Sri Lanka - Strengthened adjustment for growth and poverty reduction

Report No. 10079-CE Sri Lanka Strengthened Adjustment for Growth and Poverty Reduction January 8, 1992 Country Operations, Industry & Finance Division MICROFICHE COPY South Asia Country Department III Report No. 10079-CE Type: (ECO) FOR OFFICIAL USE ONLY SHISHIDO, / X80429 / D9091/ ASICO 6~ Document~ of the World Ban'k This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may nototherwise be disclosed without World Bank Authorizati,n. 19>,9 ,, J . .. '~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~4  CURRENCY AND EQUIVALENT UNITS (Annual Averages) Sri Lanka Rupee per US$1.00 1978 = Rs 15.61 1979 = Rs 15.57 1980 = Rs 16.53 1981 = Rs 19.25 1982 = Rs 20.81 1983 = Rs 23.53 1984 - Rs 25.44 1985 Rs 27.16 1986 = Rs 28.02 1987 - Rs 29.44 1988 = Rs 31.81 1989 = Rs 36.04 1990 Rs 40.06 1991 = Rs 41.84 FISCAL YEAR (FY) January 1 to December 31 This report was written based on findings of a mission that visited Sri Lanka during April 1991. The mission was led by Hisanobu Shishido and comprised of Zeynep Taymas, Marjorie Rose (IMF) and Dilesh Jayanntha. Terrence Abeysekera (Consultant) also made a contribution. The repert was further updated based on findings of a December 1991 mission by H. Shishido.  FOR OFFICIAL USE ONLY List of Abbreviations and Acronyms Used ADB - Asian Development Bank AGA - Assistant Government Agent ARC - Administrative Reforms Commission BOC - Bank of Ceylon CBSL - Central Bank of Sri Lanka CCPI - Colombo Consumer Price Index CPC - Ceylon Petroleum Corporation CTB - Central Transport Board CWE - Cooperative Wholesale Establishment EEC - European Economic Community EPZ - Export Processing Zones FCD - Food Commissioner's Department FIAC - Foreign Investment Advisory C;mmittee FIAS - Foreign Investment Advisor:, Service FSP - Food Stamp Program GCEO - Greater Colombo Economic Commission GDP - Gross Domestic Product GNP - Gross National Product GOBUs - Government Owned Business Undertakings HYV - High Yielding Varieties IDA - International Development Association ILO - International Labor Organisation IMF - International Monetary Fund JEDB - Janatha Estates Development Board JSP - Jana Saviya Program JVP - Janatha Vimukthi Peramuna (Peoples' Liberation Front) MDMP - Mid-Day Meal Program MPA - Ministry of Public Administration MPCS - Multi-Purpose Cooperative Societies NGOs - Non-Governmental Organizations NIC - Newly Industrialized Countries NSB - National Savings Bank NTC - National Transportation Commission O&M - Operation & Maintenance PAC - Poverty Alleviation Credit PB - Peoples' Bank PEs - Public Enterprises 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.  - 2- PMB - Paddy Marketing Board PSC - Public Service Commission RACA - Restructuring and Collection Agency RTB - Regional Transport Board SLBFE - Sri Lanka Bureau of Foreign Employment SLSPC - Sri Lanka State Plantations Corporation /  TITLE: STRENGTHENED ADJUSTMENT FOR GROWTH AND POVERTY REDUCTION COUNTRYs SRI LANKA REGION: COUNTRY DEPARTMENT III, SOUTH ASIA SECTOR: COUNTRY ECONOMIC REPORT TYPE CLASSIF MM1YX LANGUAGE 10079-CE CEM Restricted 01/92 English PUBDATE: 9201 ABSTRACT: The Government of Sri Lanka embarked on serious economic restructuring efforts in 1989. These efforts included measures to: (i) stabilize the ecoaomy; (ii) rationalize the public sector; (iii) encourage private investment; and (iv) improve the country's poverty programs. As a result of these efforts and together with good weather and improved security situation in most parts of the country, economic growth improved to 5-6 percent a year in 1990 and 1991 from the 2 percent average of the previous three years. Cautious optimism has, therefore, started to emerge as to the country's potential to sustain high growth and in the longer term to join the rank of newly industrialized countries. But, while tight macroeconomic management stance largely was maintained in 1990, it has become rather lax from the fourth quarter of 1991 and fiscal and credit targets have been exceeded. For the economy to enjoy sustainable growth, it is essential that the macroeconomic stance be tightened immediately, and, in addition, two worrisome signs in the economic adjustment patterns be removed. One of these signs is that public investment (which complements private productive investment) is plummeting while an increasing portion of private investment may be going into housing and real estate. The other sign is eroding external competitiveness; wages and domestic prices have been rising rapidly while adjustment in exchange rate in the recent past has been rather limited. The root cause of these problems lies in the larger government recurrent spending relative to its revenues--its current deficit has been 1-2 percent of GDP since 1989. This dissaving has increased consumption bias in the economy undermining the Government's efforts to encourage private investments in export sectors. The Government needs to rectify this and achieve positive recurrent surplus (about 2 percent of GDP) by implementing appropriate wage policies, restructuring the public sector pension scheme and improving further cost effectiveness of poverty programs. To improve the economy's overall efficiency, in addition, the government needs to continue privatizing commercial public enterprises, and allow market forces to play a significant role in management of public sector banks and tree crop plantations; privatization should be considered in the latter two subsectors as well. The government also needs to resort increasingly, in consultation with the IMF, to fle.ible foreign exchange rate management. These macroeconomic reforms need to be complemented by a wide range of reforms at the microeconomic and sectoral levels. The report briefly discusses four such reform areas which are seen as high priority. They are, improvement of: (i) financial institutions; (ii) the environment for foreign direct investment; (iii) labor legislation; and (iv) physical infrastructure. In addition, the Government needs to make further progress in resolving the civil conflict so as to improve the investment climate, encourage increased production in affected areas, and free up resources for development.  SRI LANKA STRENGTHENED ADJUSTMENT FOR GROWTH AND POVERTY REDUCTION TABLE OF CONTENTS Page Country Data Executive Summary i I. REVIEW OF RECENT ECONOMIC PERFORMANCE ............................. 1 Economic Performance in 1990 and 1991 .......................... 1 Background ....... ...................... 1 National Accounts and Growth ................................ 2 Growth Performance in 1990 ..... ............. 4 Savings and Investment ................................ 7 Balance of Payments ......................................... 11 Fiscal Developments .................... ..................... 16 Inflation ......................... .......................... 18 Impact of the Gulf Crisis ................................... 22 The Agriculture Sector ..................... ....................... 26 The Paddy Sector ..................... ....................... 26 Alternative Food Crops: Crop Diversification ....... ......... 29 Impact of the Civil Conflict on Agriculture ........ ......... 32 Civil Conflicts Defense Expenditures and Refugee Issues ........... 36 The Evolution of Actual Defense Expenditure ........ ......... 36 Refugees ......................... ........................... 37 II. TOWARDS A GROWTH-ORIENTED POLICY PACK&GE .......................... 39 Introduction ........... 39 Macroeconomic Management for Enhanced Export Orientation ........ .. 41 Evolution of Investments and Savings ......... .. ............. 41 Evolution of External Competitiveness ......... .. ............ 46 Summary ..... 49 Reduction of the Government's Size and Influence .. ................ 50 Establishing Administrative Capacity ........... ............. 50 Promoting Privatization/Peoplization ...... .................. 53 Public Tree Crop Sector Restructuring ...... ................. 55 Summary ................................................. 61 Creation of a Competitive Business Environment Conducive to Private Ilvestment ................ ................. 61 Establishing an Efficient Financial Sector ........ .......... 63 Promoting Foreign Direct Investment .. ....................... 65 Improving Labor Relations ................. .................. 67 Providing Adequate Infrastructure Services .................. 69 Summary ............................... . 70 Restructuring Poverty Programs .. ............................ 71 Jana Saviya Program ............... ............... 72 The Food Stamp Program .............................. 74 The Mid-Day Meal Program .............................. 74  - ii - III. 1992 AID REQUIREMENTS . ..... ............................................ 76 Recent Trend of Foreign Aid ....... ................................ 76 Balance of Payments Projections and Aid Requirements .............. 80 ANNEXES ANNEX 1: List of Public Enterprises Privatized/to be Privatized ........ 86 ANNEX 2: A Survey of Sri Lankan Firms: An Interim Result ............... 87 ANNEX 3: Unit Labor Cost Calculation .................................. . 98 STATISTICAL APPENDIX ...................................... 101 MAP  LIST OF TEXT TABLES Table No. PaRe Chater 1I 1.1 Key Economic Variab1-s 1984-1990 ........... 2 1.2 Value-added Growth Rates of Major Sectors ............... 3 1.3 Sectoral Composition and Increase in Gross National Product at Constant (1982) prices, 1989-90 .... 5 1.4 Macroeconomic Balances 1984-1990 .......... * .............. 7 1.5 Increase in Investment Goods Imports .................... . 8 1.6 Expenditure on Gross Domestic Product .. .................. 8 1.7 Sri Lanka: Commercial Bank Advances to the Private Sector and Public Corporations by Purpose .............. 10 1.8 Credit to Public Enterprises ............................. 11 1.9 Balance of Payments ...................................... 12 1.10 Merchandise Exports ................. 13 1.11 Summary of Central Government Fiscal . Operations, 1986-91 ........ ............................ 16 1.12 Monetary Developments ........ ............................ 21 1.13 Overall Balance of Payments Impact of the Gulf Crisis .22 1.14 Volume of Tea Exports, August to December, and Annual 1988-1990. 23 1.15 Estimated Breakdown by Skill Category of Sri Lankan Return Migrant Workers from The Middle East ..... 24 1.16 Summary Table of Paddy Production ........ ................ 27 1.17 Financial Returns - Other Field Crops Versus Paddy ....... 30 1.18(a) Paddy Sector - Gross Extent Sown (Hectares) During The Maha Season - 1980/81 to 1989/90 ................... 33 1.18(b) Paddy Sector - Gross Extent Sown (Hectares) During The Yala Season, 1981 to 1990 ............ 33 1.19 Paddy - Imputed Loss in Production in the North and East: Maha Season (1984/85 - 1989/90). 34 1.20 Paddy - Imputed Loss in Production in the North and East: Yala Season (1985-1990) ............... . 35 1.21 Evolution of Defense Expenditures ........................ 36 1.22 Number of Families Directly Affected by the Civil Conflict as of September 1, 1991 ................ . 37 1.23 Expenditures on Refugees (January 1 to July 31, 1991) ..... 38 Chapter It 2.1 Public and Private Investment, Selected Years ......., 42 2.2 Growth Rate of Real Investment ........................... 43 2.3 Composition of Private Fixed Investment, Selected Years......... . ...... 44  2- 2.4 Domestic Savings, Selected Years ................... .... 44 2.5 Percentage Wage and Price Changes ....... ......... 48 2.6 Evolution of Determinants of Unit Labor Cost ............. 49 2.7 Tea Production ................. .......................... 57 Chapter III 3.1 Project Aid Disbursements as a Share of Public Investment ...................................... 77 3.2 Aid Disbursements as Share of GDP ..... ................... 77 3.3 Sector Distribution of Total Project Aid ............... . . 78 3.4 Balance of Payments Projections--Base Case . .............. 80 3.5 External Financing Requirements .......................... 83 3.6 Overall Aid Pipeline, 1987-1992 ...... .................... 84  Pago 1 of 2 CONTRY DATA SRI LANKA AREA POPULATION ^/ DENSITY MU;OO sq. km X77rTTITon (mid-1990) 25W per sq. km. (l.i0) Rate of Growth: 1.1 (1990) 703 per sq. km. agricultural land (1977) POPULATION CHARACTERISTICS (1987) HEALTH (1988) Crude Birtn Rate (per '000) 21.9 Population per physician: ),168 Crud. Death Rat. (per '000) 6.9 Population per ho.pit.l bed: 6se Infant Mortality (per '000 live births) 80.0 b/ INCOME DISTR18UTION (1081/82) DISTRIBUTION OF LAND OWNERSHIP (1978) X of natlonal i come, highest quintilI: 58 X owned by top lox of owners - X of national income, lowest quintile: 4 X owned by smalloot 10 of owners: - ACCESS TO PIPED WATER (1980) ACCESS TO ELECTRICITY (1981) X-of population - urban: 47 X of population - urban: 26 X of populatlon - rural: 40 X of population - rural: 6 NUTRITION (1988) EDUCATION (1981) Calo;-reTntako: 2,400 Adult lteracy rate: 87X Per capita protein Intake (grams/day): 48 Primary school enrollmont 98x GNP PER CAPITA IN 1990: USU470 c/ OUTPUT IN 1990 BY SECTOR ANNUAL RATE OF GROWTH (X, constant prices) Value Added Mill. Us$ U 1970-77 1977-86 1987-89 1990 Agriculturo 1910 26 2.8 8.9 -1.8 8.6 Industry j/ 1791 26 1.7 6.2 4.7 7.6 Services a850 49 3.7 6.8 2.7 4.3 Total !/ m .T GROSS DOMESTIC PRODUCT IN 1990 f/ US$ Mill!,on U GDP at Market Prices 8,014 100 Investment 1,818 23 Gross National Savings 1,894 17 Current Account Deficit 420 5 Exports of Goods and NFS 2,48o 8o Imports of Goods and NFS 8,069 38 GOVERNMENT FINANCE Contral Government (Ru Million) X of GDP at MarketE Pricos 1990 1975 1984 1990 Revenue 67,984 17.2 22.1 21.2 Current Expenditure g/ 71,770 18.8 17.2 22.4 Current Surplus -3,806 -1.1 4.9 -1.2 Capltl Expenditure hl 28,04S 7.3 13.6 8.7 External Assist nco (not) 18,841 8.2 6.4 6.7 a Rogistrar General's Department. */ GDP at factor cost. /, 1961. / Includes capital revenue. cl World Bank Atlas estite. / Includes advance accounts. Manufacturlng, mlning and construction. f/ Includes not lending.  Page 2 of 2 COUNTRY DATA SRI LANKA MONEY. CREDIT AND PRICES 1981 1982 1983 1984 1986 198a 1987 1988 1989 1990 (End of perioa) -