Countries and Regions

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p. 2 of 4 BACK | NEXT I. Current Development Trends and Issues II. Implementation of the Country Strategy and Program III. Portfolio Management Issues IV. Country Performance and Assistance Levels

Country Strategy and Program Update 2005-2006: Sri Lanka

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II. Implementation of the Country Strategy and Program

A. Progress in Poverty Reduction

7. The new Government has stated that it remains committed to fighting poverty and Sri Lanka is a signatory to the Millennium Development Goals (MDGs). However, The country’s social indicators are already very good; Sri Lanka is the most advanced in South Asia in terms of infant and maternal mortality rates, education ratios, and most gender indexes. Further improvement will be difficult and can only be achieved slowly. Poverty levels have generally fallen. Work and surveys done both by the Central Bank and the Department of Census and Statistics for the first time covered the north and east, but the results of these surveys are not yet fully analyzed or the work are still in progress. Both agencies conduct regular surveys. Mechanisms to collect and obtain consistent data on poverty levels have to be institutionalized before a meaningful monitoring system can be put into place. ADB is assisting the Government in strengthening poverty monitoring and analysis, and in monitoring the poverty impact of foreign-funded projects.² An MDG unit within the Government is monitoring progress in reaching the MDGs and is expected to report regularly on progress made.

B. Progress in the Country Strategy and Program Focus Area

8. ADB’s strategy for Sri Lanka, and the program developed from it, focuses on three areas: (i) economic reform and governance, (ii) rehabilitation in the conflict-affected areas, and (iii) direct poverty reduction and rural infrastructure. Through these projects and programs, ADB in turn supports cross-cutting issues such as governance, gender equity, and the environment. For example, projects in the education and water and sanitation sectors are focusing on gender issues. ADB's assistance also focuses on strengthening regional cooperation, both in the South Asian Association for Regional Cooperation and, on a smaller scale, between Sri Lanka and the Maldives.

1. Economic Reform and Governance

9. Falling revenue collection and high budget deficits that have in the past led to cuts in capital expenditure are among the key constraints for economic growth. Although there have been increases in capital expenditure this year, it is not clear whether they are sustainable. Nevertheless, the Government's stated target for economic growth of about 8% of GDP in the medium-term will not be achieved unless basic infrastructure is put in place. The Government in June 2004 announced it would aim to reduce the budget deficit to about 5% of GDP within 3 years, starting in 2005. It is therefore important to improve the Government's ability to increase revenue collection and improve budget planning. In order to achieve these objectives, the Government will have to increasingly focus on reforms leading to more effective use of public resources. The proposed Fiscal Management Reform program, scheduled for the fourth quarter of 2004 will support the Government's efforts to develop an efficient and modern tax administration.

10. Sri Lanka's electricity prices remain among the highest in South Asia, and power supplies remain unreliable and voltage fluctuations are significant. Despite the high prices the sector is operating at a loss. The lack of any new significant investment in generation capacity during the last decades make reforms even more urgent. Adjusting tariffs, increasing private sector participation, strengthening regulation and the financial viability of the power sector are key. Some reforms have been implemented, but important follow up steps such as a satisfactory restructuring of the power sector into focused entities in generation, transmission and distribution have yet to materialize. Delays in restructuring the power sector have delayed release of the second tranche of $30 million of an ADB reform program.³ The Government has stated that the Strategic Enterprises Management Agency will address this issue, and that the Ceylon Electricity Board will be restructured by the end of the year.

11. The water sector faces problems of deteriorating service delivery, low financial sustainability of the public sector service provider, unclear water rights including groundwater development, and low institutional capacity to increase investment in sanitation and wastewater management. The National Water Resources Act that sought to remedy some of these problems, proved to be controversial, and according to a cabinet decision in June 2004 has not been approved. The Water Services Reform bill still has to be presented to parliament and might be passed by the end of 2004. Both the National Water Resources Act, and the Water Services Reform bill are ultimately important for the functioning of the multisector public utility commission that should oversee electricity, water and transport tariffs.⁴ The Water Services Reform bill is also crucial for one loan, the Greater Colombo Waste Water Management Project in 2006.

12. The road sector is characterized by poor road conditions, and public transport services. Increasing funds available for road sector operations and maintenance, promoting greater private sector participation in road construction and maintenance, and implementing a bus reform program are essential. The Government is committed to adopting a medium term reform framework in its road sector development, an approach supported by ADB. Funding road sector investment will drive ordinary capital resources (OCR) lending in the next 3-5 year period. A technical assistance (TA) loan⁵ approved in early 2004 will prepare a shelf of projects, build capacity and strengthen institutions involved in the road sector. This is underpinned by a Road Sector Masterplan⁶ now being developed with the Government. A road fund has been set up, but so far the budget allocated to road maintenance remains insufficient. The private sector has been given a bigger role in construction - and the provision of port services (para. 13). ADB is also assisting the Government in exploring public-private partnership financing models for high priority infrastructure projects in the road and port sectors. The road sector moved decisively to a greater private sector approach as the road construction company owned by the Government’s Road Development Authority was disbanded in early 2004.⁷ Primary roads will be rehabilitated in 2005 through the National Highway Sector loan and, subject to further discussion on viability and financing modality, so will the Colombo to Katunayake expressway. The port sector recorded significant improvements in labor productivity, partially due to the introduction of private sector competition. Another important infrastructure project, the Colombo Port South Harbor Development project in 2006 needs to go ahead on an urgent basis if the country is not to lose its competitive advantage in the provision of port services.

14. While the Government has yet to define its strategy for the private sector, it has made clear that it will focus on SME development. Overall, private sector development is constrained by high transaction costs arising from overregulation and a complex tax regime, unclear land titling procedures, and rigid labor laws. ADB loans support far-ranging reforms in the legal framework (both labor and regulatory), the removal of trade barriers, strengthening of capital markets, restructuring of SOEs, capacity building for SMEs, and the development of an SME policy.⁸ An SME Development Program II is scheduled for 2006. Labor regulatory reforms moved forward when amendments to the Termination of Employment of Workmen Act were enacted in December 2003, and the hours of overtime female workers were allowed to work were increased to be more in line with their male counterparts.⁹ The Government has stated that it remains committed to the further restructuring and commercialization of SOEs that continue to incur significant losses, without privatizing them (except perhaps smaller, non-strategic entities).

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2. Rehabilitation in the Conflict-Affected Areas

15. ADB, in cooperation with other multilateral institutions, completed a Needs Assessment for the conflict-affected areas in the north and east in preparation for the Sri Lanka Reconstruction and Development Conference held in Tokyo in June 2003. The assessment provides a framework for funding agency assistance in these areas. A guiding principle for all interventions is that tensions that caused and sustained the conflict must be addressed in the framework of projects and programs. All of ADB's projects in the north and east seek to (i) assist all communities evenly, (ii) understand the causes of the conflict and support reconciliation, and (iii) follow the "do no harm" principle, especially in large-scale operations.

16. Progress has been made in making conflict awareness an integral part of ADB programs in the north and east. A post-conflict specialist is now based in ADB's Resident Mission and consultation with all stakeholders in the conflict-affected areas has increased. Management information systems have been installed to track the ethnic and geographic distribution of project activities. Community based and driven development rehabilitation plans form the core of many economic and social activities of ADB's programs in the conflict-affected areas. The north east community restoration and development (NECORD) project II in 2005, will focus more on institution building, reflecting the very limited institutional capacity in the conflictaffected areas. The 2006 program includes the Jaffna water supply project, urgently required to prevent a public health crisis and epidemic outbreak in the Jaffna peninsula. This project, which is likely to cost about $80 million, will require significant co-financing.

3. Poverty Reduction and Rural Infrastructure Development

17. Greater private sector involvement in research, marketing, and extension, as well as infrastructure provision and financial services are necessary to solve some of the most pressing problems of the agriculture sector, which has suffered low growth for the last 3 years. ADB is supporting diversification in agriculture, while at the same time addressing the most pressing needs of plantation sector workers, among the poorest and most disadvantaged segment of Sri Lankan society. Loans and grants for private sector plantations help upgrade the living quarters, health and education facilities of plantation workers.¹⁰ The plantation sector suffers from low productivity, partially due to high labor costs, but also due to old stocks of trees and soil erosion. These efforts are supplemented by a comprehensive program of ongoing rural electrification, and the rehabilitation of both rural and major roads. ADB is also providing support for the development of a policy and legal framework encouraging growth and expansion of the rural finance sector.¹¹ However, the Government is still in the process of formulating its agricultural policy. The ongoing ADB pilot project that privatizes project-related extension services for perennial crops will proceed.¹² But it will be necessary to closely monitor developments in this sector and reassess whether the proposed project for Commercialization of Agriculture, scheduled for 2006, will proceed.

18. The Government also expressed interest in restarting a more substantial rural road program to reduce regional inequality and to stimulate growth in the provinces in line with its stated policy of paying more attention to previously neglected regions of the country. An innovative Basic Social Infrastructure loan in 2005 will improve the capacity of local governments to manage basic infrastructure (roads, water and sewerage).¹³ Youth unemployment remains worryingly high and has been attributed among other things to a skills mismatch and low levels of computerization in schools. Regional inequality in access and quality of education are also of concern. ADB supports both internal administrative reform and the strengthening of vocational training and increased computer literacy. ADB will support the education and training sector in 2005 with the technical education development project to improve the relevance, effectiveness, and efficiency of technical and skilled work force, and operationalize a human resource endowment fund.

C. Highlights in Coordination of External Funding and Partnership Arrangements

19. Cooperation among development partners in Sri Lanka is very good. Funding agency meetings by subgroup ensure good collaboration and sharing of information, and the chairs of these are rotated on a regular basis. An efficient division of labor is taking place in fiscal reform, with the ADB supporting in-depth institutional reforms to complement the International Monetary Fund’s tax policy reforms in an effort to enhance revenue mobilization. These efforts supplement ADB expenditure management reforms under the fiscal reform management project that also feed directly into the ongoing public expenditure review conducted by the World Bank. Projects in the conflict-affected areas, especially the NECORD Project, have also been successful in attracting cofinancing of about $40 million. Funding agencies acknowledge the efficiency of the project and either support components of this project, or use the mechanism to pass through assistance. The Government of Japan gives project support in the power sector. In microfinance, close linkages have been established with the Government of Germany, which will also support this sector. The Swedish International Development Cooperation Agency supports ADB's efforts in improving the financial sector environment, while the Norwegian Agency for Development Cooperation works closely with ADB to strengthen the country's potential in oil and gas exploration; it will also cofinance ADB-supported post-conflict rehabilitation operations. A consultative group meeting chaired by the Government, tentatively planned for later this year in Colombo, will also further cement funding agency relations within the country and with the Government.

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