Sri Lanka - Third Mahaweli Ganga Development Project

Document of The World Bank FILE CPY FOR OFFICIAL USE ONLY Report No. P-3082-CE REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC SOCIALIST REPUBLIC OF SRI LANKA FOR A MAHAWELI GANGA DEVELOPMENT PROJECT III June 1, 1981 IThis 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 US$1 = Rs 18.0 Rs 1 = US$0.0556 Rs 1 million = US$55,560 WEIGHTS AND MEASURES 1 acre (ac) = 0.405 hectare (ha) 1 mile (mi) = 1.609 kilometers (km) 1 square mile (sq mi) = 640 ac (259 ha) 1 foot (ft) = 30.5 centimeters (cm) ABBREVIATIONS AND ACRONYMS GDP - Gross Domestic Product MW - Megawatt M - Million MA - Mahaweli Authority MDB - Mahaweli Development Board MEA - Mahaweli Economic Agency GLOSSARY chena slash and burn or "shifting" agriculture district = the first subdivision in the country for Government administrative purposes (22 districts in Sri Lanka) dry zone = northern and eastern two-thirds of Sri Lanka ganga = major river maha = northeast monsoon season (October to February) oya small river paddy = unhusked rice tank 5 reservoir for local rainwater storage wet zone = southwestern one-third of Sri Lanka, including Colombo, the Capital yala 5 southwest monsoon season (April to September) FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY SRI LANKA MAHAWELI GANGA DEVELOPMENT PROJECT III Credit and Project Summary Borrower: The Democratic Socialist Republic of Sri Lanka. Amount: Special Drawing Rights 73.3 M (US$90.0 M equivalent). Terms: Standard. Co-financiers: The Government of Japan and the Kuwait Fund for Arab Economic Development. Project The proposed project would represent IDA's first involve- Description: ment in area development under the Accelerated Mahaweli Program. It would encompass development for irrigation and settlement of the downstream area to be served by the Victoria Dam Project, currently under implementation. The project would include: (i) completion of the Minipe Right Bank Transbasin Canal scheduled to supply full irrigation facilities to the System C developmental area and supple- mental irrigation to System B, located in Sri Lanka's intermediate and dry zones; (ii) provision of irrigation and drainage infrastructure, land clearing and on-farm development, social and managerial infrastructure, fuel- wood and cashew plantations, and settlement services in the northern part of System C, including about 18,500 ha of newly irrigated area; and (iii) technical assistance, monitoring, equipment, and maintenance services bene- fitting the whole of System C involving 24,100 ha of newly irrigated land and 3,600 ha of currently irrigated area. Of the 27,700 directly benefiting families, about 87% would be new farmer settlers most of whom are currently landless or operating sub-economic holdings. The project involves no special risks beyond those commonly associated with irrigation/settlement schemes. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Estimated Cost: /a US$ Million Equivalent Local Foreign Total Civil Works Construction Camp 1.5 1.0 2.5 Right Bank Transbasin Canal 12.2 18.3 30.5 Irrigation System & Land Development 19.4 22.5 41.9 Roads 1.6 1.3 2.9 Social & Administration Infrastructure Social Infrastructure 4.1 1.8 5.9 Administration Offices & Quarters 4.5 1.9 6.4 Engineering, Supervision & Administration 10.0 - 10.0 Equipment & Vehicles 0.5 9.1 9.6 Settlement Assistance 1.8 0.3 2.1 Monitoring Program 0.7 - 0.7 Technical Assistance & Training 0.5 3.6 4.1 Base Cost 56.8 59.8 116.6 Physical Contingencies 6.0 6.8 12.8 O&M During Project Construction 3.0 0.5 3.5 Price Escalation 48.6 20.3 68.9 Total Project Cost 114.4 87.4 201.8 Financing Plan: US$ Million Equivalent Local Foreign Total IDA 48.9 41.1 90.0 Government of Japan 13.5 31.5 45.0 Kuwait Fund 30.5 14.5 45.0 Government of Sri Lanka 21.5 0.3 21.8 Total 114.4 87.4 201.8 Estimated US$ Million Equivalent Disbursements: IDA FY 1982 1983 1984 1985 1986 1987 1988 Annual 20.5 23.5 11.5 10.0 10.0 10.0 4.5 Cumulative 20.5 44.0 55.5 65.5 75.5 85.5 90.0 Rate of Return: 18%. Staff Appraisal Report: No. 3128-CE, dated May 26, 1981. Maps: No. IBRD 13477R1 and IBRD 15154R. /a The project would be exempted from all taxes and duties.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC SOCIALIST REPUBLIC OF SRI LANKA FOR A MAHAWELI GANGA DEVELOPMENT PROJECT III 1. I submi- the following report and recommendation for a proposed development credit to the Democratic Socialist Republic of Sri Lanka for Special Drawing Rights 73.3 M (US$90 M equivalent) on standard terms to help finance a Mahaweli Ganga Development Project III. Co-financing arrangements are being made with the Government of Japan and the Kuwait Fund for Arab Economic Development (para 44). PART I - THE ECONOMY 2. The most recent economic report, "Sri Lanka: Policies and Prospects for Economic Adjustment" (Report No. 3466-CE, May 15, 1981) was distributed to the Executive Directors on May 26, 1981. Country Data are provided in Annex I. 3. After several years of relative stagnation, Sri Lanka's economy has experienced sustained growth. This growth has been the direct result of the economic liberalization of 1977, and the development push associated with it. Until 1977, Sri Lanka's growth performance had been below both need and poten- tial. Although GDP growth in the 1960s, at 4.4% per annum, was above the average for low income countries, growth slackened sharply in the 1970-77 period to 2.9% per annum, just below the average for low income countries. Through much of this period, the terms of trade deteriorated steadily, eroding even these modest gains; as a consequence, per capita gross national income rose by a mere 0.9% per annum during the 1960-76 period. The slowdown in economic growth in the 1970-77 period is attributable to a combination of factors, including inadequate investment, poor management of the economy, and a policy environment unconducive to growth and investment, which were compounded by poor weather in some years and a sharp rise in the cost of imported food and petroleum. 4. The three tree crops--tea, rubber and coconuts--which are still the mainstay of the economy, suffered from low replanting and inadequate incentives. These problems were exacerbated by a dual exchange rate system, introduced in 1968, that discriminated against these crops, and by the uncer- tainties surrounding a protracted nationalization (1972-75) of the larger estates. After the exceptional output growth of the 1960s, rice yields and cropping intensities declined in the 1970-77 period due to poor institutional support. Investment in manufacturing was also low, and the inefficiency of most public and private sector firms, nurtured in a highly protected environ- ment, resulted in growth of manufacturing of 1% per annum. The only bright spots were subsidiary food crops and industrial exports which benefited from good incentives.  5. An inadequate public savings effort, caused by inelastic revenues and uncontrolled growth in recurrent expenditures, inhibited public investment. Private savings and investment were constrained by an unfavorable policy environment. The low growth rates and the slow changes in the structure of output matched neither the jobs nor the changes in employment structure that the growing labor force required. Slow output growth, the excessive capital intensity of investment, the mismatch between the job aspirations of those with post-primary education and the jobs available to them, the post war demographic bulge, and rising female participation rates contributed to a massive increase in open unemployment, estimated at over 1 million, or some 18% of the labor force in 1977. 6. In sharp contrast to this poor economic performance, Sri Lanka's social achievements in relation to per capita income have been outstanding. Sri Lanka has about one and one-half times the life expectancy, almost thrice the literacy, one-quarter the infant mortality and half the birth rate that would be expected for a country at its per capita income level. Nutrition levels have been adequate, and in the 1960s there were parallel gains in income distribution. These improvements in the quality of life, in particular the rise in health standards, the spread of education and the availability of subsidized food, have been important factors in the decline in mortality. The increasing age of marriage, the spread of female education and employment, and a vigorous family planning program, have also contributed to a sharp decline in fertility. As a consequence, population growth, net of migration, has dropped steadily, from 2.7% per annum in the 1953-63 intercensal period to 2.2% qer annum in the 1963-71 period, and 1.7% per annum during 1971-81. 7. The gains in the social field were made possible by favorable initial conditions. Compulsory primary education was introduced as early as 1901. The food ration was introduced in 1942. Thus, at the time of Independence in 1948, Sri Lanka already enjoyed high levels of adult literacy and life expectancy. These initial gains were consolidated and expanded in the post-Independence period through large expenditures on social services and the food subsidy, which accounted for two-fifths to one-half of government revenues in the 1960s and early 1970s. These expenditures were traditionally financed by capturing the surpluses of the three major tree crops, which provided the Government with easy sources of revenue and foreign exchange. These surpluses began to decline in the late 1960s as government policies discriminated against these crops and export unit prices weakened. With growth in other productive sectors in the economy also decelerating in the 1970-77 period, the budgetary resources available for social programs were squeezed by inelastic revenues and rapid inflation. As a consequence, expenditures on social services other than the food subsidy began to decline as a proportion of total current expenditures and of GDP, threatening the hard-won gains in health and education. In short, the economy was no longer generating the resources needed to sustain a large program of welfare expenditures. Moreover, the very size of those programs reduced the scope for policy makers to shift resources to development. 8. The policy changes introduced in 1977, following the election of the United National Party, were intended to break this vicious circle. The new Government identified its objectives as the sustained revival and resus- citation of the economy and increased employment through (i) increased capa- city utilization in the productive sectors, (ii) stimulation of savings and  - 3 - investment, and (iii) efforts to encourage exports, and import substitution in foodgrains. A program of policy reforms was developed in close consultation with the IMF. These reforms were supported initially by an IMF standby arrangement covering 1978 for SDR 93 million. On January 26, 1979 the Fund's Executive Board approved an SDR 260 million Extended Arrangement to cover the 1979-81 period. The principal aim of the reform program was to dismantle controls over resource allocation and initiate price adjustments with a view to establishing more realistic relative prices. By 1980, these goals had largely been achieved. 9. The program of reforms comprised a number of major policy initia- tives. The exchange rate was unified 1/ on November 16, 1977 at a depreciated rate of Rs 16 = US$1.00 and allowed to float. This implied a depreciation of 46% against the official rate prevailing prior to unification, and 11.2% with respect to the Foreign Exchange Entitlement Certificate rate. The trade and payments regime was liberalized. Public sector import monopolies were almost entirely terminated. Prior licensing of imports was abolished for all but a handful of commodities. The tariff structure was revised and simplified. Other budgetary taxes and subsidies were adjusted to reflect the change in trade and exchange rate policies. In particular, rice and sugar rations were confined to the poorer half of the population, and the food subsidy was eliminated through a series of adjustments in administered prices. On September 1, 1979 the Government introduced a system of food and kerosene stamps for families with monthly incomes less than Rs 300 to replace specific subsidies and food rationing, and to target benefits to the poor. To help offset the adverse impact of these changes on real incomes, public sector wages were periodically adjusted upwards. Public corporations were asked to pass on cost increases, except for fertilizer, petroleum, milk, and public transport, where price increases were initially deferred to cushion the impact on consumers. The Government subsequently eliminated the overall subsidy on petroleum products and made sizable adjustments in bus and train fares, electricity and fertilizer prices. The burden of selected subsidies and transfers, as a consequence, fell from around 9% of GDP in 1978 to around 5% in 1980. These changes, taken together with higher aid receipts, have helped permit a sizable increase in capital expenditures. 10. Agricultural pricing policies have changed dramatically. The domestic support price for paddy was increased by 21% in November 1977, by 25% in November 1980, and by a further 5% in February 1981 following a sub- stantial increase in fertilizer prices. With the related increase in flour prices, incentives for paddy and other flour substitutes benefited. At the same time there has been a large policy-induced decline in the role of the state in domestic rice trade. Fresh coconut prices were also increased and the export duty on coconut products was appropriately adjusted. While the unification of the exchange rate ended formal discrimination against tree crops, high export duties, particularly on tea, continued to siphon off most I/ Prior to unification, all exports other than tea, rubber and coconut products and all imports other than food, fertilizers and drugs were channelled through the certificate market. Since November 1972, the FEEC rate was maintained at a 65% premium over the official rate.  - 4 - of the operating surplus for the Government. As tea prices fell and produc- tion costs rose in 1978-79, the Government responded to the reduced producer margins by a lowering of taxes on tea. The Government has also ended most price controls, and reformed the interest rate and tax systems. The burden of company and personal taxation was lowered, and the taxation system was rationalized with a view to increasing revenue elasticity; nevertheless, the overall revenue elasticity to economic growth and domestic inflation remains low as taxes on slowly growing tree crop exports have averaged over 30% of current revenues. Interest rates were also raised sharply to encourage savings and discourage speculative imports. However, inflation eroded these rates and in April 1980 further upward adjustments were made. 11. The economic reforms have been accompanied by a major effort to step up public investment. The Government's capital expenditures jumped from 6% of GDP in 1977 to an average of 13% in 1978 and 1979, and 19% in 1980, as government departments responded to the initial improvement in the budgetary resource position by embarking on long overdue replacement investments and new projects that had been shelved earlier for lack of resources. At the same time, the Government embarked on three major new programs which are to be the lead projects in a five-year rolling public investment program. These are: (i) accelerated implementation of the Mahaweli Ganga Development Program, by far the largest multi-purpose river basin development program ever undertaken in Sri Lanka (paras 25-27); (ii) a 200 square-mile free trade zone north of Colombo under a newly constituted Greater Colombo Economic Commission which has established the first of several Investment Promotion Zones near Colombo's international airport and by end-1980 had signed agreements with 64 investors involving a total investment of US$130 million; and (iii) a massive housing and urban renewal program with its main focus on the Colombo metropolitan region, including the construction of a new capital complex at Kotte, a suburb of Colombo. Budgetary expenditures on these three programs will amount to Rs 34 billion, or 52% of projected budgetary resources over the 1981-85 period. The underlying public investment strategy is to balance the large investment requirements of the Government's high priority programs against the urgent rehabilitation and fresh investment needs in other sectors. The main thrust of the public sector program is to lay the foundation for longer term develop- ment, both by improving the efficiency of use of existing infrastructure investments and by expanding the longer term growth capacity of the economy. The strategy thus implicitly relies on the private sector to respond to the economic reforms and the stimulus of the public sector investment program, and provide much of the short-term growth. Private fixed investment has so far responded well, increasing from about 7% of GDP in 1977 to 15% by 1980, and helping overall fixed investment to exceed 33% of GDP. 12. In response to the policy reforms and the accompanying acceleration in investment, economic growth in 1978-1980 averaged an impressive 6.8% per annum. This growth was shared by almost all sectors of the economy, particu- larly construction and services. The only major exception has been the tree crop sector. The impressive performance is due to a number of factors includ- ing the improved availability of inputs following import liberalization, an increased role for the private sector in distribution, and the removal of price controls. Although there is little data available on employment, Central Bank estimates suggest that unemployment dropped from 18% of the labor force to 15% between 1977 and 1979.  - 5 - 13. Despite this strong performance, major weaknesses in economic performance emerged in 1980. In particular, the national savings effort has not matched the rapid rise in investment. Gross national savings fluctuated around 15% of GDP during the 1978-80 period, while recourse to foreign savings to finance the higher investment rose from 4.5% of GDP in 1978 to 19.5% in 1980. Although the Government has succeeded in containing the costly consumer subsidy and transfer programs, which has led to their decline as a percent of GDP (para 9), relatively inelastic revenues combined with steadily rising other recurrent expenditures and declining terms of trade resulted in hardly any public savings over the 1978-80 period. As a result, the Government has financed its rapidly rising capital expenditures through foreign aid, and by increasing its level of domestic borrowings. Initially the Government was able to meet its domestic financing requirements through non-expansionary borrowings from captive financial institutions, which had been able to mobil- ize increased private savings following the interest rate reform. However, resources mobilized through these channels have not grown as rapidly as the budgetary deficit, and the Government has been increasingly forced to undertake expansionary borrowings from the Central Bank. Between 1978 and 1979, these rose from 0.4% to 1.2% of GDP and in 1980 increased sharply to 10.5% of GDP. 14. Inflation has also increased sharply since 1977. The exchange rate adjustment, other policy-induced price increases and related wage increases, the removal of price controls, and the build-up of external assets, which added to the money supply, contributed significantly to inflationary pressures in 1978 and 1979. However, these were moderated by bumper paddy harvests, increased capacity utilization in the economy, increased availability of imports, and the beneficial effects of competition from imports and in domes- tic distribution. Since then, rapid growth in the broad money supply--38% in 1979 and 32% iAn 1980--has added a sizable "built-in" increase to the system. Together with the corrective price increases designed to reduce budgetary subsidies and keep pace with the rapid increases in international petroleum, wheat and sugar prices, these pressures have caused inflation (as measured by the Colombo Consumer Price Index) to accelerate from an average of 11% in 1978 and 1979, to 26% in 1980. 15. The rapid expansion in economic activity has been reflected most vividly in the balance of payments. Import volume growth since 1978 has averaged 15%. Between 1978 and 1980, the net petroleum import bill more than tripled and increased from 11% to 36% of non-petroleum exports, while capital goods imports more than doubled in response to the acceleration in investment. However, exports have shown barely any volume growth due mainly to declining tree crop export volumes, which offset strong growth in garments exports. These adverse trade volume trends were compounded by a 20% terms of trade deterioration over the same period. The rapid growth in tourism receipts and private remittances from abroad in this period failed to offset the deter- ioration on trade account and the current account deficit rose from $124 million (4.5% of GDP) to $805 million in 1980 (19.5% of GDP). In 1978 and 1979, rapidly rising non-monetary capital inflows due mainly to increased net aid disbursements more than offset the current account deficit and Sri Lanka continued to add to its net international reserves, albeit at a declining rate. In 1980, however, net international reserves fell by $220 million, and by end-1980 gross international reserves stood at $377 million, or equivalent to less than nine weeks of imports of goods and non-factor services. With the  - 6 - rapid drawdown in reserves, the public sector, especially the public corpora- tions, have begun to make significant use of commercial financing arrangements. 16. The Government realized in early 1981 that continuation of the 1980 trends would risk continued high inflation and unsustainable pressures on the balance of payments, and took corrective steps. The 1981 budget proposes to reduce government capital expenditures from 19% of GDP in 1980 to 14% of GDP in 1981, and the overall budgetary deficit was reduced from 21% to 15% between 1980 and 1981. In addition, the Government has moved to limit public sector purchases of equipment and construction of new buildings and taken steps to raise additional resources and impose a control mechanism over capital expenditures by public corporations. Continued strong measures will be required throughout the medium term to ensure that public sector investment is consistent with available resources, as many of the large development schemes the Government has initiated are only now gathering full momentum. 17. Aid donors have responded enthusiastically to the Government's devel- opment initiatives--the average level of aid commitments in 1978-80 was almost 120% higher in nominal terms than in 1975-77; and almost 40% higher in real terms. Most of the growth came in project aid, reflecting the Government's efforts to increase investment, particularly in the Accelerated Mahaweli Program. Given that public investment is already over-programmed, continued high levels of aid will depend upon donors' ability to shift from project to non-project aid and to finance a sizable portion of local costs (see para 44) in order to provide increased budgetary and balance of payments support, and upon the Government maintaining donor confidence in its economic policies and management through a vigorous domestic resource mobilization program and continued restraint on government expenditures. External public debt outstanding and disbursed stood at US$1,328 million at the end of 1980, amounting to about 35% of GDP. However, it is almost all long-term conces- sional debt. As a result, the debt service burden is relatively low--the debt service ratio in 1980 excluding IMF repurchases stood at 9.3% of exports of goods and non-factor services, declining from 13.3% in 1977. While this sustained decline is due in part to improved export earnings, the main cause has been a decline in outstanding short- and medium-term commer- cial borrowings. Unless the ratio of the current account deficit to GDP improves, Sri Lanka will again have to begin undertaking significant shorter maturity commercial borrowings to fill the gap between the current account deficit and likely concessional aid flows. In that case, the debt service ratio could rise quickly. PART II - BANK GROUP OPERATIONS IN SRI LANKA 18. Since the beginning of its operations in Sri Lanka in 1954, the Bank Group has approved eight loans totalling US$72.9 million (net of cancellations) and 27 credits totalling US$409 million (net of cancellations and exchange adjustments) in support of 33 projects. About 43% of Bank Group assistance has been for agriculture (irrigation, agricultural, and dairy development), 17% for power, 15% for transport, and the remainder for development finance company operations, a program credit (mainly involving the import of raw materials for industry), water supply, telecommunications and small and medium  industries. Eight loans and eight credits have been fully disbursed so far. Annex II contains a summary statement of Bank Group operations as of March 31, 1981, together with notes on the execution of ongoing projects. 19. An IFC equity investment of about US$100,000 equivalent in the Development Finance Corporation of Ceylon (DFCC) and an IFC non-revolving line of credit of US$2.0 million to the government-owned Bank of Ceylon for on-lending to private small- and medium-scale industrial enterprises were approved in FY78. IFC also approved an investment of US$3.68 million in a synthetic textile mill, and US$986,000 in a polypropylene bag manufacturing plant in FY79. During FY80 IFC approved an increase in equity investment of about US$51,000 equivalent in DFCC and an investment of US$260,000 in an equipment leasing company. In FY81, an investment of about US$0.7 million in equity and about US$17 million in loans for a new hotel project in Colombo was approved. 20. The Bank Group's current strategy is focused on the agricultural sector to support Government efforts to increase food production and reduce its dependence on food imports, and to raise productivity, employment, incomes and living standards of the rural population in Sri Lanka. Projects to sup- port basic infrastructure are also included. In addition to providing financ- ing for the ongoing Mahaweli Ganga Development Project II and the Mahaweli Ganga Technical Assistance Project, the Bank Group is assisting the Government in accelerating the implementation of the Mahaweli Ganga Development Program principally through the coordination of external assistance for project preparation and implementation. A village irrigation rehabilitation project is scheduled for consideration by the Board on June 11, 1981. A second tea rehabilitation project, a second small and medium industries project and a Mahaweli Power Transmission Project are being appraised. 21. The Bank Group presently accounts for 9.7% (IBRD, 2.3%; IDA, 7.4%) of Sri Lanka's total debt outstanding and disbursed, and 6.5% (over 80% IBRD) of debt service on medium and long term debt. It is projected that the Bank Group's share in total existing external debt outstanding and disbursed will increase to 17% by 1985 (with the IBRD's share declining to 1.3%). The Bank and IDA shares in the debt service are expected to decline to about 4% by 1985. PART III - THE AGRICULTURAL SECTOR Overview 22. Agriculture remains of central importance to the economic develop- ment of Sri Lanka. In 1980, it contributed about 28% of total GDP, over 50% of total employment, 60% of export earnings, and 29% of government revenues. In addition, much of the activity in the manufacturing, transport, and the services sectors relate to either supply of agricultural inputs or processing agricultural output. 23. Agricultural development has been concentrated to date in the wet and intermediate zones which lie in the southwest portion of the island. These zones, accounting for only one-third of Sri Lanka's surface area,  contain about two-thirds of the population and 50% of its paddyland. Agri- cultural growth in these zones depends primarily on increasing productivity of already developed land. In contrast, the dry zone to the north is sparsely populated and underdeveloped despite continuing migration and colonization. Permanent agriculture there accounts for less than 30% of the 2.4 M ha which are considered potentially arable, with an additional 40% under subsistence- type slash and burn (chena) agriculture. Cultivation in the southwest monsoon season (yala) is confined to irrigated areas, but even in these, water and other constraints limit average land use intensities to about 110-120%. Considerable potential exists in Sri Lanka for both increasing cropping intensities on already developed land and expanding cultivated area. Even on rainfed lands, there is considerable scope for stabilizing chena and raising productivity. While paddy will probably continue to be the dominant crop in irrigated areas, the dry zone in general holds most promise for agricultural diversification. Objectives and Strategy for the Future 24. The present Government recognizes the pivotal role of agriculture in stimulating economic growth and rural development in Sri Lanka. Its medium-term strategy for agriculture emphasizes better utilization of existing potential through institutional and policy reform, as well as strategically selected investments to increase the production base. Among programs given high priority are: (a) establishing appropriate price incentives for pro- ducers; (b) strengthening agricultural support services such as research and extension, credit, farm power supply, and fertilizer distribution; and (c) stronger irrigation water management. Following adoption of measures in 1977 designed to implement the above and due partly to favorable weather, the sector responded well the following year. Agricultural GDP grew by 5.4% in 1978, compared to a 2% p.a. average over the 1970-77 period. While damage due to a severe cyclone in November 1978 and failure of the southwest monsoon in 1979 resulted in only 2% agricultural growth during 1979, output recovered in 1980, increasing by 3.1%. There has been steady growth in paddy, and following the removal of the flour subsidy and introduction of floor prices in 1980, increased production of subsidiary food crops. Through continuation of its adopted strategy, the Government hopes to boost agricultural growth to 5% p.a. over the next five years. Given adequate attention to potential imple- mentation constraints, this target should be attainable. For the longer-term, the Government is emphasizing further expansion of irrigated agriculture into the dry zone through accelerated development of its major river basins, such as the Mahaweli Ganga Basin. The Mahaweli Ganga Development Program 25. The Program 1/ is based on a Master Plan prepared jointly by a UNDP/ FAO team and Sri Lankan engineers in 1965-68. The Plan envisaged development of about 365,000 ha of irrigable land in the dry zone, as well as about 500 MW of hydropower. It was divided into three phases, each including several proj- ects, for stepwise implementation over a 30-year period. Late in 1977, the 1/ The Mahaweli Ganga Development Program or Scheme includes about 365,000 ha of net irrigable land situated in the Mahaweli Ganga and Maduru Oya Basins and the North-Central part of Sri Lanka.  - 9 - Government realized that at the current rate of construction and population growth, the Program as formulated would not have the desired impact of rapidly alleviating unemployment and serious food and power shortages, and that it should be accelerated. An Implementation Strategy Study, financed by the Netherlands, was then carried out to: (a) review and re-evaluate the Master Plan and each of its separate projects; (b) examine the implications of various alternative phasings of its projects; and (c) recommend a specific action plan taking into account anticipated constraints. 26. As a result of this Study, the Government decided to limit initial works on the Accelerated Program (1980-85) to four headworks (Victoria, Kotmale, Randenigala, and Maduru Oya) having a total installed hydroelectric capacity of about 500 MW and to about 60,000 ha in Systems B and C. 1/ Exter- nal assistance has been secured to finance three headworks projects, namely Victoria (UK), Maduru Oya (Canada), and Randenigala (Federal Republic of Germany). The fourth project (Kotmale) is being financed partly by Swedish import support funds. The US is providing finance for downstream development of the Maduru Oya Project (System B) and has also financed an in-depth study of the environmental impact of the Accelerated Program. Canada and the UK financed feasibility studies of Systems B and C, respectively. The Asian Development Bank is providing assistance to plan and install roads in the Accelerated area, and the EEC is providing assistance to finance downstream development of Zone 2 in System C. The proposed project would assist in financing downstream development in System C, and marks the first involve- ment of IDA and other project co-financiers (Japan and the Kuwait Fund) in area development effort under the Accelerated Program. 27. Over the past year, due to rapid domestic and international inflation and to the n-