Sri Lanka - Country assistance strategy : progress report

18711 SRI LAsNKA DEC.20, 1998 COUNTRY ASSISTANCE STRATEGY - PROGRESS REPORT Introduction 1 . The most recent CAS was reviewed by the Board in June 1996 and covered FY97-99. At the time, Sri Lanka was on the verge of a fiscal crisis. The government had postponed reforms in favor of an all-out effort to defeat the rebels and obtain approval of its proposals for a peaceful solution to the 15-year ethnic conflict. Shortly after the CAS discussion, faced with a soaring budget deficit and a loss of confidence in its economic policies, the government embarked on a program of fiscal and structural reforms. As a result, the fiscal deficit and inflation declined, private investment increased, and economic growth rebounded in 1997. A commendable start was made on reforms, especially in privatization. But the war has continued, taking an enormous toll on the country's human, financial, and physical resources. The pace of reforms has slowed over the last year as the government has become preoccupied with politics. Although the government and the opposition favor similar economic policies and recognize the importance of ending the war, their political feuding undercuts economic reforms and peace efforts. A major military setback in October has heightened political tensions. Provincial elections will be held over the next few months. Depending on the results, presidential elections could be held shortly thereafter. In this unsettled political climate, we feel it is better to postpone the full new CAS for a year. The government and the Bank agree that the main tenets of the 1996 CAS remain valid. But given the new challenges posed by the prolonged conflict and global economic developments, we felt it would be useful to present this interim report to review progress against the strategy and discuss the impact of these special circumstances. _. RECENT DEVELOPMENTS 2. The War. The govemment of President Chandrika Kumaratunga was elected in 1994 on a peace platforn, but found itself embroiled in war after the rebel Liberation Tigers of Tamil Eelam (LTTE) broke off peace talks early the next year. Since then, the President has pursued a two-pronged policy to end the ethnic conflict combining a military offensive to defeat or marginalize the LTTE with proposed constitutional amendments designed to give greater autonomy to the heavily Tamil Northeast region within the Sinhalese dominated nation. The devolution proposals have stalled in parliament, and the LTTE has turned out to be a far more formidable force than the government reckoned. After capturing the northern rebel capital of Jaffna in late 1995, the govemment has been unable to gain control of the main road connecting it to the rest of the country. Over 1,700 combatants are believed to have been killed in one week in October. The war is localized in the Northeast, but periodic LTTE suicide bombs are aimed at destabilizing the economy by striking nerve centers in Colombo and scaring tourists and investors. 3. Economic Developments. Despite the war, Sri Lanka has achieved average annual growth of 5 percent throughout the 1990s. Even during the setback of 1996, growth was 3-8 percent. In 1997, the economy responded well to improved macroeconomic policies, good weather, a more favorable external environment-including strong tea prices, and a revival of tourism. After three consecutive years of budget deficits at 10 percent of GDP, the deficit was reduced to 8 percent. The improved fiscal performance, combined with a large increase in foreign private investment, boosted national savings and growth--which reached 6 percent. Inflation declined from a peak of about 16 percent in late 1996 to about 10 percent, where it is now. Unemployment has declined, although at about 10 percent it is still a major policy concernm A credible start was made in public sector restructuring, most notably through privatization of the plantations, a gas utility, Sri Lanka Telecom, and Air Lanka.  -2- 4. In 1998, growing effects of external developments, combined with escalation of the war, have caused the government to lower its economic growth projections from 6 percent to 5 percent. Sound economic management remains a government priority, but political pressures to create jobs and increased military expenditures have again Jeopardized fiscal discipline. Defense spending, which had declined to 5 percent of GDP in 1997 and was projected to fall further, has surged again to 6 percent of GDP. As a result of this expenditure slippage, as well as weakening revenue performance, the overall budget deficit is expected to remain at about the 1997 level of 8 percent of GDP compared to an original target of 6.5 percent. Considering the prospect of elections, the 1999 budget which was announced in November shows some restraint. To boost revenues, it includes higher excise taxes on tobacco and alcohol, and an increase in the national security levy (a turnover tax) from 4.5 to 5.5 percent. But the projected decrease in the deficit to 6 percent of GDP relies, as it did in 1998, on a doubtful reduction in defense expenditures. The 1999 budget contains fewer giveaways than in the past, but it also includes few reform initiatives. The one significant measure is a reduction in the three-band tariff rates--from 10, 20, and 35 percent to 5, 10, and 25 percent (except for agriculture)--and announcement that the number of bands will be reduced to two in 2000. 5. External balances in 1997 and 1998 reflected the underlying upturn from 1996 and a favorable extemal environment. Sri Lanka's terms of trade have improved significantly following a rise in world market prices for tea and garments and a decline in food and petroleum prices. Private remittances have increased, and foreign investment has remained relatively high. The current account deficit has declined to about 3 percent of GDP in 1997 and 1998, and external reserves have remained at about four months of imports. The Sri Lankan rupee has been allowed to depreciate by about 20 percent over the last two years, which has helped protect the country's external competitiveness. 6. External Environment. Throughout 1997 and the first half of 1998, Sri Lanka remained relatively sheltered from the East Asian financial crisis-largely because of a manageable debt profile, the favorable terms of trade, effective management of the exchange rate, and partial capital controls. Earlier investor concerns about security had precluded the massive capital inflows which destabilized other Asian countries. Sri Lanka's garment exports have increased in 1997 and 1998, thanks in part to a move into higher value-added items and niche markets. Tea exports have grown by over 16 percent as exports to the Middle East have replaced those to Russia. Signs of a growing adverse external impact have, however, emerged more recently. Most manufactured exports are facing increasing competition from countries which have devalued more rapidly than Sri Lanka. Tourism is still below the pre-1997 level. A slowdown in direct foreign investment is expected since Korea, Japan, and Malaysia were Sri Lanka's leading investors in recent years. The combined effect of the retreat from emerging markets and sanctions on India and Pakistan contributed to a fall in the Colombo stock market of over 25 percent earlier this year, but it has stabilized recently along with other Asian markets. II. PROGRESS UNDER THE 1996 CAS 7. The government and the Bank agree that the CAS strategy of promoting private sector- led growth in a manner consistent with the country's traditional concern for social welfare and equity continues to be appropnrate. We also continue to agree that peace is a prerequisite for sustained economic growth and poverty alleviation-to restore the productive capacity of the Northeast, sustain private sector confidence, realize the country's tourism potential, and release resources for productive use. It is to the government's credit that Sri Lanka has achieved as much progress as it has in spite of the war. But the human and financial cost of the conflict has become ever more striking. Over 50,000 people have been killed, leaving fractured families and a financial burden for the government. A generation has known nothing but war. The Northeast has been devastated, and half a million people have been displaced. The recent military debacle  -3- has underscored the need for the government and the opposition to join together in efforts to find a peaceful solution to the conflict. 8. To complete the transition from socialism to a market economy while reinforcing Sri Lanka's deep commitment to equity and social development, the CAS suggested the government needed to: * move quickly toward a sustainable fiscal deficit; * improve the policy environment for private investment; * capitalize on earlier human resource investments; and * better focus its poverty reduction efforts. 9. The CAS noted that success would depend on engaging stakeholders-including parliamentarians, business, labor, NGOs, and environmentalists--in the policy-making process. Considerable progress has been made in the last two years in opening up the debate and setting the reform agenda in these areas. Private investment has increased in response to new incentives. But the process of transforming the role of govemment from providing jobs and welfare to providing opportunity and encouraging private initiative remains incomplete. And the momentum of reform has slowed over the last year as politics and the war have distracted policy makers. The 1996 CAS rated Sri Lanka in the low end of the base case because of the unmanageable fiscal deficit and stalled reforms. Following the policy turnaround in late-1996, it moved into and has remained in the mid-base case. The authorities have discussed a possible ESAF agreement with the IMF, but they do not feel they can agree to any specific, time-bound reform measures until after elections. Uncertainties about the future impact of the global economy make it particularly important that the government rededicate itself to fiscal discipline and structural reforms. Fiscal Discipline 10. The CAS pointed out that while the unsustainable fiscal deficit was caused in large part by defense spending, there were also serious structural problems in the non-defense share of the budget. The legacy of past years had resulted in a high debt service burden. And civil service salaries and poorly targeted transfer programs had been protected at the expense of operations and maintenance (O&M) and needed public investment. Among the major opportunities for restructuring current expenditures, the CAS included restraining wages and pensions, reducing transfers to public enterprises by closing or restructuring loss makers, curtailing generous entitlements and subsidies, and improved targeting to the poor. 11. The costly wheat flour subsidy (equivalent to 1 percent of GDP) was eliminated in 1997. Progress has also been made in reducing debt service, reflecting the deficit reduction and use of privatization receipts to retire domestic debt. The General Services Tax (GST--a value-added tax) foreseen in the CAS was implemented in April 1998. But there have also been worrisome trends. Public revenues have declined over the past three years. Since the GST was introduced at a less than revenue-neutral rate, it has contributed to the revenue shortfall in 1998. There has been only limited improvement in targeting of social transfer programs, for which half the population still qualifies. Although the government imposed strict controls on public sector employment and public finance management in late 1996, unneeded new workers have recently been hired in a number of agencies, including ports and the petroleum corporation. Thousands of unqualified teachers have been employed, undermining education reforms as well as fiscal  -4 - discipline. Non-personnel O&M costs and overdue public investment continue to feel the brunt of expenditure cuts. 12. The immediate fiscal need is to stem the hemorrhaging and enforce the government's own guidelines on public employment. For the medium-term, the need to restructure public expenditures to put them on a sustainable basis remains as great as when the CAS was discussed. The largest returns will come from reducing government employment and the pension bill. Closing unneeded statutory boards and restructuring loss-making enterprises--especially the railroads, public transport, and urban water--are also still high fiscal priorities. To reverse the revenue decline, the govemment needs to review the performance of the GST with a view to raising the rate and reducing the number of exemptions. Policy Environment for Private Investment and Employment 13. The CAS noted that Sri Lanka's success in attracting foreign private investment, its export orientation, and market-oriented reforms boded well for the country's future. But the CAS added that sustained economic expansion would require much more improvement in the policy environment and infrastructure development. It called for a redefinition of the role of the state in productive sectors by transferring some functions to the private sector or user groups, revising the incentive framework, and strengthening the government's regulatory capacity. Although President Kumaratunga came into office with a socialist legacy, she has emerged as a strong supporter of economic liberalization. The government's record on privatization is strong. Sale of the tea plantations and telecoms has improved productivity and service--building popular support for privatization and sending a positive signal to foreign and domestic investors. But the President is often blocked in her efforts-not just by the political opposition, but also by leftist members of her own cabinet and powerful interest groups, including public sector unions. Some privatization transactions have been controversial. And the recent East Asian experience has strengthened the hands of opponents of liberalization. Recent global developments have also heightened the concern, which was expressed in the CAS, that economic growth not be at the expense of equity, social welfare, and the natural environment. 14. The government appreciates the need to strengthen the legal and regulatory framework for private investment at both the systemic and sectoral levels. To address the broad obstacles and improve transparency, it is preparing the Legal Reform project mentioned in the CAS. The CAS identified restrictive labor laws and powerful public sector unions as major deterrents to private investment. Early constructive discussions with the workers have been a critical factor in each of the successful privatizations. But there has been little overall improvement in labor relations in the government and large firms. Much of the recent job growth has come from small export-oriented firms which are not subject to the more restrictive labor laws. E .orts to balance the needs of environmentalprotection with private sector growth have also been disappointing. In some instances needed infrastructure investments have been delayed because of environmental disputes, while overall environmental enforcement remains weak. 15. The pace of individual sector reforms varies-depending on such factors as degree of private sector interest, strength of vested interests, and the receptivity of the political leadership. Infrastructure and Energy. Weak infrastructure and associated services remain a major constraint to growth. But there are signs of change, especially in telecommunications and ports. Privatization of Sri Lanka Telecom in 1997 and introduction of new operators to create a competitive market for basic telephone services have augmented supply by almost 50 percent-not counting sizable cellular service. Limited liberalization has improved port services. The government has signed a contract with a private consortium for a major investment in the Colombo port. And it is preparing a project to promote greater efficiency  -5- and private investment to help ensure Sri Lanka's future as a major trans-shipment hub. There has been less progress in other state-controlled subsectors--including railways, roads, urban transport, power, and water and sanitation-which are marked by poor service, weak management, overstaffing, a deteriorating asset base, and inadequate investment. But even here, there are signs of greater receptivity to change. Preparation is underway for projects to restructure the postal service and urban water and sewerage. In the energy sector, where resistance to reform has in the past been particularly strong, the authorities have agreed in principle with the Bank and the Asian Development Bank (ADB) on a restructuring program which would pave the way for private participation. The next step is to prepare a regulatory framework for energy investments. In the meantime, the authorities have signed contracts for two small private power investments, including one partly financed by IFC. Agriculture. While privatization of the plantations has increased their productivity, overall agricultural sector performance remains below potential. The government continues to intervene in both input and output markets, land tenure laws restrict sales, and there is little cost recovery in irrigation. But in the past year, the President has encouraged more analysis and discussion of agricultural strategy, including marketing and water and natural resource conservation issues. As a first step toward liberalizing land markets, the government is preparing a pilot Land Titling project. Although there has been little movement on irrigation policies, approval of the IDA-financed Mahaweli Restructuring project (FY98) was a breakthrough. This project is expected to improve the efficiency of the huge irrigation, and power authority and demonstrate the advantages of downsizing and transferring functions to farmers and the private sector. Financial Sector 16. A recent report prepared by the Bank concluded that although the financial sector was still shallow and inefficient, there had been some improvement. Large state institutions continue to dominate banking, insurance, and pensions. The two big state banks-Bank of Ceylon and Peoples' Bank--are not presently insolvent, but they are inefficient, reduce competition, and are subject to government intervention. The govemment has ruled out privatization for the time being because of strong opposition from the banking unions. The authorities have recently signed performance contracts with the state banks, but it is too soon to see if they will have the desired effect of increasing the banks' autonomy and accountability. Banking regulation and supervision have been strengthened somewhat, and the legal framework for loan recovery has been improved. In view of the political and intemational uncertainties, the govemment needs to be vigilant in implementing these reforms. Social Development and Poverty Alleviation 17. Health and Education. The CAS cautioned that despite Sri Lanka's impressive social indicators, there were signs of deterioration in the quality of services, as well growing questions about fiscal sustainability. The incidence of child malnutrition and malaria remained high, while there were growing concems about HIV/AIDS. A Bank report on Social Services issued earlier this year noted that health and education programs had failed to adapt to the needs of an open, market economy and changing demographics--including an aging population and fewer school- age children. Past policies-whether well-intentioned or politically motivated-had had a divisive effect on social development. Over the last year, the govemment has begun to recognize the challenge it faces in preserving and building upon its past investments in human capital. Educators and health professionals who formerly guarded their professional interests jealously are contemplating far-reaching reforms. The President and others have begun to speak out about ways in which education policies divide children by language and under-serve students in poorer  -6 - areas. But resistance to change remains strong. Continued political leadership is needed to build momentum for reforn in both health and education and agree on action plans. All stakeholders-- including the private sector, unions, NGOs, and consumers-must be included in the dialogue. 18. Poverty Alleviation. The govemment and the Bank agree with the CAS premise that poverty reduction can best be achieved though rapid private sector-led growth and employment, complemented by investments in human capital and a social safety net for the very poor. But there are still questions about how to translate this general approach into a concrete poverty strategy in the Sri Lankan context, as well as about how to consider the impact on the poor in economic and sector policy making. Some officials continue to emphasize social transfer payments and public sector employment. With support from the Bank and UNDP, the authorities are reexamining sector policies and programs to see how they affect poverty reduction goals. The objective is to develop a comprehensive poverty strategy which takes account of market forces and addresses social, ethnic, and geographic concems. This willingness to address the social and economic causes of continuing poverty and inequity is a step forward. But it will take strong leadership to forge a consensus on policy and program priorities. Here again, all stakeholders, including NGOs and community representatives, need to be included in the debate. Governance 19. The CAS referred to Sri Lanka's misguided attempt at civil service reform in the early 1990s and called for another attempt to reduce public sector employment. The President recognizes the need to redefine the role of the state to serve the needs of a modernizing economy and a multi-ethnic society. And in the early years of her administration she vowed to reform public administration. But since the CAS, she has not felt she had sufficient political support to challenge strong interests-including the unions-given the need to maintain support for the war. Rather than attack comprehensive civil service reform at this time, the government is considering more limited reforms starting in the Ministry of Finance. The CAS cautioned that civil service reform at the central level should be coordinated with devolution plans to guard against uncontrolled hiring and spending at the regional level. And it urged the government to give early attention to the fiscal aspects of devolution. A partial decentralization in the late 1 980s has already caused duplication, inefficiency, and reduced accountability. Whatever the future of the devolution proposals, the authorities need to give more attention now to the financial and management relationships between the central government and the provinces. 20. Despite efforts to reduce corruption, it is still a concem.' In her 1994 campaign, the President promised to stamp out corruption, which had been a problem under previous governments. Public perception of the quality of governance appeared to improve initially. But people have become disillusioned again by the lack of progress. Insufficient transparency in awarding procurement contracts and privatizing state enterprises remains a problem. III. BANK GROUP ASSISTANCE 21. OED 's Country Assistance Note (CAN). The recent Operations Evaluation Department note on Sri Lanka concludes that the 1996 CAS remains valid. The CAN's assessment of government and Bank performance is broadly consistent with that in the CAS and this progress report. We agree that Bank assistance has had only a modest impact on institutional development. As recommended in the note, we will continue to link our assistance to progress in reforming the policy and institutional framework and avoid lending to sectors where there is insufficient government commitment. Since the government is not ready to introduce The Intemational Country Risk Guide published by Political Risk Services of Syracuse, New York rates Sri Lanka 4.0 on a scale of 1 to 6 where 6 is least corrupt. The reference group averages 2.7.  -7- comprehensive public administration reform at this time, we are focusing on sectoral restructuring. Finally, as discussed below, the Bank's plans do more to promote social and ethnic equity are consistent with OED's suggestions. 22. Client Survey. Sri Lanka was one of the pilot countries in the Bank's client survey. The value of the findings was limited by the low response rate. Nevertheless, the survey--as well as staff experience and direct client comments--suggest that Sri Lankans welcome advice based on international experience but consider it important that such advice be sensitive to the country's special circumstances, including its social goals and political constraints. Portfolio Management and Project Implementation 23. Although outcome and sustainability of completed projects is at or above Bank average, institutional development results do not compare well with the rest of the Bank, a result also noted in the OED CAN. This poor showing was caused to some extent by the disruptive effect of partial decentralization in the late 1980s and the change of government in late 1994. But the weak institutional development also reflects the deterioration of the calibre of the civil service and inadequate accountability. Insufficient executing agency ownership has also been a factor. Where there has been strong commitment--e.g., in telecoms reform, performance has been excellent. 24. Two out of 14 ongoing projects were rated "problem" projects when both this Progress Report and the CAN were written. One--the Irrigation Rehabilitation project--will close on December 31, 1998. The other--the Private Sector Infrastructure Development project (PSIDP)-- has suffeTed from resistance to private investment on the part of key sector agencies, including the power authority. Several sub-loans are now being appraised, and PSIDP is expected to be removed from problem status shortly. But, performance of two large education projects- Teacher Education and Deployment and General Education II (FY98)-has deteriorated, and they have now been rated problem projects on account of the government's failure to meet targets agreed with IDA on limiting employment of teachers and deploying them to under-served areas. We are discussing with the authorities ways to restructure the projects to minimize the adverse fiscal and educational effects of the new hiring and ensure future compliance. After increasing from 12 percent in 1994 and 17 percent in 1995 to 24 percent in FY96, the overall portfolio disbursement ratio declined to about 18 percent in FY97 and FY98 because of new lending and the resulting increase in the opening balance. The disbursement ratio is expected to be about 20 percent in FY99. 25. We share OED's concern about the disconnect ratio between supervision and completion ratings. Four projects rated over the past five years had a disconnect, as the Region's Implementation Completion Report (ICR) rated the outcome unsatisfactory while earlier supervisions had rated them satisfactory. In our current portfolio management processes and regular portfolio reviews (ARPP and semi-annual Projects at Risk reviews) we will continue to emphasize to staff the importance of realism in rating ongoing projects. 26. Since the CAS, the Bank has continued to emphasize portfolio management in discussions at the highest level of government. We have also taken a number of corrective measures including: (a) cleaning up the portfolio through early closure, partial cancellation and restructuring with borrower participation; (b) intensifying portfolio supervision by an expanded national staff in the Colombo field office; (c) increasing Bank staff resources for procurement supervision and counterpart training; and (d) insisting upon strong ownership before recommending new lending. Together with the ADB, we also plan to support efforts to train procurement professionals, streamline procurement procedures, and improve transparency in public sector procurement.  Partnerships 27. Foreign aid to Sri Lanka equals about 4 percent of GDP and finances a significant share of the development budget. Japan, the ADB, and IDA account for about 90 percent of concessional assistance. In recent years, Japan's aid has been equal to that of the ADB and IDA combined. It is not yet clear what effect global cuts in Japanese and ADB concessional funding will have on Sri Lanka. Thus far, Japan's aid has held up. The Bank and the ADB have made a concerted effort to coordinate at the country strategy and sector level, such as in ports, water and sewerage, and energy-where ADB is in the lead. The Bank and Japan's OECF continue to have differences on the extent to which the government should rely on private investment in infrastructure, but we consult frequently and keep each other abreast of our plans. 28. The UN agencies and a number of bilateral donors provide technical assistance and finance small projects, often working with NGOs. Their size and flexibility enable them to work effectively in the conflict area. The donors rely heavily on the Bank's macroeconomic work, and they-along with the government--give great weight to the Development Forum (formerly Aid Group) meeting held every 18 months. There is also good, relatively informal, coordination amongst the donors at the local level. Govemment coordination efforts have improved over the past year, but there is still a need for a stronger strategic framework in which to consider sector agency and donor initiatives. Collaboration between the Bank and the IMF continues to be especially close in Sri Lanka, and is welcomed by the authorities. The reform priorities discussed above are consistent with those highlighted in the 1998 Article IV Consultation. 29. Since the CAS, the Bank has continued to expand and deepen its contacts with civil society-including representatives of the private sector, labor, NGOs, the press, research institutes, and environmental and human rights groups. We and the government rely on local NGOs and researchers to help prepare, execute, and evaluate projects. Continuing Priorities 30. The Bank has played a key role in the macroeconomic and sectoral reforms described above. Together with the IMF, we have provided analytic and moral support to the authorities to reinforce their efforts to control the fiscal deficit in the face of political and military pressures to spend. Over the last two years, the Bank has helped prepare a blueprint for civil service and pension reform. We would consider follow-up IDA lending gauged to the government's willingness to undertake structural budget reforms. 31. The Bank has supported most of the measures to improve the policy environment for private investment at both the systemic and sectoral level. We are assisting the lead agency in charge of privatization-the Public Enterprise Reform Commission (PERC}which has successfully managed the privatization program. We are updating the 1995 Private Sector Assessment to reflect changing global conditions and identify remaining constraints to private investment. The participation of the private sector in the telecoms sector was preceded by extensive lending and non-lending support to strengthen the policy and regulatory framework. We are following a similar approach to restructuring in other sectors where there is interest in reform, including ports, urban water and sewerage and housing, the postal service, and--in partnership with the ADB in the lead-power. To improve agricultural productivity, we are supporting studies on food marketing and the land titling work noted above. We are rethinking our approach to environmental protection in view of the poor performance of the Environmental Action project (FY97) which seeks to strengthen inherently weak institutions. We plan to restructure that project and focus on including environmental components in projects in other sectors, including those designed to promote private investment. And in view of the many  -9 - overlapping donor-funded environmental activities, the Bank will finance a roundtable in early 1999 to improve coordination. 32. We have limited our lending assistance to the financial sector in recent years because of the govemment's unwillingness to privatize the two large state banks. But we have maintained a close dialogue and have been encouraged by the other measures to strengthen the banking sector. In view of the current fragility of worldwide financial markets, the Bank is working closely with the IMF and IFC to assist the authorities in crisis management and deepening reforms. We have also helped prepare on an emergency basis a project to assist the financial sector and several key government agencies in coping with the Year 2000 (Y2K) problem. Encouraged by recent modest liberalization of investment rules for state-owned insurance and provident funds, we are supporting preparation of a broad program of pension reform for possible Bank support. 33. The social sectors remain central to our assistance strategy. The two large education projects (para. 24) and a health services project approved since the CAS have yet to build momentum, in part because key stakeholders were not sufficiently involved in preparation. But our dialogue in both sectors has become stronger as the government has come to recognize the need for far-reaching reforms and has involved stakeholders in discussion of how to achieve them. We would consider support for reforms in health andl/or education, provided implementation of the ongoing projects were improved. Stronger Emphasis 34. While the Bank can do little in terms of short-term conflict resolution, we can help create the conditions for lasting peace once the conflict is ended. As suggested in the CAS, this means promoting employment generating growth and human capital development. And it means enhancing preparedness to rehabilitate the war-torn areas to incorporate the people of these areas into the economic mainstream. The CAS said that, with peace, the Bank would expect to take the lead in post-conflict reconstruction planning. In the absence of peace, the Bank and other donors have-in addition--sought means to help restore hope to people in areas of the Northeast now controlled by the govemment. Since the CAS, the Bank has used-and plans to continue to use-- funds under existinrg IDA credits in irrigation and education to finance minor reconstruction activities in the war-affected areas. Where access is constrained by the conflict, we have entered into backstopping agreements with the llN High Commissioner for Refugees and the International Committee for the Red Cross. These projects have involved strong community participation and have had considerable success in building self-reliance among the local people. They have also enabled the Bank's field office to gain experience and build working relationships which will enhance our ability to move into the rehabilitation phase once peace is achieved. In view of these good results, we are preparing a North East Emergency Irrigation project. 35. As the conflict continues, and the depth and complexity of the underlying issues become more apparent, we and the other donors have also begun to focus on the impact of our aid on social and ethnic concerns. The next CAS will examine this question more closely. It will consider how the Bank can help Sri Lanka realize its potential as a multi-ethnic society. In the meantime, we have begun to use our lending and non-lending work in education to address ethnic and equity issues through curriculum reform and deployment of teachers and resources--as well as to press for wider use of English as a bridge language to reduce the ethnic divide and increase the competitiveness of the labor force. Non-lending work underway on poverty is examining the impact of past programs and policies on the welfare and opportunities of different groups. It will consider, inter alia, the lessons from the disappointing results of the Poverty Alleviation project which were analysed in a very thorough ICR issued earlier this year. The poverty work is complemented by a study on rural development. The results of both activities will enable the Bank to help design a more effective and equitable poverty strategy (para. 18). Another study is  - 10- looking at unemployment and the reasons it has persisted in spite of economic growth. A proposed Clean Settlements project would support pilot slum upgrading efforts to address urban poverty featuring partnerships between local governments and communities. 36. While continuing to do groundwork for public administration reform, we have begun to focus on the wider issue of governance. We plan to devote more non-lending services to the problems of inadequate accountability and weak management caused by decentralization. Corruption is subject to a high degree of political scrutiny in Sri Lanka, with the government and the opposition accusing each other of improper behavior on a regular basis. We expect to complete by the end of FY99 a note on corruption for use in the South Asia region's anti- corruption plan. The next Sri Lanka CAS will consider possible Bank assistance in this effort. In the meantime, the proposed Legal Reform project is intended to reduce opportunities for corruption. And training a cadre of civil servants to evaluate tenders (para. 26) is designed to reduce irregularities in procurement. More broadly, our strategy of helping to liberalize and redefine the role of the state in the economy should reduce discretionary bureaucratic decisions which invite corruption. This is complemented by our efforts to promote openness and consultation with stakeholders in decision-making. Lending and Non-lending Assistance 37. Over the next year, while preparation of a full CAS is underway, we foresee no major change in the existing CAS objectives, scenarios, or triggers. As was the case in 1996, we continue to see a need for a range within the base case to take account of the uncertainties about the war, fiscal discipline, the momentum of reforms, and the impact of external economic developments. Table 1 is a summary matrix of perfornance against the 1996 CAS priorities and key next benchmarks. Table 2 provides more detail on performance in respect to the triggers. Table 3 displays Bank lending and non-lending since the CAS and proposed for the next 18 months. 38. IDA approved nine operations during FY96-98 totaling USS341 million. Subject to the full CAS review next year and sustained policy performance, we are working on a comparable program for FY99-01. In view of the availability of assistance from other donors, the Bank's program is heavily weighted toward non-lending and lending to support macroeconomic and sector reforms. The proposed lending program is thus a relatively high risk/high return program. As discussed earlier, we are supporting analysis and preparation of reform programs in health, poverty and rural development, food marketing, urban development, and civil service and pension reform with a view towardfocusing the role of government and improving the quality and efficiency of the services which it provides. During the next year, we hope to present to the Board several projects with policy reform objectives, including Legal Reform, Postal Service Reform, Land Titling, Ports Efficiency, and Water and Sanitation. In each case, substantial work has already gone into preparing the policy/regulatory framework. These areas were selected as ones where political leaders and stakeholders were ready to accept change and where success-as in the earlier case of telecoms--would demonstrate the benefits from reform. They would be followed in later years by restructuring in power, food marketing, and health, where reform agendas are still being defined. If the government were prepared to embark on more ambitious structural reforms following elections, the ongoing analytical work would also enable us to assist with civil service and pension reforrn-possibly in connection with an IMF ESAF. Finally, as mentioned earlier, we plan to present the emergency Y2K project to the Board shortly, followed by the North East Emergency Irrigation Rehabilitation project later in the year. 39. As part of its strategy to increase its regional presence. IFC opened an office in Sri Lanka this October, sharing facilities with the Bank. With an expanded presence in New Delhi- including a new small and medium enterprises unit--and in Sri Lanka, IFC hopes to double its  portfolio over the next two years, emphasizing infrastructure, agribusiness, and services. IFC is also helping to deepen the capital markets and develop the local debt market. 40. The Bank's current work program assumes only modest or temporary interruptions as a result of the current political uncertainties. If macroeconomic performance were to deteriorate and Sri Lanka were to fall back into the low-base case, a number of the projects might be delayed. However, in view of the government's reliance on our non-lending services in promoting and maintaining the momentum of reform, we would try not to reduce the analytical work and TA. If the impact of the extemal economic crisis on Sri Lanka were to become more severe, we might, however, need to shift some non-lending resources to assisting the authorities in protecting macroeconomic and financial stability. Given the internal and external risks, we do not expect Sri Lanka to be eligible for IBRD lending in the near future. IV. RISKS 41. The risks are substantial for both the government and the Bank's assistance strategy. First, there is the risk of prolonged intense military conflict and/or increased terrorist activity draining resources and putting further strains on the fabric of society. Second, there is the risk that heightened political activity will distract the government and forestall leadership on structural reforms, including those needed to maintain and advance Sri Lanka's human resource achievements. The strident tone of the political debate adds to this concern that the government will fail to build a consensus to accelerate reforms. In addition to these internal risks identified in the CAS, there is the new uncertainty about the future impact of global economic developments, including a possible deterioration in Sri Lanka's now favorable terms of trade. The convergence of these risks could lead to political, social, and macroeconomic instability. 42. The government deserves credit for its management of these risks so far. Despite the war, macroeconomic management has steadily improved. The President has taken a strong stand in favor of a market economy and gained support from the business community. Under her leadership, debate on policy issues has become more open, and progressive forces have been encouraged. But over the past year, there have been renewed pressures on fiscal discipline from the war and politics. And the momentum of structural reforms has slowed. We are encouraging the government to stay the course on economic management. The authorities have assured us that there will be no back-tracking. But we will monitor the situation closely and adjust our program as necessary. In view of the value which both the government and opposition leaders place on our advice and support, we will make every effort to stand by Sri Lanka during its time of trial. James D. Wolfensohn President by Caio K. Koch-Weser Washington, D.C December 20, 1998  Table I Page 1 of 2 SRI LANKA CAS PERFORMANCE BENCHMARKS 1996 CAS SUMMARY PERFORMANCE' REFORM PRIORITIES' (1996 - 98) NEXT KEY BENCHMARKS Overall rating: mid-base case Fiscal Policy IMid-hase case: Stronger fiscal adjustment: Reduce overall deficit. Reduced from 10% of GDP in 1996 to 8% in 1997 and 1998. Risk of backsliding in * Avoid backsliding and aim for deficit under 7% of GDP in 1999. 1999 because of military and political pressures to spend. 1999 budget avoids give-aways, but relies on dubious cuts in military spending to reduce deficit. e Reverse revenue decline by, initer alia, raising GST rate and reducing tax concessions. Eliminate wheat subsidy. Eliminated in 1997. Introducc General Services Tax Introduced in April 1998. (GST). * Strictly enforce limits on public sector hiring; maintain monitoring of defense spending by Finance Ministry. Use privatization proceeds to Half of proceeds used to retire domestic reduce domestic debt. debt. Public Administration Low-base case: Improved governance: Design and introduce civil service Substantial ADB and Bank assistance, but and pension reforms. no government action. * Prepare action plan and start reforms in selected government departments. Clarify respective roles of central govemment and provinces, and increase accountability. Limit recruitment of teachers and Renewed public sector hiring in 1998, redeploy. including over 10,000 unqualified teachers. * Agree with Bank on and execute plan to train and deploy new teachers and ensure no further infractions. Inadequate transparency in procurement and * Inform public before and after major decisions on privatization privatization. and procurement. Impose strict deadlines. See table 2 for detailed 1996 CAS triggers and performance.  TIable 1 _ _ __ ___ _ _ _ _ _ _ _ _ _ Page 2 of 2 1996 CAS SUMMARY PERFtlORMANCE NEXT KEY BENCHMARKS REF'lORM PRIORITI1ES (1996 -- 98) Social 'I 'ransfer Programs J.owv-base case: P ovcrty strategy: Consolidate anid improve targeting Some consolidationi of small entitlemiienits in * Complete analytical work and (lesigoi comprclienisive IICw pover ty of safety net programs. 1997, but targeting remains inadequate. strategy in partnerslhip with stakeholders, 10,000 "temporary" politlcally-appointe(l anti-poverty workers given permanecnlt 1lHlman resource r eform: ernploymcnlt in 1998. * Prcpare healthi sector strategy in partnership witlh stakeholders. * Resolve problems creatcd by new teacher recruitmenit. Agree oni new educationt reform-l agenda to address issues incltu(inlg fuiding, relevance to modern economiy, anid ethnic anid social equity. Private Sector Environmient High-base case: Increased private investmenit: Reduce tax and tariff conlcessionls. Tariff rates reduice(d in 1997/98, but still * IPromote pr ivate participatioin in infrastruLctture (power, water and maniy tax (GiST) anid tariff concessions. sewerage, ports, and( railroads) withinl strong regtulatory framework. Privatize major enterprises. Major privatizationis includinig remlaininlg plantations, telecoms, and airline -- * Improve mechanlismii for settlement of labor disputes. comiipleted( in 1997/98. * Reduce intervenition in agriculttrc hy, initer alia, phasinig oUt Liberalize agricultural markets. Continutled governmlilenit intervcntioni. Paddy Marketing Board. * Strictly enforce performance MOlUs witlh state banks; refrain tioIn governmenlciit intervenitioni in operations. Further tighteni bankilng supervisioni; comiiplete finanicial audlits of inain bankis. Project IJml)elentationl Mii-hase case: Improve(d Porttolio Managemiienit: Implemiienit 1994 action plan to Somue correctivc measures, but performallce * Appoint strong project maniagers -- give themii autonomlly andi make improve portfolio perforinmaec. at sector/projcet level unecvei. P'rocurcmncit theCmi accouLntable. Ilelays and wcak project maniagemiienit still commonl. * Rcview govCIeInmIICIlt procediores for awarding contracts. Agree on Increase tlishliisciiietit ratio. Averagc ratio of 2W0 for UY96-99. dimplement reforms, incluing strict deadliiies. ,,.1 ,l vill: 'io,ed\iii eu-s 9,/'2p;ogmes.s iepou>bemc!ioi/s aAs 1Zz .4:(/, (72/ 8(/9~S,9)  Table 2 Page 1 of 5 SRI LANKA Status of Implementation of FY96 CAS Low Base Case High Base Case High Case Performance Assessment (November, 1998) ( $70-140 million/year) ($175 million/year) Fiscal adjustment overall budget - overall budget deficit - macroeconomic - Overall budget deficit reduced from about 10% deficit (excluding (excluding grants stability, with overall of GDP in 1994-96 to 8% in 1997. Deficit for grants and and privatization budget deficit 1998 expected to be about 8 % of GDP, privatization proceeds) of 6% of steadily declining to compared to budgeted level of 6.5%, owing to proceeds) of 8% GDP by year 2000. 4% of GDP by 2000. revenue shortfalls and increased defense of GDP by year spending . Projected decrease to 6% of GDP 2000. in 1999 relies on doubtful reduction in defense spending. elimination of - elimination of wheat - elimination of wheat - Wheat/flour subsidy eliminated by end- 1997. wheat subsidy by subsidy by end- 1996. and flour subsidy by end 1997. end-1996. introduction of - introduction of value- - GST introduced in April, 1998 - but low rate value-added based added tax (GST) and (12.5%) has generated weak revenues. Pre- tax (GST) by mid- pre-shipment shipment inspection not introduced, but no 1997. inspection by end- longer an issue. 1996. - major share of - Major share of privatization receipts-totaling privatization $78 million in 1996 and $300 million in 1997-- proceeds used for were used to retire debt. retiring domestic debt. - significant - Virtually no increase in cost recovery in improvements in irrigation, urban water, or railways. Power tariff cost-recovery (e.g. in increases have not been sufficient to meet IDA irrigation, urban covenant requiring improvement in CEB's water, electricity and financial condition. railways). - adequate - Efforts to reduce fiscal deficit have caused expenditures for reductions in non-wage O&M expenditures. operation and Capital expenditures have declined for last two maintenance (road, years. Although 1999 budget says capital railway, irrigation, expenditures-especially education-will water sanitation and increase, it is not clear how this will be supply, and social achieved. sectors). - strong public - Public investment planning remains weak, with investment planning. insufficient attention to O&M implications. Also still too donor driven.  Low Base Case High Base Case High Case Performance Assessment ______________________ (November 1998) ( 70-140 million/year) ($ 175 million'year ) Public administration reform modest progress in - progress in selected - civil service reform - Initial efforts in 1996 and 1997 to contain wage selected areas of areas of the civil implemented in bill by limiting budget allocations, freezing civil service service and pension tandem with pension employment levels, and withdrawing reform agenda fund reform agenda, reform. excessively generous pension provisions. But (such as in especially in limiting no progress on structural reforms to limit future limiting teacher teacher recruitment growth of public sector wages and pension recruitment and in and in re-deployment. costs or on public administration reform In re-deployment), 1998, overstaffed public enterprises (including but some Ports and Petroleum Corporation) have expansion increased employment, and about 10,000 have elsewhere. been given permanent positions with higher pay. Some 12,000 unqualified teachers have been hired in 1998. Virtually no re-deployment of teachers. Social transfer programs modest - improved targeting, - Samurdhi program - Various transfer programs were consolidated consolidation of some consolidation curtailed, with full under Samurdhi, but targeting remains weak. safety net of safety net targeting: and Over half the population receives some programs and programs, and elimination of Samurdhi benefits. Janasaviya "interest" reduced overall reduced overall costs "interest payments" payments (a poorly targeted transfer program) costs, reflecting (over and above the of Janasaviya. have been eliminated. only elimination wheat programs as of the wheat noted above). subsidy (noted above). rationalized teacher - Modest reduction in total number of teachers in recruitment and 1997 as a result of retirement incentive. But deployment. new recruitment in 1998 has reversed this progress and violated conditions under IDA- financed Teacher Education and Deployment Project. Virtually no redeployment. _________________________________________________- 2I  Low Base Case High Base Case High Case Performance Assessment l M_____________________ (November 1998) ($70-140 mnillion/year) ($175 million/year) Private sector environment - some reduction of - substantial reduction - elimination of all - 1997 and 1998 budgets introduced numerous tax/tariff of tax/tariff quantitative new incentives and tax/tariff concessions in exemptions and exemptions and restrictions in 1996, agriculture, tourism, housing, and selected concessions and concessions, and substantial reduction industries. Also eliminated all tariffs on quantitative quantitative of tax/tariff garment and textile industry inputs. All restrictions. restrictions by 1997. exemptions and quantitative restrictions on agricultural inputs concessions -- have been removed. 1999 budget reduced three- including Board of band tariff from 10%, 20%, and 35% to 5%, Investment firns - by 10%, and 25% (except for agriculture which early 1997, and a remains at 35%) and announced that number of uniform tariff bands would be reduced to two in year 2000. structure by 1998. - progress, though - continued - progress on - Plantations have been privatized and become uneven, in privatization - privatization beyond more profitable. Government has ruled out privatization (the including plantations base case -- including privatization of two large state-owned banks, plantations and and insurance the Bank of Ceylon but agreed to performance contracts with them smaller companies - and and the Ceylon in 1998. CEB has until now resisted companies, but progress on Electricity Board restructuring of its operations and private power delays on large BOO/BOT schemes. (CEB) -- and generation, but government recently reached units) and slow BOO/BOT schemes, understanding with Bank and ADB on progress on supported by an framework for unbundling CEB functions. BOO/BOT adequate regulatory Some BOO private power projects underway. schemes. framework. Good progress in telecoms: competitive market established for basic telephone services; regulatory framework in place; sale of 35% and management control of Sri Lanka Telecoms. Sale of 40% and management control of Air Lanka. Agreement signed for major private investment in Colombo port in which IFC may participate. Preparation underway to restructure port operations--possibly with IDA support. - some liberalization of - Some liberalization of investment options for investment choices state-owed pension companies in 1998. for pension funds. - improved legal - Continued interest in improving commercial framework such as law framework and administration, with amendment of possible IDA support. But authorities fear Termination of political consequences of action to liberalize Employment Act, labor markets and considers Employment Act companies laws, untouchable. bankruptcy law. -3 -  Low Base Case High Base Case High Case Performance Assessment (November 1998) (570-140 million/year) ( $175 million/vear - some reduction in - no government - Although role of Paddy Marketing Board has government interference in the been scaled back, government continues to interference in the agricultural sector intervene sporadically in rice imports (e.g., domestic agricultural (marketing boards change tariff) and marketing. CWE continues market. and price distortions) to control wheat imports and marketing. and and introduction of play major role in chilies and onions. Pilot land land market. titling program being prepared with view to liberalizing land markets--possibly with IDA support. Project implementation mixed progress on - good progress on - marked progress on - CPPRs have been dropped in favor of intensive CPPR actior plan CPPR action plan to CPPR action plan, attention to project implementation by and IDA maintain IDA including expanded field office with government and disbursement ratio disbursement ratio at disbursement ratio. other donors. But progress remains slow: at about 14-16%. about 18-19%. project management still weak; procurement decisions slow; and frequent changes in project personnel. As expected, disbursement ratio declined from 24% in FY96 to 19% in FY97 and 18% in FY98 because of large increase in opening balance from new credit approvals. FY99 ratio projected at about 20%. -4 -  LOW CASE Serious fiscal situation: - Persistent high overall budget deficit (above 10% of GDP excluding grants). - No public administration reform and continued expansion of civil service. - Major deterioration in the private sector enabling environment (back-tracking on tariff reformn, stalled privatization and BOO/BOT schemes, and increased government interference in the agricultural sector). - Poorly-targeted social transfer programs (with high cost above 3% of GDP). - Major implementation problems under Bank Portfolio. m:\shared\linda\cas98\progress report\triggers.doc 11/25/98 5-  Table 3 page 1 of 2 Status of CAS Lending Operations and Non-Lediiding Services (Current aiid Proposed) Activity Objective Portfolio GAS Service Ensuring Promoting Enhancing Improving Rating Scen- Category Macro- the Social Quality ario economic Private Protec- of the US$ Mill stability Sector tion Environmer IP DO Status FY90-FY96 Activities still under supervision 3RD ROADS Portfolio $ 43 __ ___ x S S Closing Date 12/31/98 -IRRIGATION REHABILITAIN__Portfolio $ 30 U U Closing Date 12/31/98 COMMUNITY~7 WATER SUPPL-Y __Portfolio 247 osi S C ng Dt12/31/98 PRIVATE -FINANC-EDEVELOPMENT - ~Portfolio $ 60 x s S CoigDt 109 CO0LO0m bO URB A N T R-A-N-S P ORT ___Portfolio -- $20 -------x S -- S- Closin-g Date 6/30/99--- COLOMAbO E-NVIRO-0N-MENT_IM-PROV-E-MEN-T -- Portfolio $ 39 x S S Closing_Date 6/30101 -TEACHER EDUCATION & DEPLOYMENT Prflo $ 64 xS S ClsnDae1//0 PRIVATE SECTOR INFRASTRUCTURE DEVELOPMENT Portfolio $ -77 x U S Closing Date 6/30/02 TE-LE-COMMUNI-1CAT IONS REGULATION & PUIBL.. Portfolio $ 1 5 x H-IS S Closing Date 12/31/99 - FY97 Activities ENERGY SERVICES DELIVERY Base Portfolio $ 24__ x S S Approved March 1997; Closing Date 12/31/02 ENVIRONMENTAL ACTION __ Base Portfolio $ 15 x S S Approved March_1997; Closing Date 12/31/02 HEALTH SERVIC-ES DEVE'L0-P M-E NT Base Portfolio $ 19 __ x S S Approved December 1996; Closing Date 6/30/02 TRANSPORT SEfcToR STUDY__ _Base Non-Lending _ x Completed January 19 POLiCY DIALOGUEwm (IH IM-F-) --Base Non-Lending X --PUB3LIC INVESTMENT RE-VIEW HWigh Non-Lending _____Completed September 1996 MONTHL-Y IECONOMIC REPORTS Base Non_Lendingx ANNUAL ECON -OMIC UPDAT-E --Base Non-Lending x __ _Completed October 1996 PO0WER REST-RUCTURING STUDY ___ High Non-Lending x --_-Completed June 1997 PETROLEUM SECTOR STUD-Y -- new Non-Lending x Completed September_1996 ____ SRI LANIKA D EVE LOPMENT FORUM BaeNon_Lending ____ ____x Meeting held November 1996 TA FOR TAX AND TARIFF REFORM Base Non-Lending x Irrigation seorsatg Base Non-Lending X Dropped Rural Finance study ___ High Non-Lendingx Dropped Agriculture Policy review Base Non-Lending ____Incorporated in-other work - Land Tenure Study - -High Non-Lending - Incorporated in ot her wo rk ___ ExotDiv-ersification High Non-Lending NOTE: IP = Implementation Progress; DO =Development Objective mksharedllinda\progress report\castab53.xIs November 5,1998  Table 3 page 2 of 2 Status of CAS Lendinig Operations and Non-Leniding Services (Cuir r ent and Proposedl) Activity Objective Portfolio CAS Service Ensuring Promoting Enhancing Improving Rating Scen- Category Macro- the Social Quality ario economic Private Protec- of the US$ Mill stability Sector tion Environmer IP DO Status FY98 Activities GENERAL EDUCATION II Base $ 70 x S S Approved December 1997; Closing Date 6/30/03 MAHAWELI RESTRUCTURING Base $ 57 x Approved April 1998; Closing Date 12/31/03 CONSERVATION OF MEDICINAL Pi ANTS New GEF $ 7 x Approved March 1997; Closing Date 6130/03 POLICY DIALOGUE (WITH IMF) Base Non-Lending x On-going MONTHLY ECONOMIC REPORTS Base Non-Lending x On-going ANNUAL ECONOMIC REPORT Base Non-Lending x Completed May 1998 SOCIAL SECTOR REPORT Base Non-Lending x Completed April 1998 FINANCIAL SECTOR STUDY Base Non-Lending x Completed June 1998 CIVII. SERVICE REFORM STUDY High Non-Lending x Completed June 1998 SRI LANKA DEVELOPMENT FORUM Base Non-Lending x Meeting held May 1998 FY99/FYOO Activities (S) CLEAN SETTLEMENTS Base Lending $ 60 x Under preparation (5) LEGAL REFORM Base Lending $ 25 x. Under preparation EMERGENCY Y2K PROJECT Now Lending $ 29 x Proposed new operation POSTAL SERVICE REFORM New Lending $ 28 x Under preparation LAND TITLING High Lending $ 5 x Under preparation PORT EFFICIENCY High Lending $ 64 x Under preparation N.E. IRRIGATION REHABILITATION New Lending $ 40 x Emergency operati6n under preparation COMMUNITY & PRIVATE SECTOR WATER New Lending $ 30 x Under preparation UNEMPLOYMENT STUDY Base Non-Lending x Underway RURAL DEVEL-OPMENT & SUBSISTENCE AGRICUL-I J Base Non-Lending x Underway TELECOMMUNICATIONS REFORM ASSESSMENT New Non-Lending x Plarnined EDUCATION FINANCE Base Non-Lending x Underway PUBLIC INVESTMENT REVIEW High Non-Lending x PUBLIC SECTOR MANAGEMENT STUDY New Non-Lending x Underway ANTI-CORRUPTION INITIATIVE New Non-Lending x Underway HEAL-I H SECTOR STRATEGY New Non- endinq x Underway POVERTY & SOCIAL DEVELOPMENT New Non-Lending x Underway PRIVAT E SEC I OR UPDA1 E New Non-Lendirig x Underway TA FOR REGULAT ORY REFORM New Non-Lending x Underway POLICY DIALOGUE (WITI-I IMF) Base Non-l ending x On-golrig MON THLY ECONOMIC REPORTS Base Non- endirng x On-going ANNUAL ECONOMIC UPDATE Base Non-iLending x SRI LANKA DEVFILOPMENT FORUM Base Non-Lending x NoWI Ir = Implerrentation Progress, 00 = Development Objective rm\sharedAindn\progress rnport\castab3xIs November 5,1998  CAS Annex Al Key Economic and Program Indicators Forecast in Last CAS Actual Currenit Projections Economy 1996 1997 1998 1999 1995 1996 1997 1998 1999 2000 Growth Rates C%! GDP (market prices) 5.0 5.3 5.5 5.8 5.5 3.8 6.4 5.0 5.0 5.5 Exports GNFS 7.5 8.0 8.6 8.4 17.0 5.0 13.5 7.1 7.4 7.4 Imports GNFS 4.4 5.9 5.6 6.2 12.1 2.0 7.7 7.3 7.9 6.6 Consumer Price Index i/ 11.1 8.9 7.8 7.7 11.5 16.8 10.7 6.7 8.5 7.2 National Accounts (% GDP) External Current account balance (- deficit) -6.9 -6.5 -5.7 -5.1 -6.3 -5.3 -2.9 -3.1 -5.0 -5.0 Gross investment 24.0 24.8 25.2 25.5 25.6 23.9 24.4 26.7 27.0 27.4 Puiblic Finiance (% GDP) Central government deficit 2/ -11.5 -10.9 -9.7 -8.8 -10.3 -9.6 -7.9 -7.9 -6.5 -5.0 Current account balance (- deficit) 2/ -2.1 -1.5 -0.4 0.5 -3.3 p2.9 -1.4 0.9 0.4 0.7 Net Foreign Finiancing 2.0 1.7 2.0 2.0 3.2 1.3 1.1 1.5 1.1 1.1 International Reserves (US$ millions) 2,038 1,987 2,030 2,098 2,063 1,937 2,029 2,029 2242.0 2485.0 (as months of imports) 3.6 3.2 3.0 2.9 4.7 4.3 4.2 3.9 4.0 4.1 Program (Bank's FY) FY97 FY98 FY99 FY00 FY95 FY96 FY97 FY98 3/ FY99 FY00 Lending(US$millions) 110.0 110.0 110.0 .. 39.0 156.1 57.8 127.3 944/ 187.0 Gross Disbursements (US$ millions) 90.0 90.0 90.0 .. 95.3 108.9 83.3 71.7 79.5 95.0 Notes: 1/ End of period change in Colombo Consumer Price Index. 2/ Excluding official transfers 3/ Actual Outcome 4/ Includes Clean Settlements currently an FY00 Standby operation GNFS = Goods and Non-Factor Services GDP = Gross Domnestic Product m\shared\iinda\progress report\castab2xis  CAS Annex A2 Page 1 of 2 Sri Lanka at a glance 10/98 Lower- POVERTY and SOCIAL Sri South middle- Lanka Asia income Development diamond* 1997 Population, mid-year (millions) 18.5 1,289 2,285 Life expectancy GNP per capita (Atlas method, US$) 800 390 1,230 GNP (Atlas method, US$ billions) 14.8 502 2,818 Average annual growth, 1991-97 Population (%) 1.2 1.9 1.2 [ Go Labor force (%) 1.8 2.2 1.3 iGN \ Gross Iper v primary Most recent estimate (latest year available, 1991-97) I capita enrollment Poverty (% of population below national poverty line) 22 Urban population (% of total popuiation) 23 27 42 Life expectancy at birth (years) 72 62 69 Infant mortality (per 1,000 live births) 16 71 36 Child malnutrition (% of children under 5) 38 63 .. Access to safe water Access to safe water (% of population) 64 77 84 Illiteracy (% of population age f5+) 10 51 19 l Gross primary enrollment (% of school-age population) 113 99 11 - Sri Lanka Male 114 109 116 Lower-middle-income group Female 112 89 113 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1976 1986 1996 1997 Economic ratios' GDP (USS billions) 3.6 6.4 13.8 14.8 Gross domestic investment/GDP 16.2 23.7 24.2 24.4 Exports of goods and services/GDP 29.0 23.7 35.0 36.5 Trade Gross domestic savingslGDP 13.9 12.0 15.3 17.3 Gross national savingslGDP 14.8 19.0 19.0 21.4 T Current account balance/GDP -0.2 -6.5 -4.9 -2.6 Domestic Interest payments/GDP 0.6 1.9 2.1 1.8 . Investment Total debt/GDP 25.9 63 7 67.5 61.0 Savings Total debt servicelexports 24.4 20.9 13.6 16.2 Present value of debt/GDP .. 37.9 Present value of debt/exports .. 89.7 Indebtedness 1976-86 1987-97 1996 1997 1998-02 (average annual growth) GDP 5.3 5.0 3.8 6.4 .SriLanka GNP per capita 3.8 2.8 2.1 5.8 .. Lower-middle-income group Exports of goods and services 4.7 9.1 3.2 11.6 .. STRUCTURE of the ECONOMY 1976 1986 1996 1997 Growth rates of output and investment(%) (% of GDP) 1 Agricultu-e 29.0 27.1 22.4 21.9 Industry 27.1 26.6 25.1 25.5 0+ Manufacturing 20.0 15,2 16.2 16.4 Services 43.9 46,3 52.4 52.6 Private consumption 76.1 77.7 74.1 72.3 92 93 94 95 96 97 General government consumption 10.0 10.3 10.5 10.4 ; *GDP Imports of goods and services 31.4 35.3 43-9 43.5 1976-6 1987-97 1996 1997 Growth rates of exports and imports (%) (average annual growth) Agriculture 4.2 2.1 -4.6 3.1 20- Industry 4.9 6.1 6.0 7.9 1S Manufacturing 4.8 8.2 6.5 9.3 Services 6.7 5.6 5.8 6.8 10 Private consumption 6.2 4.9 1.7 6.6 e General government consumption 6.1 5.6 18.6 10.3 o Gross domestic investment 10.0 4.0 2.8 4.0 92 93 94 95 96 97 Imports of goods and services 9.9 7.1 2.1 10.5 - Exports 0Imports Gross national product 5.4 4.0 3.2 6.9 __ Note: 1997 data are preliminary estimates. The diamonds show four key indicators in the country ('n bold) compared with its income-group average. If data are missing, the diamond will be incomplete.  CAS Annex A2 Page 2 of 2 Sri Lanzka PRICES and GOVERNMENT FINANCE 1976 1986 1996 1997 Inflation (%) Domestic prices (% change) 80 _ Consumer prices 8.0 15.9 9 e 6D - Implict GDP deflator 10.0 5 9 12.' 8 5 40 _ Government finance -