Ceylon - Foreign exchange problem

RESTRICTED Report No. FE-45 This report was prepared for use within the Bank and its affilated organizations. They do not accept responsibility for its accuracy or completeness. The report may not b pulhed or may it b,0e. quoe ras represennng theirviews. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION OF CEYLON July 13, 1965 Far East Department AT?n"%A, TIrrvW? A? IrT9%R 4;UaRDlal;A at U.LVhAIA Currency Unit - Ceylon Rupee US$ 1 4 .76 Rupees 1 Rupee US$ 0.21 1 Million Rupees * US$ 210,000 TABLE OF CONTENTS Page No. I. INTRODUCTION 1 II. AN IMPORT PROGRAM AND EXCHANGE PROSPECTS FOR 1965 AND THE OUTLOOK FOR 5966 5 The Initial Import Program 5 The Revised Imporg Program for 1965 7 Balance of Payments - 1965 9 Financing the Revised Program 10 Prospects for 1966 10 III. THE NEED AND SCOPE FOR CORRECTIVE ACTION 12 The Possibilities of Growth 13 The ImDlications for the Balance of Payments 14 The Implications for Consumptions Savings and Investment 15 The Implications for Economic and Financial Polinv 17 Financial Stabilization 17 A1lnntlin nf Rnamimps 20 Direction of Investment 22 Conclusions 24 AmirY TT I. iNPROD.JUTION 1. The causes of the foreign exchange crisis, which Ceylon faces, are discussed in the background paper "The Economic Situation of Ceylon" which accompanies this memorandum. They are summarized here so that they may serve as the basis both for presenting the immediate ex- change problem and for examining possible courses of corrective action by the Government of Ceylon. 2. Some of the causes of the crisis are fortuitous, such as the sharp rise in the world market price of sugar in 1963 and 196 and the partial failure of Ceylon's rice crops in 1965. They involved Ceylon in additional outlays of foreign exchange amounting to nearly Rs. 300 million in 1964 and 1965. These are large amounts in relation to Ceylon's import budget of Rs. 1,700-1,800 million. They precipitated the present crisis because these additional requirements could only be met by cutting back on other imports - mainly intermediate and capital goods, thus affecting adversely domestic production and growth - and by reducing exchange reserves to a precarious level. Being outside Ceylon's control, these factors are not relevant to a discussion of possible corrective action by the Government of Ceylon. However, it is important to bear them in mind when analyzing import requirements in 1965 and 1966 and the conse- quent need for foreign financial assistance. 3. Basic to the present foreign exchange crisis is the fact that for nearly ten years Ceylon has lived beyond its means. It has done so not because the standard of living has risen to a level of comfort and luxury, but because the standard of living was permitted to rise at all during a period when real national income per person fell as a result of declining export prices and slow growth of domestic production. In fact, it was the previous Government's deliberate policy to counteract the potential depression of the standard of living through injecting additional purchasing power into the economy by running large infla- tionary budget deficits. 4. In short, with purchasing power rising faster than real income, imports in excess of export earnings were sucked in to fill the gap. This was possible for a time by running down reserves. Later, import restrictions were imposed. These aggravated the supply situation and caused a deterioration in the capital stock. However, since the restrictions were not coupled with a corresponding reduction in purchasing power - indeed redistribution of income in favor of low income and thus low saving groups continued unabated - demand was partly diverted to unrestricted imports in the category of basic commodities and partly created shortages and rising prices. Thus reserves continued to fall while prices rose, until the present crisis brought the new Government face-to-face with the necessity for immediate action. 5. Tn brief, the facts of the crisis are as follows: if the level of consumption reached in 1964 - the last year of office of the previous - 2- Govrnen tWo- +.ra h m-ntained n imports1 o~f for-,o-d.ffs- nn basic consumer goods would absorb over 70o of Ceylon's import capacity, exclu,ding foreign aidl or a +u.he deeirto of M the rre pos iti.n The remainder, some Rs. 500 million, would be less than two-thirds of 'MY'%O:ts ofP ineredat an 4ntl ^^at ,n Aniipe levelslo It would be grossly insufficient to keep the economy functioning, let capital stock or for growth in output. 6. While faced with a problem of such dimensions, the Government fiuud tat all the lss paLnUl palliatives normally resorteU oU in dealing with an immediate exchange crisis have been exhausted already. Imports of luxury and semi-essential consumer goods have been pro- gressively restricted in the last four years as exchange outlays on consumer goods other than foodstuffs and textiles were reduced from Rs. 235 million in 1959-1960 to Rs. 90 million in 1964. Imports for the maintenance of capital were cut to such an extent that there has been a considerable deterioration in the capital stock of the country, especially in transportation. Allocations for industrial raw materials in 1964 did not enable existing capacity of high priority to be utilized fully. Imports of new industrial machinery were severely restricted. Imports of trucks and tractors for use by the private sector have been negligible since 1962. 7. At the same time, Ceylon has already gone further than pru- dence would permit in drawing down its foreign exchange assets. In mid- June 1965 their position, excluding securities held in sinking funds against sterling obligations, was as follows: Gross Foreign Exchange Assets (Rs. million) Government 1.0 Semi-Government Institutions 29.1 Central Bank 164.3 Commercial Banks 99.8 Composition of Central Bank Assets: Securities 97.5 Credit Balances on Bilateral Accounts Lb.2 Liquid Balances 22.6 67T Of these assets, only a small fraction could be used freely, even in an emergency. Commercial bank holdings represent no more than minimum workine balances. Credit balances on bilateral accounts are prnatially illiquid. A major part of the Central Bank's securities is pledged as security aprainst a short-term bank lon. The re1ihle rach vnine of - 3 - tne tunpleagea Central BanK securities and or the securities hld Dy semi-.government institutions, together with the Central Bank's liquid balances thus constitute usable reserves. They amount to about Rs. 75 million, equivalent to less than two weeks' imports. Against this, there are short-term liabilities payable before the end of the year totalling about Ra. 100 million, including a repayment to the IMF. This is a precarious situation indeed which it would be highly imprudent to complicate further by deliberate use of reserves. In any case, the amount is so small as to be insignificant in relation to Ceylon's exchange problem. 8. This leaves the question to what extent it is possible to relieve the immediate pressure on the balance of payments in 1965 and 1966 by reducing further imports of consumer goods below the amount that would be necessary to maintain the 1964 level of per capita consumption. This question is essentially one of the scope for curtailment of basic consumption items like foodstuffs and textiles because inessential consumer imports have already"been reduced.to a minimum. Obviously, there is no clear cut answer to this question. The difficulties are both economic and political. Economically, no undisputable standard exists for judging what a proper level of per capita consumtion would be for foodstuffs and basic consumer goods. There is, of course, the basic premise that imports can no longer exceed available exchange. However. Ceylon's inort canacity. without foreian aid, is so grossly inadequate that this is not a practical standard. Perhans the ver. 1909-60 mi gnt h takpn as A rniuA to reasonable import requLrements of basic foodstuffs and other basic consumer goods at a per capita level annrnpriat tn the difficultisa of rAynnts nresent exchange situation. At that time there was already some expansion of mass demand fnr hinin rnnanmi Imnrt asar ailn+.nf t.he incme rPdstribution policies of the government. However, this expansion had been still fairly moderate and pr apnni+ availabilities of thee nacinv 4mnr+ continued to rise in the 1961-1964 period of tightening import controls. The monan P +h4 ez the -n4t-a+4on of 4-sm- eds bution policIen and the effect of controls which tended to concentrate demand on "essential" imnnrt.n hannq nf +ho vI-+nI hnn nn 4mnr%Y. r%f linvnry znd qAmi-..AntAil goods. Certain imports in the "essential" list appear high on a per capita Ena1 mpared wUIh Nhoter contrie .g sugar and potatos n . 4a kI h7owe reflects traditional food consumption patterns, and Ceylon's per capita similar per capita incomes. 9. Political difficulties arise out of the fact that any reduction .LAmL MpoUtUs 01 10 uVU110 "LAU UL1r DuIS Co1Iluel ruOUS W.LW Ule .1.7U4 level of per capita consumption would hit particularly Ceylon's low Iuuume groups. For years, these groups were favored uy the inelm re- distribution policies of the previous Government and they have become accustomed to experienCig a 1.b.IIg UsanuarU of lving, i neUU be aU the expense of the higher income groups# They are politically vocal : - and not likely to take lightly any action by the Government which would infringe upon what they have come to regard as their privileged position. The new Government itself is based on an untested coalition. One of its pledges in the election campaign has been to bring down the cost of living, whereas in fact prices have been rising more rapidly since it took office. Thus any reduction in the standard of living below the level enjoyed in 1964 - however much that might have exceeded the level that Ceylon could afford - will undoubtedly cause the Government difficulties which one cannot ignore. 10. It, is, therefore, encouraging to note that the Government has agreed to an import program for 1965 which reduces exchange allocations for foodstuffs and other basic consumer goods by Rs. 200 million below the amount that would be required to maintain per capita consumption of such goods at the 1964 level. Broadly speaking, these allocations would mean a return to the 1959-1960 level of Per capita consumption. In the circumstances, such reduction would seem to be a reasonable contribution for the Government to make towards relieving immediate pressures on the balance of payments. In the case of certain commodities such as textiles and some subsidiary foodstuffs. the reductions in per capita consumtion that are implied in the import program as compared with 1964, may even prove to be too much. With reardA to theA. the situation will have to be watched carefully and some additional imports may be necessary to avert severe shortages and sharn increases in orines. Tn order to stnV within the "Limits of the program, corresponding reductions would in that event have to be made in othnr imnort.n Runh a diverqion would- of nourRp. be regrettable. However, if the Government succeeds in coping with the nolitin.l nre.qursq fnr 1nrar imnnor+ of consqmer anM that will undoubtedly develop, without significant concessions in the form of Inorr a01nntion- for impnrta of nnonsumer anAd it would otill make an important first step towards sounder economic policy. 11. However, it will not be possible for Ceylon to set about the task of restoring it -c-no'.V- to a level~ ~ cn ~ ,M~~ the stage is set for accelerating growth, without a large amount of ndditional fvoign aid. Thia +.nk will be an amerency rnation. Tt rill require flexibility on the part of potential donors in tailoring their f.niatance to +.ha mos+. uren+. nod nf Celans cnnnmr. For 1-rn and 16AA these needs will be mainly in the form of maintenance imports, not of financing SnpnifieI i'uaQJ'man. AL,D THE OUTLOOK fOR 1966 Government for 1965 was based on foreign exchange earnings for the year. 1Thi. est-ImaELU Utgethr WIth a forecast, of the amount of net foreign. financing that would be available, determined the amount of exchange ava1LabLe for iU pors. lte uUUget, aC UrawnI up, waS SuutquentLy aU- justed to take account of additional needs for imported foodstuffs, but in tme folloing dscussion it is referred to an bne Initia.L bdQget. 13. Iaoe I snows the approximate allocations for various imported goods in the initial 1965 import budget, as compared with imports in pre- vious years. The allocation of the 196> budget among the categories of imports in the table is only approximate, since the categories used in drawing up the budget itself were rather different (see Annex 1). 14. The last column of the table shows a revised import program for 1965, drawn up in consultations between the Ceylon Government and the IBRD mission and designed to increase the flow of raw materials, other inter- mediate inputs, spare parts and machinery, and to make some reduction in the present allocation for foodstuffs. Notes on the details of this pro- gran are provided in Annex I. Only the underlying principles and the broad outlines are sketched out below. The Initial Import Program 15. The priorities adopted in allocating foreign exchange among different imports in the 1965 import budget were substantially the same as those used in earlier years. First, imports of the three basic food- stuffs - rice, flour, and sugar - were fully provided for in accordance with requirements as estimated by the Commissioner, who is the sole im- porter of these commodities. As mentioned in Chapter I, these require- ments in 1965 for rice and flour were Rs. 172 higher than in 1964 due to a failure in the 1965 rice crops. This failure is estimated to have halved the domestic purchases which the Food Commissioner will be able to make in 1965. In view of the tight foreign exchange position and the increased rice requirements, allocations to textiles and subsidiary foodstuffs were reduced below the import levels of 196h. This was the first time the import restrictions were used effectively to reduce the sunnv of any mass nonsumntion items. Senondlv. government cornorations and goverment departments were allocated sufficient exchange to meet their renirement.. Thirdlv. nrivate industry was allnoated a nortion of estimated requirements for raw materials and machinery. Fourthly, the remainder of the availabl ovehange was allocated on h ns of ratios broadly relating this amount to imports in 1960-61. - 6- Table I IMPORTS 1959-19651/ (Rs. Million) Approximate Suggested present allocation allocation 1L9 9o 196L 1962 .90 1964 f or 19 - - i6 CONSUMER GOODS 1,203 1,195 972 979 919 1,172 1,134 17092 of which Rice 283 242 217 248 250 283 432 402 Flour 106 65 69 89 85 100 128 128 Sugar and Products 75 79 78 60 125 174 97 83 Milk and Milk Products 78 72 66 76 77 94 80 80 Meat, Fish, Eggs 99 115 77 62 65 74 54 54 Grams, Pulses, Currystuffs 94 113 113 117 112 139 145 145 Drink and Manufactured Tobacco 15 14 16 5 5 3 v.small v.small Textiles (including clothing) 179 196 172 149 83 165 100 00 Tires and Tubes 9 9 7 8 5 4 4 4 Drugs 32 32 27 25 20 26 25 25 Other Consumer Goods 233 258 130 140 92 110 69 69 INTERMEDIATE GOODS 396 397 383 409 372 410 455 523 of which Fertilizers 61 58 57 60 68 78 80 95 Petroleum Products 135 124 127 126 119 106 115 115 Other (mainly industrial raw materials) 200 215 199 223 185 226 260 313 INVESTMENT GOODS 389 355 339 337 324 305 361 446 of which Building Materials 88 100 89 100 77 93 58 65 Transport Equipment 146 118 100 92 100 58 70 93 Machinery and Other Equipment 155 137 150 145 147 154 233 288 UNCLASSIFIED 17 13 9 8 13 10 144 144 TOTAL 2,005 1,960 1,703 1,733 1,628 1,897 2,094 2,205 J7 The unclassified item in the columns relating to 1965 is nct directly comparable with the same item for previous years since, on present information, it was not possible to allocate all items in the Vport Budget for 1965 among the categories in this table. AA. AcensIng systlem is operated to control imports under tUe third and fourth categories mentioned above. Licensing for the third category is administered by the Ministry of Industries and Licenses for the fourth category are issued by the Import Controller. The licensing system is extremely detailed, with each importing firm being granted a license for each of the various commodities it imports, with no dis- cretion to switch exchange from one item to another. This tends to make the system inflexible and may result in a wasteful use of exchange resources. 17. The initial allocations for 1965 left little room for further cut--backs in imports of consumer goods in the present political circum- stances, apart from the reductions in the provision for rice and sugar suggested below. However, with the total foreign exchange resources at present available, the allocations for consumer goods, which were given first priority, necessitated reduced allocations for intermediate and investment goods which were well below requirements. Imports of raw materials have been allowed to rise far less than the growth of indus- trial capacity would warrant. Imports of fertilizers and other agri- cultural imports have been held below requirements. The initial import allocations for investment goods would result both in a further deteri- oration of the quality of the present capital stock of the country and also some curtailment of the expansion of productive capacity. The Re-rised Import Program for 1965 18. The possibility of obtaining additional foreign aid together with the realization that even the Dresent imort Drogram would leave a financing gap which could not be covered without additional aid, promoted the Cev1on Government to invite the Bank to anraise Ceylon's import requirements and to help revise the import program, on the as- Simntinn thit qMiiornql fnriorni-- wmd b vailablp- The Aim of the revised program is to increase both proportionately and in absolute amoun+ +he nntitr nf fnrpign ovhnn n11nncot1 to.n inn%ty. inftr- mediate and investment goods. As stated above the initial import pro- g~ramn ofrred litl scon fnv q rchiie-+in in inn-rt.r n~f e-nn.qimpr annrlq However, it appeared that rice and sugar requirements had been over- a 4nated and +hat+. _+ wuld be nossihle to make do with 1_ 42mllo less of these foodstuffs in 1965 than initially estimated, with only shortfalls in domestic rice purchases under the guaranteed price scheme, Or- u,,n .Oesln. c,,rr dm Ind v -F-- ei- An.-,+ P"Om, +Inan , +OThC +I,n ^l+InO ^nn-l sumer items in the import program have been left unchanged in view of eXltir Shortag%-Z andd. thle peliic-1 dfiUlte thMtwolbe U aSV V'J%-d_ -- ated with a further reduction. Among the intermediate and investment allocation for industrial raw materials fell well below the amounts needed Uo keep existing inusrial capacity adequately utaiizeU. te allocations for spare parts for both vehicles and other machinery were such that it would be possible to put in wor4±ng order onuy part o u -8- V MMIVIZAJG I %D". & £R.1jAL..CLUVJJJ L.L. MI1X..L110 , L.L ±VUJ.L VCU Cl tLLU- back on industrial development plans which had already been approved. Th1 -J~1ntaL.UL rLU U.L _L UULL.4.L UtCAJ LU .LbiuU:: WA :jUllus, 1.'UL zue pianosexun auu u *ou'*ovan sector would conut-u bterI shortages of commercial vehicles, while imports of fertilizer, tractors and ouuLUng materials wou.d be inauequate to meet requirements. 19. .or all these tems, increased allocations nave been recom- mended for 1965. The details of these increases, which total Rs. 153 million, are to be found in Annex I. it can be seen that the revised program for 1965 is a first step towards the longer term aim of chan- neling a larger proportion of the foreign exchange resources available towards maintaining and increasing the productive capacity of Ceylon. As compared with 1964, when over 60% of total imports were allocated to consumer goods, the revised program for 1965 provides under 50% of a higher total for these goods, despite a sizeable increase in rice imports. 20. It is difficult to estimate when these additional supplies will arrive in Ceylon, given the uncertain timing of bilateral aid agreements and subsequent delays in issuing licenses and actual ship- ment of the goods. The estimates are for a six-month period, for con- venience called 1965. No doubt in practice there will be an unpre- dictable carry-over into 1966. It should be further recognized that, while the suggested increases reflect the ri-ht broad orders of magni- tude of supplies which the economy could absorb in a six-month period, it was not possible in the time available to do the kind of detailed study, industry by industry and sector by sector which would be neces- sary to make a really accurate assessment of the needs. 21. Under the init-ial proaram. imnort licenses have been issued in two semi-annual installments. Apart from the Food Commissioner's imnrts01. nilnnitioni were mnrdp for R. (o million of imnorts for the first half of 1965. The value of licenses (including imports by the SU-n.nn rn+.ntin n+ of anvre rnen. j_q.qi orl n uIi n .TAnr yiinyrr +o May was also around Rs. 600 million, although issues within the total diffPriml in nrt.in items from thr nririnnl first half a11nqtions. Of these licensed imports, about Rs. 65 million were for government departments and non-industrial state orporations while R"_ 3. mlnon were under the licensing system administered jointly by the Import Con- been made again, with Rs. 535 million of licenses being issued. How- e ver, in V.L %.A.L UVJ VXLL. V ULIC7,V VL11U 4 LLLJ.L LO _J_)_) ±IL...4 .JI d. LIWV V 1kS. AUA .L1 in the third quarter, which might lead to an embarrassing bunching of pa-m n s pJayments o tI . Ue S _L_LUU10t:: -"I LIC± UL"I-JU LJUL1_.UU1- LICLV?; Ut::za limited to Rs. 360 million. Although it is not possible to forecast wi any precision wuIU bone rUtiLLU0 e reQ.rLLcb"n W4.±U vLn ii u1rm1 of value of orders placed and the timing of payments made, it is possible that there will be about Rs. 175 million of imports which may not be - 9 - not have to be made until late 1965 or early 1966. In addition, pay- menS amuun-1Lngs Lo some 'As. (V. mu'Uon on UeLla-LI V. ULIU rVU UV1iU- sioner will not fall due until 1966 and payments for some proportion of second half government imports also would fall due next year. 23. This means that on top of the suggested increases in alloca- tion of Rs. 153 million, there may be some Rs. 170 million of imports which will not be ordered until the fourth quarter, some of which might be included in an aid program. This makes a total of some Rs. 323 million of imported goods which it might be possible to finance under an aid program. This figure could be further augmented if aid sources were prepared to take over payments for goods already ordered from suppliers in their respective countries. The total aid suggested in this paper is Rs. 252 million (see below). This leaves some room for manoeuvre, which will be necessary since it would not be practical to provide every commodity under the aid program. Despite this leeway, it is likely that there will still be problems in matching commodities needed with suppliers in aid-giving countries and it will be necessary to see how far traditional suppliers can be fitted into the aid program and how far it will be feasible to switch to new sources of supply. Balance of Payments - 1965 24. The implications of the initial and revised import programs for the balance of payments in 1965 are discussed fully in Annex I and briefly summarized below. Export earnings have been projected at Rs. 1.83() million and some relaxation in the moratorium on the remittance of profits and dividends has been assumed. The revised program also orovides for an increase in reserves of Rs. 75 million. Tqhl TT (Rs. million Initial Program Revised Program Exports 1,830 1,830 Tmn..vL+fl .-9 -O o), Net Invisibles - 20 - 20 Financed by: Short Term Loan (exc. IMF) 49 49 r V e ( r -f )E- Reserves (increase -)-75 Vap VV) - 10 - 25. it can be seen that even on the initial import program after taking account of the IF drawing, a financing gap of Rs. 66 million emerges. Any shortfall in export earnings from the amount assumed would involve an even larger gap. If the liberalization of the revised program, involving the net increase of imports of Hs. 111 million, is added to a Rs. 75 million increase in reserves, the gap to be financed by additional foreign assistance becomes Rs. 252 million. It should be noted that the volume of import payments provided for in the table may not be all made in calendar 1965, but since commitments will be made during the year, it is necessary that the exchange should also be comir.tted. Financing the Revised Program 26. It is estimated, therefore, that Ceylon needs around Rs. 250 million in additional foreign exchange resources as soon as possible if she is to take care of immediate import requirements and make a start towards rehabilitating the economy. The form this aid will take is important for two reasons. First, it is desirable that the increased flow of supplies reach Ceylon as soon as possible. Because of the likelihood that aid tied to specific commodities will involve delays in the process of allocatina particular import reauirements to particu- lar contributing countries and delays in the course of bilateral negoti- ations for particular imnort items3 it would be nreferable if a con- siderable part of the foreign support for Ceylon's 1965 exchange re- niirements were in t.hi fnrni of fr- Pchanpe. Snondly. althonrh Ceylon's present external debt service is not large, any debt service is nariiffiil+br. rc in th+ tih tene ciicmstaqnncs of thep presezfnt. Ceylon exchange situation. It is therefore desirable that as much of the ass Stnc as pos-'ole sholltd be. n rant or 'Isoov'+ t Prolpect forY-et 1966/- ad106 (Rs. million) Revised Program Exports 1,830 1,860 Net Invisibles - 20 - 38 1jul cli -,. 7;? - )V Financed by: rants and Long Term Loans (net) _LU 47 Short Term Loans (exc. IMF) 49 - 48 Ind knet) U - Reserves (increase - ) - 75 - 50 Gap 2 2 a9 - 11.- LC. I U L",±U IUJiMda LLe ufLPJu'.L' 4L~iIL L u -L7uu ±YOlia not been attempted. This will have to be worked out in the course of tne coming months, in the lignt of te progress uat iS maue in rectifying some of the crucial shortages. In order to make a rough estimate of import requirements in 19yo, a return to normal rice crops and unchanged per capita consumption of food and textiles has been assumed. This gives a saving on these items of Rs. 115 million over the revised 1965 import levels. Increases in the allocations for inter- mediate and investment goods of Rs. 10 million over the revised pro- gram for 1965 have been tentatively assumed. For raw materials and other inputs, this broadly assumes that full requirements for priority industrial and agricultural activities will be met. The increased alloca- tion for investment goods is a more shaky estimate, since it depends on the number of new public and private investment projects which can be prepared on a reasonably satisfactory basis. Taking account of a reduc- tion in commodity and project aid at present committed for 1966 as com- pared with 1965, a total import figure of Rs. 2,210 million emerges. 28. This estimate may be somewhat low since no increase has been assumed in imports of non-industrial government corporations or govern- ment departments which might, in the event, prove necessary. Table III shows that with a slightly higher level of expected export earnings in 1966, not entirely offset by higher net payments on invisibles (due to some further relaxation of the moratorium on dividends), the current deficit works out at a slightly lower figure than in the revised program for 1965. On capital account, only foreign loans and grants already committed have been included. It has also been assumed that there will be a decrease of Rs. L8 million in short-term liabilities and also a further increase in reserves of Rs. 50 million. All this results in a financing gan of around Rs. &iO million, which may be taken at this time as an approximate assessment of reasonable foreign aid disbursement requirmnts during 1966- To the extent that aid nommittments in 1966 were for projects for which actual disbursements would be spread over a nmber of years, hhe an t of aid cofmmiTmnts in 196 rqud eir t .b correspondingly higher than the figure of disbursement requi.rements. - 12 - III. THE NEED AND SCOPE FOR CORRECTIVE ACTION 29. For the reasons explained in the introductory chapter, there is at ths root of Ceylon's current exchange problem the fact that at the present level of domestic demand exchange requirements exceed exchange earnings by a considerable margin. Even if imports of consumer goods, including foodstuffs, are kept in check by import restrictions as outlined in tha preceding chapter, meeting the needs for imported intermediate goods and providing for a moderate increase in capital stock involves a financing gap of some Rs.425-475 million, or US $90-100 million a year in the immediate future. Moreover, there is no ground for optimism that growing export earnings will diminish this gap over time. 30. Despite moderately favorable prospects for increasing the volume of exports, it would now atmear that export earnings in the period until 1970 are not likely to rise by more than Rs.30-40 million a year., This projection is based on the assumption that the price of tea will declinn slightly in 1964-1970 and that the prices of rubber and coconut products will decline by 15-20%9 below the 1964 level durine the remainder of this decade. Table IV Actual and Projected Exports (Tfs- miffLonj 1oC0o 10A.1 loAL, 1QA7 1Q7 PrArille.tAnn (Twillion lbs ----) ).1.... 41 485l A82 e f7 Exports (million lbs.) .,...,,,,,,,, 384 456 455 493 540 TTnit ny-in (e no-h 1 9 70 Efn. . EN 2 I7n 2 kn Export value (Rs. million)........, 1046 1141 1140 1233 1300 Rubber Production (million 1bs.),,,....,. 205 231 246 287 330 Unit price.(Rs. per lb.),....... 1.45 1.23 1,19 1.05 .95 Exports (million nuts equiv.)....... 1131 1216 162 1n90 1600 Export price index 1/,............ 106 80 83 77 71 Exportsvalu (Rillion ntsequ)....... 2131 116 123 240 2 (Contd) - 13 - 1959 1963 1964 1967 1970 Other domestic exports (Rs, million).. 105 110 137 140 150 Total domestic exports (Rs,million) .. 1693 1706 1840 1915 2040 Re-exports (Rs. million)SO10.,0,.... 62 26 34 35 35 Total exports (Rs. million).,.....,... 1755 1732 1874 1950 2C25 1/ 1959-1960 = 100 Composite index for coconut oil, copra and desiccated coconut. 31. These prolections imply that over the next five years export earnings will grow by an amount just sufficient to meet the increasing requirements in imported consumer goods. including foodstuffs. resulting from the growth of population. Without major advances in import substitut- ion, there would be no room for increasing the provision. out of Ceylonts earnings, for intermediate and capital goods, and the financing gap would rema:Ln unchanged- Even if one were to assume that foreign aid at the level sought for the immediate future would continue indefinitely, the imnlications of such nrosnents are dim indApd- Thav wmuld suggest that the supply of goods in the economy will barely keep pace with the growth of nnnilAtiAnn_ ie._ that the stnrinr elof livino will niot imnrnve 32Te gnrawvr_ ifP sucnnh bl0onle nrqAtt weimre to nte4l.te woild solely reflect the Government's inability effectively to exploit existing n + +4 a -P^-A + n,4i4P fl+,,e nA Yfwnm5ne+ ^f +hm knnnin e%f payments. They would certainly not be warranted by the potential of the cnn, .wr P,'. A_-1 -~ -~. - -na -l . - T- - - ,4-4-1-~*, 4+ --1,a,A *'nno,+1-In+_ +hI economy, with the help of foreign aid would be capable over the next five years to make sinfcn prgrs toad ovromn -theu retIL 4 .Tlno the present exchange shortage imposes on growth. The Possibilities of Growth 33. It should be understood that at the moment no development program LOI tvJt dU 4,Uab, 11 11,14OLVU611 OUULZ V.L ILUtf UWVIW.LVJILJ"&# ~JL~J . the major sectors of the economy have so far been undertaken. All projections Wna unu I n m1arW now are Uuxulore Waou LargmLy on rougu cos.meone unu guesses and the results are, at best, illustrative of the direction and pace of growth that might be possible in Ceylon in the period until 1970 34, 'Tne contrioution wacn export agricuLture w3JL be aole To make to growth of income over the nt few years wilprobably be limited. Invest- ment in replanting offers opportunities for accelerating the growth of output in the future, but as it takes five years and longer before replanted acreage begins to yield, the effects of such investment would not be felt befcre the early 19701s. Moreover, the increases in fertilizer use and improvements in cultivation techniques will in considerable part be offset by declining prices if present views on the prospective markets for rubber and coconut products are borne out by events. Thus, as shown in paragraph 30, earnings of export agriculture are expected to increase by only Rs.200 million or .2% between 1964 and 1970. - 14 - . 5 in view o tis export outlook.. it5 Ls eviaent wat Ceya.on 1 growth prospects depend primarily on the possibilities of increasing production for domestic use, principally along inport-saving lines. Considerable opportunities for growth along such lines appear to exist in domestic agriculture. Increasing the production or rice has been one of the more favorable aspects of economic performance in the past, If growth continues along the past trend, it should be possible to increase the output of rice by about 5% a year. Such growth would suffice to meet the needs of the increasing population and would permit imports to be kept at the present level of 500,000 tons in normal crop years. Other major possibilities are in subsidiary foodstuffs of which now, excluding milk products, some Rs,250 million are imported annually. If a program for the cultivation of these crops were worked out and a determined effort made it may be possible to replace about Rs,80-100 million of present imports by local production over the next five to six years. Promising possibilities also exist in expanding the production of fish. Plans for major investments in small and large fishing craft do not appear to be wholly unrealistic, and althouRh it may be too soon to look forward to the time when Ceylon can export fish, it should be possible to reach self-sufficiency by 1970. Altogether. including expansion in the production of suzarcane to the full capacity of existing mills and some acceleration in the growth of output of meat. Doultry. eas and various minor mroducts. it may be possible to raise the output of domestic agriculture by some Rs.500-350 million, or roughly 30% by 1970. 146- Tn annmaiinp thp nnssibilitiAn fnr fiirt.hpr innst-tal (iAvA1_nnThPnt_. it is well to remember that Ceylon's open economy and low tariffs virtually nrecluded maor navances in this f0ild unt1 the hegnning of the 1 0ts when import restrictions were imposed, Thus, there are practical and Awarmona4va annaw^--+VnY4+4,nc P-v- 4mn_"e an e4+s4 ro aAn w n a A W1 Y . h,.. &.Q& w a.Ir J 7 W W fJJ Wj ka%JS JVW& a a. products and the main question is whether entrepreneurs and capital will be LV-JLWS% U~LJLIAr,). .L4 OU.L.LJ.6%LAW UL&AW.W.%Q* 1CJVA_ kJVCQO.U..L. V.LWQ =&J.LLI VjWIV.L.VQ where present capacity is sufficient only to meet less than one-third of consumptuin. Enough other opporunIIL.LU ULst in a wXUe variety of other fields to enable output of manufacturing9in the private and public sectors, to grow by U a year on t1w average, Tiso would MrWae ouput uy roughly Rs.250 million, or about 50% by 1970. 37. Economic activity in the commodity producing sectors as described above, comDined with the investment required to support,it would exert a strong influence on growth in the rest of the economy, particularly construct- ion, transportation and trade. Taking all sectors together, it would seem that gross domestic production could grow by about Rs.1,800 million or 25% between 1964 and 1970. In other words, gross domestic product could rise annually by around 4.5%. The Implications for the Balance of Payments 38. Growth at the pace and pattern described above would imply that over the next five years the pressure of imports for current consumption on the balance of payments, which currently besets the economy and circum- scribes its ability to grow could be relieved appreciably. The possibilities, - 14 - which appear to exist for improvement in this direction, are illustrated in the following table: Table V. Balance of Payments (Rs.million) 1965 1970 Exports 1,830 2,040 Services, invisibles (net) - 20 - 80 i1,81l0 -1..960Eo + Foreign grants and loans (net) 470 340 - Increase in reserves - 75 - 2,205 2,300 Composition of Imports: Consumer Goods 1,200 900 ofwich: Fodstuffs 9 0 790 Textiles 100 80 Other consumer goods 150 130 Intermediate Goods 550 800 of which: Fertilizers, agrochemicals 103 17 Petroleum products 115 110 1/ Industrial raw materials and other intermediate goods 332 525 anital annds h<0 Ann 1/ Assumes that the Government carries out the planned construction of a petroleum refinery, 39. As illustrated in this table, it would appear that such major advances in the domestic production of foodstuffs and manufactured consumer goods, which seem to be in the realm of practical possibilities, could make it possible over the next five years to reduce direct imports of these commodities, Such reductions, together with the expected increase in export earnings, would enable the econony to become less dependent on net foreign aid and yet to maintain imports at a level which would support a much increased manufacturing capacity and an enhanced investment effort. The Implications for Consumption, Savings and Investment 4o. Imports of capital goods at the level projected for 1970 should make it possible to support gross domestic investment in the order of Rs.1,,500 million. Historically, investment has had an import component in the range of 30-35% (at c.ief, prices). If investments in manufacturing - 16 - increase their share in total investment, as is assumed, the import component of investment will no doubt rise. Assuming it to become about 0%, imports of capital goods of Rs.600 million as projected for 1970 would enable total investment in the order of Rs.l,,500 million to be undertaken. If each rupee in additional net output were to require investment of Rs.3,00 - 3.50 - which would require substantial improve- ment in the use of investment resources as compared with the past record - investment at such a level would generate additional real income in 1970 equivalent to 4.5 - 5% of gross domestic product. Growth at such rate would correspond to the projections made earlier. Investment in the order of Rs.l,500 million in 1970 would be roughly equivalent to 16% of gross domestic product projected for that year, as compared with 13 - 14o in 1964. In order to reach this level, investment would have to rise by 50% in absolute amount. or by 8% a year, over the period 1964-1970. It would not appear to be entirely unrealistic to think that such increases could hA nnhipvpd- l. TakdnL achisvement of such a IvAl of invstm+.nti as the determinant of the other national income aggregates, the position in 1Q70 as comnared with 1QA- may h 411in.ncj ns fnlinT. Table VT (Rs.million) 1964 1970 GDP (at factor cost prices) 7,200 9,000 * .LL4A.& W' U LW'U "A V 14 L4L.4,) + Net imports 200 350 Total Resources 7,820 9,800 -~.. &VI1IU .1%AJV uioumi-4"on ovou %.AU P.Jj VD.L. OUUVU U.-) U U Domestic Savings 820 1,150 44. It would appear possible to permt consumption to increase by about 3,3% a year during the period 1964-1970. Simultaneously, population may be expecTed to grow annually Dy e, - 2eoo. Hence, it would still seem possible for per capita consumption to rise by 0.5 - U.8% a year without Jeopardizing achievement or the stipulated level of investment. For the period as a whole, marginal savings would have to be around 20% in order to raise domestic savings to 12.5% of GDP by 1970 as compared with 10.5% in 1964, Thus the policy requirements with regard to consumption would appear to be manageable, However, a word of caution is necessary here, Achievement of the acceleration of growth projected is vitally dependent on the availability of -17 - imports of intermediate and capital goods. For these imports exchange will be available only if imports of consumer goods are reduced at the same pace as domestic, import-saving production increases. For the immediate future this probably means that strict austerity will have to be observed and that no increases in per capita consumption are possible until domestic. imort-savin7 nroduction Lrows sufficiently to make improvements in the standard of living possible. The Iplications for Economic and Financial Policy 43. Economic improvement along the lines illustrated above will nt n ch n nm n mT.+.ow ^f anni"o T+_ r.Tcnen 411 -mon-Mv-m n ~ bou as a matte of coursev -- It ac-veetwil -eu determined action on the part of the Government of Ceylon over a broad front ofjvnn&nca ndi economc polcies At ths sa.ge +-c -Wr is ob iculyN not possible to state in detail what these policies should be. In broad o,itli4ne - -~erne aproc - - --. 1 -1 -- +- I-P4 - -+ OJ.& C LLVV&J% &JIJV WWJ LV I L.J.&L W V Wj prevent the creation of additional money incomes in excess of increases V.LIA UJ±L& VJL%~UAOL.L VI.. X6Oj UW414aL.L1%A%JAL.'11 UVJ1XLL1%A .LV.L- .LMVUkJ. VO# W.LU11IJ. the limits of available resources. Secondly, to ensure that, in contrast to tUe past wUen inurwueu in rebour"eb UenuUu UQe be aooruUu UnrieLy by additional consumption, a rising portion of such increases is devoted to investment. Thirdly, to follow a pattern of investment that gives first priori-by to growth along import-saving lines in agriculture and manufacturing as well as to the growth of export agriculture. Financial Stabilization 4. In a situation where, because of excessive monetary expansion, resources are inadequate to meet monetary demand and therefore prices rise, the temptation is inherent to assuage social discontent by allowing more imports of consumer goods, if need be at the expense of intermediate and capital goods. This has been the pattern of events in Ceylon for too long to be confident that it would not continue if excessive monetary expansion were allowed to persist. Financial stabilization will, therefore, have an important role to play in achieving economic improvement, 45. As a first step in this direction, the Government has concluded with the International Monetary Fund a stabilization agreement covering the twelve-month period beginning June 1965. This agreement provides, inter alia, that the net domestic assets of the Central Bank should not increase by more than 7.5% during the period. It also imposes limitations on the size of the budget deficit requiring bank financing and on the expansion of bank credit to the private sector. In view of these various limitations, net domestic credit is unlikely to increase by more than 6-9% during the next twelve months, as compared with about 12% annually during fiscal years 1961/62 to 1963/64. 46. It is encouraging to note that the outcome of the budget for 196h-1965 will probably involve only a small deficit requiring bank financing, perhaps in the order of Rs.40-60 million, as compared with rmahlv Rs.1( millinn in the twn nrevions vAars. However, it is also - 18 - important to recognise that this improvement in the Government' s overall financial position has been the accidental by-product of the failure in the 1965 rice crop and the fall in sugar prices. As a result of these events, net food subsidies will be some Rs.120 million less than in the previous year. Nevertheless, collection of revenue was also stepped up considerably, after having stagnated for two years. This increase, together with economies in current expenditure, made it possible to raise capital expenditure significantly above the very low level of 1963/64 and, as stated above, to reduce bank financing of the deficit by a considerable amount, 47. The Government has also undertaken to present a budget for 1965/66 that promises to keep the inflationary deficit within the limits stipulated by the agreement with the IF. This will be somewhat more difficult to achieve than in the present year, Revenue at existing rates of taxation is unlikely to exceed significantly the amount expected to be realized this year. However, funds available to the Government from non-bank domestic sources may be some Rs. 25 million larger. Assuming foreign aid for Government use to be unchanged, total expenditure could rise by about Rs. 90 million without violating the limitation on bank financing of the deficit. Of this amount, at least Rs,25 million should probably go towards increased caital outlays. Another Rs.h0 million would be needed to cover additional food subsidy payments if the 1966 rice crop were again normal. Contractual obliations covering pensions. interest on public debt, etc. are likely to require Rs.15-20 million more than this year. Thus. there may be a margin of about Rs-q-10 million left fromwhich increases in other current expenditures could be met. This corresnnnds- nverall. to an innrasA of lnsa than 1< Kn.nino qdditAnal expenditures within this limit would be a major achievement, and the Treasury is attampting +n Ansve that h i imit . ll be kpn+ w4h1 AhIpn-nt h also considering possible ways of raising additional revenue. 48. While the coming fiscal year may be difficult, it is in 1966/67 tht1 eros rn+, are 1-11-1- to --4- in -u4+-- ng prge s +n --..e rd - financial stability. Depending on monetary developments and the credit nonAQ ^.f' _1-, v"4-mo m nw w 4 + n-tr, V% A~~ a- n'l +^,=A le~.0,h,d f4n~~ nn"f of the budget deficit substantially below the 1965/66 level. Also, capital the food subsidy bill may go up by Rs.30 million, and payments of pensions, .Lnerest e L-oJ %D Zl e 20 11 11 %JJ. L AOU J1_L_LVVV.L46 Al 11'J. A I AL.A U .L%J. in otter current expenditures raises the total amount for which additional revenue will have to be fuUnU to e1J.-4"ug UL1u u u u considerable margin the additional revenue likely to be forthcoming, unlss taxes were ncedu Du-uer - [o1wVW1, for the reasons expaed in the next section, such additional transfer of resources from the private sector would be unue-irale. ius in order to ensure continuing progrezn towards financial stability, it would appear imperative that the Government look for ways of stemming the ever-rising tide of current expenditures J-n Ceylon's welfare state. It is unlikely that this can be achieved without touching the food subsidies which in normal crop years will rise by Rs.20-25 million. As the minimum, any plan that the Government may devise - 19 - should provide initially for keeping gross payments for food subsidies cons' at i U J L7U~21 UU L1,vJ U. .L cILA. LA L.' 160. 4 1 -,, I1iL LL ~ reduction below this level is achieved in the following years. In addition, a start should be made in eliminatig the operatiUg lose OU goveUment enterprises such as the railways and posts and telecommunications as well as publ ic corporations. So far, the Government Ias not decided on a course of action for meeting the financial problems likely to arise after the current fiscal year, and no specific commitments have therefore been made. Definite assurances will no doubt have to be obtained towards the end of 1965 or early 1966. 49. If a major aid program for Ceylon gets under way, the problem of public finances in particular and of overall financial stability would probably be eased somewhat. Indirectly, aid-financed imports of inter- mediate and capital goods would help expand economic activity, and such growth mould improve the supply situation and be reflected in increasing Government revenue. Directly, aid would probably generate counterpart funds. To the extent that aid finances commodities other than capital goods for which it may be desirable to grant the ultimate user extended terms of repayment, it would appear reasonable to expect the purchaser to pay immediately in rupees. During the emergency phase of the aid program, commodLties suitable for the generation of counterpart funds are likely to constitute the bulk of aid-goods. 'In order to facilitate drawing up and administering a rational program for the use of counterpart funds, the Central Bank should be the depos itory. qO. Thp accumilation o f ciinh -riin e wnii .peet ihrwlo purchasing paer from circulation. It would, therefore, be deflationary. In~ .ho Pnn+.o% ^ n m~r-nY-m othe-i ; desgne to- expA economic a &-t and to accelerate growth, a large measure of deflation would hardly seem de j n *%n Tk +'n -.s -;- to wb a U~1 4LI e-4 -3l L -U±~ expansion of credit should be permitted as counterpart funds accrue. The pare1y oUjcuiV guiding te use o counterpart funds should be the achleve- ment of monetary stability. It is roughly estimated that adherence to this W q ;4V-J- V v VUULAU ±LU]"U IULIV jF1JJl.L.L JJL- !it t LEI IIU[IULV biUJJIJ-y to 15. ( V-U V Mli. a year. In contrast, it is now expected that in the immediate future bank financing Of the Government deficIt will be at an annual rate around Rs. LU million. In addition, exchange reserves are projected to rise by Rs. 75 miUaLlo L 1Y6 ana R,s. 5u million in lyoo. It is clear, therefore, that in order to offset the expansionary effects of these increases and to bring the rise in money supply within the limits consistent with monetary stability, a considerable part of the counterpart funds accruing will have to be frozen in the Central Bank. As for counterpart funds in excess of this amount, ways and means will have to be devised to ensure that any credit extended against them would serve to finance additional investment, particularly in the private sector. 51. At the moment, it is not possible to predict in what amount counterpart funds are likely to accumulate as a result of an aid program for the latter half of 1965. It is also not clear what preference, if any, various donors may have with respect to the use of counterpart funds. Moreover, when these - 20 - facts are known, the general objectives set out above will have to be translated into operative terms and. the ei agreement amenaed with respect to the use of counterpart funds. Finally, an understanding should be reachei with the Ceylon Government to ensure that the use to which counter- part funds are put serves a twofold purpose: first, to help bring about internal financial stability without lessening the need for action by the Ceylonese authorities; secondly, to increase investment. Allocation of Resources $2. It is certain that whatever Ceylon may be able to do in improving the productive returns from investment in the future, it will have to devote a much larger share of its total resources to investment than in the past, if it is to reach an adequate rate of growth - say 4.5-5.0% a year. The illustration that was presented earlier of a possible pattern of resource allocation in 1970, suggests that investment would have to rise by 8% a year. In absolute terms, this would mean an annual increase of investment by roughly Rs. 100 million. In order to free the resources, both internal and external, for investment at such rising level, a major change will be required in the pattern of resource allocation as it has developed over the past ten years. 53. In any effort to arrest and to reverse the past tendency of con- sumption expenditures to absorb an increasing share of total resources at the expense of investment, the principal role will fall to the Government budget.. Instead of continuing to be what it has become in the past. namely a collector of funds for the benefit of income redistribution, the budget will have to be geared to facilitating economic growth. Such a shift in emnhasis would affect both revenue nnd eynenditure noliri-s. In th. ou.t. the bu:-den of financing rapidly expanding current expenditures fell almost evolnsnIvely on exrn-ag.iculture and +he middle and hicher-inonme gvrnn It appears that this burden has been raised to a level where taxes come into public ar, through subsidies, private consumption. This process has Sh). Asrgrsrvneplce,there woul1d appear to be wide scope for action. One of the most urgent topics for consideration would be the enjoys the benefits of free education and health, virtually free irrigation OU V v.l ;Q C 0 tAFJV.LVJ L JL.L%,V0 A.%.L iJO XU%AY OL10.U_1/UVVL t-L -JTi cL e IIe o ld C.r'uV -p ic an various subsidy schemes for fertilizer, seeds and seedlings, but contributes litl to revenue . Lorver,Vt ' aseplie U.P..Earlier dmriestic;' dgV'1_o.urU1 is likely to benefit further in the future by an intensive effort to increase producaton wnicu will iuvolve consideraule uovern1ment outlays. There wuULU thus seem to be ample justification for making a major tax effort in domestic agricu.Lture in order to keep increases in consumption there wirnir permissible bounds and to avoid having to raise taxes elsewhere in the economy in order to finance the increased outlays on agriculture. Such a tax effort might include the levy of higher water rates and the re-introduction of the land tax, complemented by a reduction in the producer subsidy on rice referred to belowo - 21 - 55. With the same aim of curbing the increases in overall consumption ex-Penitu.rep it wuld tippea4nr -oqnecsayto f consideir raisqi ng t.he. ri rp.- of government enterprises and public corporations which are now incurring employed. The railways and post and telecommunications are now incurring Board, although much improved, is earning only a marginal return on its ca a- UL .L L UAId LtOg L.UVJ 11"LL..LU19 LJUCLt.V L."LLUOU Cli %'VL.L ~ .LJJV1 .WA achieved a net return on capital of only 2.8% overall in 1963/64. Thus, un1rouu a1uprpiaEut prig punwee; 1t uIuuiU.u Lie pujLnu.Le W race)V t-VCnUU by at least Rs. 60 million. 56. Against these possibilities for raising taxes as a means of curbing the growth of consumption and thus facilitating increased invest- ment, the case for reducing certain taxes, that now appear to impede capital formation in the private sector, should be considered carefully. This question was mentioned earlier in the discussion of counterpart funds. It is premature now to estimate how much tax relief may be needed to ensure that private sector investment plays its assigned role in developing the economy as no development program yet exists to show what the role of the private sector will be. However, it is clear that at least a large part of the plantation industry would find it difficult, if not impossible, under present taxation to finance the major investments that will be needed to make up the accumulated backlog in vehicles and plant and machinery. To facilitate capital formation in other sectors of the economy it may be necessary to review present tax incentives for investment. It appears that present regulations make it difficult for potential investors to avail themselves of such tax benefits. 57. In addition to revenue policies, the Government will also have to reappraise existing policies governing current expenditures. The need to restore financial stability will, in the short run, make tight and rather indiscriminate ceilings on increases in all current expenditure items unavoidable. However, they are no substitute for a thorough-going review and, where appropriate, revision of present policies which give the budget a strong bias in favor of outlays on transfers and social services. Some of them, such as free education for all from elementary school to post- graduate studies are generally considered to be essential elements of a modern welfare state. Yet Cevlon nan ill afford them And nrrhans it will be possible to consider some modification that would free some resources for invP.qtTmPnt nnd aroAh_ CM. The needi fnr -nn eqrly, revtiewr of- foodi qiihirlpc hn--~ nlronrli been mentioned. It needs to be stressed again in the present context because i+ wuld eh AiP-4 Nii1+ +r% cinle nu+ anr n+hr nlir +ha+ hs donn so much to distort the pattern of consumption and production. Tn its effect on at tIe expense of substitutes like wheat flour which, for the economy as a consumer items. As a producer subsidy, it has encouraged the cultivation - 22 - of paddy to the extent that other, economically more valuable crops are neglected. It is difficult to see how a sound agricltural deveooment policy can be devised without some modification of the present producer ,ubsidv on naddy. 59Q RTven a bhrieof survey of thei posszii1it.iesz fo)r curb ingr the1 ornwt11 of consumption through changes in Government policies and practices would sector. Although no comprehensive data about Government employment are ing teachers ana doctors,has risen by 60% in the past seven years suggests U.LI. L L ;WL~1t~LL 1i0 ±L e.O U Vt:±,y UU1101iUU1LUJY* Z':J.VL c tALI. _LLAJJ1t:;11U0 11t.JY represent more than one-third of total Government expenditures. It is also eviuent uLIaU puvk UliUU1VL1 aLbu dul-u-UIb ae goVty ov6UcULt:u ct a result of political patronage. The use of public employment for political advantage and public welfare is of course not unique to Ceylon. However, in a country where the public sector is as large as in Ceylon, the waste of resources involved in such practices can easily reach large amounts. Con- versely, a reduction in the public work force through nomal attrition, could, over time, yield significant amounts for more productive purposes. Direction of investment 60. This is the area where it is least possible to be specific about Government policies. Too little is presently known in detail about the requirements for investment in the various sectors of the economy to achieve growth and improve the balance of payments along the lines suggested earlier. These, it will be recalled, stressed the possibilities of substituting local production in agriculture and manufacturing for imports. The pattern of investment should reflect the urgent need to exploit these possibilities. To serve this end, Government policies with regard to investment will have to undergo major changes. 61. The extent to which growth of agricultural production, particularly in the field of subsidiary foodstuffs, will accelerate will depend decisively on the Government's efforts in this direction. The Ministry of Food and Agriculture recognizes the need to modify the exclusive concern for paddy cultivation which is reflected in the design of the major irrigation schemes, in legislation reserving the use of water from such schemes exclusively for paddy, and in the producer subsidy for paddy. The recognition of the need for changes in this respect will have to be translated into anDrooriate action, including provision for closer coordination between the Ministry of Food ard Agriculture and the Ministry of Lands. Irrigation and Power which designs and constructs the major irrigation works. 62. In the immediate future, the extension of irrigation facilities to suh.idiary fnnH.qiff.q will ruire-a n eontrnion of mannower and nt.h.r resources which may be incompatible with a continuation at the present lOval of maoin laed oalvepmen+t tchaem alon +the traditinael pattern. Officials in Ceylon have estimated that about 200,000 acres of irrigated - 23 - land will be required to replace present Limorts of subsidiary foodstuffs worth Rs. 120 million. Chrrontlv. Rome 4040.000 Acres are brought under irrigation annually under various programs and schemes. Although lift i rria-q+.inn -Prn-m nv--i.q+.in n117 -'Pq nf T.T-+Pr m_qv nrmHrie 1unter for nq~rt of the irrigated acreage required for subsidiary foodstuffs, it is evident that a redirection of reSOu rces away Pvrm t-radiinanl schemesa will pro)- bably have to be considered, if a program for increased cultivation of subsidiary foodstuffs is to be c rid ou + . _'. 1JI or th d ve-Lopment of L . .J ,L 'J - -. - -I -~L - appear desirable to subject present practices of land development to a ing the period of construction and lowering the cost, possibly through pz1U--W.V- ofL fe-wer amenties to settlerS. Tt Should cub to5r es)tab)CW_lsh the characteristics, in size and cropping pattern, of viable farm units which do not serve to perpetuate rural poverty and inefficiency as present policies are threatening to do. 64. Outside of agriculture, present policies with regard to trans- portat'on and manufacturing would seem to require reappraisal. in trans- portation, the future role of the railways in passenger traffic, in relation to the Ceylon Transport Board's buses, and in freight service, in relation to private road haulage, would a?pear to be at issue. The future develop- ment of manufacturing depends a great deal on the Government's policies with regard to the delineation between the private and public sectors as well as to the operation and expansion of public corporations. As explained in the background paper, manufacture of a large number of so-called basic or essential commodities is now reserved for the public sector. Strict delineation along these lines explains in part why private industrial development in the past has frequently taken place in fields of relatively low priority. If this delineation remained in force, it would not be pos- sible to tap private initiative, talent and capital for a large part of the major investments in manufacturing that seem to be called for. However, without a major contribution from the private sector it would be highly doubtful if growth anywhere near the pace sug!ested earlier could be attained. 65. As regards government-owned industrial corporations, it would appear desirable to undertake a study of their operations and management, including pricing policies as mentioned before, in order to determine by what means their contribution to national product can be improved. The policy implication here would seem to be that these corporations should be run as business enterprises. not for welfare purposes. As for future investments, involving the expansion of existing lines or entry into new ones. economic considerations of reasonable returns should become the Drin- cipal criteria for decisions, instead of political advantage or ill-defined notions hoiit, the need to hild nn qn-illed hasir industries reardle-s of expected return on investment. - 24 - Conclusions 66. The projections that were presented earlier in this chapter are only illustrations of the acceleration of growth and the imorovement in the balance of payments that might be achieved by 1970. They are not projections of develonments that one might Pxnpct. as q matter of conurs. to follow from present policies. This fact cannot be emphasized too much. There is in Ctavlon at the nresent time no functro n mnP cn Petent nlanning off ice thnt. could prepare projects and programs and that could be relied upon with a reaonale egee ocnidceto translate th.em. into reaity, --- -- office is only now being set up. Furthermore and, in this context, per- lines of policy which it intends to follow. It has also no-r been in office lory enou ,g1to0halve e anted na n ,rcord of.4 aci-v ---- .- ,-?i ~, n,, ^Ir hon one's expectations for the future. 67. There is no doubt that carrying out a program of development that MLD. jJ101.110u, of ac e.L--l-dULJI4, r,1UW 11 c=LU _U1IJJ1U VLI1r, Li4t, UkdLCUL U. Jj111:I1 U along the lines suggested earlier, will in many respects require a sharp Ueparture from the policies and practices of the past. In decisions regard- ing economic policies, including the pattern of investments and the choice of pro;ects, considerations of economic benefit have to replace political advantage as the principal criterion. The growth of consumption will have to be contained, affecting prImarily the majority of population in the lower income groups, by changes in Government policies with regard to deficit financing, taxation, subsidies and the provision or free services, and the pricing of services and goods supplied by public enterprises and corporations. 68. It is possible that the new Government will accomplish the much- needed improvements in the management of Ceylon's economy. However, it should also be recognized that almost every step toward sounder economic policy is likely to be highly charged politically. For this reason, there is the likelihood of considerable frustration and even the risk of complete failure which no one should fail to recognize. However, along with the risks, there are also promising chances for economic improvement which appear to be sufficient to justify external support. 69. In the expectation that the most urgent exchange and monetary diffic,itties will be taken care of through foreign assistance for 1965 import requirements and through the stabilization agreement with the IMF, the Bank has discussed with the Ceylonese authorities the problems which should occupy official attention over the next several months. A brief outline as it was handed to the Government of Ceylon is attached as Annex II. 70, As a condition of further external assistance the Ceylon Govern- mon+. 01ima e he xpeted in the course of the next six months to formulate the policies and programs which it expects to follow in improving the tcoen t a enit Spr to t.-i's.0,d sul b -muNTan't 7An t +trt time bu.t a definite program to this end should be formulated and started - 25 - as soot as practicable. The elements of the program should encompass the following: a. Further progress toward monetary stabilization. Counterpart funds accruing from foreign assistance should be allowed to accumulate as an offset to budget financing by the banking system to the extent necessary to maintain mone- tary stability. b. Providing, to the largest extent possible after allowance for necessary consumption imports, for imports to use and maintain priority production capacity and to carry out important public and private projects. To this end, a detailed balance of payments program should be prepared for 1966 on the basis of projected exports and expected receipts and payments on transfer and capital accounts. The program should be prepared within the limits of a gap between exchange payments and receipts already in prosoect of no more than $100 million. This should include provision for a further increase during 1966 in forein exchange reserves of at least the equivalent of Rs. 50 million. c. Policies and measures of development to ensure over the nevt four nr five yern a bhtantial favorqbl impact on production and the balance of payments. The need is 'm- naprorm of pYrc.tcabhIe stepsz nencssa-r +.toiaccleratei production and import substitution in, e.g., rice, subsid- should also establish priorities for public investment in year which will indicate the steps to be taken in 1965/1966 and in Ue subsequent three or four years to manage puulc finances in a way to increase the proportion of domestic rsu o devuouu u uumoeavc aeve±opmeu expenuIouLe within a stable monetary framework. This will require an CApau±u In public savings and it is difficult to see how this can be accomplished without a progressive reduction in Government subsidies, especially the sub- sidies for the production and consumption of rice, Hence, the financial program should indicate the intentions of the Government to reduce over the next four or five years the subsidies and to take other necessary measures to increase public savings. Measures should also be specified for improving the financial position of government corpora- tions and enterprises. Finally, the financial program should indicate priorities in the use of additional financial resources resulting from expanded foreign assistance; e.g. in increasing public development expenditure and providing additional financing for private development either directly or by reducing selectively the burden of taxation where this might facilitate private development. ANNEX I THE IMPORT PROGRAM AND BALANCE OF PAYMENTS IN 1965 AND EXCHANGE OUTLOOK FOR 1966 A. Notes on the Import Proaram for 1965 1. Table I (see next Daze) sets out the present and revised import programs for 1965 in approximately the same categories as those used by the Government in its imnort budet. The broad outlines of this exercise were discussed in Chapter II. Notes on the detailed items in the program arp sAt out halw, Tmnorts.:; ef -Rinp- Flmnnti Siianr 2, 7hdo Vnu (r%m-i ir%nnY isc t.ho Qno imnny.-.or n~f t.ho.q nrnmrtiP-. At present he estimates that a total of Rs. 655 million will be needed for ric ,~v' lour, an sugar, 'oAf '14cf r)"a i P 41" ;fr-11r10 poA~ T?s 19 milli ~rm for rice (i.e., about 819,000 tons). In a normal year rice imports would be a runv, d, Iff0A 00nf -o- 4-, -.AA4 4-4--n +4- ln ,i n,.e ,-.t4a- +1-r --r,,....... A price scheme. This year the Food Commissioner estimates that the maximum Ll'- VV..L.. ge fron,I lo.L~ p ou c i n I isLl ro wi 200LJL~V.,%-1,)0 tonsL, insULOIU vJ.L LA1 usual 450,000. This is due to a failure in the rice crop. By the end of June ne nau PurhUseu arounu ±2v,uvJ tons -Loca'L'J'-±y y.' u ounso'ders til purchases during the remainder of 1965 may be rather small. He needs an eco *maUe- nu ^ 0 vu tons of rJce to mee Lue requ±remeuve oz 0 e1 rL0e caLUL so that if he manages to buy 200,000 tons locally, it should be possible to limiu imports to (.UVuuu tons, provided no provision is made to raise stocks above the 104,000 tons at the beginning of 1965. In the revised program it has been assumed that it will be possible to make do with about 750 - 770,000 tons of rice imports, giving a saving of Rs. 30 million over the estimated requirements of the Food Commissioner. 3. The estimates for flour imports have not been adjusted, since the Food Commissioner has already contracted to buy the total estimated needs of 295,UO0 tons for 1965. 4. Imported sugar requirements were initially estimated at 230,000 tons. The Government has agreed that this figure could be reduced by 30,000 tons without reducing per capita consumption of sugar from that ruling in earlier years. This reduction has accordingly been made in the revised program, enabling a saving of Rs. 12 million to be made. 5. Overall these adjustments enable a total saving of Rs. 42 million to be made over the initial estimate of requirements for imports of rice, flour, and sugar. Other Foodstuffs 6. The initial allocation for other foodstuffs was Rs. 319 million and includes Rs. 39 million of foodstuffs imported by the Food Commissioner, -AnT7- IMPORT PROGRAM -. 1965 Present Suggested Suggested New Al-ocation Increases Reductions Allocation Rice 432 -30 h02 Flour 128 128 Sugar 95 -12 83 Other Foodstuffs 319 319 Textiles 100 100 Drugs 25 25 Private Industry 190 90 280 of which Raw Materials l7Ú 50 225 Machinery _5 0 55 Public Industry 55 55 of which Raw MatArials 20 20 Machinery 35 35 Pe-trneinm li5 115 Fertilizer 80 15 95 AgoOemcl 8 8 Tractors 3 3 6 Replacemn f unehitcles - 10 10 Spares f or Vehicles 15 10 25 C-m-n & B d nteril in Engineering Stores for Plantation Sector 60 15 75 Other Trade Quota Items 120 120 jo,,erm,ent DepartmAents (excluding Food) 100 100 Vion-IndC-usZrl, State Corporations 50 50 n--4..-L TT.-.-.- Imports tied to Foreign Ald already committed 135 135 TOTAL JIMPORTS 2,094 153 -2 2,205 I/ TnliAude Pe . i0 Ynilinn inr Trd Qn. ana Rs. 2oo milion imported tnrougn otner channeils. uosiiary loodatula consist chiefly of meat, fish, chillies, other vegetables and curry stuffs, and milk products. The initial allocation represented a reduction in per capita consumption over that enjoyed in 1964. However, imports of these commodities have been rising fairly rapidly since 1Y5Y and the allocations would provide for per capita consumption at about the 1959/60 level. The Government has indicated that it would be politically extremely difficult to cut back the allocations for these other foodstuffs any further, even if such action might seem advisable on economic grounds. For this reason the allocation for other foodstuffs has not been changed in the revised program. Textiles 7. The initial allocation was for Rs. 100 million of piece goods to be imported in 1965. This represents a considerable reduction from the import level of Rs. 165 million in 1964 and reduces per capita consumption in terms of yards considerably below the levels ruling in 1961 - the last year before restrictions were applied, if imports of clothing in 1961 are taken into account. There does not, therefore, appear to be scope for reducing the allocation for textiles any further in 1965. Drqgs 8. The initial allocation of Rs. 25 million for drugs has not been altered in the revised program. Pri vats Manufacturing Tndusftry 9. The init.ial alloctio+e-n for ranw maeral, npre panrts,q aqnd ma- chinery for private manufacturing industry was Rs. 190 million. Of this, s. 180 A miioin (Psq 165 million forY rawv mn,on, ovirl Pz It,' m4ll-n- Pn"' machinery) is administered by licenses issued by the Ministry of Industries nnid ahnt Rs 10 millinn nn-qi - f ra motoria+1lm nn lit-mn issued to import traders by the Import Controller. After consultation Wj+1i +i MF;rinc+Vr ^P Tndniic+vI e r.Trn h rre en1rrorrA +hn cinr,-m-+e P raw materials and machinery of private industry, an increase in the allo- million is recommended for the rest of 1965. These figures represent the by private manufacturing industry if it is to return to a satisfactory use r uvizu riau±avouUring ±Couunve,y LU. The initial allocation for raw materials was R5. 20 million and for machinery, Rs. 35 million. The Ministry of Industries considers that this allocation will meet all the reasonable needs of the public sector industries and no increase in the allocations for public manufacturing industry is recommended. figure is Rs. 10 million higher than imports in 1964 and would appear to be ample to meet all reasonable requirements. No change in this figure is recommended. Fertilizers 12. It was not possible for the IBRD mission to examine the fertilizer needs of the economy in detail. The initial allocation of Rs. 80 million (equivalent to some 300,000 tons of various fertilizers), however, has created seasonal shortages and there is danger that export crops will suffer and the momentum gained in spreading fertilizer used in paddy cultivation will be lost, unless additional supplies are made available. An increase of Rs. 15 million for the rest of 1965 is recommended. Agrochemicals 13. The initial allocation of Rs. 8 million for agrochemicals was the result of a detailed study by a government committee of the needs of the agricultural and plantation sectors. The imports recommended in the study were agreed to. Under these circumstances no increase in the allo- cation for agrochemicals is recommended. Tractors 1. The Ministry of Agriculture considers that there is an acute shortage of tractors. A doubling of the initial allocation of Rs. 3 million is recommended so that a total of Rs. 6 million worth of tractors can be imported in 1965. Replacement of Vehicles 15. The initial allocation for commercial vehicle imports by the nrivate sAntor wns nPsiriblP. Sinet there have been virtuallv nn imnorts of commercial vehicles for the private sector for nearly three years, the note.ntian1 demand is lnre An allocatinn of Rs. 101 million (i e at a thousand commercial vehicles) is recommended to begin to relieve the vehicles for the manufacturing and distribution sectors. Spares for Vehicles 16. A large number of the commercial vehicles in Ceylon are im- LILULJ.L..L -%A~J tAL_UUr,1 L-aVll. V.1. DjPJ.LW VL .L-D L11 au.LLULon1f Wi " L I_uL.±Lu VVLL'YI Department estimated that no less than 40% of the mobile construction equipment waS 011 the roau awating repair. IIn view of t1 stuation, an increase of Rs. 10 million to the initial allocation of around Rs. 15 million for spare parts for commercial vehicles is recommended. - v- Cement and Building Materials 17. The initial allocation for imports of cement was Rs. 25 million Wi1 a 1 urtLhner a,l10Cd tiQUJ. .11b. 7 iiLL-LiUn for owler bJuildin.g maerials. It has not been possible to make an accurate estimate of how far this figure falls short of priority requirements. However, the fact of shortages is admitted by all concerned and an additional allocation of Rs. 10 million for cement and building materials is recommended. Engineering Stores for the Plantation 0ector 18. The initial allocation for engineering stores which serve mainly the plantation sector was Rs. 60 million. Discussions with the Import Controller and evidence from the Planters' Organizations indicates that this figure is inadequate and that the productive capacity of the planta- tion sector is suffering accordingly. An increased allocation of Rs. 15 million to go towards import of these items is recommended. Other Trade Quota Items, Government Departments (Excluding Food, Non-Industrial State Corporations and Direct Users 19. No increase in the allocation for imports in these categories is recommended. Total Imports 20. Increases totalling Rs. 153 million have been recommended. Set against this are reductions totalling Rs. 42 million in rice and sugar. The net result of the revised oroeram. therefore. is to raise the total import bill by Rs. 111 million from Rs. 2,094 million to Rs. 2,205 million. B. wtnfn An Balann of Payment.- for 1965 21. Table TT (see nwxt pAae) shows t.he projectedH baIanop. of payment.s situation for 1965 on the basis of the revised import program described 4" 1049f 1-v I~ - 4-4-- '~A D ~O. L I A 7 I.LJ.3'& -4.Jion on th basis of customs figures. This projection assumes the volume of tea ex- jJJJ r I.L - "J . l '. L J. VJ ll iJ1 A JLA. ' U Wi.L L L ~ t J V VU11A %A . A VY " " ";~L L J~ J . c per pound will fall by 10 between 1964 and 1965. This would mean that LIRV Vd.W.UU .1 "_&FJUL WVUU..LU± L c Lll%;.-WtL0 1A0o ±,.L4C-il L ull±± .Ul L,-u4 UU Rs. 1,165 million in 1965. For rubber the volume of exports is expected to De aUouT Lsationary, which, combined with an assumed fal in the price, leads to a value reduction from Rs. 290 million in 1964 to Rs. 282 million in 1965. The volume of exports of coconut products is likely to fall markedly from the levels of 1,618 million nuts equivalent in 1964 to - vi - TABLE II BALANCE OF PAYMENTS 1965 1966 0 -444-L~ 0--A4L 'J U4- J.IJU4).4L Imports 21205 2,210 Net Twaiba1hlo (Ryv A4BAnnael2 Dividends, etc. 18 36 2., 227 2,204 vayAvne n0auu Grants 66 37 IED 19 7) 10 )7 ;anaua / Yugoslavia 2 ) ) ) West Germany .> ;#F 44 27 U.S.S.R. 12 L ) ) France 3) ) ) Po.land 4 ) ) Settlement of Bilateral Accounts 5 43 U.S.i3 ..I East Germany 4 Rumania 7 China 19 Hungary 1 Food Commissioner 84 64 - - Grants 8 Deferred Payments / 76 45 I.M.F. 122 57 Repayments Capital Subscription 21 Drawing April 39 Drawing June 71 1/ 1/ Drawing December 12 Drawing 1966 Other Short term loans 48 48 Change of Reserves 75 50 Total Capital 394 251 91 132 Capital Balance .u4.3 41 Gnap wi,hsgese,victon ~ Gap on present allocations 66 ( 429 1/ No estimates are given for IF drawings or repayments in 1966 since these will depend on negotiations nearer the time. To the extent that Ceylon receives net credit from the Fund in 1966, the gap of Rs.429 million will be reduced. - via - Footnotes continued 2/ In 1965, deferred payments are due from Ceylon to Burma (Rs. 36 million) and to Australia (Rs. 9 million). New short-term liabilities are being incurred from Burma (Rs. 42 million), Australia (Rs. 26 million) and France (R. 8 million) ThA IAtter Arp dAfArrAd nAvmpntR due in 1966. For the the projected balance of payments for 1966, it has been assumed that such nnyments will he bnlanced hv new trPIi+ which Cevlnn normally ohtain for its imports of rice and flour. - vii - 1.375 in 196q. However. prices are expected to be around 10% higher in 1965. All together, the value of exports of coconut products is expected to dron from Rs. 271 million in 1964 to Rs. 255 million in 1965. 23. Thore is a techninn1 nroblem in tonvertinr the roiention of exports in 1965 on a customs basis to a figure for export receipts on a hnl.ne- of nrmnt ha Roftgnn 1gn qnd 19?S' thp ann hAtwen navmpnts and customs figures averaged around Rs. 40 million, the payments figure beinFe 'gr bcueepot fol ukr A ~ "~wr treated as invisibles in the payments accounts while appearing as commodity vn,rn+n- 4 n ne+-me P4.nu- T- 1041. 1nn - +,-rrn + -- -w v4AnaA +n Rs. 110 million and no satisfactory explanation could be found for this high gap in 1964 was an exceptional occurrence and in 1965 the gap will return ou its ormal evel.C10 Arvso. AJ?VWUr±IvLU UVwJ1u u u l "Pzul W amuo L.)rJ.-U0 for the first four months of 1965 would suggest that the gap is indeed re- have been projected at a figure of Rs. 1,830 million. Net Invisibles 24. On the assumption of no loosening of the restrictions on leave and no relaKation of the moratorium on dividends a net current invisibles deficit of Rs. 2 million has been projected for 1965. For the purposes of this re- vised projection a relaxation of the moratorium has been assumed to the extent of allowing remittances from the backlog of untransferred dividends of Rs. 16 million in 1965 together with a further Rs. 2 million as a result of some easing of the restriction on leave and other foreign travel. Balance on Current Account 25. If imports of Rs. 2,205 million plus net invisible payments of Rs. 20 million are set against exports of Rs. 1,830 million the resulting current account deficit for 1965 comes out at Rs. 395 million. Long-Term Capital 26. On the long-term capital account, it is at present anticipated that there will be foreign grants amounting to Rs. 66 million and long- term loans amounting to Rs. 69 million in 1965. These amounts represent estimated drawings on grants and loans already committed. Against this are set repayments of long-term loans amounting to Rs. 31 million. Settlement of Bilateral Accounts 27. Ceylon has a number of bilateral trading accounts on which a certain swing credit is permitted, but settlement over and above the swing must be mand within a snpeified npriod- Tt has beAn assumed that Cvlon will not receive further accommodation on the bilateral accounts, and that amounts due at the end of 1964 E +'bott and from n over and above - viii - the swing permitted in the agreements will be settled during the year. It should be noted that the Burma bilateral account is dealt with under fi- nancing for the Food Commissioner. Food Commissioner 28- The imnnrt nrogram includes the atual imnort renirments of the Food Commissioner for 1965. This item on the capital account takes annount n the fact that snmP fnd nnymants will he dofer-rd under various agreements, until 1966. Other payments in 1965 will be for imports actually re eaiwel in 10A. T+- n1.e +nL- ,z ze%P e?P+c e%-P fl iv nmniin+ ne + Rs. 8 million from Canada and Australia. Overall the net additional credit Wy. L ne ue.u .Un LLA-.i uy I .e ULum o £7u oa. .;o7 Ion nA been assumed. Drawings on the Fund amount to Rs. 122 million - Rs. 39 million in April, Rs. 71 million in june and Rs. 12 million in December. This latter figure assumes that of the additional US$15 million which can be drawn in the second half of the "stand-by" year, USe.> million will De drawn in December. Against these drawings, allowances made for repayments to the Fund of Rs. 30 million and for payments of Rs. 21 million towards Ceylon's increased capital subscription. Other Short-Term Loans 30. It has been assumed that the private credit of Rs. 48 million under this heading will not be repaid during 1965. Change Ln Reserves 31. A rise of Rs. 75 million in reserves has been assumed as the minimum needed to provide a cushion against month to month fluctuations and the gap between receipts and payments. Overall Balance on Capital Account and Financing Gap 32. All this leads to a surplus of Rs. 143 million on capital account. If this figure is set against the current deficit of Rs. 395 million, a gap of Rs. 252 million emerges which indicates the estimated order of additional foreign assistance requirements. If the Government's initial import program had not been increased and no provision for increasing reserves had been made. the L7n in 196q would have been about Rs. 66 million. A.r nnJ mv, . r ' nt r P"ebni.,z Pw zn..+, fnv- ICA - at about the same level as in the revised program for 1965. Increased 01-f-n+4s have been made for Jmnem-A4p4-- -A q^rema+anAg whilN41 imports of rice are assumed to revert to their normal levels. A balance paLjJLy!.I1,ents proIjet -.LU .L. .7UU ±Lo Y1-VV.LAU"L -Lai LJ.L L_i. CL1%. IA%J LV" VALI wAv~ details of it are set out below. Exports, 34. Exports in 1966 on a customs basis are projected at Rs. 1,900 miaon. This is an increase compared with ±yop wnich is made up ol a rise of Rs. 20 million in tea exports, Rs. 2 million in rubber exports and Rs. 1 million in the export of coconut products. Tea prices are assumed to remain constant, rubber prices to fall by just under 3% and coconut prices to rall by about 117 from the unusually high levels in lyo>. On a payments basis export earnings are projected at Rs. 40 million less - i.e., Rs. 1,860 million. (See note for 1965 Exports above.) Invisibles 35. A deficit of Rs. 38 million on invisibles has been projected. This assumes divident payments, etc., in the region of Rs. 36 million in 1966. Current Deficit 36. Taken together these items give a current deficit of Rs. 388 millio.a for 1966. Financina Grants and Lon--Term Loans 37. This item only takes into account foreign aid at present committed. on the perhaps heroic assumption that Chinese aid under the Rice-Rubber AprRement will continue at Dresent levels. On thisbasis major aid cornitments in 1966 amount to Rs. 91 million. Scheduled loan repayments in 1966 amount to Rs. 1h million. giving net financing from foreign aid at nresent in the pipeline of Rs. 57 million. Short-Term Lending and Additions to Reserves 38. It has been assumed that Ceylon will: (a) reduce her short-term liabilitie sn aq thf n n 196 T by Rs. 48 million and (b) Urid11 make nyn- vision for an additional Rs. 50 million in the reserves. Gap to be Financed by Additional Foreign Assistance 39. All this produces a capital account deficit of Rs. 41 million. If Rs. 429 million emerges to be financed by additional foreign assistance. This gap will be reduced if Ceylon is able to re-negotiate ner stand-by agreemenU with the IMF in such a way that additional net credit is provided in 1966. ANNW TT INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVEJLOPME 1818 H Street. N.W.. Washington, D.C. 2033, U.S.A. 14th June. 1965 Dr. Gamani Corea Before a second meeting is organized among possible foreign to economic development should be clarified by the Government of Ceylon. The m1in requi rns in"s oneto A balance of payments program for A9u which is compatle with foreign financing from IBRD member countries of $ 100 million. The program should make the largest possible provison, compValUe wto essential consumer goods requirements, for imports necessary for the use and maintenance of exsting production capacity o Ighu p4ority and for urgent private and public capital projects. Imports of consumer goods, including foodstuffs, should be so calculated as to maintain the present level of consumption, bearing in mind prospective increases in local production. The balance of payments program should contain detailed projections of exports for 1966 and should also indicate in detail the prospective receipts and payments expected on napital accounts, including some provision for a further increase in reserves in 1966. Consideration should also be given to a reasonable allowance for transfers of foreign income and capital. The import program should contain detailed estimates of required imports of commodities. In connection with this program, a list or com- modities suitable for foreign financing should be drawn up, indicating donor countries which might be sources of supply. 2. The outline of a program designed to make an early impact (within the next four or five years) on production and on the balance of payments. This outline should indicate the specific policies and measures which the Government of Ceylon intends to put into effect in order to ensure that in the allocation of investment resources emphasis is given to obtaining maximum produrt.nvn returns rather than serving social ends. There appear to be, for example, favorable prospects for an acceleration of growth through further - 11 - increasing rice production; through programs to substitute for imports doeo4 f^AAc4iv a-nPaA4 P fade+n,ffe a Calh a^" +k M practical possibilities appear established; and through the provision ofP cr-d4t, ---Uh,v,w -A -+U--. P-n41444- P--a, 4 ...A. a4 . , lAfffe W I.LZo%.6V G6S% U .LAW-6 LGLi." J%? L .L%'A%AIO .6 . . .L4 Priorities should also be established and indicated for infra-structure investments. r-oects should be indicated which, prospective returns and nature, would appear to be suitable for foreign fIancig. Suc1 proeLtE might inUlUde power, irrigation, sOurieAW manufacturing (including financing channeled through the DFCC), roads and possibly ports an raUway improvements, telecomnmunanLo udu vocational education. 3. Prospective availability and proposed allocation of resources in fiscal year 1965/66. A financial plan for the period 1966/67 - 1969/70 is also needed. This should indicate the specific policies and measures by which the Government expects to increase the proportion or domestic resources devoted to domestic development expenditure within a stable monetary framework. For both 1965/66 and for the longer period account should be taken of the additional financial resources that would be available as a result of the expanded foreign assistance program that is proposed. Clear indications should be given of the use of these additional resources; e.g. in increasing public development expenditures, in providing larger financing for private development, in reducing select- ively the burden of taxation 1where such reduction might facilitate develop- ment. 4. Consideration should also be given to policies which would minimize the adverse impact of the tax system on private development, adjust the prices of commercial goods and services produced by the Government sector in accordance with costs, and reduce the burden of transfers of government funds for subsidizing the Production and con- sumption of rice and other goods and services. I.P.M. Cargill Director Far East Department Copies to: The Hon. Dudley Senanayake PriTnA Mini ntr nhon J T._ TvawardPna Minister of State The Hon. U.D. Wanninayake