Ceylon - Economic position and prospects (Vol. 2 of 3) : Annexes : public finance, industry, industrial labor policy, population, nutrition, and national accounts

RESTRICTED Report No. SA-30a This report is for official use only by the Bank Group and specifically authorized organizations or persons. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION THE ECONOMIC POSITION AND PROSPECTS OF CEYLON VOLUME II - ANNEXES Public Finance Industry Industrial Labor Policy Population Nutrition National Accounts April 21, 1972 South Asia Department  CURRENCY EQUIVALENTS Currency Unit - Ceylon Rupee Prior to November 21, 1967 US $1.00 = Rs 4.76 Rs. 1.00 = US $0.21 Rs. 1 million = US $210,000 After November 21, 1967 US $1.00 a Rs. 5.95 Rs. 1.00 = US $0.17 Rs. 1 million = US $167,000 Foreign Exchange Entitlement Certificate Rate = $1.00 = Rs 9.23  PREFACE This report was prepared by a mission comprising Messrs. Jean Baneth (Chief of Mission), Jean-Pierre Beguin, Alfred S. Cleveland, Basil Kavalsky (South Asia Department), Arun Shourie and W1lter B. Stolber (Economic Program Depart- ment). The mission was in Ceylon from mid-November to mid-December 1971.   VOLUME II - ANNE[ES TABLE OF CONTENTS Page ANNEX I - PUBLIC FINANCE 'Introduction 1 Major Trends and Issues 2 Mobilization of Private Savings 31 Monetary and Credit Policy 34 Annex - Salary Adjustments, 1967-71 39 ANNEX II - INDUWSTRY Summary and Conclusions 42 The Symptoms of Industry's Problems 43 The Plan's Diagnosis and Prescription 44 Curing the Ills of Public COrporations 54 The Plan's Treatment of the Private Sector 58 The Needs of a Healthy Private Sector 59 ANNEX III - INDUSTRIAL LABOR POLICY Summary and Conclusions 64 Expansion of Emloyment 66 Anomalies of the Labor Market 68 Productivity of the Work Force 71 ANNEX IV - THE POPULATION PRO3BLEf Summary and Conclusions 78 Demographic Trends 80 Family Planning 82 ANNEX V - NUTRITION Summary and Conclusions 91 Inadequate Diets 93 Malnutrition of the Vulnerable Groups 95 Nutrition Intervention Programs 98 Future Policy 99 ANNEX VI - A NOTE ON CEYLON'S NATIONAL ACCOUNTS 105   ANNEX I - PUBLIC FINANCE Introduction 1. Ceylon's budgetary problem has continued to deteriorate over the past year. The major problem is to substantially reduce consumption, both public and. private, and thereby mobilize more resources to finance urgently needed development programs. This problem has now become more pressing especially.because Ceylon's current account, for the first time in less than a decade, is showing a deficit. Instead of the expected. surplus of Rs. 106 million, a deficit of Rs. 124 million is estimated for 1970/71. This deficit has been projected.by last year's economic mission to materialize only in 1972/73. It is true that the insurgency had some aggravating effects on current expenditure on law, order and police, but there are other items contributing to this deterioration, such as the reduction of receipts from FEECs, export and import duty collection, and other revenues. The effects of the balance of payments problem on te budget could only partly be offset by additional measures.generating revenue from domestic sources, such as the turnover tax, sales and income tax. The unfavorable long-term prospect of a rapidly rising current expenditure over revenue is aggravated by the fact that the budgetary situation is extremely sensitive to short-term changes. In theory, this sensitivity should be expected to work in both ways, i.e., this year's shortfall may be followed by an improvement in the next year. But in practice, even if an improvement occurred the net effect on savings may be uncertain as any favorable budgetary condition is likely to stimulate pressures to step up salaries in the public sector (in fact plans have already been discussed, in this direction). 2. An optimistic reviewer would recognize the government's increasing willingness to solve the country's basic economic problems and its increasing determination to cope with these problems. New tax measures have been introduced in 19.70/71 wbi-h added about Rs.sJ_2LCmillio to remnues Rail, port, bus and air fares have subsequently been raised.?/ Most importantly, the government raised certain basic consumer prices to reduce consumption expenditure in the 1971/72 budget. Out of the several proposals to raise consumer prices, however, one only was implemented:; one fell short of the original estimate; one was amended; while another was completely 1/ The fiscal data in Volume I, the Main Report, was updated following the mission's return from Colombo. Similar data cited in this Annex therefore varies slightly from Volume I. Tables referred to as 5.3, 5.4 etc., are in the separate Statistical Annex. 2/ However, only rail fares and port charges affect the outcome of the budget. The others are part of the public corporation sector.  -2- withdrawn. I/ Despite the withdrawal of certain measures due to pressures from the Parliament, it is the psychological breakthrough, i.e., the government's willingness to face these budgetary problems which can be interpreted favorably. Unfortunately, the budgetary situation is deteriorat- ing so fast that whatever attempts were made by the government were just not enough to stop or- even reverse Ceylon's unfavorable budgetary trend. 3. Under certain circumstances it is easier to implement sweeping budgetary reforms. Such a situation did exist immediately after the upheaval had been brought under control. However, fiscal year 1970/1971 has been the worst year over the last decade, from the point of view of mobiliza- tion and allocation of resources, but also because they were unable to generate the kind of action necessary to improve the country's budgetary resources. Measures such as the cQmpulsory savings-scheme2/ under the 1970/71 budget, and the income ceiling plan, which aimed to mobilize resources by reducing higher income, under the 1971/72 budget, were just not sufficient to solve Ceylon's resource problem. What is needed is a drastic reduction of the country's mass consumption and a determined effort to raise the countryis productivity.'' MaWor Trends and Issues 4. The major issues in Ceylon's public finance over the last decade have been: (1) a continuous and fast growth of current expenditure; (2) failure to increase government revenue as rapidly as current expenditure I ..- . .. . . . . (3) stagnation of government savings resulting in the extensive' financing of the government budget through increased reliance on internal borrowing (and, recently, on external borrowing), thus creatirg inflatio- nary pressures on the eoconomy; (4) a tendency to reduce government invest- ments; and (5) a public corporation sector which does not generate enough resources to finance its own investments. 1/ For details, see pages 3 and 4. The Ceylonese authorities, however, have expressed their determination to submit to Parliament soonr-alternative proposals to fill the budgetary gap caused by the withdrawal of these measures. 2/ Outlined in detail in last year's IBRD Report.  -3- I. Current Expenditures: Growth and Structure 5. It has been repeatedly emphasized in various IBRD Reports and again recently in the 110 Report on employment opportunities that the curtailing of excess purchasing power directed to consumption is crucial to any development strategy in Ceylon. It has also been recognized that a purchasing power of the size existing in Ceylon makes it extremely difficult to reduce the balance of payments deficit and to control inflation. This excess purchasing powfer is found. to a large extent in the private sector, but to a large extent it originates from athe ~iblic sector through generous government policies. It has also been emphasized in last year's IBRD Report that a major problem in generating adequate funds for financing the develop- ment program is the rapid growth of current expenditure. Current expenditure rose again by 11 percent in 1970/71 so that the problem remaini unchanged. 6. Expenditure for food subsidies has been the most important expenditure item. Although its relative share since 1967/68 has been declining continuously from 27.3 percent to 21.2 percent in 1970/71, its size and relative importance is obvious as can be seen in Table 5.4. With almost Rs. 600 million of food subsidies in 1970/71, or Rs. 649 million including subsidies on fertilizer, out of Rs. 2822 million total current expenditure, food subsidies remained the largest single expenditure item. According to the revised estimates of 1970/71, the budgetary cost has risen by Rs. 180 million on account of the net food subsidy. This increase is primarily the result of subjecting imports of sugar to FEECs, which is expected to add Rs. 127 million to the total sugar import bill. As revenue from FEECs increased by the same amount this rise is in reality only a bookkeeping operation which, however, shows the "true" cost of the food subsidy program. Furthermore, the import price of sugar which rose sharply in 1969/70 increased even further in 1970/71 reducing profits from sale of sugar by Rs. 15 million. Profits on flour also dropped from Rs. 20 million to Rs. 10 million. If flour had been subjected to FEECs, it would have shown a loss instead of a profit, thus increasing the net food subsidr bill even further. 7. The government, aware of the decreasing profits and the rising burden of what is considered to be the normal increase, suggested for the 1971/72 budget that: (a) the selling price for the second measure of rice be raised from 75 cents to one rupee; (b) the selling price of flour should be increased by 15 cents per pound; and (c) sugar should be rationed at two pounds per month at the controlled rate of 72 cents per pound. Sugar above the ration should be freely available for sale at the price of RA. 1.50 per pound. These proposals indicated a major shift in the government's policy and, if passed would have considerable implications on the budget. However, the government succeeded only partially. Out of Rs. 356 million, originally estimated for 1971/72, only Rs. 112 million is now being expected for a 12- month period. The Parliament forced the government to withdraw the flour proposal completely and to modify the sugar proposal to that of three  pounds under the ration at the controlled price of 72 cents per pound. Cnly the change in the selling price of the second measure of rice was maintained; however, instead of the original estimate of Rs. lO million only RE. 45.5 million is naw being expected. As the price of flour was not raised a shift in the consumption from rice to flour can be expected. 8. Whilst expenditure on subsidies has been long recognized to be of crucial importance;2 for Ceylon's savings problem, several other expenditure items, in recent years, are becoming-increas-ingly important. Among those which are growing absolutely and relatively, interest on public debt should be mentioned first. Over the last decade expenditure on interest increased from Rs. 83 million to Rs. 340 million or from 5 percent to over 12 percent of total current expenditures. The breakdown of interest payments on public debt over time is shown in the following table: Interest on Public Debt- (Rs. Million) 1965/66 1966/67 1967/68 1968/69 1969/70 1970/71 Revised Estimate 1. Foreign 18.8 22.6 31.0 37.9- 42.8 81.3 2. Domestic - 103.2 118.5 133.0 165.5 206.1 255.9 3. Temporary Borrowing 1.2 2.4 2.5 2.8 14&.4 3.5 Total 123.2 143.5 166.5 206.2 253.3 340.7 The bulk of the payments 1i being made on behalf of domestic debt.. Out of a total of Rs. 341 million-in-1970/71 Rs. 256 million is made avai-lable for this pur- pose. By far the large8t share of the domestic debt, about 85 percent, is being held by government or- semi-government institutions. In fact, this part does not 1/ This problem has never been put so bluntly by the Finance Minister as he had done in this year' a budget speeoh: ItWe oannot continue to pay for the food we consume with the savings of people in other lands; in other words, out of foreign borrowings which our future generations will have to pay long after we are dead and gone. Neither can we continue with the level of social subsidies we have been accustomed to without recourse to inflationary financ- ing. We have in this situation to weigh the alternative before us. The continuation of the present policy will in the end place a far more serious burden on the masses in particular than what I now propose".  - 5- create a real burden, although it adds to the budget, as the funds which are paid out are made available fQr further government use. However, rising interest rates, which are expected to go up to 10 percent in the near future, might attract more private sector borrowing and thus increase the government's interest burden. If the relative share of foreign debt service would grow as fast as in the past five years (from 15 percent in 1964/65 to almost 24 percent in 1970/71):intere8t on public debt can be expected to become an expenditure item, similar to food subsidies. Assuming that Rs. 600 million per year would be borrowed from domestic sources at a rate of 10 percent during the period 1972 to 1976, and assuming that an annual average of Rs. 290 million would be borrowed from foreign sources at a rate of 3.4 percent4' the estimated total interest payable by the government on public debt in-1976 would be Rs. 656 million, of which Rs. 125 million will be interest payable to foreign loans. An estimated amount of Re. 290 million will create a real butden to the budget, but the actual impact of this bWd=n will depend on the govern- ment's willingness and ability to mobilize savings to finarnce the development program under consideration. 9. Pensions and other current expenditure items are becoming increasingly important. The total non-pension current expeaditure has increased at a much faster rate at 15 percent per annum. The pensions expenditure has increased continuously from 4 percent in the fifties to 5 percent and 6 percent in the sixties, up to 8 percent in the early seventies. Pensions have a special feature, that is, they have a tendency of irreversibility -- once introduced, hardly any govern- ment can afford to reduce the benefits granted. Under a more favorable public savings performance, political pressures to improve the pension scheme can be expected. It is only when the government will take the development objective more seriously will it succeed in opposing this pressure and preventing the increase of welfare expenditure. Once granted, pensions will not only remain at a higher level, but will. also automatically increase at the "normal" rate of growth. 10. From a generous system introduced by the colonial British administra- tion primarily for the benefit of a limited number of expatriate officers, pen- sion rights were granted to a progressively growing number of cadres of govern- ment departments'as a result a very large proportion of the 300,000 public ser- vants are entitled to pension rights which are oonsidered to be the most generous for a developing country. Some of its principal features ares 1/ These figureshave been derived from the last five years and should be considered to be rather on the optimistic side.  -6- (a) it is non-contributory, (b) in computing his pension, a climate bonus of 60 months is added to an officer's service when he retires provided his actual service exceeds 120 months; (c) the maximum pension payable is two-thirds of the retiring salary; (d) there is provision for commutation of the annual pension into a lump sum gratuity amounting to one-fourth of the annual pension for a period of 10 years; (e) after commutation, the full pension is restored after a period of 12