Sri Lanka - Reconstruction and rehabilitation program

Report No. 6998-CE Sii Lanka Reconstruction and Rehabilitation Program November 6,1987 Asia-Country Department I FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may riot otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (Annual Average) Sri Lanka Rupees per US$1.00 1987 - 29.7 GLOSSARY AND PRINCIPAL ACRONYMS CEB - Ceylon Electricity Board DDC - District Development Council DRCC - District Reconstruction Coordinating Committee GA - Government Agent HDFC - Housing Development Finance Corporation MLGHC - Ministry ot Local Government, Housing and Construction MLLD - Ministry of Lands and Land D'.velopment MOE - Ministry of Education MOFP - Ministry of Finance and Planning MOH - Ministry of Health MWATH - Ministry of Women's Affairs and Teaching Hospitals NGO - Non-Governmental Organization NHDA - National Housing Development Authority NRSC - National Reconstruction Steering Committee NWSDB - National Water Supply and Drainage Board RDA - Road Development Authority REPPIA - Rehabilitation of Persons, Properties and Industries Authority RRP - Reconstruction and Rehabilitation Program SMIB - State Mortgage and Investment Bank Fiscal Year January I to December 31  FOR OMCIAL USE ONLY SRI LANKA - RECONSTRUCTION AND REHABILITATION PROGRAM Table of Contents. Page No. EXECUTIVE SUMMARY ................................... i I. INTRODUCTION .......................... 1 A. Background ................................ . 1 B. Aftermath of Conflict ........................ 2 C. Ptospects for Reconstruction .................. 3 II. THE RECONSTRUCTION PROGRAM AND THE ECONOMY ....... 5 A. Macroeconomic Framework ........................ 5 B. Longer-term Development Issues ................ 9 III. AN ASSESSMENT OF THE DAMAGES ..................... 10 A. Overview ................................,.10 B. Estimates of Damages by Sector ................ 11 Housing ............... 11 Commercial Sector ............. ............ 13 AgricuLture and Fisheries ................. 14 Irrigation ................... . 16 Water Supply and Sanitation ............... 17 Roads and Bridges ..... ..*.................. 17 Public Transport ......................... 18 Teailways eouctn............ ....... 19 Iorts A RABLTINPOA......................... 20 Telecommunicationstruction Program ........ 20 Power ............ -21 Industry ....Proram...................... 21 Education Prgrm.y. ecor............. 22 Health ten...... ...... ......... 23 Public Buildings ........ ................. 24 IV. RECONSTRUCTION AND REHABILITATION PROGRAM . ...... .. 25 A. Approach to the Reconstruction Program .......... 25 Bo Reconstruction Program ................ 25 C. Reconstruction Program by Sector .2.ooo,oooo*,........... 27 Resettlement ..................27 Housing ..................27 Commercial Sector ................... 33 Agriculture and Fisheries ..................35 Irrigation ... . ..... ...... .... . 38 Water Supply and Sanitation ............... 40 Rtoads and Bridges ..... 42 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  -ii- Public Transport ..... ...................... 45 Telwecomunications .. ....................... 47 Power ..................................... 51 Indusry ........... .. . ... ...... ............ ...... 53 Industry ........... 53 Education .................... 55 Health .............. ,..... 58 Public Buildings ....... ............. 60 D. Immediate Needs ....... .......... 61 V. IMPLEMENTATION OF THE RECONSTRUCTION PROGRAM ..... 63 A. District Approach ........ ........... .......... 63 B. Coordination and Execution .... ................ 65 C. Cross Sectoral Linkages ....................... 67 D. Implementation Capacity and Constraints ....... 69 E. Employment Generation ......................... 72 F. Aid Requirements . .......................... . 74 ANNEXES Annex I The Peace Accord Annex II : Centralized Casework and Job Referral System Annex III : Rehabilitation of Irrigation Sector Annex IV : Water Supply and Sanitation Rehabilitation Annex V Rehabilitation of Telcommunication Sector Annex VI : Reconstruction and Rehabilitation Program by District Annex VII Summary of Public Sector Employment Map ------------------------------------------------------------- This report is based on the findings of a mission which visited Sri Lanka from August 31 - September 24, 1987. The mission consisted of Messrs. Hari Aggarwal (Chief of Mission), Roberto Zagha, Chandra Godavitarne, Terry Hall, Jagdish Srivastava, Louis Cazoni, Grant Sinclair, Richard Leonard, Mmes. Danielle Berthelot, Shanta Pai, and Consultants Messrs. Frederick Cuny and John Flynn. Messrs. Arnold Clift, Chief of Country Operations Division, AS1 and Iain Christie Chief of Infrastructure Division, AS1 also joined the mission to participate in the discussions with the Government.  TEXT TABLES Page No. Table 1: Summary o. Central Government Fiscal Operations, 1986-90 8......................................... 8 Table 2: Selected Indicators of the Impact of the Conflict on the Economy .................................. 11 Table 3: Estimated Damages in the Housing Sector- A. Houses Damaged or Destroyed 12 B. Types of Houses Damaged .......... ........... 12 Table 4: Estimated Damages in the Commercial Sector 14 Table 5: Losses by Farming Families 15 Table 6: Number of Affected Fishing Families and Equipment Losses 15 Table 7: Summary of Damage to Roads and Bridges 18 Table 8: Vehicle Damage ..... 19 Table 9: Damages to the Power Sector 21 Table 10: Damage to School Buildings and Ministry of Education Offices 23 Table 11: Damages to the Health Sector 24 Table 12: Reconstruction Program by Sectcr .................. 26 Table 13: Rehabilitation of Housing Sector A. Estimated Support Costs for Housing Reconstruction 29 B. Planning Assumptions for Housing Reconstruction 29 Table 14: Rehabilitation of Commercial Sector A. Estimated Costs by District 34 B. Planning Assumptions for Commercial Sector Rehabilitation 34 Table 15: Farm Rehabilitation Program Requirements by District .......... 35 Table 16: Equipment Needs for Fishing Industry by District 36 Table 17: Fisheries Rehabilitation Program Requirements by District 36 Table 18: Requirements of Funds for Restoration of Facilities 39 Table 19: Rehabilitation Requirements for Water Supply 444444 41 Table 20: Annual Implementation Program for Water Supply and Sanitation 42 Table 21: Roads and Bridges Reconstruction Program .......... 43 Table 22: Phasing of Road Construction Expenditure Program 44 Table 23: Rehabilitation Program for Public Transport 45 Table 24: Reconstruction Program for Railways 46 Table 25: Rehabilitation Program for Ports .......$.......... 47 Table 26: Telecommunications Sector A. Cost Estimates by Equipment Category 444444444 48 B. Cost Estimates of Rehabilitation by District.. 49  -ii- TEXT TABLES (Cont.) Table 27: Rehabilitation Program for the Power Sector ..,.... 52 Table 28: Reconstruction Program for Industrial Sector ...... 53 Table 29: Rehabilitation Requirements of Education Sector ... 57 Table 30: Rehabilitation Costs for the Health Sector A. Hospitals and Clinics ........................ 59 B. Teaching Hospitals ....... ......... ..... *. 59 Table 31: Reconstruction Program for Public Buildings ....... 61 Table 32: Priority Reconstruction needs for Remainder of 1987 62 Table 33: Reconstruction and Rehabilitation Program by District ..................... 64  EXECUTIVE SUMMARY (i) The recent Peace Accord signed between the Governments of Sri Lanka and India aims at putting an end to a four year bitter and costly conflict that caused extensive damages predominantly in the Northern and Eastern parts of the country and accentuated the country's already serious macro-economic imbalances. In particular, it provides for a considerable degree of administrative autonomy to the Provinces; Tamil to be an official language, and agreement on procedures to determine the ethnic composition of all land settlement schemes. (i.) The four years of the ethnic conflict caused considerable damage. About 7,000 lives were lost and thousands more wounded. Almost 100,000 families or about 500,000 people lost their homes. The Northern and Eastern parts of the country suffered the greatest disruptions. Many workplaces were destroyed or damaged. Not only were urban areas affected but fighting was widespreaa in the rural areas as well; thousands of farmers were forced to leave their lands and in many areas, the irrigation systems they were so dependent on were damaged. Fishermen lost their boats and whole fishing villages were destroyed. Schools, hospitals, cLinics were damaged resulting in serious hardships to children and patients. (iii) The conflict has disrupted activities in all sectors of the economy--farming, fishing, manufacturing, transport, trade--put a heavy burden on both the budget and the balance of payments, and caused damages to the country's infrastructure estimated to be at about US$700 million. This US$700 million is only a portion o'- the quantifiable economic losses that the country has suffered. The decline in tourist arrivals after the beginning of the conflict caused a US$200 million reduction in foreign exchange earnings since August 1983. Another US$500 million had to be allocated to strengthen the security forces, some US$300 million of which was for imports of military equipment. About US$250 million of foreign investment that could have materialized in the last four years under normal conditions were lost because foreign investors were reluctant to invest in a country with an uncertain political climate. Lost agricultural and fishing production is estimated to be at US$250 million. All in all, the ethnic conflict has caused since its beginning losses to the economy that are probably over US$2 billion, i.e. a third of the current GDP, once the indirect effects of the conflict--such as the increased production that foreign investment would have brought about--are taken into account. (iv) The Government intends to rehabilitate all the parts of the country that suffered from the conflict and bring them back to normalcy as quickly as possible. This requires rehabilitating the damaged infrastructure and get- ting displaced people back to work and facilitate start of economic activities. Three principles have guided the Reconstruction Program as  -ii- discussed in this report. First, it is not necessary to rehabilitate every- thing that was damaged. Unproductive infrastructure or assets do not need to be included in the Reconstruction Program. Second, wherever possible, the replaced infrastructure should be smaller in size and therefore of lower cost, a principle that is particularly relevant in the case of houses, local and public buildings. Finally, the reconstructed assets should be within the Government's capacity to maintain them. (v) Based on the above criteria, reconstruction and rehabilitation needs total about Rs 13 billion (US$388.4 million), including contingencies, over three years. The estimates are based on the districts' evaluation and were reviewed and revised by the staff based on visits to eight of the most affected districts. They must be viewed as preliminary and would have to be refined as Reconstruction activities proceed. In particular, the extensive damage to Jaffna and Trincomalee during mid-October clasbes are not included here nor are damaged areas where for lack of government scaff, an assessment could not be made. The Reconstruction Program of US$388.4 million includes replacement of buildings and equipment destroyed or lost by small entrepreneurs, traders and shopkeepers, but does not include an estimate of their losses in terms of inventories damaged or destroyed. (vi) Since the end of the hostilities, the Government has begun to make arrangement for the displaced people to return to their houses. A grant of Rs 10,000 is being provided for all affected families. Based on estimated 100,000 families displaced, resettlement program amounts to Rs 600 million (US$20 million). Housing .s the most extensively damaged sector and will require about US$73 million for rehabilitation. Reconstruction of other sectors which suffered extensive damage include: Roads and Bridges, US$70 million3 Agriculture and Fisheries, US$64 million; Telecommunications, US$37 million; Commercial Sector, US$25 million; Railways, US$17 million; Irrigation and Water Supply, US$16 million. (vii) During the Mission's visit to the districts, it was apparent that many of the affected people were frustrated in not getting assistance to resettle or start economic activities. In many cases they did not know about the Government's resettlement assistance program of Rs 7,000 (excluding NGO contribution) per affected family. There is an urgent need to announce this program nationwide and make these funds available to the displaced people. This assistance program will go a long way in reducing the anxiety of the affected people, hasten re-establishment of normal life and promote accept- ance of the Peace Accord. Assistance in other areas such as agricultural inputs (seeds, fertilizer, sprayers, and machine tools) for farmers to cul- tivate their lands in time for the upcoming Maha season; fishing inputs for fishermen who already have boats but need equipment such as fishing nets; temporary sheds for schools; and temporary clinics and dispensaries should be provided urgently. In other sectors such as roads and irrigation, some of the equipment needed urgently could be made available from the nearest non-affected areas until new supplies arrive. It is estimated that about Rs  -iii- 431 million (i.e. about US$15 million) is required to address priority recon- struction needs for the remainder of 1987. Since the flow of grants may be slow for the remainder of 1987, it is recommended that the Government provide Rs 250 million towards these needs out of the Rs 500 million set aside in the 1987 budget to absorb grants. (viii) During the Mission's discussions in each district, people were of the view that the priorities of reconstruction needs of each district should be made in the districts. The people wanted a close association with both the program formulation as well as participation in its implementation. The Reconstruction Program is thus structured to reflect the priorities of each district. Consistent with the Government's intention to devolve administra- tive power to the proposed provincial councils, it is appropriate to put each district administration in charge of its Reconstruction Program. Therefore, the recommended implementation structure is to give the districts the plan- ning and prioritizing role, to the Central Government, financial approval monitoring and problem resolution, and to the line agencies that of the execution of works. Although the districts would be the main focal point of preparing detailed programs, there would be some programs such as Railways, Ports, Public Buildings, and Public Transport that would be national in scope which would require planning by the concerned line ministry. (ix) The district approach would require close coordination between the district and the center. Therefore, coordinating committees are recommended at the center and in all the affected districts. In addition, in the case of most affected districts, the district coordinating committees would be sup- ported by a Secretariat. (i) rhe District Reconstruction Coordinating Committee (DRCC): Since each district would be in charge of implementing its program, a task force headed by the Government Agent (GA) and assisted by a Technical Direc- tor and technical staff of I1ne ministries in the district should be formed. the membership of DRCC will also include district or regional heads of line ministries, citizens committee representatives, and NGOs. The DRCC will plan and prioritize reconstruction activity and monitor implementation of the district program. The DRCC will be represented at the National Reconstruc- tion Steering Committee by the CA. Although some of the required staff already exists in some districts, each district should examine and prepare staffing plans to implement the district program. Since the GA in each district has multiple functions to perform, a Technical Director would be appointed to assist the GA and be in charge of the day-to-day operations. It is recommended that the exercise to prepare staffing plans should begin immediately and be ready befoce the Aid Group meeting and staff in place by January 1, 1988. In some districts this timetable may have to be altered due to the recent violence. (ii) The National Reconstruction Steering Committee (NRSC): In order to monitor agreed yearly programs, resolve any inter-district issues, approve  -iV- financial resources and determine administrative procedures, especially for reimbursement of foreign aided expenditures, a task force at the center would be created. This task force would be headed by a Senior Government official acting as Chairman and be assisted by a secretariat headed by a Chief Execu- tive Officer to oversee day-to-day operations. This task force would be located in the Ministry of Finance and Planning (MOFP) and would include the GAs in charge of district programs and representatives of line ministries at the center. In order to ensure that all development ministries are involved in the reconstruction effort,. the Development Secretaries Committee would be regularly informed of the Reconstruction Program and its implementation. (x) The NGOs are playing a useful role in assisting in the reconstruction effort, especially in the housing, health, and agriculture sectors. However, each of these agencies have their own agenida, its own zlientele, and its own way of doing things. For example in housing, some NGOs are helping recon- struct houses, some are providing material subsidies, but in varying amounts and only in some villages. The issue facing the Government is equity,. i.e., ensuring that-every affected family has equal access to reconstruction benefits. Therefore, it is extremely important that the Government knows of all NGO programs and coordinate their activities to ensure that there is no duplication of efforts and that all affected villages benefit equally. Similarly, all NGOs should be informed of the various reconstructijn activities and assistance programs. In order to ensure proper coordination, it is recommended that all NGOs coordinate their activities with che Govern- ment Agent and appoint a representative or the DRCC. (xi) The three-year Reconstruction Program recommended in this report is well within the country's implementation capacity. Many skilled workers are looking for jobs, some factories are operating below capacity, some equipment is underutilized, many banking branches have been shut down and could be easily reopened. In addition there are already some materials available for the rehabilitation of the housing, agricultural and fisheries sectors and could be utilized at least in the early stages of the program; what is not available, can easily be imported. However, since domestic supply and/or imports may not respond immediately due to increasing demand, some con- straints may be experienced in sectors which will compete for the same materials and resources, but they are not believed to be substantial. (xii) Donor participation will be critical for the success of the Recon- struction Program. It is estimated that donor commitments of about US$320 million on highly concessional terms will be required, while the Government would finance about US$70 million or 18 percent of the program. It is recom- mended that the donors make a one time commitment so that the reconstruction plans for the three years can be developed and firmed up. Preliminary dis- cussions with Sri Lanka's donors suggest that the US$320 million can be entirely financed through grants and concessional loans.  (xiii) The Peace Accord was signed at a time when the Government had already announced, and taken the first preliminary steps, of a far-reaching program of economic reforms, to be supported by an IMF Structural Adjustment Facility (SAF) aimed at (i) reducing the public sector deficit from 12 percent of GDP in 1987 to about nine percent in 1990, a deficit that could be financed without having to resort to the use of credit from the Central Bank or comr- mercial foreign borrowing. The reduction in the deficit would be achieved through the maintenance of fiscal revenues at about 20 percent of GDP, and the reduction of total Government expenditures from 33 percent of CDP in 1986 to 29 percent of GDP by 1990; and tii) changing industrial incentives so as to make manufacturing enterprises more competitive and more export-oriented. A more flexible management of the exchange rate, a reduction in the protec- tion afforded by the tariff and licensing system, export promotion policies, divestItures of Public Sector Manufacturing Enterprises (PMEs) and better management of PMEs that cannot be privatized immediately are the essential components of the program of industrial reforms. As the Government did not anticipate a Reconstruction Program of this magnitude from 1988, it may be necessary to modify slightly the economic reform programs to accommodate this ReconstrucLion Program. (xiv) The Reconstruction Program is not expected to affect the program of industrial and administrative reforms, but would have an impact on the budget. Over a three-year period Rs 13 billion (US$388.4 million) will be required to carry-out the Reconstruction Program thus putting on the budget additional claims equivalent to some 1.5 to 2 percent of GDP every year, on the average during 1988-90. While cuts in expenditure related to imports of military equipment of Rs 3.5 billion, i.e. 1.5 percent of GDP projected for 1988, are expected to ease the fiscal situation other factors will add to fiscal pressures. First, the Government has decided to restructure civil service salaries over a two year period in accordance with the recommenda- tions of the Committee on Administrative Reform, a working group formed in 1984 to advise the Covernment on matters related to the public administra- tion. This restructuring of salaries will result in a 30 percent increase in civil servic( salaries (1.2 percent of GDP) with larger adjustments at the professional and managerial levels. Despite this, civil service salaries would remain substantially below those of the private sector. Second, the devolution of power to the Provinces will create additional expenditures, as the Provincial Councils, the position of Chief Minister and the Board of Ministers are created. Finally, under the new set up, the Provinces will prepare their own budget and prepare public investment projects. This is another potential source of pressure on the budget. (xv) To reach its medium term fiscal target and accommodate the Recon- struction Program, the Government has decided to prepare a program to reduce public expenditures with the assistance of the World Bank which has scheduled a public expenditure review mission for December 1987. Under the program, both current and capital outlays will be examined with a view to identifying specific reductions and also measures that would increase the efficiency of  -vi- expenditures. There are four areas of expenditures where the scope for and the consequence of expenditure reductions are being examined: i) public administration, where the implementation of the recommendations of the Com- mittee on Administrative Reforms should help in streamlining the public administration and reduce wage costs; ii) budgetary support to public cor- porations and public bodies such as Air Lanka where expenditure reduction could be achieved through efficiency increases; iii) subsidies such as the fertilizer subsidy, and the subsidies to the Central Transport Board (CTB); and iv) investment in irrigation schemes (including Mahaweli), power and transportation which account for close to half of the public investment program and where some rephasing could bring about substantial reduction in public expenditures.  I. INTRODUCTION A. Background 1. After four years of a bitter and violent conflict between the militant groups from the Sri Lankan Tamil 1/ community and the Government security forces, the Governments of Sri Lanka and India signed a Peace Accord (see Annex I) on July 29, 1987 aimed at solving this conflict. The Peace Accord provides the basis for the reestablishment of peace and normalcy in the country. In particular, it provides for a considerable degree of administrative autonomy to the Provinces; Tamil to be an official language, and agreement on procedures to determine the ethnic composition of all land settlement schemes. 2. Under the administrative arrangements covered in the Accord, 25 districts (see Map) will be merged into eight 2/ provinces with a fair degree of autonomy. Each province would have its elected Provincial Council, con- sisting of a Chief Minister, a Board of Ministers and a Governor appointed by the President. Together they will be responsible for educa.ion, health, police and the formulation of development budgets. The provinces will deter- mine the ethnic composition of all new minor resettlement schemes whereas the center will determine the composition in major new settlement schemes, such as Mahaweli-System B, taking into account both the country's overall ethnic composition and the composition of the population living in districts where new settlements would take place. Further, Tamil will also be an official language and therefore, hold equal status as Sinhala. This should make access to education and employment opportunities more equitable, particularly in the Government sector. 3. The provincial councils will depend on the Central Government for funding of their expenditure programs since the structure of the Sri Lankan tax system is such that most taxes are levied in Colombo and neighboring Central and Southern districts. Revenues from import taxes are almost l/ Tamils comprise about 18 percent or a little less than three million of Sri Lanka's 16 million population. About 13 percent of these are Sri Lankan Tamils whose roots in the country are several centuries old. The remaining 5 percent are Indian Tamils who migrated from South India in the second half of 1800s and early 1900s to work in the then thriving tea and rubber plantations. About 82 perce.L of the Indian-Tamils live in the Central and Southern-Central districts where most of the tea and rubber is produced, while about 75 percent of the Sri Lankan-Tamils live in the Northern and Eastern districts. 2/ The Peace Accord provides for referendum to be held by December 1988 in the Eastern Province to allow the population to decide whether the East- ern districts should merge with the Northern areas.  -2- entirely collected in Colombo and so are export taxes on the tea, rubber and coconuts produced in the Central and Western districts. Export and import taxes have historically accounted for about half of Government revenues. There are no data available in the case of the other two main sources of Government revenues, the Business Turnover Tax (BTT) and the income tax on corporations and individuals, to assess the geographical distribution of their collections but it is likely that they are, again, mostly collected in Colombo and neighboring areas where incomes are higher than in the rest of the country and where most of the corporations have their headquarters. Moreover, most taxes are collected from the formal sector of the economy which is, also, mostly localized in Colombo. 4. Such a tax system is unlikely to change, at least in the short and medium term, and this implies that the Provinces will depend on the transfers from the Central - -ernment to carry-out their functions. The allocation of Central Government funds to the Provinces is expected to be made by a Commis- sion headed by the President and consisting of the Governor of the Central Bank, the Secretary of the Treasury and Representatives of each one of the three major ethnic communities (Sinhalese, Tamils, Muslims), to be appointed by the President. Preliminary indications suggest that over 90 percent of provincial expenditures will be funded by transfers from the Central Govern- ment. In spite of their fiscal dependence, the Provinces will acquire a considerable degree of autonomy. First, they will be able to develop public expenditure programs and determine priorities; to carry-out and monitor the public expenditure programs, and to hire staff. Ea&h Province will prepare its own budget and it will be responsibLe for its monitoring and execution once it is approved by the Central Government and incorporated in the national budget. B. Aftermath of the Conflict 5. Visits to the affected areas givP An imnrpqsinn thAt rnnflirt was intense and highly destructive. The human toll was tragic. An estimated 7,000 lives were lost and thousands more were wounded. Almost 100,000 families, of which about 90,000 were farmers and fishermen, lost their homes; with an average of 5 people per family, that translates to 500,000 people homeless. Of these, as many as 200,000 people fled for safety to other parts of the country and another 20n,000 (125,000 to India) fled the country as refugees. In other words, over 20 percent of the population in the North and East were made homeless and about 10 percent were forced into the numbing existence of living in camps. 6. The northern and eastern parts of the country suffered the greatest disruptions. Fighting there was heavy and very disruptive. Many workplaces were destroyed or damaged, and thousands of others closed, to protect their assets and their employees' lives. Not only were commercial areas affected but the fighting was widespread in the rural areas as well; thousands of  -3- farmers were forced to leave their lands and in some areas, the irrigation systems they are so dependent on were damaged. Fishermen, suspected of smuggling arms, were special targets. Their boats were sunk or destroyed on land, and their villages were often singled out for retaliatory attacks. In some areas, whole fishing villages were destroyed. 7. Schools were damaged and others forced to close. In some areas, children continued their studies under temporary sheds or in their houses. Similarly, some hospitals and clinics were damaged, and while medical serv- ices continued, the staff and patients were under great hardships. Some public health services faltered, immunizations particularly, and the result was that many children became susceptible to diseases they are usually protected from. At the end of the conflict, a polio epidemic was detected in the North; under normal circumstances all the children in the area would have received their preventive vaccine. 8. The physical dama'es indic.ate the type of fighting that took place. Most of the North and Easc is flat paddy land. The need to devote as much land as possible to cultivation dictates that many of the people live along the edges of the roads and it was along the roads that much of the fighting was centered. To control an area, one had to control the access to it. For the militants, this meant blowing up the bridges and culverts, mining the roads at key intersections, sinking the ferries, and forcing traffic, espe- cially government patrols, into narrow, restricted areas where they could be fired upon from captured houses. For the Government, the response was to establish camps along the roads by occupying any installation large enough to use as a base: schools, cooperative buildings, hospitals, large industrial complexes all served the 3urpose. To deny the Government the use of these installations, the militants attempted to destroy them before they could be occupied; a measure of their success is that in some areas there are miles of road where no government or semi-government installation is left standing. To keep the houses along the roads or near the army's camps from being used for ambushes, the army simply razed the nLouses. In many cases, the housing was not only knocked down, but the debris was physically removed to keep the rubble from being piled up and used as a revetment by the militants. In Jaffna district, the militants stole railway sleepers to build bunkers. In many areas, coconut trees were felled for bunkers or simply burned for the fear that they would be used by the opposing side. C. Prospects for Reconstruction 9. The signing of the Accord was initially met with considerable discon- tent that ended-up in short lived but violent riots that caused extensive damages in areas that had remained unaffected until then by the ethnic con- flict. Very quickly, however, hostilities came to a halt; by September the country had returned to near state of normalcy; farmers displaced by the conflict had begun to return to their home villages to resume farming activities; the few fishermen who had not lost their equipment were fishing  -4- again; several important private manufacturing companies that had suffered plant damages during the conflict had restarted tneir basinesses. Nonethe- less, there was a resurgence of violence in October, this time between the majcr Tamil militant group and the Indian Peace-keeping force. Hopefully, such violence will abate as the militant groups are disarmed. In addition, strengthening of civil administration through the establishment of interim provincial councils and, ultimateLy, through the provincial council elections and the Reconstruction Program is likely to help in further abating violence. There is thus, an urgent need to take an early action to support reconstruc- tion and reactivation of economic activities. This would further strengthen the Peace Accord and return to normalcy. 10. The volume of resources needed to sustain the reconstruction effort, how to channel these resources to private individuals and public agencies in need of such resources, and the Government actions end policies that are necessary to ensure that the Reconstruction Program provides adequate returns to the economy, are the main themes of this report. The report first evaluates the likely impact of the Reconstruction Program on the economy and highlights the economic policy actions that would be necessary to accommodate the demands that the Reconstruction Program will put on the economy without disrupting the development goals and strategies that the Government had announced recently. Next, it provides an assessment of the damages that have occurred in each affected district and each sector of the economy. Finally, it formulates the broad guidelines and priorities of a proposed three-year Reconstruction Program.  -5- II. THE RECONSTRUCTION PROGRAM AND THE ECONOMY A. Macroeconomic Framework 11. The Peace Accord was signed at a time when the Government had taken the first steps of a far-reaching program of economic reforms aimed at (i) reducing the public sector deficit from about 12 percent of GDP in 1986 to 9 percent in 1990, a deficit that could be finat.ced without having to resort to the use of credit from the Central Bank or commercial foreign borrowing. The reduction in the deficit would be achieved through the maintenance of fiscal revenues at about 20 percent of GDP, and the reduction of total Government expenditures from 33 percent of GDP in 1986 to about 29 percent of GDP by 1990; and (ii) changing industrial incentives so as to make manufac- turing enterprises more competitive and more export-oriented. A more flexible management of the exchange rate, a reduction in the protection afforded by the tariff and licensing system, export promotion policies, divestitures of Public Sector Manufacturing Enterprises (PMEs) and better management of PMEs that cannot be privatized immediately are the essential components of the program of industrial reforms. 12. The Government's intention to reduce the fiscal deficit was announced in the November 1986 Budget Speech, and the industrial reforms in the report of the Industrial Policy Committee (IPC) that was approved by the Cabinet in February this year. Both were described and discussed in detail in the Country Economic Memorandum that was distributed to the Government and to the members of the Sri Lanka Aid Group last June. As a result of the fiscal adjustment program, the public sector deficit is expected to decline by 0.5 percent in 1987 (11.8 percent of GDP) in relation to 1986 (12.3 percent of GDP), and a further 3 percent of GDP by 1990. The program of industrial reforms would begin in 1988 when the first round of tariff reduction, the elimination of most import licensing requirements, the first phase of the privatization program, and changes in PMEs management systems are expected to take place. The management of the exchange rate has already been made more flexible. The adjustment of the Sri Lanka rupee vis-a-vis the US$ since late 1984 (the rupee was at Rs 26.2/US$ at end 1984 and at Rs 30.5/US$ at end October 1987) coupled with the devaluation of the dollar vis-a-vis the major international currencies, has meant in real terms a depreciation of over 25 percent vis-a-vis the currencies of Sri Lanka's trading partners. This has corrected the substantial real appreciation of the rupee that had taken place in 1980-84, and it is expected that continued flexibility will support the economic reform program. 13. The Reconstruction Program described in this report, amounts to Rs 13 billion (US$388.4 million) over a three year period. The Reconstruc- tion Program is not expected to affect the program of industrial reforms, and should have a positive impact on the balance of payments. Concessional foreign flows are expected to finance as much as 82 percent of the total cost  -6- of the program while its import content is estimated to be at 35 percent. The Reconstruction Program will, however, create new pressures and put addi- tional claims equivalent to 1.5 to 2 percent of CDP a year on the average on the budget. This will add to other fiscal pressures. First, the Governr.ent has decided to restructure civil service salaries over a two year period in accordance with the recommendations of the Committee on Administrative Reform, a working group formed in 1984 to advise the Government on matters related to the public administration. This restructuring of salaries will result in a 30 percent average increase in civil service salaries (1.2 per- cent of GDP) with larger adjustments at the professional and managerial levels. Despite this, civil service salaries would remain substantially below those of the private sector. Second, the devolution of power to the Provinces will create additional expenditures, as the Provincial Councils, the position of Chief Minister and the Board of Ministers are created. Finally, under the new set up, the Provinces will prepare their own budget and prepare public investment projects. This is another potential source of pressure on the budget. 14. I. should be possible, however, to accommodate these pressures, as well as the increase in expenditures brought about by the Reconstruction Program, within medium-term fiscal targets, provided that the Government takes strong action in reducing public expenditures. In addition to the Rs 3.5 billion (1.5 percent of CDP) reduction in defense expenditures that has already been decided for 1988, the Government will prepare, with the assistance of the World Bank which has scheduled a public expenditure review mission for December 1987, a program to reduce public expenditures. Under this program both current and capital outlays will be examined with a view to identifying specific reductions and also measures that would increase the efficiency of government outlays. The balance between current and capital expenditures and the adequacy of budgetary allocations for the social sectors are also part of this review. There are four main expenditure-areas where the scope for reductions and the effect of potential cuts would be examined. 15. The first is related to the civil service. Sri Lanka's civil service has a long and well deserved reputation of excellence but, in the past, the Government has attempted to reduce the high levels of unemployment in the economy through an increase of employment in the civil service. At the same time, to reduce the budgetary impact of such a policy, the Government has limited the increase in the salaries of civil servants. As a result, Sri Lanka's civil service is now both overstaffed and underpaid. The problem of underpay is particularly serious at the senior level. In addition, over the years, there has been a multiplication of ministries and agencies (tnere are some forty ministries) with fragmented and overlapping functions and little coordination. The Government appointed a Presidential Committee on Administrative Reforms in 1984 to study these problems. The Committee issued its recommendations in mid-1987 which consist of (i) reducing the number of civil servants by 25 percent; (ii) introducing a new salary structure that would narrow the wide disparity between the remuneration of professionals and  -7- managers in the public and private sector; and (iii) reducing the number of entities to eliminate duplication of functions. A precise timetable for the implementation of these recommendations will be developed during 1988, after the implications for the civil service of the planned devolution of administrative functions to provincial councils is assessed. Meanwhile, the present freeze on the hiring of new staff and the filling of vacancies will be continued. 16. Budgetary support to public corporations is the second expendi- ture-area being examined by the Government. There are three public corpora- tions (Air Lanka, the Cement Corporation and the Ceylon Shipping Lines) which have absorbed the bulk of the budgetary support to public enterprises in the past few years. The Government has already decided to reduce its budgetary support to Air Lanka in 1988. The rationalization of the corporation's operations and the disposal of assets (a Boeing 747 has already been sold and another is expected to be sold in the next few months) has reduced Air Lanka's need for budgetary support. Moreover, the Government is expected to examine what would be the budgetary consequences of: (i) closing down the airline; (ii) restructuring its routes to concentrate on regional traffic exclusively; and (iii) continuing the current routes. In the case of the Cement Corporation (also see para 112), the Government is developing a restructuring plan with the assistance of the World Bank. Under such a plant the corporation will undergo a financial and technical restructuring that would improve its efficiency and make it internationally competitive. The case of the Ceylon Shipping Lines is more difficult. The company suffers from the contraction in international sea traffic, the reduction in freight rates, and a large debt overhang. The Government has already reduced the number of vessels from 14 in 1983 to 8 in 1986 and is studying ways to mini- mize the budgetary assistance to the corporation. 17. Subsidies and transfers is the third expenditure-area being studied by the Government. The fertilizer subsidy, the subsidy to the Central Tran- sport Board (CTB), and the National Food Stamp Program are the main ones. An assessment of the impact of the fertilizer subsidy on production and farmer's costs will be made with a view to preparing a plan for elimination of the subsidy by 1990. 18. Finally, the Government intends to reduce the s.ze of its Public Investment Program and it is currently analyzing the social and economic consequences of reptasing its investment in Mahaweli and in other irrigation schemes, power, and uransportation. These public investment projects account for close to 40 percent of development expenditures in the next five years. Concrete proposals will be developed during 1988 for implementation in the 1989 and 1990 budgets. Meanwhile, no new projects in these areas will be included in the Public Investment Program.  -8- Table 1: SUMMARY OF CENTRAL GOVERNMENT FISCAL OPERATIONS, 1986-90 Preliminary Actual Estimates Projected 1986 1987 1988 1989 1990