Sri Lanka - Sustaining the adjustment process

Report No. 8951-CE Sri Lanka Sustaining the Adjustment Process September 26, 1990 Asia Country D)epartnment 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 not otherwise be disclosed without World Bank authorization.  CURRENCY AND EQUIVALENT UNITS (Annaal Averages) Sri Lanka Rupee per US$1.00 1978 = Rs 15.61 1979 = Rs 15.57 1980 Rs 16.53 1981 Rs 19.25 1982 = Rs 20.81 1983 = Rs 23.53 1984 = Rs 25.44 1985 Rs 27.16 1986 = Rs 28.02 1987 = Rs 29.44 1988 = Rs 31.81 1989 = Rs 36.04 FISCAL YEAR (FY) January 1 to December 31 This report was written based on findings of a mission ti t visited Sri Lanka during April-May 1990. The mission was led by Hisan Shi.aido and comprised Zeljko Bogetic, Dilesh Jayanntha, Wouter van Ginneken (ILO) and Leslie Abbie (Consultant). Roberto Zagha and Christopher Adam (Consultant) also contributed to the report. In addition, the mission worked closely with another Bank mission on private sector development consisting of Enrique Rueda-Sabater, Brian Levy and Rafael Herz.  FOR OMCIAL USE ONLY List of Abbreviations and Acronyms Used ADB - Asian Development Bank ARC - Administrative Reforms Commission BOC - Bank of Ceylon BOP - Balance of Payments CCPI - Colombo Consumer's Price Index CD - Commercialization Division, Ministry of Finance CFB - Central Freight Bureau CFF - Compensatory Financing Facility CFS - Consumer Finance Survey COPE - Committee on Public Enterprises CPC - Ceylon Petroleum Corporation CSE - Colombo Stock Exchange CTB - Central Transport Board C'WE - Cooperative Wholesale Establishment DFCC - Development Finance Corporation of Ceylon DFIs - Development Finance Institutions ECU - Evaluation & Coordination Unit, Ministry of Policy Planning and Implementation EPF - Employees Provident Fund EPZ - Export Processing Zone ERC - Economic Restructuring Credit ESAF - Extended Structural Adjustment Facility FIAC - Foreign Investment Advisory Committee FTC - Fair Trading Commission FSP - Food Stamp Program GCEC - Greater Colombo Economic Commission GDP - Gross Domestic Product GNP - Gross National Product GOBUs - Government Owned Business Undertakings IDA - International Development Association IMF - International Monetary Fund JEDB - Janatha Estates Development Board JSP - Jana Saviya Program LFSES - Labor Force & Socio-Economic Survey MDMP - Mid-Day Meal Program MOt - Ministry of Industry MOT - Ministry of Textiles 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.  NCHS National Council of Health Services NDB - National Development Bank NS8 - National Savings Bank NTC - National Textile Corporation O&M - Operation and Maintenance PB - Peoples' Bank PC - Provincial Council PD - Policy Division, Ministry of Public Administration & Provincial Councils PEs - Public Enterprises PFP - Policy Framework Paper PHC - Preventive Health Care P1MB - Public Investments Management Board PMB - Paddy Marketing Board PMEs - Public Manufacturing Enterprises PMEAC - Public Manufacturing Enterprises Adjustment Credit PSC - Public Service Commission RMC - Rubber Manufacturing Company RRDB - Regional and Rural Development Bank RTB - Regional Transport Board SAF - Structural Adjustment Facility 3CC - Salaries and Cadres Commission SFI - Strategy for Industrialization SLDHS - Sri Lanka Demographic Health Survey SMEs - Small and Medium Enterprises SMI - Small and Medium Industry SPC - State Plantations Corporation TB - Treasury Bills UM - United Motors USAID - United Stated Agency for International Development VAT - Value Added Tax WHO - World Health Organization  TITLE: SUSTAINING THE ADJUSTMENT PROCESS COUNTRY: SRI LANKA REGION: ASIA COUNTRY DEPARTMENT I SECTOR: COUNTRY ECONOMIC REPORT TYPE CLASSIF M"/n LANGUAGE 8951-CE CEM Restricted 09 90 English PUBDATE: 9009 ABSTRACT: The Government of Sri Lanka embarked on serious economic restructuring efforts in 1989. The efforts consist of short-term stabilization measures (removal of subsidies and targeting of welfare programs aided by substantial currency depreciation) and medium-term structural adjustment measures (rationalization of the large public sector including administrative reform, public transport privatization, and rationalization of the state-owned plantation sector). The short-term measures have been effective and caused a significant turn-around in macroeconomic and growth performance. However, much remains to be done. The future priorities include: successful completion of the ongoing reforms assisted by sound and efficient fiscal management; and creation of an enabling environment for the private businesses and maintaining the impetus of and expanding the coverage of the privatization process. This report discusses these future priority actions as well as the recent economic developments. In addition, given the widespread concern regarding poverty and unemployment in Sri Lanka and its impact on overall economic policy design, the report tries to understand the dimensions of the poverty problem and how the poor may be cushioned during the reform process. A conclusion derived in the report is that the target poverty group is probably less than a quarter of the population, and given their high child dependency rates, a targeted nutrition intervention program for pre-school children and pregnant and lactating mothers should have a high priority. Furthermore, the majority of the unemployed are young and single first-time job seekers supported by their families, a significant portion of whom are likely to be queuing up for a good job in the formal sector, in particular, the Government. The ongoing reform in the Government's hiring practices should in this regard be highly effective in reducing unemployment, but the solution to problems of poverty and unemployment lies in more rapid and sustained economic growth based on the country's comparative advantage in more labor- intensive, export oriented activities.  SRI LAM SUSTAINING THE ADJUSTMENT PROCESS TABLE OF CONTENTS Country Data Executive Summary i I. REVEW OF RECENT ECONOMIC PERPORMANCE AND REFOM EFFORTS........... 1 Introduction. ... 1 Background .. 1 Recent Economic Developments... 3 Short-term Measures. . . 6 Recent Economic Performance. . . 8 Medium-tem Measures ........ ................................ 21 Developments in 1990 . . . 25 Future Priorities .............................................. 30 1I. SUSTAININGHAMGEABLE FISCAL DEVELOPMENTS ......................... 32 Introduction ............ ....................................... 32 Recent Fiscal Developments ..................................... 33 Some Indication of Sustainable Fiscal Deficits .... .......... 41 Fiscal Picture 1990 and Beyond: Towards Sustainable Fiscal Patterns .............................................. 44 Aid Flows Consistent with the Sustainable Fiscal Pattern ....... 54 Financing Public Investment ...... ........................... 54 Balance of Payment Projections ...... ..................... 55 III. PROUOTING PRIVATE SECTOR DEVELOPMENT ...... ........................ 62 Background ..................................................... 62 Obstacles and Opportunities for Small and Medium Enterprises .... 64 Obstacles to Securing Inputs ...... .......................... 65 Constraints on Access to Credit ...... ..................... 68 Tax Constraints ............................ ................. 71 Sustaining and Improving the Privatization Process ............. 72 Introduction .............................. .. .................... 72 The Growth of the Public Enternrise Sector .. ................ 72 Recent Public Enterprise Structure & Performance ............ 74 Privatization Efforts: The Past Experience ................ .. 77 Constraints in the Privatization Process and Measures for Improvement ........................................... 82 Establishing an Enabling Environment for the Private Sector .... 87 Summary and Remaining Constraints ... ..................... 87 Financial Sector Reforms & Development of Capital Market ..... 90 Immediate Measures .......................................... 94 Medium-Term Measures ...................... . ......... . ....... 96  -ii- IV. POVERTY AND UNDENLOYENT .......................................... 8g Introduction *................................................... 98 Sri Lanka's Social Programs .................................... 100 Health and Education 1........................................ 10 Food Subsidies and Food Stamps .............................. 103 Extent of Poverty and Characteristics of Poverty .... ............ 106 The Multi-faceted Nature of Poverty .......................... 106 Evolution of Poverty During 1980s ........................... 111 Unemployment .................................................... 116 Introduction ................................................. 116 Labor Force Participation, Unemployment, Underemployment, and Poverty ................................................. 117 Who are the Unemployed? ...................................... 121 The Level and Nature of Sri Lanka's Unemployment .............. 123 Reducing Unemployment ....................................... 131 Poverty, Unemployment and Income Growth ........................ 131 The Social Costs of Adjustment ................................. 132 ANNEXES Annex I Transfers to the Provincial Councils .136 Annex II Obstacles and Opportunities for Small & Medium Enterprises - An Empirical Analysis .138 Annex III Size Distribution of Agricultural Land Holdings .............. 154 STATISTICAL APPENDIX . ................................................... 158 MAP  LIST OF TEXT TABLES Table No. ..e ChZapter I 1.1 Implementation of Policy Measures .................. 4 1.2 Key Economic Variables 1984-1989 ..8........... 1.3 Value-added Growth Rates of Major Sectors . . 9 1.4 Public Sector Major Industry Output Index 1987-1989 ....... 10 1.5 Tea: Key Indicators 1988189 .. 11 1.6 Macroeconomic Balances 1984-1989 .......................... 12 1.7 Sri Lanka: Balance of Payments .. 14 1.8 Balance of Payments 1989 Performance Relative to Expectations ........................................... 15 1.9 Debt Outstanding and Debt Service Payments ................ 16 1.10 Summary of Budgetary Operation, 1985-1990 ................. 17 1.11 Major Current Expenditure Outturns Relative to the Budgetary Allocation 1989 ..8.............. i 1.12 Major Capital Expenditure Underruns By Sectors in 1989 ..8....................... i 1.13 Monetary and Price Developments, 1985-1990 . . 19 1.14 Changes in Prices and Wages .. 20 1.15 Evolution of Fiscal Intentions for 1990 . . 29 chapter 11 2.1 Composition of Government Revenues . . 33 2.2 Comparison of Tax Structures ............................. 35 2.3 Composition of Government Expenditures . . 36 2.4 Composition of Capital Expenditure . . . 37 2.5 The Pattern of Fiscal Deficits and Their Financing ........ 37 2.6 Ownership of Domestic Debts as of End February 1990 ....... 39 2.7 The Pattern of Fiscal Expenditures 1990 Budget ............ 50 2.8 Current Transfers to Households (1981-89) ................. 51 2.9 Fiscal Patterns 1990--Program and Desirable . . S3 2.10 Sources and Uses of Funds for Public Expenditures . . 55 2.11 Balance of Payments Projections: Base Case ............... 56 2.12 Base Case Financing Requirements 1990-1993 ................ 59 2.13 Overall Aid Pipeline, 1987-89 ... 60 Chapter III 3.1 Access to Bank Credit by Size and Age of Firm ............. 70 3.2 Public Finance Impact of Public Enterprise Sector ......... 73 3.3 Sector Distribution of PEs ........................ .... .... 75 3.4 Government Shares in Comme,cial and Financial PEs ......... 76 3.5 PEs Financial Performance . .. ........ .... . 77 3.6 Characteristics of CSE 1985-89 ...... ..... ................. 91 3.7 Capital Market Development: Selected Asian Countries ...... 92  chapter IV 4.1 Sri Lanka's Living Standards Relative to Low- and Middle-Income Countries ................................ 98 4.2 Social Expenditures and Achievements ...................... 102 4.3 Allotment and Prices of Rice and Wheat Rations, 1952-78 ................................................ 103 4.4 Basic Mechanics of the Food Stamp Scheme .................. 104 4.5 A - Percent of Households Receiving Food Stamps and the Share of Total Food Stamps Outlay by Expenditure Quintile, 1981/82 ......................... 105 B - Receipt of Food Stamps and Average Monthly Food Expenditure by Income Class of Households: 1986/87 .... 105 4.6 Real Wage Rates: 1976-1989 ................................ 106 4.7 Households Characteristics, 1985 .......................... 108 4.8 Educational Attainment of Individuals 15 and Older, 1985 ............................................ 109 4.9 School Attendance Rates, 1985 ............................. 109 4.10 Reasons for Child Inattendance of School, 1985 ............ 110 4.11 Per Adult Equivalent Calorie Consumption by Expenditure Decile by Sector 1978/79, 1980/81, 1981/82, 1985/86 ....................................... 112 4.12 Evolution of Poverty ...................................... 113 4.13 Child Malnutrition ........................................ 115 4.14 Indicators of Child Malnutrition .......................... 116 4.15 Labor Force Participation, Unemployment, and Underemployment Rates of Heads of Households, 1985 119 4.16 Labor Force Participation, Unemployment, and Underemployment Rates in 1985 .......................... 120 4.17 Distribution of Poverty and Unemployment, 1985 ............ 120 4.18 Employed and Unemployed Population by Age and Level of Education, 1985/86 ............................ 122 4.19 Unemployment Rates in Sri Lanka by Sex and Sector ......... 123 4.20A Starting Monthly Salaries for Selected Government Employees .............................................. 125 4.20B Central Government Salaries Compared to Public and Private Sector ......................................... 125 4.21 Educational Levels in the Public Sector, 1985 ............. 126 4.22 Number of Students Sitting for the 0- and A-Level Examinations, 1982-1987 .127 4.23 Hiring in the Public Sector as Percent of New Entrants in the Labor Force, 1970-89. 128 4.24A Employed Persons by Sector of Employment and Educational Attainment by Sex . .129 4.24B Employed Persons by Sectors/Zones/Provinces and Sector of Work...... ..... 129 4.25 The Price Effects of Adjustment and International Price Increases, 1987-90.. 134  Page 1 of 2 COUNTRY DATA - SRI LANKA AREA POPULATION R/ DENSITY Wl.NOS sq. km 16.6 milion (mid-1988) 253 por sq. km. (1989) Rate of Grouth: 1.4 (1988) 763 per eq. km. agricultur&l land (1977) POPULATION C0ARACTERISTICS (1987) HEALJH (1988) Crude Birth Note (per 000) 21.9 Populstion per physician: 7,168 Crude Death Rate (per '000) 6.9 Population per hospital bed: 368 Infant Mortality (per '000 live births) 30.0/ INCOME DISTRIBUTION 1981/82) DISTRIBUTION OF LAND OWNERSHIP (1978) 5 of natlo*al ancome, highest quintile: 58 55 owned by top 1053 of owners - X of national Income, lowest quintil o: 4 %3 owned by smallest 10ff of ouners: - ACCESS TO PIPED WATER (1980) ACCESS TO ELECTRICITY (1981) % ot population - urban: 47 5 of population - urban: 48 % of population - rural: 40 X of population - rural: n.a. NUTRITION (1986) EDUCATION (1981) CaloriT intake: 2,400 Adult literacy rate: 97% Per capita protein intake (grams/day): 48 Primary school enrollment 98SX NP PER CAPITA IN 198 : USS c/ OUTPUT IN 1989 BY SECTOR ANNUAL RATE OF GROWTH (%, constant prices) Value Added Mill. UsS $ 1970-77 1977-86 1987-89 Agriculture 1648 26 2.8 3.9 -1.6 Industry