Sri Lanka - Economic Restructuring Credit and Public Manufacturing Enterprises Adjustments Credit Projects

DocumenL of The World Bank FOR OFFICIAL USE ONLY Report No. 14986 2(PLEMENTATION COMPLETION REPORT SRI LANKA ECONOMIC RESTRUCTURING CREDIT (2128-CE) AND THE PUBLIC MANUFACTURING ENTERPRISES ADJUSTMENTS CREDIT (2185-CE) SEPTEMBER 18, 1995 Country Operations Division Country Department I South Asia Regional Office 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 EQUIVALENTS Currency Unit: Rupees (Rs.) End Year Rates Rs./US$1.00 1990 Rs40.24 1991 Rs42.58 1992 Rs46.00 1993 Rs49.56 1994 Rs49.98 WEIGHTS AND MEASURES Metric System FISCAL YEAR January I to December 31 ABBREVIATIONS AND ACRONYMS CTB Ceylon Transit Board ERC Economic Restructuring Credit GDP Gross Domestic Product IDA Internationial Development Association ILO Internationial Labor Organization IMF Iinternationial Monetary Fund JTF Janasaviva Trust Fund OECF Japan Overseas Economic Cooperation Fund PIMB Public Investment Management Board PFP Policy Framework Paper PMB Paddy Marketing Board PMEAC Public Manufacturing Enterprise Adjustment Credit SAF IMF Structural Adjustnment Facility VAT Value-added tax  FOR OFFICIAL USE ONLY CONTENTS Summary ...........................................................1 Project Background ...........................................................3 A. Project Objectives ..........................................................3 B. Achievement of Objectives ..........................................................4 C. Major Factors Affecting the Project ..........................................................8 D. Project Sustainability ..........................................................8 E. Bank Performance ..........................................................9 F. Borrower Performance ..........................................................9 G. Assessment of Outcome ......................................................... 10 H. Future Operation ......................................................... 10 I. Key Lessons Learned ......................................................... 10 STATISTICAL TABLES ........................................................... II Table l a: ERC - Summary of Assessment .......................................................... 11 Table Ib: PMEAC - Summary of Assessment .......................................................... 12 Table 2: ERC & PMEAC - Related Bank Credits .................................................... 13 Table 3a: ERC Project Timetable .......................................................... 14 Table 3b: PMEAC Project Timetable .......................................................... 14 Table 4a: ERC Credit Disbursements, Cumulative Estimated & Actual .................... 15 Table 4b: PMEAC Credit Disbursements, Cumulative Estimated and Actual ........... 15 Table 5: ERC & PMEAC - Key Indicators for Project Implementation ................... 16 Table 6: ERC & PMEAC - Key Indicators for Project Operation ............................ 16 Table 7a: ERC - Studies Included in Project .......................................................... 17 Table 8a: ERC - Project Costs & Financing .......................................................... 18 Table 9: ERC & PMEAC - Economic Costs and Benefits ........................................ 19 Table 1 Oa: ERC - Status of Legal Covenants ....................................... 20 Table lOb: PMEAC - Status of Legal Covennant ......................................................... 23 Table 11: ERC & PMEAC - Compliance with Operational Manual Statements ........ 26 Table 12a: ERC use of Bank Resources: Staff Inputs ................................................... 27 Table 12b: PMEAC use of Bank Resources: Staff Inputs . ........................................... 27 Table 13a: ERC - Bank Resources: Mission ........................................ 28 Table 13b: PMEAC - Bank Resources: Mission .......................................................... 29 ANNEX 1: Government Evaluation of the PMEAC ...................................................... 30 ANNEX 2: Government Evaluation of the ERC ........................................................... 40 ANNEX3: Japan OECF Evaluation of the ERC ........................................................... 41 ANNEX4: IDA Completion Mission Aide Memoire .................................................... 50 |This document has a restricted distribution and may be used by recipients only in the performance of their l official duties. Its contents may not otherwise be disclosed wiihout World Banlc authorization.l   IMPLEMENTATION COMPLETION REPORT for the SRI LANKA ECONOMIC RESTRUCTURING CREDIT (Number 2128-CE) and the PUBLIC MANUFACTURING ENTERPRISES ADJUSTMENT CREDIT (Number 2185-CE) Summary 1. Background and objectives. The Economic Restructuring Credit (ERC) and the Public Manufacturing Enterprise Adjustment Credit (PMEAC) of 1990 supported the program set forth in the Policy Framework Papers (PFP) of 1989 and 1990. The program was supported by the International Monetary Fund (IMF) through a Structural Adjustment Facility (SAF) and by Japan, which provided co- financing for the ERC. The ERC sought to stabilize and then expand the economy and alleviate poverty by developing the private sector and rationalizing government expenditures. To this end, the ERC included specific measures to reform the tax and customs system, consolidate and target the social transfers, and reform and down-size the civil service. The PMEAC focused on the commercialization and privatization of state-owned manufacturing enterprises. 2. Achievement of objectives. The credits were successful on balance because the program of privatization and liberalization they supported led to a sustained, export-led, acceleration of growth that was associated with a decline in poverty. When the credits were prepared in 1989, Sri Lanka was destabilized by severe civil conflicts that had slowed growth and drained reserves. Through the program outlined in the PFP, the Government was able to stabilize the macro-economy in 1990. To assure that recovery would continue, the Government took steps to reduce tariffs and privatize public manufacturing enterprises, which helped spur a vigorous expansion of manufactured and especially garmnent exports. The deficit in the current account of the balance of payments narrowed from 7.1 percent in 1989 to 6.1 percent in 1992. Real GDP growth accelerated to 4.4 percent in 1992 and reserves recovered as well. This was not an isolated achievement as growth then accelerated to 6.9 percent in 1993 and 5.6 percent in 1994. This growth appears to have been associated with a downward trend in poverty, as documented in the Sri Lanka Poverty Assessment. 3. The outcome of the ERC is rated satisfactory on the strength of its contribution to the achievement of several necessary structural reforms and to the macro-economic stabilization and recovery of Sri Lanka. The Credit fully achieved its objective of promoting private sector development and privatization and, in doing so, significantly rationalized employment in the state enterprises, such as the bus company. However the achievement of several other objectives was slow or incomplete. For example, the reform of the civil service failed because the retrenchment program did not ease the fiscal burden but deprived the civil service of some of its most qualified senior staff members. Moreover, special incentives for voluntary retirement doubled the pension bill; the fiscal loss was worsened when the incentives were left in place at the close of the restructuring. The fiscal situation was further complicated because the Pension and the Employee Provident Funds were not reformed. There was an initial effort to reform the Food Stamp program through targeting benefits to the poor. But this trend was  2 reversed following release of the second tranche. Moreover, the recent re-establishment of the wheat and fertilizer subsidies reversed progress on transfer policy under the ERC. 4. The last Government did make progress in reducing the cost of the major social transfer programs, expressed as a percentage of GDP. While it did not succeed in targeting Food Stamps there was some progress in targeting the benefits of the Janasaviya program. The new Government has now established a Samurdhi program that will consolidate parts the Janasaviya and Food Stamp programs and will attempt to improve targeting, in part by setting a higher level of benefits for the poorest recipients. 5. The outcome of the PMEAC was satisfactory because it largely achieved its objective of reforming and privatizing public manufacturing enterprises, and because the Government has since built upon and continued these reforms. No public manufacturing enterprise has been re-nationalized but many additional small and medium state enterprises have been privatized. The new Government is planning strategic alliances involving partial privatization for several large state enterprises (e.g. Telecom and Air Lanka). However, there have been challenges to the transparency and fairness of past privatizations. 6. Reasons for slippage. Sri Lanka probably had to achieve several structural reforms at once to sustainably recover from the crisis of 1988-89. However the large number of structural measures supported by the ERC probably contributed to slippage in implementation. Efforts to reduce subsidies to state enterprises, raise tariffs, contract the civil service, and limit and target social transfers while privatizing enterprises meant that many Sri Lankans would suffer some losses from the reform program, at least over the short-run. Therefore the ambitious reform effort probably led to reform exhaustion and then reversal of some reforms as the Government expended its capacity to sustain short-run costs for medium and long-run benefits. 7. Agreement on policy was achieved through centralized negotiations between a small group of Bank and Government officials. The commitment of the Government was then undermined by inadequate explanation of policy to the line ministries and to the public. Commitment might have been stronger, and a greater part of the program might have been implemented, if the Bank and its negotiating partners in the Government had agreed to build support for the adjustment program through a broader effort at persuasion and consultation. The absence of such an effort made it more difficult to sustain reforms through the electoral cycle. 8. Lessons. The main lesson from the credits is that an adjustment effort should focus on building broad support for the two or three most important policy measures. The PMEAC may have been more successful than the ERC because it focused on the central goal of privatization. This points to the importance of explaining policy issues through seminars, press conferences, and through the translation and dissemination of economic and sector work, and then of sequencing policy measures reasonably. 9. The failed attempt to reform the civil service provides lessons for the future. Retrenchment should focus on specific categories of employees. The bulk of Sri Lankan civil servants are in the low- skill job categories. Efficiency in these categories is low because of over-staffing and the slow introduction of office technology. Moreover, many new teachers are entering the civil service with low levels of education. With a large share of employees occupying lower level positions and absorbing the bulk of the wage bill, there is a strong case for focusing on rationalizing staff within this cohort. A further lesson is that, rather than attempt to retrench civil servants throughout the Administration, efforts should be concentrated on those parts of the Administration that have lost their function and on the consolidation of units that have over-lapping responsibilities.  3 Project Background 10. In 1977, the Government of Sri Lanka initiated a new economic policy that sought to increase the role of markets and the private sector by removing restrictions on pricing, investment, and external trade and payments. However, after an initial period of intense adjustment, the reform effort slowed in the early 1980s. Moreover, ethnic and political conflict that began in 1983 and reached its peak in 1987- 89 severely hurt economic performance. Structural constraints and the civil disturbance inhibited gains in efficiency, and GDP growth declined to 2.9 % per year from 6 % during 1978-92. The main structural constraint was the over-extended public sector, and in particular the size and losses of the public enterprises. In the absence of reform of budgetary reform, the fiscal deficit exceeded 12 % of GDP during 1985-89. In view of these results, the Government strengthened its adjustment efforts in 1989, efforts supported by the ERC, PMEAC, and by the IMF through a SAF. A. Project Objectives. 11. The broad objectives of the ERC and the PMEAC were to support the program agreed between the Government, the Bank, and the IMF and set forth in the Policy Framework Paper (PFP).' The ERC emphasized macro-economic stabilization and poverty-reducing growth through structural measures to rationalize government expenditures, alleviate poverty, and develop the private sector. The PMEAC focused on the development of the private sector through measures to deregulate, commercialize, and privatize public manufacturing enterprises. 12. ERC obiectives. The main macro-economic objective of the ERC was to accelerate the growth of GDP from its depressed war time level of 2.3 percent in 1989 to the historical range of 4 to 4.5% by 1992, while lowering the current account deficit to 6 % of GDP and the inflation rate to 7%. The ERC aimed to realize these targets by encouraging export-oriented growth of the private sector, in part by freeing resources then claimed by the Government for use by the private sector. The main macro-economic condition for enhancing private investment was to narrow the fiscal deficit through cuts in government current expenditures. The decline in the fiscal deficit and the borrowing requirement would then facilitate continued monetary discipline and a declining rate of inflation. 13. Therefore the ERC supported a program of adjustment whose structural objectives were to: a) reduce subsidies and rationalize revenue extraction by (i) eliminating subsidies to rice, wheat flour, fertilizer, and to the transport boards, (ii) eliminating sugar subsidies and reducing its domestic price, and by (iii) beginning implementation of the recommendations of the Tax Commission; b) reform the civil service by (i) reducing the central and provincial administration staff by 40,000 persons in 1990-91 and by 80 to 90,000 over the medium-term, (ii) agreeing on and budgeting a plan to reduce staff in non-commercial parastatals, (iii) converting the Employees Provident Fund into an employee pension scheme, and by (iv) adopting a plan to reform the civil service pension scheme; c) accelerate poverty alleviation by (i) restructuring the Food Stamp program and reducing the number of beneficiaries to I million households, (ii) restructuring the Janasaviya Program and the Mid-day Meal Program, and (iii) maintaining expenditure for 1990 and 1991 on the three programs within agreed limits; d) and to develop the private sector by (i) deregulating air freight operations, (ii) introducing a four-band tariff system and reducing the maximum nominal tariff, (iii) restructuring the Paddy Marketing The ERC supported the PFP of October 1989, when the second year SAF was approved, while the PMEAC supported the updated PFP of October, 1990, when the third year SAF was approved.  4 Board, (iv) by reaching agreement on a plan to restructure the plantations, and by (v) partially privatizing the Sri Lanka Central and Regional Transport Boards. 14. PMFAC objectives. While the ERC had broad objectives, the PMEAC focused on developing private industry. Its specific structural objectives were to: a) reduce government protection of manufacturing by removing specific tariff protection of public manufacturing enterprises; b) reduce government intervention in the management of manufacturing enterprises by providing a new institutional framework for supervising the Government's investment in public enterprises, including those that would continue to be held by the Government. c) and to commercialize and privatize public manufacturing enterprises by (i) developing strategies for modernizing and divesting specific manufacturing industries, (ii) establishing a legal framework for privatization, (iii) converting the enterprises into companies and privatizing the viable enterprises, and by (iv) divesting at least half of the asset value of the shares in public manufacturing companies (amounting to at least 40 percent of Treasury shares in public mining and mineral companies, excluding the Salt Corporation, and 60 percent of Treasury shares in non-mining and non-mineral enterprises, excluding the Paper Corporation). 15. Assessment of ob3ectives. To sustainably recover from the crisis of 1989-90, Sri Lanka had to achieve several objectives at about the same time. But the extensive program of structural measures in the ERC (see the economic conditions of the Development Credit Agreement listing in Table 10a) along with design flaws in the civil service reform undermined implementation (Sections B and E). With regard to the PMEAC, the focus on the reform of the public enterprises may have advanced implementation. While the objectives of the PMEAC are clear, the statement of the key condition regarding privatization seems vague. The President's Reprt does not define how "Treasury shares" and "asset values" of public manufacturing enterprises should be measured. Moreover, the President's Repo does not provide a baseline table of the shares and asset values of the enterprises to be privatized --which makes it difficult to assess achievements. B. Achievement of Objectives. 16. Overall success of the credits. The credits were successful on balance because the program of privatization and liberalization they supported led to a sustained, export-led, acceleration of growth that was associated with a decline in poverty. When the credits were prepared in 1989, Sri Lanka was destabilized by severe civil conflicts that had slowed growth and drained reserves. The Government was able to stabilize the macro-economy in 1990. It also took steps to reduce tariffs and privatize public manufacturing enterprises, which helped spur a vigorous expansion of manufactured and especially garment exports. The deficit in the current account of the balance of payments narrowed from 7.1 percent in 1989 to 6.1 percent in 1992, approximately meeting the 6 percent target set in the PFP. Real GDP growth accelerated to 4.4 percent in 1992, compared to the 4 percent target and reserves recovered as well. This was not an isolated achievement as growth then accelerated to 6.9 percent in 1993 and 5.6 percent in 1994. This growth appears to have been associated with a downward trend in poverty, as documented in the Sri Lanka Poverty Assessment. 17. Fiscal ad'justment. However the Government was not as successful in sustainably narrowing the fiscal deficit --a point documented in the OECF report (Annex 3). At the start of the adjustment, the deficit narrowed significantly, falling from 11.2 percent of GDP in 1989 to 7.3 in 1992. The quality of the adjustment was weak in that practically the entire adjustment was achieved at the expense of lower capital expenditure. For example, by 1992, capital expenditure, adjusted for financial payments such as  S privatization proceeds, had declined to 7.9% of GDP from 12.7% in 1988. Moreover, the Government's efforts to contain current expenditure had limited success: it fell to 21. 1% of GDP in 1992, compared to a target of 19.7%. Therefore, interest payments rose significantly, from 3.4% to 6.3% of GDP between 1980 and 1993, reflecting the growing public debt burden and high interest cost on domestic debt. By 1994 current expenditures had increased to 22.3% of GDP and the fiscal deficit had widened to 10%. These reversals can be explained by slippage in carrying through structural measures of the ERC that would have controlled current expenditures. 18. Fiscal measures. For instance, the Government did not sustain reductions in subsidies: the fertilizer and wheat subsidies were eliminated, but were re-introduced in September, 1994. Subsidies to sugar producers were eliminated, but tariffs on sugar keep the domestic price far above the international price. The Government did eliminate subsidies to the Ceylon Transit Board (CTB) but did not restructure the Railway Department or reduce its subsidy to the Rs. 350 target for 1991 mentioned in the President's Report. The Railway received a current subsidy of Rs 616 million in 1991 and a capital transfer of Rs 1,756 million. 19. Tax reform. In contrast, there has been progress in reforming the tax system. The Government and the IMF prepared a plan to implement the Tax Commission's recommendations, as agreed under the ERC. The main measure recommended by the Commission was to replace the cascading gross turnover tax with a value-added tax (VAT). The preparation work for the VAT has been completed and the present Government intends introduce the VAT. 20. Civil service and retirement fund reform. The most serious and clear failure of the ERC was the attempted reform of the civil service, because the reform did not ease the fiscal burden but deprived the civil service of some of its most qualified senior staff members. To launch the reform, the Government offered a generous separation package to induce voluntary departures, with a target of 60,000 departures over three years. Through this incentive program, the Government was able to reduce the central government civil service by 43,000 persons during 1990-91. 21. Despite this vigorous effort, the reform did not succeed in meeting its goals. The generous voluntary separation package was not withdrawn at the end of the reform, but left available for all retiring civil servants. The immediate fiscal cost of the scheme was very high, resulting in more than a doubling of the pension bill to 2 percent of GDP in 1991. Furthermore, the effectiveness of the civil service deteriorated as many of the high skilled personnel took higher paying jobs in the private sector. Savings on wages and salaries were reduced as the Government replaced some departing high skill employees and then absorbed unemployed school graduates into the civil service. By 1994 the civil service was 23,000 persons larger than in September 1990, when the first census of the civil service was taken. Moreover, the share of civil service wages and pensions, including defense, was back up to the 1989 peak of 7.5 %. 22. A related weakness in implementation of the ERC concerns the reform of the retirement programs: the Provident Fund, which pays a lump sum on retirement to employees in the state-owned enterprises and many employees in the formal private sector, and the Pension Fund, which pays monthly pensions to civil servants. The main goal of the reform was to eliminate the incentive to choose employment in the Government rather than in industry in order to benefit from the more generous benefits of the civil service Pension Fund. Another goal was to eliminate the possibility that pensioners would spend lump sum payments unwisely. To control fiscal costs, a reform would have had to increase employee contributions, capitalize the Pension Fund, and link benefits to the return on investments. Failure to reform the civil service Pension Fund then complicated efforts to convert the Provident Fund into a pension fund.  6 23. The reform of the Provident Fund was also complicated by an ILO report that recommended partial indexation of the civil service Pension Fund, which would have reduced fiscal control over costs. Furthermore, the unions in the state enterprises were concerned that the dominant role of the Government in managing the converted fund would subject benefits to an increased fiscal constraint. Acting on the recommendation of the region, the IDA Board waived the conversion condition for second tranche release because the Parliament could not approve the conversion because it was not in session. The conversion was never approved because of the design questions and opposition from effected unions. 24. Social transfer reform. There was some limited success in improving the targeting and effectiveness of the social transfers. The largest transfer programs are the Food Stamp Program, which distributes food coupons to up to 40 percent of the population, the Mid-day Meal, which distributes food coupons to households with school-going children, and Janasaviya, which is a two-year program of intensive transfers accompanied by some poverty-alleviation efforts. The fiscal cost of the three large programs was kept well below the agreed upper bound of 3 to 3.5% of GDP, falling from 2.6% of GDP in 1990 to 1.8 % in 1994; but this was achieved largely by letting inflation erode the real value of transfers rather than by targeting to the poorest segment of the population. 25. For instance, the Government brought the number of Food Stamp recipient households down to 1.1 million, compared to a target of I million, through a community-based screening. Given this progress, and acting on the recommendation of the region, the Board then waived the I million household target for second tranche disbursement. Following release of the second tranche, the Government responded to a drought by re-admitting households that the screening identified as not qualifying for food stamps. By late 1994 the number of households receiving food stamps stood at about 1.5 million, despite massive departures to the Janasaviya program. The cost of the transfers to this relatively large number of recipients meant that it was not fiscally feasible to increase benefits for the poorest households remaining in the program. 26. There was no progress in targeting the Mid-day Meal Program to poor families or in launching an island-wide nutrition program focusing on pre-school children and lactating mothers. The mid-day meal stamps are received by many middle and upper income households. The Government has not launched the nutrition program, aside from a small program conducted as part of IDA's Poverty Alleviation Credit (Janasaviya Trust Fund). 27. The Government has improved the main Janasaviya Program by developing a relatively effective method for screening entrants --as agreed under the ERC. The screening was conducted through inspections and community meetings and focused on observable indicators such as possession of consumer durables. The monthly transfer has also been reduced from Rs 2,500 per month to under Rs 1,500, as agreed, by treating Rs 1,042 as savings. The Government pays Rs 250 per month in 'interest' on the cumulated 'savings' upon graduation from the Program. The Janasaviya program has however not been given a production orientation, as agreed under the ERC. The Government and IDA did launch the Janasaviya Trust Fund (JTF) which executes production-oriented poverty alleviation activities, under the Poverty Alleviation Credit. But the JTF has operattd largely independently of the main Janasaviya Program and at a smaller scale. 28. Most recently the Government has taken further steps to improve the transfer programs through a new Samurdhi program that would consolidate parts of the Food Stamp and Janasaviya Program. Under the Samurdhi program the Government would attempt to target benefits and would set a higher level of transfers for the poorest recipients.  7 29. Import tariffs. There has been relatively better progress in reducing protection, to encourage development of efficient export industries. Tariffs have been reformed and lowered, but at a slower pace than anticipated in the President's Repo. One reason for the delay was to retain revenues from tariffs to meet the target for the overall deficit. The maximum tariff was reduced from over 100 % in 1989 to 45 percent in 1994 and 35 % in the 1995 budget. The Government did not establish the four-band tariff system in 1991, as agreed under the Credit. It did however establish a four-band tariff system in 1994 and a three-band system in 1995 with a short list of exceptions (e.g. autos, liquors, tobacco, and agricultural goods). Tariff rates were often not effective because of the number of duty waivers and exemptions. About a third of all imports were covered by specific duties in 1991. In some cases, these specific duties were equivalent to ad valorem equivalent rates of well over 100 %. Most specific duties on non- agricultural goods have been removed. Specific duties and quantitative restrictions remain for several important agricultural goods. 30. Private sector development--ERC: There was much initial progress in liberalizing agriculture. The Government restructured the Paddy Marketing Board (PMB) by substantially reducing its budget and staff. The PMB's purchases of paddy fell to 2% of the marketed quantity. However in 1994 the wheat- flour subsidy led to substitution away from rice. The PMB then supported the price of rice by increasing its purchases to about 10% of the 1994 annual harvest. The Tree Crops study supported under the credit was a positive step that contributed to the development of private management contracts for most of the state plantations. 31. The ERC envisaged implementation of a restructuring plan involving breakup of the Central Transport Board (CTB) and full divestiture of the bus system by early 1991. At end-1990, the system was broken up into 13 workshops and 96 bus companies and staffing was rationalized. Formally, half of the equity of the bus companies was subsequently transferred to the workers, and the workshops were partly privatized. However the Government retained ownership of the bus stations and depots which included valuable real estate. At the time of the restructuring, 13,500 employees took voluntary retirement and 28,000 transferred to the new bus companies, significantly reducing the number of employees indirectly dependent on the state. The National Transport Commission Act that would deregulate fares was passed by the Parliament, but the companies have not been allowed to set fares in practice. This has made it difficult to adequately maintain buses and has discouraged prospective buyers. Despite these difficulties, bus service is increasingly available and the OECF report documents the improvement in the efficiency of operation of the buses (Annex 3). 32. Private sector development--PMEAC. The PMEAC was more successful in achieving its objectives than the ERC. The Government has met and exceeded many targets set in the Development Credit Agreement and continues to act in the spirit of the Agreement. Specific protection of the state enterprises has been eliminated along with direct government intervention in setting wages and prices. As agreed, the public manufacturing enterprises were converted to companies. Most significantly, the textile mills have been filly divested and the Government does not intervene in management and pricing. Recently however there have been challenges regarding the transparency of past privatizations which could potentially slow the pace of future privatizations. More thorough planning of the methods for valuing public enterprises and of executing sales of the enterprises in the PMEAC would have helped avoid these difficulties. 33. Delays in privatization led to a one-year delay in release of the second tranche until December 1992. By that time the Government had divested about 48% of its shares in public mining enterprises and 75% of its shares in non-mining enterprises. Enterprises such as Paranthan Chemical could not be  8 privatized because they were in the conflict zone. The petroleum refining activities of Ceylon Petroleum were apparently not covered under the PMEAC, and are still publicly owned. The Government has privatized much of the non-mining and non-mineral manufacturing firms that are not in the conflict zone. Since the release of the second tranche, the Government has approved divestiture of most of the Ceramics company, while Mineral Sands cannot be privatized because it is in the conflict zone. 34. The main institutional reform contemplated in the PMEAC was the establishment of the Public Investment Management Board (PIMB) for the purpose holding the Government's shares in state enterprises and of supervising and commercializing the enterprises. The reform was not entirely successful because the PMEAC did not clarify the overlapping oversight responsibilities of the line ministries and the PIMB, which was attached to the Ministry of Finance. C. Major Factors Affecting the Project. 35. The environment for achievement of the Credits' objectives was largely favorable: the industrial countries were in recovery, demand for Sri Lanka's output was rising, and foreign investment in developing countries, and in Sri Lanka, was improving. The only significant external disruption was the brief rise in oil price and damage to tea exports that followed from the Iraq war. The drought of 1992 was another transitory shock that briefly slowed growth. The success of the credits was complicated by the conitinued civil conflict in the North, which consumed valuable human and physical resources. The unrest was punctuated by acts of violence such as the assassination of President Premadasa in May 1993. In spite of these difficulties, it seems on balance that implementation of the Credits was not significantly slowed by factors outside the control of the Government or the Bank. D. Project Sustainability 36. The commitment to policy reform of the recently elected Government and continued progress in reform suggest that several of the achievements of the credits could be sustained. For instance, there has been continued progress in structural areas such as tariff reform and replacement of the turnover tax with a VAT. There has also been progress toward privatization of state enterprises. No public manufacturing enterprise has been re-nationalized but many additional small and medium state enterprises have been privatized. However, after a slow start, the current Government is planning further divestiture of state- owned enterprises through strategic alliances involving partial privatization of large state enterprises such as Sri Lanka Telecom and Air Lanka. The Government has leased most of the state plantations to private operators, but there has been little progress in increasing the term of the leases beyond 5 years to provide an incentive to plant. Moreover, the Government has continued to intervene, for instance, by increasing the wages of plantation workers. Private confidence has also been influenced by hesitation in tackling labor difficulties in manufacturing. 37. Fiscal problems, however, may be severe enough to compromise future growth by crowding out private investment. The establishment of new government programs (e.g. the wheat and fertilizer subsidies) in 1994 and 1995, and the consequent increases in government current expenditure and the budget deficit are leaving a legacy of higher domestic debt, whose service will complicate control of current expenditures. Unfortunately, the prospects for reforming the civil service or even sustaining its current size and cost appear poor as the Government continues to hire civil servants who may not be effective, such as teachers. The renewal of the civil conflict may also worsen fiscal performance.  9 E. Bank Performance. 37. The Bank's performance was satisfactory in several aspects of identification, preparation, appraisal, and supervision of the ERC. It was particularly satisfactory in outlining a macro and structural adjustment program to stabilize the economy and then accelerate growth. The Bank was also successful in coordinating the adjustment program of ERC with the Fund's SAF and in coordinating assistance with the Japanese OECF --the co-financier of the ERC. With regard to the PMEAC, the Bank's performance was satisfactory in that the design of the credit focused on a key area of reform which had Government support, was achievable, and had wide indirect benefits. 38. The Bank's performance appears to have been less than fully satisfactory, however, in the design of the ERC. Efforts to reduce subsidies of state enterprises, raise tariffs, contract the civil service, and limit and target social transfers while privatizing enterprises meant that many Sri Lankans would suffer some losses from the reform program, at least over the short-run. Therefore, the ambitious reform effort probably led to reform exhaustion and then reversal of some reforms as the Government expended its capacity to sustain short-run costs for long-run benefits. 39. This probably contributed to the reversal of the reform of the civil service. The reform was important for stabilization of fiscal expenditures and for improving the quality of government services. But the design of the reform seems flawed because it focused on reducing overall numbers of civil servants rather than eliminating redundant or obsolete functions, granted high benefits for voluntary retirements (under Circular 44/90), and because it continued the benefits once the reform ended. The Bank staff advised the Government to follow the advice of the Sri Lankan Administrative Reform Commission by targeting the staff cutbacks, but this did not become a condition in the Development Credit Agreement. 40. Agreement was reached through centralized negotiations between the Bank team and senior officials of the Government. The commitment of the Government to the ERC program was then undermined by inadequate explanation of the agreed program to the line ministries and to the public. Commitment might have been stronger, and a greater part of the program might have been implemented, if the Government and the Bank had agreed to build support for the adjustment program through broader efforts at communication and persuasion . The absence of such an effort made it more difficult to sustain reforms through the electoral cycle. F. Borrower Performance 41. The Government's performance was satisfactory in the preparation of the ERC and in the preparation and implementation of the PMEAC. There was however a one year delay in implementation of the conditions of the PMEAC. There were, in contrast, more significant delays and also reversals in the ERC program. These reversals suggest weak commitment, which should be understood in the context of the ambitious design of the ERC program and the difficult of mobilizing and sustaining political support. 42. It was however distressing that the Government reversed progress in the targeting of the Food Stamp Program and did not resolve the pension issues after release of the second tranche. These are special concerns because the Bank had demonstrated flexibility on the issues by providing a Board waiver that permitted release of the second tranche. Furthermore, the second tranche release was also followed by significant new hiring, especially of teachers. The re-establishment of wheat and fertilizer subsidies in late 1994 also reversed earlier progress under the ERC.  Jo G. Assessment of Outcome 43. The outcome of the ERC is rated satisfactory on the strength of its contribution to the development of the private sector and to the macro-economic stabilization and recovery of Sri Lanka following an intense civil conflict. Many of its structural measures, however, were realized late or incompletely. The clearest examples are the failure of the civil service reform and slippage in reforming the social transfer programs. The outcome of the PMEAC was satisfactory because it largely achieved its objective of reforming and privatizing public manufacturing enterprises, and because the Government has since built upon and continued these reforms. H. Future Operation. 44. 'Future operation' refers mostly to the operation of projects. The ERC and the PMEAC were adjustment credits oriented toward stabilization of an economy in crisis through balance of payments assistance and structural reforms. Therefore there are no provisions for operations, as in a project credit. The new Government's budget for 1995, however, could be regarded as a partial plan for future operation because it provides for progress in several areas supported by the ERC and PMEAC: rationalization of the social transfer programs, simplification and reform of the trade regime, the introduction of the VAT, and privatization. Since the budget was announced there has been some slippage in control of the social transfer programs and the breakdown of the cease-fire has increased military expenditures. As a result the fiscal deficit appears off-track --headed toward about 10 percent of GDP for 1995. 45. The Poverty Alleviation Credit continues to support the poverty alleviation objective of the ERC by supporting the operations of the JTF. The Private Finance Development Credit follows through on the private sector development objectives of both credits by supporting the privatization of banking and reform of the financial system. The development of the private sector would receive further support from a planned credit to facilitate private sector investment in infrastructure. I. Key Lessons Learned. 46. The main lesson from the ERC and PMEAC is that an adjustment effort should focus on building broad support for the two or three most important policy measures. The PMEAC was more successful than the ERC because it focused on the central goal of privatization and received broader support from the Government. In contrast, the impact of the ERC was somewhat dissipated by its multiple policy measures. It was difficult to achieve progress in many areas at once when adjustment created short-term losers and when fear of adjustment may have been widespread. This points to the importance of explaining policy issues through seminars, press conferences, and through the translation and dissemination of economic and sector work. 47. The failed attempt to reform the civil service provides lessons for the future. First, retrenchment should focus on specific categories of employees. The bulk of Sri Lankan civil servants are in the low- skill job categories. Efficiency in these categories is low because of over-staffing and the slow introduction of office technology. Moreover, many teachers are entering the civil service with low education and training levels. With a large share of employees occupying lower level positions and the bulk of the wage bill, there is a strong case for focusing on rationalizing staff within this cohort. A further lesson is that, rather than attempt to retrench civil servants throughout the Administration, efforts should be concentrated on those parts of the Administration that have lost their function. The consolidation of units that have over-lapping responsibilities may also open possibilities for retrenchment.  11 STATISTICAL TABLES Table la: ERC - Summary of Assessments Achievement of Objectives Substantial Partial Negligible Not applicable Macroeconomic policies X Sector policies X Financial objectives X Institutional objectives X Physical objectives X Poverty reduction X Gender concerns X Other social objectives X Environmental objectives X Public sector management X Private sector development X Project Sustainability Likely Unlikely Uncertain x Bank Performance Likely Highly satisfactory Satisfactory Deficient Identification X Preparation assistance X Appraisal x Supervision X Borrower Performance Likely Highly satisfactory Satisfactory Deficient Preparation X Implementation x Covenant compliance x Assessment of Outcome Highly satisfactory Satisfactory Unsatisfactory Highly unsatisfactory x  12 Table lb: PMEAC - Summary of Assessments Achievement of Objectives Substantial Partial Negligible Not applicable Macroeconomic policies X Sector policies X Financial objectives X Institutional objectives X Physical objectives X Poverty reduction X Gender concerns X Other social objectives X Environmental objectives X Public sector management X Private sector development X Project Sustainability Likely Unlikely Uncertain x Bank Performance Likely Highly satisfactory Satisfactory Deficient Identification X Preparation assistance X Appraisal X Supervision X Borrower Performance Likely Highly satisfactory Satisfactory Deficient Preparation X Implementation X Covenant compliance X Assessment of Outcome Highly satisfactory Satisfactory Unsatisfactory Highly unsatisfactory x  13 Table 2: ERC & PMEAC - Related Bank Credits Credit title Purpose Year of Status Approval Poverty Alleviation (a) to provide a production- FY91 Lending oriented structure for the Govermnent poverty strategy and (b) to alleviate poverty by financing micro-infrastructure, micro-credit, and social mobilization projects. Small & Medium Industry FY91 Lending IV Private Finance FY93 Lending Development  14 Table 3a: ERC Project Timetable Steps in project cycle Date planned Date actual/latest estimate Identification 5/3/89 5/29/89 Preparation 12/13/89 2/13/89 Appraisal 11/6/90 1/14/90 Negotiations 3/28/90 3/26/90 Board presentation 5/1/90 5/1/90 Signing 5/2/90 5/2/90 Effectiveness 5/4/90 5/4/90 Project completion 6/30/94 12/31/94 Credit closing 6/30/94 12/31/94 Table 3b: PMEAC Project Timetable Steps in project cycle Date planned Date actual/latest estimate Identification 11/17/88 11/17/87 Preparation 4/1/88 2/28/88 Appraisal 1/14/89 5/14/90 Negotiations 9/1/89 8/1/90 Board presentation 11/1/89 11/27/90 Signing 11/2/89 11/30/90 Effectiveness 12/10/89 12/13/90 Project completion 11/30/94 11/30/94 i/ Credit closing 11/30/94 11/30/95 1/ Technical assistance on-going to 11/30/95.  l) Table 4a: ERC Credit Disbursements, Cumulative Estimated and Actual FY90 FY91 FY92 FY93 FY94 FY95 Appraisal estimate (mill US$) 42.5 42.5 2.5 2.5 Actual (mill US$) 28.0 27.6 50.4 1.2 0.8 1.4 Actual as % of estimate 65.9 64.9 48.0 Date of final disbursement 3/13/95 Table 4b: PMEAC Credit Disbursements, Cumulative Estimated and Actual FY90 FY91 FY92 FY93 FY94 FY95 Appraisal estimate (mill US$) 57.5 57.5 2.5 5.8 2.5 Actual (mill US$) 56.6 5.1 57.7 6.8 0.4 Actual as % of estimate 98.4 8.9 117.2 16.0 Date of final disbursement 3/14/95  16 Table 5: ERC & PMEAC - Key Indicators for Project Implementation (Not applicable) Table 6: ERC & PMEAC - Key Indicators for Project Operation (Not applicable)  17 Table 7a: ERC - Studies Included in Project No studies included at appraisal. Table 7b: PMEAC - Studies Included in Project Study Purpose as defined at appraisal Status Impact of Study Strategy for the To promote modernization of the Completed, Satisfactory. Development of the industry and its development by 11/1991 Pulp & Paper the private sector. Industry Strategy for To liberalize and modernize the Completed Satisfactory. restructuring salt industry. 1992 operations. Strategy for To modernize and privatize the Not The Government and restructuring and industry. completed the Bank agreed that the modernizing the completion was no Cement Industry. longer necessary following privatization of the industry. Strategy for To streamline, modernize, and Completed, Satisfactory. streamlining the pulp commercialize the enterprise. 1992. and paper operations of the National Paper Corporation.  18 Table 8a: ERC - Project Costs & Financing Project costs Item Appraisal estimate Actual or latest (SDR (SDR million) million? Goods 65.064 64.686 Consultant's services 3.490 2.656 Total 68.554 67.342 Project financing Item Appraisal estimate Actual or latest (SDR (SDR million) million) Total (all IDA) 68.554 67.342 Table 8b: PMEAC - Project Costs & Financing Project costs Item Anpraisal estimate Actual or latest (SDR (SDR million) million) Goods 87.226 87.253 Consultants services 2.105 1.186 Total 89.332 88.443 Project financing Item Appraisal estimate Actual or latest (SDR (SDR million) million) Total (all IDA) 89.332 88.443  19 Table 9: ERC & PMEAC - Economic Costs and Benefits (Not applicable)  20 Table 10a: ERC - Status of Legal Covenants i/ Agreement Section Covenant Present Original Revised Descriptions of covenant Comments type status fulfillment fulfillment date date Development 2.02c I C Open and maintain a special Credit account in US dollars Agreement (DCA) DCA 3.04b I C Audit records and accounts Audits for 1990 through 1994 have and provide IDA with an been submitted. The first audit was audit report within six submitted on 12/31/92. months of the end of the fiscal year. Covenant tvp I = Accounts/Audit 2 = Financial performance 3 = Flow and utilization of Project Funds 4 = Counterpart Funding 5 = Management aspects of the Project or of its executing agency. 6 = Environmental covenants C = Covenant complied with CD = Complied with after delay NC = Not complied with SOON = Compliance expected in reasonably short time CP = Complied with partially. NYD = Not yet due.  21 Table 10a: ERC - Status of Legal Covenants (continued) Agreement Section Covenant Present Original Revised Descriptions of covenant Comments type status fulfillment fulfillment date date Schedule 3 1 a 12 NC 6/90 Rice, wheat-flour, fertilizer, At present, the price of rice is of the and transport subsidies not subsidized indirectlv through Agreement reinstated purchases by the Paddy Marketing (DCA) Board, wheat-flour is subsidized directly at a cost of about Rs 5 billion per year, and fertilizer is subsidized directly and through distribution of coupons. lb 12 C 6/91 Agreement on plan to restructure the sugar industry. Ic 12 CP 6/91 Agreement on plan to The capital gains tax and stamp duty implement recommendations on share transfers were eliminated in of the Tax Commission. the 1991 budget but the VAT has not be introduced. Id II CP 6/91 Macro-economic policies agreed in the 2nd year PFP implemented. 2a 12 NC 6/91 Reduction in central and provincial administration staff. 2b 12 C 6/91 Agreement on a plan to There was an initial 40,000 person reduce central and provincial reduction in the civil service. This administration staff in 1990, was followed by hiring which more and the plan is reflected in than reversed the initial reduction. the budget, 2c 12 C 6/91 Agreement on a plan to reduce staff in non- commercial parastatals in 1991, and the plan is reflected in the budget.  22 Table 10a: ERC - Status of Legal Covenants (continued) Agreement Section Covenant Present Original Revised Descriptions of covenant Comments type status fulfillment fulfillment date date Schedule 3 2d 12 C 6/91 Cabinet approval of of the DCA legislation to establish a civil service commission. 2e 12 NC 6/91 Conversion of the Employees The Board waived this condition for 2nd Provident Fund into an tranche release because parliament employee pension scheme. could not approve the conversion because it was not in session . The conversion was not approved because of design problems and union opposition. 2f 12 C 6/91 Agreement on a plan to reduce the cost of the civil service pension scheme. 2g 12 C 6/91 Agreement on a plan to rationalize public investment, and incorporation of the plan into the budget. 2h 12 C 6/91 Deregulation of air freight On June 28, 1991, the Government operation. allowed all airlines to register to carry air freight. 2i 12 C 6/91 Agreement on a plan to In September 1990 a 4-band tariff was introduce a 4-band tariff and introduced and the maximum rate was to reduce the maximum lowered to 50%. In the 1995 budget the tariff. maximum rate was lowered to 45%. However several goods remained outside the standard tariff system, were imported under exemptions, or were subject to quotas.  23 Table 10b: PMEAC - Status of Legal Covenants Agreement Section Covenant Present Original Revised Descriptions of covenant Comments type status fulfillment fulfillment date date Development 2.02c I C Open and maintain a special Credit account in US dollars. Agreement (DCA) 3.04b 2 CP Audit records and accounts The statements of accounts and and provide IDA with audit audits of the special account for reports within six months of 1990 through 1993 have been the end of the fiscal year. submitted. The documents for 1994 have not yet been submitted. Covenant type I = Accounts/Audit 2 = Financial performance 3 = Flow and utilization of Project Funds 4 = Counterpart Funding 5 = Management aspects of the Project or of its executing agency. 6 = Environmental covenants C = Covenant complied with CD = Complied with after delay NC = Not complied with SOON = Compliance expected in reasonably short time CP = Complied with partially. NYD = Not yet due.  24 Table 10b: PMEAC - Status of Legal Covenants (continued) Agreement Section Covenant Present Original Revised Descriptions of covenant Comments type status fulfillment fulfillment date date Schedule 3 1 12 C 11/91 Submission of a Bill to The Parliament passed the Act in of the Parliament for enacting an October 9, 1990, and the Development Industrial Promotion Act. Industrialization Commission to Credit implement the Act, was established Agreement in January 1991., 2 12 C 11/91 Submission of a Bill to The Parliament passed the Act, Parliament for enacting a which introduces private Mining & Minerals participation to the sector, in June Development Act. 1992. 3 12 CD 11/91 Progress in conversion of Conversion was completed in early companies held by the 1992. Ministry of Industries into companies. 4 12 CD 11/91 Divestiture of at least 40% of About 48% of Treasury shares in the the Treasury's shares in the sector representing more than half mining & mineral sector the asset value had been divested at (excluding salt), representing second Tranche release (Dec., at least half the asset value of 1992). such public enterprises. 5 12 CD 11/91 92 Adoption of a strategy to IDA and the Government agreed on restructure and private salt the plan in 1991. operations.  25 Table lOb: PMEAC - Status of Legal Covenants (Continued) Agreement Section Covenant Present Original Revised Descriptions of covenant Comments type status fulfillment fulfillment date date Schedule 3 6 12 CD 11/91 Divestiture of at least 60% of About 70% of Treasury shares in the of the the Treasury's shares in the sector representing 75% of the asset Development non-mining & non-mineral value had been divested at second Credit sector (excluding salt), Tranche release (Dec., 1992). Agreement representing at least half the asset value of such public enterprises. 7 12 C 11/91 11/91 Adoption of a strategy to IDA and the Government agreed on streamline the pulp and paper a strategy. operations of the National Paper Corporation 8 12 NC 11/91 Completion Adoption of a strategy to In 1991 the Government privatized a not restructure and modemize the cement plant in the south and in necessary cement industry. Sept. 1992 it privatized a plant in the West. The remaining plant cannot be privatized because it is in the conflict zone. Therefore, IDA agreed that a restructuring and modemization strategy is no longer necessary or desirable.  26 Table 11: ERC & PMEAC - Compliance with Operational Manual Statements (Not applicable)  27 Table 12a: ERC use of Bank Resources: Staff Inputs. Stage of Planned Revised Actual Project Cycle Weeks US$ Weeks US$ Weeks US$ Through appraisal 141.0 122 60.8 142.3 Appraisal-Board 88.0 101 51.0 105.0 Board-effectiveness - Supervision 31.0 33.3 57.8 136.5 Completion - 6.0 16.4 - Total 260A 2623 1696 383 8 Table 12b: PMEAC use of Bank Resources: Staff Inputs. Stage of Planned Revised Actual Project Cycle Weeks US$ Weeks US$ Weeks US$ Through appraisal 192.0 408.5 Appraisal-Board 29.5 74.0 Board-effectiveness - - - - - Supervision 45.9 46.9 97.5 202.3 Completion - - 6.0 14.8 iTtal  28 Table 13a: ERC - Bank Resources: Mission Stage of project cycle Month/year Number of Days in field Specialized staff PerforTnance rting Types of persons skills represented problems Implementation Development status objectives Through appraisal 10/89 10 10 Economics, bid. 1/90 15 15 Appraisal through board approval Board approval through effectiveness Supervision 7/90 4 10 Economist, S S 8/90 3 11 Technical S S 12/90 2 18 assistance S S 4/91 4 17 (op/fnance) S S 11/93 3 5 S S Completion 7/95 1 2 Economist S S  29 Table 13b: PMEAC - Bank Resources: Mission Stage of project cycle Month/year Number of Days in field Specialized staff Perfornace rating Types of persons skills represented problems Implementation Development status objectives Through appraisal 1/90 2 12 Industry, finance 4/90 2 16 5/90 1 i8 Industry Appraisal through Board approval Board approval through effectiveness Supervision 3/91 Ind, finance, eng. 6/91 10/91 Industry/finance 3/92 Engineering 4/92 Engineering 11/92 Technical assist. 12/93 Technical assist. Completion 7/95 1 1 Economics  30 ANNEX 1 GOVERNMENT EVALUATION Public Manuifactirinig Eniterprises AdJUjstnaent Credit (PMEAC) The PMEC specifically supported the PME rcform programimie whicih encompassed new legislation, tariff reforms, trade reforimis, dismiiantalling of licellse controls and imaniy other measures wliich contributed to create an eivironimeint in whichi the PME restructuring was carried out. The PME's were primarily frced fromii Line Ministry controls by converting them to companies so that-thiey could rcspondl to market forces. Monopolies were removed and import tariffs were rationalized progressively. As of now, four tariff bands prevail witli the maximnum at 35%. Furthier movement is expected. Non-tariff controls have also becn removed, other than in respect of a few items whiich have been specified in tihe law due to strategic reasons. Formal approval for setting up industries was done away with and the new Industrial Promotion Act provided for the setltiig up of industries freely, while registration was required for purposes of record. A to)tally new regime in the mines and minerals sector has been brougilt about with the enactmenit of a new Mincs and Minerals Act. 2. hlie Industrial Prwolnuotiozi Act One of the most important itcJlls of legislation that was introduced during the period under review was the Industrial Promotion Act No. 46 of 1990. This Act provided for the automatic approval of industries. It also established an Industrialization Commission to advise the government on ticd promotion of industry. It also provided for the setting up of an Advisory Council for Industry where the Local Cliambers, Federations and Associations in the private sector are heavily represented. This Council providcd a forum for representatives of industry to discuss issuies with Ilte governmnit for the developmcnt of industry and also to advise the Minister on the effcctiveicss of mcasures taken. Anothier institutionial arrangemiient providled for in tlhe. Act was thc sciting ul) or Regional Industry Scrvice Committees, whiich would concentrate on tlIe preparation of plans and programmes. for the development of industries in the regions. 3. Only a few industries were subijecited to controls. They were industries manufacturing arms and ammunition, explosives, military hiardware, poisons, narcotics, dangerous drugs etc. and industries producing currency, coins and security documncits.  31 ANNEX 1 Page 2 4. The new Minies anid Minerals Act Thlc mineral scctor was identified by the Governmenit as a key area for rapid economic development. The Minerals Law No. 4 of 1973 whichi existed tip to July 1992 did not cater sufficiently to modern day developiicint of the mineral sector. Investors bothi local and foreign, started showing interest in participatinig in mineral exploration and mining activities in Sri Lanka but the lack of an effective and upto date mining legislation, witli the institutional framework which provided an even playing ficid was a major drawback in catalysing such investment opportunities. Tlhe new Mines and Mi, erals Act No. 33 of 1992 provided for the most up to date, requirciicimts of a minling regime. I of the Act provided tKA for the establishinent of a Gcological Survey anid Mines Bureau (GSMB). The former Geological Survey Department was absorbed into this Bureau. The iiain functions of the Bureau were :- (a) to undertake the systematc geological mapping of Sri Lanka and the preparationi of geological maps; (b) to identify and assess the mineral resources of Sri Lanka; (c) to evaluate the cominercial viability of mining for, processing and export of, stuch, minerals; (d) to regulate the exploration and mininig for minerals and the processing, trading in and export of such minicrils, by thc issue of licences; (e) to advise the Minister on nieasures to be adopted for the promotion of the extraction and production of minerals, on a commercial basis. 5. Part II of the Act provided for the exploration, mining, transport, processing, sale and export of minerals, under license issued under the provisions of the Act. It also provided for the reservation of certain minerals and natural resources, mineral waters, and geothiermal deposits with the Minister being authorised to designate any other miinerals he deemed necessary to reserve. It also prescribed conditions on exploration, mining and trading activities and also for the protection of the environiment of mining areas.  32 ANNEX 1 Page 3 6. Three leading consultants who contributed towards revicwing mining legislation tilat existed at the time and hclped to preparc the new lcgislationi and the supporting regulations were, Mr. Hunt Talmage Ill (April 1990) Mr. Jcrry Cape (May 1990) and Dr. Jack Garnctt (September 1993 and thereafter). The current legislation is generally recognized as one of thie most up to date in the Asiani region. 7. Ihle Geological Survey ansd Mines Burenu Tlhe Geological Survey and Mines Bureau whiich was set up under the new Act has given a completely new shrust to investincnt in thc mineral sector. The establishment of the Mineral Titles Registry was a great step forward in providing confidence to investors. This was primarily done witih the assistance of Dr. Jack Garnett during one of his assignments here under PMEAC. Meanwhile another Consuiltant Mr. Stephien Hurst (under PMEIAC) from Canada worked out important clerical details in the establishlilicnt of a fully opcrational Minerals Titlcs Registry. Sincc the Minerals Titles Registry became operational there has becn a gradual influx of applications for rights and concessions. The licences applied for were mainly in respect of Grapiite, Mica, Silica Quartz, Rock Plhosphate, Calcite, Feldspar, Dolainite and Coral Limes Stone. Meanwhiile Mr. Trevor Wliarren, a consulting mining Engineer from Zim)babwe who was got down again under the PMEAC on a two months mission has drafted regulations pertaining to the mxanagemcnt, safety and healthi of miners. Meanwihile a comprelhensive set of environmental regulations formulated by the local Central Environimilental Autliority have also becin gazcttcd by teie Ministry incliarge of environmcntal matters. 8. Since senior level geologists with experience were not available to expand lhe activities of the GSMB, arrangeinents were made with the British Geological Survey (BGS) for one of thleir senior geologists, Dr. I'eter Mosely to work wilh the GSMB for one-year in the first instance withi effect from November 1993. This contract has since becei extended by anotlier year and will now expire in November 1994. His main tasks were to make recommenidations for thie establisheiicnt of a user-frcndly data base, identify areas of minieral potential for promotion to investors and idcntify areas of minieral potential for additional regional investigation. He was also to assist in the planning of a multipliase geological map publicationl programme. His contribution to the work of the GSMB has becn outstanding.  33 ANNEX 1 Page 4 9. Geological Mapping Programine Meanwhile action had also to bc takeit to overcomc one major slhortcoming that ilic GSMB had i.e. the lack of geological maps. hlic prime necd for any systematic search for mincrals by modern mehliods is the availability of adequate base iiaps. Even thoughi the formicr Geological Survey Dcpartiimenit had collcctcd a considerable amounit of data, they have not been able to bring outany geological maps whichi could be used by those prospecting for minerals. Some of the material available had even perished. In order to meet this short- coming a Geological Mapping Project was formulated based on a report from the BGS. The main objective of gcological mapping and the printing of geological maps is to demarcate areas whicii are of interest from tlie poinit of view of niiferal exploration. Phase I of tlhe mappinig project was compicetd by end last year and Phase 11 has just commenced. Phase 11 will be over by Noveniber 1995 whien tie .PMEAC will be wound up. Seven maps on tlic scale 1:100,000 full colour prinited in UK will bc brought out by the end of Phase 11 and this woould cover virtually 55% of the country. Meanwhile the capability of thie GSMB to continue tihis work on their own.in respect of the balancc 45% is being strengthened witi tlihe provision of training consultancies and a computcr and digitizing equipment, all funded under the PMEAC. This is a rare instanice wherc whilc comipletinig almost half the mapping work including final printinig of maps, actioll lias bcen taken to develop local capability, so that this work could continue thercafter in local hanids. 10. Sub-Sector lPolicy docuiientis Consultancics provided under the I'MIMAC also helped to develop subsector policy documents. Two sucih documents wcre on the Salt Industry and the Paper Industry in Sri Latnka and these were approved by the IDA/World Bank. 11. Tlie Salt Iidustiry The policy document oni tihe salt industry concentrated on a strategy to restructure and privatize salt extracting and processing operations. The report subniitted by Mr. Peter Harben, Consultant was used as the basis for tlie development of this strategy. The monopoly in the productioni of salt that existed for a vcry long time was removed witli the repealing of the Salt Ordinanice. Privatc Sector salt manufacturing units hiave since slepped up production and now  34 ANNEX 1 Page 5 account for virtually 30% of the country's salt production. Among the measures that were adopted to restructiure the salt industry wcre (a) improving thc existing production and semi-production areas and developing potential areas. In addition to the traditional saltcrns in the Soutlierin area, a private sector joilt venture projcct witlh Japanese collaboration has alrcady been approved by thc Board of Investment. (b) Restructuring Lanka Salt Ltd wliich was the successor to tihc National Salt Corporation, by braking it up into two companies, one for the Southern and one for the Western regioni. (c) Encourage growth of efficienit and competitive privatc sector salterns. (d) Diversifying the salt induustry for by-products. The National Healthi Council of Sri Lanka recommnended that salt consumed by people should be iodised. T his programme has now gathered momentum. lodisation equipment was provi(led by UNICEF and iodisation will become compulsory witlh cffect from July '95. Mcanwilie the possibility of exporting salt is also being looked into. Steps have to be taken hiowever to improve quality and also the scale of production, if exports are to be achiieved. Thle joint venture project in the Soutliern region will enter .thc export market for salt. 12. Tlic Paper Iiidustry Tile strategy to streamlinie the pull) and paper opcrmtions of tilc National Paper Company was derived primarily fromii the advise given by two consultalnts viz: Mr. R. Lallouclie of France and Mr. Ray Clialk of the World Bank. In view of the fact that imiport tariffs are being rationalized and that the National Paper Company has continuously faced difficulties in satisfactorily .reating tih effllucint dischiarge (Black Liquor) tlie vital question lias bceni whicthier the company could meet (lic challeniges of duty rationalization wihile being environmenit frienldly. One of the iniportant factors in rcstructuiring thc company was to be the progressive replacemcilt of rice straw witli wood as the raw matcrial for chemical pulping.  35 ANNEX 1 Page 6 The use of rice straw has created serious environmental problems and the Chemical Recovery Systcm that had been set up to treat the efnfuent bcfore discharge and also recovcr the caustic soda, failed to funictioni. Alternative strategies arc now being looked into. Meanwhile thle progressive chanige over froin the use of straw to wood pulp is being implcmlclnltcd. Action has bcen initiated to coordinate with the Forest Department to ensure the cultivation of tropical woods such as Pinus and Eucalyptus. The private sector has becn encouiraged to supply Albizzia. Meanwhilie waste paper recycling has also been stepped up. Nevertheless the National Paper Company continues to face difficulties due to increasing costs. This situation demanded a complete viability study of the National Paper Company. This was entrtisted to GOPA Consultanits of Gcrmaniy and was funded by the PMEAC. They made a complete assessmenti of the equipmnctt capabilities of thei mills, domestic demand, raw material needs, investmc.;:s required to improve production and efficiency and a complete techno-econiomic feasibility of the two mills. TIhe findings of the study would help the National Paper Conipany in its futLire management decisions. 13. Lanka Mineral Sands Ltd wliicih exports llnienitc, Rultile, and Zircon has been operating under difficult circumstances due to its location in the North Eastern region, whici is withini the conflict area. Neverthieless a comprclehiesive report on improving thie management and marketing aspects of the comi1pany has becn provided by Dr. David Moore who did a short terml consultancy unider the l MEAC. Value additioll processes have been identified but any concrete action will hiave to await bctter security conditions in the area. 14. I'lhosphate Fertilizer Manufacture The PMEAC also funded consultancies to assist negotiations conducted by government to set up a joint venture to manufacture Phosphate fertilizer utilizing the rock phospilate deposit in the North Central Province which was discovered in 1972. Explorations have revealed a proven reserve of 25 million MT. of Phosphiate rock witli an average of 37% P content in this deposit. However the infcrred reserves are in the region of 60 million MT. This phiosphate rock is hiowever not solubic in water and tlherefore cannot be used for short term crops. The rock carried a higih content of Chloride, Iron and Alluminium. The high chloride contenit gives rise to corrosion in plant anid machinery while the high iron and  36 ANNEX 1 Page 7 alluminiiuin content results in a low filtration rate. In order to set up a joint venture with a partner who had the technology to get over the above dificultlics, proposals werc invited on a worldwide basis and Freeport McMoRan Resource Partiners of USA were identified for negotiations. Tllereafter two rounds of negotiationis have already been conducted witli tlhen with a view to setting up a joint venture witlh the local company, Lanka Phosphate Ltd. These negotiations which have been of a highily complicated and wide ranging nature have not yet been concluded.-1n case, the govermncit is succcssful In setting up this joint venture, it will be the biggest single foreign investncint in Sri Lanka. The project cost is likely o exceed US $ 400 M. This will also give confidence to other foreign investors who will follow. 15. Privatisatiozi As far as privatization of entirprises coming under the purview of the Ministry of Industrial DevelopriTent is concerned, particulars arc given in summary form in Annex I. The procedure followed was to convert the govermnent owned business undertaking and public Corporations into companies in tihe first instance, in terms of the Conversion of Public Corporations or Government Owned Business Undertakings into Public Companies Act No. 23 of 1987 and thereafter privatise these companies. The extent of privatization in each case is given in the Annexure. In all cases where over 50% of the shares have been divested anolier 10% of the shares have been distributcd free among employees. The formula used for the distribution of these free shares has bcen the period of service of the employee without any other consideration. In tIIe privatisation process, tecliniqucs adopted in Sri Lanka have been basically the following (a) Management contracts culminating in a buvout. Loss making institutions such as some of the textile mills were turndcd around as a result of the infusion of foreign management expertise and thereafter, shares were issued to the public when the mills became viable. In this exercise, ownership was retained, a defined degree of control was maintained and a high level of inanagemnent and otler skills were injected into the enterprise enhiancing its overall efficiency.  37 ANNEX 1 Page 8 (b) Public offering of shares - as was done in the case of United Motors Ltd. and Bogala Graphitc Lanka Ltd. (c) Negotiated sale of shares. The advanlage of a negotiatcd sale is that the prospective buyer is known in advance and can be evaluated and be selected on his ability to bring in such benefits as techniology, market access and even management, if necessary. The Ceylon Oxygen Company would be a good example, whiere the successful buyer was Norsk Hydro A.S. of Norway, a "Fortune 500 Coinpany". (d) Sale of assets, as in the case of the Ceylon Plywoods Corporation, wiere thie liabilities were so high that it could not be sold as a "going concern". The Government had to take over all the liabilities and the assets have becn offcred for sale thereafter. 16. The annexure also reflects a few companies that have yct to be privatized. The Government has recently appointed a "Public Enterprises Reforms Commission" whicih is entrusted witlh the task of future-privatizations. Tliey are in the process of conducting studies, working out stratages and identifyinig on a priority basis the companies to be privatized progressively. 17. The restructuring of the PMEs and their privatization was part and parcel of the structural adjustment process and the libemlization of the economy. In consequence the economy showed remarkable improvemeint. Privatization is a logical step in the governments programme where the private sector is expected to be the engine of growth. 18. The PMEAC supported the restructurinig of the PMEs, evolution of new policy approaches, privatisation of enterprises and the setting up of new institutions and upto date systems. The present status of the Geological Survey and Mines Bureau and its geological mapping programme stand out as unique contribuitions of the Credit to the minerals sector. The privatisation programme gathered momiienitiuim under the PMEAC and tile short term consultancies provided expert advice and guidance to these enterprises.  38 ANNEX 1 Page 9 Ocialisation and PrivatisatiDn of Enterprises undver the Ministry of Industrial Develcpnent Na.e of Corporation Date of Name of Canpany Eguity Extent of Nature Of Privatisatim Canversiom Capital Privat- to a isation 1. GOBU of United Motors 9.05.89 United Motors Lanka Ltd Rs. 100 M 100% Public share Issue 10% free to employees 2. GDBU of Ceylon Oxygen 5.12.89 Ceylon Oxgen Ltd. Rs. 60 M 100% Public Share Issue 10% free to aeployees 3. Ceylon Ceranics 19.01.90 Lanka Ceramic Ltd, Rs. 300 M 73% Public Share Issue Corporation 4. Cevlon Leathe- Products 28.09.90 Ceylon Leather Products Rs. 50 M 100% (90% negotiated sale Corporation LTD (10% free to ermlovees 3. Sri Lanka Tvre 4.10.90 kelani Tyres Ltd. Rs. 260 M 100% (60% negotiated sale Corporation (30% Public Share issue (10% free to e-mloyees 6. Ceylon State Hardware 5.11.90 Lanka Loha Hardware Ltd Rs. 75 Nl 100% (90% negotiated sale Corporation (10% free to erplovees 7. National Salt 21.12.90 (a) Lanka Salt Ltd Rs. 35 M _ Corporation 18.03.94 (b) Puttalam Salt Ltd Rs. 25 M 8. Ceylon Plywoids 9.01.91 Lanka Plvwocod Products Ltd Rs. 175 M closed down Assets being sold. Corporation 9. Paranthan Cherdcals 17.01.91 Paranthan Chemicals Co. Ltd Rs. 40 M Corporation  ANNEX 1 Page 10 Qrme=rcialisation and Privatisation of Enterprises under the Ministry of induvstrial Dwevelprent .-me of Corporation Date of N kar of Czparry Equity EXtent of Natu