Sri Lanka - Transport Sector Strategy Study (Vol. 1 of 2) : Main Report

Report No. 16269-CE Sri Lanka Transport Sector Strategy Study (In Two Volumes) Volume 1: Main Report January 1997 Infrastructure Operations Division South Asia Country Department I Government of the Democratic Socialist Republic of Sri Lanka with assistance from the UNDP FOR OFFICIAL USE ONLY Document of the WorWd Bank This document has a restricted distribution anId rnybe used by recipients only irtth~ performance of their offcial duties. Its contei~-ayn teisbdslosedwithi World Bank autoohiwieeds World Bank authoriza~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~bn~~~~~~  CURRENCY AND EQUIVALENT UNITS (January 1996) Sri Lanka Rupee (Rs.) I = US$0.0180 US$1.00 Rs. 55.60 (July 1996) WEIGHTS AND MEASURES 1 meter (m) 1.1 yard 1 kilometer (km) 0.62 mile (mi) I hectare (ha) 2.47 acres (ac) I metric ton (m ton) = 2,205 pounds (lbs.) ABBREVIATIONS BOI - Board of Investment BOT - Build, Operate, Transfer CAS - Country Assistance Strategy CEIP - Colombo Environmental Improvement Project CMR - Colombo Metropolitan Region CPC - Ceylon Shipping Company CTB - Ceylon Transport Board CUTS - Colombo Urban Transport Plan IMTs - Intermediate Modes of Transportation MEIP - Metropolitan Environmental Improvement Program MTIP - Medium Term Investment Program NESC - National Environmental Steering Committee NMT - Non-Motorized Transport NTC - National Transport Commission PIP - Public Investment Program PSA - Private Sector Assessment PTAs - Provinicial Transport Authorities RCDC - Road Construction and Development Company RDA - Road Development Authority SLPA - Sri Lanka Ports Authority SLR - Sri Lanka Railroads SMEs - Small Scale Enterprises T&CP - Town and Country Planning TEC - Technical Evaluation Committee TEU - Twenty-foot equivalent units TSPC - Transport Studies and Planning Center UDA - Urban Development Authority ULAs - Urban Local Authorities WHO - World Health Organization Vice President: Mr. D. Joseph Wood Director: Ms. Mieko Nishimizu Division Chief: Ms. Marie Robinson Task Manager: Ms. Frannie Humplick  (Gkasry Access Fees: payments made to the owner of a network of infrastructure (usually public) based on an agreed upon system of charges such as incremental cost incurred by the owner through the use of the system by another (usually private) operator Build-Operate-Transfer (BOT): a form of concession involving finance, construction, and maintenance of a facility for a specified period before ownership is transferred to a public authority Commercialization: transition of public or non-market enterprises to commercial market-based behavior Concession: grant or sale by a public authority of a right to develop or operate assets owned, or reverting to, the ownership or authority, usually for an extended period of time Devolution: transfer of functions or decision-making authority to legally incorporated local governments, such as provinces or municipalities Externality: an unpaid-for effect of a transaction or activity on third parties Liberalization: allowing entry into the provision of goods and services formerly in the hands of a single entity Motorization: transition to higher levels of ownership and use of road motor vehicles (motorcycles, automobiles, and trucks) Open Access: opening the transport networks to private operators in a manner such that infrastructure networks such as railway track can be used by private freight operating companies, in return for access payments Peoplization: term used to denote transfer of assets owned by the state to former employees of public enterprises in Sri Lanka Restructuring: the process of reorganizing the assets, liabilities, and work force to enable an existing public enterprise to respond more efficiently to its customers' needs Transport Infrastructure: all fixed facilities associated with the movement of freight or passengers, such as rights of way, track or terminals, and associated traffic management systems such as traffic lights, signals, and communication systems Transport Services: all activities associated with conveyance of passengers and freight   SRI LANKA TRANSPORT SECTOR STRATEGY STUDY TABLE OF CONTENTS EXECUTIVE SUMMARY .............................................i A. Background ....................................................... B. Short Term Strategy: Increase Efficiency of Public Investments ............................................... iii C. Medium Term Strategy: Economic and Financial Sustainability ............................................... vi D. Long Term Strategy: Environmental and Social Sustainability ............................................... viii E. Sector Specific Reforms ......................................................x F. Policy Implementation Process ..................................................... xviii G. Logical Framework for the Transport Sector Strategy ..................................................... xx H. Summary of Recommendations for Transport Sector Strategy ............................................... xxi 1. INTRODUCTION ........................................... I A. Objectives and Scope .....................................................1l B. Audience ......................................................2 C. Ownership and Participation ......................................................2 D. Major Themes Covered ......................................................2 E. Framework for Transport Sector Strategy .....................................................4 This report is based on the findings of a joint World Bank/Government of Sri Lanka team. The team was integrated by Frannie Humplick (WB, team leader, author of Volume I and editor of Volume II of this report), and included Jose G6mez-Ibdftez (Harvard University, competition in passenger services), Ajay Kumar (WB, planning and implementation), Gerard J. McCullough (Putnam, Hayes, and Bartlett, restructuring the railway), Ismail Mobarek (WB, ports and shipping), and Nancy Zhao (WB, co-team leader and public sector reform). The Government counterpart team led by W.L.P. de Mel, Director TSPC, consisted of TSPC Staff and several other participants who carried responsibility for sub-sectors within the transport sector, transport consultants and leading private sector construction and transport managers. Contributions were also received from Sheoli Pargal (PRDEI, environmental sustainability). Funding for the workshop and the consultants was provided by a technical assistance grant from the UNDP. Background papers used in the report were prepared by a number of local participants, as well as representatives of OECF and ADB. Their names appear in Volume II of this report. Internal peer reviewers were Ian Heggie (TWUTD), Gerhard Menckhoff (LA1IU), Lou Thompson (TWUTD), Zmarak Shalizi (PRDEI), and Dominique Van De Walle (PRDPE). External reviewers were Harry Garnett (ABT Associates). Mieko Nishimizu is the Director and Marie Robinson is Division Chief. The report was processed by Jack Williams.  II. REORIENTING TRANSPORT SECTOR POLICY .......................................... 6 A. The Government's Policy Agenda and the Transport Sector .......................................................6 B. Coverage and Performance ..................................................................9 C. Transport Demands of Export-Led Growth ................................................................. 11 D. Urbanization, Environmental, and Social Sustainability ............................................................. 13 E. Institutional Weaknesses in Planning and Implementation ........................................................ 15 III. IMPROVING THE EFFICIENCY OF PUBLIC INVESTMENTS ................. 19 A. Planned Investments in Transport ................................................................. 19 B. Pattern of Public Expenditures in Transport ................................................................. 19 C. Composition of Transport Expenditures ................................................................. 20 D. Devolution and the Capacity of Sub-National Agencies .............................................................. 25 E. Revenue Generation and Subsidies ................................................................. 26 F. Recommendations to Improve Efficiency of Public Investments ................................................ 26 IV. ECONOMICALLY AND FINANCIALLY SUSTAINABLE DELIVERY OF TRANSPORT INFRASTRUCTURE AND SERVICES ................................... 29 A. Role of the Government in Transport ................................................................. 29 B. Competition in the Provision of Road Infrastructure ................................................................. 31 C. Strategy for Reforming the Ports and Shipping Sector ............................................................... 36 D. Competition in Bus Passenger Services ................................................................. 42 E. Pricing and Financing in Roads ........................ 45 F. Restructuring the Railroads . 47 V. ENVIRONMENTAL AND SOCIAL SUSTAINABILITY ............................... 55 A. Physical Planning and Environmental Issues in Transport . 55 B. Environmental Planning and Implementation ...................................... 60 C. Traffic Management for Congestion Control and Safety. . 62 D. Role of Transport in Poverty Alleviation and Regional Dcvelopment ....................................... 63 E. Access and Mobility in Rural Areas .............................. . 64 F. Regional Integration Through Transport .65  List of Figures Figure 1 Dominant Position of Colombo .................................................................. 66 Figure 2 Modal Shift to Private Transport .................................................................. 67 Figure 3 Expenditure as a Share of GDP .................................................................. 68 Figure 4 Demand for Land Transport .................................................................. 69 Figure 5 Composition of Public Expenditures in Transport .............................................................. 70 Figure 6 Ratio of Recurrent to Capital Expenditures in Transport ................................................. 71 List of Tables Table 1 Transport Infrastructure: Coverage and Performance ..................................................... 10 Table 2 Priority Ranking by the Private Sector of Transportation Bottlenecks ............................ 11 Table 3 Patterns of Urbanization in Asia .................................................................. 13 Table 4 Structure of Public Investments 1995-1999 (Rs. Million) ................................................... 19 Table 5 Sectoral Composition of Expenditures in Transport 1995-1999 ........................................ 20 Table 6 Modal Balance in Capital Investments in Transport .......................................................... 21 Table 7 Financial Allocations to the Road Sector by Source ........................................................... 25 Table 8 Expenditures on Roads by Levels of Government .............................................................. 26 Table 9 Market and Regulatory Structure in Transport ................................................................. 30 Table 10 Comparative Costs of Providing Roads .................................................................. 32 Table 11 Share of Transshipment Cargo in Colombo Compared to Major Ports ........................... 37 Table 12 Performance and Reliability of Colombo Port .................................................................. 37 Table 13 Comparative Costs of a 24 Hours Connection of Transshipping Containers ................... 38 Table 14 Passenger km of Travel Between 1985 and 1995 ................................................................. 42 Table 15 Performance of the Peoplized Bus Sector .................................................................. 43 Table 16 Structure of Charges and Costs for Road Usage in 1995 .................................................... 46 Table 17 Countries with Railway Concessions .................................................................. 51 Table 18 Income Distribution of Users of Rail, Bus and Van Passenger Services ............................ 51 Table 19 Road Accident Fatality Rates by Country .................................................................. 56 Table 20 Growth in Vehicular Emissions 1992-1996 .................................................................. 58  List of Boxes Boxi1 ..12 Box 2 ...16 Box 3 ...16 Box 4 ...t18 Box 5 ..22 Box 6 ..23 Box 7 ..24 BoxS8...33 Box 9 ..35 Box 10 ..40 Box 11 ..49 Box 12 ..61 Annexes Annex 1 Impacts and Issues of Sri Lanka Clean Air 2000 Annex 2 Estimated Investment Needs and Payoff from Proposed Reforms Annex 3 List of Workshop Participants  EXECUTIVE SUMMARY A. BACKGROUND 1. Sri Lanka aspires to achieve economic growth and poverty reduction comparable to that of its more prosperous neighbors in East Asia'. To realize this dream the country is focusing on an export-oriented and private-sector led growth strategy, which is to be environmentally and socially sustainable. To increase export competitiveness, the Government is focusing on ways to improve the productivity of key export earning sectors: agriculture and manufacturing. To encourage export development, the Government is actively promoting higher value added items. The economic growth strategy followed by the Government is not to come by sacrificing the natural environment, nor the quality of urban life. Moreover, to guarantee social sustainability, growth strategies are to ensure that the poor are included by providing access to services and employment. 2. The transport sector has a critical role to play in achieving these goals. To increase economic productivity through export oriented growth, the country needs a transport system that functions in a seamless fashion from the perspective of the exporter. This requires more focus on transport facilities and services attending to export regions and products as well as an integrated intermodal transport sector strategy; in particular, maintaining, upgrading, modernizing, and ensuring connectivity between those transport facilities and services. Within manufacturing, the Government proposes to promote higher value added items such as garments, toys, and fashion accessories as well as entry into higher technology and skill-based activities such as electronic and electric assembly and manufacture of precision engineering parts and tools; sports goods and footwear; and scientific instruments and software. In agriculture, the objective is to also promote high value added products especially in the non-plantation crop sector. All these products have very specific demands for transport. Products like garments, toys, and fashion accessories require reliable, safe and secure transport services, contracted on demand. Electronic goods, scientific instruments, and precision tools, require specialized packaging and suspension. Products like spices, fruits, vegetables, and flowers need refrigeration and specialized containers. Also necessary are efficient and reliable public transit systems, offering a variety of service options, and traffic management and restraint measures to relieve congestion and pollution. 3. Recognizing the critical role the transport sector has to play, a sector strategy was jointly prepared by the Government of Sri Lanka and the World Bank, with technical Sri Lanka: Country Assistance Strategy of the World Bank Group. Report No. 15633-CE, 1996. 2Policy Statement by Her Excellency Chandrika Bandaranaike Kumaratunga, President of the Democratic Socialist Republic of Sri Lanka, 1995.  assistance from the UNDP. It has the following objectives: (i) identifies the principal issues affecting the transport sector's ability to perform; (ii) sets a clear vision, founded on principles of an effective public-private partnership, for the sector to provide efficiently the infrastructure and services needed to underpin growth in the country; and (iii) lays out a reform agenda and an investment strategy for the sector. 4. Successful policy reform in the transport sector can have significant payoffs for the country. At present, the transport sector contributes to -about 50% of the public sector share of GDP (1991). Improving the performance of the transport sector could remove major bottlenecks to economic growth and productivity. The transport sector is also an important source of employment, generating about 6% of direct employment (1995) and 4% of indirect employment (1995)3. The sector also absorbs, at present, a large share of public investments (about 22% of planned investments in the period 1995-1999). Improving the effectiveness of transport expenditures could result in major savings in the projected needs for investment. Estimates indicate that projected savings from reforms in the highway sector alone could be as high as 70% of estimated expenditures without reforms. In other words, with reform the Govermnent could invest 30% of the estimated funds otherwise needed to support economic growth (see Annex 2). 5. The transport sector in Sri Lanka has not performed as well as that of its East Asian neighbors, failing to meet the demands necessary for the country to sustain higher levels of economic growth. Furthermore, rising expectations as a result of Sri Lanka's long-term per capita growth as well as changing characteristics of Sri Lanka's production and trade, have placed new challenges on the sector. Among these challenges is the need for reliable, efficient, and safe services for passenger and freight transport, while managing the negative consequences such as congestion, air pollution, and accidents. 6. Basic coverage has been good in terms of extending transport networks but existing systems are aged, obsolete, and congested. Misguided capital investments, inadequate balance between transport modes, and inattention to maintenance have further reduced the ability of the transport sector to perform. The transport sector is suffering from a low level equilibrium trap. Misallocation of expenditures in transport has led to improper modal balance in capital investments as well as an underinvestment in recurrent relative to capital expenditures. This has led to insufficient maintenance, causing deterioration in assets and service quality, and the consequent decline in willingness to use public services. This has made it difficult to raise revenues through higher prices, as users have resisted having to pay more for increasingly deteriorated services. The country, and especially the Greater Colombo Region, has seen a high rate of motorization, and the private vehicle has captured a larger share of the growing demand for transport. In combination with deterioration in urban bus and rail services, motorization has led to large modal shifts from public transit to private vehicles. The Annual Report 1995, Central Bank of Sri Lanka and TSPC, Transport Sector Data Bank.  iii consequences have been congestion, accidents, and pollution. The private sector cites a number of transport bottlenecks as factors constraining their potential. Addressing these bottlenecks is critical if the country is to widen its export base. 7. The Government plays a major role in the transport sector in Sri Lanka. Public enterprises are responsible for direct provision of road, railway, and port infrastructure. There is no private provision of infrastructure. The Government plays a smaller role in the direct provision of transport services, with the exception of railways which are in the hands of Sri Lanka Railways, a Government Department, and bus transport where the Government is a 50% share holder of the peoplized bus companies. The poor performance of the transport sector has been mainly because the public sector has overextended itself as a direct provider of facilities and operator of services and is failing to meet important functions as manager of competition, custodian for the environment, and guarantor for social concerns. The challenges of operating and managing transport infrastructure and services have absorbed a lot of effort from the public sector, fostering weaknesses in planning, implementation, and regulation. 8. The strategy proposed has three main objectives. In the short-run (1997-1999) the strategy focuses on actions to improve the efficiency of investments in the transport sector. Medium term (2000-2005)concems addressed by the proposed strategy are policy reforms and institutional changes to achieve economic and financial sustainability in the transport sector. The long term (2006-2010) is aimed at making transport sector expenditures socially and environmentally sustainable. The strategy proposes staged investments, with proper balance across modes, emphasis on redressing past neglect in maintenance, and policy and institutional reforms which are key to the strategy's success. B. SHORT TERM STRATEGY: INCREASE EFFICIENCY OF PUBLIC INVESTMENTS 9. There are three key reforms needed in the short run. First, there is a need to correct the imbalance in the composition of transport expenditures between modes, as well as the ratio of recurrent to capital investments. This will address the problems caused by past misallocations of capital investments and will begin reversing the negative cycle the transport sector has settled into. Second, the capacity of agencies responsible for formulating and implementing policies in the transport sector needs to be strengthened. Third, in order to address the shortfall in capital for investments in the transport sector, there is a need to mobilize funds from other sources including the private sector and user charges and fees. 10. Addressing Past Imbalances Across Transport Modes. Past allocations in capital expenditures, according to official records, went mostly to railways, with very low investments in the highway sector. However, the official records of past capital allocations in railways overestimate the real level of investments in the sector, as many of the current expenditures were misclassified as capital ones. There is a need to improve  iv the balance across modes, focusing on improving transport connections in regions contributing the most to exports and regions whose export products are growing faster. Also needed is upgrading and modernization of transport facilities and services for intermodal linkages with proper logistic support. Such a focus requires attention not only to the Greater Colombo Region, which is responsible for about 50% of total freight movements and 54% of all exports, but to regions such as North Central, North Western, Uva, Sabaragamuwa, and Northern and Eastern provinces with export growth rates between two and twenty times higher than those in Greater Colombo. The public sector is not well-equipped to provide such services on its own. Efforts need to be made to define an intermodal strategy with proper logistical support that can be carried out by the private sector in partnership with the public sector. Critical to success of an intermodal strategy is a need to shift the sectoral balance of investments to meet the objectives of a seamless transport system. The Government should seek private sector participation in the integrated provision of containerized transport by road, rail, and ports, as well as the transport of specialized cargo by sea and air. Such partnerships should include arrangements for dedicated telecommunication, information processing, and warehousing facilities and services. 11. Redressing Past Maintenance Neglect. There have also been insufficient allocations to maintenance. In the case of roads in the 1990's, the country has under- allocated to maintenance by a factor of about 2.5 compared to international benchmarks. Neglect of maintenance has caused gradual deterioration of road and rail infrastructure and facilities, leading to a decline in the quantity and quality of passenger and freight services. The Government needs to address the past inattention to maintenance by making available sufficient resources in the recurrent budget to meet maintenance needs. These allocations would also need to be protected so that they would not be diverted to meet other expenditure requirements during the budget year, as has been the practice. The road sector is the largest consumer of the maintenance budget. For this sector it is recommended that the Government put in place a mechanism with the following characteristics to protect maintenance funds4: (a) the protected funds would be used to undertake routine and periodic maintenance but not capital and major rehabilitation works; (b) a portion of revenues from user charges (not all user charges and especially not those from congestion or pollution charges) would be allocated towards meeting maintenance needs; (c) stakeholders would participate in managing maintenance funds; and (d) controls would be put in place to avoid opportunistic and gaming behavior among stakeholders. In roads, as well as in railways, the budgetary and planning process needs to be improved so that the appropriate levels and types of capital investments and During a Workshop held in December 1996 to ratify this Transport Sector Strategy there was an agreement to direct adequate funds to maintenance and to shield such funds from diversion to other uses, as well as to include stakeholders in decisions about maintenance priorities. Consensus was not reached on the need for a road maintenance fund. The World Bank's experience, however, shows that until traditional mechanisms for allocating and protecting maintenance funds are functioning appropriately, a road maintenance fund as recommended in this report is a good interim measure to ensure that priority maintenance is carried out.  v recurrent expenditures are made. Critical to this end is the need to adopt a proper classification of expenditure items so that the effectiveness of capital expenditures can be established and the size of operating deficits determined. The practice of classifying recurrent expenditure items as capital expenditures needs to be stopped to prevent further decapitalization of the infrastructure stocks. A key input to such a mechanism is a clear definition of what constitutes maintenance, rehabilitation, and reconstruction activities, and an adherence to these definitions in the budgetary process. 12. Capacity to Formulate and Implement Sector Policy. To ensure that the imbalances in the composition of transport expenditures are appropriately addressed, there is a need to strengthen the capacity to formulate and implement sector policy. This includes improving the budgetary and planning process so that transport planning can be integrated with other sectors. At present, there is no single body with responsibility for strategic planning for both transport services (bus, rail, and shipping) and infrastructure (highways, ports, railway track and facilities). A key change to build capacity includes integrating urban development and intermodal planning in transport sector strategy formulation. To ensure that urban development and intermodal issues are incorporated in transport planning and that the recommended reforms in budget and expenditure formulation are implemented, we recommend the creation of a body to be responsible for transport sector policy and strategy. This body would also assist sub-national agencies. There is a need for representation to this body from concerned ministries and stakeholders, including provincial authorities, the private sector, and consumer groups. The functions of such a body should include: (a) overall planning for transport in the country with prioritization among different modes; (b) information gathering and analytic responsibility to support key policy decisions; (c) development of policy guidelines for transport infrastructure at national, provincial, and local levels; and (d) support to provincial and local levels in planning and policy implementation including providing for capacity building at these levels. Six options for such a body have been identified following discussions with key stakeholders in two workshops in Colombo (see paragraph 49). An evaluation, spearheaded by the TSPC, is ongoing of the pros and cons of each option. The study is to be completed by early February, 1997, after which a recommendation will be made to implement one of the options. 13. Devolution and Capacity of Sub-national Agencies. Critical to improving the efficiency and effectiveness of public expenditures is the capacity of sub-national units of government. Provincial governments and other local bodies have been delegated responsibilities for transport service provision including roads and bus services. Ongoing discussions for devolution may result in transfer of even more responsibilities. Sub- national units have access to many sources of funds that they use for financing expenditures on their devolved responsibilities. It is necessary to make sure that the expenditures made do not duplicate those made by national agencies for similar types of services, and are coordinated across different modes such as road, rail, and ports. The capacity of sub-national agencies to undertake these responsibilities needs to be strengthened, as at present they seem to be limited in their ability to implement the responsibilities given to them, returning allocated funds at the end of each fiscal year.  vi Furthermore, it is necessary to link their functional responsibilities to their revenue generation capacity and the system of intergovernmental transfers currently in place. All provincial governments should prepare a 3 to 4 year investment program with items indicating their revenue generation capacity. The funds required from the Central Government should be identified by the end of each year on a program that could be modified to ensure implementation at the beginning of the next fiscal year in order to reduce underutilization of funds. 14. Mobilization of Resources. To meet the projected expenditures in the sector it will be necessary to mobilize funds from other sources including the private sector, user charges, and fees. Reducing waste in the implementation of transport projects, especially in the road sector, would be a logical source of investment savings. The rail and port sectors are main candidates to attract private sector funds. The Government needs to put in place policies and incentives conducive to private sector participation in infrastructure finance. Institutional reforms needed to achieve this objective include strengthening the capacity of the BOI to handle investment proposals in transport. Improving the capacity to generate revenues from users of transport infrastructure and services would also allow the Government to tap other sources of financing the needed expenditures in the sector. The Government needs to continue to rationalize the system of rail and bus tariffs to increase revenue generation from users and reduce the dependence of sector agencies on treasury to meet their recurrent cost needs. It is also critical to reform the system of road user charges to make them meet the revenue needs for modernizing, upgrading, and rehabilitating the highway network. Particularly, the Government needs to raise the level of charges for larger vehicles who are currently not meeting even the financial costs of damage they cause on the highways. Critical to this end is a reform in the price and tax structure for diesel as well as the system of licensing and registration of vehicles. Other areas where savings can be generated are from restructuring the system of subsidy allocations in the sector, especially for school bus operations, to reduce the abuse of the existing system and better target the subsidies. C. MEDIUM TERM STRATEGY: ECONOMIC AND FINANCIAL SUSTAINABILITY 15. In the medium term, the proposed strategy focuses on two key aspects. The first aspect relates to the role of government in the direct provision of services and infrastructure in the transport sector. There is a need to define the appropriate share of responsibility between the public and private sector in transport, so that an effective partnership can be built to handle the demands of an export-oriented private sector-led growth strategy. In particular, it is important to increase private sector participation in transport infrastructure and service provision, at all stages, including policy setting as well as direct provision of services. The Government should create and adopt appropriate regulatory structures to ensure the efficient functioning of the public-private partnership. The second aspect relates to improving the efficiency of public sector agencies through introducing competition, making public sector management more market sensitive, and restructuring pricing and financing systems.  vii 16. Role of the Government in Transport. The World Bank's experience in reforming the transport sector indicates that successful reform involves a new role of the Government in the transport sector, less as a producer of services, and more as a regulator--the enabler of competition and the custodian of environmental and social interests5. In general, the Government has a role when the potential for competition in service provision is low, cost recovery from users is difficult, equity concerns are important, and externalities (environment) are high. In the short-term, given social unrest and the growing fiscal problems, policy will need to concentrate on improving the efficiency of planned public investments in the sector. In particular, efficiencies will need to be sought so that more can be accomplished with existing allocations and efforts. The Government should seek ways of improving the quality of services rendered under existing allocations, mainly by focusing on maximizing the number of passenger and freight units served per dollar of investment than the number of employees per passenger or freight unit. In the medium and long-term, policy needs to address the appropriate role of government in each of the transport subsectors. Recommendations in this regard are made for each subsector in subsequent sections of the report. 17. Private Sector Participation. There are a number of expenditures that will need to be made in order for the transport sector to support the expected projections for economic growth. Key among these are modernization and expansion of the facilities at the ports as well as improvements in the reliability and connectivity of land transport systems, especially railways. The Government should seek private sector participation in the financing and execution of these activities. This is critical not only for addressing the budgetary pressures that such activities would create on public sector finances, but also to inject into these activities the client focus and financial discipline that accompanies private sector participation. 18. Regulation and Control. The Government needs to strengthen its regulatory functions in terms of enhancing and managing competition in urban bus transport as well as in road construction, rehabilitation, and maintenance. Misguided controls, such as in hiring and firing of personnel at the port or in making procurement decisions for railway operations, reduce the autonomy of line managers and delay processes of implementation. The Government will need to reduce the extent to which it interferes in day to day management of transport services, focusing its efforts on concerns such as managing safety and reducing air pollution. There is a need for an independent regulator who is only answerable to parliament, who will play a fair and just role by introducing regulations for public and private sector institutions and organizations providing transport infrastructure and services. 19. Improve Efficiency of Public Agencies. For those supply activities that will remain under the responsibility of the public sector, reforms will be needed to introduce more competition in the production of transport services and facilities, make public sector management more market sensitive, and restructure the pricing and financing systems Sustainable Transport: Priorities for Policy Reform. The World Bank, 1996.  viii currently in place. These reforms, in addition to properly directed investments to meet capacity expansion and modernization requirements, as well as the long-term needs for maintenance and upkeep, will contribute to higher efficiency in the sector, an element that is key to achieving and sustaining the high levels of growth Sri Lanka aspires. Recommended reforms include introducing competition in the provision port and rail services that are now in the hands of public monopolies which is critical to make the service operators more sensitive to customers' needs, and reduce the costs of service provision. Enhanced intermodal competition for freight markets will also be possible when the efficiency of railway freight operations has been improved by allowing contract access for freight services. Franchising bus routes would also allow more effective competition in the provision of bus services. To ensure that competition is effective, it is necessary to subject the RCDC to hard budget constraints. Other institutional reforms relate to refining the ongoing clustering of peoplized companies, and strengthening NTC's capacity to manage the competition process. Regulatory reform to enhance the degree of competition and control the negative costs of transport such as accidents and pollution is needed to prevent future loss of market share from public transit to the private automobile, thereby obviating the need for expensive investments in capacity expansion of the existing system of roads. Commercialization of the remaining activities in the public sector-- provision of road infrastructure, operation of activities at ports, and railway passenger services--would also improve the efficiency of these activities. Detailed recommendations for reform in each of the subsectors along these lines follow in Section E of the Executive Summary. D. LONG TERM STRATEGY: ENVIRONMENTAL AND SOCIAL SUSTAINABILITY 20. Three key issues are dealt with in the proposed long term strategy. The first relates to the need for more efficient management of congestion, pollution, and safety. The second has to do with integrating the needs of the poor for access and mobility in transport strategy and policy setting. The third focuses on the processes by which transport investments are made and managed; recommending that participation of stakeholders including the rural poor in planning and implementation be enhanced. Reforms and investments to address participation and rural concerns as well as congestion, pollution, and accidents are discussed under the sector-specific reforms in section E. 21. Congestion and Pollution. Estimates indicate that the cost of congestion in the Western Province (Colombo Metropolitan Region) was around Rs. 550 million (US$ 9 million) in 1995. The degree of congestion and associated cost is expected to double over the next decade. In addition, estimates indicate that for a 6% increase in GDP, the demand for road space increases by 8%. Measures outlined in Clean Air 2000 need to be implemented in order to control the effects of congestion. Demand side measures should be given first priority, given the fiscal crisis and the limited ability to expand capacity and restructure institutions in the short term. Such measures need to ensure motor vehicle  ix users pay the full cost of driving. Among the instruments available are congestion pricing and parking fees and other traffic restraint measures. On the supply side, priority should be given to restructuring of the public and private bus systems, to improve their reliability, frequency of service, comfort, and level of safety, to attract more consumers to travel on buses. Upgrading the suburban rail system to mass transit standard is also a possibility. This is an activity that can be concessioned out to the private sector on a negative bid basis as has been done in Argentina. 22. Other supply side options to reduce congestion include the construction of key highway improvements and new highways to develop a better network. Given the density of the highway network in Sri Lanka, and the high costs of providing new highways in terms of land acquisition and relocation, this option is more limited. Furthermore, capacity improvements may not always lead to reduction in congestion, as they may result in attracting more traffic. Other options that have been defined in Clean Air 2000 need to be considered when the appropriate institutional structures are in place. These include: (a) set standards for import of vehicles by age and fuel efficiency, especially for operation as buses, school, and office vans and for encouraging the purchase of four-stroke rather than two-stroke motorcycles and three-wheelers; (b) undertake more efficient inspection of vehicles to ensure they meet standards; (c) implement fuel reformulation policies; and (d) encourage and support the use of non- motorized transport (bicycles and animal drawn vehicles) and make provisions for pedestrians in urban areas (see paragraphs 41 and 42). 23. Safet. In addition to the costs of congestion, are the costs of accidents. The level of safety in Sri Lanka is low compared to its East Asian neighbors which have much higher levels of motorization. Measures to ensure safety would involve structural and institutional reform, including setting up systems for transportation planning and traffic management. 24. Poverty and Rural Mobility. Poverty alleviation requires a transport policy focused on the poor. Lack of such a policy and the respective information basis in Sri Lanka has made it difficult to analyze how the transport sector is doing vis a vis the poor. It has been assumed that the mobility needs of the poor can all be resolved by improving transport networks and public transport services in rural areas. However, it may not always be cost-effective to alleviate poverty problems through the transport sector alone. In particular, transport services do not and cannot penetrate all rural areas. Problems of mobility and access are acute in such disadvantaged areas. In these areas attention needs to be focussed on means and modes of travel other than public transport services. Transport policy has to include promoting non-motorized modes and providing local rural roads in such areas. Moreover, a large proportion of rural dwellers are low income earners, and there is a need to look at the distributional consequences of transport investments and policies. 25. Focus on Access to Service. To improve access of rural dwellers to service it is necessary to have a transport policy that includes the needs of rural populations, beyond  x those of providing for mobility. At present, the most time consuming activity in rural areas is collecting water. Policies that improve rural water supply and also provide non- motorized means of transport for rural dwellers can go a long way to improving rural productivity. At present it is Government policy to establishyprimary schools in village areas, and research studies conducted by the NTC and others show that there is a primary school within 2 km of many village centers. Access to secondary schools is still a problem, with children having to travel on average 5 to 10 km away, and sometimes up to 30 km or more in more remote rural areas. There is a critical need to link transport policy to education policy to meet these demands. Other access solutions include the use of mobile banks and clinics; in other words, bringing the facilities closer to the people. Critical to improving the access to services is the need to know the distributional consequences of transport investment. Ability to measure distributional consequences will become more critical as the government reduces its role in the direct provision of services and fosters private sector provision and competition. The Government should collect information on price differentials, expected savings in transport costs as a result of improving services, and wages and prices in rural areas, to measure the distributional impact of transport policies. Using such information, decisions to provide transport for access to services can be made more optimal. 26. Participation. Given the limitations in information available to make detailed assessments of the best ways of meeting the needs of the poor, it is imperative to foster the participation of rural communities. This will ensure that the perspectives of rural people and poor communities are included in the setting of policy. Where poverty alleviation programs exist and unemployment levels are high, participation of rural labor to improve roads can provide a least cost option for carrying out such works. E. SECTOR SPECIFIC REFORMS 27. Ports. A major problem facing the port sector is providing adequate capacity to meet demand for transshipment growth, to enhance revenue earnings in foreign exchange for the country. Other problems result from constraints imposed on the port sector by various interventions. There is a tendency for the port to be used as an employment generating entity which contradicts the pursuit of normal port objectives such as efficient port operations. As a result, port management is weakened, productivity is lowered, and timely provision of services is hampered. These problems impose high direct and indirect costs for provision of port services, with two significant consequences--loss of market share for international transshipment and higher economic costs of providing for port infrastructure and services. 28. The port sector is embarking on a very costly, but needed, expansion plan. Due to fiscal problems facing the country, it may be difficult to finance the required capacity 6 See Diandas J. and M.J. Sahabandu, "Study on Subsidy Allocation in Rural Transport and Operation of Bus Services on I ,remunerative Routes", June 1996, in Volume II of this report.  xi expansions (such as for common access facilities) entirely from public funding sources. Seeking partnerships with the private sector may be the only available option to meet the financing needs for expansion. The Government would need to select partnerships that not only provide the necessary financing but meet the objectives of a planned port expansion and modernization plan, and lead to improved efficiency, enhanced productivity, and lower operating costs. Critical to efficient competition in a public- private partnership is the need for a level playing field among various port operators, including similar treatment for tax incentives including import tariffs for capital goods, access to loans, and control over tariffs. 29. The following recommendations need to be implemented as soon as possible and progress on implementation should be monitored by the highest Government levels, on a continuous and sustainable basis. To improve the efficiency of investments in the port sector, the Government should implement the institutional strengthening recommendations and action plan from the OECF financed study. The port authority should focus its efforts on the main port-related activities by disposing of all non-port related activities to autonomous entities or private sector organizations. To further increase the efficiency of investments in the port, it is necessary to carry out the recommended Port Development Study (Phase I and II) under the PHRD grant. 30. For economic and financial sustainability in port operations it is important to reduce the role of government in direct provision of port services, focusing efforts on managing competition and regulation. This would require enacting legislative reforms in the port sector to enhance private sector participation. The port authority should adopt a "landlord" strategy in the provision of port infrastructure and services, where it retains ownership of assets and responsibilities for development of common user facilities but allows private sector participation by earmarking certain operational activities for partnership with the private sector through concessions, leases, joint venturing, BOT 7 and/or BOO. A landlord strategy may require creating an independent Port Regulator7. To increase the degree of autonomy, it is important to shield port management and operations from political structure interference. To establish some competition in handling containers of Sri Lankan imports and exports, it would be desirable to allow different operators to operate different terminals. This would require the following steps: short term actions for cost containment purposes and medium term actions to create an enabling environment for private sector participation. Among the short term actions are: (a) allow public-private partnerships to operate berths at the ports on a BOTIBOO basis to improve throughput, productivity, and efficiency. Public-private partnerships should be selected according to a clearly defined process with clear goals and objectives; and (b) rationalize the port's labor force through negotiations with the unions to reach agreement on voluntary retrenchment, golden handshakes, early retirement and possible retraining. 7During the December 1996 Workshop to ratify the recommendations made in the Transport Sector Strategy, two members of the discussion group declined endorsing this recommendation in favor of looking at options other than the landlord strategy.  xii It worthwhile to note that the port has a very large redundant labor force and at the same time is short of skilled stevedores. 31. In the medium term, it would be necessary to: (a) strengthen port planning and management decision-making capabilities by providing qualified staff competent in operation research techniques and modem management methods; (b) undertake the recommended development by the UDA of 700 ha adjacent to the port to relieve the pressure for land shortage; (c) implement the Inland Container Depot (ICD) utilizing the rail link, possibly to be operated by a public-private partnership; and (d) initiate and implement a marketing study to attract private sector participation. More measures are needed to further increase efficiency of port operations, and should be given high priority: (a) rationalize the tariff structure at the port; (b) establish incentive-productivity based schemes for port employees; and (c) introduce national Electronic Data Interchange (EDI) systems and further develop port EDI systems. 32. To ensure that port investments and activities are environmentally and socially sustainable the Government should give high priority to: (a) improve the port's safety by adopting a safety code and replacing obsolete floating craft according to SLPA's requirements; (b) improve and monitor environmental conditions at the ports by providing private sector operated ship waste collection and disposal facilities, as well as creating and enforcing environmental safety rules and code of practice; and (c) undertake a Port efficiency Improvement Project and improve the capacity to carry out port marketing. The key actions and investments required in the port sector along with tentative cost estimates and timing are summarized in section G and discussed in detail in Chapter IV, section C. 33. Roads. Sri Lanka is a road dependent economy. The road network covers the country adequately, but is in serious state of disrepair, with only 10% of the paved road network in good condition. The immediate concern in the short run, to increase the efficiency of road investments, is to resolve the maintenance neglect problem. Among the reasons for maintenance neglect, is that funds allocated to maintenance are diverted to meet cost overruns and counterpart funds for foreign-financed projects. To address the serious backlog in maintenance it is necessary first to increase recurrent expenditure allocations for road maintenance, especially for the provincial and local road network. To ensure that these funds are appropriately used for maintenance, there is a need to develop mechanisms to protect funds allocated to maintenance. The Bank's experience in other countries indicates that a Road Maintenance Fund can provide such a mechanism (see Box 7 on the case for and against road funds). 34. To reduce the impact of cost overruns and other inefficiencies in the provision of road works, which make the cost of road provision in Sri Lanka very high, there is a need to: (a) reduce the amount of time it takes to process projects; and (b) increase the degree of competition in the provision of road works. The tendering and project appraisal procedures need to be reformed in order to reduce project preparation and implementation time. The roles of the Road Development Authority (RDA) and its subsidiary the Road  xiii Construction and Development Company (RCDC) need to be redefined. In the short term, the RCDC should compete with the private contracting industry on an equal footing for contracts in road improvement and maintenance. In the medium term, the RCDC should divest its activities in operation of quarries, asphalt plants, and the leasing of construction machinery and equipment to the private sector. In the short-term, and until the private sector can handle these activities, the RCDC should use prices for leasing equipment to the private contractors that reflect the true cost of maintaining and replenishing the fleet. However, care should be taken to make sure that inefficiencies in maintaining the equipment fleet are not transferred to the private contractors. The current process of contracting out maintenance activities and domestically funded rehabilitation to the private contractors should be continued, with particular attention to increasing the degree of competition for the works. The RCDC should continue to reduce its direct involvement in carrying out works and increase participation by local private contractors. Appropriate support should be provided to the local construction and consulting industry to facilitate its development, as is being done in other countries such as Bangladesh. Once a sufficient number of capable domestic contractors are available, the RCDC should be converted into a management body, providing project management services to the local contracting and consulting industry. This would require transferring management capacity and training from the RCDC to domestic contractors and consultants. Criteria to monitor this phasing out process need to be developed. 35. The Government has already taken action to implement some of these recommendations. Following recommendations from an ADB financed study, the Government is setting up a permanent tender board with a technical evaluation committee and a full time secretariat to be responsible for all procurement procedures. Guidelines have also been issued on the allowed processing time for feasibility studies and consultant reports to less than 3 months, and less than 3 months for the tendering process. Also following a Cabinet Decision on October 16, 1996, the RCDC is to compete with the private sector for road improvement contracts, and RDA is to stop giving any road improvement contracts to the RCDC without such competitive bidding. 36. Other measures targeted towards improving the capacity of the private sector, especially small scale enterprises (SMEs) include: packaging contracts and designing contracting programs at a scale and scope suitable for SMEs, providing training for SMEs, modifying prequalification criteria for the SMEs, extending mobilization advances to SMEs, coordinating with other donors on the need to support the local construction industry, and developing credit schemes for the private sector to obtain machinery in order to establish a competitive market. The key actions and investments needed in the road sector are summarized in Section G and discussed in detail in Chapter IV Section B. 37. Road Transport. To improve the efficiency of investments in road transport, urban and regional development and transport planning should be coordinated so that transport and development plans are consistent and reasonable. It should no longer be possible, for example, to prepare a development plan for the Southern Region without a transport component, as was recently done. For institutional strengthening, in a  xiv discussion of the recommendations of this report, the proposal recently approved in Cabinet to create special human settlement committees at the provincial and district levels, was endorsed. These committees, to be chaired by the chief secretary of the province or district will include the relevant provincial and district officials as well as representatives from relevant national agencies. 38. To attain economic and financial sustainability, it is necessary to rationalize bus fares, restructure the bus industry, and enhance competition in the provision of bus services. Bus services-provide important social benefits, and it is important to maintain selective subsidies for non-economic rural bus routes and low fares for poor school children. With these exceptions, however, bus fares should be raised to a level that would allow an efficient bus operator offering service without excessive overloading to recoup the costs of providing that service, including an adequate reserve to replace their buses approximately every 9 or 10 years. Chapter IV, section D of this report, provides details of the formula to use to determine fare increases. To ensure that fares keep pace with costs despite political pressure to hold fares down, it is recommended that a law be passed requiring the NTC to phase in price increases and to approve regular annual fare increases in the manner described in the formula. The law would stipulate that the increases would not be subject to Cabinet approval, although Parliament could review and disapprove an increase if it thought it inappropriate. If the Government decides not to raise fares for political reasons, proper compensatory measures need to be put in place, to allow bus operators to meet their operating costs. 39. There is a need to restructure the system of providing bus services in Sri Lanka which is now shared by the private sector and joint public-private "peoplized" companies. This will require maintaining the positive aspects of competition and public/private provision while minimizing the negative aspects related to accidents and congestion. First, the present 93 "peoplized" companies should be clustered to achieve economies of scale and improve their management and performance. There is a law currently before Parliament proposing to have 11 companies. During discussions of the recommendations of this report, there was sentiment that it might be advisable to have more than 11 companies to enhance competition. Private buses should remain unclustered for at least several years in recognition that the proposed consolidation in the bill before Parliament might reduce some of the advantages of low costs and overheads that the private operators currently enjoy. In the interim, the NTC and PTAs ought to use their statutory authority to supervise schedules, dispatching and evening services so as to improve the quality of service that the private and peoplized companies offer. Such regulatory authority is being used on an experimental basis in the Western and Southern provinces and needs to be applied to other provinces. If the NTC and PTAs are unable to improve the performance of the private sector, then forced consolidation and a system of competitive bidding for exclusive route franchises for limited terms of 5 years need to be introduced. Such franchise arrangements should allow restructured "peoplized" companies to compete or merge with private operators to bid for the franchise. To ensure implementation, it is necessary to strengthen the capacity of the NTC and PTAs to supervise bus operations. Also necessary is the need to affirm that the peoplized as well  xv as the private companies are subject to the regulatory authority of the NTC and the PTAs. The Government should monitor the efforts of the NTC and PTAs to improve bus services. 40. In discussions of the recommendations of this report in the December 1996 Workshop in Colombo, it was agreed that there might be an argument for providing some financial support for the "peoplized" bus companies as long as they are providing socially important services, such as night and early morning services or school fares, that the private companies were not providing. However, to the extent that the differences between the private and peoplized companies in this regard are narrowed, then it weakens the case for special aid to the peoplized companies in the form of buses sold at below cost and other means of support. 41. For social and environmental sustainability in road transport, the Government should support the use of non-motorized transport and intermediate technology modes. Non-motorized travel includes walking as well as bicycles and bicycle trailers. The support should take the form of aid for research and development (R&D) as well as the encouragement of the dissemination of information on these modes. In the case of walking, support should also take the form of the construction of sidewalks and pedestrian crossings on congested streets in urban areas. A key institutional component needed to ensure the proper balance across transport modes is the need to establish a unit within the Ministry of Transport, Environment, and Women's Affairs to sponsor R&D and dissemination by NGOs and others. At the local level, urban councils should be aided in the construction of sidewalks and pedestrian crossings. Provision of socially beneficial bus services should be improved. In particular, the practice of competitive bidding for non-economic rural bus services should be expanded, with private as well as peoplized companies participating in the bidding. In addition, processes for targeting concessionary fares to poor children and introducing those fares on private buses should be explored. This would require strengthening the capacity of the NTC and the PTAs to supervise rural bus services and school fares. 42. Efforts are also needed to control the congestion and pollution generated by private motor vehicles. Measures recommended include: (a) controls on parking and other measures to discourage the use of private motor vehicles in congested and polluted urban areas; (b) priority for buses in the allocation of street space in congested urban areas; and (c) raising the cost diesel private motor vehicle use, excluding buses and perhaps trucks. These measures could include increases in the annual and new registration fees for targeted diesel vehicles. To control air pollution, more attention needs to be paid to particulate emissions. Sri Lanka is in serious violation of WHO ambient air standards for particulates while it complies with WHO ambient standards for lead. Additional efforts to control particulate emissions include: (a) better enforcement of existing laws against poorly maintained and heavily polluting diesel vehicles. In particular, enforcement against "belching" vehicles can be improved by using simple Polaroid cameras; and (b) importing crude oils with lower sulfur content or other characteristics that might reduce particulate emissions. There is a need to strengthen the  xvi capacity to enforce emission laws and to develop practical measures to control traffic and congestion, and to reduce particulate emissions. The key actions and investments needed in road transport are summarized in Section G and discussed in detail in Chapter IV Section D. 43. Railways. Looking at the historical capital outlays for the railway suggests that the Government has invested quite heavily in railways. However, official records grossly overestimate the real capital expenditures due to misclassifying recurrent expenditures as capital expenditures. The railway infrastructure and rolling stock is deteriorated and in bad need of repair, reducing the quantity and quality of service the system is able to provide. There is a need to address the problem of misclassifying recurrent and capital expenditures so that rational allocations can be made to meet the needs for rehabilitation and maintenance, as well as capital. Critical to this end is upgrading of the Management Information Systems (MIS) and accounting procedures at the railway. 44. For the railway to be able to compete efficiently with the road sector, there is a critical need to restructure the operations of the SLR. While the railway plays an important economic role in the commuter passenger market, it is marginally utilized for freight transport. Intermodal competition has eroded the railway's pre-World War II's monopoly on land transport to only 12% of the passenger market and 6% of the freight market. Given the structure of the transport industry at present, the railway will continue to depend on transfers from treasury for meeting part of its operating costs as well as capital needs. However, there is a critical need to improve the operational efficiency of the railway. 45. The Government has just completed preparing a structured Business Plan for the railways which identifies four key railway markets