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Countries and Regions Country Partnership Strategies Document
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Country Strategy and Program 2004-2008: Sri Lanka
V. ADB’s Assistance ProgramA. Overall Assistance Level75. Sri Lanka was classified as B1 in December 1998 and has since been a blend ADF/OCR country in terms of its access to ADB’s financial resources. It is proposed to increase the overall lending level to Sri Lanka to $700 million in 2004–2006 from $600 million in the last planning cycle (2003–2005). This is a response to the higher level of economic activity arising from peace thus far, the future needs of reconstruction and development as peace progresses, and the new government strategy. However, the level and timing of assistance will be contingent on positive development in the peace process and good project performance, without either of which the lending level scenario will be reviewed and may be adjusted accordingly. The lending level and pipeline program will be monitored and evaluated in consultation with the Government and appropriate stakeholders as part of the annual process of CSP updating. 76. An indicative level of $400 million in ADF and $300 million in OCR lending is programmed for 2004–2006. Depending on ADF resource availability in 2004, the ADF lending program will need to be reviewed. The issue will be reviewed and confirmed during the annual Country Program Confirmation Mission. The 2005 and 2006 ADF lending program will depend on the outcome of the discussions regarding ADF replenishment. Owing to the limits on the availability of ADB’s concessional funds, Sri Lanka will have increased access to OCR resources, but contingent upon the country’s ability to service the additional debt. An ADB study on Sri Lanka’s borrowing capacity assessment, based on conservative projections for the country’s macroeconomic indicators, concludes that the country can absorb the additional levels of OCR being proposed to $100 million per year from about $66 million in recent years. The Government agrees with this. ADB will continue to ensure that its lending is consistent with the country’s efforts toward fiscal consolidation and maintaining debt sustainability. 77. ADF allocations and lending to Sri Lanka are triggered by country-specific performance indicators, namely: (i) macroeconomic management; (ii) reforms in major infrastructure sectors; and (iii) portfolio management as agreed in the CSP update of July 2002. In this context, official reserves have increased to 2.7 months of imports, the budget deficit has been reduced to 8.9% of GDP, and the Government has started to implement improved budgeting procedures and to pilot multiyear budgeting in the preparation of its 2003 budget. Spending ceilings were introduced in 2003. The Government has also created the Public Utilities Commission (a regulatory authority for all public utility services), and made progress in improving the financial viability and the planning and implementation capabilities of the sector agencies in energy, roads, and water supply, although portfolio management is still not satisfactory. Accordingly, an overall assessment of these performance triggers concludes a base-case lending scenario for 2004.18 78. Performance triggers to determine future ADF allocations are given in Appendix 1, Table A1.10. The main focus is on the structural reforms and portfolio performance, as adherence to the agreement with IMF’s poverty reduction and growth facility and extended fund facility conditions should ensure macroeconomic stability. However, control of the fiscal deficit and extension of the tax base have been included as they directly affect the country’s ability to manage its public debt. The structural reforms focus on the key infrastructure sectors in ADB’s operations (energy, transport, and water supply), while portfolio performance is emphasized, as this needs improvement if the additional funds to support reconstruction are to be absorbed. 79. The lending pipeline for 2004–2006 is included in Appendix 1, Table A1.11. Of the proposed lending volume, 46% are poverty interventions, of which 44% are core poverty interventions. The nonlending program is in Appendix 1, Table A1.12 and amounts to $12.8 million of which $2.8 million cofinancing is envisaged. The nonlending program includes 19 projects to support project preparation (11), institutional development (6) particularly to promote good governance, and economic, thematic, and sector work (2) in the road and energy sectors in preparation for future interventions. B. ADB Assistance for Strategic Priorities80. This section describes how ADB’s pipeline program for 2004–2006 supports the strategy. It summarizes the likely areas of sector and thematic involvement and describes their interdependence, with thematic and sector strategies and roadmaps discussed in more detail in Appendix 3; and the concept papers of pipeline projects are in Appendixes 4 and 5. 1. Promoting Pro-poor Economic Growtha. Physical Infrastructure81. In the transport sector, the main emphasis will be placed on roads and, secondarily, on ports. Inefficient road transport has constrained the expansion of economic opportunities and the reduction of poverty principally by hindering local investment, by restricting the access of the poor to markets and social services, and by inhibiting the emergence of subsidiary growth poles and the dispersion of opportunities from them. Critical sector needs include: (i) rehabilitating and improving a rundown road network; (ii) constructing expressways to connect major cities in order to expand and integrate the domestic market; (iii) providing sufficient road maintenance funds so as to sustain new or refurbished construction; (iv) improving bus transport services; (v) strengthening deficient institutional capabilities to manage the road network properly; and (vi) promoting greater private participation in financing, building, operating, and maintaining the road network. The ADB’s medium-term sector strategy will be to continue to address these needs so as to improve marketing opportunities and accessibility, and to optimize sector efficiency. 82. In its port operations, ADB’s strategy is to enhance private sector development through promoting an enabling environment for private sector activity, encouraging public-private partnership, and directly investing in private companies. Efficiency improvements will be a necessary component of infrastructure expansion schemes, and establishing a credible port regulator will be important to attract private sector investment on more appealing terms. ADB will continue to support government policy of strengthening the position of Colombo port as a hub port in the South Asian region, and to consider integrated port development in the country based on the needs of particular hinterlands, the availability of alternative and complementary transport modes, as well as national and international shipping trends. 83. In energy, the sufficient, uninterrupted delivery of energy, either as electricity or petroleum products, is a prerequisite for economic growth, both in rural and urban areas. This is a basic pillar in reaching the economic and social targets outlined in the Government’s development strategy, in ensuring improved service deliveries at affordable prices, and in accelerating socioeconomic recovery in the North and East as peace unfolds. The Government is committed to the ADB-financed restructuring of the power sector, including unbundling the two state-owned power companies. Moreover, to be consistent with national GDP growth projections,19 power demand over the medium and long term has to be met in an affordable and efficient manner, particularly ensuring adequate, reliable, and uninterrupted power supply from 2004.20 Since reliance on emergency power is costly and poses an additional challenge to the sector’s financial viability, low-cost base-load generation facilities need to be developed. They need to be decided upon, built, and commissioned in time to meet projected power demand. 84. ADB will thus focus on power sector restructuring and the beginning of oil and gas exploration within the marine borders of Sri Lanka. In addition, ADB is considering assistance for further rural electrification, with particular emphasis on providing electricity to some of the poorer segments of the rural population. Toward the end of the CSP period, it will be timely to undertake a review of the sector reform implementation process, evaluate the actual changes, and recommend further reforms and/or possible corrective actions. Private sector participation in energy should continue to increase as the operating environment becomes more conducive to competition in the areas of power generation, transmission and distribution, petroleum, and oil and gas exploration. ADB will continue to support this. b. Agriculture and Rural Development85. ADB supports the Government’s strategy to raise productivity in agriculture, where crop yields are currently among the lowest in Asia and could be greatly enhanced by improving the policy and regulatory environment for private activity and promoting broader commercialization of the sector. Greater private sector involvement in research and extension, infrastructure provision, and marketing and financial services will be necessary to raise the technological level in agriculture and enhance responsiveness to market opportunities. In this regard, ADB will assist in developing viable project interventions as well as identifying key policy or regulatory features of the enabling environment that need to be redefined to make agriculture more commercialized, with investment and growth driven by the private sector. ADB’s program in agriculture will allow flexibility to respond to immediate and medium-term rehabilitation needs in the North and East, where the conflict has severely disrupted agricultural production and marketing systems, including support to restore rural infrastructure (access roads, small bridges, drainage networks, and small irrigation tanks) and livelihoods (crops, fisheries, and livestock), among other areas. 86. In addition, the expanded agribusiness management capacity resulting from privatization of the plantation companies would be harnessed to promote best practices in contract farming, management contracts, and processing of agricultural outputs for organized small-scale farmers outside the estate crop subsector. Similarly, the ongoing assistance in the Southern Province, which seeks to encourage the private sector to lead rural development with the Government limited to being a facilitator, will be drawn upon for lessons and future intervention strategies. c. Financial Sector and Small and Medium Enterprises87. The Government’s development strategy places explicit and expanded emphasis on the lead role expected of the private sector in the country’s future development, and it devotes a significant amount of discussion to analyzing the factors that currently impede its role and to proposing reforms to them. Critical areas of reform to be supported by ADB will focus on strengthening the nonblank financial markets, deepening the capital market through a wider range of financial instruments, establishing a suitable regulatory framework for nonbank financial institutions (including those operating in rural finance), supporting availability of financing for SMEs and rural finance, providing easy access to business development services for SMEs, developing a SME website to support SME growth, and develop a SME database to assist the Government in formulating SME policy. Some of these are being supported under ongoing technical assistance attached to the private sector and SME loans. But new innovative products attracting domestic and international capital, and improved access to these products, will reduce the cost of capital and financial risk; enable the diversification of investment opportunities and savings instruments; improve market liquidity, efficiency and transparency; and mobilize savings.  2. Advancing Social Development88. The complex characteristics of those living in poverty and deprived circumstances take many forms, and extend far beyond having low incomes alone. Moreover, these characteristics are often mutually reinforcing and self-perpetuating as a group, with each reacting on the others in a vicious circle of cause and effect. To support the interventions that primarily address the income dimension of poverty, ADB’s strategy highlights interventions that support progress in the nonincome, human dimension of poverty. While the Government has shown a long-standing commitment to the social welfare of its people, significant disparities in access to social services remain, with marked regional variations in human development. a. Education89. Despite the notable achievements of the country in the field of education, numerous issues remain, especially at post-primary levels. ADB will continue to support secondary and postsecondary education to enhance human resources development. In addition, ADB will seek to (i) accelerate poverty reduction through targeted investments to raise the educational attainments of low-income groups; (ii) develop Sri Lanka's higher-level human resources to achieve skills-based competitiveness on which its future growth heavily depends; (iii) seek to narrow, where possible, the prevailing wide gender gap in access to technical and vocational education as well as to information technology; and (iv) help influence the advancement of curricula design in order to reflect the needs of a modern labor market more appropriately. b. Water Supply and Sanitation90. The Government is committed to providing safe water for the entire population by 2025. In rural areas, community based, demand-driven systems will be developed along with the increasing participation of local government and communities in cost recovery and operation and maintenance. ADB will assist the Government in the decentralization of service delivery to local governments and continue to use the community participatory approach in rural areas. Township and urban water supply delivery will aim for greater operational efficiency and financial sustainability of networks, by implementing reforms in the National Water Supply and Drainage Board (NWSDB) and supporting public-private partnerships. 91. The Government has also expressed, as a priority, expanding sewerage services in major cities. ADB will support the Government in introducing sewerage tariffs and other necessary reforms, including greater operational and financial efficiency of NWSDB and the increasing participation of the private sector in the sector. ADB will consider supporting the Government in implementing the Urban Policy, especially a solid waste disposal strategy through a basic social infrastructure development project proposed for 2004. 
3. Supporting Improved Governance92. Improving governance is a key priority of the Government’s strategy. It is concerned with improving the effectiveness and efficiency of public services and public policy management within the overall objective of achieving higher sustainable economic growth, a reduction of poverty, and fiscal consolidation. A service delivery policy framework that ensures services are equitable, accessible, efficient, and sustainable is an essential vehicle for improvements in service delivery. The policy framework will need to be formulated as an integral part of programs directed at improving services, and this will require an approach enabling governance to be mainstreamed in specific sector investments. A twin-track approach is proposed: (i) a core service delivery reform initiative that allows for evolving and introducing a service delivery policy framework through pilot projects in selected priority services in certain areas (including the North and East), and the subsequent upscaling of these; and (ii) ADB’s proposed projects in roads, energy, and water supply and sanitation could mainstream this approach through developing and implementing service delivery policies for their sectors. These will be in addition to sector management reform measures currently being applied under individual project loans. 
C. External Funding Coordination and Partnership Arrangements93. As noted earlier, there are many external assistance agencies active in Sri Lanka but three major ones: Japan and ADB (jointly providing some 70% of total annual commitments in 1998–2002), and the World Bank providing some 8%. Twenty-two other sources of different size provide 22% between them. They comprise Australia, Canada, People’s Republic of China (PRC), European Union, France, Germany, India, International Fund for Agricultural Development (IFAD), Korea, Kuwait, Netherlands, New Zealand, Norway, Nordic Fund, Organization of Petroleum Exporting Countries (OPEC), Saudi Fund, Sweden, United Kingdom, United States, and several agencies of the United Nations. 94. ADB regularly consults with multilateral organizations, including IMF, and the main bilateral agencies, while 20 or more countries and international organizations attended the Local Development Forum in June 2002, and even more attended the Tokyo Conference on Reconstruction and Development in June 2003.21 Moreover, in view of the large proportion of external assistance coming from Japan, ADB, and the World Bank, particular attention is paid to close coordination among them to ensure compatibility of policy advice and the harmonization of their investments. A joint strategy seminar was organized by the Japan Bank for International Cooperation in Tokyo, in February 2003, in which ADB and the World Bank participated, to exchange views on respective strategy formulation.22 In this, the Sri Lanka Resident Mission is playing a crucial role in local funding agency coordination, particularly in those sectors where ADB has been especially prominent, notably in roads, energy, water and sanitation, and environmental and natural resources management. A matrix of external funding coordination—summarizing the current strategies and activities of ADB and its development partners—is presented in Appendix 1, Table A1.5. 95. ADB has progressively strengthened its operational partnerships with its development partners through regular and development agenda-specific consultations in order to enhance the benefits of its development assistance. The developing peace process has provided ADB with additional opportunities to pursue cofinancing operations. The needs assessment jointly undertaken by ADB, World Bank, and the United Nations demonstrates effective collaboration and further coordination and cofinancing opportunities. In support of its overall thematic priorities, ADB will continue to pursue official cofinancing (particularly from grant and concessional sources) for public sector projects and commercial cofinancing (including the use of guarantees) for viable private sector projects in line with the Government’s external borrowing policy under IMF’s current poverty reduction and growth facility and extended fund facility arrangements. D. Indicative Internal Resource Requirements96. An assessment of indicative staff resources required ensuring that adequate delivery of the assistance program for the next 3 years of the CSP was undertaken. Assistance programs for 2002 and 2003 were used as a benchmark for comparison. Substantial staff resources were utilized for preparation of the new CSP in 2002 and 2003 during which 36 person-weeks of international and domestic staff consultants were engaged for background studies. Less than half of staff resources for CSP preparation will be necessary in subsequent years for the preparation of CSPUs and no staff consultants will be required. However, an average increase of one project a year in the lending pipeline and the emphasis in policy and institutional reform measures require additional staff resources in project processing and appropriate skill mix in the next few years. While there will be a slight overall increase in staff resources required for 2004–2006, it is not envisaged to be substantial and will be mitigated with staff deployment within South Asia Department and use of staff consultants. ____________________
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