersin the sector. However, the dearth of infor-mation in this regard makes any observationdifficult at present.

16.5 Remedial Measures16.5.1 ICT as an Enabler

It is noted that with the impact of the globaleconomic crisis on core businesses, the im-pacts have also affected their respective IToperations. As IT plays a key role in mainte-nance and uplifting the productivity of orga-nizations, IT divisions may be required totake precautionary and proactive measuresto mitigate the downside effects. Many ofthe players in the local ICT sector that wereinterviewed were of the opinion that recruit-ment has been halted, unless it is extremelynecessary, and role stretching and other prac-

tices have been introduced. As such, effortsto incorporate and adhere to best practicesand industry standards, and to focus on ab-solute requirements and concentrate on tighterintegration with the core business have beenobserved.

Careful cost reductions have taken place.However, according to those engaged in lo-cal multinationals and conglomerates, thecost reduction measures due to the globaleconomic crisis have not impacted the longterm strategies so far. The impacts have alsonot gone down to the level of entering a vi-cious cycle of cost reduction on IT services,affecting the quality of services provided,which in turn impacts the core business. In-dustrialists were of the view that the globaleconomic crisis has actually provided thema positive opportunity to improve and upliftcost effectiveness, efficiency, and standardsof the services provided.

16.5.2 Mobile and Telecommunication

As previously mentioned, mobile operatorsare better placed than fixed line operators toweather the current economic crisis.10

Nonetheless, telecom services are expectedto come under further price pressure, requir-ing operators to take a more rigorous approachto control costs and improve internal effi-ciency.

Despite the global upheaval, it was notedthat the local mobile and telecommunica-tion sector has not been impacted much. Itwas also noted that there has not been anydemand decrease, and the customer surplusis increasing. Moreover, the local scenarioseems to be driven more by internal compe-tition - i.e., competition between local tele-communication providers, rather than exter-nal forces, including the current global out-look.

10 Many analysts highlight differences in cost structure between fixed and mobile operators, with mobile operators enjoying greater flexibilityin terms of capex commitments (as capex represents only 20-30 per cent of total costs for mobile operators). See discussion on "MobileOperators Capex Analysis 2008"at: http://www.abiresearch.com/research/1001072Mobile_Operator_Capital_ Expenditures_Analysis.


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National telecommunication infrastructureplays a prominent and vital role in drivingbusiness. As was previously noted, in theinternational scenario, there may be instanceswhere governments have to intervene and in-vest in the Next Generation Networks, in theevent that telecommunication investors pullout due to financial constraints. However,according to leading telecommunication pro-viders in Sri Lanka, this has not been the caseso far, where almost all plans and invest-ments on expansions of network, bandwidthand coverage, and introduction of new tech-nologies in the mobile and telecommunica-tion sector are going ahead despite the eco-nomic downturn.

This is primarily because there is an expecta-tion that the mobile and telecommunicationindustry will continue to grow during thecrisis times as well. In addition, with theend of the 30 year long separatist conflict inthe country, operators believe that the North-ern and the Eastern Provinces will provideopportunities to improve market penetrationand revenue growth.

However, one of the areas where revenue hasdropped - which may be attributed to theglobal economic crisis - is income generatedfrom roaming communication. As observed,the drop may be due to reduced activity inthe tourism sector, as well as other factors.

Box 16.1Government ICT Initiatives

ICT is an enabler and a tool that can help people increase their income levels inwhatever fields of employment they are involved in. The government of Sri Lanka hasinitiated several programmes with the objective of promoting information technologyliteracy of the people in the country. As a major step towards this, 2009 has beendeclared as the "Year of ICT and English".

One of the goals identified under the government's "e-Sri Lanka" initiative is to facili-tate access to ICT amongst the most vulnerable groups, and to ensure that the benefitsof ICT development flow to these groups. In view of the declaration of 2009 as the yearof ICT, the Information and Communication Technology Agency of Sri Lanka (ICTA)has taken steps to implement an extensive national programme to disseminate andcreate awareness about ICT.

The “Nenasala” of the e-Sri Lanka project is intended to empower rural communitiesall across the country with affordable access to computers and the Internet. It is in-tended to provide a catalytic effect for the rural communities in poverty reduction,social and economic development, and peace building while aiming at providing ser-vices in a long term sustainable manner. The Nenasala project aims to establish 1,000centers throughout the country by end 2009. Out of this proposed total, 500 Nenasalahave already been established.

The e-government initiatives implemented by the ICTA have been progressing success-fully in meeting their objectives. One example is the Government Information Centerproject which was recently declared as one of the winners of the World Summit Award2009, a contest which has been launched as a part of the United Nations Summit onInformation Society. This implemented project, which provides general informationsuch as how to obtain a passport or a national identity card, getting a loan facility froma government bank, and other related information to the general public over an easilyaccessible telephone number "1919" has been declared as a winner with best practicesin high quality e-Content, and has been quoted as a worldwide example of outstandinge-Content.


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The decline is not considered to be signifi-cant with respect to the overall revenue gen-erated.

16.5.3 Role of FOSS

Free or Open Source Software (FOSS) areprogrammes or applications that have licenceswhich allow users to run, modify, distributecopies of it, as well as to distribute theirown modified version of the programme orapplication, free of charge. However, thoughthe software is free it does not mean the qual-ity is poor. There are many FOSS applica-tions powering up business-critical servicesworldwide. With the economic crisis andresultant trend towards cost cutting, wheremany industries worldwide are going intomore cost effective alternatives, FOSS basedapplications may present such an alternative.

Several ICT sector players in Sri Lanka havealready moved into, or are moving into us-ing FOSS applications where applicable as acost cutting measure due to the current eco-nomic downturn. Developing reputed FOSSbased applications (which will be availablefor the customers free) and offering the ser-vice at a cost is a business model followedby some software companies. One localcompany operating on the above businessmodel informed that their revenue has al-ready doubled to date as a result. The abovebusiness model may present opportunitiesto attract more business even during turbu-lent times, as well as enabling companies tocompete directly with the big players in theindustry.

16.6 ConclusionThe global economic crisis has had an im-pact on the Sri Lankan ICT industry, espe-cially in the IT-BPO/software developmentsectors. However, the current outlook seems

to be positive, based on the feedback receivedfrom discussion with relevant industrialists.Most expect the local ICT industry to pickup in around a year's time, assuming thatthere will not be any protectionist measuresadopted by developed countries. However,it also should be noted that under the cur-rent uncertain circumstances, it is quite dif-ficult to make definitive predictions.

Employment opportunities, especially fornew graduates, seem to be declining some-what. However, most industrialists expressedthe view that so far, the global economiccrisis has also been an opportunity for busi-nesses to grow, to be more focused and costefficient with new and efficient businesspractices and technologies coming up. Thus,there is some expectation that the local ICTindustry may emerge more resilient andgeared towards the future through this crisis,as it did through the dot.com collapse.

It was noted that almost all government e-governance ICT initiatives have been goingon successfully, and have not been affectedby the current economic environment. Ac-cording to officials, there has not been anyindication so far about the impacts of theeconomic crisis on the local ICT sector whichnecessitates action by the government.11

Nonetheless, many players in the ICT sectorare of the opinion that the government couldexplore the possibility of providing tax in-centives to locally built/developed software,which might be particularly helpful duringthe current tough times the industry is fac-ing. In addition, it was also noted that thecost of Internet bandwidth is high in Sri Lankacompared to other countries, and exploringpossibilities for the government to bring costsdown might be a timely intervention.

11 Thought it may not be directly related, it was also noted that there has not been any decrease in the number of websites being registeredunder the LK domain registry (i.e., websites ending with the .lk prefix, the country's top level domain).

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17. Prospects

Despite the general gloom pervading theoutlook for the global economy, Sri Lankahas reasons for some optimism. The militaryvictory ending a 30 year long separatist con-flict in the country in May 2009 has revivedexpectations of long term political stabilitythat can create a conducive environment forsustained growth and development. Indeed,the near term economic outlook has alsobrightened. In early July 2009, the CentralBank of Sri Lanka (CBSL) revised the GDPgrowth forecast for the year to a more opti-mistic 4.5 per cent. Assurances that the firsttranche of the long awaited IMF Stand-ByArrangement - enhanced from an initial US$1.9 billion to US$ 2.6 billion - would bedisbursed from July 2009 further boostedexpectations of a better-than- expectedeconomic recovery.

The anticipated economic dividends from theconclusion of the war effort are many. In theimmediate short term, the mere revival ofeconomic activity - in agriculture, fisheries,etc. - in the previous conflict-affected regionscan stimulate output. In the more mediumterm, reconstruction of damaged anddestroyed infrastructure - road/rail networks,housing, schools, hospitals, etc. - willprovide an additional stimulus. It is quitelikely that active economic participation ofthe private sector in the Northern andEastern Provinces will inevitably be linkedto progress in restoring large scaleinfrastructural needs in energy, transportation,communication, etc. Private sector investorsmay be averse to finance specific investmentsin tourism related facilities, for instance -until such infrastructure materializes, or there

is a credible commitment to improve facili-ties. Nonetheless, the emerging evidencepoints to strong private sector interest inentering markets in previously conflict-affected areas. By mid-June 2009, the CBSLhad already granted approval for 67 new bank-ing service outlets to be opened in the North-ern Province - the largest number of approv-als given during a comparable period.

The economic resurgence of the Northern andEastern Provinces are inextricably linked toensuring socio-political stability in thecountry. Thus, reconstruction needs cannotbe delayed on account of financial constraintsof the government, exacerbated by theglobal economic downturn. Not only is SriLanka facing a revenue crunch as economicactivity slows, but bilateral donors are alsodistracted by their own domestic economicconcerns. In this context, the enhanced loanfacility of US$ 2.6 billion from the IMF is amixed blessing. It will undoubtedly ease SriLanka's external resource constraints, but itcould well impose fiscal restraints on aspeedy reconstruction process. Indeed, theIMF noted that it supported the government'sgoals of "reducing the fiscal deficit to a sus-tainable level" with the initial announcementunder the Staff Level Agreement.1

Conditionalities - attaching demandingconditions that have become shorthand forausterity - lie at the root of arguments infavour of and against IMF programmes. Insome instances, such conditionalities areviewed positively, as imposing externaldiscipline to macroeconomic managementin the face of lax domestic macroeconomic

1 http://www.imf.org/external/np/sec/pr/2009/pr09265.htm.


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Table17.1Key Fiscal Developments (January-April)

% Change % of GDP

2008 2009 2008 2009

Revenue 23.5 -9.6 4.8 3.9

Expenditure 24.2 28.0 6.9 8.0 Current 23.5 34.5 5.2 6.2 Public investment 11.4 9.1 1.8 1.7Overall budget deficit 25.8 113.7 2.1 4.0

Domestic financing 98.8 165.3 1.7 4.0

Source: Ministry of Finance and Planning, Mid Year Fiscal Position Report, various issues.

prudence. Alternatively, the very standard,"one-size-fits-all" approach can also prove tobe counter-productive in dealing with spe-cific country situations. This partly explainswhy countries prefer to avoid the IMF untilthey have run out of options. But it also un-derlines why it is critical to practise prudentmacroeconomic management, and avoid thenecessity of being subject to lending condi-tionalities - and thus, surrender some degreeof policy flexibility.

For instance, Sri Lanka at present needs toretain a degree of fiscal flexibility to respondeffectively to the reconstruction needs of thepreviously conflict-affected areas, not leaston political-economy considerations. Fiscaldevelopments so far in 2009 have beenunfavourable. Revenue growth has contractedsharply by 9.6 per cent during January-April2009 compared to a growth of 24 per cent inthe corresponding period in 2008, while ex-penditure has grown at 28 per cent - slightlyabove the 24 per cent growth recorded in thecorresponding period in 2008 (Table 17.1).As a result, the overall budget deficit esti-mate for the period has doubled to 4 percent of GDP relative to the 2.1 per cent re-corded in the same period of 2008. Thesedevelopments suggest that Sri Lanka's fiscalsituation is set to weaken considerably, con-trary to the optimistic fiscal deficit target of6.5 per cent of GDP announced in Novem-ber 2008 in the government budgetary esti-

mates for 2009. Indeed, the revised fiscaltarget of 7 per cent of GDP announced fol-lowing the Letter of Intent with the IMF alsolooks to be similarly optimistic.

The deficit financing pressures will be sig-nificant, with more immediate implicationsfor monetary policy management as well. Theentirety of the deficit bridging needs duringJanuary-April 2009 has been met throughdomestic financing (Table 17.1). While thegovernment has rightly appointed a Presiden-tial Taxation Commission with a view tostrengthening revenue generation in the me-dium term, there is limited room to raiseadditional revenues in the near term. Busi-nesses are struggling in the current economicenvironment, while consumers have seen anerosion of their real incomes in view of thehigh inflationary environment of recent years.The Nation Building Tax (NBT) introducedthrough the 2009 budget proposals, for in-stance, has been raised already from 1 to 3per cent as of May 2009. Thus, the immedi-ate response calls for rationalization of ex-penditures - cutting back on any profligateexpenditure - so that priority areas are notunduly affected.

The rapid decline in inflationary pressuresseen in recent months - initially as a responseto the tighter monetary policy stance that sub-sequently coalesced with the impacts of theglobal economic crisis - should not be re-

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ignited. The annualized rate of inflation stillstands high at 10.4 per cent in July 2009.Therisks for continued price stability are two-fold: domestic borrowing pressures from thefiscal side, and the potential for oil prices torecover as the global economic recession bot-toms out.

These factors - the global economic down-turn and the accompanying commodity priceglut - have been a mixed blessing for Sri Lanka.While the global downturn undoubtedly im-pacted negatively by hurting the country'sexport sector, the sharp drop in oil pricesallowed the country to avert a looming for-eign exchange crisis. During January-June2009, Sri Lanka's trade deficit contracted by60 per cent to US$ 1,249 million - primarilyon the back of a sharp drop in the importexpenditure bill. While export earningsdropped by 18 per cent, the reduction inimports was much more pronounced at 37.7per cent over the period (Figure 17.1).

The much reduced import expenditure billand general slowdown in economic activityeased mounting pressure for an adjustmentin the exchange rate. Sri Lanka's depletedforeign exchange reserves hit a low of US$1,272 million in March 2009 on the back of

Figure17.1Trends in Trade Flows (September 2008-June 2009)


an ill advised attempt to prop up the cur-rency in spite of a rapidly worsening foreignexchange gap. Having approached the IMFfor a Stand-By Arrangement of US$ 1.9 bil-lion in February 2009, the CBSL eased itsinvolvement in the foreign exchange market.The rupee depreciated to a high of Rs. 120to the US dollar in March 2009, before be-ginning to recover, as the demand for dollarsdropped sharply with the fall in import de-mand.

In addition, Sri Lanka continued to see a rela-tively healthy inflow of remittance inflows.After an initial drop in the first quarter of2009, private remittances remained steadyat US$ 1,505 million in the period January-June 2009 (up 5.4 per cent over the corre-sponding period in 2008). As anticipated,remittance inflows are unlikely to see animmediate reversal on account of the globaleconomic crisis. At the same time, Sri Lankawill also not have the benefit of the robustgrowth in remittance inflows of approxi-mately 15 per cent per annum seen in recentyears.

The resulting liquidity in the domestic for-eign exchange market allowed the CBSL tomop up dollars. This not only prevented an


186

undue appreciation of the rupee in view ofthe already uncompetitive real exchange ap-preciation of recent times, but also helpedthe CBSL to re-build the country's foreignreserves position. By June 2009, official re-serves stood at US$ 1,618 million, equiva-lent to 1.7 months of imports. By mid-Au-gust 2009, net foreign exchange purchasedby the CBSL in the domestic market is esti-mated to have exceeded US$ 600 million.Excluding the first tranche of the IMF dis-bursement, official reserves had thus creptup to US$ 2.3 billion. A steady increase innet foreign inflows to the Treasury bills andbonds market of US$ 270 million by mid-August 2009, received a further boost withan inflow of US$ 850 million from an esti-mated US$ 1.2 billion commitment from aninternational hedge fund in the US. Addi-tionally, a new allocation of the reserves ofthe IMF saw Sri Lanka receive an equivalentof US$ 475 million to push the country'sofficial reserves to an estimated US$ 4 bil-lon by end August 2009.

Despite the significant improvement in netinflows of foreign capital, Sri Lanka's exter-nal payments position will need to bewatched carefully in the near term. There areinherent risks of capital flight related to port-folio investment flows - such as those in gov-ernment debt securities - as experienced inthe fourth quarter of 2008. The country stillhas to meet outstanding settlements on bi-lateral lines of credit, oil price hedging, for-eign borrowing, etc., in the course of 2009-10. It is in that context that the long delayedagreement between the IMF and the GOSLfor the disbursement of a Stand-By Arrange-ment saw Sri Lanka's stock market rallyingimmediately. The proposed disbursement ofa US$ 2.6 billion facility (amounting to 400per cent of the country's quota) - in eighttranches over 20 months, and at an interestrate of approximately 1.5 per cent - is aboost to medium-term investor confidencein the economy.

Figure17.2Changes in Inflation and Policy Rates (September 2008-July 2009)

0

5

10

15

20

25

30

Sep Oct Nov Dec Jan Feb Mar Apr May June July

2008 2009

%

Repo CCPI (Annual) CCPI (Point-to-point)


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187

The 'mopping' up of liquidity from the for-eign exchange market has ensured that infla-tionary pressures remain under control, andthe easing of interest rates could continue.The CBSL which began to use policy rateadjustments in February 2009 once more, aftera lapse of one year, had successively cut therepurchase rate (Repo) by 200 basis pointsby June 2009 (Figure 17.2). By end 2009, itis quite likely that Sri Lanka's annual rate ofinflation will fall to single digit levels forthe first time since 2004.

However, medium term inflationary pressureswill need to be watched closely. Inflation isexpected to pick up in the second half of2009, despite the anticipated decline of an-nual inflation to single digits by year end.The latter will materialize as the lagged ef-fects of the sharp decline on a point-to-pointbasis seen in the first half of 2009 (reaching0.9 per cent in June 2009) gets reflected inthe more gradual decline in the annualizedrate by end 2009. As previously mentioned,the outlook on inflation for the more me-dium term will depend on fiscal develop-ments, and external conditions related tointernational oil price trends.

As evident from the discussion earlier, SriLanka's developing fiscal situation in 2009looks fragile. The IMF funding will go a longway to easing external resource constraints,and thus help towards fiscal consolidationby easing the need to resort to costly shortterm commercial borrowing. Nonetheless,the magnitude of funding needed for the re-construction process will be quite significant.For instance, the re-building of roads alonein the Northern and Eastern Provinces is esti-mated to cost US$ 750 million. In addition,the country is also likely to experience thegeneral tendency towards some degree of fis-cal slippage associated with electoral cycles.Presidential and General Elections are widelyexpected to be held by end-2009 or early2010. Past experience in this regard high-

lights the risks; the 14-month Stand-By Ar-rangement entered into with the IMF in April2001 fell apart before the General Electionsof end 2001, before it was rescued once moreby the incoming new government.

Sri Lanka will undoubtedly hope to tap bi-lateral donors and international developmentagencies for reconstruction related finance.But, there is always a considerable time gap- of at least 12 months or more - betweenthe issuance of pledges/commitments andtheir translation to the actual disbursementof funds. In the interim, the government willhave to take the lead in financing reconstruc-tion and rehabilitation related needs. Thesedevelopments can hold inflationary impli-cations.

Other risks to macroeconomic stability havealso to be considered. A significant inflowof foreign capital can cause destabilizing ef-fects on exchange rate policy management.Apart from bilateral/international develop-ment agency support for the reconstruction,capital inflows can also come by way ofmany other channels. With the re-boundingof the Colombo Stock Exchange - with stocksup by 60 per cent so far in mid-2009 - "hotmoney" can flow in to take advantage of in-vestor opportunities. With the improvementto Sri Lanka's sovereign credit rating follow-ing the IMF agreement, the government mayresort once more to foreign currency denomi-nated borrowing to ease pressure on domes-tic sources of funding.

A heavy inflow of foreign capital - some ofit of a likely volatile nature - will compli-cate attempts to sustain macroeconomic sta-bility in the longer term. If policy is gearedto exchange rate stabilization, central banksintervene in the foreign exchange market andincrease their holding of reserves - as doneby the CBSL in recent months. However, ris-ing net foreign assets become a major sourceof money supply growth. To ensure price sta-


188

bility, governments can resort to sterilizationof domestic monetary expansion. Sri Lankadoes not maintain a fully liberalized capitalaccount, and thus, there is still some leewayto implement both monetary and exchangerate stabilization policies. For instance, evenif open market operations result in higherinterest rates, domestic borrowers are con-strained from accessing funds from abroad.Nonetheless, whilst such a policy thrust mayhelp stabilize short run macroeconomic equi-librium, it can also raise the long run risks ofinstability.

Over the 20 month period of disbursementagreed with the IMF, the loan conditionali-ties will be aimed at keeping Sri Lanka on afairly tight fiscal and monetary policy path -to achieve the targeted fiscal deficit of 5 percent of GDP by 2011. In that constrictedpolicy space, addressing weaknesses in fis-cal management - raising revenue and cut-ting down on unnecessary expenditures - tosupport the reconstruction drive in the North-ern and Eastern Provinces will be critical. Itis only from a platform of sound macroeco-nomic fundamentals that the country willbe able to reap the full economic dividendsof the end to the 30 year separatist conflict.

i

Appendix A: Macroeconomic Indicators

Appendix A: Macroeconomic Indicators (Statistical Base)

Table A1: Socio-Economic Indicators

1. Basic indicator Unit

Area: Sq. km. 65,610Mid year population (2008) ('000) 20,217Population growth rate (2008) % 1.0Life expectancy at birth (2005) years 71.6Infant mortality rate (2005) per 1000 live births 12.0Gross school enrolment ratio (2005)(a) % 62.7Adult literacy rate (2005) % 90.7Human development index (HDI) (2005) Value 0.7Human poverty index (HPI) (2005) Value 17.8

2004(g) 2005 2006 2007 2008(e)

2. Output, Labour force and Employment

GNP at current market prices Rs. bn. 2,070.0 2,423.0 2,898.0 3,540.0 4,311.0GDP at current market prices Rs. bn. 2,091.0 2,453.0 2,939.0 3,579.0 4,411.0GDP at current factor cost prices Rs. bn. 1,800.7 2,098.0 2,484.2 2,233.0 2,365.0GDP per capita at current market prices US$ 1,062.0 1,241.0 1,421.0 1,634.0 2,014.0Labour force(b) mn. 8.1 7.3 7.6 7.5 7.6(c)Labour force participation(b) % 48.6 48.3 51.2 49.8 50.2(c)Unemployment (b) % 8.3 7.7 6.5 6.0 5.2(c)

3. Real output growth

GDP % 5.4 6.2 7.7 6.8 6.0Agriculture, forestry, and fishing % 0.0 1.8 6.3 3.4 7.5Mining and quarrying % 7.9 14.1 24.2 19.2 12.8Manufacturing % 5.1 6.0 5.5 6.4 4.9Construction % 6.6 8.9 9.2 9.0 7.8Services % 6.7 6.4 7.7 7.1 5.6

4. Prices & wages

CCPI (annual average) % change 7.6 11.6 13.7 17.5 22.6New CCPI (2002=100) % change 9.0 11.0 10.0 15.8 22.6WPI (annual average) % change 12.5 11.5 11.7 24.4 24.9Implicit GNP deflator % change 8.8 10.4 11.2 14.0 16.3Real wage ratesWorkers in wages boards trades % change -4.8 -3.5 -9.9 4.4 2.6Government employees % change 2.9 -7.0 -11.8 5.0 -12.4

5. Consumption, investment, and savings

Consumption % of GDP 83.6 82.1 83.0 82.4 85.9Gross domestic capital formation % of GDP 25.3 26.8 28.0 28.0 27.5Gross domestic savings % of GDP 16.4 17.9 17.0 17.6 14.1Gross national savings % of GDP 22.0 23.8 22.3 23.3 18.2Net Imports of goods and services % of GDP -8.8 -8.9 -11.0 -10.4 -13.4

6. Government finance

Revenue % of GDP 14.9 15.5 16.3 15.8 14.9Expenditure & net lending % of GDP 22.8 23.8 24.3 23.5 22.6Current expenditure % of GDP 18.6 18.1 18.6 17.4 16.9Capital expenditure & net lending % of GDP 4.2 5.8 5.6 6.1 5.7Current a/c balance % of GDP -3.7 -2.6 -2.4 -1.6 -2.0Budget deficitPrimary deficit % of GDP -2.2 -3.6 -2.9 -2.6 -2.9Overall deficit (before grants) % of GDP -7.9 -8.4 -8.0 -7.7 -7.7Public debtExternal % of GDP 47.6 39.0 38.4 37.1 32.8Domestic % of GDP 54.7 51.6 50.3 47.9 48.3

Contd..../-

ii


Unit 2004(g) 2005 2006 2007 2008(e)

7. External trade

Terms of trade % change -5.2 -4.2 -3.5 -1.0 -10.6Import price index % change 9.7 7.8 8.0 5.9 18.7Export price index % change 4.0 3.3 4.2 4.8 6.1Import volume index % change 9.0 2.7 7.1 4.1 4.4Export volume index % change 7.8 6.6 4.1 7.3 0.3

8. External finance

Trade balance % of GDP -11.2 -10.7 -11.5 -11.3 -14.4Current account balance % of GDP -3.2 -2.8 -5.3 -4.3 -9.3Capital & financial account balance % of GDP 3.1 2.8 6.7 6.5 4.4 Foreign direct investments % of GDP 1.1 1.0 1.7 1.7 1.7 Foreign portfolio investments % of GDP 0.05 0.03 0.19 0.31 0.2Import capacity months of imports (d) 5.2 5.7 4.7 5.3 3.3External debt % of GDP 61.8 53.3 50.3 51.0 43.7Debt-service ratio % of exports 11.6 7.9 12.7 13.1 15.0

9. Exchange rates (year end)

U.S.A. Rs./US$ 104.61 102.1 107.7 108.7 113.1U.K. Rs./UK Pound 201.37 175.9 211.3 217.1 163.3Japan Rs./Yen 1.02 0.86 0.90 0.97 1.25European Union Rs./Eoro 142.32 120.96 141.58 160.27 159.5India Rs./Rs. Indian 2.40 2.27 2.40 2.76 2.35SDR Rs./SDR 161.60 145.90 162.00 171.60 174.27

10. Money supply

Narrow money supply (M1) % change 16.6 22.4 12.6 2.7 4.0Broad money supply (M2) % change 19.6 19.1 17.8 16.6 8.5Domestic credit % change 25.0 18.7 25.9 16.3 18.0External banking assets % change 1.9 20.3 -15.0 33.2 -57.3

11. Interest rates

Treasury bills3 month % per annum 7.2 10.1 12.8 21.3 17.312 months % per annum 7.6 10.4 12.9 19.9 18.6Call money rates % per annum 9.0 10.3 11.5 12.0 11.0Average prime lending rate % per annum 10.2 12.2 15.2 17.9 18.5Commercial banks saving % per annum 7.7 10.2 10.5 16.5 16.5NSB saving % per annum 5.0 5.0 5.0 5.0 5.0Commercial banks fixed deposits % per annum 9.8 11.5 14.0 20.0 20.25NSB fixed deposits % per annum 8.0 9.0 11.0 15.0 15.0

12. Share market indicators

Annual turnover Rs. bn. 59.0 114.6 105.1 104.9 110.4Companies listed No. 242 239 237 235 235Market capitalisation Rs. bn. 382.1 584.0 835.0 821.0 489.0Net purchases by non-nationals Rs. mn. 1109 6,143.0 5,377.0 11,254.0 13,950.5Share price indicesCSE share (Index, 1985=100) 1506.9 1,922.2 2,722.4 2,541.0 1,503.0CSE sensitive(f) (Index, 1985=100) 2073.7 2,451.1 3,711.8 3,291.9 1,631.3

Notes: (a): Combined first, second, and third level gross enrolment ratio.(b): Excluding Northern and Eastern Provinces.(c): Average of four quarters.(d): Months of same year imports.(e): Provisional.(f): The Milanka Price Index (MPI) was introduced in January 1999, (1998 December=1000) to replace the Sensitive Price Index.(g): From 2003, data are based on GDP estimates compiled by the Dept. of Census and Statistics.

Sources: IPS database.Central Bank of Sri Lanka, Annual Report, various issues.Colombo Stock Exchange, Annual Report, various issues.UNDP, Human Development Report, various issues.Dept. of Census and Statistics, Quarterly Report of the Sri Lanka Labour Force Survey, various issues.

iii


Table A2: Gross Domestic Product (GDP), Mid-year Population (POP), Per Capita GDP(PGDP), and their Growth Rates, 1986-2008

Constant Prices (c) Growth Rates GDP PGDP POP(b) GDP PGDP POP

Rs. mn. Rs.mn. (‘000)

1986 456,316.2 28,312.7 16,117 4.3 2.5 1.8

1987 462,949.6 28,295.9 16,361 1.5 -0.1 1.5

1988 475,441.7 28,665.2 16,586 2.7 1.3 1.4

1989 486,140.6 28,926.6 16,806 2.3 0.9 1.3

1990 516,152.7 30,335.2 17,015 6.2 4.9 1.2

1991 539,954.8 31,270.9 17,267 4.6 3.1 1.5

1992 563,061.9 32,311.6 17,426 4.3 3.3 0.9

1993 602,171.5 34,125.1 17,646 6.9 5.6 1.3

1994 636,061.5 35,571.9 17,891 5.6 4.2 1.3

1995 670,742.2 36,984.0 18,136 5.5 4.0 1.4

1996 695,934.0 37,954.5 18,336 3.8 2.6 1.1

1997 739,763.0 39,875.1 18,552 6.3 5.1 1.2

1998 774,796.0 41,225.7 18,794 4.7 3.4 1.3

1999 808,340.0 42,448.1 19,043 4.3 3.0 1.3

2000 857,035.0 44,270.6 19,359 6.0 4.3 1.7

2001 843,794.0 45,045.6 18,732 -1.5 1.8 1.4

2002 877,284.0 46,155.8 19,007 4.0 2.5 1.5

2003(d) 1,733,222.0 90,028.2 19,252 5.9 4.6 1.3

2004 1,827,597.0 93,905.9 19,462 5.4 4.3 1.1

2005 1,947,671.0 99,027.4 19,668 6.2 5.5 1.0

2006 2,090,548.0 105,126.6 19,886 7.7 6.2 1.1

2007 2,232,656.0 111,563.6 20,010 6.8 6.1 0.6

2008(a) 2,365,500.0 117,005.5 20,217 6.0 4.9 1.0

Notes: (a): Provisional.(b): From 2001 the figures are based on Census of Population and Housing-2001.(c): Up to 2002 data are based on 1996 prices and 2003 onwards data are based on 2002 prices(d): From 2003, data are based on GDP estimates compiled by the Department of Census and Statistics.

Source: Central Bank of Sri Lanka, Annual Report, various issues.

iv


Tab

le A

3: S

truct

ure

and G

row

th o

f O

utp

ut,

2000-2

008

Unit

2000

2001

2002

2003(c

)2004

2005

2006

2007

2008(a

)1998-2

007

1999-2

008(b

)

1. S

truct

ure

of o

utp

ut

Agr

icul

ture

, for

estry

, and

fish

ing

% o

f tot

al o

utpu

t20

.420

.120

.513

.212

.511

.811

.311

.912

.112

.213

.4A

gric

ultu

re%

of t

otal

out

put

15.9

16.0

16.6

14.7

14.3

14.3

13.4

10.8

10.9

11.6

12.7

Tea

% o

f agr

icul

ture

8.9

9.0

7.2

10.9

11.6

11.4

10.5

13.6

11.0

8.3

9.4

Rubb

er%

of a

gric

ultu

re2.

32.

41.

22.

63.

23.

86.

15.

95.

42.

83.

3C

ocon

ut%

of a

gric

ultu

re11

.110

.08.

413

.411

.911

.310

.111

.212

.58.

710

.0Pa

ddy

% o

f agr

icul

ture

20.4

20.1

18.0

14.8

13.7

14.8

13.1

12.3

19.1

12.7

14.6

Min

ing

and

quar

ryin

g%

of t

otal

out

put

1.7

-1.8

1.8

1.4

1.4

1.5

1.6

1.6

1.6

0.9

1.1

Man

ufac

turin

g%

of t

otal

out

put

17.4

-16.

915

.818

.618

.719

.519

.218

.518

.011

.112

.9Ex

port

proc

essin

g%

of m

anuf

actu

ring

12.0

11.7

11.3

4.2

4.0

3.4

3.1

3.3

4.1

5.3

5.7

Fact

ory

indu

stry

% o

f man

ufac

turin

g80

.680

.877

.289

.689

.890

.991

.491

.591

.069

.278

.3Sm

all i

ndus

try%

of m

anuf

actu

ring

7.4

7.5

7.6

6.3

6.2

5.7

5.5

5.3

4.9

5.1

5.6

Con

struc

tion

% o

f tot

al o

utpu

t7.

37.

67.

26.

06.

16.

87.

47.

47.

45.

66.

3Se

rvic

es%

of t

otal

out

put

53.3

53.9

54.9

58.3

58.8

58.0

58.0

58.4

57.3

45.4

51.1

Unit

2000

2001

2002

2003

2004

2005

2006

2007

2008(a

)1998-2

007

1999-2

008(b

)2. R

eal o

utp

ut g

row

thA

gric

ultu

re, f

ores

try, a

nd fi

shin

g%

gro

wth

1.8

-3.5

2.5

-54.

9-5

.5-6

.1-4

.33.

47.

5-6

.7-5

.9A

gric

ultu

re%

gro

wth

1.7

-4.3

1.9

-12.

9-2

.80.

0-6

.72.

37.

3-2

.1-1

.4Te

a%

gro

wth

7.8

-3.5

5.1

33.9

6.4

-2.3

-8.7

-1.8

4.3

3.7

4.1

Rubb

er%

gro

wth

-9.7

-1.5

5.0

53.2

20.5

15.8

37.7

4.2

10.3

12.5

13.6

Coc

onut

% g

row

th8.

0-1

3.5

-13.

637

.3-1

2.4

-5.2

-12.

15.

15.

2-0

.6-0

.1Pa

ddy

% g

row

th-0

.3-5

.75.

1-2

1.9

-7.6

7.4

-13.

2-6

.222

.9-4

.2-1

.9M

inin

g an

d qu

arry

ing

% g

row

th4.

80.

7-1

.1-2

8.5

2.8

1.6

6.8

19.2

12.8

0.6

1.9

Man

ufac

turin

g%

gro

wth

9.2

-4.2

2.1

15.0

0.7

4.1

-1.5

6.4

4.9

3.2

3.7

Expo

rt pr

oces

sing

% g

row

th4.

2-6

.7-0

.9-1

70.6

-3.4

-19.

3-7

.92.

45.

3-2

0.2

-19.

7Fa

ctor

y in

dustr

y%

gro

wth

10.4

-3.9

2.5

13.8

0.3

1.2

0.6

6.7

5.0

3.2

3.7

Smal

l ind

ustry

% g

row

th5.

5-3

.52.

1-2

1.3

-1.8

-7.4

-4.8

4.5

5.6

-2.7

-2.1

Con

struc

tion

% g

row

th4.

82.

5-0

.8-1

9.2

1.1

10.8

7.2

9.0

7.8

1.5

2.3

Serv

ices

% g

row

th2.

3-0

.56.

15.

90.

8-1

.50.

17.

15.

62.

02.

6G

DP

% g

row

th6.

0-1

.54.

05.

96.

97.

98.

96.

86.

04.

65.

2

Not

es:

(a):

Pro

visio

nal.

(b):

Ave

rage

ann

ual g

row

th ra

te.

(c):

From

200

3, d

ata

are

base

d on

GD

P es

timat

es c

ompi

led

by th

e D

epar

tmen

t of C

ensu

s and

Sta

tistic

s.

Sour

ce: C

entra

l Ban

k of

Sri

Lank

a, A

nnual

Rep

ort

, var

ious

issu

es.

v


T

able

A4

: V

alu

e A

dd

ed in

In

du

stry

an

d I

nd

ust

rial

Pro

du

ctio

n, 1

99

6-2

00

8

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008(a

)

1.V

alue

added

, curr

ent p

rice

s (R

s. m

n.)

Food

, bev

erag

es a

nd to

bacc

o32

,891

35,5

8540

,452

44,5

0349

,031

54,2

8261

,550

136,

058

158,

229

202,

785

241,

854

282,

843

348,

358

Text

ile, w

earin

g ap

pare

l and

leat

her p

rodu

cts

31,1

4840

,581

47,4

8255

,263

69,4

5171

,263

77,0

2876

,511

85,1

7910

3,19

811

3,95

613

1,52

214

7,82

2

Woo

d an

d w

ood

prod

ucts

(inc

ludi

ng fu

rnitu

re)

1,25

01,

258

1,31

31,

390

1,55

41,

639

1,73

61,

085

1,12

11,

143

1,24

51,

353

1,44

7

Pape

r and

pap

er p

rodu

cts

2,58

02,

633

2,57

82,

664

2,80

83,

103

3,12

41,

669

2,07

92,

963

3,99

84,

857

5,78

9C

hem

ical

s, pe

trole

um, c

oal,

rubb

er a

nd p

lasti

c pr

oduc

ts8,

957

10,7

4514

,274

13,8

3217

,771

19,2

4522

,653

46,1

3358

,912

72,0

8995

,346

112,

915

135,

447

Non

met

allic

min

eral

pro

duct

s (ex

cept

pet

role

um a

nd c

oal)

10,5

3711

,600

12,4

6313

,817

14,2

4016

,010

17,2

7311

,388

13,4

3215

,805

17,9

3020

,352

22,7

76

Basic

met

al p

rodu

cts

450

598

710

777

959

1,13

11,

306

970

998

1,06

11,

292

1,52

11,

638

Fabr

icat

ed m

etal

pro

duct

s, m

achi

nery

and

tran

spor

t equ

ipm

ent

4,80

95,

924

6,77

97,

367

7,71

48,

731

9,69

828

,339

30,2

1734

,480

38,8

7247

,947

55,1

85M

anuf

actu

red

prod

ucts

n.e.

s.2,

763

3,15

73,

426

3,79

93,

965

4,15

44,

695

1,30

71,

350

1,44

61,

879

2,20

82,

508

Tota

l95

,385

112,

011

129,

477

143,

412

167,

493

179,

559

199,

063

303,

460

351,

517

434,

970

516,

372

605,

544

720,

979

2. C

om

posi

tion o

f indust

rial

pro

duct

ion, %

Food

, bev

erag

es a

nd to

bacc

o34

.531

.731

.231

.029

.330

.230

.944

.845

.046

.646

.846

.748

.3

Text

ile, w

earin

g ap

pare

l and

leat

her p

rodu

cts

32.7

36.2

36.7

38.5

41.5

39.7

38.7

25.2

24.2

23.7

22.1

21.7

20.5

Woo

d an

d w

ood

prod

ucts

(inc

ludi

ng fu

rnitu

re)

1.3

1.1

1.0

1.0

1.0

0.9

0.9

0.4

0.3

0.3

0.2

0.2

0.2

Pape

r and

pap

er p

rodu

cts

2.7

2.4

2.0

2.0

1.7

1.7

1.6

0.5

0.6

0.7

0.8

0.8

0.8

Che

mic

als,

petro

leum

, coa

l, ru

bber

and

pla

stic

prod

ucts

9.4

9.6

11.0

9.6

10.6

10.7

11.4

15.2

16.8

16.6

18.5

18.6

18.8

Non

met

allic

min

eral

pro

duct

s (ex

cept

pet

role

um a

nd c

oal)

11.0

10.4

9.6

9.6

8.5

8.9

8.7

3.8

3.8

3.6

3.5

3.4

3.2

Basic

met

al p

rodu

cts

0.5

0.5

0.5

0.5

0.6

0.6

0.7

0.3

0.3

0.2

0.3

0.3

0.2

Fabr

icat

ed m

etal

pro

duct

s, m

achi

nery

and

tran

spor

t equ

ipm

ent

5.0

5.3

5.2

5.1

4.6

4.9

4.9

9.3

8.6

7.9

7.5

7.9

7.7

Man

ufac

ture

d pr

oduc

ts n.

e.s.

2.9

2.8

2.6

2.6

2.4

2.3

2.4

0.4

0.4

0.3

0.4

0.4

0.3

Tota

l10

0.0

100.

010

0.0

100.

010

0.0

100.

010

0.0

100.

010

0.0

100.

010

0.0

100.

010

0.0

Not

es:

(a):

Prov

ision

al.

(b):

From

200

3, d

ata

are

base

d on

GD

P es

timat

es c

ompi

led

by th

e D

epar

tmen

t of C

ensu

s and

Sta

tistic

s.

Sour

ce:

Cen

tral B

ank

of S

ri La

nka,

Annual

Rep

ort, v

ario

us is

sues

.

vi


Tab

le A

5: M

ajor

Agr

icult

ura

l Cro

ps,

Pro

duct

ion a

nd P

rice

s, 1

986-2

008

Tea

R

ubber

Coco

nut

Pad

dy

Pro

duct

ion

Pri

cePro

duct

ion

P

rice

Pro

duct

ion

P

rice

(a)

Pro

duct

ion

Pri

ce(b

) M

n. k

g.C

olo

mbo (n

et)

Export

(f.o

.b.)

M

n. k

g.C

olo

mbo (R

SS 1

)Ex

port

(f.o

.b.)

M

n.n

ut

Rs.

/nut

‘ 0

00 M

t R

s./b

ush

el(c

) R

s/kg

. R

s/kg

.

R

s/kg

.

R

s/kg

.

1986

211.

030

.28

44.5

213

7.8

16.6

223

.83

3,03

91.

462,

588

70.0

019

8721

3.0

38.0

652

.97

121.

819

.87

27.6

32,

291

2.64

2,12

870

.00

1988

227.

041

.59

55.9

512

2.4

24.4

037

.33

1,93

64.

002,

477

80.0

019

8920

7.0

52.1

666

.91

110.

722

.63

36.1

82,

484

3.36

2,06

380

.00

1990

233.

065

.72

91.7

811

3.1

22.9

335

.50

2,53

23.

632,

538

110.

0019

9124

1.0

57.1

384

.12

103.

923

.59

34.5

52,

184

4.82

2,38

913

6.00

1992

179.

060

.51

81.9

810

6.1

29.2

837

.65

2,29

66.

472,

340

136.

0019

9323

1.9

68.8

891

.16

104.

235

.48

44.3

42,

164

6.31

2,57

015

5.00

1994

242.

265

.12

91.3

210

5.3

50.3

651

.81

2,62

25.

672,

684

155.

0019

9524

5.9

72.2

110

2.31

105.

772

.04

83.6

92,

755

6.08

2,81

015

5.00

1996

258.

410

3.88

139.

5611

2.5

67.8

579

.78

2,56

19.

422,

061

155.

0019

9727

6.9

119.

4015

8.40

105.

856

.70

75.4

02,

631

9.60

2,23

915

5.00

1998

280.

113

4.30

184.

9095

.749

.70

67.7

02,

552

8.30

2,69

215

5.00

1999

283.

711

5.30

162.

4096

.645

.30

54.0

02,

828

9.90

2,85

715

5.00

2000

305.

813

5.50

184.

4087

.655

.00

66.9

03,

096

7.40

2,86

015

5.00

2001

295.

114

3.90

208.

9086

.255

.00

66.4

02,

796

7.10

2,69

5-

2002

310.

014

9.30

216.

3090

.568

.80

69.5

02,

392

12.1

02,

859

-20

0330

3.2

149.

0522

1.01

92.0

102.

5010

5.25

2,56

29.

983,

071

-20

0430

9.5

180.

7424

8.92

94.7

127.

2012

8.51

2,59

111

.00

2,62

8-

2005

(d)

317.

218

5.84

263.

3110

4.4

147.

4114

7.73

2,51

513

.00

3,24

6-

2006

310.

819

8.87

279.

9710

9.2

202.

5018

9.90

2,78

524

.30

3,34

2-

2007

305.

227

9.10

364.

2811

7.6

234.

2223

4.50

2,86

916

.87

3,13

1-

2008

(e)

317.

730

1.63

430.

4012

9.2

269.

5127

8.20

2,90

922

.71

3,87

5-

Not

es:

(a):

Ave

rage

exp

ort p

rice

of th

e th

ree

maj

or c

ocon

ut p

rodu

cts o

nly.

(b):

Gua

rant

eed

pric

e.(c

): 20

.9 k

g. o

f pad

dy =

1 b

ushe

l of p

addy

.(d

): Rev

ised.

(e):

Prov

ision

al.

Sour

ce:

Cen

tral B

ank

of S

ri La

nka,

Annual

Rep

ort

, var

ious

issu

es.

vii


Table A6: Labour Force Participation of the Household Population All Island, 1998-2008

Household Labour Labour Labour forcepopulation force force Employed Unemployed(10 yrs. & over) participationNo. mn. No. mn. rate (%) No. mn. Rate No. mn. Rate

1998q1 12.9 6.6 51.6 5.9 89.5 0.7 10.5q2 12.9 6.6 51.0 6.0 90.5 0.6 9.5q3 12.9 6.7 51.9 6.1 90.9 0.6 9.1q4 12.9 6.6 51.4 6.0 91.2 0.6 8.8

1999q1 12.9 6.7 52.3 6.2 91.4 0.6 8.6q2 13.1 6.5 49.5 5.9 91.5 0.6 8.5q3 13.2 6.7 50.8 6.1 90.9 0.6 9.1q4 13.5 6.8 50.2 6.1 90.8 0.6 9.2

2000q1 13.5 6.9 50.8 6.3 92.0 0.5 8.0q2 13.5 7.0 52.0 6.5 93.0 0.5 7.0q3 13.5 6.7 49.4 6.2 92.0 0.5 8.0q4 13.6 6.7 49.2 6.2 92.6 0.5 7.4

2001q1 13.7 6.7 49.2 6.2 92.3 0.5 7.7q2 14.0 6.9 49.0 6.3 91.7 0.6 8.3q3 13.9 6.7 48.3 6.2 92.2 0.5 7.8q4 14.1 6.8 48.9 6.2 91.7 0.5 8.3

2002q1 14.1 7.2 51.7 6.7 91.3 0.6 8.7q2 14.2 7.0 49.5 6.3 90.2 0.7 9.8q3 14.2 7.1 49.4 6.4 90.9 0.6 9.1q4 14.3 7.2 50.6 6.7 92.5 0.5 7.5

2003q1 15.6 7.6 49.1 6.9 90.8 0.7 9.2q2 15.6 7.5 48.3 6.9 91.9 0.6 8.0q3 15.7 7.6 48.6 7.0 91.6 0.6 8.4q4 15.8 7.8 49.6 7.2 92.1 0.6 7.9

2004 (a)q1 16.3 7.9 49.0 7.3 91.9 0.6 8.1q2 16.5 8.0 48.6 7.3 91.0 0.7 9.0q3 16.7 8.0 47.8 7.3 91.5 0.7 8.5q4 16.7 8.1 47.8 7.4 91.8 0.7 8.2

2005 (b) 16.9 8.1 48.3 7.5 92.3 0.6 7.72006

q1 14.8 7.6 51.7 7.1 92.8 0.5 7.2q2 14.8 7.6 51.1 7.1 93.7 0.5 6.3q3 15.0 7.6 50.7 7.1 93.5 0.5 6.5q4 15.0 7.6 51.0 7.1 93.7 0.5 6.3

2007q1 15.0 7.5 49.8 7.0 93.3 0.5 7.1q2 15.0 7.4 49.0 7.0 94.6 0.5 7.1q3 15.0 7.5 50.2 7.1 94.7 0.4 5.6q4 15.1 7.6 50.1 7.2 94.7 0.4 5.6

2008q1 15.1 7.5 49.8 7.1 94.7 0.4 5.1q2 15.1 7.5 49.6 7.1 94.7 0.4 5.3q3 14.8 7.6 51.1 7.2 94.7 0.4 5.2q4 15.2 7.6 50.3 7.2 94.7 0.4 5.2

Notes: (a) Up to 4th quarter 2002, data excludes both Northern and Eastern Provinces. Commencing from 1st quarter 2003, EasternProvince is included and only the Northern Province is excluded from the survey.

(b) Quarterly labour force survey was conducted as a one-off survey in August 2005.

Source: Department of Census and Statistics, Quarterly Report of the Sri Lanka Labour Force.

viii


Table A7: Gross Domestic Fixed Capital Formation, 1986-2008 Private(a) Public(b) Private(a) Public(b) Private(a) Public(b) Private(a) Public(b)

(Rs. mn., current market prices) (As % of GDP) (at constant prices(c)(e)) (Growth in real terms)

1986 32,692 9,634 18.2 5.4 91,122.2 26,852.8 0.6 17.2

1987 34,536 11,216 17.6 5.7 89,958.6 29,215.2 -1.3 8.8

1988 37,156 12,805 16.7 5.8 86,801.6 29,914.3 -3.5 2.4

1989 39,943 14,306 15.9 5.7 85,114.8 30,484.7 -1.9 1.9

1990 57,910 12,507 18.0 3.9 102,852.2 22,213.3 20.8 -27.1

1991 68,368 15,838 18.4 4.3 109,412.4 25,346.3 6.4 14.1

1992 86,407 13,632 20.3 3.2 125,717.4 19,833.8 13.0 -27.8

1993 105,305 20,570 21.1 4.1 139,953.2 27,338.1 10.2 27.4

1994 136,649 17,611 23.6 3.0 166,094.3 21,405.8 15.7 -27.7

1995 147,280 23,595 22.1 3.5 165,105.2 26,450.7 -0.6 19.1

1996 160,181 23,328 20.9 3.0 160,181.0 23,328.0 -3.1 -13.4

1997 186,950 29,923 21.0 3.4 172,145.0 27,553.4 6.9 15.3

1998 221,754 33,960 21.9 3.3 188,246.2 28,828.5 9.4 4.6

1999 266,518 35,210 24.1 3.2 216,505.3 28,602.7 15.0 -2.6

2000 311,460 41,132 24.8 3.3 237,212.5 31,326.7 9.6 9.5

2001 267,298 42,346 19.0 3.0 181,058.0 28,683.6 -23.7 -8.4

2002 298,731 31,812 19.1 2.0 188,863.2 19,913.6 4.1 -44.1

2003(f) 318,909 46,285 17.5 2.5 325,998.0 47,784.0 42.1 58.3

2004 422,060 51,262 20.2 2.5 387,917.5 47,115.2 19.0 -1.4

2005 478,917 94,347 19.5 3.8 398,641.6 78,532.7 2.8 66.7

2006 624,972 105,938 21.3 3.6 467,495.5 79,244.4 17.3 0.9

2007 807,400 192,900 22.6 5.4 468,438.9 111,916.2 0.2 41.2

2008(d) 928,800 286,000 21.1 6.5 480,877.6 148,092.2 2.7 32.3

Notes: (a): Private sector and public corporations.(b): Government and public enterprises.(c): Current series deflated by GDP deflator.(d): Provisional.(e): Up to 2002 data are based on 1996 prices and 2003 onwards data are based on 2002 prices.(f): From 2003, data are based on GDP estimates compiled by the Department of Census and Statistics.


ix


Tab

le A

8: S

avin

g an

d Inve

stm

ent,

1994-2

008

(As %

of G

DP)

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003(c

)2004

2005

2006

2007

2008(a

)

Gro

ss d

omes

tic c

apita

l for

mat

ion

27.0

25.7

24.2

24.4

25.1

27.3

28.0

22.0

21.3

20.0

22.6

23.4

24.9

27.9

27.5

Gro

ss d

omes

tic sa

ving

s15

.215

.215

.317

.319

.119

.517

.415

.814

.516

.016

.417

.917

.017

.614

.1

Net

impo

rts o

f goo

ds a

nd n

on-fa

ctor

serv

ices

(b)

11.8

10.4

8.9

7.1

6.0

7.8

10.6

6.2

6.8

6.4

6.6

7.1

6.7

10.4

13.4

Net

fact

or in

com

e fro

m a

broa

d-1

.4-1

.0-1

.5-1

.1-1

.1-1

.6-2

.1-1

.7-1

.6-0

.9-1

.0-1

.2-1

.4-1

.1-2

.2

Net

priv

ate

trans

fers

5.4

5.2

5.1

5.2

5.4

5.6

5.9

6.2

6.6

6.4

6.5

7.1

6.7

6.8

6.3

Gro

ss n

atio

nal s

avin

gs19

.119

.519

.021

.523

.423

.521

.520

.319

.521

.522

.023

.822

.323

.318

.2

Fore

ign

savi

ngs

7.9

6.2

5.2

5.2

1.7

3.8

6.5

1.7

1.8

-1.5

0.6

-0.4

2.6

1.1

2.2

Not

es:

(a):

Prov

ision

al.

(b):

Also

refe

rred

to a

s ext

erna

l inf

low

or t

he re

sour

ces g

ap.

(c): F

rom

200

3, d

ata

are

base

d on

GD

P es

timat

es c

ompi

led

by th

e D

epar

tmen

t of C

ensu

s and

Sta

tistic

s.

Sour

ces:

IPS

data

base

; Cen

tral B

ank

of S

ri La

nka,

Annual

Rep

ort

, var

ious

issu

es.

x


Tab

le A

9: S

um

mar

y of G

ove

rnm

ent Fi

scal

Oper

atio

ns,

1996-2

008

(As

% o

f GD

P)19

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

0620

0720

08

Reve

nue

19.0

18.5

17.3

17.7

16.8

16.7

16.5

15.7

15.4

16.1

16.3

15.8

14.9

Gra

nts

1.0

0.8

0.7

0.6

0.4

0.4

0.4

0.5

0.4

1.5

1.7

1.6

1.6

Expe

nditu

re

Cur

rent

exp

endi

ture

22.8

20.8

19.6

18.7

20.2

21.6

20.8

19.0

19.2

18.7

18.6

17.4

16.9

Cap

ital &

net

lend

ing

5.7

5.7

6.7

6.5

6.5

5.9

4.5

4.7

4.3

6.0

5.6

6.1

5.7

Cur

rent

acc

ount

bal

ance

-3.8

-2.2

-2.4

-1.0

-3.4

-4.9

-4.4

-3.3

-3.9

-2.7

-2.4

-1.6

-2.0

Prim

ary

defic

it-3

.1-1

.7-3

.8-1

.9-4

.2-4

.1-1

.6-0

.9-2

.2-3

.6-2

.9-2

.6-2

.2

Ove

rall

defic

it (b

efor

e gr

ants)

-9.4

-7.9

-9.2

-7.5

-9.9

-10.

8-8

.9-8

.0-8

.2-8

.7-8

.0-7

.7-7

.7

Fina

ncin

g bu

dget

def

icit

For

eign

fina

ncin

g2.

31.

91.

70.

70.

41.

40.

62.

98.

23.

42.

53.

70.

6

N

et b

orro

win

gs1.

31.

11.

00.

10

1.0

0.1

2.4

1.8

2.0

1.4

2.8

-0.1

G

rant

s1.

00.

80.

70.

60.

40.

40.

40.

50.

41.

41.

00.

90.

7

Dom

estic

fina

ncin

g6.

53.

47.

16.

89.

48.

88.

04.

55.

85.

25.

63.

67.

0

M

arke

t bor

row

ings

5.1

4.5

7.1

6.8

9.2

8.7

8.0

4.5

5.5

5.0

5.6

3.6

7.0

B

ank

1.7

-0.2

1.9

2.5

4.5

3.5

-0.3

-1.2

2.1

1.1

2.7

0.4

4.4

N

on-b

ank

3.4

4.7

5.2

4.4

4.7

5.3

8.3

5.7

3.4

3.9

2.9

3.1

2.6

Oth

er b

orro

win

gs1.

3-1

.1-0

.1-0

.10.

30.

1-0

.1-

0.2

0.2

--

-

Priv

atisa

tion

proc

eeds

(a)

0.6

2.5

0.4

--

0.6

0.4

0.6

0.1

--

--

Not

es:

(a):

Sinc

e 19

94, p

rivat

izat

ion

proc

eeds

hav

e be

en sh

ifted

from

the

capi

tal e

xpen

ditu

re a

nd n

et le

ndin

g ca

tego

ry to

the

finan

cing

sect

ion.

(b):

Prov

ision

al.

(c):

From

200

3, d

ata

are

base

d on

GD

P es

timat

es c

ompi

led

by th

e D

epar

tmen

t of C

ensu

s and

Sta

tistic

s.

Sour

ce:

Cen

tral B

ank

of S

ri La

nka,

Annual

Rep

ort

, var

ious

issu

es.

xi


T

able

A10: M

oney

Supply

and U

nder

lyin

g Fa

ctors

, 1989-2

008

Unit

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1. F

inan

cial

dep

th N

arro

w m

oney

supp

lyM

1/G

DP

14.0

12.3

12.5

11.8

11.9

12.2

11.3

10.2

10.7

10.5

Br

oad

mon

ey su

pply

M2/

GD

P30

.328

.129

.730

.532

.133

.134

.233

.035

.934

.62. M

onet

ary

expan

sion/c

ontr

action

N

arro

w m

oney

supp

ly%

gro

wth

9.1

12.1

17.7

7.4

18.6

18.7

6.7

4.0

9.8

12.1

Br

oad

mon

ey su

pply

% g

row

th12

.518

.522

.117

.423

.419

.719

.210

.813

.89.

73. C

ausa

l fac

tors

3.

1 Ex

tern

al b

anki

ng a

sset

sRs

. mn.

4,73

2.0

3,41

9.0

12,2

58.0

20,9

40.0

48,1

19.0

64,4

67.0

66,5

32.0

61,8

61.0

89,2

92.0

93,7

24.0

% g

row

th-3

3.0

-27.

725

8.5

70.8

129.

834

.03.

2-7

.044

.35.

0

3.2

Dom

estic

cre

dit

Rs. m

n.10

2,32

1.2

115,

964.

312

7,75

1.2

144,

003.

015

0,69

6.9

173,

795.

622

3,79

8.3

252,

317.

027

2,73

3.0

311,

626.

0%

gro

wth

5.6

13.3

10.2

12.7

4.6

15.3

28.8

12.7

8.1

14.3

3.

2.1

Gov

ernm

ent

Rs. m

n.36

,118

.035

,358

.035

,392

.033

,065

.026

,993

.028

,148

.035

,214

.048

,537

.046

,365

.058

,591

.0%

gro

wth

0.1

-2.1

0.1

-6.6

-18.

44.

325

.137

.8-4

.526

.4

3.2.

2 Pr

ivat

e se

ctor

Rs. m

n.66

,203

.280

,606

.392

,359

.211

0,93

8.0

123,

703.

914

5,64

7.6

188,

352.

020

3,78

0.0

226,

368.

025

3,03

5.0

% g

row

th8.

921

.814

.620

.111

.517

.729

.38.

211

.111

.8

3.3

Oth

er li

abili

ties

Rs. m

n.-3

0,61

9.8

-28,

838.

0-2

9,43

5.0

-35,

150.

0-3

8,67

9.0

-46,

590.

0-6

1,79

4.0

-60,

978.

0-7

3,76

8.0

-89,

176.

0%

gro

wth

-14.

9-5

.82.

119

.410

.020

.532

.6-1

.321

.020

.9

Con

td…

Unit

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

1. F

inan

cial

dep

th

Nar

row

mon

ey su

pply

M1/

GD

P10

.910

.59.

88.

88.

99.

09.

48.

87.

46.

3

Broa

d m

oney

supp

lyM

2/G

DP

36.0

36.0

36.0

32.2

31.9

32.9

33.6

33.8

32.1

29.1

2. M

onet

ary

expan

sion/c

ontr

action

N

arro

w m

oney

supp

ly%

gro

wth

12.8

9.1

3.2

14.0

16.0

14.2

18.3

11.2

2.7

4.0

Br

oad

mon

ey su

pply

% g

row

th13

.313

.011

.413

.215

.315

.616

.417

.115

.611

.73. C

ausa

l fac

tors

3.

1 Ex

tern

al b

anki

ng a

sset

sRs

. mn.

83,8

92.0

59,4

48.0

82,9

66.0

101,

717.

012

9,48

7.0

129,

152.

016

7,14

7.0

185,

005.

027

3,00

0.0

354,

700.

0%

gro

wth

-10.

5-2

9.1

39.6

22.6

27.3

-0.3

22.7

9.6

7.6

8.0

3.

2 D

omes

tic c

redi

tRs

. mn.

374,

120.

046

9,08

4.0

513,

457.

054

8,57

8.0

602,

898.

073

4,60

5.0

864,

392.

01,

138,

805.

01,

607,

800.

01,

897,

500.

0%

gro

wth

20.1

25.4

9.5

6.8

9.9

21.8

11.6

24.1

44.9

43.0

3.

2.1

Gov

ernm

ent

Rs. m

n.85

,881

.013

4,48

4.0

161,

735.

015

3,17

1.0

143,

444.

018

1,11

1.0

249,

565.

035

7,28

9.0

374,

100.

057

2,00

0.0

% g

row

th46

.656

.620

.3-5

.3-6

.326

.311

.630

.110

.513

.0

3.2.

2 Pr

ivat

e se

ctor

Rs. m

n.28

8,23

9.0

334,

599.

035

1,72

2.0

395,

407.

043

0,57

5.0

526,

236.

068

0,69

3.0

856,

842.

01,

184,

500.

01,

278,

500.

0%

gro

wth

13.9

16.1

5.1

12.4

16.2

22.2

22.7

20.0

33.1

29.0

3.

3 O

ther

liab

ilitie

sRs

. mn.

-99,

936.

0-1

23,8

63.0

-145

,696

.0-1

39,8

99.0

-151

,638

.0-1

75,7

93.0

-208

,608

.0-3

30,5

45.0

-431

,800

.0-4

72,0

00.0

% g

row

th12

.123

.917

.64.

08.

515

.915

.736

.812

.110

.7

Not

es:

Dat

a ha

ve b

een

recl

assif

ied

starti

ng fr

om 1

990.

For

mor

e in

form

atio

n, se

e C

entra

l Ban

k of

Sri

Lank

a, 1

995,

Annual

Rep

ort

.Fr

om 2

003,

dat

a ar

e ba

sed

on G

DP

estim

ates

com

pile

d by

the

Dep

artm

ent o

f Cen

sus a

nd S

tatis

tics.

Sour

ce:

Cen

tral B

ank

of S

ri La

nka,

Annual

Rep

ort

, var

ious

issu

es.

xii


Tab

le A

11

: In

tere

st R

ates

, 1

99

5-2

00

8

(%, e

nd o

f per

iod)

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Bank

rate

17.0

17.0

17.0

17.0

16.0

25.0

18.0

18.0

15.0

15.0

15.0

15.0

15.0

15.0

Trea

sury

bill

s, yi

eld

rate

s 3

Mon

th19

.317

.510

.012

.012

.117

.812

.99.

97.

37.

210

.112

.821

.317

.3 1

2 M

onth

19.0

17.4

10.2

12.6

12.8

18.2

13.7

9.9

7.2

7.6

10.4

13.0

20.0

19.1

Repu

rcha

se ra

te16

.512

.811

.011

.39.

317

.012

.09.

97.

07.

58.

810

.010

.510

.5C

all m

oney

rate

Max

imum

102.

031

.020

.016

.514

.332

.013

.010

.98.

210

.611

.115

.140

.019

.0 M

inim

um16

.013

.09.

011

.39.

820

.312

.510

.27.

49.

510

.512

.716

.013

.0W

eigh

ted

aver

age

prim

e le

ndin

g ra

te20

.018

.414

.215

.115

.221

.514

.212

.28.

910

.212

.114

.718

.018

.5C

omm

erci

al b

ank

savi

ng M

axim

um13

.013

.011

.010

.010

.010

.012

.011

.07.

27.

710

.310

.516

.516

.5 M

inim

um5.

04.

53.

02.

02.

02.

04.

03.

52.

13.

03.

03.

03.

03.

0N

SB sa

ving

12.0

12.0

10.8

10.5

9.2

8.4

8.4

6.0

5.0

5.0

5.0

5.0

5.0

5.0

Com

mer

cial

ban

k fix

ed d

epos

it (o

ne y

ear)

Max

imum

17.0

17.8

15.3

13.0

12.5

15.0

14.5

11.0

7.8

9.8

11.5

14.0

20.0

20.3

Min

imum

10.0

12.0

8.5

9.0

9.0

9.0

9.5

7.5

5.0

5.0

5.5

5.5

8.5

8.5

NSB

fixe

d de

posit

(one

yea

r, pa

id o

n m

atur

ity)

16.0

15.0

11.0

11.5

11.5

15.0

13.0

10.0

7.0

8.0

9.0

11.0

15.0

15.0

Sour

ces:

Cen

tral B

ank

of S

ri La

nka,

Annual

Rep

ort, v

ario

us is

sues

.

Cen

tral B

ank

of S

ri La

nka,

Bulle

tin, V

ario

us Is

sues

.

xiii


Table A12: Basic Indicators of the General Price Level, 1988-2008

CCPI CCPI WPI GDPD(1952=100) % change (2002=100) % change (1974=100) % change (1996=100) % change

1988 744.1 14.0 488.7 17.8 42.8 11.5

1989 830.2 11.6 532.9 9.0 46.9 9.6

1990 1,008.6 21.5 651.1 22.2 56.3 20.0

1991 1,131.5 12.2 710.8 9.2 62.5 11.0

1992 1,260.4 11.4 773.0 8.8 68.7 10.0

1993 1,408.4 11.7 831.8 7.6 75.2 9.5

1994 1,527.4 8.4 873.4 5.0 82.3 9.3

1995 1,644.6 7.7 950.7 8.9 89.2 8.4

1996 1,906.7 15.9 1,145.1 20.4 100.0 12.1

1997 2,089.1 9.6 1,224.3 6.9 108.6 8.6

1998 2,284.9 9.4 1,298.7 6.1 117.8 8.4

1999 2,392.1 4.7 1,295.3 0.3 123.1 4.4

2000 2,539.8 6.2 1,317.2 1.7 131.3 6.7

2001 2,899.4 14.2 1,471.2 11.7 147.6 12.3

2002 3,176.4 9.6 1,629.0 10.7 159.9 8.4

2003 3,377.0 6.3 1,679.1 3.1 168.2 5.1

2004 3,632.8 7.6 115.3 9.0 1,889.0 12.5 183.0 8.8

2005 4,055.5 11.6 128.0 11.0 2,105.9 11.5 202.1 10.4

2006 4,610.8 13.7 140.8 10.0 2,351.6 11.7 224.9 11.3

2007 5,416.1 17.5 163.1 15.8 2,924.4 24.4 256.4 14.0

2008 199.9 22.6 3,653.6 24.9 298.3 16.3

Notes: CCPI : Colombo Consumers’ Price Index.GCCPI : Greater Colombo Consumers' Price Index.WPI : Wholesale Price Index.GDPD : GDP deflator.

Sources: Department of Census and Statistics. Central Bank of Sri Lanka, Annual Report, various issues.

xiv


Table A13: Wage Rate Indices, 1988-2008 (December 1978=100)

Workers in wages boards trades(a) Government employees(b)

Nominal Real Nominal Real

1988 335.8 107.9 390.9 125.4

1989 338.1 112.0 421.8 121.9

1990 453.5 107.6 476.8 113.2

1991 518.8 109.7 534.6 113.2

1992 590.0 112.0 557.6 106.0

1993 685.8 116.6 675.5 114.8

1994 712.4 111.7 735.5 115.4

1995 740.3 107.8 792.5 115.4

1996 801.7 100.7 818.2 103.5

1997 849.1 97.3 906.5 104.0

1998 953.3 99.9 1,001.4 104.9

1999 977.6 97.8 1,001.4 100.2

2000 1,000.4 94.3 1,084.7 102.1

2001 1,049.3 86.6 1,310.8 108.1

2002 1,126.5 84.9 1,525.3 115.0

2003 1,205.2 85.4 1,525.0 108.1

2004 1,233.0 81.3 1,872.1 123.3

2005 1,329.7 81.3 2,417.5 142.7

2006 1,358.2 70.7 3,150.8 164.0

2007 1,648.8 73.6 3,828.4 171.6

2008(c) 2070.4 75.5 4,116.1 150.4

Notes: The wage rates used in the calculation of index numbers are minimum wages.(a): Combined index for workers in agriculture, industry and commerce, and services.(b): Combined index for non-executive officers and minor employees.(c): Provisional.


xv


Table A14: Sri Lanka's Direction of Foreign Trade, 1991-2008

Unit 1991 1992 1993 1994 1995 1996 1997 1998 1999

1.Exports to selected countries and groupings

U.S.A US$ mn. 559.0 837.6 1,006.8 1,115.3 1,353.5 1,395.8 1,666.4 1,890.2 1,791.8U.K. US$ mn. 126.2 170.2 203.5 285.4 345.3 388.6 525.4 530.4 604.2Germany US$ mn. 148.8 211.8 227.5 222.5 254.3 239.3 230.0 231.9 215.7Japan US$ mn. 101.6 128.0 148.0 165.3 200.4 256.4 234.2 196.1 159.1

EC % of total exports 27.0 32.8 31.2 31.3 31.0 29.4 35.0 33.6 35.3Germany % of exports to EC 27.0 26.3 25.5 22.2 21.6 19.8 17.1 17.9 16.2UK % of exports to EC 22.9 21.1 22.8 28.4 29.3 32.2 39.0 41.0 45.0

ASEAN % of total exports 5.5 2.4 2.9 3.9 3.7 2.8 3.4 3.0 3.1 Singapore % of exports to ASEAN 59.8 56.5 58.6 60.6 52.3 52.0 43.7 38.1 37.9 Malaysia % of exports to ASEAN 23.6 7.7 4.0 4.6 15.7 23.5 16.6 10.1 6.0

SAARC % of total exports 3.0 2.3 2.5 2.7 2.7 2.6 3.1 3.0 3.8 India % of exports to SAARC 20.8 20.3 27.6 27.2 31.3 39.6 37.0 33.2 33.7

NAFTA % of total exports 30.0 36.4 37.1 36.8 37.3 35.6 45.5 51.5 49.8USA % of exports to NAFTA 91.4 93.5 94.9 94.4 95.4 95.6 95.3 95.4 95.1Canada % of exports to NAFTA 5.2 4.3 3.4 4.3 3.5 3.1 3.2 3.1 3.1

APEC % of total exports 43.7 47.6 48.7 49.6 50.1 48.7 59.8 58.9 56.3USA % of exports to APEC 62.7 71.5 72.3 70.1 71.0 69.8 72.4 83.4 84.1Japan % of exports to APEC 11.4 10.9 10.6 10.4 10.5 12.8 10.2 8.6 7.5Singapore % of exports to APEC 0.4 0.3 0.2 0.2 0.1 0.1 0.1 1.9 2.1

2. Imports from selected countries and groupings

Japan US$ mn. 358.4 415.6 452.6 526.6 498.6 497.3 479.3 555.9 560.9India US$ mn. 220.1 301.9 342.9 404.4 469.2 561.9 559.8 539.4 511.6Hong Kong US$ mn. 212.5 241.0 312.4 316.6 357.4 354.1 411.3 411.0 459.1U.S.A US$ mn. 174.5 159.4 131.3 284.7 172.7 198.3 186.6 229.5 216.2U.K. US$ mn. 166.3 172.8 184.8 247.6 242.6 251.7 282.4 304.8 251.1Taiwan US$ mn. 207.4 214.0 225.7 250.2 286.4 287.8 372.1 378.7 347.1

EC % of total imports 15.2 14.7 15.8 16.3 15.3 15.4 17.6 23.3 19.4 Germany % of imports from EC 22.0 24.7 21.9 21.8 20.5 18.4 20.5 20.2 15.8

UK % of imports from EC 36.0 33.5 29.2 31.8 29.8 30.1 31.6 30.3 29.1

ASEAN % of total imports 13.8 15.1 14.5 13.2 12.8 12.6 14.7 19.6 21.1Singapore % of imports from ASEAN 32.3 44.8 35.8 37.2 36.6 37.7 38.3 36.8 48.2Malaysia % of imports from ASEAN 33.4 24.1 29.5 28.8 31.1 26.7 22.3 22.8 18.0

SAARC % of total imports 10.3 11.8 10.7 10.3 10.2 11.9 13.1 15.1 14.2India % of imports from SAARC 70.3 72.7 80.1 82.7 86.1 86.9 83.9 83.3 81.4

NAFTA % of total imports 6.3 5.2 3.7 6.3 3.6 4.3 5.7 7.1 5.5USA % of imports from NAFTA 91.3 87.0 89.4 95.0 91.3 84.6 64.7 75.0 89.0Canada % of imports from NAFTA 8.3 11.6 10.1 4.6 7.9 10.0 19.0 13.6 9.3

APEC % of total Imports 58.5 57.1 55.7 55.4 50.2 50.4 61.9 45.9 53.4USA % of imports from APEC 9.8 8.0 5.9 10.8 6.5 7.3 5.9 11.6 9.1Japan % of imports from APEC 11.8 11.9 11.3 11.0 9.4 9.2 9.4 28.1 23.6Singapore % of imports from APEC 7.6 11.9 9.3 8.8 9.3 9.5 9.1 15.7 19.0

xvi


Unit 2000 2001 2002 2003 2004 2005 2006 2007 2008(a)

1. Exports to selected countries and groupings

U.S.A US$ mn. 2,192.5 1,925.9 1,764.0 1,777.4 1,869.3 1988.1 2,005.5 1,970.0 1,869.3U.K. US$ mn. 736.7 576.4 590.3 640.4 779.2 777.3 880.1 1,018.0 1,090.4Germany US$ mn. 230.2 198.5 199.3 232.4 274.1 271.8 328.8 437.9 405.3Japan US$ mn. 229.7 185.8 140.3 165.4 157.6 144.6 163.6 159.6 159.0

EC % of total exports 33.4 32.3 35.2 35.9 38.3 37.2 40.7 37.6 37.3Germany % of exports to EC 15.2 15.8 14.4 15.3 14.9 13.9 14.5 15.2 13.4UK % of exports to EC 48.5 45.8 42.8 42.2 42.3 39.9 38.7 35.4 35.9

ASEAN % of total exports 3.5 2.9 2.6 2.5 2.6 2.9 3.4 2.8 2.9Singapore % of exports to ASEAN 38.7 51.4 63.6 61.8 67.9 52.2 39.0 37.6 31.8Malaysia % of exports to ASEAN 5.0 5.9 8.4 11.7 7.1 9.5 12.9 16.7 18.6

SAARC % of total exports 4.2 4.1 6.5 8.3 10.5 12.5 10.7 8.5 6.9India % of exports to SAARC 30.6 45.6 66.5 70.0 77.3 86.7 81.6 79.8 74.6

NAFTA % of total exports 50.5 52.0 47.6 44.5 41.2 40.4 38.1 27.6 24.9USA % of exports to NAFTA 95.4 95.1 94.6 94.5 94.5 94.1 94.2 93.3 92.4Canada % of exports to NAFTA 3.1 3.4 3.3 3.4 3.6 3.7 3.6 3.7 4.4

APEC % of total exports 57.8 59.5 54.6 52.2 47.8 46.2 44.0 37.1 35.0USA % of exports to APEC 83.5 83.1 82.5 80.6 81.4 82.3 81.5 69.4 65.6Japan % of exports to APEC 8.7 8.0 6.6 7.4 6.9 5.9 6.6 5.6 5.6Singapore % of exports to APEC 2.3 2.5 3.1 3.0 3.8 3.3 3.0 2.8 2.7

2. Imports from selected countries and groupings

Japan US$ mn. 646.0 336.9 355.3 448.1 411.7 379.7 449.6 413.2 424.5India US$ mn. 600.1 709.3 852.9 1,073.2 1,439.1 1,835.4 2,172.9 2,610.1 3,443.0Hong Kong US$ mn. 515.9 500.3 491.0 559.5 619.4 648.2 659.1 724.8 694.6U.S.A US$ mn. 254.9 265.6 218.7 188.3 240.1 204.5 200.6 412.1 272.6U.K. US$ mn. 311.4 220.6 262.9 272.9 312.1 276.2 303.4 229.8 243.2Taiwan US$ mn. 390.1 322.8 288.0 276.1 290.8 278.7 274.8 263.6 251.2

EC % of total imports 18.8 18.0 18.0 18.8 18.2 16.7 15.9 12.4 12.4Germany % of imports from EC 16.5 16.3 13.5 13.4 15.7 14.3 16.2 16.4 16.2UK % of imports from EC 32.8 26.0 29.3 25.5 25.2 22.2 22.1 16.5 14.0

ASEAN % of total imports 21.0 19.4 19.1 19.8 20.0 20.5 21.7 16.7 15.7Singapore % of imports from ASEAN 46.7 44.8 46.0 46.2 51.2 48.2 52.9 59.3 56.7Malaysia % of imports from ASEAN 20.5 22.7 21.7 25.6 24.1 25.7 23.7 15.0 16.3

SAARC % of total imports 14.0 15.1 19.1 19.9 23.1 26.6 27.2 24.9 26.1 India % of imports from SAARC 84.8 84.4 89.4 91.5 91.4 92.6 92.4 92.7 94.1

NAFTA % of total imports 6.0 6.2 4.7 4.1 4.1 3.9 4.8 4.4 4.7 USA % of imports from NAFTA 84.1 91.5 93.8 85.4 84.4 71.2 48.0 83.5 41.6 Canada % of imports from NAFTA 15.6 8.2 5.8 14.2 15.3 28.0 51.4 16.1 57.9

APEC % of total imports 54.9 55.6 52.1 49.2 46.4 44.0 43.8 42.5 39.4USA % of imports from APEC 9.2 10.1 8.5 7.1 7.6 6.2 5.3 8.6 4.9Japan % of imports from APEC 23.2 12.8 13.8 16.0 13 11.6 11.9 8.6 7.7Singapore % of imports from APEC 17.8 15.6 16.8 18.7 20.5 22.4 26.2 23.3 22.5

Note: (a): Provisional.

Sources: International Monetary Fund, Direction of Trade Statistics, various issues; Central Bank of Sri Lanka, Annual Report, various issues.

Cont../

xvii


T

able

A1

5: St

ruct

ure

of

Co

mm

od

ity

Imp

ort

s, 1

98

9-2

00

8

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1. C

onsu

mer

goods

V

alue

(US$

mn.

)58

1.5

709.

478

2.1

734.

677

4.5

930.

698

2.0

1,03

0.0

1,08

4.0

1,12

8.0

G

row

th6.

122

.010

.3-6

.15.

420

.15.

65.

24.

94.

0

%

of t

otal

impo

rts26

.126

.425

.521

.019

.319

.518

.519

.018

.519

.2

1.1

Food

Val

ue (U

S$ m

n.)

364.

439

0.0

404.

941

9.7

415.

948

3.9

522.

059

7.0

642.

059

6.0

Gro

wth

13.5

7.0

3.8

3.7

-0.9

16.4

7.8

14.3

7.5

-7.2

% o

f tot

al im

ports

16.4

14.5

13.2

12.0

10.4

10.2

9.8

11.0

11.0

10.1

1.2

Oth

erV

alue

(US$

mn.

)21

7.1

319.

437

7.2

314.

935

8.7

446.

646

1.0

433.

044

2.0

532.

0

Gro

wth

-4.4

47.1

18.1

-16.

513

.924

.53.

1-5

.81.

820

.6

% o

f tot

al im

ports

9.8

11.9

12.3

9.0

8.9

9.4

8.7

8.0

7.5

9.0

2. I

nte

rmed

iate

goods

V

alue

(US$

mn.

)1,

255.

41,

391.

71,

553.

31,

884.

42,

154.

42,

425.

02,

900.

02,

971.

03,

235.

73,

108.

0

G

row

th-1

.010

.911

.621

.314

.312

.619

.62.

68.

9-3

.9

%

of t

otal

impo

rts56

.451

.850

.753

.853

.750

.954

.654

.655

.252

.8

2.1

Petro

leum

Val

ue (U

S$ m

n.)

232.

435

8.7

311.

531

8.0

309.

229

6.3

386.

947

9.9

539.

534

5.0

Gro

wth

-5.7

54.4

-13.

22.

1-2

.8-4

.230

.624

.112

.4-3

6.1

% o

f tot

al im

ports

10.4

13.3

10.2

9.1

7.7

6.2

7.3

8.8

9.2

5.9

2.2

Text

iles

Val

ue (U

S$ m

n.)

276.

933

5.8

498.

276

5.5

865.

11,

038.

11,

158.

51,

168.

81,

386.

91,

397.

0

Gro

wth

0.1

21.3

48.3

53.7

13.0

20.0

11.6

0.9

18.7

0.6

% o

f tot

al im

ports

12.4

12.5

16.3

21.9

21.6

21.8

21.8

21.5

23.7

23.7

3. I

nve

stm

ent g

oods

V

alue

(US$

mn.

)33

3.4

584.

472

0.1

850.

91,

046.

81,

366.

51,

189.

01,

203.

01,

324.

01,

477.

0

G

row

th-1

2.2

75.3

23.2

18.2

23.0

30.5

-13.

01.

510

.011

.3

%

of t

otal

impo

rts15

.021

.723

.524

.326

.128

.722

.422

.122

.625

.1

4. T

ota

l im

port

s

V

alue

(US$

mn.

)2,

225.

62,

689.

03,

061.

13,

503.

44,

011.

34,

767.

35,

311.

15,

439.

05,

864.

05,

889.

0

G

row

th-0

.320

.813

.814

.514

.518

.811

.42.

67.

70.

4

xviii


Con

td…

./1999

2000

2001

2002

2003

2004

2005

2006

2007

2008(a

)

1.C

onsu

mer

goods

V

alue

(US$

mn.

)1,

131.

01,

261.

01,

126.

01,

189.

01,

344.

01,

440.

01,

503.

01,

782.

01,

768.

02,

174.

0

Gro

wth

0.3

11.5

-10.

75.

613

.07.

14.

418

.6-0

.823

.0

% o

f tot

al im

ports

18.9

17.3

18.9

19.5

20.1

18.0

16.9

17.4

15.6

15.5

1.1

Food

Val

ue (U

S$ m

n.)

551.

056

6.0

545.

056

6.0

564.

059

6.0

611.

075

7.0

831.

01,

130.

0G

row

th-7

.62.

7-3

.73.

9-0

.45.

72.

523

.99.

836

.0%

of t

otal

impo

rts9.

27.

89.

19.

38.

57.

56.

97.

47.

38.

11.

2 O

ther

Val

ue (U

S$ m

n.)

581.

069

6.0

581.

062

3.0

780.

084

4.0

891.

01,

024.

093

7.0

1,04

4.0

Gro

wth

9.2

19.8

-16.

57.

225

.28.

25.

614

.9-8

.511

.4%

of t

otal

impo

rts9.

79.

59.

710

.211

.710

.610

.110

.08.

37.

52. I

nte

rmed

iate

goods

V

alue

(US$

mn.

)3,

168.

03,

916.

03,

430.

03,

622.

03,

948.

04,

828.

05,

458.

06,

161.

06,

751.

08,

716.

0

Gro

wth

1.9

23.6

-12.

45.

69.

022

.313

.012

.99.

629

.1

% o

f tot

al im

ports

53.0

53.5

57.4

59.3

59.2

60.4

61.6

60.1

59.8

62.2

2.1

Petro

leum

Val

ue (U

S$ m

n.)

500.

090

1.0

731.

078

9.0

838.

012

09.0

1,65

5.0

2,07

0.0

2,50

1.0

3,36

8.0

Gro

wth

44.9

80.2

-18.

97.

96.

244

.336

.925

.120

.834

.7%

of t

otal

impo

rts8.

412

.312

.212

.913

.715

.118

.720

.222

.124

.02.

2Te

xtile

sV

alue

(US$

mn.

)1,

320.

01,

471.

01,

320.

01,

321.

01,

372.

01,

514.

01,

531.

01,

546.

01,

632.

01,

702.

0G

row

th-5

.511

.4-1

0.3

0.1

3.9

10.3

1.1

1.0

5.6

4.3

% o

f tot

al im

ports

22.1

20.1

22.1

21.6

20.6

18.9

17.3

15.1

14.5

12.2

3. I

nve

stm

ent g

oods

V

alue

(US$

mn.

)1,

565.

01,

737.

01,

081.

01,

169.

01,

320.

01,

670.

01,

869.

02,

246.

02,

685.

02,

979.

0

Gro

wth

6.0

11.0

-37.

88.

112

.926

.511

.920

.219

.510

.9

% o

f tot

al im

ports

26.2

23.6

18.1

19.2

19.8

20.8

21.1

21.9

23.8

21.3

4. T

ota

l im

port

s

V

alue

(US$

mn.

)5,

979.

07,

320.

05,

974.

06,

105.

06,

672.

08,

000.

08,

863.

010

,254

.011

,296

.014

,008

.0

Gro

wth

1.5

22.4

-18.

42.

29.

319

.910

.815

.710

.224

.0

Not

es:(a

): P

rovi

siona

l.

Sour

ces:

Cen

tral B

ank

of S

ri La

nka,

Annual

Rep

ort

, var

ious

issu

es; I

PS d

atab

ase.

xix


Table A16: Structure of Commodity Exports, 1989-2008

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

1.Agricultural exports

Value (US$ mn.) 611.7 721.0 641.4 604.7 655.3 702.1 829.0 961.0 1060.0 1088.0

Growth -3.2 17.9 -11.0 -5.7 8.4 7.1 18.1 16.1 10.3 2.6

% of total exports 39.3 36.3 32.3 24.6 22.9 21.9 21.8 23.5 22.9 22.9

1.1 Plantation crops

Value (US$ mn.) 518.7 617.7 538.5 468.1 514.9 546.8 660.9 801.3 882.1 878.1

Growth -2.4 19.1 -12.8 -13.1 10.0 6.2 20.9 21.2 10.1 -0.4

% of total exports 33.3 31.1 27.1 19.0 18.0 17.0 17.4 19.5 19.0 18.0

1.1.1 Tea

Value (US$ mn.) 379.1 494.8 431.9 339.8 412.7 424.2 481.0 615.0 719.0 780.0

Growth -2.0 30.5 -12.7 -21.3 21.4 2.8 13.3 28.2 17.0 8.5

% of total exports 24.3 24.9 21.7 13.8 14.4 13.2 12.6 15.0 15.5 16.4

1.1.2 Rubber

Value (US$ mn.) 86.3 76.9 63.8 67.5 64.0 72.5 111.0 104.0 79.0 44.0

Growth -25.9 -10.9 -17.0 5.8 -5.3 13.3 53.8 -6.6 -24.4 -44.3

% of total exports 5.5 3.9 3.2 2.7 2.2 2.3 2.9 2.5 1.7 0.9

1.1.3 Coconut kernel products

Value (US$ mn.) 53.3 46.0 42.8 60.8 38.3 50.1 69.0 81.0 82.0 56.0

Growth 89.2 -13.7 -7.0 42.2 -37.0 30.9 37.1 17.7 2.0 -31.8

% of total exports 3.4 2.3 2.2 2.5 1.3 1.6 1.8 2.0 1.8 1.2

1.2. Minor agricultural crops

Value (US$ mn.) 66.8 79.9 82.4 113.1 120.7 129.2 134.0 132.0 145.0 170.0

Growth -17.0 19.5 3.2 37.3 6.7 7.0 3.5 -1.4 9.9 17.7

% of total exports 4.3 4.0 4.1 4.6 4.2 4.0 3.5 3.2 3.1 3.6

2. Mineral exports

Value (US$ mn.) 74.7 87.0 61.9 62.7 75.7 86.9 87.0 96.0 90.0 60.0

Growth -9.1 16.4 -28.8 1.3 20.7 14.7 -0.1 10.3 -6.7 -33.1

% of total exports 4.8 4.4 3.1 2.5 2.6 2.7 2.3 2.3 1.9 1.3

3. Industrial exports

Value (US$ mn.) 789.8 1,036.1 1,237.3 1,763.2 2,102.3 2,398.9 2,870.0 3,006.0 3,436.0 3,607.0

Growth 10.8 31.2 19.4 42.5 19.2 14.1 19.6 5.0 14.3 3.2

% of total exports 50.7 52.2 62.3 71.7 73.4 74.8 75.4 73.4 74.1 74.9

3.1 Textile & garments

Value (US$ mn.) 489.1 628.1 803.9 1,214.0 1,412.4 1,551.9 1,853.0 1,902.0 2,274.0 2,460.0

Growth 9.1 28.4 28.0 51.0 16.3 9.9 19.4 2.9 19.6 8.2

% of total exports 31.4 31.7 40.5 49.3 49.3 48.4 48.7 46.4 49.0 52.0

3.2 Petroleum products

Value (US$ mn.) 62.2 99.2 79.5 63.2 78.8 80.1 85.0 104.0 97.0 73.0

Growth -12.7 59.5 -19.9 -20.5 24.6 1.7 5.9 22.4 -6.3 -25.9

% of total exports 4.0 5.0 4.0 2.6 2.8 2.5 2.2 2.5 2.1 1.5

4. Total commodity exports inc. petroleum

Value (US$ mn.) 1,558.4 1,983.9 1,987.5 2,460.8 2,863.7 3,208.6 3,806.6 4,199.0 4,736.0 4,871.0

Growth 5.6 27.3 0.2 23.8 16.4 12.0 18.6 10.3 12.8 2.9

5. Total commodity exports excl. petroleum

Value (US$ mn.) 1,496.2 1,884.7 1,908.0 2,397.5 2,784.9 3,128.5 3,721.7 3,991.0 4,542.0 4,725.0

Growth 6.6 26.0 1.2 25.7 16.2 12.3 19.0 7.2 13.8 4.0

xx


Contd../1999 2000 2001 2002 2003 2004 2005 2006 2007(a) 2008(b)

1. Agricultural exports

Value (US$ mn.) 947.0 1005.0 932.0 938.0 965.0 1065.2 1,153.8 1,292.7 1,507.2 1,854.8

Growth -13.0 6.1 -7.3 0.6 2.9 10.4 8.3 12.0 16.6 23.1

% of total exports 20.6 18.2 19.3 20.0 18.8 18.5 18.2 18.8 19.7 22.8

1.1 Plantation crops

Value (US$ mn.) 738.0 806.0 755.0 728.0 770.0 849.0 905.9 1,027.1 1,194.9 1,479.0

Growth -16.0 9.2 -6.3 -3.6 5.8 10.3 6.7 13.4 16.3 23.8

% of total exports 15.8 14.3 15.5 15.3 14.8 14.5 14.0 14.4 15.6 18.2

1.1.1 Tea

Value (US$ mn.) 621.0 700.0 690.0 660.0 683.0 739.0 810.2 881.2 1,025.2 1,271.5

Growth -20.4 12.7 -1.4 -4.3 3.5 8.2 9.6 8.8 16.3 24.0

% of total exports 13.5 12.7 14.3 14.1 13.3 12.8 12.8 12.8 13.4 15.6

1.1.2 Rubber

Value (US$ mn.) 33.0 29.0 24.0 27.0 39.0 51.0 46.9 93.1 109.4 125.1

Growth -25.0 -12.1 -17.2 12.5 44.4 30.8 -8.0 98.5 17.5 14.4

% of total exports 0.7 0.5 0.5 0.6 0.8 0.9 0.7 1.4 1.4 1.5

1.1.3 Coconut kernel products

Value (US$ mn.) 84.0 77.0 41.0 41.0 48.0 59.0 48.8 52.8 60.3 82.4

Growth 50.0 -8.3 -46.8 0.0 17.1 22.9 -17.3 8.2 14.2 36.7

% of total exports 1.8 1.4 0.9 0.9 0.9 1.0 0.8 0.8 0.8 1.0

1.2 Minor agricultural crops

Value (US$ mn.) 165.0 155.0 136.0 168.0 150.0 162.0 183.4 194.6 231.5 287.3

Growth -2.9 -6.1 -12.3 23.5 -10.7 8.0 13.2 6.1 19.0 24.1

% of total exports 3.6 2.8 2.8 3.5 2.9 2.8 2.9 2.8 3.0 3.5

2. Mineral exports

Value (US$ mn.) 64.0 97.0 86.0 90.0 84.0 120.0 143.3 119.9 127.8 122.4

Growth 6.7 51.6 -11.3 4.7 -6.7 42.9 19.4 -16.3 6.6 -4.2

% of total exports 1.4 1.8 1.8 1.9 1.6 2.0 2.3 1.7 1.7 1.5

3. Industrial exports

Value (US$ mn.) 3,551.0 4,283.0 3,710.0 3,631.0 3,977.0 4,506.0 4,948.4 5,401.1 5,967.3 6,159.5

Growth -1.6 20.6 -13.4 -2.1 9.5 13.3 9.8 9.1 10.5 3.2

% of total exports 77.0 77.6 77.0 77.3 77.5 78.3 78.0 78.5 78.1 75.7

3.1 Textile & garments

Value (US$ mn.) 2,425.0 2,982.0 2,543.0 2,424.0 2,575.0 2,809.0 2,894.6 3,080.4 3,339.6 3,468.7

Growth -1.4 23.0 -14.7 -4.7 6.2 9.1 3.0 6.4 8.4 3.9

% of total exports 52.7 54.0 52.8 51.6 50.2 48.8 45.6 44.8 43.7 42.6

3.2 Petroleum products

Value (US$ mn.) 74.0 98.0 68.0 73.0 65.0 100.0 130.9 188.4 168.9 254.8

Growth 1.4 32.4 -30.6 7.4 -11.0 53.8 30.9 43.9 -10.4 50.9

% of total exports 1.6 1.8 1.4 1.5 1.3 1.7 2.1 2.7 2.2 3.1

4. Total commodity exports inc. petroleum

Value (US$ mn.) 4,684.0 5,620.0 4,885.0 4,772.0 5,198.0 5,856.7 6,477.6 7,140.3 7,640.0 8,136.7

Growth -3.8 20.0 -13.1 -2.3 8.9 12.7 10.6 10.2 7.0 6.5

5. Total commodity exports excl. petroleum

Value (US$ mn.) 4,536.0 5,424.0 4,749.0 4,626.0 5,068.0 5,657.6 6,215.8 6,882.7 7,740.5 7,881.9

Growth -4.0 19.6 -12.4 -2.6 9.6 11.6 9.9 10.7 12.5 1.8

Notes: (a): Revised.(b): Provisional.

Sources: Central Bank of Sri Lanka, Annual Report, various issues; IPS database.

xxi


T

able

A1

7:

To

uri

sm,

19

89

-20

08

Unit

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Tour

ist a

rriv

als

No.

184,

732

297,

888

317,

703

393,

669

392,

250

407,

511

403,

101

302,

265

366,

165

381,

063

Excu

rsio

nist

arr

ival

sN

o.4,

064

3,95

42,

665

5,65

16,

093

8,41

310

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12,8

6318

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27,6

29To

uris

t nig

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000

1,97

03,

225

3,63

34,

055

4,14

84,

251

4,02

42,

947

3,68

03,

944

Earn

ings

Rs.

mn.

2,73

9.7

5,30

3.3

6,48

5.8

8,82

5.6

10,0

36.8

11,4

01.6

11,5

51.6

9,55

9.1

12,9

80.0

14,8

68.0

US$

mn.

76.0

132.

015

6.8

201.

420

8.0

230.

722

5.4

173.

021

6.7

231.

5R

ecei

pts

per t

ouri

st p

er d

ayU

S$38

.641

.142

.849

.750

.154

.256

.157

.958

.659

.5A

vera

ge d

urat

ion

Nig

hts

10.7

10.8

11.4

10.3

10.6

10.4

10.0

9.8

10.1

10.4

Acc

omm

odat

ion

Room

sN

o.9,

459

9,55

69,

679

10,2

1410

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10,7

4211

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11,6

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12,7

72 B

eds

No.

18,4

6418

,669

18,9

4719

,907

20,2

4220

,929

21,6

8022

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22,9

4423

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Occ

upan

cy ra

te, g

rade

d%

31.0

47.2

48.4

55.3

57.0

56.6

52.6

40.3

49.1

52.8

Sri L

anka

nat

iona

ls A

rriv

als

No.

258,

950

306,

367

237,

424

339,

109

375,

740

422,

367

459,

441

488,

055

482,

850

481,

793

Dep

artu

res

No.

285,

510

296,

884

310,

373

420,

749

416,

246

448,

437

504,

420

494,

258

530,

712

518,

050

Empl

oym

ent

Dir

ect

No.

21,9

5824

,964

26,8

7828

,790

30,7

1033

,956

35,0

6831

,963

34,0

0634

,780

Indir

ect

No.

30,7

4134

,950

37,6

2940

,306

42,9

9447

,538

49,0

9544

,748

47,6

0848

,692

Con

td…

/

Unit

1999

2000

2001

2002

2003

2004

2005

2006

2007(a

)2008(b

)To

uris

t arr

ival

sN

o.43

6,44

040

0,41

433

6,79

439

3,17

450

0,64

256

6,20

254

9,30

855

9,60

349

4,00

843

8,47

5Ex

curs

ioni

st a

rriv

als

No.

28,3

3544

,518

60,0

0863

,560

82,0

6611

0,00

011

9,61

812

8,71

998

,432

87,6

95To

uris

t nig

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000

4,47

94,

056

3,43

53,

989

5,09

35,

742

4,75

45,

793

4,94

04,

165

Earn

ings

Rs.

mn.

19,2

97.3

19,1

62.2

18,8

63.3

24,2

02.0

32,8

10.0

42,6

66.3

36,3

7742

,586

42,5

1937

,094

US$

mn.

274.

925

2.8

211.

125

3.0

340.

041

6.8

362

410

384

319

Rec

eipt

s pe

r tou

rist

per

day

US$

61.4

62.3

63.1

63.4

66.8

72.2

74.6

83.4

79.1

76.7

Ave

rage

dur

atio

nN

ight

s10

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.19.

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2213

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1814

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14,7

93 B

eds

No.

24,2

1624

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25,5

9525

,956

26,5

1126

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24,7

4027

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27,5

0028

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Occ

upan

cy ra

te, g

rade

d%

57.6

52.3

42.1

43.1

53.2

59.3

43.6

39.8

46.2

43.9

Sri L

anka

nat

iona

ls A

rriv

als

No.

521,

073

514,

448

487,

356

493,

947

560,

602

646,

990

683,

169

734,

421

817,

524

900,

815

Dep

artu

res

No.

496,

963

524,

212

505,

341

533,

565

561,

126

680,

248

727,

301

756,

735

862,

011

966,

337

Empl

oym

ent

Dir

ect

No.

36,5

6037

,943

33,7

1038

,821

46,7

6153

,766

52,0

8555

,649

60,5

1651

,857

Indir

ect

No.

51,1

8453

,120

47,1

9454

,349

65,4

6575

,272

72,9

1977

,909

84,7

2372

,599

Not

es:

(a):

Rev

ised

.(b

):Pr

ovis

iona

l.

Sour

ce:

Cey

lon

Tour

ist B

oard

, Annual S

tatist

ical R

eport

, var

ious

issu

es.

xxii


T

able

A1

8:

Mo

nth

ly T

ou

rist

Arr

ival

s, 1

99

7-2

00

8

1997

1998

1999

2000

2001

2002

No.

Gro

wth

No.

Gro

wth

No.

Gro

wth

No.

Gro

wth

No.

Gro

wth

No.

Gro

wth

Janu

ary

32,6

525.

537

,224

14.0

44,3

7919

.243

,311

-2.4

44,1

872.

128

,296

-36.

0Fe

brua

ry35

,010

18.5

35,2

830.

841

,526

17.7

43,2

874.

246

,575

7.6

31,6

83-3

2.0

Mar

ch34

,098

29.0

32,2

56-5

.441

,022

27.2

40,1

10-2

.244

,290

10.4

33,0

84-2

5.3

Apr

il26

,907

32.1

25,5

78-4

.934

,443

34.7

33,6

42-2

.336

,906

9.7

27,0

57-2

6.7

May

22,4

0726

.920

,394

-9.0

25,2

1223

.623

,404

-7.2

26,9

24-1

5.0

26,6

61-1

.0Ju

ne23

,160

17.8

22,4

10-3

.226

,184

16.8

21,8

25-1

6.6

28,3

2329

.826

,355

-6.9

July

30,8

6721

.629

,529

-4.3

33,2

8812

.733

,267

-0.1

28,5

66-1

4.1

35,7

4225

.1A

ugus

t32

,034

29.4

31,4

46-1

.839

,081

24.3

34,4

22-1

1.9

15,7

17-5

4.3

35,4

7512

5.7

Sept

embe

r29

,793

28.4

31,6

536.

233

,915

7.1

31,0

35-8

.511

,758

-62.

132

,982

180.

5O

ctob

er28

,314

20.4

31,7

6712

.235

,112

10.5

26,6

58-2

4.1

12,9

04-5

1.6

36,2

5818

1.0

Nov

embe

r31

,995

28.4

38,4

2120

.141

,952

9.2

32,4

69-2

2.6

17,3

44-4

6.6

37,3

9511

5.6

Dec

embe

r38

,928

8.6

45,1

0215

.940

,326

-10.

636

,984

-8.3

23,3

00-3

6.9

42,1

8381

.0To

tal

366,

165

21.1

381,

063

4.1

436,

440

14.5

400,

414

-8.3

336,

794

-15.

939

3,17

116

.7

Con

td../

Janu

ary

40,6

4743

.649

,950

22.9

38,1

87-2

3.5

52,1

0336

.456

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8.5

56,9

160.

6Fe

brua

ry39

,081

23.4

43,5

8411

.536

,645

-15.

952

,687

43.8

43,0

51-1

8.3

40,5

51-5

.8M

arch

40,8

1823

.438

,418

-5.9

50,4

1831

.254

,746

8.6

35,0

31-3

6.0

38,0

498.

6A

pril

33,7

1424

.630

,672

-9.0

42,2

6137

.849

,776

17.8

33,0

39-3

3.6

29,7

47-1

0.0

May

30,0

4812

.730

,162

0.4

40,8

7835

.543

,825

7.2

26,3

07-4

0.0

31,1

4018

.4Ju

ne31

,836

20.8

32,1

190.

845

,699

42.3

44,0

66-3

.630

,810

-30.

127

,960

-9.3

July

43,7

4322

.450

,525

15.5

56,7

4512

.355

,354

-2.5

44,1

42-2

0.3

32,9

82-2

5.3

Aug

ust

42,1

1118

.748

,675

15.6

51,2

165.

252

,931

3.3

44,7

42-1

5.5

30,6

72-3

1.4

Sept

embe

r36

,054

9.3

51,5

2542

.943

,536

-15.

538

,485

-11.

637

,104

-3.6

29,5

29-2

0.4

Oct

ober

49,9

2237

.759

,442

19.1

44,0

95-2

5.8

38,8

15-1

2.0

37,0

11-4

.635

,103

-5.2

Nov

embe

r54

,946

46.9

64,9

7118

.248

,457

-25.

437

,591

-22.

445

,102

20.0

36,9

01-1

8.2

Dec

embe

r57

,722

36.8

66,1

5914

.651

,171

-22.

739

,224

-23.

361

,116

55.8

48,9

25-1

9.9

Tota

l50

0,64

227

.356

6,20

213

.154

9,30

8-2

.955

9,60

31.

949

4,00

8-1

1.7

438,

475

-11.

2

Not

e:M

onth

ly g

row

th fi

gure

s ref

lect

per

cent

age

chan

ges c

ompa

red

to th

e sa

me

mon

th in

the

prev

ious

yea

r.(a

): P

rovi

siona

l.

Sour

ce:

Cey

lon

Tour

ist B

oard

, Annual

Sta

tist

ical

Rep

ort

, var

ious

issu

es.

2003

2004

2005

2006

2007

2008(a

)N

o.

Gro

wth

No.

Gro

wth

No.

Gro

wth

No.

Gro

wth

No.

Gro

wth

No.

Gro

wth

xxiii


Table A19: Tourist Arrivals by Country of Residence, 1997-2008

1997 1998 1999 2000 2001 2002

No. Growth No. Growth No. Growth No.Growth No. Growth No. Growth

North America 15,951 28.0 17,529 10 18,477 5 17,319 -6 15,983 -8 19,866 24

Canada 6,477 38.1 7,542 16 7,905 5 7,503 -5 7,609 1 8,304 9

U.S.A. 9,474 21.9 9,987 5 10,572 6 9,816 -7 8,374 -15 11,565 38

Western Europe 212,052 26.7 238,959 13 275,796 15 260,824 -5 203,984 -22 200,295 -2

Germany 59,814 32.7 74,058 24 77,259 4 70,584 -9 60,405 -14 55,170 -9

United Kingdom 62,997 20.9 66,432 5 80,919 22 84,693 5 67,830 -20 67,533 0

France 25,392 18.2 26,874 6 34,458 28 25,992 -25 20,949 -19 19,989 -5

Italy 14,424 20.3 15,867 10 19,815 25 16,833 -15 12,074 -28 12,177 1

Netherlands 15,957 45.1 22,977 44 29,670 29 22,618 -24 12,569 -44 11,748 -7

Asia 113,565 10.7 99,702 -12 114,375 15 91,521 -20 89,732 -2 143,064 59

Japan 13,374 14.1 13,785 3 16,332 19 10,226 -37 9,237 -10 13,602 47

India 47,010 9.8 37,356 -21 42,315 13 31,860 -25 33,924 7 69,960 106

Pakistan 11,439 -2.6 10,782 -6 11,421 6 10,005 -12 8,562 -14 6,756 -21

Australasia 11,712 33.7 12,159 4 15,159 25 18,228 20 13,105 -28 13,209 1

Australia 10,392 36.3 10,329 -1 13,218 28 16,443 24 11,457 -30 11,217 -2

Other(a) 12,912 15.9 13,092 1 12,633 -4 12,522 -1 13,990 12 16,737 20

Total 366,165 21.1 381,063 4 436,440 15 400,414 -8 336,794 -16 393,171 17

Contd…/

2003 2004 2005 2006(b) 2007 2008(c)

No. Growth No. Growth No. Growth No.Growth No. Growth No. Growth

North America 25,110 26 29,759 19 46,457 56 35,323 -24 28,355 -20 24,311 -14

Canada 11,164 34 14,633 31 21,185 45 14,623 -31 11,869 -19 10,258 -14

U.S.A. 13,946 21 15,126 8 25,272 67 20,700 -18 16,486 -20 14,053 -15

Western Europe 255,169 27 284,440 11 227,191 -20 228,447 1 194,448 -15 167,187 -14

Germany 58,908 7 58,258 -1 46,350 -20 47,402 2 35,042 -26 30,625 -13

United Kingdom 93,278 38 106,645 14 92,629 -13 88,306 -5 94,060 7 81,331 -14

France 28,585 28 29,996 5 26,653 -11 22,693 -15 8,091 -64 10,594 31

Italy 15,654 29 18,862 20 10,192 -46 12,424 22 11,451 -8 13,030 14

Netherlands 18,197 55 21,455 18 15,156 -29 19,360 28 17,526 -9 9,116 -48

Asia 177,351 24 198,068 12 223,351 13 242,132 8 202,480 -16 173,039 -15

Japan 17,115 26 19,641 15 17,148 -13 16,189 -6 14,274 -12 10,075 -29

India 90,603 30 105,151 16 113,323 8 128,370 13 106,067 -17 85,238 -20

Pakistan 9,704 44 9,638 -1 11,029 14 11,145 1 10,204 -8 7,885 -23

Australasia 22,965 74 26,540 16 29,738 12 25,127 -16 22,924 -9 21,839 -5

Australia 19,958 78 23,247 16 25,986 12 21,849 -16 20,241 -7 19,536 -3

Other(a) 20,047 20 27,395 37 22,571 -18 28,576 27 45,801 60 52,099 14

Total 500,642 27 566,202 13 549,308 -3 559,603 2 494,008 -12 438,475 -11

Notes: (a): Latin America & the Caribbean, East Europe, Africa, and Middle East.(b): Revised.(c): Provisional.

Source: Ceylon Tourist Board, Annual Statistical Report, various issues.

xxiv


Tab

le A

20: B

alan

ce o

f P

aym

ents

, 1997-2

008

U

nit

1997

1998

1999

2000

2001

2002

2003(c

)2004

2005

2006

2007

2008(a

)

1.Tr

ade

bala

nce

US$

mn.

-1,2

25.0

-1,0

92.0

-1,3

69.0

-1,7

98.0

-1,1

57.0

-1,4

06.0

-1,5

39.0

-2,2

43.0

-2,5

16.0

-3,3

70.0

-3,6

56.0

-5,8

71.0

% o

f GD

P-8

.1-6

.9-8

.7-1

0.8

-7.4

-9.5

-8.1

-10.

9-1

0.3

-11.

9-1

1.3

-14.

4

2.Se

rvic

es b

alan

ce U

S$ m

n.15

9.1

145.

014

7.0

38.0

175.

029

5.0

399.

041

9.0

338.

025

7.0

302.

040

2.0

% o

f GD

P1.

10.

90.

90.

21.

32.

02.

12.

01.

40.

90.

71.

0

3.. I

ncom

e, n

et U

S$ m

n.-1

60.0

-180

.0-2

54.0

-305

.0-2

67.0

-253

.0-1

72.0

-204

.0-2

99.0

-389

.0-3

58.0

-972

.0

% o

f GD

P-1

.1-1

.1-1

.6-1

.8-1

.9-1

.7-0

.9-1

.0-1

.2-1

.4-1

.1-2

.4

4.N

et p

rivat

e tra

nsfe

rs U

S$ m

n.78

8.1

849.

088

7.0

974.

098

4.0

1,09

7.0

1,20

5.0

1,35

0.0

1,73

6.0

1,90

4.0

2,21

4.0

2,56

5.0

% o

f GD

P5.

25.

45.

65.

97.

07.

56.

36.

57.

16.

76.

86.

3

5.N

et o

ffici

al tr

ansfe

rs U

S$ m

n.44

.552

.026

.024

.022

.031

.036

.030

.093

.010

1.0

97.0

101.

0

% o

f GD

P0.

30.

30.

20.

10.

20.

20.

20.

10.

40.

40.

30.

2

6.C

urre

nt a

ccou

nt b

alan

ce U

S$ m

n.-3

93.0

-226

.0-5

63.0

-1,0

66.0

-244

.0-2

37.0

-71.

0-6

48.0

-650

.0-1

,499

.0-1

,401

.0-3

,775

.0

% o

f GD

P-2

.6-1

.4-3

.6-6

.4-1

.7-1

.6-0

.4-3

.1-2

.7-5

.3-4

.3-9

.3

7.C

apita

l and

fina

ncia

l a/c

US$

mn.

602.

041

3.0

373.

044

3.0

562.

044

4.0

722.

063

1.0

1,22

4.0

1,80

8.0

2,09

7.0

1,77

3.0

% o

f GD

P4.

22.

62.

42.

74.

03.

03.

83.

15.

06.

46.

54.

4

Cap

ital a

ccou

nt U

S$ m

n.87

.180

.080

.050

.019

8.0

65.0

74.0

64.0

250.

029

1.0

269.

029

1.0

Fina

ncia

l acc

ount

US$

mn.

515.

033

4.0

293.

039

3.0

364.

037

9.0

648.

056

7.0

974.

015

17.0

1828

.014

83.0

8.Lo

ng-te

rm U

S$ m

n.71

6.0

398.

043

5.0

304.

016

4.0

326.

072

2.0

680.

079

8.0

907.

012

51.0

1016

.0

Fore

ign

dire

ct in

vestm

ent

US$

mn.

128.

613

7.0

177.

017

3.0

82.0

181.

017

1.0

217.

023

4.0

451.

054

8.0

691.

0

Priv

ate

long

-term

(net

) U

S$ m

n.47

.02.

019

6.0

82.0

-257

.0-2

1.0

-33.

014

.011

.0-3

5.0

31.0

74.0

Gov

ernm

ent l

ong-

term

US$

mn.

239.

020

3.0

62.0

47.0

249.

016

2.0

554.

043

9.0

553.

049

1.0

672.

025

2.0

9. S

hort-

term

US$

mn.

-201

.0-6

4.0

-142

.088

.020

1.0

53.0

-75.

0-1

12.0

176.

061

0.0

577.

046

6.0

Fore

ign

portf

olio

inve

stmen

t U

S$ m

n.13

.0-2

4.0

-13.

0-4

5.0

-11.

025

.02.

011

.060

.051

.010

1.0

60.0

10. O

ther

(b)

US$

mn.

27.3

-116

.1-1

01.0

174.

071

.0-1

45.0

-2.0

202.

032

3.0

293.

036

4.0

-185

.0

11. O

vera

ll ba

lanc

e U

S$ m

n.16

3.0

37.0

-263

.0-5

22.0

220.

033

8.0

502.

0-2

05.0

501.

020

4.0

531.

0-1

225

% o

f GD

P1.

81.

4-1

.7-3

.11.

62.

32.

6-1

.02.

10.

71.

6-2

.9

Not

es:

(a):

Prov

ision

al.

(b):

Val

uatio

n ad

justm

ents,

erro

rs, a

nd o

miss

ions

.(c

): Fr

om 2

003,

dat

a ar

e ba

sed

on G

DP

estim

ates

com

pile

d by

the

Dep

artm

ent o

f Cen

sus a

nd S

tatis

tics.

Sour

ce:

Cen

tral B

ank

of S

ri La

nka,

Annual

Rep

ort

, var

ious

issu

es.

xxv


Tab

le A

21

: Ex

chan

ge R

ate

Beh

avio

ur,

19

97

-20

08

Cur

renc

yU

nit

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Nom

inal

exc

hang

e ra

tes

U

.S.A

.S.

L. R

s. pe

r US$

61.2

967

.78

72.1

280

.06

93.1

696

.72

96.7

410

4.60

102.

1210

7.71

108.

7211

3.14

Jap

anS.

L. R

s. pe

r Yen

0.47

0.59

0.71

0.70

0.71

0.82

0.90

1.02

0.87

0.90

0.97

1.25

U. K

.S.

L. R

s. pe

r Pou

nd10

1.60

112.

6211

6.72

119.

3713

5.06

155.

1217

2.19

201.

3717

5.94

211.

2921

7.15

163.

28

Eur

opeo

n U

nion

S.L.

Rs.

per E

uro

--

72.5

374

.32

82.2

710

1.38

121.

6014

2.32

120.

9614

1.58

160.

2715

9.45

Indi

aS.

L. R

s. pe

r Ind

. Rs.

1.56

1.59

1.66

1.71

1.93

2.02

2.12

2.40

2.27

2.44

2.77

2.36

24 c

urre

ncy

Nom

inal

effe

ctiv

e ex

chan

ge ra

tes (

NEE

R)N

EER

2006

=10

0-

--

--

-11

0.31

97.5

710

4.77

94.3

587

.79

93.7

1

Real

effe

ctiv

e exc

hang

e rat

e (RE

ER)

REER

200

6=10

0-

--

--

-92

.01

89.6

410

0.15

99.2

610

5.64

125.

47

Sour

ces:

Cen

tral B

ank

of S

ri La

nka,

Annual

Rep

ort

, var

ious

issu

es.

xxvi


Appendix B: Capital Market

Table B1: Sri Lanka's Capital Market Structure, 2004-2008

2004 2005 2006 2007 2008(a)

1. Equity market:

Market capitalization 382,100 584,000 834,800 820,700 488,812

of which central depository 195,032 259,780 370,076 418,088 488,813

2. Debt market: 1,165,491 1,266,802* 1,460,644* 1,507,693* 1,026,400

(i) Private 48,000 29,060* 42,260* 50,320*

(ii) Public 1,117,491 1,237,742 1,418,384 1,457,373

(a) Short-term(TBs) 243,886 234,174 257,732 307,012 402,600

(b) Medium & long -term 873,605 1,003,568 1,160,652 1,351,999 1,623,863

3. Total debt and equity (Rs. mn) 1,547,591 1,850,802* 2,295,444 2,328,393 1,515,212

as a percentage of GDP(%) 86.07 88.20 78.11 65.09 34.35

of which actually traded 209,532 270,680 393,576 449,288

through the central depository

As a share of total (%) 13.5 14.6 17.1 19.3

4. Foreign participation in the central 14 14 14 19

depository as a per cent

of market capitalization (%)

Notes: (a): Provisional.* Debentures listed is no longer available. (Source: CSE Fact Book 2005, 2006 & 2007).

Sources: Colombo Stock Exchange, Annual Report; Central Bank of Sri Lanka, Annual Report, various issues.

xxvii


Note: 1000 Million = 1 Billion.

Source: Colombo Stock Exchange, Annual Report, various issues.

Table B2: Recent Developments in the Share Market, 2000-2008

2000 2001 2002 2003 2004 2005 2006 2007 2008

1. Number of companies listed 239 238 238 244 242 239 237 235 235

New listings 5 2 9 8 5 6 2 - 3

De-listings 3 3 9 2 7 9 4 2 2

2. Number of companies traded 228 225 231 236 241 242 232 231 232

3. Market capitalization Rs. bn. 89 124 162 263 382 584 835 821 489

US$ bn. 1.2 1.4 1.7 2.7 3.8 5.8 8.0 8.0 4.3

4. Price -earnings ratio times, year end 5.2 7.5 12.1 11.1 10.8 12.4 14.0 11.6 11.3

5. Number of shares traded No. mn. 449 747 1,220 2,255 2,752 5,128 3,912 2,952 3,155

Domestic No. mn. 350 607 1,035 1,932 2,479 4,313 3,178 2,049 1,935

Foreign No. mn. 99 140 185 323 273 815 734 902 1,220

6. Trades (‘000) 160.0 159.7 283.2 481.3 645.1 1100.4 952.4 876.9 776.2

Domestic ('000) 150.0 152.8 273.2 460.9 611.6 1038.5 908.2 831.7 730.4

Foreign ('000) 10.0 6.8 10.0 22.0 33.4 61.9 44.2 45.3 45.8

7. Turnover: Rs. bn. 11 14.1 30.5 73.8 59.0 114.6 105.1 105.0 110.5

US$ bn. 0.1 0.2 0.3 0.7 0.6 1.1 1.0 1.0 1.0

Domestic Rs. bn. 7.9 11.4 24.3 59.9 48.3 89.9 70.7 63.8 50.8

Foreign Rs. bn. 3.1 2.6 6.2 13.8 9.8 24.6 34.5 41.2 59.7

8. Liquidity- turnover / market

Capitalization ratio (%) 12.4 11.4 18.8 28.1 15.4 19.6 12.6 12.8 22.6

9. No. of new issues 4 _ 5 4 _ _ _ _ _

10. Total no. of shares issued (mn.) 80 _ 244 _ _ _ _ _ _

11. Value of shares issued (Rs. bn.) 0.1 _ 3.6 _ _ _ _ _ _

12. Central depository:

Domestic (Rs. bn.) 30.9 50.9 66.5 98.2 140.4 179.8 248.7 260.4 162.3

Foreign (Rs. bn.) 9.5 12.2 19.5 37.8 54.6 79.9 121.4 157.6 108.0

Total (Rs. bn.) 40.4 63.1 86.0 136.0 195.0 259.7 370.1 418.0 270.3

Percentage of market cap. 45.4 50.9 53.1 51.7 51.0 44.5 44.3 50.9 55.3

13. Non-national activity

Net purchases (Rs. mn.) -3,364.6 -1,024.8 2,441.5 209.3 1,106.3 6,144.5 5,377.0 11,254.3 13,950.5

Purchases (Rs. mn.) 1,445.0 2,111.9 7,477.7 13,943.9 11,278.0 27,712.4 37,167.0 46,796.8 66,632.2

Sales (Rs. mn.) 4,809.9 3,136.7 5,036.2 13,734.6 10,172.0 21,567.9 31,790.0 35,542.5 52,681.7

14. Price indices

All Share 1985 = 100 447.6 621.0 815.1 1,062.0 1,506.9 1,922.2 2,722.4 2,541.0 1,503.0

Growth % change -21.8 38.7 31.2 30.2 41.9 27.6 41.6 6.7 40.9

Sensitive 1985 = 100 698.5 1,031.0 1,374.6 1,898.0 2,073.7 2,451.1 3,711.8 3,291.9 1,631.3

Growth % change -25.4 47.6 33.3 38.1 9.3 18.2 51.4 11.3 -11.3

xxviii


Table B3: Market Concentration(% of total market capitalization)

Company 2008 (%)

SLT 39.75

AMW 8.79

JKH 5.98

Distilleries 2.78

Dialog 2.58

Hayleys 2.23

Hotel services 2.02

Ceylinco Insurance 1.09

CDIC 1.05

Commercial leasing 1.01

Total 67.28

Note: As at 2007, the top ten of the 232 listed companies account ed for 55.1% of totalmarket capitalization.As at 2008, the top ten of the 232 listed companies accounted for 67.3% of totalmarket capitalization.

Source: Colombo Stock Exchange, Fact Book, various issues.

xxix


Contd...../-

Table B4: New Equity Listings, 2006, 2007 & 2008Company No. of shares Issue price No. of shares No. of shares Date listed

offered Rs. subscribed devolved toby public underwriters

1. New listings-2006Blue Diamonds Jewellery Worldwide Ltd. 65,589,385 2.50 30,057,291 – 6-Jan-06Cargo Boat Development Co. Ltd 3,400,012 15.00 3,400,012 – 4-Jan-06Commercial Leasing Co. Ltd 2,016,667 60.00 2,016,667 – 30-Jan-06Regnis (Lanka) Ltd 1,207,271 50.00 1,207,271 – 20-Jan-06Chemical Industries (Colombo) Ltd 8,100,000 62.00 8,100,000 – 29-Mar-06Chemical Industries (Colombo) Ltd 2,430,000 35.00 2,430,000 – 29-Mar-06Dankotuwa Porcelain Ltd 18,094,296 10.00 12,791,509 5,302,787 25-Apr-06Seylan Merchant Leasing Ltd 5,047,475 18.00 5,047,475 – 20-Apr-06The Fortrees Resorts Ltd 38,882,344 10.00 38,882,344 – 23-May-06Seylan Bank Ltd 83,560,000 12.50 83,560,000 – 2-May-06Vidullanka Ltd 2,981,250 20.00 2,981,250 – 3-May-06Overseas Reality (Ceylon) Ltd 69,057,200 15.00 10,133,921 58,923,279 23-Aug-06Pan Asia Banking Corporation Ltd 55,571,883 10.00 55,068,524 – 26-Oct-06Seylan Merchant Leasing Ltd 3,028,485 20.00 3,028,485 – 30-Oct-06Diesel & Motor Engineering Co. Ltd 1,100,000 50.00 1,100,000 – 20-Nov-06People's Merchant Bank Ltd 12,500,000 20.00 12,500,000 – 14-Nov-06 Value (Rs) 4,705,479,692 Issues (No.) 15

Right issues - 2006 by sector No.of issues No. of shares Value (Rs.)

Banks, Finance & Insurance 6 161,724,510 2,122,643,100Chemicals & Pharmaceuticals 1 10,530,000 587,250,000Hotels & Travels 1 38,882,344 388,823,440Land & Property 2 72,457,212 1,086,858,180Motors 1 1,100,000 55,000,000Manufacturing 3 84,890,952 405,279,972Power & Energy 1 2,981,250 59,625,000Total 15 372,566,268 4,705,479,692

New listing-2007 No. of shares Issue price No. of shares No. of shares Date listedoffered Rs. subscribed devolved to

by public underwriters

Kshatriya Holdings PLC 19,679,528 10.00 19,679,528 – 12-Feb-07Kelsey Development Ltd 5,809,758 20.00 5,809,758 – 12-Feb-07The Fortress Resorts Ltd 20,161,215 10.00 17,242,725 2,918,490 27-Feb-07Lanka Tiles Ltd 5,052,420 35.00 5,052,420 – 1-Mar-07John Keells Holdings PLC 92,103,534 140.00 92,103,534 – 6-Feb-07Amana Takaful PLC 12,500,099 30.00 12,500,099 – 22-Mar-07Commercial Bank of Ceylon Ltd 40,288,996 138.00 40,288,996 (Voting) 4-Apr-07Commercial Bank of Ceylon Ltd 2,790,138 65.00 2,790,138 (Non-voting) 4-Apr-07ACME Printing & Packing Ltd 4,472,160 14.00 3,510,191 961,969 24-Apr-07DFCC Bank 21,639,134 140.00 21,639,134 – 27-Apr-07Kshatriya Holdings PLC 73,798,230 10.00 73,798,230 – 21-Jun-07Dialog Telecom PLC 740,343,492 21.00 740,343,492 – 21-May-07John Keells Hotels PLC 496,413,675 5.75 496,413,675 – 28-Jun-07Marawila Resorts Ltd 14,000,000 4.00 14,000,000 – 7-Aug-07Muller and Phipps (Ceylon) Limited 216,000,000 1.00 87,571,714 – 31-Dec-07First Capital Holdings PLC 18,750,000 10.00 18,750,000 – 17-Aug-07Parquet (Ceylon) Ltd 1,324,800 10.00 1,324,800 – 23-Oct-07LB Finance Ltd 10,100,000 17.00 10,100,000 – 27-Nov-07Coco Lanka Ltd 6,300,000 18.00 6,300,000 – 7-Nov-07Ceylon Glass Company PLC 395,869,200 1.90 395,869,200 – 5-Nov-07The Lanka Hospitals Corporation Ltd 67,119,651 15.00 67,119,651 – 20-Dec-07Ceylon Hotels Corporation PLC 150,000,000 2.00 150,000,000 – 31-Dec-07 Value (Rs) 44,622,201,960 Issues (No.) 21

3.

2.

xxx


Company No.of issues No. of shares Value (Rs.)

Right issues - 2007 by sector

Banks, Finance & Insurance 5 106,068,277 9,504,919,448Beverage Food & Tobacoo 1 6,300,000 113,400,000Hotels & Travels 4 680,574,890 3,411,990,781Healthcare 1 67,119,651 1,006,794,765Manufacturing 4 406,718,580 1,004,844,420Diversified Holdings 3 185,581,292 13,829,272,340Land & Property 1 5,809,758 116,195,160Stores & Supplies 1 216,000,000 87,571,714Telecommunication 1 740,343,492 15,547,213,332Total 21 2,414,515,940 44,622,201,960

4.

5. New listings - 2008 No. of shares Issue price No. of shares No. of shares Date listedoffered Rs. subscribed devolved to

by public underwriters

Janashakthi Insurance Company Ltd. 33,000,000 12.00 33,000,000 21-Jul-08 Ceylinco Insurance PLC 8,500,000 175.00 6,414,480 14-Aug-08

6. Right issues - 2008 by sector No.of issues No. of shares Value (Rs.)

Banks Finance & Insurance 3 46,519,739 1,136,239,907 Chemicals & Pharmacuticals 2 21,000,000 1,335,856,107 Healthcare 2 76,502,766 165,000,000 Manufacturing 1 1,464,044 14,640,440 Investment Trust 1 1,366,667 27,333,340 Total 9 146,853,216 2,679,069,794

Source: Colombo Stock Exchange, Fact Book, various issues.

xxxi


Notes: (a): Provisional.** All corporate denbentures listed on the Colombo Stock Exchange were transferred to the DEX with effect from

August 2005.* Debentures listed is no longer available. (Source: CSE Fact Book 2005, 2006 and 2007).

Sources: Central Bank of Sri Lanka, Annual Report, varios issues; Colombo Stock Exchange, Annual Report, various issues.

Table B5: Structure of Debt Market, 2004-2008(Rs. bn.) 2004 2005 2006 2007 2008(a)

1. Private debt:

(a) Commercial paper(year end) 14.50 10.90 23.50 30.00 24.00

(b) Certificates of deposit 21.03 18.16 18.76 19.10 19.10

(I) Commercial banks 19.79 17.06 17.70 17.76 17.76

(ii) Finance companies 1.23 1.10 1.06 0.86 0.91

(c) Debentures (listed) 12.47 ** ** ** **

Total private debt 48.00 29.06* 42.26 50.30 43.10

2. Public debt:

(a) Short terms

(i) Treasury bills 243.88 234.17 257.73 307.01 402.60

(ii) Central Bank securities _ _ _ _ _

(b) Medium & long term

(i) Treasury bonds 643.35 751.57 885.97 1018.85 1281.97

(ii) Rupee securities 164.76 140.56 116.71 131.51 130.01

(iii) Certificates of deposit _ _ _ _ _

Total public debt 1,052.00 1,126.30 1,260.41 1,456.37 1,814.58

3. Total debt 1,100.00 1,155.36* 1,302.67* 1,507.67* 1,857.68*

xxxii


Table B6: Listed Debentures, 2006-2008 Issuer Issued Par value Interest No.of debt Date listed

(No.) (Issue price Rs.) (p.a.) subscribed

1. Listings 2006Seylan Merchant Leasing Ltd. 10,000,000 with an option 100 13.00% 7,646,400 25.07.06

to issue up toa further 100 13.50% 4,620,800 25.07.065,000,000 if oversubscribed 100 Floating 305,950 25.07.06

DFCC Bank 1,000 13.75% 200,000 17.11.06Unsecured subordinated Floating 170,000 17.11.06

redeemable debenture Floating 40,000 17.11.0614.00% 590,000 17.11.06

2. Listings 2007Commercial Bank of Ceylon Ltd Issue of 1,000,000 with an 1,000 13.50% 527,800 23.01.07

option to issue up to a further 1,000 Floating 131,020 23.01.07500,000 1,000 13.75% 250 23.01.07

1,000 Floating 300 23.01.071,000 14.00% 467,260 23.01.071,000 Floating 400 23.01.07

Seylan Merchant Bank PLC 950,000 100 16.00% 321,390 08.01.07100 17.00% 628,260 08.01.07100 Floating 350 08.01.07

Issue of 1,000,000 with 100 16.00% 588,080 01.01.07an option to issue 100 16.50% 352,300 01.01.07

upto a further 950,000 100 16.25% 9,000 01.01.07100 16.75% 6,300 01.01.07100 16.50% 11,120 01.01.07100 17.00% 8,500 01.01.07100 17.00% 8,600 01.01.07100 17.50% 16,100 01.01.07

Seylan Bank PLC Issue of 5,000,000 with 100 15.75% 2,916,200 18.01.07an option to issue 100 16.75% 4,275,450 18.01.07

upto a further 100 Floating 302,350 18.01.075,000,000

Sampath Bank Ltd Issue of 10,000,000 100 15.50% 222,650 04.10.07with an option to 100 17.50% 5,206,725 04.10.07

issue up to a 100 Floating 9,570,625 04.10.07further 5,000,000

Nation Trust Bank PLC 14.10% 1,650,000 25.05.07Floating 1,650,000 25.05.07Floating 1,700,000 25.05.07

Hatton National Bank PLC Floating 2,625,000 13.01.07Floating 2,500,000 13.01.07Floating 3,000,000 13.01.07

Zero coupon 5,143,445 13.01.07Zero coupon 13,628,000 13.01.07

16.00% 5,000,000 28.11.0716.75% 7,000,000 28.11.07

Nationla Development Bank PLC 17.50% 250,000 24.12.07

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Issuer Issued Par value Interest No.of debt Date listed(No.) (Issue price Rs.) (p.a.) subscribed

3. Listings 2008Seylan Bank PLC Up to 10,000,000 100 17.00% 2,089,550 14.01.08

Unsecured subordinated 100 Floating 107,550 14.01.08redeemable debentures 100 Floating 433,350 14.01.08

559,285,000 100 18.00% 2,962,400 14.01.08

LB Finance PLC Up to 450,000 1000 21.00% 149,480 21.10.08Unsecured subordinated 1000 14.00% 296,570 21.10.08

redeemable debentures450,000,000 1000 Floating 2,500 21.10.08

1000 Floating 1,450 21.10.08

Singer (Sri Lanka) Up to 6,000,000 100 Floating 280,000 28.10.08PLC Unsecured redeemable

listed rated A+300,000,000 100 19.75% 2,720,000 28.10.08

Bank of Ceylon Up to 50,000,000 100 19.00% 3,451,000 19.12.08Unsecured subordinated

redeemable debentures4,272,370,000 100 Floating 36,993,900 19.12.08

225 Zero 2,277,900 19.12.0810,000,000

Nations Trust Unsecured subordinated 21.00% 06.11.08Bank PLC redeemable debentures

Source: Colombo Stock Exchange.

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