Countries and Regions

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p. 2 of 7 BACK | NEXT Executive Summary I. Current Development Trends and Issues II. The Government's Development Strategy III. ADB’s Development Experience IV. ADB's Strategy V. ADB's Assistance Program VI.Risks and Performance Monitoring and Evaluation

Country Strategy and Program 2004-2008: Sri Lanka

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I. Current Development Trends and Issues

A. Development Context

1. Sri Lanka is emerging from two decades of civil conflict. Over this period, and apart from the enormous human cost, the conflict has had an acutely debilitating effect on the economy. It has reduced the level of resources available for economic and social development, damaged the investment climate, in particular in terms of its capacity to attract foreign direct investment (FDI), and suppressed the rise in tourism during a time when Asian tourism in general has taken off. As a result, it has reduced gross domestic product (GDP) growth by about 2 percentage points a year, curbed expansion in productive employment, contributed significantly to fiscal pressure, and weakened the fight against poverty.

2. In the North and East, in particular, hostilities cut the regional contribution to GDP from 15% in the 1980s to 7.5% in 2001, and caused 65,000 deaths, internally displaced 800,000 people,¹ and caused countless injuries and major damage to infrastructure (roads, bridges, harbors, health facilities, buildings, schools, etc.). They also led to extensive relocation of people and investment from the area to elsewhere nationally or abroad; major losses of productive assets; little new investment in the region for 20 years; pervasive disruption in the movement of people, goods, services, and trade; and breaks in marketing, distribution, and agency systems. Every sector and innumerable people have been affected; psychological disorders—especially among children—have been extensive; and food security has fallen.

3. With the chances of peace now significantly enhanced, and the issuance of a radically changed government strategy—Regaining Sri Lanka²—the country’s development context is radically different from what it was. There should be a decline in physical destruction, opportunities for transferring war-related expenditures to civilian and social uses, a more helpful setting for reducing poverty, and a less unsettling backdrop for domestic and foreign investment and for tourists. Although the advent of peace will not remove underlying growth constraints, it presents a more conducive atmosphere for growth and poverty reduction. And it augurs well that the present Government has moved positively toward introducing a comprehensive reform agenda that, as it continues to develop, promises a major socioeconomic peace dividend for the country. It is in this development context of radical reform proposals on the one hand, and the ongoing peace process on the other, that this country strategy and program (CSP) is framed.

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B. Economic Growth

4. During the 1980s and 1990s, the annual real growth rate of Sri Lanka’s GDP fluctuated at around 5%. It rose to 6% in 2000, driven mainly by the services and industry sectors, which now account for almost 80% of GDP. GDP fell in 2001 for the first time since independence (by 1.5%), and recovered in 2002 (Table 1). This has been quite good growth in the face of prolonged conflict, and stems largely from the policy reforms of 1977 and 1989 and from the privatization and corporatization of the 1990s. But the country has not lived up to its growth potential and economic performance has lagged well behind East and Southeast Asia. Moreover, reform slowed in the late 1990s, unemployment remained high, the public debt position deteriorated, and the fiscal situation weakened. The Government now seeks to attain greater stability and annual rates of real GDP growth of 8–10% rather than the more typical rates of 4–6%. While ambitious, this could be within reach if reforms are as radical as the Government plans and, crucially, if the reform momentum is sustained over time.

5. In the 1950s and 1960s, government policies led to serious fiscal deficits, a depressed domestic and foreign investment climate, severe inefficiency, a narrow range of exports, and a repressed financial sector. Moreover, absorbing job seekers into the civil service led to an overly large bureaucracy. While liberalization has taken place since the late 1970s, albeit unevenly, and privatization has moved reasonably well since the early 1990s (especially in plantations), the earlier socialist policy bias has contributed to fairly high achievement in social indicators but also has left a legacy on the modern economy that Regaining Sri Lanka directly seeks to tackle: inefficiency, low productivity, state ownership, distrust of private enterprise, uncompetitiveness, and political interference.

6. Two critical aspects of the current situation concern debt and unemployment. In the case of debt, the Government recognizes that “…Sri Lanka is in the thick of an economic crisis–a crisis born of deep indebtedness.”³ Large expenditures on security, civil service salaries, government pensions and, increasingly, domestic debt service, exert undue strain on the budget balance and crowd out payments on other recurrent and capital expenditure items. Public debt by the end of 2002 stood at over 105% of GDP (up from 87% in 1997) and public debt service payments stood at 109% of government revenue (up from 51% in 1997). While over 80% of such payments are on domestic rather than foreign debt, their size is unsustainable, thus making policy reform and improved governance critical. Challenges for the Government include: reforming central and local governments, widening the revenue base and strengthening fiscal management, accelerating the privatization and corporatization of state-owned enterprises and commercial activities, reducing the weight of subsidies, and boosting the overall efficiency of government. The Government is actively addressing these issues and this is reflected in its reform agenda and in its medium-term macroeconomic targets agreed with the International Monetary Fund (IMF).⁴

7. Moreover, job creation has lagged behind job demand, causing high unemployment and growing overseas employment. While unemployment fell from 16% of the labor force in the early 1990s to about 9.2% in 2002, two of the principal reasons for this were the increase in government service employment during the 1990s (of over 200,000) and the rise in the security forces required by the conflict (of around 150,000). Neither of these safety valves remains a viable option, the first because it is unsustainable in the present fiscal situation, and the second because it is incompatible with emerging peace. There is also doubt over whether employment abroad can continue to increase as rapidly as in the past to ease domestic job pressure. There are 750,000 Sri Lankans working in the Middle East—11% of the labor force—but there are rising technical qualifications required for overseas jobs which Sri Lankans often do not have, while domestic labor supply could swell if overseas workers return home as peace continues.

8. Unemployment is a highly emotive economic and political issue, and a major goal of Regaining Sri Lanka is the creation of 2 million jobs. Over 650,000 people were unemployed in 2002, 50% with General Certificate of Education ordinary level qualifications or higher and 77% having been unemployed for more than a year.⁵ Moreover, unemployment was already some 31% among 15–19-year-olds and about 21% among 20–29-year-olds, both rates having increased since 1998. The Government recognizes that absorbing these productively will not be easy, particularly if there is to be a parallel reduction in the numbers working in government and semi-public positions in line with the needs of administrative reform and improved efficiency. High unemployment, even when it is not an obvious cause of poverty, is a potential source of social discord, even of renewed ethnic violence. In consequence, the Government’s reform agenda places considerable stress on improving the investment climate, raising productivity and efficiency, and upgrading the quality of education in line with the needs of a modern economy.

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C. Political Environment

9. In late 2001, the President dissolved Parliament and called for Parliamentary elections in December 2001. The United National Front (UNF) won these elections and formed a Government with a three-seat majority. The President, leader of the People’s Alliance, is Commander-in-Chief of the armed forces while the Prime Minister is the head of Parliament and Cabinet of Ministers. The UNF has continued the efforts of the previous Government, which was led by the current President, to bring about peace and resolve the prolonged ethnic conflict.

10. The key achievements of the UNF Government are the signing of a ceasefire agreement in February 2002 between itself and the Liberation Tigers of Tamil Eelam (LTTE), and the attempts at peace talks. The cessation of hostilities is in its second year of implementation. This is the third and longest attempt at ceasefire; the two previous attempts in 1989 and 1994 ultimately failed. The Government is in discussion with the LTTE about ending the conflict and establishing a federal structure in the North and East of the country, within the framework of a unitary state. The Government of Norway is facilitating the peace talks which began in September 2002. Six rounds of peace talks had been conducted up to early April 2003, but the LTTE has temporarily withdrawn from the process for a number of reasons. Among these is their insistence on an interim administration for the North and East that ensures political and economic freedom for the people there. To date, the Government has removed most economic and travel sanctions imposed in those areas, including the restriction on movement of people, tradable goods, and building materials; and the ban on fishing. The Government has released some of the high-security zones, particularly in the Jaffna peninsula, for resettlement and agricultural activities. The Government is also considering the release of other high security zones for resettlement on a case-by-case basis.

11. The Sri Lanka Muslim Congress (SLMC), a minority party in the coalition UNF Government, has also made its demands for Muslim people in the North and East. The SLMC also participated as representatives of the Muslim people at the peace talks. The constitution provides for the President to dissolve Parliament anytime one year after parliamentary elections (starting December 2002). The President, along with her party, the People’s Alliance, has had discussions with the socialist Janathi Vimukthi Peramuna (People’s Liberation Front) on memorandum of understanding for a future political coalition, which may lead to a possible dissolution of Parliament and elections.

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D. Poverty

12. Reducing poverty is a major theme of Regaining Sri Lanka. The most recent official poverty survey was undertaken in 2002⁶ but results have not been finalized. Prior to this, the most recent surveys date from the 1990s but omit the North and East.⁸ These show that poverty was relatively high during the period and that it was higher in parts of the South and in the North and East than elsewhere. This picture remains broadly accurate⁸ (Appendix 3). But, whatever the poverty situation in the rest of the country, poverty and human deprivation in the North and East are aggravated by the destruction, dislocation, and emotional stress of protracted conflict.

13. About 20% of Sri Lanka’s population in the early and mid-1990s was poor according to the lower poverty line, and over 30% according to the higher poverty line. In overall terms, poverty is overwhelmingly a rural issue, especially where access to social infrastructure is least developed. Rural poverty and income disparity also stem from the fact that agricultural growth has averaged 2.3% a year in the past 20 years, in contrast to GDP increasing at over double that rate. The incidence of poverty also varied inversely with urbanization: Western, Central, and Southern provinces were the most urbanized and had the lowest incidences of poverty, while Uva and North Western provinces were the least urbanized and had the highest incidences of poverty. Occupationally, farmers constituted 41% of the total number of poor, production workers 37%, and sales workers 8%.

14. While the general characteristics of Sri Lankan poverty probably did not change all that significantly between the mid-1990s and 2002, there will certainly have been some changes, possibly in the incidence of poverty itself and in the spatial distribution of the poor. Accordingly, the latest situation will need to be reflected in the design and location of any projects targeted at alleviating the plight of the poor when results of the 2002 survey are finalized and, in particular, when the results of the survey of the North and East are published. The characteristics of poverty in the North and East, and probably its incidence, are likely to be revealed as being especially worrisome.

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E. Governance and Institutional Capacity

15. The outcome of over five decades of the evolution of the political system is that Sri Lanka is burdened with a malfunctioning of its devolved political system due to the lack of clarity in the demarcation of the functions, responsibilities, and authority at the three levels of government (central, provincial, and local levels); and the absence of institutional arrangements for the active participation of the public in decision making at these levels. The administrative system and its structures have fared no differently. However, the recent setting up of an Administrative Reforms Committee under the Office of the Prime Minister provides an opportunity for the provision of support for strengthening governance and public management, the major areas of which that need to be addressed are rationalization and strengthening of the areas of public policy management, planning, budgeting, and performance management; strengthening of public financial management, fiscal decentralization, and audit; isolation of the public service at all levels of government from political influence; improvement of human resources management particularly in the areas of recruitment, career management, capacity enhancement, and performance appraisal; enhancement of the effectiveness of service delivery; widening and facilitating citizens’ access to information; and widening use of “e-governance”. In all these areas of reform, the continued participation of civil society and its constituent organizations will be critical. This factor also draws attention to the support required by civil society in enhancing its own capacity for effective participation. Parallel with the required agenda of action identified above is the major challenge faced by the Government in addressing the post-conflict needs of reconstruction, rehabilitation, and reconciliation.

16. Again, the Government recognizes these shortcomings and outlines proposed reforms in Regaining Sri Lanka. It has already introduced some reforms⁹ and is committed to restructuring state enterprises (including state-owned banks), reforming public administration, reducing public sector involvement in commercial activities, and introducing a new organization to implement externally funded projects. While these, and the laws and regulations on which they will be based, will inevitably take time to implement fully, a commendable start has been made.

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F. Gender Assessment and Selected Social Issues

17. The economic and social status of Sri Lankan women is relatively better than in many other developing countries (Appendix 3). Compared with other South Asian countries, Sri Lankan women have fared favorably. But, gender equality or empowerment in the context of all the provisions of the UN Convention on the Elimination of All Forms of Discrimination Against Women remains to be achieved. While the country has made major progress in promoting human development among women, women had reached only 69% of the level of human development achieved by men, as measured by the Gender Development Index¹⁰ (not including the North and East). According to the Human Development Report (2002), the Gender Empowerment measure was only 0.274.

18. Relative achievements in the human development of women are especially pronounced in terms of life expectancy, which is significantly longer than the average in developing countries. This has resulted in increased number of widows and impoverished elderly women in the country. The situation in the North and East is worse than in other parts of the country: For example, there are 30,000 war widows; 300,000 displaced children; a maternal mortality ratio and an infant mortality rate of double and treble the national average, respectively; home birth deliveries of up to 10 times the national average; a school dropout rate of four times the national average; significantly poorer access to sanitation facilities; and the collective trauma as a result of the war.

19. Two decades of armed conflict have exacerbated constraints and generated new social problems resulting in deterioration in the quality of life of women. Many women have been thrust abruptly into positions of heads of households, responsible for the welfare of their families in the context of deprivation and instability. Communities have been disrupted, physical and social infrastructure destroyed and productive assets lost. Current challenges facing Sri Lankan women include poverty and deprivation as they share a disproportionate burden of survivors in conflict affected areas, increased violence against women as a consequence of militarization and forging a space and role for women in the peace and reconciliation process.

20. Women are most disadvantaged in the labor market as they are concentrated in low-paying semi-skilled labor-intensive jobs (often in the Middle East), and subject to long hours, poor wages, job insecurity, subordinate positions, few promotion opportunities, and inequitable gender division of labor. Gender mainstreaming in sector policies, or its monitoring, is also rare, and issues of governance rarely go beyond efficiency concerns to include gender equity. This is despite the fact that remittances and tea and garment exports depend largely on women. Currently, unemployment rates among women in Sri Lanka are twice those of men (but fell more quickly than among men in the 1990s) and women still experience gender stereotyping in job choice.

21. The The country ranked 89th out of 173 countries in 2000 in UNDP’s Human Development Index—higher than that suggested by its income—and it attained the highest level in South Asia (0.74). Some of the Millennium Development Goals (MDGs) (Appendix 1) have already been met. However, the quality of social services is often poor. Moreover, inadequate calorie intake in low-income families causes wasting among the under-5s and maternal undernutrition, the latter triggering a fairly high incidence of low-birth-weight babies. Access to safe water is at 80% overall but the water is often of relatively poor quality especially in the North and East (where water sources are frequently badly polluted) and in the rural areas more generally. In the conflict-affected areas, population displacement has led to a rise in infectious diseases and malnutrition. Malaria has increased tremendously since the conflict began owing to disrupted vector control activities, inadequate numbers of health workers, and limited access to treatment facilities.

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G. Private Sector

22. Constraints on private sector initiatives continue to hold back all areas of the economy, and they serve to maintain low productivity or to reduce it, to discourage domestic investors, to deter foreign investors, and to constrain Sri Lanka’s international competitiveness. Potential opportunities for GDP and income growth are thus missed, and those for job creation forgone. There are many issues to be tackled, and they are related to the legislative and regulatory base, restrictive labor regulations, inadequately trained labor, skills’ deficiencies, high labor turnover, mechanism for labor disputes, weak corporate governance, and poor infrastructure, etc.

23. In the particular case of private small and medium enterprises (SMEs), which seem to offer major potential for investment, job creation, poverty reduction, and exports, several issues curb their activities: (i) stringent and inflexible labor laws, and legislative restrictions on business restructuring; (ii) the absence until late 2002 of an overall strategy, while there have been numerous SME incentives, there has been no coordinating mechanism; (iii) the absence unitl mid 2003 of a reliable SME database; (iv) a complex regulatory framework, something that has affected all firms but is particularly demanding for SMEs and leads to high transaction costs for them; (v) a complex, uncertain tax/incentive system causing procedural difficulty with compliance; (vi) difficulties in obtaining finance, high interest costs on short-term borrowing, and delays in the payment for goods and services supplied to government institutions; and (vii) limited access to facilities for strengthening business capabilities.<

24. In Regaining Sri Lanka, the Government addresses these deficiencies and outlines its commitment to improving the enabling environment, generating business opportunities, and catalyzing private sector development through withdrawing from commercial activities; reforming and liberalizing its tax, trade, and regulatory policies; extending privatization and public-private partnerships; loosening market entry and exit; amending finance, bankruptcy, and labor laws; strengthening the finance and banking system; and improving corporate governance and accounting standards. As its reforms progress, and many are being implemented with ADB and other external agency assistance, the Government sees them as the basis for higher productivity, increased savings and investment, and less unemployment.

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H. Environment

25. Forests cover a total of 28% of the country’s land area, with about 1.65 million hectares (ha) of natural forests. Sri Lanka’s high population density and sustained efforts to improve living standards have placed tremendous pressure on the country’s natural environment. The Government’s State of the Environment Report 2001 identifies five key environmental issues—land degradation due to soil erosion, inadequate disposal of solid and liquid waste in urban areas, pollution of inland waters, loss of biodiversity, and degradation of coastal resources—as priority problems necessitating urgent corrective action. Land was identified as the most critical and severely threatened natural resource, given its importance to agriculture, where the majority of Sri Lanka’s poor continue to obtain their livelihoods. Deforestation in particular has led to flooding and erosion in rainfed agricultural areas where many rural poor live, triggering loss of fertile topsoil and increased siltation, which in turn have impaired the efficiency of the country’s irrigation and hydropower systems.

26. The Government recognizes that its regulatory and institutional framework is inadequate to deal effectively with the environmental challenges that have emerged and is now in the process of strengthening its capacity to undertake natural resource and environmental management. Following the establishment of the Ministry of Environment and Natural Resources in 2001, a new environmental policy and national environmental action plan have been prepared and are in the process of being enacted. A number of natural resource subsector policies and plans (e.g., in forests, wildlife, biodiversity, fisheries, water resources, watersheds, and coastal resources) are also in preparation, and progress is being made at the subsector level with development planning, drafting of new legislation, and capacity building in the relevant government institutions. However, implementation of the evolving natural resource and environmental management framework—which is often the responsibility of local government agencies that lack the required institutional, human, and financial capacity—remains inadequate and must be further strengthened if adverse impacts on the environment are to be effectively managed and mitigated.

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I. Regional Cooperation

27. The Government considers that it has been somewhat slow in fostering greater bilateral and regional integration and cooperation when compared with Southeast Asia, the Pacific Rim, and the European Union. Given that Colombo is one of the few deepwater ports close to the subcontinent and lying on the main shipping route connecting East and Southeast Asia, Europe, and North and South America, the Government regards the country as being ideally located to serve as a hub for regional container and transshipment traffic, for example.

28. At bilateral level, commitments under the Indo-Lanka Free Trade Agreement (ILFTA) are progressing, steps for a similar agreement with Pakistan have been initiated, further diplomatic missions abroad have been set up, and relations with other trading groups and institutions are being strengthened. At the regional level, progress in establishing preferential trading relationships and in settling further areas of interest are being made under the South Asian Association for Regional Cooperation (SAARC); the South Asian Preferential Trading Arrangement (SAPTA); the Bangladesh, Myanmar, India, Sri Lanka, Thailand-Economic Cooperation (BMIST-EC); the Indian Ocean Rim Association for Regional Cooperation; and the South Asian Cooperation on Environment Program (SACEP). The role of ADB in these has thus far been limited but it has been involved in the development of a SAARC protocol on air quality

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