Sri Lanka - Issues in macro-economic and industrial development policy

Report No. 670 I-cr Sri Lanka Issues in Macro-Ecootnic and InduJ.strial D(e;velopnment Policy April 20, 1487 " I \'1.I I ii .I FOR OFFICIAL USE ONLY Document of the World Bank I h iof duint lt has 1 ret'ri n distribution ancl may be used by recipients only in [he pertorimiarn e of their official dutic-, Its contents may not otherwise be disJloscd wvithout WNIorld Batik dthtoiroiization.  CURRENCY EQUIVALENTS (Annual Averages) Sri Lanka Rupees per US$1.00 1978 - Rs 15.61 1979 - Rs 15.57 1980 - Rs 16.53 1981 - Rs 19.25 1982 - Rs 20.81 1983 - Rs 23.53 1984 - Rs 25.44 1985 - Rs 27.16 1986 - Rs 28.02 GLOSSARY AND PRINCIPAL ACRONYMS BTT - Business Turnover Tax CCPI - Colombo Consumer Price Index CDS - Committee of Development Secretaries CWE - Cooperative Wholesale Establishment EDB - Export Development Board EDISS - Export Development Investment Support Scheme FCBU - Foreign Currency Banking Unit FIAC - Foreign Investment Advisory Committee FTZ - Free Trade Zone GCEC - Greater Colombo Economic Commission GOBUs - Government Owned Business Undertakings IPC - Industrial Policy Committee IPZ - Industrial Processing Zone JEDB - Janatha Estates Development Board LIAC - Local Investment Advisory Committee NPC - National Price Commission PMEs - Public Manufacturing En erprises PTC - Presidential Tariff Commission SPC - State Plantations Corporation Fiscal Year January 1 to December 31  VOl OMCM1 US ONLY TITLE SRI LANKA - ISSUES IN MACROECONOMIC AND INDUSTRIAL DEVELOPMENT POLICY COUNTRY s SRI LANKA REGION s SOUTH ASIA SECTOR : COUNTRY ECONOMIC REPORT TYPE CLASSIF MN/YY LANGUAGES 6701-CE CEM Restricted 04 87 English PUBDATE : 8704 ABSTRACT The Government of Sri Lanka is now confronted with the most difficult problems it has had to face since it took office in 1977. Growth is slowing, unemployment is rising, the fiscal situation is precarious, and a balance of payments crisis is not unlikely. The reasons for the deterioration of the economy are complex. They are related to insufficient adjustments in macroeconomic policies, adverse external developments and a complex political situation. The report notes that delaying the corrective measures that are needed would increase their cost and may dis.zpt Sri Lanka's development process. The analysis of the corrective measures- a change in the exchange rate policy; a reduction in public expenditures accompanied by an improvement in their quality; and a change in industrial policies focussing on tariff reform, export promotion measures and efficiency improvement of public manufacturing enterprises--constitutes the main theme of the report. This document has a stricted distribution and may be used by reipients only in the perfornance of their offici duties. Its contents may not otherwise be disclosed without World Bak authoiation.  SRI LANA - ISSUES IN MACRO-ECONOMIC AND INDUSTRIAL DEVELOPMENT POLICY Table of Contents Page llo. Country Data EECUTIVE SUmmARY i PART I: ECONOMIC DEVELWPMENTS AND PROSPECTS ..................... 1 1. The 1977 Liberalization *........o..,,..,.o.oeoo.o 1 A. The Background to Liberalization in 1977 .............. 1 B. Liberalization in 1977. The Changes in the Incentive Structure ........... 5 C. The Impact of Liberalization. Growth, Exports, and Employment .........00 , 6 II. The Weaknesses in Macro-Economic Management ... ........... 10 A. An Overview .......................................... 10 B. Public Expenditures ................................... 15 C Government Tax Revenues .....0.0............**.00oo* .. 21 D. Balance of Payments e 25 III. The Need for Adjustment *...000.................0.0.0... 0 28 A. The 1987-89 Stabilization Prografi ....... .............. 28 B. Balance of Payments Projections ....................... 34 PART II - INDU-STRIAL DEVELOPMENT ISSUES ........................... 39 I. Introduction . *00000000000009000****060 .............o* 39 II. Tariff Policies .................... .. .******** 43 Ao Goals of Tariff Policies *0.. ......................... 43 B. The Tariff Schedule ................ .*......*. 44 C. Non-Tariff Protection 0.0.00...... 00040000 .....e.o00 47 D. Assessment of Statutary Protection ....................e 47 E. Agenda for Future Reforms ............................. 49  -2- III. Export Promotion Measures .......................... 51 A* Background ........... 51 B. Export Promotion Schemes and Recommendations 51 IV. Role of Public Manufacturing Enterprises .o....*..o....... 55 A . Ba4kground aao 4 0 # I 0*0 5 5 B. PME's Business Practices ....*......................... 57 C. Agenda for Future Reforms o.*o..oo.*. o****.*.... *..*.*. 60 V. Business Climate ................ . 61 A. Impact of Past Policies 61 B. Other Factors Affecting the Business Climate .......... 63 Annex It The Public Investment Program and the Balance of Payments 70 Annex IIS Fiscal Impact of Alternative Tariff Systemstems....o..o.. 73 STATISTICAL APPENDIX ..17...... 77 MAP This report is based on the findings of an economic mission which visited Sri Lanka during November/December 1986. The economic mission consisted of Mr. R. Zagha (hief of Mission), Mmes. K. Uchimura (Industrial Development Issues) and P. Aizenman (Public Investment Program and Macroeconomic projections). The report benefitted from the contributions of the industrial sector mission which visited Sri Lanka at the same time. The industrial sector mission consisted of Mr. D. Groves (Chief of Mission), Messrs. T. Maxwell, D. Kochav, D. Vittas, and Ms. Candoy-Sekse. Mr. D. Jayantha of the Resident Mission contributed to the industrial sector part of the report.  -3- TEXT TABLES Page No. Table 1: Indicators of Sri Lanka's Growth Performance since Independence *..0000 ..... *.*.oo a .0.... 000000 4 Table 2: Key Economic Variables, 1977-86 *..O..........*...