Sri Lanka - Urban sector report

Report No. 4640-CE Sri Lanka Urban Sector Report June 29, 1984 South Asia Projects Urban & Water Supply Division FOR OFFICIAL USE ONLY U FILE COPY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their ofticial duties Its contents may not otherwise be disclosed without World Bank authorization  SRI LANKA URBAN SECTOR REPORT CURRENCY EQUIVALENTS US$1.00 = Rs 25.00 Rs 1.00 = US$ 0.0481 GSL FISCAL YEAR January 1 - December 31 MEASURES AND EQUIVALENTS 1 millimeter (mm) = 0.0394 inches (in) 1 meter (m) = 3.2808 feet (ft) 1 kilometer (km) 2 0.6214 mile (mi) 1 square meter (m ) 2 10.7639 square feet (sq ft) 1 square kilometer (ke ) = 0.3861 square mile (sq mi) 1 hectare (ha)=0.Olkm = 2.4711 acres (ac) or 10,000 sq m 1 liter (1) = 1.0567 quarts liquid or 0.2642 US gallon (gal) or 3 0.9081 US quart dry (qt) I cubic meter (m3) = 35.3147 cubic feet (cu ft) 1 liter per capita = 0.2642 US gallons per capita per day per day (lcd) = (gpcd) 1 cubic meter per second (m /sec) = 264.1721 US gallons per second (gal/sec) PRINCIPAL ABBREVIATIONS AND ACRONYMS CMC - Colombo Municipal Council CEB - Ceylon Electricity Board GCEC - Greater Colombo Economic Council GSL - Government of Sri Lanka LA - Local Authorities MLGHC - Ministry of Local Government, Housing, and Construction NHDA - National Housing Development Authority UDA - The Urban Development Authority USAID - United States Agency for International Development WDB - National Water Supply and Drainage Board This report was prepared jointly by a team set up by the GSL and World Bank missions, which visited Sri Lanka in March 1983 and March 1984. A list of participants of each team is attached in Annex 7. It was agreed with the Government of Sri Lanka that the large number of recent studies on the shelter problem prepared by the Ministry and consultants financed by USAID, would be utilized. Extensive data from these studies has been incorporated. However, the views expressed in this report do not necessarily reflect those of the USAID.  FOR OFFICIAL USE ONLY SRI LANKA URBAN SECTOR REPORT TABLE OF CONTENTS Page No. SUMMARY AND RECOMMENDATIONS ................................. i - xii I. URBAN DEVELOPMENT AND THE PUBLIC INVESTMENT PLAN .... ........ 1 Urban Population Growth ............................. . ........ 1 Prospects for Urban Growth .... 3 Urban Public Investment Plan .... 4 Housing ...................................................... 5 Urban Development Investments ... . 5 Water Supply Investments .... 6 Electricity Supply .... 6 TelecommunLications .... 7 Economic Overhead Investment . . ............................... 8 Central Government Transfers .... 8 Local Fina,ncial Needs - An Overview ... . 8 Local Government Resource Mobilization .... 10 AdministreLtion and Staffing .... 11 II. THE NATIONAL INSTITUTIONAL FRAMEWORK FOR URBAN DEVELOPMENT .. 12 A. Departments ................................................ 12 B. Authorities ............................................... 12 C. Boards-* . ........................................ ....... 13 D. Corportions . . .13 E. Funds. ..13 a. The Department of Local Government. 13 b. The Department of Local Government Service ........... 13 c. The Urban Development Authority (UDA) ... . . .14 d. The Na-tional Housing Development Authority (NHDA) . .15 e. The National Water Supply & Drainage Board (WDB) . .15 f. The Common Amenities Board (CAB) .. .. 15 g. The Greater Colombo Economic Commission (GCEC) . .15 h. The Ceylon Electricity Board (CEB) . .16 III. LOCAL GOVERNMENT ADMINISTRATION, SERVICES, AND FINANCE .18 A. Administration . .................... 18 B. Urban Services: (a) Urban Land ....19 (b) Land Values ....20 (c) Tenure .... 20 (d) Water Supply ....21 (e) Sanitation. ... . ........ . .23 (f) Solid Waste ....25 (g) Roads/Highways/Streetlighting . .............. . 25 (h) Public Transport ....26 (i) Power Supplies ..................,.. ............. 26 (j) The Impact of Tourism Development on Urban Services 27 (k) Operation & Maintenance of Existing Services .27 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  -ii- C. Finance . .................................................. 28 a. Status of Accounting, Auditing, Budgeting in LA's ...... 28 b. A Financial Profile of Local Government (1977-87) ...... 29 Urban Authority Expenditure in the National Context .... 30 Expenditure and its Financing . . 32 Financial Position of Colombo & Seven Other Major Urban Authorities .................................... 34 c. Sources of Local Revenue .............. 36 * Property Taxation .............................. . 36 * Other Local Taxes . . 38 * Cost Recovery - Charging for Urban Services ..... 38 d. Central Government Financial Assistance to Local Authorities .......................................... 40 Revenue Grants ... . 40 * Capital Grants .................................. 42 The Local Loans and Development Fund ............ 42 * Capital Expenditure Planning & Financing Arrangements . . 44 D. Electricity Supply .... .................................... 45 E. Water Supply and Sanitation ............................... 48 IV. THE SHELTER PROGRAM - POLICY AND FINANCE ..................... 51 A. Introduction ........................................... . . 51 B. Public Sector Housing Performance . . . . 52 C. Construction Costs and Design Standards .................. 53 D. Affordability ............... . . 54 E. Cost Recovery and Replicability . ......................... 54 F. Agencies Involved in Financing .......................... . 55 G. The Financial Implications ........ 56 H. State Mortgage and Investment Bank (SMIB) . . .............. 57 I. Future Urban Shelter Needs and Housing Strategy ... 58 V. THE COLOMBO METROPOLITAN REGION .59 ANNEXES 1. Misc. Population and Housing Census, Sri Lanka 1981, Data 2. Institutions - Agencies of the MLGHC - Outline Notes 3. Local Government Finance - Summary Data 4. Shelter Program - Affordability, Estimates of Housing Needs 5. Traffic and Transportation in Colombo - 'A Close-up' 6. Bibliography 7. List of Contributors to the Sri Lanka Urban Sector Report MAP IBRD 16784  SUMMARY AND MAIN RECOMMENDATIONS Background and Objective of this Report 1. The setting for this report is a period of rapid readjustment in Sri Lanka. The increase in investment since the 1977 liberalization and the spurt in economic development have been impressive achievements. They have not been matched with an increase in national savings, with the result that large and unsustainable foreign savings flows have been necessary to finance investments. The Government has recognized the need to reduce the savings-investment gap and has taken steps to reduce many important subsidies and to somewhat restrict the pace of investments. In general, the urban sector has not, until now, suffered from either of these adjustments; sub- sidies to local governments have continued to grow, as have Central Govern- ment investments in urban-directed infrastructure. It was in this context that the Government and the Bank agreed to do this study. 2. The civic disturbances in July '83 led to widespread damage and destruction focused on the urban areas, with consequent further deterioration in the housing stock, industrial infrastructure, municipal finances and the economy as a whole. The Government has since taken a number of emergency steps in response to the disturbances. The report's conclusions, however, remain unchanged and discuss the trend in the sector and on possible actions for arresting f'urther deterioration. 3. Sri Lanka's urban population is relatively small (3 million) at 21.5% of the total population. The growth rate of about 2.5% per annum is low by regional comparisons, (3.9 for India or the 5% to 8% growth typical in other countries). The slow growth of urban areas is based on solid achievements: demographically, death rates, birth rates and population growth rates are lower in Sri Lanka than in any other country of its income class; welfare, education, health, and development expenditures are widely spread over the island; and therefore the push and pull from countryside to cities less serious. 4. The urban problems are manageable, subject to certain policy shifts in favor of strong efforts to improve the financial and managerial perfor- mance of local governments and utility agencies. The deterioration in the finances of local governments has led to massive subsidies through revenue and capital grants and is having a direct adverse impact on two sectors which have hitherto had significant Bank financing (Water Supply and Power). Con- sistent defaults in payments to the Water Supply and Drainage Board (WDB) and the Ceylon Electricity Board (CEB) by the local authorities (and hence sub- sidies by Government of Sri Lanka (GSL) and support through grants for revenue and capital expenditure amount to approximately Rs. I billion (US$40.0 million) annually and rising. 5. At the same time, there is also an urgent need to improve operation and maintenance of urban infrastructure. Because city revenues require constant attenl:ion to prevent revenue erosion - for example, through revalua- tion of property for tax purposes, reassessment of user chargers in line with inflation, etc. - they have suffered greater erosion than national revenues and considerab:Le efforts will be required to restore urban local governments  -ii- 5. At the same time, there is also an urgent need to improve operation and maintenance of urban infrastructure. Because city revenues require constant attention to prevent revenue erosion - for example, through revalua- tion of property for tax purposes, reassessment of user chargers in line with inflation, etc. - they have suffered greater erosion than national revenues and considerable efforts will be required to restore urban local governments to financial soundness. In Chapter I, it is estimated that additional local revenues of about Rs 1 billion would be required between 1983 and 1987, from the Central Government to meet operating deficits while at the same time providing enough financing to carry out much needed maintenance operations and a modest capital investment program. To raise additional revenues of this magnitude would require mobilizing additional local resources by an additional Rs 25 (i.e. one US dollar) per capita per month. To raise this much additional revenue would require careful timing and political skill, as well as commitment, but it is not beyond the capacity of the average household. 6. The objective of this Sector Review is to support the GSL's efforts in the above areas. This should over time reduce the savings-investment gap. The specific purpose of the Review is to identify measures that would help: (a) increase domestic resource mobilization (Municipal Finance, Housing Finance, stimulation of Private Sector Development Finance, etc.); (b) improve the efficiency and effectiveness of resource utilization for land, infrastructure, and service delivery; (c) improve and strengthen institutions for urban management and training. Urban Employment 7. The urban formal employment situation has improved in the decade 1971-1981, with overall employment (relative to working age population) going from 35.9% to 36.8%, and employment relative to the labor force going from 76.6% to 81.4%. Nevertheless, many urban households continue to have very low incomes whether because of unemployment or low-productivity employment. While average urban household incomes in 1981 were about Rs 1,820 (US$72.80) per month, about 40% of all households had monthly incomes of less than Rs 1,000 (US$40.0) and about 18% have incomes below Rs 500 (US$20.0) 1/. Thus, the only realistic way to solve urban service problems for a major part of the urban population is to make the solutions cheap. Employment also com- mands emphasis in the choice of technology for urban investments. Par- ticularly in housing, there is a prospect for the new programs of Government to be substantially more labor intensive than the previous programs. i/ See Annex 4 - Table 1.  -iii- Sri Lankan Cities and Towns 8. The general condition of Sri Lanka's cities is, as might be expected, superior to tha,t of neighboring countries. The cities suffer, however, from the familiar litany of underachievements: housing and land development have not kept pace with population growth; safe water supplies are not yet univer- sally available; electricity connections are far from ubiquitous and phone connections are scarce. Maintenance of water supply installations and dis- tribution systems and of streets and drainage is not systematic enough to prevent deterioration, and management of infrastructure, including electrical distribution, is in general, inadequate. Central Government Transfers and Municipal Finances 9. Underlying each of these underachievements is the failure to fund adequately the investment and maintenance activities of governments in cities and/or the failure to adopt standards that are affordable at Sri Lanka's income level. The failure of funding is largely at the city level. Central Government and its agencies have been quite generous in their funding of all major forms of urban infrastructure with the exception of roads and drainage, where the cities are responsible for all but major national roads. Thus, the Central government finances bulk water projects, bulk electricity development, telephone services, most health and education services, and further contributes a large and growing transfer to offset cities' deficits in their recurrent budget. By contrast, cities' tax effort and charging system have not: been adequate to cover their own administrative expenses, the tertiary distribution systems, operating, and maintenance expenses of main infrastructure items such as water and power. 10. Some of the major findings of the Review include: (a) For al:L urban services (administration, physical planning, water supply,, sanitation, refuse collection, roads and street lighting, health and welfare services) except electricity, local govern- ments spent about Rs 87 (about $3.50) per capita in 1983 which is a relatively small amount for even essential maintenance of existing services; (b) Local governments are financing an increasingly smaller proportion of expenditures from local taxes. In 1977, 44% of local expenditures were financed from local taxes; 29% in 1979; 26% for 1982; and 18% projected for 1987. This is a tax deterioration rather than a spending acceleration; real per capita expenditures are approximately stable for the period. Local authorities have been defaulting in paying National Water Supply and Drainage Board (WDB) and the Ceylon Electricity Board (CEB) for water and power retailed through these authorities. Trends in Urban Service Delivery 11. Unrealistic design standards relative to the affordability of the target groups, apply mainly to housing and land development investments. A very large program in monetary terms, over one billion rupees per year at the peak, has translated into very few units of high cost urban housing, rather  -iv- the opposite of what is urgently needed in Sri Lanka's cities. 1/ This has resulted largely due to inadequate planning and analysis of the implications of these investments by the executing agencies. 12. Largely because of a severe overall shortage of investment funds at the Central Government level, central expenditures are being stabilized or reduced in important infrastructure items for cities - housing expenditures particularly are being drastically reduced - under the pressure to conserve investment funds for other high priority uses. Central Government has never been active in maintenance of urban infrastructure, except in as much as large current transfers can be used for these purposes, and financial strin- gency at the Central level will ultimately force stabilization or curtailment of these transfers as well. It was in this context of severe shortage of funds combined with continuing interest in promoting cities' orderly develop- ment that the Government initiated this analysis of the urban problems of Sri Lanka. 13. From an examination of the trends in available resources and the needs of cities, it is concluded that the financing problem is rather more severe than most verbal analysis at the Central or city levels seem to sug- gest. In spite of a needed reorientation of the housing program toward much lower standards, the public sector can do much less than they would like to do about the overall urban housing shortage. Subsidies needed for water supply operations and maintenance are increasing, and so are the financial requirements for reconstruction and repair because of delayed maintenance. Electricity distribution systems (as opposed to bulk supplies and transmis- sion which are nationally funded) are in bad shape through delayed main- tenance, with no source of funding in sight. And the general capital needs of local governments, from secondary roads to garbage trucks, are simply not funded systematically under any existing system. Urban Administration 14. Turning to local government administration, one finds a generally adequate national framework in place and functioning reasonably well. Although the main Government Ministry - the Ministry of Local Government, Housing and Construction - has a plethora of functions which probably detract from its main duties, its administrative staffing and its agencies are power- ful enough to undertake not only supervising functions but urban development tasks as well. The main agencies: The Urban Development Authority (UDA), the National Housing Authority, the National Water Supply and Drainage Board and (in other ministries) the Ceylon Electricity Board and the Chief Valuers Office - are all competent by developing country standards and have shown themselves capable of rapid developmental efforts. However, the UDA, in particular, would benefit from a review of its intended and current activities to concentrate on its most important functions. For example, UDA is responsible for urban planning, a major and very sensitive function which 1/ "Urban Development" expenditures are sometimes cited as another failure of standards. Expenditures under this category were largely devoted to a new national capital and administrative complex, however, and had little to do with the ordinary business of financing urban areas.  _v requires close cooperation with local governments, and for implementation of several major works. Institutional strengthening in economic and financial skills are urgently required. It is inefficient and distracting to also use UDA's management resources to undertake miscellaneous minor functions (Chapter II and annexes to this report describes these institutions in some detail). 15. Local government administration in major urban areas (the 12 municipalities and 39 urban councils) follows the traditional British model and is, at least on paper, a strong form of city organization, capable of handling the full range of local government duties. It has independent taxing authority (property, entertainments, business, and trade taxes, and various charges and fees for services) and borrowing power. Local expendi- tures are limited by law to a given set, but this set is sufficient for operational and developmental purposes. 16. Local government morale, however, though elusive to observe, appears to be in the doldrums with consequent adverse implications on finance. Except for electricity charges (which are generally paid for fairly promptly due to fear of disconnection) all forms of local taxing and charging seem to have a reverse momentum. For example, a valuation force sufficient to value all urban property on a five-year cycle is largely unused, while obsolete and incomplete asse!ssments reduce the most potential local tax, the property tax, to near insignificance. Similarly, water charges, in the face of rising costs and massive investment expenditure to benefit urban areas, remain at extremely low historical levels, often tied to the stagnating property rates. Though not exclusively a tax matter, the fact that nearly all local authorities are already far behind legal requirements in closing their books and getting them audited, and are getting farther behind, is probably an indicator of growing fiscal laxity. All of these indicators, combined with the rapidly expanding Government subsidy on recurrent account, support a hypothesis thal; the local authorities have lost a sense of responsibility for their own fiscal soundness and for financing their own urgently needed serv- ices, or, alternatively, that such a sense of responsibility is not being adequately supported by the current administrative and financial framework. 17. An administrative problem arises in the management of peripheral growth in the Colombo metropolitan area. Land in Colombo Municipality is very scarce, and the areas for expansion are in adjacent municipalities. Two particularly important development problems concern the Greater Colombo Economic CouncLl (GCEC) and the municipality of Kotte, a relatively under developed municipality which contain the new Parliament and Central Govern- ment administrative complex in the new Capital. The problems are elaborated in Chapter V. How these areas develop - e.g. the balance between housing and employment locations, and links to the metropolitan center, the transporta- tion available for intrametropolitan, intermunicipality communications, etc. - will affect all of the Colombo area municipalities, but no municipality has a strong or official voice in the development of its neighbors. At a mini- mum, an active joint committee of the municipalities should be set up to share informatLon on development plans and budgets and allow for mutual advice. 18. In the larger cities visited by the mission, staffing and skills of the town service seemed to be adequate but two cautions should be noted:  -vi- first, this may not extend to the smaller towns, which are at a disadvantage in recruitment of qualified staff; and second, perhaps more important, the appearance of adequate staffing may be an illusion deriving from the fact that the towns are not attempting to perform many of their possible develop- ment functions because of shortage of funds. Any attempt to increase sig- nificantly the developmental activities of cities, or for that matter to collect reasonable levels of taxes and charges, might reveal weaknesses. Land Acquisition and Municipal Service Levels 19. These are discussed more fully in Chapter III. Land for urban development purposes can be acquired effectively through the powers of the Urban Development Authority, the National Housing Development Authority and the Commissioner of Lands. From discussions, there appear to be no difficul- ties encountered in a well established land procurement procedure, and the speed of vesting land for use by Government is impressive - generally a few months. Government agencies own significant quantities of land, dating from the National Land Reform Act of 1973 or earlier acts. Recent rapid develop- ments of housing by Government made use of this land. The land tenure system in the private market, however, has serious weaknesses, since custom and inheritance laws have resulted in widespread joint ownership of undivided land. It is very difficult to clear title to a whole parcel of land that is jointly owned, to sell interest in it, or to claim undivided right to any part of it. In Colombo, there is a growing absolute scarcity of land near the center, although, because of development on large plots, densities are not high outside the core area. Most low-rent parcels of residential land are owned by their occupants; Government has transferred tenure to occupiers, after having acquired these under the Ceiling on Housing Property Law of 1972. (12,347 of the 17,250 slum properties in Colombo were transferred under this law). 20. Conditions of urban health-related services vary. 1/ Piped water is available to less than half of urban households and of those with piped water only half have piped water within the premises. Per capita supplies in the piped water systems vary widely from adequate supplies to very limited sup- plies. The level of maintenance is not uniformly satisfactory and a large percentage of urban authorities show no capability of maintaining and operat- ing a distribution system. 2/ Sewerage and sanitation is underdeveloped. Only parts of Colombo have water-borne sewerage systems and those are in poor repair. About 57% of urban households have a toilet for their own use, 23% share a toilet, and 20% have no toilet facilities. Among households having or sharing toilets, the common types include flush, water seal, pit type, and bucket type toilets in about equal numbers. Solid waste collection appears to be generally good, with daily collections in most areas, and disposal of solid waste ranges between highly efficient (e.g. Kandy composting with 1/ A World Bank Health and Population Sector Mission visited Sri Lanka in June 1983 and covers the sectoral issues in greater detail. 2/ See Sri Lanka Water Supply and Sanitation Sector Study, IBRD Report No. 4190-CE.  -vii- nightsoil to produce fertilizer) to grossly inadequate (e.g. uncovered and burning landfills in built-up areas in Colombo). 21. Roads, drainage, and street lighting are generally of a fair standard although road space is very limited. (In Colombo, for example, only 7% of land area is devoted to roads and streets). Maintenance, however, is generally poor, because of shortage of funds, and considerable damage is done to roads and drains which are not engineered well enough to tolerate sus- tained neglect. The coverage and standard of service of bus transportation is good. The public and private bus companies together carry about 80% of the daily passenger trips in Colombo, at low cost per kilometer to the pas- sengers. The system of allowing wide latitude to private bus companies, with no regulation on fares and routes, has worked well. Present bus fares in the public bus company, after a 25% increase in 1983, may be nearly adequate to cover full cost, including interest and depreciation, assuming efficient operations. The availability of cheap and efficient bus transport makes possible the present massive commuting between towns and villages for daily employment, which serves among other benefits to slow the growth of towns. 22. Urban H[ousing is a manageable problem in Sri Lanka, compared to most countries, because of the slow growth of urban population. (See Chapter IV). For the last decade, the average urban housing situation has improved, with slightly less overcrowding and better service provision to the average household. Nevertheless, the absolute number of families living in slums and shanty units is growing, with over 20% of Colombo's household now living in improvised bhousing units, in illegal squatting on public lands, and in subdivided permanent structures with inadequate services. Although the political and financial commitment to housing, on the part of the present government, has been massive, with peak year expenditures over Rs 1 billion, the standards aLnd costs of this housing have been so high (up to Rs 125,000, (US$5,000) per unit) that they have not made a major quantitative impact on the urban housing problem. The new direction of Government policy, as put forward in the 1983-87 public sector investment program, calls for a cut in expenditures of almost two-thirds (to a yearly average of around Rs 300 million) and a radical redirection of the program, from direct construction of finished housing units towards sites and services (at under Rs 20,000 per serviced plot) and slum upgrading (Rs 12,000 per plot). This will result in serving more families with much lower expenditures, and should introduce the possibility of recovering from beneficiaries a significant portion of Govern- ment's cost. For the lower end of the income distribution range (10-30 percentile), affordable housing would be of the order of Rs 10-Rs 30 thousand per plot. In the past, cost recovery has been poor, with units underpriced to begin with, and poor collection records of the amounts due. This was, no doubt, partly caused by inappropriate costs and standards in the direct construction program. Toward a Program for Action 23. The conclusions in this respect were unanimous: (a) Persistent arrears by the local authorities to the national agencies on water and electricity bills and deterioration (through lack of maintenance) of present assets should be addressed first, with new investment taking a secondary  -viii- place. The general investment guidelines contained in "Public Investment, 1983-87", restraining Central Government investments in various sectors, is appropriate. The reduced expenditure for housing combined with its redirection (lower cost solutions with improved cost recovery), is an improvement. The ongoing water supply projects would serve the medium-term need for bulk water in most cities. New water projects would focus on improved operation and maintenance, rehabilitation and distribution, tied specifically to improvements under (b) below; (b) It is also of high priority to restore the financial health of the local governments. This could be done by realizing the full potential of the tax, improving the coverage and collection from other charges, rationalizing the Central Government grants and using a reasonable level of Government loan funds. Simultaneously, the financial accountability of the local governments would need to be improved through better performance measures and monitoring, which would also require better bookkeeping and more prompt auditing. Attention should be given to incorporating appropriate local government incentive schemes in such a financial recovery program. (c) There will be the need to invest in urban areas, (within the investment guidelines contained in the "Public Investment, 1983-87"), both to arrest the deterioration through overuse of existing infrastructure and to enable modest expansion to match population growth. However, in order to determine priority of investments, a comprehensive view should be taken of capital investments aggregating within urban area, even if these are funded from diverse budgets (NHDA, UDA, LG, WDB, etc.) with emphasis on the local authorities' ability to operate and maintain completed assets. Prioritizing these options and budgeting for such investments will require considerable technical assistance and training. The Bank and bilateral agencies can assist in this task and would do well to work within an overall and agreed urban strategy. A Comprehensive Strategy 24. While reducing direct Central investment, Government should generally support an aggressive policy of investment by the cities themselves. A "banking" approach, blending financial discipline, ordering of priorities, rigorous project analysis, and stress on the overall creditworthiness of cities is recommended. This will not result in a rash of new investments in the short run, but it should lay the foundation for gradual improvement of cities. Specifically, the following steps seem to constitute a minimum package of preparations for major investments: (a) Each city should have at least a skeletal investment plan, and a supporting financial plan, that outlines the taxes and charges that will be used for debt service and and maintenance of new investments.  -ix- (b) Present current liabilities of cities and maintenance should command first priority. Persistent arrears on water and electricity bills, and deterioration of present assets, should be solved first, before appropriate scale and pace of new investments are determined. (c) Central recurrent grants should be rationalized according to some equitable formula providing appropriate incentives and strictly limited to a predictable amount consistent with other Central priorities. (It is beyond the scope of this report to judge whether the levels recurrent transfers are appropriate, but they should be limited and predictable to lay the groundwork for local fiscal responsibility). (d) A reasonable level of Government loan funds, through a resuscitated Local Loans and Development Fund, (LLDF) or other Ministry of Local Government channel, should be available to support the investments of local governments who can demonstrate their creditworthiness and the priority and return on the proposed investment. Government capital grants should be rigidly systemal:ized and limited, similar to the proposed treatment of recurrent grants, to predictable amounts for each local authority. Immediate Next Steps 25. It is obvious from the above discussion that the recommended plan of action will comes to nothing unless the local councils themselves reverse the trend toward fiscal helplessness and take steps to generate regular recurrent surpluses, subject to whatever level of recurrent grants is decided upon. The cities of Sri Lanka are not in such bad shape, nor are their problems so overwhelming, as to justify large scale support in the absence of strong fiscal self-help initiatives. It remains, however, for the Central Govern- ment to facilitate fiscal efforts by the cities by systematizing the grant system and by making it clear that Government stands ready to lend to credit- worthy cities for worthwhile purposes. 26. The report recommends that the Government through the Directorate of Local Government, immediately implement certain actions to arrest further financial deterioration as the first stage of a financial recovery program: (a) Embark on program to ensure that local governments operate more effectively within the existing financial systems and practices for boolkkeeping and audits. (b) Actively encourage local governments to improve the coverage, collection and administration of potential revenues now available to them, in particular the property tax but also other charges and fees.  _x (c) Simultaneously with (a) and (b), initiate a public information and education program to increase awareness of the crisis in Local Government financing with a view to developing and eventually implementing the new approach outlined in paras 23 and 24 above. External Assistance 27. Finally, the guiding principles for urban investments by external lenders, can be outlined. While the World Bank in other documents and forums recommends various urban investments as sound within a sector context, (see for example the discussion of housing program in this report, and the recent water sector report), these should be interpreted within the framework of the recommendations set out above. Briefly, the required context for any major urban investment is a timebound program for substantial fiscal improvement by local governments. No doubt this creates difficulties, as it will be neces- sary to identify investment opportunities and creditworthiness at the level of the individual city or town. It remains true, however, that not much can be done about the problems of cities from the Central level, beyond facilita- tion and encouragement of fiscal progress, assistance in planning and increased lending in cases where fiscal improvement programs are undertaken. We recommend a comprehensive approach to urban investment programs, taking into consideration investments made also by agencies not directly involved in providing urban services. Exceptions occur in the case of direct interface between central agencies and final customers, such as in telecommunications, where the city is not involved in any but a trivial way, in providing serv- ices or maintenance or in paying for them. Post Script: Implementation of Recommendations 28. In March 1984, this report was discussed in draft form with the GSL and specifically with the GSL counterpart team. The findings and recommenda- tions were unanimously accepted and conceptual alternatives for further actions discussed. It was agreed that the GSL team, (in collaboration with other officials, as appropriate) will continue to develop the framework for a proposed approach and a strategy for its implementation. The plan should positively respond to GSL's objectives of strengthening Local Government and make urban development programs more responsive to immediate priorities in minimum needs as defined by local communities in consultation with their elected representatives. 29. In carrying out this task, the GSL team will pay particular attention to the following: (i) to the extent possible the existing institutional framework should be utilized, with improved coordination and clearly defined roles and responsibilities for each institution. For example, between the DLG, UDA, NHDA, WDB the most effective use of limited resources (skills and finance) would need to be ensured.  -xi- (ii) There is an opportunity to utilize the efforts and products of other development programs previously financed by Multilateral and Bilateral programs e.g. the Construction Industry Training Program (CITP) for planning and service delivery standards; etc. (b) Financial: (i) The formulation of an improved planning and budgeting system at the local level that incorporates at least a 4-5 year perspective; (ii) The potential for incentive schemes towards encouraging greater local resource mobilization and improved fiscal discipline; (iii) The potential for full or partial cost recovery from several types of urban investments, including appropriate policies for the pricing of services, and the implications on municipal finance; (iv) A revised grant structure through the consolidation of the many existing revenue grants and better defined phasing of such transfers, this would be tied to an incentive scheme as noted in para (b)(ii); (v) Improved access of local governments to capital for development. The possibility of developing the LLDF into an urban development bank through managerial, financial and operational restructuring would be explored. The routing of previous capital grants, supplemented by capital funds from other programs (e.g. UDA) could considerably increase the effectiveness of this agency in mobilizing and lending for the development of municipal and urban programs; (vi) The arrangements for financing urban expenditure (tariffs, loans vs. grants, terms for loans, mobilization of private sector funds, etc.). (c) Implement:ation: The logistics for encouraging decentralization and local decision making, and at the same time facilitating centralized coordination, direction, program management, monitoring and evaluation. Existing models would be considered, e.g. the District Agriculture Program and the Rural Housing Program currently being formulated by NHDA; (d) Training Needs for Manpower Development: To help local governments more effectively plan, manage, operate and maintain such a national urban program, there is likely to be a significant demand for specialized training across a broad spectrum to increase awareness, knowledge, develop skills, and change attitudes. For example, courses targeted to:  -xi i- (i) Political leadership at the local level; (ii) Chief administrative levels; (iii) Middle Management; (iv) Line personnel; (v) Technical staff and operatives for operation and maintenance; This will necessitate the preparation of Terms of Reference for a study to include: (i) An assessment of training needs; (ii) Inventory of existing institutions and curriculums that can be utilized; and an (iii) Identification of areas for new curriculum development.  I. URBAN DEVELOPMENT AND THE PUBLIC INVESTMENT PLAN 1.1 Substantial improvements in urban institutions, management, and capital stock are urgently required. There are favorable elements facilitat- ing improvements: current and projected urban population growth rates are low; the planned urban investments of the Central Government show better inter- and intrasectoral balance than in the past, with the major improve- ments being in shelter design; and overall maintenance and administration at local levels has been fair, despite fiscal constraints. There are also some serious limits to what can be done: Central Government investments and transfers to local governments will be strained for the forseeable future because of overall resource constraints; and resource mobilization efforts of the towns require overhauling. This chapter will briefly discuss each of those background elements. Urban Population Growth 1.2 General population growth rates in Sri Lanka are quite low, compared to other countries in its income group, in spite of the low Sri Lanka death rate and high life expectancy. The following table, which brackets Sri Lanka with the countries of similar per capita income, shows Sri Lanka's unique population picture among countries in its income class and indicates its level of demographic maturity; the major transition to low death rates and low birth rates is complete. Table 1.1: SRI LANKA: COMPARISON OF DEMOGRAPHIC INDICATORS IN INCOME CONTEXT Crude Death Rate Life Expectancy Average Annual Per Capita Per 100 Population at Birth Population Growth Income $ (1980) (1980) (1980) (1970 - 1980) Zaire 220 18 47 2.7% Malawi 230 22 44 2.9% Mozambique 230 18 47 4.0% India 240 14 52 2.1% Haita 270 14 53 1.7% Sri Lanka /a 270 7 66 1.6% Sierra Leone 280 18 47 2.6% Tanzania 280 15 52 3.4% China 290 8 64 1.8% Guinea 20 45 2.9% Industrial Market Economies - 9 74 0.8% /a The data for Sri Lanka differ slightly from most country sources but are included here as contained in the World Development Report, for purposes of comparison. Source: World Development Report, 1982.  -2- 1.3 The behavior of urban population growth rates is still more striking; for the period 1963-1981, census data show increases of only 2.6% per year, consisting of 4.4% annual growth in the first intercensal period (1963-71) and 1.2% growth in the period 1971-81. Thus for the period as a whole, according to census data, urban growth was only slightly higher than total population growth, and for the period 1971-81 urban growth was slower than total population growth. Table 1.2: SRI LANKA: POPULATION GROWTH AND URBAN POPULATION GROWTH ANNUAL GROWTH RATES Annual Growth Rates 1953 1963 1971 1981 1963-71 1971-81 1963-81 Population ('000) 8,098 10,582 12,690 14,848 2.3 1.6 1.9 Urban Pop. ('000) 1,239 2,016 2,848 3,194 4.4 1.2 2.6 % Urban 15.3 19.1 22.4 21.5 Source: Population Census 1971, 10% sample of census 1981. Population of the 50 municipalities and urban councils in 1981 was 2,178 thousand. 1.4 Although there are difficulties in comparison, it seems quite clear that no other low income or middle income country had as low a rate of urban population growth as Sri Lanka in the last decade. Most countries at this level of income have urban growth rates that are around 150% to 200% of total population growth rates; none except Sri Lanka has slower urban population growth than total population growth. Table 1.2 overstates the growth of particular urban areas in the period 1963-71. Nearly half the urban growth in 1963-71 was caused by the reclassification of new areas and their popula- tions are urban. Without this definitional change, annual urban growth in 1963-71 would have been only 2.4%. 1.5 Slower natural population growth rates in urban areas account for some of the slow growth of towns. Although no direct urban or rural natural population growth rate can be calculated from census data, total fertility rates are probably good indicators of relative natural population growth rates, because urban and rural areas have the same percentage of women in the reproductive age groups, and death rates appear to be similar.  -3- Table 1.3: SRI LANKA: RURAL AND URBAN FERTILITY DIFFERENTIALS /a (Children 0-4 years of age per 1,000 women aged 15-49) Year Urban Rural Urban % Rural 1953 549 672 81.7 1963 594 712 83.4 1971 492 569 86.5 1981 393 516 76.2 /a Ten percent sample of 1981 census. Women aged 15-49 comprised 26% of both rural and urban populations. Death rates are less easily compared. 1.6 From a comparison of fertility rates we would expect the natural growth rate in urban populations to be about 76% of that of rural populations in 1981, and for the decade 1971-81, between 76% and 87% of rural growth. Total urban population growth rates, however, were only 71% of rural growth rates for the decade, implying that significant net urban to rural migration took place. Prospects for Urban Growth 1.7 Unofficial projections prepared by the Ministry of Plan Implementa- tion estimate urban population growth of about 2.4% per year for the period 1981-1991, that is, higher than the growth rate of the last decade and slightly below the rate for 1963-1981. 1/ This would increase the urban population share from 21.5% to 23.2% over the period 1981-91. Although this result is contrary to the most recent experience it may be a reasonable estimate, since several factors point to an acceleration in the urban growth rate. 1.8 First, slow urban growth during the 1970s can be partly explained by the stagnation of manufacturing income during the period 1971-77 (growth of only 0.5% per year). This trend has been improved markedly (4.6% growth for 1978-81) but the growth of manufacturing late in the decade was probably not yet reflected in migration by the time of the census in 1981. Employment in manufacturing which grew at 5.2% per year over the decade 1971-81, almost certainly concentrated in the last years, will eventually result in pulling more people to urban areas. 2/ Urban employment ratios defined as employed persons per 100 persons of working age, have risen from 35.9 in 1971 to 36.8 in 1981. UrbarL employment rates, defined as employed persons per 100 1/ A.T. Abeykoon, Population Division, Ministry of Plan Information, 1983, unpublishecL. These projections were prepared by first projecting total population growth (1.58% per year on average for the decade) and then projecting urban share on the basis of long-term historical trends, taking 1963-81 as a single period. 2/ Growth rates calculated from 1981 Labor Force and Socio-Economic Survey. No comparable observations exist for intermediate years.  -4- economically active persons, have increased from 76.6 to 81.4 during the same period. The improvement in the latter indicator was particularly dramatic for women whose employment rate jumped from 52.4 to 70.7. Again, it is likely that most of the improvement in employment ratios and employment rates, taking place late in the decade, did not have its complete effect on location of residence by the time of the 1981 census. 1.9 In contrast to growth in manufacturing employment, employment in agriculture increased slowly during the 1970s (1.7% per year). Growth in employment ratios in rural areas was scarcely significant (from 39.9 to 40.0). Relatively speaking, the rural labor market lost ground to the urban one. 1.10 International economic recovery, which is likely to improve urban employment prospects, would add to the pull of the cities. It is significant that most of the improvement in the urban labor market occurred in spite of a severe international slump which coincided with the period of reform and increased vitality in Sri Lanka. 1.11 Several factors, however, will keep Sri Lanka urban populations from growing very fast. Among them are the conscious decentralization efforts of government which have resulted in geographically dispersed social services and nearly equally social welfare indicators. For example: literacy rates for those over 10 years old are similar (93% in urban areas, 85% in rural areas); 1/ crude death rates and infant mortality rates appear to be similar (in the mid-sixties 7.8 and 64.4 per thousand urban, and 8.8 and 53.4 per thousand rural); 2/ and apparent nutrition of lower income groups is similar (in 1969-70, 1,901 calories and 44 grams of protein per capita per day, urban, and 2,099 calories and 46.5 grams of protein per day rural). Cheap and abundant road transportation allows commuting from farms and villages to urban employment. In Colombo, for example, city officials estimate that between one-third and one-half of all employees are nonresident. Finally, government policy has actively aided rural resettlement. The primary reset- tlement program, the Mahaweli program, is expected to absorb during the next five years about 8,000 families per year i.e., about 16% of the annual increase in population. Urban Public Investment Program 1.12 Major urban public investments are undertaken by the Central Govern- ment and its agencies under the heading of housing, urban development, water supply, power, telecommunications and economic overhead investment. The overall shortage of investment funds has forced a re-evaluation of all of these investment programs, emphasizing greater revenue generation from char- ges on the recipients of services, and in the cases of housing and urban development, substantially lower cost solutions and reduced public outlays. 1/ Ten percent sample, 1981 census. 2/ Population of Sri Lanka, Economic and Social Commission for Asia and the Pacific, 1976.  -5- Housing 1.13 Housing investments have been substantially reduced and drastically restructured, moving from provision of relatively high cost housing furnished by direct construction financed by the Budget, toward slum upgrading and sites and services provision in which only minimum public services are provided. 1.14 The housing programs are discussed in detail in Chapter IV. The basic conclusions are that the new approach to urban housing is sound, and that the main problems of the old strategy -- poor equity effects because of the expensiveness of housing, and continuing lack of supply of housing affor- dable by the large majority of the population - can be solved by the new approach. The new approach to housing is also an improvement in macro- economic terms because, first, the immediate direct cost to the government is sharply reduced, and second, the prospects for financing part of this cost through cost recovery are enhanced. While there was a reluctance of foreign aid donors to finance Government's urban housing programs in the past, because of an over-investment in housing for a narrow income group which crowded out investments that were potentially more productive, the lower investment levels and the better balance of the new programs eliminate these impediments. Table 1.4 below shows the change in the total public investment in urban housing and in its structure. Table 1.4: PUBLIC SECTOR HOUSING PROGRAMS (RS MILLION) ACTUAL INVESTMENTS 1979-82, PLANNED INVESTMENTS 1983-87 1979 1980 1981 1982 1983 1984 1985 1986 1987 Urban Housing Direct Construction /a 372 1,021 625 696 321 180 - - - Slum Upgrading - - - - 32 32 42 45 49 Urban Sites & Services - - - - - 152 186 200 216 Subtotal 372 1,021 625 696 353 6 228 T4_5 265 Partly Urban Allocation to National Housing Bank - - - - 45 60 100 100 100 Total 372 1,021 625 696 393 424 328 345 365 /a Includes expenditures for public servants quarters of Rs millions 7, 15, 22, and 17 for 1979-82 respectively. Excludes the electoral housing program which was, prior to 1982, partly urban. This understates expenditures by a small amount for 1979-81. Source: Planning Department. Urban Development Investments 1.15 Investments classified as Urban Development were an important budget item through 1982, consisting mainly of three items: The Parliamentary complex Rs 967 million; the new administrative complex Rs 975 million; and new fish market Rs 304 million. These projects are substantially completed and no new projects are planned for the period 1983-87. Planned budget  -6- expenditures of Rs 320 million and Rs 433 million in 1983 and 1984 respec- tively will meet the delayed payments and final costs of these projects. Water Supply Investments 1.16 After a rapid acceleration up to 1983, Water Supply investments are expected to level off, declining in real terms, through 1987. While the evidence from the census shows only slight improvements in urban water supply over the period 1971-81, major water supply projects are currently being completed in all large urban centers except Kurunegala so that the need for further large investments for urban services is mitigated. 1/ Most of the new water supply investments to be started during the next few years will be for rural supply. 1.17 While the funding of future urban water supply programs in the next few years does not present a macroeconomic problem (most of the larger ones having been at least partially completed) the funding of on-going projects still constitutes a major expenditure, and the current subsidy on water supply operations and maintenance threatens to escalate beyond reasonable levels to become a significant drain on central resources. From 1979 to 1986, according to estimates prepared by the Water Supply and Drainage Board, the need for operating subsidies will escalate from Rs 24 million to 350 million. The estimated operating subsidy in 1986 will amount to about 1.0% of the total aggregate recurrent expenditure of the Central Government. The completion of the major on-going urban projects, most of which come on-stream in 1985 or 1986, will substantially increase the required operating subsidy. 1.18 Assuming that water supply operating subsidies might well double as new projects come on stream, they begin to be extremely important drains on revenue, equal, for example, to about twice the projected levels of public investment on housing. In this perspective, water supply user charges and improved financial and operational management of the sector as a whole are clearly seen as major urban policy issues. Electricity Supply 1.19 The Ceylon Electricity Board, a government owned corporation, is responsible for generation of electricity, for its direct sale to about 280,000 consumers, and for its sale in bulk to urban governments who serve a similar number of consumers. Urban governments are responsible for extension and maintenance of distribution systems in their areas, for collecting user charges, and for paying the CEB for electricity delivered to them. 1.20 Maintenance of existing distribution facilities owned and operated by local authorities has been grossly inadequate, with the result that there are routine power drops in peak periods, excessive losses, and periodic 1/ For details see Sri Lanka Water Supply and Sanitation Sector Study, May 1984, IBRD Report No. 4190-CE.  -7- unscheduled outages. 1/ As a solution to the problem of the poor maintenance record of urban governments, there were plans in the early 1980s to have CEB take over from local authorities the tasks of retail distribution, and one larger system (Mt. Lavinia, near Colombo, with 14,000 customers) was actually taken over. Because such an expansion of their functions would put an unsus- tainable burden on the capacity of CEB, however, this process of takeover has been discontinued. (In general, the local authority governments resisted the idea of CEB takeover.) For the near term future, therefore, the problems of expansion of electricity distribution networks and their maintenance, remain with local governments. 1.21 The cost of bringing the distribution systems of the local authorities up to the standard of CEB's system is estimated at about US$50 million, i.e. about Rs 1.1 billion. Compared to this cost, which would make up for years of delayed maintenance, the need for capital for system expan- sion is minor, since most urban households have nearby access to distribution lines. 1.22 It must be stressed that, at the present time, urban governments have no savings, deriving from electricity profits or from taxes and other charges, to meet any of the expenditure needs for system maintenance or expansion. This is a problem additional to that of arrears on electricity bills due to CEB for purchase of bulk delivery, which is discussed in Chap- ter III. Telecommunications 1.23 Telecoimmunications services are provided by the Post and Telecom- munications Department of the Ministry of Posts and Telecommunications. All revenues go into the government's Consolidated Revenue Funds and the depart- ment depends oa budget allocations for both capital and current expenditure. Funds from telephone subscribers are sufficient to meet current expenses and a significant part of expansion costs. The adequacy of expansion of supply, however, is not ensured, since telecommunications must compete directly for expansion funds from the Government budget. The level of supply is about average for Asian countries at approximately Sri Lanka's level of develop- ment, but far below effective demand. For urban areas, there are about 1.3 direct exchange connections per 100 persons. Approximately three-fourths of all connections are in government offices or businesses, one-fourth in residences. Telecommunications could obviously be expanded greatly 2/ on a self-financing basis, to the betterment of urban efficiency. While it is beyond the scope of this report to compare this investment opportunity to others facing the Government, it is at least clear that expansion of telecom- munications would be a sound urban investment. 1/ The customers served directly by CEB have benefitted from reasonably adequate maintenance and supply. See SAR Sri lanka, Seventh Power Project, January 1982. 2/ Official estimates put excess demand of about 50% of current supply. This is almost certainly an underestimate, since with improvement in service and availability, significant latent demand would surface.  -8- Economic Overhead Investment 1.24 The categories of economic overhead investments are power, posts, and telecommunications (discussed above), transport, which is overwhelmingly concentrated in railroads and highways that are not directly urban, and an "others" group that consists largely of integrated rural development. In transportation, there are not significant urban macroeconomic issues; Chapter V of this report discusses the impact of urban transportation problems on the most important metropolis -- the Colombo area. While significant local resource problems can be identified, the effect on overall financial needs is minor. Central Government Transfers 1.25 In addition to financing some of the major urban investments, as discussed above, the Central Government provides recurrent transfers to urban local government and minor capital transfers and loans. These transfers have grown rapidly in the recent past, and they are projected to form an even larger portion of the Central Governments support for urban activities. The external financial requirements of local governments, met mostly by Central Transfers or grants, have gone from Rs 35 million in 1979, to Rs 190 million in 1982 and a projected Rs 578 million in 1987. 1/ Local Financial Needs -- An Overview 1.26 Confining attention to strictly urban financial needs, that is, excluding such areas as bulk power supply, and undifferentiated economic overheads, an order of magnitude estimate of total financial needs can be pieced together. The following are quantitatively important categories: (a) Housing. Proposed investments by the Central Government for new sites are on the order of Rs 200 million per year for the next five years. This compares to projected growth or urban population of about 16,000 households per year, which, using the standards of the Governments cheapest site and service projects, would require investment of about Rs 320 million. With this public investment sufficient sites would be available for private investment in housing to serve the new population. Upgrading of existing slum areas is an additional planned investment Rs 40 million per year, which will serve 3,300 households of the approximately 39,000 households now living in unserviced slums. To serve all new households with a serviced site, and to upgrade all existing slums over five years would require about Rs 415 million per year. (b) Water Supply. Urban investments on projects already begun by the Central Government will taper off drastically, reaching low levels by 1987, and most of the expenditure on new projects 1/ Projection based on compilation of budget projection done by the 50 municipalities and urban councils.  -9- will b,e in non-urban areas and particularly for rehabilitation of existing assets. At current tariff levels, operation and maintenance subsidies could easily average Rs 500 million per year over the next five years. (c) Electricity. Delayed maintenance, corrected over a five year period, would cost about Rs 250 million per year. Required investments for distribution system expansion are relatively minor. (d) Current subsidies to local governments will average about Rs 300 million per year, given present trends, over the next five years. (e) Other capital works in cities for such projects as streets and roads, trash collection and disposal, and additions to public buildings must somehow be financed. At present there is no substantial source of savings for such purposes and it is unlikely that Central capital transfers or loans will make up this lack. For purposes of estimating total financial needs, these capital expenses are estimated at Rs 200 million per annum, about twice the present level of capital expenditures. 1.27 While it is clear that urban financial needs exceed this limited list (even with the arbitrary addition of the general capital works category) it may still be useful to sum up these more important items (See Table 1.5 below). In thinking about the required changes in the fiscal performance of cities, an annual sum on this order of magnitude, i.e. around Rs 1,500 mil- lion should be kept in mind. Various assumptions are possible; for example, it might be judged that current subsidies of Rs 300 million is a reasonable level of Central Government support and that annual capital grants or loans of Rs 200 million can also be sustained by the Central Budget. This would reduce the need for locally generated additional revenues to around Rs 1,000 million. This reduced estimate of additional local resources is about twice the level of recurrent expenditure (60% more than total expenditure) of the 50 major urban areas in 1982. 1.28 Two conclusions stand out. First, massive improvements in local fiscal performance (or Government transfers grossly in excess of those which are planned) are necessary to run a minimum program of urban development. Second, these improvements are well within the potential of cities as a whole. As Chapter III of this report shows, the actual tax revenues of the cities are not close to the potential yield of existing sources. Table 1.5 below shows the approximate need for additional funding over the next five years.  -10- Table 1.5: ANNUAL REQUIREMENTS FOR ADDITIONAL /a LOCAL RESOURCE MOBILIZATION (Rs Million) 1983-87 Housing (estimated need less government planned program) 175 Delayed maintenance of electricity distribution 250 (no current source) Water supply operating and maintenance costs in excess of current charges 500 Current subsidies of Central Government to Local Authorities 300 General capital expenditure of Local Authorities (no major current source) 200 Total 1,425 /a Over and above present allocation in Public Investment Plan. It is somewhat unrealistic to sum the resource requirements for cities as if they were homogeneous in need and in potential for policy change. In fact, it is quite realistic to expect that different cities will have very dif- ferent responses to fiscal stress, and that some of them will simply improve very slowly. Local Government Resource Mobilization 1.29 Chapter III examines local finances and has implications for local resource mobilization. The main conclusions are the following: (a) Local taxes are steadily falling behind local government recurrent expenditure needs. Rates, for example, which were 52.4% of total local recurrent revenues and 52.5% of total local recurrent expenditure in 1977 are projected at 31.6 and 23.3 percent of recurrent revenue and expenditure in 1987. (b) User charges, particularly for water, have not kept pace with costs. Electricity charges have been adjusted to reflect costs, but there are problems of collection which need to be addressed as a priority. (c) The mechanisms for taxing and charging have been allowed to deteriorate. Thus, for example, property valuations for rates (and for non-metered water charges) are grossly out-of-date, with serious consequent inequities between households as well as low revenue yields. Although the staff required to correct this situation is largely in place, the updating of property  -ll- rolls to a reasonable level will undoubtedly meet strong political resistance from the many who benefit from the current inequities. Administration and Staffing 1.30 Chapter II of this report is devoted to institutional description of the important urban agencies. While the questions of overall adequacy of staff could not be examined by the mission, some facts stand out: (a) At least in the larger towns visited by the mission (Colombo, Kandy, Kuranigalla) the overall level of staffing, in terms of quality and quantity, appeared quite adequate. In smaller towns, staff shortages or inadequacies may inhibit execution of some of the suggestions presented in this report. (b) Central urban institutions are complex, with a multiplicity of agencies and functions under the single main urban ministry--The Ministry of Local Government, Housing and Construction. While this surely aids communication, it also involves ministerial procedural blockages in areas where expertise is thin. Complicating the general overload on this ministry, is the fact that many of its operations are quite dynamic or even new. For example, MLGHC is involved (for approval) in the controversies surrounding electricity charging, where it was necessary to change rates dramatically, using a new tariff principle; MLGHC is central to the new directions in housing policy where a new program, sites and services, is just being piloted and brought up to scale; MLGHC has a major guidance responsibility in water supply, sewerage and drainage programs in urban development programs (which been been large and often controversial), in direct construction programs and so on, in addition to the ordinary task of guiding and assisting local authorities. (c) Sufficient staff exists for routine revaluation of priorities for taxing purposes and for expeditious assembly of land for public purposes. To reevaluate the entire urban system would take about five years. This is an adequate cycle during ordinary times. Unfortunately the valuation capacity has been largely unused in the recent past, so an obsolete valuation is inevitable, for most of the urban areas, until a full cycle can be completed. In the interim, alternative means for adjusting the property tax base through charges in the valuation process and policies should be addressed. In property assembly for public purposes, however, there has been substantial recent activity and a record of efficient performance. (d) Important agencies for urban development such as the CEB and the WDB, though not staffed to optimal levels, have a demonstrated capacity for executing projects and for maintenance.  -12- (e) The Government has been willing to supplement its ordinary staff and the staff of its agencies with consultants and other tempo- rarily employed experts, including expatriates where necessary, in implementing major investment programs. 1.31 On the basis of limited study, it appears that for most of the improvement required in local government management as well as for develop- ment purposes the nucleus for accelerated activity is in place. While it will be necessary still, in any particular activity, to pay strict attention to the needs for enhancement of capacity and the needs for upgrading or supplementing skills, the basic absorptive capacity for the high priority urban programs is hardly in doubt. II. THE NATIONAL INSTITUTIONAL FRAMEWORK FOR URBAN DEVELOPMENT 2.01 Urban development policy at the national level is decided by the Cabinet of Ministers under the chairmanship of H.E., the President on the recommendation of the Cabinet Subcommittee on urban development. This Sub- committee, also headed by H.E. the President consists of cabinet ministers who are directly concerned with activities related to urban development. The cabinet subcommittee is serviced by the Urban Development Authority (UDA) (see para 2.05) which provides technical advice on physical planning and urban development issues. The Secretary to the Ministry of Local Government, Housing, and Construction (MLGHC) who is also the Chairman of the UDA func- tions as Secretary to the Cabinet Subcommittee. 2.02 At the level of the central government, the MLGHC has responsibility for controlling and guiding the development of urban areas. Reporting directly to the Ministry are an assortment of at least 18 Departments, Authorities, Boards, Corporations and Funds, which have a role in the development of urban areas and the provision of urban services. These are: A. Departments 1. Department of Local Government 2. Department of Local Government Service 3. Department of Town & Country Planning 4. Department of National Housing 5. Department of Buildings B. Authorities 1. Urban Development Authority 2. National Housing Development Authority 3. Central Environmental Authority 4. Tower Hall Foundation  -13- C. Boards 1. National Water Supply and Drainage Board 2. Common Amenities Board 3. Local Government Service Advisory Board 4. Local Government Service Disciplinary Board D. Corporations 1. State Engineering Corporation 2. Building Materials Corporation 3. The Government Owned Business Undertaking of the Colombo Commercial (Engineers) Ltd. E. Funds 1. Local Loans and Development Fund 2. National Housing Fund A brief note on each of these is found in Annex 2. For the purpose of this review, some of the functions of a few key agencies are described. (a) The Department of Local Government 2.03 This department, within the MLGHC, headed by the Commissioner of Local Government, has the overall responsibility for guiding, assisting, and supervising the local authorities (see para 3.02) in the administration of their areas of jurisdiction. The Department assists the local authorities through financial grants, to maintain and develop urban services and amenities, provides training and technical assistance, and inspects and audits their operations. The budgets of the Local Authorities must be sub- mitted to the Department for information, but not for approval. (b) The Department of Local Government Service 2.04 This department is responsible for recruiting and appointing the staff to fill the higher level positions in the Local Authority administra- tions. These officials are members of the Local Government Service. Salary levels and conditions of service are determined by the Minister; these have been equated since 1978 with salary scales and conditions of service applicable to comparable grades in the Public Service of the Central Govern- ment. New higher level posts proposed by a Local Authority have to be approved by the Commissioner of Local Government in the case of Urban Coun- cils. Municipal Councils can create new posts without such approval, but only if the Council can fund the position from its own resources. In prac- tice, the Central Government exercises a close control over the staffing of the Local Authority administrations, particularly as it provides as a grant a major part of the salaries of higher level staff (see Chapter III, Part C). At the end of Diecember 1982, there were nearly 9,500 officials in the Local Government Service and 22,600 lower level (paid daily) staff over whose hiring and firing the Local Authorities have discretion.  -14- (c) The Urban Development Authority (UDA) 2.05 The UDA was established in 1978, specifically to promote the integrated planning and development of urban areas (see Annex 2a). In con- cept, the UDA was given adequate powers to carry out a whole range of activities, that normally would have been the domain of a number of different agencies, in an attempt to cut across the complicated bureaucratic red tape resulting from the previous multiplicity of institutions. In practice, UDA is now committed in a vast assortment of. activities, that could significantly hamper its effectiveness in the near future. For example, the UDA is involved in the acquisition and partial improvement of prime real estate in central Colombo; and for their subsequent 'sale' by way of long leases; and in 'Development Control' activities, in virtually all urban areas. At the other end of the spectrum, it has taken over the management responsibilities for tourist 'rest houses' in a number of areas. 2.06 In December 1979, a three-year 'corporate plan' for the UDA stated: "the UDA is a development agency and its activities have to be commercially and economically viable. It should meet all its expenses from revenues generated from its operations." It was anticipated that the UDA would (a) raise money through the issue of debentures to meet all capital expendi- ture on development projects in excess of the initial capital of UDA; (b) generate sufficient revenues from its operations to meet all recurrent expen- ditures including interest on debentures and loans. The most recent year end accounts available (December 1981) indicate a very sound financial position. However UDA's establishment and operational costs (excluding interest and depreciation) had increased 16 times over the previous year. A significant transformation in the market place, over the past 18 months, in terms of declining land values, tight credit, and hyperinflation in the construction industry will have had a major negative impact on UDA's earlier financial projections. Not all UDA's development schemes are commercially viable either, as many were started pursuing social and other objectives. Although the financial systems for UDA appear to be well thought out (based on cost-center accounting principles) doubts were expressed during mission discussions concerning the adequacy of pricing and cost recovery policies. It may also be desirable to review the extent of the merger between commer- cial and social-oriented projects, and establish a balanced portfolio, as well as clear financial objectives and guidelines for each. 2.07 There are some other general points that emerged during discussions: (a) the UDA's professional and technical staff is spread very thinly and is carrying out a multitude of tasks of a public works nature; (b) It is being called upon to handle projects and schemes that other existing agencies (with some strengthening) should be doing; (c) It is experiencing staffing shortages in some critical areas, specifically through loss of experienced personnel to the private sector and to more lucrative employment in the Middle East and elsewhere. 2.08 Over the past five years, a lot of work had to be done quickly. UDA was clearly the organization with the powers, resources and capacity to undertake the challenge. The effort has been tremendous and the performance impressive. However, the current economic downturn provides an opportunity for a critical evaluation of UDA's role, its future financial status and its  -15- staffing with a view to defining future objectives more clearly within an overall urban strategy. (d) The National Housing Development Authority (NHDA) 2.09 The NHDA was also established at the time of the UDA in 1979, with a mandate to plan and implement an ambitious program in the housing sector. (See Annex 2b). The performance of NHDA has been remarkable. For example, between 1971-1977, the public sector contribution to the housing stock was around 4,800 units. In 1979, the GSL launched the '100,000 houses' program, made up to 50,000 rural units and 36,000 urban units; and a further 14,000 to be financed through by housing loans of the Government. Under the overall program, around 35,000 units have been completed to date, with another 22,000 units still under production. However, the urgency of schemes, the geographic spread, the multiplicity of projects and inadequate time for preparation, led the NHDA into some difficulties, particularly in the area of cost control. An evaluation of its programs is still under way. The experience gained has been invaluable towards formulating a shelter strategy for the future, as well as in the identification of the weak points within the administration which require strengthening. The NHDA suffers from many of the same staffing problems in the UDA. It would benefit from receiving strong and immediate institutional and financial support, particularly if the policy options outlined in Chapter IV, are pursued. (e) The National Water Supply and Drainage Board (WDB) 2.10 The WDB was discussed in detail under the Sri Lanka Water Supply and Sanitation Sector Study (Report No. 4190-CE). The WDB is an autonomous body under the MLGHC. It was formed in 1975 out of the Department of Water Supply and Drainage and is the leading institution in the development for all urban and rural piped water schemes, urban sewerage schemes, and non-piped (wells) rural water supply schemes (see Annex 2c). (f) The Common Amenities Board (CAB) 2.11 The CAB was established in 1973 under the MLGHC to provide 'basic amenities' to low income areas in urban centers and particularly to manage tenement gardens and other housing units (about 6,000) which were vested with the commissioner of national housing under "The Ceiling on Urban Housing Law". Such basic amenities consist of the provision of toilets, water taps, and environmental improvements. The technical assistance to carry out these improvements is provided by the slum and shanty upgrading unit of the Urban Development Authority and the work is carried out by employing private con- tractors. Although the CAB also operates in Kandy, Galle, Trincomalee, and Jaffna, its major efforts are concentrated in the Colombo Metropolitan Area. The CAB now have extended powers to generate finance and construct more than just basic amenities. (g) The Greater Colombo Economic Commission (GCEC) 2.12 Finally, in this outline of institutions providing urban services, the unique role of the Greater Colombo Economic Commission must be noted. The GCEC was established in 1978 as an autonomous statutory body functioning directly under the President, as part of Government's response to the rapidly  -16- growing unemployment problem. It was created to promote foreign private investment in Sri Lanka by the development of Investment Promotion Zones, where manufacturing plants for the export of goods can be set up by foreign or local investors without ownership restrictions and with very attractive tax incentives. Entrusted with wide-ranging powers, the GCEC is the only agency foreign investors need to deal with. The GCEC handles all preliminary inquiries and provides information to interested investors; answers all questions on the technical and infrastructure facilities of the Investment Promotion Zones; provides data such as the price and availability of materials; approves assistance in the fields of transport, telecommunica- tions, and import and export shipping and clearance; screens and trains job applicants. 2.13 With respect to infrastructure, the GCEC's main role is that of a planning and coordinating authority. The provision and maintenance of infrastructure within the Zones is entrusted to appropriate government agen- cies. A site of about 415 sq. km. just north of Colombo has been designated exclusively under GCEC's authority. 2.14 Outside the MLGHC and the GCEC, other organizations are charged with the provision of certain aspects of urban services. These include The Ceylon Electricity Board, The Department of Highways, and the Department of Telecom- munications. All these institutions have been studied in connection with projects financed by the World Bank and IDA, under the sectors. However, for the purpose of this review, the role of the Ceylon Electricity Board as a bulk supplier to the Urban Local Authorities needs to be explained. (h) The Ceylon Electricity Board 2.15 The responsibility for electricity supply in Sri Lanka rests with the Ceylon Electricity Board (CEB), a statutory corporation established in 1969. The CEB generates and transmits electricity for direct consumption by its own consumers (250,000) or for sale to 214 local authority licensees, who supply a similar number of consumers. Local authority sales account for between 20-25% of CEB total sales. The CEB supplies all heavy industrial and commercial consumers and about 200,000 domestic consumers (including Colombo). The local authorities supply mostly domestic and small commercial consumers. Overall the level of domestic electrification is low in Sri Lanka and only about one in seven households is connected but urban service levels are considerably higher and a growing majority of families now have access to electricity. Rural electrification is slower and only 15% of villages will be supplied by the mid-1980's. 2.16 CEB has a presently installed capacity of 559 MW, but this will more than double by the late 1980's following the commissioning of three major hydro-electric projects under the Accelerated Mahaweli Program. After a period of slow growth in the period 1970-1977, demand grew by about 12% annually from 1977-1980, particularly due to low tariffs during this period. Demand was forecast to continue at about 14% annually in the period through 1985 but power shortages resulting from successive poor monsoons and the impact of the very considerable increase in tariffs together with a fuel  -17- adjustment surcharge introduced by CEB since 1978 1/ have caused CEB's sales to fall below the forecast level in 1981/1982. Despite this, CEB will however, continue to have difficulty in meeting demand through 1984, when the first of the Mahaweli stations is commissioned. 2.17 The Bank Group has given considerable financial assistance to the sector since 1954 (about US$ 200 million). Three Bank Group-assisted projects 2/ are currently under construction which will improve CEB's trans- mission and distribution network and augment capacity by the installation of 80 MW of diesel plant. The Bank Group has also sought to strengthen CEB's organizational, managerial and financial position through its lending opera- tions since 1969. 2.18 CEB continues to experience severe organizational and managerial difficulties as a result of recent rapid expansion and the continuous loss of experienced staff to more lucrative positions overseas. Management consult- ants 3/ have been working with CEB to resolve these problems and, currently, a reorganization of CEB is being introduced which will create a separate generation division and two regional distribution divisions. However, these proposals do not resolve CEB's fundamental staffing difficulties, which have yet to be tackled. 2.19 CEB's financial position has improved dramatically in recent years, as a result of three tariff increases since 1978. The rate of return on currently valued net fixed assets has increased from about 2% in 1978 to about 12% in 1982, as against the 8% agreed with the Bank Group. CEB's internal cash generation through 1985 should be sufficient to meet debt service, working capital needs and the local costs of its investment program. Foreign costs are covered by committed foreign loans or credits. CEB's large investment program should, therefore, not impose any burden upon GSLs budgetary resources. However, the CEB's cash flows have already been adver- sely affected by the poor state of municipal finances as discussed in Chapter III, paras 3.44-3.92). 1/ The average tariff, including fuel surcharge, rose from the equivalent of US cents 1 to 9/kwh presently. 2/ The Sixth (transmission and distribution), Seventh (Mahaweli Transmis- sion) and Eighth (Diesel) projects. 3/ Urwick International Ltd.  -18- III. LOCAL GOVERNMENT, ADMINISTRATION, SERVICES, AND FINANCE A. Administration 3.01 Basic urban services are delivered through the structure of local government. Sri Lanka, with a highly centralized unitary form of government, nevertheless provides for a certain degree of local autonomy through its local government structure which is single-tiered and consists of popularly elected councils, each with an independent corporate status, whose powers and duties are conferred by statute. 1/ 3.02 There are a total of 75 Local Authorities. Of these, 12 Municipal Councils (MCs) and 39 Urban Councils (UCs) have responsibilities \in urban areas. Both these categories have been in existence since the 19th century. There are also 24 Development Councils (first established in 1979) with local government responsibilities mainly in rural areas. The latter have incor- porated the former town and village councils. This review is confined to urban areas falling within the jurisdiction of Municipal and Urban Councils. 3.03 All Municipal and Urban Councils are composed of elected members headed by a Mayor or Chairman respectively. The Mayor/Chairman is the chief executive of the Council. The chief administrative officer of the Council is the Municipal Commissioner or the Secretary (of an Urban Council) who is an official of the Local Government Service (see para 2.04). 3.04 The financial powers and duties of urban authorities are: (a) to incur expenditure on the provision of statutory services; any illegal spending may be disallowed by the Auditor General and recovered from the persons responsible for its incurrence; (b) to impose license fees; to make charges for services provided; to levy an annual tax on all non-exempt property and on entertainments, businesses, and trades, conducted within the area; and (c) to borrow, with Ministerial approval, towards the cost of capital projects. GSL provides financial assistance to urban authorities by way of grants towards recurrent ("revenue") expenditure and capital projects. 3.05 The Local Authorities (MCs and UCs) are responsible for the regula- tion and administration of all matters relating to public health, public utility services and public thoroughfares, and generally with promoting the welfare and amenities of their respective urban areas. All MCs and UCs are responsible for streets, drainage, sanitation, solid waste collection and disposal and recreation/welfare services (e.g., playgrounds, libraries). Responsibility for water and electric power distribution rests at present 1/ Municipal and Urban Council Ordinances.  -19- with the Local Authority in some urban areas, while in others, it rests with the WDB and the CEB respectively. Other public services in urban areas are the responsibility of national sectoral organizations such as the Department of Telecommunications, the Department of Highways in respect of national highways which traverse urban areas, and the Ceylon Transport Board in respect of public bus services. Urban land for improvement of services, expansion of urban areas, and specifically for housing is dealt with by different agencies working with the Department of Land and Land Development. B. Urban Services (a) Urban Land 3.06 Land management and land use functions still reflect to some extent the difficulties of coordination, given the large number of government agen- cies with land use planning responsibilities. In urban areas, the MLGHC through the responsibilities of the UDA and the NHDA is rapidly acquiring very significant control over land management policy. The GCEC exercises an independent jurisdiction of approximately 415 sq km immediately to the north of Colombo. The UDA law No 41 of 1978 (as amended in 1982) gives wide-reaching powers for the acquisition and disposal of land required for development purposes, and for the terms of compensation for compulsory land acquisition. 1/ From discussions, there appear to be no problems with what can be regarded as a well established land acquisition procedure through which private land can be appropriated for public purposes. Although the completion of the procedures can be protracted (2-3 years), the actual pos- session of the land can be accelerated considerably under special provisions recently introduced to these procedures, under which, land can be vested in the Government within 2-3 months, pending the finalization of valuation and payment of compensation. 3.07 Availability. In Colombo, the major constraint to the supply of land is a physical one. Around 26% of the land in Colombo is marshy or subject to flooding. The marshes and low-lying areas function as retention areas during heavy rains as a result of neglect of the canal network and the poor drainage system. Some eixpensive land reclamation through filling and diking has taken place, but to date, no systematic reclamation plan has been prepared. As a result, the sporadic and ad hoc reclamation of small plots of land all over Colombo has aggravated the drainage problems in other areas. This is not a serious problem in other urban areas. 3.08 The lack of clear title reduces the quantity of available land for housing construction. The land tenure system and inheritance laws of the country have resulted in the fragmentation of ownership interest to undivided property. Legal procedures involved (in such parcels) in clearing titles and reaching a settlement among all claimants take years to finalize. 1/ Up to 50% difference between market value price on takeover and assess- ment at time notification made through provisions of the Land Acquisition Act.  -20- 3.09 On the other hand, due to low density development in the past, par- ticularly in the City of Colombo, a considerable amount of land is still available even in the Central Area. For example, overall densities are about 70 persons per acre (294 per hectare) and residential densities average about 140 per acre (588 per hectare). This is less than half the density found in other nearby cities such as Calcutta and Madras. Low rates of rural-urban migration in the past and the restrictions imposed by planning regulations until recently, requiring a minimum plot size of 15 perches (375 sq m ) which limited the densities to about 6-8 dwellings per acre, have resulted in the low densities. 3.10 The ease with which the first phase of NHDA's public housing program was implemented during the last five years (particularly in rural areas) can be attributed to the availability of large tracts of land, in the possession of different Government agencies. Two historial pieces of legislation have vested in the State, large extents of land in every part of the country including urban areas. (a) The Waste Lands Ordinance of 1835 enforced by the British, vested in the government of all lands against which tenural right could not be established. As a result, all undeveloped lands in the country, including a large amount of land which was enjoyed by the peasants but against which claims could not be established due to traditional prac- tices of inheritance, came to be vested in the Government. (b) The National Land Reforms Act of 1973, which restricted the private ownership of land to a maximum of 50 acres per person, transferred plantations and other large land holdings to the State. (b) Land Values 3.11 There has been a significant increase in land values in recent years. The most dramatic increases were recorded in 1979, when the land values appreciated by a factor of five and in some cases the increases were as much as tenfold (see Annex lc). Fueling this precipitous rise were, among other things, the optimism and speculation caused by the new economic policies of the Government, new demand generated by the workers returning from Middle East employment, and the absence of government instruments to increase and regulate the supply of land to the land market. 3.12 The GSL has recognized the need to improve the supply of land and thus to moderate land speculation. The sale of public land and increased housing supply on the market have somewhat contributed to stabilizing prices although at a relatively higher level. In recent months, the GSL has been developing other approaches to improve the supply of land and check specula- tion through a process of selective intervention which may include reclama- tion of land, provisions of serviced sites and facilitating the resolution of title questions, etc. Careful detailing of this strategy is recommended with specific (separate) policies for commercial/industrial land and for residen- tial and related land use. (c) Tenure 3.13 The GSL has also made significant moves towards resolving the problems of tenure which impact most adversely on slum and shanty dwellers in urban areas. The most important step in this direction was the transfer of ownership of houses, with a monthly rental less than Rs 25, which were vested  -21- in the Government under the Ceiling on Housing Property Law of 1972. Of the 17,250 slum properties, 12,347 or 71.6% were vested with the Government under the above Law. This dramatic change in the ownership pattern, supported by the decision of the government to redistribute them amongst the present occupants resolves satisfactorily the problems of tenure of some of the urban low-income settlements. However, even in these vested properties, although the ownership of the housing units have been resolved, the ownership issues of common areas needed for amenities continue to bring up conflicts with %owners' in the planning of upgrading. 3.14 The tenural problems of shanties are relatively more complicated. Shanties are situated largely on low-lying lands on banks of rivers and canals and as a result, a permanent solution to their problems of tenure is more difficult. A recent survey has indicated, that due to these reasons, only about 9,300 out of the 15,000 shanties in the city are eligible for upgrading. Arrangements have now been made to provide present tenants of these properties long leases, so that they could be motivated to improve their dwelling units in addition to the provision of improved services and community activities. Even in the case of non-citizens who are resident in these communities, provision has been made to grant temporary leases, until their problems of citizenship are resolved. (d) Water Supply 3.15 Levels of service in terms of quantity, quality, reliability, and accessibility vary widely in Sri Lanka, both between and within urban areas. Hence average figures relating to the type of facility serving different sections of the community may be misleading. Nevertheless, the housing census of 1981 gives types of water service available to the urban popula- tion, and when compared with data from the 1971 census provides a measure of development over the decade. 3.16 The data from the 1971 and 1981 Housing Census show a small increase in the proportion of urban housing units supplied with piped water over the decade, and a corresponding decline in the proportion supplied from wells and other sources. Table 3.1: PERCENTAGE DISTRIBUTION OF OCCUPIED URBAN HOIJSING UNITS BY SOURCE OF WATER SUPPLY - 1971 and 1981 Piped Water River, Tank, Not on Tap Well or other source Stated Total 1971 45.3 50.5 2.0 2.1 100.0 1981 46.5 48.7 1.1 3.7 100.0 Source: Census of Population and Housing, Sri Lanka, 1981. There were at the time of the 1981 census nearly 510,000 occupied housing units in urban areas. Their main sources of drinking water were classified as follows:  -22- Table 3.2 PERCENTAGE DISTRIBUTION OF ROUSING UNITS BY MAIN SOURCE OF DRINKING WATER AND HOUSING TYPE - 1981 Housing Type Permanent Semi-Permanent Improvised Total Served by: Piped Water: within premises 32.7 7.5 4.6 24.4 outside premises 18.5 29.5 31.0 22.1 Protected well: within premisis 31.1 21.2 17.8 27.7 outside premises 11.0 25.1 32.2 16.1 Unprotected well: 2.5 10.6 8.7 4.9 River tanks and other sources: 0.5 2.3 2.4 1.1 Not stated 3.7 3.8 3.3 3.7 TOTAL 100.0 100.0 100.0 100.0 Source: Census of Population and Housing, Sri Lanka, 1981. 3.17 Although almost half the urban population was supplied with piped water in 1981, only just over a half of these had piped water installation within the premises. Wells still supplied 27.7% of urban housing units in that year. This was true even in Colombo, but in respect of piped water supplies Colombo was better off than the average for all urban areas, with 31.1% of housing units having piped water within their premises and another 19.4% having access to piped water outside their premises. 3.18 Data on per capita supplies in urban areas are limited. The WDB designs small to medium-sized urban water systems on the basis of 30 to 40 gpcd for house connections, while for urban populations exceeding 20,000 water demands are based on individual requirements. Standpost supplies are designed in all systems on the basis of 10 gpcd. Of the 66 urban water supply systems currently in existence, there is data to indicate that less than 20% enjoy a supply of 40 gpcd or over, while on the lower end of the scale some 20% receive an average supply of less than 5 gpcd. 3.19 Of the 50 municipal and urban councils in Sri Lanka, 8 have no protected piped water supply system, while in 2 the systems are currently being developed. Of the remaining 40, WDB is responsible both for water production and distribution in 17 urban areas; it is responsible for produc- tion, but the local authorities are responsible for distribution, in a fur- ther 9. In 12 urban areas, the local authorities (MCs and UCs) are respon- sible for both water production and distribution, while in the remaining two urban areas, the District Councils have assumed this responsibility. In Colombo, the WDB has subcontracted responsibility for distribution back to the Municipal Council due to WDB's manpower constraints and its increasing responsibilities in the sector as a whole.  -23- 3.20 This rather complex pattern of responsibilities for water production and distribution has evolved partly as a result of policy decisions and partly because some local authorities who find themselves unable to operate and maintain water systems effectively have handed over responsibility to the WDB. Some urban authorities, like the Kandy Municipal Council, have effi- cient organizatLions responsible for water production and distribution, while others appear willing that production should be the responsibility of WDB while the locaL authority retains responsibility for distribution. 3.21 Under the conditions of earlier IDA Credits, it was envisaged that WDB would gradually assume increasing responsibilities both for the produc- tion and distrLbution of water, taking into account that many of the dis- tribution systems are currently being very poorly maintained by the local authorities. However, WDB's manpower constraints, despite the progress made in staff training in recent years, preclude an early assumption of respon- sibility for operating and maintaining water distribution systems and col- lecting revenues on a nation-wide basis. Hence, where the local authority is able effectively to operate and maintain distribution systems and also levy rates on consumers sufficient to cover the costs both of purchased water and of operation and maintenance of the distribution system, there may be a good case to allow the local authority to continue to do so. Where, however, the local authority is not able to operate and maintain the distribution system effectively and levy appropriate water tariffs, and where it has been in default to WDB on purchases of bulk water for some time (say for one or more years), then there is a strong case for WDB to take over responsibility for water distribution in the area. 'Ground rules' for implementing such a policy need to be developed. (e) Sanitation 3.22 The Housing Censuses of 1971 and 1981 analyzed sanitation service standards in urban areas. The data show improvements in several respects over the decade and generally higher standards in urban areas than in the country as a whole. Table 3.3: PERCENTAGE DISTRIBUTION OF HOUSING UNITS BY TOILET FACILITIES 1971 AND 1981 Toilet for Shared No Toilet Exclusive Use Toilet (incl. not stated) 1971 1981 1971 1981 1971 1981 Urban Sector 48.9 56.8 30.7 23.5 20.4 19.8 Country Average 45.5 53.0 19.0 13.6 35.5 33.4 3.23 In terms of type of sanitation facility, the proportion of urban housing units served by flush toilets declined over the decade, while there was marked progress in the substitution of water seal for bucket latrines.  -24- Table 3.4: PERCENTAGE DISTRIBUTION OF HOUSING UNITS BY TYPE OF TOILET 1971 AND 1981 Urban Sector Country Average Type of Toilet 1971 1981 1971 1981 Flush toilet 22.8 15.6 6.7 4.3 Water Seal 19.2 38.9 14.3 21.9 Pit Type 18.3 17.0 38.8 37.9 Bucket Type 19.4 8.8 4.8 2.0 None 19.1 16.4 34.3 30.9 Unspecified 11.3 3.4 1.2 2.5 TOTAL 100.0 100.0 100.0 100.0 3.24 A relatively high proportion of urban households continued to use pit latrines or to have no toilet facilities at the end of the decade. This reflected the levels of service for the urban poor. The 1981 housing census classified 58% of housing units as improvised (temporary) or semi-permanent. Some 30% of the urban population is estimated to live in such premises. In respect of water supplies, the urban poor are normally served by public standpipes or wells outside their premises while only 4.6% of improvised housing has piped water inside the premises. Water supplies to low income groups are particularly deficient in Trincomalee, Batticaloa and Jaffna where the water supply for the whole population of these centers averages only 3 gpcd. 3.25 The table below shows the type of toilet faclity available in urban areas to different types of housing according to the 1981 Housing Census. Table 3.5: PERCENTAGE DISTRIBUTION OF PERSONS IN OCCUPIED HOUSING UNITS BY TYPE OF HOUSE AND TOILET FACILITY - 1981 Housing Type Served by Permanent Semi-Permanent Improvised Total Flush Toilet: Exclusive 17.4 1.3 0.5 12.6 Shared 5.2 2.9 0.7 4.4 Water Seal: Exclusive 40.4 9.6 3.7 30.5 Shared 2.8 10.8 9.3 5.1 Bucket Type: Exclusive 4.7 2.5 1.9 4.0 Shared 3.8 8.1 6.4 4.9 None 6.0 29.6 59.6 15.1 Not stated 2.2 4.0 3.4 2.7 TOTAL 100.0 100.0 100.0 100.0 Source: Census of Population and Housing, Sri Lanka, 1981. 3.26 The low standards of sanitary facilities for the urban poor are reflected in the high proportion of those living in improvised and semi-permanent housing who have no facilities of any type. Only 2% of slum  -25- dwellers as a whole have exclusive use of any type of toilet, while 73% of the remainder of the urban communities enjoy such facilities. 3.27 Responsibility for sanitation services in urban areas normally rests with the Local Authority under the supervision of the Ministry of Health. A waterborne sewerage system exists only in parts of Colombo; the system serves about half the city's population and is the responsibility of WDB. As a condition of Credit 1041-CE. WDB assumed ownership and control of Colombo's sewerage system in early 1981. WDB would have absorbed Colombo Municipal Corporation's (CMC) employees who were working in that department, but MLGHC doubted whether WDB could recover the costs of operating the system by bill- ing CMC. Therefore, though WDB owns the system and oversees its operation, it has subcontracted the actual operation to CMC at cost. 3.28 Elsewhere, septic tanks, water-seal (pour-flush) and bucket latrine systems serve the bulk of the urban populations, with small numbers of per- sons using pit latrines in the outskirts of some urban areas. Programs are in progress in some municipalities (e.g., in Colombo and Kandy) to replace bucket latrines by water-seal toilets. Night soil collection is the respon- sibility of the Local Authority. Night soil is trenched or in some instances (e.g., Kandy) a part is composted with garbage and given without charge to anyone prepared to take it away. (f) Solid Waste 3.29 The Local Authorities are responsible for solid waste collection in urban areas. Normally, daily collections are made, and in general, the collection system appears to work quite well. Solid waste is dumped either as landfill or at dump sites where it may be partially burned. In some urban areas (e.g., Kandy), sanitary landfill is practiced. In others, no soil is used to cover the waste, and in some instances (e.g., Colombo), the dump sites are insufficiently removed from built-up areas, creating obvious health hazards. The management of solid waste in Colombo has been the subject of a separate report (1981) 1/ but little has happened since. As noted above, in some local authorities, part of the garbage is composted with night soil. (g) Roads/Highways/Streetlighting 3.30 The responsibility for constructing and maintaining urban roads is shared between the Department of Highways (DOH) and the Local Authorities (MCs and UCs). National highways which traverse urban areas are built and maintained by the DOH, except in Colombo where the Municipal Council main- tains these roads with the Government reimbursing the cost. The highways are generally built to Class I standard with a width of 40 ft, a 9" rubble base course and asphaltic surface. Most roads in urban areas, are, however, of Class II and C:Lass III standards. Class II roads are 20-40 ft in width with a 4-inch rubble base course and asphaltic surface. Class III roads are 15-20 ft in width with a 2-inch base course and asphaltic or metalled surface. 1/ Solid Waste Management Plan for Colombo, Sri Lanka, 1982 - Solid Waste Management Consulting Services, Ltd.  -26- 3.31 Of the 240 miles of public roads in Colombo, 32 miles are national highways. Of the remaining 200 miles, 60 miles are Class I, 100 miles are Class II, and the balance are Class III roads. In addition, there are estimated to be some 50 miles of private roads in Colombo, which are mostly unpaved and for which the Council provides no maintenance. 3.32 A shortage of funds for road maintenance is a constraint in all urban areas. This problem is more acute in some towns (e.g., Kandy) because the roads and streets were not properly engineered and lack proper drainage with a consequent rapid deterioration of the road surface. Resurfacing is rarely possible owing to the shortage of funds, and patching is normally all that can be afforded. New road construction in urban areas is on a very restricted scale. Despite the deficiencies of the urban road networks--poor surfaces, inadequate drainage, narrow rights of way, traffic congestion--the networks nevertheless provide the urban populations with reasonable access. In Colombo, no part of the population is more than a short walk (5-10 minutes) from a asphalt-surface road, and this appears to be broadly true in other urban centers. 3.33 Streetlighting consisting of an assortment of lighting fixtures and types, are provided and maintained by the municipality. Standards of illumination, coverage, and consequently operating costs vary considerably between the urban areas, and do not reflect any attempt at consistency, nor the ability of the local authorities to afford to operate and maintain such fixtures. (h) Public Transport 3.34 It is estimated that 1.5 to 2 million passengers use public transport in the Colombo metropolitan region on a typical weekday. Of these, about 5% travel by train, 70% by Government buses, and 25% by private buses. The latter group experienced an enormous expansion in the last four years, fol- lowing the liberalization of the transport sector in Sri Lanka. The charac- teristics of public and private bus transport are discussed further in Annex 5. (i) Power Supplies 3.35 All local authorities have access to a power supply, although power outages are frequent during the dry season, particularly in Colombo. However, the sector still suffers from an inadequate supply of electricity which will only be remedied in about two years when the first of the Mahaveli Station becomes operational. Of immediate concern, however, is the inability of a large number of low income persons to avail themselves of a minimum supply due to inadequate funds for wiring their residential premises. Home improvement loans under the shelter program (Chapter IV) would be a desirable and recommended option. Unless these options are fully developed, the country may be left with excess operating capacity (acquired at a high cost) in the future.  -27- (j) Tle Impact of Tourism Development on Urban Services 3.36 The fast growth of tourism and the expansion of accommodation capacity over the past 15 years has resulted in demands on utility sys- tems--particularly water and electricity--which the responsible authorities have not always been able to meet. Expansion of hotel capacity in Colombo has been supported by the necessary provision of services, but in other areas along the west and south coasts hotels have had to rely largely on their own wells for water, and have installed their own sewage treatment plants. More recently, WDB has taken account of tourism demand in its planning, par- ticularly in Trincomalee and on the west coast (south of Colombo) to Kalutera and Hikkaduwa where augmented supplies from WDB are expected to be available by 1984. In the future, the process of approving new hotel projects, will include a review by WDB, to ascertain that the project: (a) the WDB or the local authority can supply the necessary water or (b) alternative and ade- quate sources of water supply and sewage disposal have been provided. 3.37 Tourism development 1/ in the Negombo area has made major new demands on the town's water supply, which the system has been unable to meet. Hotels there have had to augment supplies from their own wells. The expansion of water supplies to the town and to the hotels depends primarily on the availability of finance for developing a new bulk supply and strengthen- ing/expanding the distribution network. 3.38 Physical congestion as a result of tourism development and conflicts in land use has become most acute at Hikkaduwa, where some tourism develop- ment has also been contrary to planning and environmental regulations. Beach erosion has also been severe at that location. The Urban Development Authority has prepared a physical plan for the redevelopment of Hikkaduwa, but its implementation is uncertain owing to financial constraints. 3.39 The UDAI has recently been assigned responsibility for planning a one-mile deep strip of coast along the perimeter of Sri Lanka. The impact of rapid tourism growth is also being felt on inland sacred and scenic sites. There is clearly a need to balance the accelerated investments in some sec- tors in a more structured and coordinated manner to: (a) ensure more effec- tive use of resources; (b) alleviate the adverse social and environmental impacts; and (c) strengthening local government finances. For example, the local authority should exploit the potential towards achieving more equitable pricing of services to the local population through substantial but reasonable property tax increases and utility charges. (k) 2peration and Maintenance of Existing Services 3.40 The maintenance of 'services' infrastructure has generally not been given a high priority. The water sector report outlines some of the problems relating to inadequate maintenance in the water sector through which neglect has resulted in existing assets being allowed to fall into extreme disrepair and premature deterioration. The report cites old treatment plants which 1/ Tourism declined substantially following July 1983 civil disturbances, but appears to be gradually improving.  -28- have deteriorated in the absence of timely repairs or the availability of spare parts to the point of treatment standards being so low as to endanger public health. 3.41 This same attitude to maintenance appears to be common in other sectors. For example, in the vicinity of Colombo, poor maintenance over the years has resulted in a deterioration in the functioning of the drainage canal systems with consequential flooding and related problems, with con- siderable cost to the communities affected. Similarly, the road network other than the main thoroughfares is being allowed to deteriorate due to inadequate maintenance. Solid waste is allowed to accumulate and clog in surface water drains. 3.42 The concept of preventative maintenance does not appear to have been firmly established. The constraints for adequate operation and maintenance are several, including funding, training, and management. This inadequacy of funding is discussed in Chapter III, Part C. Plant operational staff in the case of water supply are handicapped by a lack of training, and often maintenance procedures are not clearly established. Procedures for report- ing, execution, and testing of plant and equipment are ill-defined or non-existant. Similarly, in the case of equipment, the practice of purchas- ing from a wide diversity of suppliers whether for pumps, solid waste vehicles or road maintenance results in a wide range of equipment obtained from different countries in which the availability of spares, coupled with time and labor-consuming procedures for procurement and procurement custom clearance, distribution, and payment aggravate these problems. Underlying all these, is the inadequacy of training of operatives at all levels on the priorities and elementary procedures required for preventive maintenance. 3.43 Poor management is also directly to blame for poor maintenance. There is scope for better work planning, and maintenance schedules and greater emphasis on supervision and accountability. C. Finance (a) The Status of Accounting, Auditing, and Budgeting in Local Authorities 3.44 The Municipal and Urban Councils Ordinances require councils to use a standard system of "Programme Budgeting". Local authority activities are included within the following seven programmes: - general administration - public health (health services, solid waste disposal and conservancy), - physical planning (highways, land and buildings), - water supply, - public utility services (markets), - welfare services (recreation, libraries), and - electricity. 3.45 It is clear however, that in many cases prescribed financial systems and practices are not being observed and the standard of local financial  -29- administration is weak. In part this is attributable to inadequate staffing and to the dismissal of many experienced staff as a result of strike action in 1980. 3.46 The Aucditor-General is responsible for the audit of local authority accounts and for reporting thereon to Parliament. However, a local authority is not required to publish its accounts, nor does the audit procedure provide for public examination or objection to the accounts. These are serious weaknesses in the system of public accountability. The Auditor-General is empowered to disallow and to surcharge any expenditure contrary to law, or any loss due to negligence or fraud, upon the persons concerned. 1/ A con- tinuous system of auditing is in operation but the preparation of annual accounts (whichL should be rendered for audit within three months of the year end), is considerably in arrears: the latest report of the Auditor-General is in respect of the accounts for 1979 and, at the time of its preparation (August 31, 1980), 22 of 50 urban authorities had not rendered accounts for 1979. In some cases satisfactory accounts may never be rendered in respect of 1980/81 becaLuse of inadequate documentation during the staff disturbances. 3.47 A considerable effort is needed to bring accounting to a current basis and improve public accountability. Furthermore, GSL should strengthen the finance staffs of local authorities through the recruitment of better qualified staff and the establishment of training programs, designed to improve the skills of finance staff. 3.48 All urban authorities are required to prepare an annual budget con- sisting of estimates of revenue and expenditure on both recurrent and capital account. By law the budget should be balanced by levying sufficient local rates, through the property tax system, to meet the difference between proposed expenditure and income other than rates. In practice, this is not done as the system of property taxation is not operating satisfactorily (para 3.60) and service fees and charges are insufficient to recover costs (para 3.64). Furthermore, local authorities have curtailed expenditure and, in many cases, have simply not paid bills due to public sector organizations such as CEB and WDB in order to remain solvent (paras 3.83, 3.92). Local authorities have come to rely heavily upon GSL grants to finance growing budget deficits (para 3.71). (b) A Financial Profile of the Urban Local Government (1977-1987) 3.49 The financial information supplied by the fifty urban local authorities 2/ was analyzed to show the following salient features: 1/ Surcharges amounting to Rs 3.4 million (of which Rs 1.3 million related to urban authorities) were outstanding at December 31, 1979. 2/ In support of this study, GSL collected information on the activities and financial status of the fifty urban authorities. Background notes and the questionnaire are available on request.  -30- (a) the pattern and trend of expenditure and financing both in and outside "Greater" Colombo, and in total for the years 1977, 1979 1982 and 1987 (Annex 3a). The last year for which audited information is available was 1979. (b) the financial position of the eight major urban authorities in 1977 and 1982 (Annex 3b), (c) summarized balance sheets as at December 31, 1981 (Annex 3c). (i) Urban Authority Expenditure in the National Context 3.50 Urban local government expenditure 1/ is a small proportion of total public expenditure, no more than 3% of GSL's recurrent expenditure and 1% of capital expenditure. While they may thus not cause GSL serious immediate concern from the point of public expenditure control, the level of GSL finan- cial support to local government, including the newly constituted Development Councils, has risen rapidly in recent years from 1.3% of Central Government recurrent expenditure in 1977, to 2.3% in 1983, in spite of a quadrupling of Central Government expenditures in that period. This support takes the form of direct cash grants to local government and grants/subsidies to the CEB and WDB in respect of unpaid bills incurred by the local authority due to those bodies. Since there is little evidence of these transfers coming under control, the imbalance in local finances could become a serious drain on Central Government revenues. Since 1977, the position has progressed as set out in Table 3.6: 1/ Information on total local government expenditure, including that of Development Councils, was not collected for this review.  -31- Table 3.6:: URBAN AUTHORITIES EXPENDITURES IN THE NATIONAL CONTEXT 1977 1978 1979 1980 1981 1982 1983 ----------------------Rs million-------------------- Recurrent Expenditure: Urban Authorities 185 236 283 305 397 571 726 Central Government a/ 6053 9967 10887 12730 15025 21484 26615 Capital Expend.ture: Urban Authorities 35 56 94 157 171 118 189 Central Government a/ 2093 5266 7347 12857 11834 17845 20700 Revenue grants and Subsidies for Local Govt. Services: Local Authority Grants 78 85 118 136 156 282 363 WDB Subsidy (total ops.) - - 24 34 56 190 237 CEB Grant - - 35 120 158 - - b/ Total 78 85 177 290 370 472 600 a! Economic Adjustment in Sri Lanka: Issues and Prospects (3901-CE). b/ A further GSL grant of Rs 167 million in respect of local authority unpaid bills is due to CEB. 3.51 The recurrent expenditure of urban authorities rose by some 300% between 1977 and 1982 as a result of rapid cost escalation. In particular, the cost of electricity supplied by CEB for sale by local authorities 1/ increased dramatically in 1981/82. In constant 1977 prices, 2/ if elec- tricity expenditure is excluded, urban authorities' current expenditure increased after 1977 but has remained broadly constant since 1979. Capital expenditure, while rising between 1977 and 1982, declined in real terms after 1979 reflecting the worsening financial position of urban authorities and their inability to proceed with major projects. Financial projections through 1987 indicate a doubling of current expenditure but little growth in real terms and a significant real growth in capital expenditure plans: 1/ Based on expenditure actually recorded in local authority accounts or provided in budgets, but excluding amounts due to CEB but not recorded which amounted to Rs 230 million at December 31, 1982. 2/ GDP deflator 1977-1981, projected through 1987 using current Bank Group guidelines for Sri Lanka's price escalation: 1982 17%, 1983 14%, 1984 12% and 10%, thereafter.  -32- Table 3.7: GROWTH IN EXPENDITURE - CURRENT AND CONSTANT PRICES Actual Actual Estimate Projection 1977 1979 1982 1987 ---------------Rs million------------- Recurrent Expenditure: (a) in current prices 185 283 571 1047 (b) in real terms (1977 prices) 185 227 279 300 less electricity (38) (38) (89) (108) 147 189 190 192 Capital Expenditure: (a) in current prices 35 94 118 304 (b) in real terms (1977 prices) 35 75 57 87 3.52 While local authority expenditure is a small proportion of total public expenditure, present projections for the five years through 1987 indicate that the capital expenditure of the 50 urban authorities would represent about 6% of the total of the combined public investment on housing, water supply, urban development and power in those years. 1/ (ii) Expenditure and its Financing 3.53 Table 3.8 highlights several significant trends since 1977 in the overall financial position of the fifty urban authorities: (a) a higher proportion of recurrent to capital expenditure, following the recent dramatic increases in electricity tariffs charged by CEB, (b) a serious decline in the proportion of expenditure financed from local taxation, (c) a reversal in 1982 of the decline in fees and charges, as a proportion of expenditure, resulting from increases in electricity tariffs; and, (d) an increasing need for external financial support and its provision through GSL grants. 1/ Sri Lanka: Public Investment Survey 1983-87.  -33- Table 3.8: OVERALL FINANCIAL POSITION OF FIFTY URBAN AUTHORITIES Actual '77 Actual '79 Estimate '82 Project.'87 ---------------Rs mil. at current prices------------ Expenditure Recurrent 185 84% 283 75% 571 83% 1047 77% Capital 35 16% 94 25% 118 17% 304 23% Total 220 10_0 377 100% 89 100% 1351 100% Financed From: Internal financial resources: Fees and charges 88 40% 108 29% 311 45% 529 39% Local taxes 97 44% 108 29% 182 26% 244 18% 185 84% 216 58% 493 71% 773 57% External financial requirements: 35 16% 161 a/ 42% 196 29% 578 43% 220 100% 377 100% 689 100% 1351 100% Government Grants 49 22% 108 a/ 29% 245 36% 326 24% Borrowing (all local authorities from LLDF) b/ n/a 12 n/a n/a a/ Local authorities met the balance (Rs 53 million) of their requirements after Government grants, by a combination of borrowing, and cash balances and by allowing accounts payable to increase. b/ Local Loans and Development Fund (para 3.78); n/a denotes information not available. 3.54 The total cost of the urban authority services, expressed per 1,000 population, varies considerably as between the "Greater" Colombo area and elsewhere. While bare financial statistics do not reveal the reasons for such variations, they should be examined closely to establish relative cost efficiencies or relative levels of service provision which may result from demographic characteristics or from insufficient local financial resources. The following table highlights the position. Note that, excluding elec- tricity, the total local Government expenditure per capita is on the order of the US$4.00 per year, at current exchanges rates. It should also be recalled that only about half of this sum is raised through local taxes.  -34- Table 3.9(a): CURRENT EXPENDITURE PER 1,000 POPULATION a/ 1977 1979 1982 1987 Current 1977 Current 1977 Current 1977 prices prices prices prices prices prices -----------------------Rs '000----------------------------- Colombo 117 204 167 360 176 532 153 "Greater" Colombo Total 90 144 115 239 117 419 120 Total excluding electricity 79 133 106 218 106 365 105 Outside "Greater" Colombo Total 70 115 92 289 141 549 157 Total excluding electricity 56 80 64 135 66 244 70 All urban - Total 85 130 104 263 128 481 138 Total excluding electricity 68 108 86 179 87 307 88 a/ Based on 1981 census figures. 3.55 An investment program of the size indicated by projections through 1987 (para 3.52) would need improved planning and budgeting systems at the local level with improved co-ordination by the Department of Local Govern- ment. GSL should require the local authorities to prepare five-year develop- ment programs and financial budgets and furthermore, should facilitate this type of development through the provision of technical assistance facilities (para 3.47). (iii) The Financial Position of Colombo and Seven Other Major Urban Authorities 1/ 3.56 While there is a general need to strengthen the financial administra- tion of urban local government, particular attention should be directed initially towards the larger towns, eight of which have a population in excess of 50,000. Their combined population is 1.355 million, representing 62% of the urban population and in 1982 they accounted for 67% of total urban authority expenditure. Their financial position, extracted from balance sheets at December 31, 1981 and financial operations in 1982 - are summarized in Annexes 3b and 3c. Property taxation statistics are summarized in Annex 3d. Any comparison among the towns is made difficult by the fact that their responsibilities differ: neither Colombo nor Dehiwela - Mt. Lavinia act 1/ Urban authorities with a population in excess of 50,000: Colombo, Dehiwela - Mt. Lavinia, Moratuwa, Kotte, Negombo, Galle, Kandy and Jaffna.  -35- as electricity licensees while WDB supplies water to consumers in Colombo, Dehiwela - Mt. Lavinia, Moratuwa and Kotte. On the other hand, Colombo acts as agent for GSL in maintaining all major highways and for WDB in respect of water supply. The financial analysis of the eight major towns highlights a number of problems which are probably common to many other urban authorities, and confirms the need to strengthen accounting arrangements and financial administration: (a) fixed assets levels are very low except in Colombo and Kandy; in the other six towns outstanding loans exceed fixed assets - fixed asset accounting practices need to be reviewed, (b) cash levels were very low at end 1981, both in absolute terms and in relation to current liabilities; (c) current liabilities appear low due to many expenses not being reflected in accounting records - accrual accounting practices need to be reviewed; (d) the level of accounts receivable, as a percentage of current revenues was excessive at end 1981, indicating a lack of concern for cash flow; as substantial electricity tariff increases were introduced in 1982 and other major cost recovery measures are being recommended there is a need to review present billing and collection arrangements to ensure adequate cash flow in future; (e) the level of outstanding loans is very low in relation to internal generation ("accumulated funds") - capital financing arrangements, including improved access to loan capital, need to be strengthened (para 3.79); (f) based on the 1982 accounts, the current expenditure of Moratuwa and Kotl:e is low in relation to the cost of purchasing electricity from CE]3 and there is an optimism about the level of fees and charges in relation to current expenditure: an examination of the 1983 budgets of these towns indicates that provision for utility bills is generally adequate and estimated billings are sufficient to meet such bills (subject to timely cash collection) but not to reduce overdues; and (g) government grants were generally more significant as a source of revenue than local taxation in 1982, whereas in 1977 the reverse was true; (h) While tax collections in 1982 as a percentage of taxes assessed in that year, seem satisfactory (ranging from 88% to 123%), arrears at end 1982 were generaly higher than at end 1981 and ranged from 57% to 122% of taxes assessed in 1982. 3.57 Assessing Colombo's true financial position is particularly dif- ficult. Accounting information is substantially in arrears and only budgeted figures are available after 1979. The financial picture on water supply, in particular is confused because of the impact on Colombo's finances of the transfer of Colombo's water supply system to WDB in 1981 and attempts to  -36- obtain compensation for the transferred assets and the subsequent engagement of the Colombo municipality as WDB's agent to manage the water supply serv- ice. The financial arrangements for the agency operation have not yet been resolved. The resolution of this issue is critical and has broad sectoral implications with respect to the appropriate role of the WDB in the sector. It is urged that GSL carefully consider this matter. 3.58 Colombo also maintains major "trunk" highways on behalf of GSL's Department of Highways. The financial arrangements are vague and it is alleged that far more is spent than is recovered from GSL. Again, agreement should be reached on the level of expenditure to be reimbursed, based upon an adequate standard of maintenance. The cost of a reasonable standard of lighting and drainage of major "trunk" roads should similarly be a GSL responsibility, not only in Colombo but elsewhere. 3.59 Finally, GSL should examine the need to establish a single-tier (Greater Colombo) metropolitan authority not only to provide existing serv- ices, electricity, and water supply, but also to act as the agency respon- sible for the implementation of urban development policy, and other urban services, as discussed in Chapter V. (c) Sources of Local Revenue (i) Property Taxation 3.60 Rates (property tax) are levied by local authorities on the occupiers of property, in respect of the annual value of the property. The annual value is defined by statute as "the rent at which a (property) might reasonably be expected to let from year to year if the tenant undertook to pay all rates and taxes and the landlord undertook to bear the cost of repairs necessary to maintain the (property) in a state to command that rent or, if higher, the actual rent paid. 1/ The annual rental value is often hypothetical as many properties are owner-occupied or subject to rent con- trols while other rents may reflect extreme scarcity values. The amount of rates payable annually by the occupier are assessed by the local authority, as a percentage of the annual value. Any increase in the percentage rate levy requires Ministerial approval and must be justified in terms of improved local services. Different percentages may be applied in different parts of a local authority's area, depending upon the range of local service provision. The assessment of the annual value of a property is the responsibility of a government official, the Chief Valuer, except in Colombo where the municipality has its own staff for this task. In the past, annual values were revised every five years; in recent years GSL has not permitted a general revaluation, although new property is assessed on a current rental basis. In Colombo, non-residential property is being revalued quinquennially. The present GSL policy of holding down annual values and restricting percentage rate levies has created for local authorities a situation in which existing standards are difficult to maintain, in the face of escalating costs, and improvements are impossible. This policy seriously undermines the initiative 1/ Municipal Councils (Amendment) Act 1981 empowers this alternative basis in an attempt to tax foreign and other high-income occupiers.  -37- and the financial viability of local government and increases its dependence upon GSL's financial assistance. 3.61 The property tax is often the only local tax from which to generate sufficient revenues to finance local services. In Sri Lanka other local taxes have been tried, in recent years, but have been ineffective (para 3.64). Urban authorities should therefore be permitted greater freedom to utilize the property tax to finance local needs and, in particular, the following improvements should be adopted: (a) valuations should be brought onto a current rental basis, and thereafter revised every five years; the impact of increased values could, if necessary, be phased over a three-year period; staffing is adequate to take up this task immediately; (b) present restrictions on the percentage tax which local authorities may levy should be eased and authorities encouraged for instance, to levy an additional rate specifically to meet capital expenditure (para 3.82); and (c) all property should be assessed and present exemptions from the payment of rates (including UDA "tax-holidays") should be withdrawn or contributions should be paid in lieu of rates by government or its agencies (e.g. railways). 3.62 Property revaluation would have a significant impact upon the local resource base (Annex 3d). Annual values are assessed on a conservative basis: the often hypothetical nature of rents, combined with an admitted cautious approach to valuation produce annual values which are often sig- nificantly below the current level of market rents. Most valuations were last revised in the early 1970's. 1/ Using price movements in Sri Lanka as a guide, 2/ the total annual value of property in the seven largest urban authorities outside Colombo could increase by between 150% and 350% if cur- rent valuations were introduced, as shown in Table 3.9(b): 1/ Property values in Anuradhapura and Velvettiturai, with populations of 36,000 and 14,000 respectively, were revised recently and the total rateable value increased by about 120%. 2/ The Sri Lanka GDP deflator has risen from 100 in 1970 to over 400 by end 1982.  -38- Table 3.9(b): EFFECT OF UPDATING ANNUAL VALUES IN THE EIGHT LARGEST URBAN AUTHORITIES (Rs per head) 1982 Present Current Rental % Valuation Basis Increase Colombo 636 n/a Dehiwela - Mt. Lavinia 179 459 156 Moratuwa 73 186 156 Kotte 175 777 343 Negombo 116 516 343 Galle 88 362 310 Kandy 169 751 343 Jaffna 129 357 177 (ii) Other Local Taxes 3.63 Urban authorities are empowered 1/ to tax entertainments, business and trades carried on within their areas, and to charge licence fees on animals and vehicles (other than motor vehicles) kept in their areas. Their current yield is relatively small as the amount of tax is regulated by law, rather than by the urban authority but can prove to be a significant source if enforced. GSL is planning to withdraw the taxing powers contained in the 1979 Act and is considering alternative revenue sources for local government. The prospect of urban authorities obtaining significant additional tax revenues, other than through some form of tax-sharing with GSL, seems remote. Most urban authorities are too small to administer any form of local tax other than property tax while GSL is unlikely to authorize the larger urban authorities to levy a local income, sales or vehicle tax at a time when its own taxable resources are severely strained. Consequently, if GSL is to reverse the growing dependence of urban authorities upon grant-aid it must, in addition to strengthening the property taxation system, require much greater measure of cost recovery from these authorities. (iii) Cost Recovery - Charging for Urban Authority Services 3.64 Some local authority services lend themselves to direct charging for benefits received. This is true for public utility services such as elec- tricity and water supply and activities such as markets, car parking and crematoria. It is also true of services such as trash disposal, libraries, recreation and certain health services although the extent of cost recovery may be limited. The costs of highway and footpath maintenance, drainage, street lighting and cleansing are difficult to recover through direct charges and are usually met from local taxes. Other urban services like shelter and transportation increasingly provide for full cost recovery. 3.65 Cost recovery by urban authorities - expressed by the ratio of fees, charges and rents 2/ to recurrent expenditure - declined after 1977 as a 1/ Municipal and Urban Councils (Amendment) Act 1979. 2/ All income other than local taxes and GSL grants.  -39- result of the failure to increase charges in line with increases in expendi- ture. The accounts of urban authorities overstate the extent of cost recovery, in view of the failure to pay or to record many dues to CEB and WDB, a large part of which was subsequently funded by GSL. The position, based on urban authority figures, is as follows: (Rs million) 1977 1979 1982 1983 1987 Fees, charges and rents 88 108 311 415 529 Current: Expenditure 185 283 571 726 1047 % Cost recovery 48% 38% 54% 57% 51% 3.66 The recent improvement in cost recovery shown in the 1982 and 1983 figures reflects the increases in electricity tariffs made in 1982 by all urban authorities, following an agreement between GSL and the Bank Group to ensure full cost recovery at the local authority level. Urban authority estimates for electricity in 1983 are as follows: (Rs million) Recurrent expenditure 255 Billings (urban authority consumers) 256 Recurrent expenditure is substantially understated: CEB's bills to local authorities, based on January 1983 billings, could amount to Rs 252 million in 1983, to which must be added local distribution and administrative costs. Furthermore, urban authorities' dues to CEB at end 1982 amounted to Rs 127 million 1/, against which urban authorities had Rs 50 million cash available. Present electricity tariffs are, therefore, unlikely to be sufficient to cover all service costs and also repay outstanding amounts to CEB. Success in paying CEB's current dues will depend on the urban authorities' own col- lection performance. Urban authority electricity tariffs should, therefore, be reviewed in the coming months to ensure satisfactory funding of all expen- diture, including past dues. 3.67 Although major improvements 2/ in charging for water and metering of services have recently been initiated by the WDB for is direct customers, regrettably, similar actions have not been taken by urban authorities in respect of water supply services. Some urban authorities have metered water supplies but most continue to fund water supply expenditure through the property tax system. Again, 1983 estimates do not appear to reflect a realistic position. In past years many of WDB's bills have gone unpaid - dues to WDB in respect of 1982 billings amount to Rs 22 million. The shortfall in WDB's revenues have been made good by GSL subsidies. The 1983 estimates of the urban authorities which either operate their own water supply systems, or purchase water from WDB for distribution, indicate as follows: 1/ Net of the total fuel cost to May 30, 1982 which GSL has agreed to pay to CEB. 2/ See Sri Lanka Water Sector Study, May 1984. IBRD Report No. 4190-CE.  -40- (Rs million) Current expenditure 28 Billings 40 However, bulk water purchases from WDB are estimated at Rs 26 million which leaves little provision (Rs. 2 million) to cover local distribution costs. This indicates again the inconsistency of budgeted information. 3.68 The Bank Group Sri Lanka Water Supply and Sanitation Sector Study highlights cost recovery as probably the most difficult problem facing the sector. Action at urban authority level to introduce flat-rate charges for water supply sufficient to meet all operating costs would lead to an immediate strengthening of the financial position of such authorities, pend- ing the restoration of the property tax system. GSL should ensure thereafter that charges are revised annually to maintain an adequate level of cost recovery. 3.69 It is clear that the level of fees and charges for other services is well below "what the market will bear". Additional revenues could be raised from trash removal and recycling, markets, parking, property rentals, crematoria and licenses for various services. All urban authority fees and charges should be reviewed as a matter of urgency and, thereafter, an annual revision should be instituted at the time of approving the budget to ensure that such charges are increased at least in line with cost increases. (d) Central Government Financial Assistance to Local Authorities (i) Revenue Grants 3.70 In recent years local authorities have come to depend increasingly upon GSL to finance the shortfall between current expenditure and income. This is partly attributable to the inability to raise local taxes and the failure of local authorities to impose adequate charges for services. However, the nature of the present grant system, which automatically reimbur- ses local authorities much of the increase in employee costs which has occurred in recent years, is partly to blame for this situation. 3.71 Direct grants to all local authorities including Development Councils rose from, Rs 78 million (Rs 5 per head) in 1977 to Rs 156 million in 1981, Rs 282 million in 1982, and are estimated at Rs 363 million (Rs 24 per head) in 1983. The additional Rs 100 million grants in 1982 represents the alloca- tion to local authorities of Rs 50 million of the additional revenues from motor vehicle licence duties (of which Colombo received Rs 40 million) and special assistance of Rs 50 million to Colombo to meet overdue bills. A number of small specific grants are paid to local authorities but they are of a fixed or reducing amount. Most of the grant is allocated in relation to increases in employee costs as part of GSL's policy of ensuring that local government staff enjoy salaries and conditions equivalent to GSL's employees. The grants provided in GSL's 1982 budget were as follows:  -41- (Rs million) Specific service grants 7 Motor vehicle licences 50 Contribution in lieu of Business turnover tax 36 Reimbursement of salaries and allowances /a 140 Colombo-special grant 50 283 /a Excludes Colombo which will receive some part (Rs 31 miLlion) of the additional grant (Rs 117 million) provided in 1983. The above grant: figures relate to all local authorities, and cannot be readily analyzed between the urban and rural authorities. However, the financial data from the 50 urban authorities indicate a considerable increase in revenue grants from GSL, both in total and as a proportion of local taxes between 1977 and 1982, as shown in Table 3.10 below: Table 3.LO: THE RELATIVE SIZE OF GRANTS AS AGAINST LOCAL TAXES Local Taxes Revenue Grants Tot. Assess- Am't/head Total Am't/head % of Local ment (Rs m) (Rs) a/ (Rs m) (Rs) a/ Taxes 1977 1982 1977 1982 1977 1982 1977 1982 1977 1982 Colombo 59.6 127.77 102 218 13.8 95.1 24 162 24 74 Other urban Authorities 37.6 54.4 24 34 31.3 88.4 20 55 83 162 Total 97.2 182.1 45 84 45.1b/ 183.5b/ 21 84 47 100 a/ Based on 1981 census data. b/ The figures represent 57% and 67% respectively of total local authority revenue grants. 3.72 The above table demonstrates a very unsatisfactory trend in the financing of urban local government. Whereas in 1977 revenue grants repre- sented 47% of local taxes by 1982 this has increased to 100% of local taxes. Local authority financial projections through 1987 indicate a continuation of this percentage relationship between local taxes and revenue grants. This seems unrealistic: current expenditure is forecast to increase in the next five years from Rs. 571 million in 1982 to Rs. 1047 million in 1987. As revenue grants are highly geared to employee costs, which generally increase more rapidly, the proportion of grant aid to local rates would increase. 3.73 In view of the trend of GSL grant assistance to local authorities and the prospect of even greater demands in the next five years, GSL should undertake an urgent review of grant arrangements for local authorities, preferably with external assistance. (para 3.48). The present open-ended revenue grant arrangements, related to employee costs,are unsatisfactory. Recent arbitrary additions to revenue grants, combined with increasing sub- sidies to CEB and WDB provide only a temporary relief against the chronic financial weakness of many urban authorities. Were GSL to introduce measures to improve cost recovery and strengthen the property taxation system, much of  -42- the need for revenue grants would disapear. Some of the savings could be used to improve the system of capital grants (para 3.77). 3.74 GSL may need, however, to retain a selective form of revenue grant to compensate those urban authorities whose local taxation resources, even on a current valuation basis, are insufficient to provide a reasonable standard of service and/or who may have to meet special needs, involving expenditure in excess of normal levels. GSL would need to define "reasonable standards" and "special needs" in devising a revised grant formula. 3.75 Indirectly, GSL has provided financial assistance to local authorities by settling amounts due to CEB and WDB in recent years. Such assistance is not reflected in local authority accounts. CEB received Rs 313 million between 1979-1981 and GSL plans to fund another Rs. 167 million (in respect of fuel surcharges up to May 1982) due from the local authorities to CEB. WDB has also received increasing subsidies since 1979 to enable it to meet its obligations. WDB's shortfall has arisen from the failure of WDB and the local authorities to introduce any form of direct charging for water supply or to increase the proportion of property tax attributable to water supply to meet increasing operating and maintenance costs and debt service. Since 1979 WDB has incurred deficits of some Rs 250 million and a further substantial escalation to Rs 300 - 350 million annually by 1984 is forecast, unless present attitudes towards charging for water are changed (para 3.70). (ii) Capital Grants 3.76 There appears to be no formalized system of capital grants for urban authorities. Any assistance tends to be provided on an ad hoc basis, through a small (Rs 0.2 million) allocation of funds to individual Members of Parlia- ment and through GSL's decentralized budget system. However, most of these funds are used in the rural areas and urban authorities must either generate internal resources or borrow to cover the cost of capital projects. Borrow- ing is generally restricted to loans from the Local Loans and Development Fund (LLDF) for self-sufficient public utility projects (paras 3.78-3.79). There is a clear need to encourage urban authorities to undertake sound capital projects in other sectors but this is hampered by the absence of a system of capital grants, combined with the general lack of forward planning. GSL should, therefore in its review of present grant arrangements (para 3.73), devise a system of capital grants to urban authorities which reflects (a) the availability of local resources to meet a part of the capital cost; (b) relative access to loan finance and financial capacity to meet debt service; and (c) the financial performance of the local authority, measured by such indicators as collection performance and cost efficiency in providing local services. (iii) The Local Loans and Development Fund (LLDF) 3.77 LLDF was established in 1916 to lend to local authorities for public utility works. A background note on the constitution and recent operations  -43- of LLDF is at Annex 3e. LLDF's present role in providing capital finance for urban authorities is limited by its own dependence upon GSL as a source of finance. In recent years lending has amounted to some Rs. 10-12 million annually, but local authority capital investment has been a low priority. One reason for this is, allegedly, their limited capacity to service debt: debt service arrears to LLDF were Rs. 16 million at end 1981. LLDF has no access to commercial borrowing, in view of public expenditure restrictions, while local authorities are unable to obtain commercial loans in their own right. At end of 1981, local authority loans outstanding to LLDF amounted to Rs. 130 million of which about Rs 70 million related to urban authorities (equivalent to Rs. 32 (US$ 1.50) per head of urban population). Rs. 2 million of the urban aut:hority loan debt was past due, together with about Rs. 6 million accrued interest. Debt servicing by local authorities in recent recent years has exceeded new lending by LLDF as indicated below but is nevertheless a small proportion (about 2%) of total local authority current expenditure. 1/ Table 3.11: LLDF LOANS (Rs million) Lending Debt Service Ave. Interest Rate 1978 5.6 13.8 6.9 1979 11.9 16.4 7.2 1980 11.5 10.7 7.6 1981 9.5 16.3 7.5 38.5 57.2 3.78 While presently urban authorities are not unduly burdened with debt servicing charges, their capacity to absorb new loans - if such were avail- able - and meet higher debt service charges would require improved levels of cost recovery for public utility services and the restoration of an effective property tax system. The execution of major capital works projected through 1987 by urban authorities would require not only improved internal cash generation but also more flexible borrowing arrangements. GSL should, there- fore, review the present LLDF arrangements to improve the effectiveness of this agency as a source of loan finance possibly by its conversion into a true development: bank for the sector. 3.79 In particular, GSL should consider: (a) alternat:ive non-concessional financing arrangements for public utility projects, where full cost-recovery, including full provision for debt service is possible; LLDF could borrow commercially for such activities and any future Bank Group assistance for electricity distribution improvements might be channelled through a strengthened LLDF; 1/ Assuming the urban authority proportion of debt service to LLDF is cur- rently Rs. L0 million.  -44- (b) adequate loan financing for other local authority services, in combination with generally improved capital financing arrangements (paras 3.77 and 3.82). (iv) Capital Expenditure Planning and Financing Arrangements 3.80 Present arrangements do not encourage forward planning of capital investment by urban authorities. Capital expenditure projections through 1987 are simply extrapolations of past trends rather than a representation of planned schemes. The Kandy Municipal Council, however, presented an addi- tional schedule of special projects 1/ amounting to some Rs 1.35 billion (equivalent to US$60 million) and representing high-priority schemes to benefit the town. Generally, the lack of formal arrangements to mobilize financial resources impedes any system of advance identification and evalua- tion of projects and their inclusion in rolling programs of capital invest- ment, similar to GSL's five-year Public Investment Survey. 3.81 GSL should review present arrangements for not only the planning of capital expenditure by urban authorities (para 3.52), but also for the financing of such expenditure. Present capital grants arrangements were reviewed in para 3.77 and borrowing arrangements in para 3.79. The availability of grant and loan funds to urban authorities should be condi- tional upon the satisfactory financial performance and, in particular, the raising of a proportion of capital expenditure requirements internally. Several options should be examined by GSL: (a) a percentage contribution to investment could be specified for public utility services, to be achieved through tariffs, direct consumer contributions and security deposits; (b) a betterment tax could be levied by the local authorities to finance a part of the capital investment needed for other local services; this could be applied to immediate expenditure or accumulated in a capital fund, to be utilized subsequently in financing major projects--legal amendments may be required for these purposes; (c) satisfactory fixed asset accounting should be established in all urban authorities and proper provision for depreciation should be made in the accounts; supplementary depreciation to cover the full replacement cost of plant, vehicles, and equipment should be provided; (d) leasing of plant, vehicles, and equipment should be explored within the expanding banking and financial services sector in Sri Lanka; and 1/ These schemes are not included in the capital expenditure projections in this report as their execution is not solely the resposibility of the municipal council.  -45- (e) joint venture capital should be sought for development projects with commercial potential, e.g., markets buildings, off-street parking; lease-back arrangements may be possible on some existing developments. Further, and finally, urban authorities should review their present arrange- ments for administering those services with high capital investment needs and with a potential for private-sector participation; solid waste management and car parking in "'Greater" Colombo are possibilities for "privatization". D. Electricity Supply 3.82 CEB's cash flow is seriously threatened by the failure of the local authority licensees to pay their dues to the CEB. 1! Generally, CEB's col- lection performance is satisfactory, particularly as it retains a tight control over heavy industrial users, whose dues are usually within three months' billings. The local authority sector has been neglected in recent years and, although demand has been rising rapidly little investment has been undertaken by the local authorities. In 1979 CEB assumed responsibility for electricity supply in Dehiwela - Mt. Lavinia and had to spend the equivalent of Rs 4,700 (US$200) per consumer to raise service standards to CEB's level. It is estimated that not less than Rs 1 billion (US$ 50 million) would be needed to bring all local authority systems to a similar standard. Further- more, despite earlier asssurances given to the Bank Group, local authority tariffs were not increased in line with CEB's and, consequently, the local authorities havie been unable to pay CEB's bills. Following agreement between GSL and the Bank Group (Credit 1210-CE) local authority tariffs were to be raised from October 1981 to a level sufficient to cover CEB's bills and local and their own distribution costs. In other words they were to break-even. However, action was not taken to raise tariffs until the summer of 1982. 3.83 As indicated below the amount due by the local authorities to the CEB at December 31, 1982, was about Rs 409 million, of which Rs 231 million related to the 44 urban authorities which retail electricity: Table 3.12 Total due to CEB Fuel surcharge billed December 31, 1982 October '81 - May '82 -----------------Rs million---------------- Urban authorities (44) 231 104 Other local authorities (180) 178 63 Total (214) 409 167 1/ The largest single amount due to CEB at December 31, 1982 is Rs 62.3 million from WDB.  -46- GSL previously paid some Rs 313 million to the CEB in respect of local authority dues outstanding to September 30, 1981, on the understanding reached with the Bank Group that local authority tariffs would be increased sufficiently to meet future costs of providing the service. GSL had earlier intended to transfer all local authority systems to CEB, and local authorities had continued to pay at pre-December 1978 tariffs, arrears of which at September 30, 1981 were about Rs 29 million. However, tariffs were not increased from October 1981 and GSL advised the local authorities to withhold payment to CEB of the fuel surcharge imposed between October 1981 and May 1982. This amounts to about Rs 167 million of the Rs 409 million outstanding and GSL proposes to pay this amount to CEB as a grant. Despite recent increases, current local authority tariffs are insufficient to meet the net amount (Rs 242 million) due to CEB. 1/ Furthermore, current CEB bills are not being settled satisfactorily, despite assurances that separate bank accounts are being maintained by local authorities. Local authority accounts with the CEB since 1978 are summarized below: Table 3.13: (Rs million) Opening Total Cash GSL Closing Year Balance Billings Due Received Grant Balance 1979 16.9 80.1 97.0 41.0 35.0 21.0 1980 21.0 179.4 200.4 39.4 119.7 41.3 1981 41.3 290.1 331.4 59.1 158.3 114.0 1982 114.0 473.7 587.7 157.5 - 430.2 a/ 313.0 a/ Includes street lighting Rs 21.1 million) and fuel adjustment charges of Rs 167.1 million for the period October 1981-May 1982. 3.84 The present accounts of the 44 urban authorities which retail elec- tricity purchased from CEB is shown in the following table. In most cases the amount due to CEB represents between 4 and 9 months current billings, a substantial obligation by any standard. 1/ 44 urban authorities have indicated some Rs 50 million cash available to meet the net amount due to CEB.  -47- Table 3.14: (Rs million) Amount due Equivalent Electricity Cash Short- Consumers to CEB a/ No.months Bank Balance fall/consumer Name ('000) 12/31/82 billings 12/31/82 Rs Galle 6.6 6.9 7 5.0 288 Jaffna 13.7 5.5 3 0.7 350 Kalutara 4.1 5.4 8 0.4 1220 Kandy 10.7 13.9 5 12.7 75 Kotte 10.5 Est 13.4 8 5.0 800 Moratuwa 9.2 8.3 5 1.5 739 Negombo 6.2 7.8 6 1.4 1032 Panadura 4.0 Est 6.7 11 0.7 1500 Trincomalee 4.1 4.7 9 1.0 902 Other urban (35)b/' 74.4 54.3 5 21.7 438 Total 143.5 126.9 6 50.1 535 a/ Net of fuel surcharge through May 1982. 'b,/ Each owing less than Rs 5 million. 3.85 In the short-term GSL should ensure that: (a) all local authorities that retail electricity, bill and collect charges at the revised tariffs and deposit their collections into a separate bank account; (b) any surpluses presently held in those bank accounts should be paid to CEB and, thereafter all electricity collections should be paid mcnthly to CEB; (c) prompt disconnection actions are enforced by local authorities against delinquent consumers; (d) the adequacy of present tariffs in relation to current billings to CEB's reviewed and satisfactory arrangements made with CEB for the phased payment of amounts now due to CEB; (e) the Rs 167 million due to CEB in respect of accrued fuel surcharge throught May 1982 should be paid to CEB as a grant, in accordance with CEB's cash needs. 3.86 CEB, in turn, should review with GSL the present tariff structure applied to the local authorities having regard in particular to; (a) the local authorities difficulties in recovering the fuel surcharge from its consumers most of whom are domestic and exempt from payment of the surcharge as they consume less than 150 units monthly;  -48- (b) the higher maximum demand charges now imposed on local authorities; 1/ and (c) the need to standardize CEB and local authority tariffs, and, in particular, domestic tariff levels. 3.87 However, any tariff concession made to the local authorities would be at the expense of CEB's own consumers, if its financial performance is to be preserved. 3.88 Discussions are continuing within GSL and CEB about the future organization of the sector and the need to improve, in particular, the local authority systems and finances. A recent proposal focuses upon the estab- lishment of a joint venture between CEB, the local authorities and the private sector to assume responsibility for the improvement of the local authority distribution systems. This would operate as a private company, enjoying greater freedom in relation to staffing and finance than either CEB or the local authorities. While such freedom would be a considerable advantage it is difficult to envisage the success of such a venture without substantial tariff increases and concessionary finance to improve and expand distribution systems. 3.89 However, such innovative thinking should be encouraged as improve- ments are overdue. Such a company could conceivably take-over some of CEB's distribution and retail operations to produce a more viable situation. On the other hand, municipal enterprise should not be discouraged while there is a willingness to provide an efficient service and to ensure adequate cost-recovery. 3.90 Regardless of the institutional issues there is a need to establish the present condition of the local authority distribution systems-- technical data is scant--in order to assess the need for and cost of improvements and to provide a realistic program of works. This task should be undertaken urgently, probably using consultants as CEB manpower is not able to handle it. Provided that satisfactory organizational arrangements can be agreed to manage such a program of improvements, and thereafter ensure satisfactory operation and maintenance, a project along these lines would be appropriate for Bank Group financing either in the power or urban sectors. E. Water Supply and Sanitation 3.91 The Sri Lanka Water Supply and Sanitation Sector Study describes in considerable detail the very serious financial problems facing the sector and a series of measures which are being undertaken by the WDB and GSL to overcome present weaknesses. However, it must be noted that these measures apply only to the WDB's customers and are not adopted by the local authorities for their respective customers. The measures, described below, which are being implemented by the WDB, must be complemented by similar financial and operational discipline at the local authority level in order to restore financial health of the sector nationally. WDB has introduced from 1/ Present maximum demand charges are about 20% of low-cost marginal cost.  -49- January 1984, a flat monthly rate for unmetered consumers, metered tariffs have been incre!ased on an average by 60% and all metered consumers are now being billed. These actions form a part of a broader Financial Recovery Program which GSL and WDB is now implementing in order to address the short and medium-term financial policies in the Sector. It is unlikely that WDB's operating deficits can be eliminated in the short term; the best that can now be expected is to first contain these deficits and provide the platform for improving its future financial position through gradual elimination of operating subsidy requirements of the Sector. The following are some prin- cipal elements of the Financial Recovery Program: (a) Introducing a flat water charge for all unmetered consumers with connections, possibly varying with pipe size or number of taps on premises; (b) Increasing the existing volumetric tariff to reflect more properly the basic cost of producing and distributing water and the effect inflation has had on that cost in recent years; (c) Implementing aggressively a more comprehensive metering program to enable consumption based charges nationwide and to assure that the heaviest consumers pay their fair share as quickly as possible; (d) Improving billing and collection activities to ensure that potential revenues are actually realized; (e) Improving WDB's accounting data base in order to gain a clearer understanding of WDB's cost structure and to identify and eliminate ineffective expenditures; (f) Introducing accounting for water to identify and control leakage and other waste and, in consequence, to defer the need for future investment; (g) Formulating a macro-investment plan for the next five years with due consideration being given to the availability of funds for proper operations and maintenance and with priority emphasis being placed on rehabilitation of existing assets; and (h) Conducting an affordability and tariff study to recommend suitable and affordable rate structures and procedures for WDB's own future review and adjustment of tariffs on an annual basis. 3.92 To better reflect manpower and other constraints in the national economy, GSL should also urgently review the Sector's investment program and formulate an intermediate term investment plan for future investments in the Sector. In recent years, WDB's fixed assets base has grown from about Rs 360 million in 1979 (including Works in Progress) to an estimated Rs 3,900 mil- lion by the end of 1983. Currently, WDB plans on completing new construction averaging about Rs 1,200 million in each of the next three years, based largely on existing commitments. Unless contained and carefully redirected, this rapid escalation of the investment program will undermine any other effort for achieving long term and sustainable financial recovery in the  -50- Sector. In determining the appropriate reduction of the investment program, more attention also must be given to the impact of future investments on the recurrent subsidy requirements discussed above, particularly through opera- tion and maintenance and debt service requirements. In determining the appropriate structure and content of the investment program, future invest- ments in the Sector must focus on: (a) Rehabilitation of existing assets, particularly production facilities; (b) Improvement of Operation and Maintenance facilities with emphasis on training at the Operator level; (c) Upgrading of distribution works in selected areas; (d) Projects involving low-cost appropriate technology; and (e) Projects which have good revenue generating potential. 3.93 While future financial viability of the WDB will partly depend on its ability to charge and collect appropriate tariffs, it is important that the concept of affordability of the consumers must be given due consideration while setting tariff levels. In recent years, many subsidies previously approved by GSL have now been eliminated. There have also been regular and often large increase in the price of other goods and services (e.g. elec- tricity) which have generally outpaced increase in income levels, par- ticularly for the lower end of the income distribution range. Consequently, the impact of these increases on the average household budget must be con- sidered in determining how much a household can afford to pay for water and sanitation, particularly in a society where water has been traditionally considered a free good.  -51- IV. THE SHELTER PROGRAM - POLICY AND FINANCE A. Introduction 4.01 Sri Larika's housing needs for the urban areas are estimated to average about 38,000 units annually over the next 20 years. Inspite of this, by comparison to many developing countries, the nation's shelter problem is solvable, subject to GSL making decisive shifts in policy in respect of land supply, standards of planning and levels of services, affordability criteria, financing (through the elimination of capital/interest subsidies), improved cost recovery, and maintenance of public areas. A sharp decline in fertility and a modest rural urban drift, have combined to lower the rate of population growth in the urban areas. For example, since about 1955, the proportion of the urban population has increased by one percent. Since 1971-72 (last census), the growth of only 1.2%, compares favorably with the 2.1% for the rural sector and the 1.6% recorded in the 1981 census for the total popula- tion (see Annex l(b), Tables 1,2). As a result, the urban population in the country, remairns constant at 21.5% of the total. During the same 10-year period, Sri Larka has housed its people more rapidly than the growth in population, and in better quality structures. The increase of population during this period has been 17% while the number of occupied housing increased by 26.8%. This pattern is reflected in the urban sector, as shown in Table 2, Annex l(b). The percentage of permanent housing has also increased from 35.4% to 41.8% in 1971 while that of semi-permanent and improvised housing has decreased correspondingly. 4.02 In the urban sector, more than 24% of the housing units are of semi-permanent materials and 13% are made completely of temporary materials. The high densities and congestion in urban areas presents greater health and safety risks, when coupled with the inadequate level of amenities. In the urban areas as a whole, about 23.5% of the population share their toilets with others, while nearly 20% are reported to have not even shared toilet facilities (Table 3, Annex 1(b)). In Colombo, for example, almost 59% of the slum population does not have access to suitable toilets even on a shared basis. And less than 28% have a flush or water-sealed toilet. Only 36% of all low-income housing units in Colombo have exclusive use of a source of water and the slums have as little as one water tap per 128 persons and one toilet for over 36 persons. 4.03 The large and growing slum and shanty areas particularly in the vicinity of Colombo, are evidence of Sri Lanka's growing inability to increase the supply of serviced urban residential land and affordable hous- ing. According to the 1981 census, occupation of improvised (temporary) housing has increased from 160,000 to 180,000 in 1981. Of this number, 38,820 are estimated to be in the urban sector with more than 20,000 of these units in Colombo. Of the population in the city of Colombo, more than 125,000 or 21.5% live in shanties. The complex socio-political issues of the land tenure system and inheritance laws (paras 3.13-3.14) constrain the availability of land.  -52- B. Public Sector Housing Performance 4.04 Political commitment to alleviating the housing problems has been unprecedented under the leadership of the Prime Minister, who is also the Minister of Housing. Prior to 1978, from about 1971, the total contribution of the public sector to the housing stock was around 4,800 units. In 1979, the '100,000 Housing Program' was launched. It was to be made of 50,000 rural units and 36,000 urban units; the balance of 14,000 were to be financed by housing loans of the Government. The program was intended to cater for all income groups and was broadly distributed on the basis of 80% for the low-income groups, 15% for the middle-income groups, and 5% for the rest. The program can be broadly divided as follows: (a) the Aided Self-Help (ASH) program (primarily rural) which provides financing for a package of building materials in the neighborhood of Rs 25,000 and payments of Rs 50 per month over 30 years. The repayments do not even recover full capital costs; (b) the Direct Construction Program (primarily urban). Prices range from 100,000 per unit and interest rates vary from 6-12%, depending on cost; (c) the Urban Loans Program targetted to families owning their own land. Interest rates charged are at a maximum of 9%; and (d) the Slum and Shanty Upgrading Program, which provides for upgrading infrastructure in slum neighborhoods, but does not include any home improvement. Under the overall program, around 35,000 units have been completed to date with another 22,000 units still under production (estimated to require a further Rs 500 million by 1985). Although this was a tremendous performance as compared to the previous five years, it amounts to only 12% of the addi- tion to the total housing stock produced between 1977-82 mainly by the private informal sector. The production by the private (formal and informal) sector is outlined in paras 4.14-4.17. 4.05 The massive allocation of resources to carry out the 100,000 houses program launched in 1979, accounted for 12% of the total public sector investment during these years. Given the urgency with which Government perceived of the housing problem, the program was inevitably launched with inadequate preparation and attention to broader policy issues as well as the technical logistics for implementing such a program. For example, the ability of the GSL to indefinitely sustain an allocation of resources on that scale, or the institutional capacity of the public sector to deliver the number of units then envisioned, was not adequately examined. GSL have already cut back the allocation for housing in the future to 5% of the public investment, and are currently examining the public sector delivery system and its ability to play a dominant role in housing production. 4,06 The absence of a comprehensive and consistent national policy or framework by the Government dealing with, for example: land supply, standards of planning, construction and service levels, affordability, financing, cost recovery, and the maintenance of public areas has been a constraint; the  -53- institutions and industry have instead been subjected to a series of ad hoc laws and regulations have been developed over time to deal with specific issues as they were addressed. The need for a comprehensive policy within the overall development framework development has been recognized and GSL are currently examining this aspect in detail and should be shortly be in a position to set out the guidelines and policy for a coordinated shelter program. C. Construction Costs and Design Standards 4.07 The construction industry has suffered rapid inflation during the last five years, thus with rising land prices aggravating housing costs, particularly in public sector construction. The average increase in con- struction cost in the public sector had been around 50 percent per year although it exceeded 100 percent and in the direct construction housing programs. It even exceeded 100 percent. For example, the standard materials package provided in the Aide Self-Help (ASH) program has increased from Rs 7,500 in 1975 to Rs 15,000 in 1979 and to near Rs 30,000 today. As a result, the NHDA has been forced to modify designs and materials to reduce the cost of this program. Experimentation with local building materials and tech- nologies have indicated that typical rural house construction on this basis could be reduced to around Rs 17,000-20,000 per unit. 4.08 There has been considerable variation in the case of Slum and Shanty upgrading projects. Experimentation here too, with a range of solutions to test replicability, have resulted in wide differences in actual costs depend- ing on existing physical conditions and types of improvements provided. Of these, in the least expensive project, the cost was Rs 491 per unit while the most expensive had an estimated cost of over Rs 23,000 per unit. The latter cost was due to substantial requirements for plot regularization and family relocation. The average cost of Rs 10,400 for shanty improvement projects is almost double the average cost of slum upgrading projects at Rs 5,800. There have been complaints from the public that in the slum upgrading, the stand- ards are too low. In most cases, services are provided by standpipes, public toilets, and shower facilities. These would seem to be the most practical on the basis of sites visited. 4.09 It is in the direct construction program particularly for those aimed at the lower end of the income distribution range, however, that standards and costs have received inadequate attention. Standards are generally very high for various services, such as paved streets, sidewalks, street lighting, individual water and electrical connections, piped sewer systems, and exten- sive landscaping. Very low density (in spite of high land values) con- tributes to higher costs per unit. There has also been little or no attempt to relate the quality and the standard of finishes to the siz Is of units, e.g., between a 400 sq ft (37m ) unit and a 1,200 sq ft (lllm ) unit, with the result that smaller units will be overpriced for those who can afford but the size would be inacceptable to those who can afford it. Units under the direct construction program are four to six times higher per unit than for ASH units. The cost for 425 sq ft (39.5m ) house is in the region of Rs 100,000 or Rs 230 per sq. ft. In the middle and upper income category of housing, where the standards are higher, the cost per sq. ft. is very much higher.  -54- D. Affordability 4.10 This raises the major issue of affordability by the individual beneficiary, and the nation as a whole. Under the present program, all housing is affordable because there is little cost recovery directly from beneficiaries. Sri Lanka incomes are relatively low; even with innovative technical approaches, the capacity of beneficiaris paying the full cost of a completed house is limited. For example, Table 1, Annex 4(a) indicates the monthly affordable expenditure on housing by Sri Lankan households at dif- ferent income groups. Alternative solutions which concentrate on upgrading the provision of essential services (with the superstructures left to the private sector (or self help), and schemes that provide for incremental housing (sites & services) are to be encouraged. Recent Government programs with their massive capital and interest subsidiaries are unsustainable. These have cost the public sector about Rs 1.0 billion per year, for a small fraction of required housing at high average costs per unit. A significant expansion of a rational housing program necessitate solutions that are affor- dable within given ranges by the various income groups, through a mix of innovative technical solutions (planning layouts, land use) and innovative financial management (variable interests, internal cross subsidies, alterna- tive loan packages, etc.). This task is underway by the NHDA housing task force. The present program with a new unit cost of about Rs 12,000 for slum upgrading and above Rs 125,000 per unit for the direct construction program is clearly not reaching the target groups. E. Cost Recovery and Replicability 4.11 A recent consultant's report evaluated the performance on cost recovery. 1/ The record is poor. The GSL only has not had any cost recovery policies for its housing program, only initial deposits in the case of new unit purchase have been recovered. In the case of rental property, recovery performance has been somewhat better, given that rental payments are heavily subsidized and are well below market levels. 4.12 Data on cost recovery for the program as a whole is somewhat scarce. However, one report indicates that as of June 1982, the accumulated arrears on rural housing totalled Rs 6,465,526 (US$323,276). By mid-1982, only 11.4% of the total rent due on all programs for the month was collected while 4.8% of the arrears was collected. Much of these problems appear to stem from poor management performance of the executing agencies. Data on cost recovery under the direct housing program is not available. GSL will clearly have to define and implement more aggressive cost recovery policies if its shelter program is to be replicable beyond more than a couple of years. 4.13 The Formal Private Sector. The growth of the formal private sector, and thus its contribution to housing production has been modest, probably inhibited by several factors: (a) the absence of an organized housing finance system for either construction finance or mortgage loans; only a few firms that have been able to provide mortgage finance to prospective buyers. 1/ PADCO, October 1982, USAID.  -55- (b) existing land laws (see Chapter III, para 3.06-14) with their complica- tions and risks discourage builders from undertaking land development on a large scale. (c) Restrictive government policies (rent control, ceiling on property acts, (atc.) of the past have not provided a healthy environment for entrepreneural capital. (d) The imposition of excessive legislation (land use, zoning, building standards, permits, licenses, inspections taxes, fees, etc.) increase the overheads on private builders, thus encroaching unreasonably on entrepreneural profit expectations. (e) Most small firms lack the management capacity for large-scale production. 4.14 The Informal Private Sector. The recent census data indicates that the housing production by the informal private sector has increased steadily from 1977-1981 and accounts for slightly over seven units for each unit produced by the public sector over the five-year period. The informal private sector caters to the middle and upper income groups through construc- tion by private individuals, and to low-income groups, through the slum and shanty settlements, increasingly visible in the urban areas. Most of the shelter built in rural areas also belong to this category. 4.15 Construction costs by this group are relatively low. For example, for the lower/middle income group, a modest house of around 700 sq. ft. can be built for around Rs 120,000-140,000 (US$6,000-7,000) exclusive of land or interest cost. For low-income groups using traditional materials and lower standards, the cost could be reduced to about Rs 20,000 (US$1,000). 4.16 Most houses are constructed by small private contractors for individual clients or by individuals who hire labor on a daily basis and in the low income urban and rural sectors, using their own labor. The informal sector's contribution of low income housing in the urban areas is primarily through (a) subdivision of older buildings in 'run down' locations, which are grouped as 'slums' or (b) through construction of shanties. Shanty dwellers include a number of migrants from rural areas who continue to live in the city with virtually no urban services, usually on public land (para 3. ). There is consid(erable scope of tapping the potential of the informal, private sector, and through appropriate policies and strategies to bring urban land legally on the market, provide security of tenure, access to trunk services, etc., as part of an comprehensive Shelter Study. F. Agencies Involved in Financing 4.17 There has heretofore been no formal organization specifically respon- sible for the provision of housing finance in Sri Lanka. One institution, the State Mortgage and Investment Bank (SMIB) is engaged primarily in provid- ing housing finance while a number of other various institutions and commer- cial banks (para 4.19) provide loans for housing as a part of their total operations. There is no secondary market available for mortgage or housing bonds. 4.18 In this context, the commercial banking system can be broadly divided into three groups: (1) State-owned banks; (2) Sri Lankan private banks; and (3) branches of foreign banks; which are not involved in the provision of housing finance. While the two Sri Lanka private banks participate in a very limited way in housing loans, the two State-owned banks (The Bank of Ceylon and the People's Bank) have been playing a more important role in the area.  -56- However, the tight credit situation since 1981, led the Bank of Ceylon to discontinue the granting of housing loans from June 1981, at which time its outstanding loans for this purpose aounted to about Rs 325 million, which was less than 5 percent of its total loans and advances. The People's Bank continues to grant housing loans on a limited scale, the outstanding amount of which, as at the end of March 1982, was Rs 775 million. This was about 10 percent of the Bank's total loans and advances outstanding at this date. Thus the total outstanding housing loans of the State Banks are equal to about one year's budget allocation for housing for the 1978-1982 period. Commercial banks in general are reluctant to commit any significant part of their resources for longer term lending for liquidity consideration and given the recent period of high and volatile interest rates, which makes 15 or 20-year commitments unattractive. G. The Financial Implications 4.19 The public housing program is presently financed out of the national budget. The annual allocation of resources in the Public Investment Plan for shelter activities averaged around Rs 35.0 million in the early 70's to almost Rs 1.0 billion/year from year 1979, thus increasing its share of the public investment to more than 12 percent. The program has now been substan- tially revised with the objective of easing the demand on the national budget. The revised share of public resources allocated to the public hous- ing program is now planned at around Rs 500 m per year. That is approximately the annual public expenditure required to meet housing needs by the year 2001, exclusive of the total private expenditure over this period estimated to be in the region of Rs 7 billion. 4.20 A number of considerations contribute to an overall viable financial strategy for a national shelter program, including the assumptions of expen- diture by the private sector program through beneficiaries, a sector very sensitive to government policies or actions; e.g., relating to construction costs and design standards. These aspects are currently being reviewed by a Government task force housing program, particularly given the experience gained from the existing program, which has direct relevance to financial outlays. 4.21 The National Savings Bank (NSB) set up for the specific purpose of mobilizing domestic savings and channeling them for purposes of national development, also has assisted in the provision of housing finance, again in a very limited way. The NSB is required by law to invest not less than 60 percent of its total deposits in Government and/or Government guaranteed securities. Arising from other Government needs, more than 90 percent of the Bank's deposits are invested in such securities at the present time. Its direct investment in housing loans is only about 5 percent of its total deposits. The NSB however, supports the activities of the State Mortgage and Investment Bank through purchase of its debentures, (a glimmer of a secondary market). 4.22 The Insurance Corporation of Sri Lanka provides housing loans to its life policy-holders as well as to employees, but the amount loaned annually has not been very significant.  -57- 4.23 Other housing loans are also provided by private finance companies, private provident funds, and by individual companies whose employees benefit under their employment. H. State Mortgage and Investment Bank (SMIB) 4.24 The StaLte Mortgage Bank and the Agricultural and Industrial Credit Corporation (now known as the SMIB) whose origins date back to the pre-war period is the only financial institution that is primarily engaged in the provision of housing finance. This bank grants loans for the following purposes: (a) construction of new dwelling purposes; (b) extension of exist- ing dwelling houses; (c) purchase of building sites for construction of dwelling houses; (d) purchase of house properties and agricultural lands; (f) redemption of debt incurred in connection with any of the above purposes. 4.25 The authorized capital of the SMIB Bank is Rs 200 million of which Rs 75 million have been subscribed. The other source of finance available to the Bank is through the sale of debentures. Due to competition in the form of high interest rates paid on deposits by other institutions, the Bank's debentures have! to be placed with official institutions that normally sub- scribe to Government securities. (The demands on Government finance compel the Government to place limits on the volume of debentures issued by the SMIB. While the Bank is by law authorized to accept time deposits, it has not done this Up to now. With the present high interest rates, "time deposits" as a means of finance to the Bank do not seem to be a viable proposition. 4.26 The rates of interest charged by the SMIB on housing loans vary between 12 and 22 percent per annum depending on the size of the loan, with an upper limit of Rs 1 million. Repayment of the loan is by equal install- ments over a period not exceeding 25 years. 4.27 Although the SMIB also provides finance for other purposes like development of agriculture and redemption of debts under mortgages, there has been a very distinct shift of emphasis in its lending operations towards housing. For example, in 1979, 56 percent of its total loans was granted for housing purposes, both construction and purchase. In 1980, the proportion rose to 78 percent and in 1981, to 89 percent. The SMIB's lending policies also seek to encourage new construction rather than purchase of existing houses. Of the loans granted for housing purposes, 62 percent went into new construction in 1979, 75 percent in 1980 and 85 percent in 1981. The SMIB's lending polici(es also encouraged smaller loans than larger loans, with the average size of its loan in 1981 being Rs 90,000. 4.28 RecentLy, the legislation relating to the State Mortgage and Invest- ment Bank was amended to confer on the Bank additional powers. Under which the Bank plans to purchase develop and sell urban land outside Colombo, in small parcels to individual purchasers. 4.29 There has in the last few years been some discussion in Sri Lanka on the establishmesnt of a new 'Housing Bank' and capital funds for this institu- tion are included in the latest five year investment plan. Any significant impact of this new institution on housing finance must come either from an enlargement of the resource pool which seems unlikely or from a concentration  -58- on very low cost shelter investment, which would serve to spread the avail- able resources over a larger population. There does not seem to be an acute need for a new housing finance institution in the middle or upper end of the market, although the resources available to the present institutions are extremely limited. I. Future Urban Shelter Needs and Housing Strategy 4.30 Alternative estimates of Sri Lanka's future urban shelter needs have been computed in two recent consultant studies (Annex 4(b), Tables 1 and 2). Depending on assumptions about the rate of population growth and the pace of improvement from the present conditions, the estimates of need for new urban housing range from 20,000 to 46,000 units per year. 4.31 The Government's direct financial contribution to a housing program must be limited, simply because of a severe and continuing shortage of Government funds. Recognizing this, the Government has recently reduced its program for urban housing from a peak of just over Rs 1 billion in 1980 to a range of Rs 300-350 million for the period 1983-1987. To get the widest possible population coverage from this reduced spending, the Government's program is being radically restructured: direct construction is being phased out, slum upgrading and sites and services are being expanded, and an alloca- tion to a new Housing Bank is being introduced. 4.32 The results of this set of programs are not yet predictable, as many details of the subprograms have still to be worked out. Several points in the strategy are, however, already obvious: (a) There is simply no way that Rs 350-400 million per year can be stretched to cover all, or even a major portion of, the urban housing needs, however estimated. It will be necessary to concentrate on the portion of the housing package that only the public sector can provide, that is, the plan- ning and subdivision of land for housing and the provision of basic services (the monopoly of municipalities): water, urban roads and drainage, public lighting, waste removal, and the like. The shift of the Government program in favor of affordable shelter programs such as slum upgrading and sites and services, and the abandoning of the direct construction program, indicate that Government have benefitted considerably from the experience to date, and are willing to take the tough but essential policy decisions in this sector. (b) Serious attention must be given to the speed of delivery of housing sites. The cheapest options (See Annex 4(a)) offer the possibility of financing most of the needed sites within the present allocation in the public investment plan. The more expensive options do not. Policies on cost recovery will have to be strengthened considerably. The process of reor- ganizing the SMIB into a housing bank is underway. The Government apparently intends to have it continue to operate and increase its activity in the primary mortgage market and begin to deal in mortgage discounting, forming a base for a secondary mortgage market. In view of the overall shortages of investment funds, and bearing in mind that the planned budget contribution to the housing bank is modest, this institutional change is not likely to have great influence unless the proposed Housing Bank pioneers in lending to the very low income end of the market.  -59- (c) The informal private sector will inevitably continue to provide most of the urban housing over the next several years. It is important that this housing be built in serviced (or at least servicable) areas and that minimum essential services eventually be provided. It would be very desirable to ti:Lt the lending portfolio of the housing bank toward loans for cheap housing o01 minimally serviced sites, with the aim of further encourag- ing private informal development. 4.33 In March 1983, the Prime Minister announced the Government's proposal to build one mi:Llion houses over the next decade. The GSL housing task force is currently addressing the above issues and is expected to complete its work towards the latter half of 1983, in anticipation of implementing 'the Million House Program'. V. THE COLOMBO METROPOLITAN REGION 5.01 During the mission, the administrative problems resulting from the absence of a metropolitan-level management for the Colombo Metropolitan Region (CMR) was brought into focus. The CMR has not been defined offi- cially, but has been variously represented as including approximately 1,800 contiguous sq km, with a population of just over 4 million people. Its urbanized core of about 230 sq km has a population of just over 1-1/2 million people. At the center is Colombo Municipality (approxmately 37.5 sq km) with a 1981 population of 585,776 persons. 5.02 Colombo City, the hub of economic, commercial, financial, shipping, and administrative activities, is the dominant local authority in the CMR, and subject to pressures of peripheral growth. This growth is taking place within the jurisdiction of other local authorities, which number includes two municipal councils and nearly a dozen urban councils, all of which are responsible for a set of urban services as discussed in Chapter III. Super- imposed on the CMR are two important Goverment development programs with autonomous area-wise jurisdictions: the New Capital Project Development Area (Sri Jayawardanapura), and that of the GCEC (Chapter II, para 2.12). The new capital, about 7 kms east of Colombo is located in an as yet, underdeveloped municipality of Kotte (an ancient capital), surrounded by the five regional towns of Negombo, Veyangoda, Avissawella, Horana, and Kalutara to the North, Northeast, Southeast, and the South on a radius of approximately 48 kilometers. The region encompassed by the five towns centered on Colombo occupies approximately 1,763 sq km of which about 800 ha are low-lying mar- shes with some areas lying below sea level. The National Capital Development Area Plan 1/ is based on a population growth projection from about half a 1/ This report does not deal with an evaluation of the plan. The cursory review of the model and architectural plans indicates the plan to be a low density 'garden city' concept complete with rapid transit system, mode-separated transportation corridors, linear parkways and lush landscaping. To accelerate implementation, it is recommended that the plan be subjected to a detailed technical, economic and financial evalua- tion given Government resources; the alternative may prove to be an 'open-ended' and unsustainable expenditure program.  -60- million people to an eventual 1.5 million people. A new, architecturally impressive Parliamentary Complex has already been constructed and plans for the development of three "administrative complexes" are well advanced. 5.03 About 1.2 million square meters of public sector office accomodation has been provided for in the plan. Detailed plans for the next phase anticipate the construction of approximately 260,000 sq m which include office space, a General Hospital, a National Police Headquarters, a National Youth Service Council Headquarters, a Central Bank Training Institute, an Open University, a secondary-level boarding school, and a five-star 400 bed hotel, as well as the construction of approximately 700 conventional housing units. These investments, excluding infrastructure and other related expen- ditures is conservatively estimated to cost approximately Rs 1.3 billion in 1983 prices. The construction to date of infrastructure and buildings in the National Capital Development Area have hitherto been funded by the Central Government directly out of the Public Investment Plan under the heading of 'urban development'. There is no such allocation for the current five-year plan. The planning of the National Capital Development Area has been entrusted to a specially staffed division of the UDA. 5.04 Immediately to the north of the National capital project area and contiguous to Colombo City is the 415 sq km under the GCEC's authority The first Investment Promotion Zone adjacent to Katunayaka Internatioal Airport (KIPZ) is now nearly fully developed and projected employment at full capacity is expected to exceed 50,000. The land is well serviced with all utilities, post office, customs offices, a training center, service organiza- tions, transport terminals, a sewerage treatment plant, two primary electri- cal substations, and a modern telcommunications system, for an estimated cost of approximately Rs 300 million. 5.05 The source of these funds was a direct allocation from the Central Goverment Budget. The GCEC now has ambitious plans for the regional develop- ment of the rest of the 415 sq km area under its authority. The extensive long-term integrated development includes the setting up of the Katanayake-Seeduwa township within close proximity of the KIPZ. The GCEC has also recently approved an executive housing project, "Singapore Garden," within two miles of the KIPZ. It is a private development by Sentosa Development Co. Ltd. of Singapore which, like the firms in th KIPZ, was offered tax concessions to undertake the project. A 2200-unit 'low-income' housing scheme near KIPZ is underway to cater to workers' housing needs. Other plans call for the redevelopment for the Negombo town, an alternative road from Colombo to Kayanayake (which will also connect the Port of Colombo to the airport), improvements to the railway, creation of Katana new town for workers, Kadolkelle Township, and a warehousing complex at Peliyagoda. 5.06 A second Investment Promotion Zone will be situated on 180 ha acres of land at Biyagama, 17 km east of Colombo. This zone will accommodate heavy industries and high water consumption industries. Preliminary work to improve access to the site has already begun. 5.07 A third Investment Promotion Zone is slated for a 100 ha site at Welisara, 11 km from Colombo. This zone is designed for light industries which are low consumers of water.  -61-- 5.08 To administer the KIPZ, GCEC must coordinate with a number of other government agencies. In the past, these agencies have included the Central Transport Board., Ceylon Electricity Board, the Treasury, the National Housing Development Authority, and the Urban Development Authority (UDA). The NHDA which has launched a master plan to improve housing in the Greater Colombo area works closely with the GCEC and the chairman of the UDA serves on the five-member board of GCEC. 5.09 The somewhat independent 'planning' of these two 'priority' invest- ment areas (New Capital and GCEC) diminish considerably the possible role or participation of other local authorities in the region. When the resposibilities of other country-wide agencies, such as the NHDA have also to be discharged in the region to complement the plans, the potential for con- flict in budgeting, phasing, standards of service delivery, land use deci- sions, and accessibility is greatly increased, with the implications of escalating costs or indecision. 5.10 Perhaps more than any other single stimulant or deterrant to urban development is the existence and efficiency of transportation facilities and effective traffic management. The integration and subtle manipulation of the existing networks requires careful and sophisticated coordination. 5.11 Serious urban traffic and transportation problems in Sri Lanka are largely confined to Colombo. Other towns, being much smaller in area and population, do not generate intense congestion, nor the need for extensive planning and traffic management. This report therefore describes briefly the traffic and transportation situation in Colombo. A separate 'close-up' report (Annex 5:) examines transportation problems in greater depth and makes detailed recommendations for solutions to them. 5.12 About 1.1 million people commute to destinations in Colombo Municipality by some form of motorized transport. Another 25,000 are employed in GCEC, and many of them commute from outside that area. In addi- tion, there is some motor commuting to suburban locations and people commute by walking or bicycles. Colombo also handles the goods and persons traffic associated with its role as the governmental, commercial, and industrial center of Sri Lanka. 5.13 Traffic to and from the port of Colombo is almost all by truck which use roads through residential zones and the commercial area to haul goods to destinations in Colombo and throughout Sri Lanka. 5.14 Colombo is one terminus of a very large share of inter-city traffic of goods and people within Sri Lanka. Over 40% of all urban and inter-urban buses serve Colombo and four rail lines converge there. Traffic in CMC has grown at an estimated 10% per year for the last five years, with truck traf- fic growing faster. Trucks and vans in Colombo have increased from 10,000 to 27,000 between 1975 and 1980, cars from 36,000 to 60,000. About 50% of commuting traffic is concentrated in the sort Area (0.85 km2) and the adjacent commercial area of Pettah (3.5km ) and all port bound traffic must pass through Pettah. Thus, the traffic problem is a fairly typical one of congestion in the Central Business District and the need to move large volumes of traffic within and through a small area. The new area plans cannot realistically diffuse this congestion.  -62- 5.15 Physical infrastructure for urban transport consists of the railroads which serve Colombo and the system of streets and roads. The railroads do not offer special commuter services, but three main broad gauge lines go to the north, northeast, and south, and they carry more than 70,000 commuters daily, that is, about 5% of the daily commuting volume. The street system is sparse, occupying only 7% on the land area in CMC and probably even less in the suburbs. This is comparable to Calcutta (6%) and other seriously road-deficient cities, and is about one-third the street space of a typical developed-country city of comparable size. Nevertheless, the street system serves about 95% of the total motorized passenger movements. 5.16 In addition to the railway service mentioned above, Colombo is served by a public bus company (CTB) and private bus operators. Overall, about 80% of all persons travelling by motorized means use buses. CTB carries between 1.1 and 1.4 million passengers in a typical work day in Colombo 1/ and private bus services about 400,000. About 20% of all person trips are made by private car, motorcycles, and three-wheeled motorized rickshaws. The linkage between where people live, work, and will live and work in the future between the GCEC plans, and the new capital area would benefit from further deliberation. 5.17 Private bus operations have expanded rapidly since the liberalization of urban transportation in 1979. Prior to that, CTB had a monopoly on stage transportation. Since then, private bus companies are allowed to operate almost without restriction on routes or fares and with minimal Government supervision. 5.18 Government responsibilities for urban transportation are widely dispersed but for Colombo City, a traffic management committee, consisting of high-level officials of the municipal and Central Governments, has begun to take an active part in traffic planning. A broader mandate for such a com- mittee appears to be required. 5.19 The financial problems faced by Colombo will inevitably need to be addressed for the Region as a whole. The Central Government transfers to the Colombo Municipality are inadequate to service 'national' roads, deficits on public bus transportation may increase 2/ and the general lack of savings of the municipality which hampers both investment and adequate maintenance of the general city street system will no doubt be replicated unless the whole issue of resource mobilization by local governments as discussed in Chapter III, is tackled more aggressively. 1/ CTB is an island-wide company that keeps no separate statistics for urban services, therefore these and other estimates of CTB's Colombo operations are subject to error. 2/ Historically, this was an important deficit--about Rs 350 million per year, including interest and depreciation. A 25% fare increase in 1983 has substantially reduced this problem, but no data are yet available on financial balances under the new rate structure.  -63- 5.20 Managing the peripheral growth of Colombo, allocating financial resources selectively, developing vast new areas of urban land, ensuring a coordinated and efficient transportation structure to facilitate intra-metropolitan and inter-municipality communication requires some fine-tuning of administrative resources available in the region. At a mini- mum, and a first stage, an active joint committee of selected municipalities should be set up to share information on development plans and allow for mutual advice.  -64- ANNEX l(a) SRI LANKA URBAN SECTOR REPORT POPULATION OF THE MUNICIPAL COUNCILS AND URBAN COUNCILS IN 1981 1/ (above 14,000 persons) Name of Town Population 1981 Census Colombo Municipal Council (MC) 585,776 Dehiwela - Mt. Lavinia (MC) 174,385 Jaffna (MC) 118,215 Moratuwa Urban Council (UC) 135,610 Kandy (MC) 101,281 Kotte (UC) 101,563 Galle (MC) 77,183 Negombo (MC) 61,376 Trincomalee (UC) 44,913 Batticaloa (MC) 42,934 Matara (UC) 39,162 Anuradhapura (UC) 36,248 Badulla (MC) 32,954 Matale (MC) 29,745 Ratnapura (MC) 37,354 Kalutara (UC) 31,495 Kurunegala (MC) 26,519 Puttalam (UC) 21,463 Chilaw (UC) 20,830 1tuwara Eliya (MC) 21,319 Kegalle (UC) 14,920 1/ There are 12 Municipal Councils, 38 Urban Councils, and 24 Development Councils. Source: Census of Population and Housing, Sri Lanka - 1981  -65- ANNEX l(b) SRI LANKA URBAN SECTOR REPORT Table 1: GROWTH OF POPULATION AND HOUSING BY SECTORS, 1971-1981 Sector Population Occupied Housing Units 1971 1981 1971 1981 All Sectors 12,689,897 14,850,001 2,217,478 2,811,406 Urban Sector 2,848,116 3,194,879 421,155 509,459 Rural Sector 8,707,455 10,721,671 1,558,765 2,084,496 Estate Sector 1,134,326 933,451 237,558 217,451 Table 2.1: RATES OF INCREASE AND GROWTH OF POPULATION AND HOUSING BY SECTORS, 1971-1981 Population Occupied Housing Units Sector % Increase $ Increase/year % Increase $ Increase/year All Sectors 17.0 1.6 26.8 2.4 Urban Sector 12.2 1.2 21.0 1.9 Rural Sector 23.1 2.1 33.7 3.0 Estate Sector -17.1 -1.9 -8.5 -.88 Table 3: PERCENTAGE DISTRIBUTION OF HOUSING UNITS BY TOILET FACILITIES BY SECTORS, 1971-1981 Total for Shared No Toilet Sector Total Exclusive Use Toilet (Including Not Stated) 1971 1981 1971 1981 1971 1981 All Sectors 100.0 45.5 53.0 19.0 13.6 35.5 33.4 Urban Sector 100.0 48.9 48.9 56.8 30.7 23.5 19.8 Rural Sector 100.0 48.5 55.5 9.0 7.9 42.5 36.5 Estate Sector 100.0 20.5 18.4 63.9 45.1 15.6 36.6 Source: Census of Population and Housing, Sri Lanka - 1981, Housing Tables, Preliminary Release No. 3, June 1982.  -66- ANNEX 2 Page 1 of 4 SRI LANKA URBAN SECTOR REPORT MINISTRY OF LOCAL GOVERNMENT, HOUSING, AND CONSTRUCTION OUTLINE OF AGENCIES (a) The Urban Development Authority (UDA) 1. The UDA was established by-law in 1978, specifically to promote the integrated planning and development of urban areas, as designated from time to time by the MLGHC. The Authority is empowered: (a) to formulate and submit development plans, including capital investment plans for approval and to undertake the execution of development projects and schemes; (b) to enter into contracts for the execution of development programs and/or under- take the completion of approved schemes in default of completion by other parties; (c) to formulate capital improvement schemes for designated areas, and to formulate and implement urban land use policies and develop environ- mental standards and schemes for improvements in such areas; (d) to undertake building engineering and infrastructure developrent operations; (e) to acquire and hold movable and unmovable property, and dispose of it as neces- sary; (f) to formulte and execute plans for the clearance of slum and shanty areas and to undertake the development of such areas; (g) to prepare develop- ment plans and planning schemes on behalf of other Government agencies, and to coordinate and supervise such schemes, and control development projects of other Government agencies if so requested; (h) to provide technical planning services as consultant to other Government agencies. 2. The Authority can regulate development and land use and can charge rents and fees for any buildings or services it provides. Its powers were further extended in 1982 to permit UDA to make contracts or agreements for the purpose of carrying out any development project or schemes, and to strengthen its regulatory functions. The amendments also outlined in detail the procedures for UDA carrying out its regulatory functions and planning functions more rigorously. 3. The UDA is financed through funds voted by the Parliament, its self- generated funds donations, gifts, and grants, and Government guaranteed debentures and Bank overdrafts. In 1979, the UDA's initial funding was increased from Rs 20 million (US$960,000) to Rs 100 million (US$4.8 million). 4. The Authority is governed by its Board comprising a Chairman nominated by the Minister (currently the Secretary, MLGHC), Senior officers of the Ministries of Local Government, Finance, Lands, Industries, Transport, Health, Education and Irrigation, Powers, and Highways; the Director of the Town and Counry Planning, the Chairman of NHDA; two members nominated by the Minister to represent local authorities; and two members nominated by the Minister for their special knowledge and experience of urban development. The General Manager of the UDA acts as the Board's secretary, who is also appointed by the Minister. The General Manager may in turn appoint an Advisory Committee to advise the Board, on any matters he may consider neces- sary.  -67- ANNEX 2 Page 2 of 4 (b) The National Housing Development Authority (NHDA) 5. NHDA was also established at the time of the UDA in 1979. The Authority is empowered to formulate schemes to establish housing development projects in order to alleviate the housing shortage; (a) to directly engage itself in the construction of flats, houses, and other living accommodation or buildings; (b) to cause the clearance of slum and shanty areas and redevelopment of such areas; (c) to develop or redevelop land for carrying out of any of the objectives of the Authority; and (d) to conduct and promote and coordinate activities in relation to all aspects of housing development. 6. The NHDA is funded directly by Government through allocations as part of the Government's capital budget. It then receives long-term repayments from housing beneficiaries, cash through the sale of housing units and through the sale! of land to builders. It has over the past two years also formed joint ventures for housing development in which it offers land as equity with the other parties in joint venture providing financing and experience. It has a staff of about 100 senior management, 200 middle-level employees and nearly 2,000 supporting and other administrative staff. It too suffers from nmany of the staffing problems as discussed in para 2.12 in respect of the IUDA. (c) The National Water Supply and Drainage Board (WDB) 7. The WDB was discussed in detail under the Sri Lanka Water Supply and Sanitation Sector Study (Report No. 4190-CE). The WDB is an autonomous body under the MLGHC. It was formed in 1975 out of the Department of Water Supply and Drainage and is the leading institution in the development for all urban and rural piped water schemes, urban sewerage schemes, and non-piped (wells) rural water supply schemes. In recent years, the WDB has been assuming increasing operational responsibilities for the distribution and operational aspects of most schemes which have hitherto been the responsibility of the local authorities. The WDB now has separate units for planning and design, ground water development, and training. Although WDB is divided operation- ally into 8 regional offices, and administered by regional managers whose offices are located in the field, the regional offices rely almost wholly on the central headquarters for assistance in field investigations, project design, logistical supply, functional, and managerial support. 8. The Board is headed by a Chairman (with a General Manager reporting to him) who reports to the MLGHC. A high turnover of senior personnel between 1978 andl 1980 coupled with the loss of professional and technical skills to more lucrative employment elsewhere led to a weakening of the institution. Since January 1980, in conjunction with the appraisal of IDA Credit 1041-CE, there has been a strategy for institutional strengthening through management support, technical assistance, and staff training. This program is currently being implemented. An Organization and Management study  -68- ANNEX 2 Page 3 of 4 anticipating WDB's future requirements and recommendations for its develop- ment towards meeting expected responsibilities is nearly complete. Major emphasis is being given to management decentralization within the WDB. The consultant's report will also include a design for comprehensive reporting procedures for planning and budgetting and monitoring. (d) The Town and Country Planning Department 9. Was previously responsible for 'physical planning' for the whole country, now its role limited to the planning for sacred areas, and prepara- tion of maps and plans for rural and semi-rural areas. (e) The National Housing Department 10. Was responsible for administration and rent collection of approximately 6,000 Government-owned apartments, administration of the rent-control act and enforcement of the Ceiling on Housing Property Act of 1973. (f) National Housing Fund 11. Was established in 1954 and up to 1981 was administered by the National Housing Department. Since then, it has been transferred to the NHDA for administration of the Government housing loan program. Management of the NHF portfolio has been inadequate dating back to the early 1960's and deteriorated to the point of being irretrievable on its own. (g) Local Loans and Development Fund (see note, Annex 3(e)) (h) The BuildinRs Department 12. Provides architecture, engineering, and construction support to other ministries and local governments. Concentrates its efforts on individual buildings, such as schools, town halls, etc. leaving the larger projects and housing construction to the State Engineering Corporation. (i) The State Engineering Corporation (SEC) 13. A Corporation with building design and construction capacity working exclusively on Government projects; it has about 100 technical and profes- sional staff in its design sector and about 8,000 skilled and unskilled employees in its construction division. Both divisions operate independently and separately. With the recent decline of other Government projects, the SEC has undertaken construction of projects for the NHDA and the UDA.  -69- ANNEX 2 Page 4 of 4 (j) Building Materials Corporation (BMC) 14. Was established in 1972 with monopoly powers to regulate the price and availability of building materials. The monopoly was lifted in 1977, but the BMC has evolved as an efficient corporation, and it is said to have contributed to the success of the Government's construction program to date. It operates as distributor of a wide range of building materials through a network of retail outlets located in various parts of the country.  SRI LANIA Review of Urban Local GovernmeOt Finance Summary of linancee 1971 through 1987 (Is. Thoueande) Urban Authorities (9 Urban Authoritioe (11) Total Colombo In Creater Colasbn _/ Outside 'Creater' Colosbo Urban AuthoritieS (50) 1977 1979 1982 1967 1977 1979 1982 1987 1977 1979 1982 1987 1977 1979 1982 1987 Annual Value of Property 186227 241711 372429 500000 252488 310855 448947 592572 66255 71570 84646 106069 318743 382425 533593 698661 Annual Valug/par head (Ra)