Sri Lanka 2010 Annual Report by Fekade Tadesse

Annual Report 2010

Central Bank of Sri Lanka

Annual Report 2010 Preliminary Pages List of Acronyms

Part I Key Economic Indicators Key Social Indicators Chapters 1. Economic, Price and Financial System Stability, Outlook and Policies 2. National Output and Expenditure 3. Economic and Social Infrastructure 4. Prices, Wages, Employment and Productivity 5. External Sector Developments and Policies 6. Fiscal Policy and Government Finance 7. Monetary Policy, Money, Credit and Interest Rates 8. Financial Sector Performance and System Stability Major Economic Policy Changes and Measures : 2010 Part II Accounts and Operations of the Central Bank of Sri Lanka

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Annual Report 2010

Part III Major Administrative Measures Adopted by the Monetary Board in 2010

Part IV Major Legislative Enactments of 2010 Relating to the Functions and Operations of the Central Bank and Banking Institutions in Sri Lanka

Statistical Appendix

Special Statistical Appendix

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CENTRAL BANK OF SRI LANKA

ANNUAL REPORT

OF THE MONETARY BOARD TO THE HON. MINISTER OF FINANCE

FOR THE YEAR

2010

ISBN 978-955-575-213-8 ISSN 1391-359X

Price per copy Counter sales

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Rs. 350 per copy

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Despatch abroad

Printed at Printcare Packaging (Pvt) Limited, 21 Sri Pushparama Mawatha, Pahala Biyanwila, Kadawatha and published by the Central Bank of Sri Lanka, 30, Janadhipathi Mawatha, Colombo, 00100.

Ajith Nivard Cabraal The Governor

Central Bank of Sri Lanka 30, Janadhipathi Mawatha Colombo 01, Sri Lanka.

March 31, 2011 His Excellency Mahinda Rajapaksa President of Sri Lanka and Minister of Finance and Planning Presidential Secretariat Colombo 01. Your Excellency, Annual Report 2010 Section 35 of the Monetary Law Act (Chapter 422) requires the Monetary Board of the Central Bank of Sri Lanka to submit an Annual Report to the Minister of Finance on the state of the economy, the condition of the Central Bank and a review of the policies and measures adopted by the Monetary Board, within four months after the end of each financial year. The Sixty First Annual Report of the Monetary Board of the Central Bank, in respect of the year 2010, is submitted herewith in fulfilment of this obligation. Yours sincerely,

CENTRAL BANK OF SRI LANKA THE MONETARY BOARD (As at 31 December 2010)

Ajith Nivard Cabraal Governor P. B. JAYASUNDERA Secretary to the Ministry of Finance and Planning NIMAL WELGAMA Appointed Member mrs. m. ramanathan Appointed Member N. A. UMAGILIYA Appointed Member

PRINCIPAL OFFICERS AS AT 31 DECEMBER 2010 Deputy Governors k. G. D. D. Dheerasinghe P. D. J. Fernando

Assistant Governors Appointed on 03.12.2007 MRS. C. PREMARATNE P. SAMARASIRI (Secretary to the Monetary Board)

Appointed on 10.08.2009 W. M. KARUNARATNE MRS. J. P. MAMPITIYA B. D. W. A. SILVA P. N. WEERASINGHE (on release)

Appointed on 15.06.2010 Y. A. DE SILVA W. M. HEMACHANDRA S. LANKATHILAKE C. J. P. SIRIWARDENA

DEPARTMENTAL HEADS Bank Supervision Department MRS. T. M. J. Y. P. FERNANDO N. W. G. R. D. NANAYAKKARA

- Director - Additional Director

Centre for Banking Studies U. P. ALAWATTAGE t. d. h. karunaratne

- Director - Additional Director

Communications Department S. J. A. HANDAGAMA

Director

Currency Department c. p. a. karunatilake MRS. H. P. T. WIJESURIYA

- Superintendent - Additional Superintendent

Domestic Operations Department R. A. A. JAYALATH D. A. G. K. WIJETUNGA

- Director - Additional Director

Economic Research Department K. D. RANASINGHE MRS. S. GUNARATNE

- Chief Economist/Director - Additional Director

Employeesâ&#x20AC;&#x2122; Provident Fund Department mrs. r. dheerasinghe MRS. K. GUNATILaKE MRS. C. M. D. N. K. SENEVIRATNE

- Superintendent - Additional Superintendent - Additional Superintendent

Exchange Control Department P. H. O. CHANDRAWANSA A. M. R. K. ATTANAYAKE

- Controller - Additional Controller

Finance Department M. I. Sufiyan P. V. L. NANDASIRI

- Chief Accountant - Additional Chief Accountant

Financial Intelligence Unit D. M. RUPASINGHE D. K. WIJESURIYA

- Director - Additional Director

Financial System Stability Department Miss. k. saravanamuttu

Director

Governorâ&#x20AC;&#x2122;s Secretariat Department mrs. k. dasSanayake T. M. Z. MUTALIPH

- Director - Additional Director

Human Resources Department A. R. K. WIJESEKERA W. R. A. DHARMARATNE

- Director - Additional Director

Information Technology Department Mrs. R. A. S. M. DAYARATHNA C. B. PATHBERIYA

- Director - Additional Director

International Operations Department h. a. karunaratnE a. a. m. thassim

- Director - Additional Director

Management Audit Department A. M. N. GUNAWARDANA h. amaratHunga

- Director - Additional Director

Payments and Settlements Department MRS. R. B. WEERASINGHE

Director

Policy Review and Monitoring Department M. J. S. ABEYSINGHE P. W. D. N. R. RODRIGO

- Director - Additional Director

Premises Department U. H. E. SILVA K. L. L. FERNANDO

- Director - Additional Director

Provincial Offices Monitoring Department F. c. s. mendis S. M. A. SIRIWARDANE

- Director - Additional Director

Public Debt Department s.s. ratnayake

- Superintendent and Registrar

Regional Development Department E. A. HETTIARACHCHI M. S. K. DHARMAWARDANE

- Director - Additional Director

Secretariat Department A. KAMALASIRI MRS. P. WIJESINGHE

- Secretary - Additional Secretary

Security Services Department S. Wanigasekera b. l. j. s. balasuriya

- Director - Additional Director

Statistics Department d. wasantha miss. a. s. de alwis

- Director - Additional Director

Supervision of Non-Bank Financial Institutions Department MRS. K. M. A. N. DAULAGALA H. m. ekanayake J. P. R. KARUNARATNE h. b. d. karunaratna MRS. n. h. e. r. siriwardhana

- Director - Additional Director - Additional Director - Additional Director - Additional Director

Welfare Department mrs. s. n. perera K. P. N. S. KARUNAGODA

- Director - Additional Director

AUDITOR h. a. s. Samaraweera Acting Auditor-General

CONTENTS PART I

Page

1. ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES 1.1 Overview … 1.2 Macroeconomic Developments, Stability and Policy Responses in 2010 Real Sector Developments ... External Sector Developments ... Fiscal Sector Developments ... Monetary Sector Developments ... Financial Sector Performance and System Stability ... 1.3 Global Economic Environment and Outlook … 1.4 Medium Term Macroeconomic Outlook, Challenges and Policies

… … … … … … … … …

1 4 4 7 10 11 13 15 18

… … … … … … … … … … … … … … …

29 32 32 32 34 36 36 37 40 47 49 49 51 53 54

3.1 Overview … … 3.2 Economic Infrastructure, Policies, Institutional Framework and Performance … Communication Services … … Energy … … Electricity … … Petroleum … … Oil Exploration ... ... Transportation … … Road Development ... … Road Passenger Transportation ... ... Railway Transportation … … Civil Aviation … … Port Services ... … Water Supply and Irrigation … … 3.3 Social Infrastructure Policies, Institutional Framework and Performance … Health … … Education … … Housing and Urban Development … … Safety Nets and Poverty Alleviation … … Environment … …

… … … … … … ... … … ... … … … … … … … … … …

… … … … … … … … … … … … … … … … … … … …

57 58 58 60 60 63 64 64 64 65 66 67 68 70 71 71 74 77 78 79

2. NATIONAL OUTPUT AND EXPENDITURE 2.1 Overview … 2.2 Sectoral Output, Policies, Institutional Support and Issues … Agriculture … Export Crops … Domestic Agriculture … Fishing … Livestok … Forestry … Industry … Services 2.3 Expenditure … Consumption … Investment … Availability and Utilisation of Resources … Savings …

3. ECONOMIC AND SOCIAL INFRASTRUCTURE

Page

4. PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY 4.1 Overview 4.2 Prices Price Movements and Contributory Factors Colombo Consumers’ Price Index (CCPI) Wholesale Prices Index (WPI) GDP Deflator 4.3 Wages Public Sector Wages Formal Private Sector Wages Informal Private Sector Wages 4.4 Population, Labour Force and Employment Population Labour Force Employment Unemployment Foreign Employment Labour Productivity Labour Relations and Labour Market Reforms

... … … … … … … … … … … … … … … … … …

… … … … … … … … … … … … … … … … … …

81 82 82 82 87 88 88 88 89 89 90 90 90 91 93 93 96 97

5.1 Overview … … 5.2 External Sector Policies and Institutional Support … … 5.3 Trade in Goods, Trade Balance and Terms of Trade … … Export Performance … … Import Performance … … Trade Balance … … Terms of Trade … … Direction of Trade … … 5.4 Trade in Services, Income, Current Transfers and Current Account Balance Trade in Services … … Transportation Services … … Travel and Tourism … … Communications Services … … Computer and Information Services … … Inflows and Outflows of Income … … Current Transfers … … Current Account … … 5.5 Capital and Financial Flows and Balance of Payments … … Foreign Direct Investment (FDI) … … Medium and Long-term Capital to the Government … … Short-term Capital to the Government … … Long-term Capital to the Private Sector and Public Corporations … Short-term Capital to the Private Sector and Public Corporations … Balance of Payments … … External Reserves … … 5.6 External Debt and Debt Service … … External Debt … … Foreign Debt Service Payments … … 5.7 Exchange Rate Regime and Exchange Rate Movements … … Nominal and Real Effective Exchange Rates … … Developments in the Domestic Foreign Exchange Market … …

… … … … … … … … … … … … … … … … … … … … … … … … … … … … … … …

99 100 105 105 107 109 109 110 111 111 111 112 113 113 113 114 114 114 114 117 118 118 118 119 119 122 122 123 124 125 127

… … … … … …

129 130 133 133 133 135

5. EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

6. FISCAL POLICY AND GOVERNMENT FINANCE 6.1 Overview 6.2 Fiscal Policy Direction and Measures 6.3 Government Budgetary Operations Revenue and Grants Revenue Grants

… … … … … …

Page

Expenditure and Net Lending … Key Fiscal Balances … Financing the Budget Deficit … 6.4 Budgetary Operations in Sub National Governments ... Policy Direction and Measures of Sub National Governments Budgetary Operations in Provincial Councils … 6.5 Government Debt and Debt Service Payments … Government Debt … Debt Service Payments …

… … … … … … … … …

135 138 139 140 140 141 142 142 148

… … … … … … … … … … … … … …

149 150 154 154 155 156 156 158 159 159 160 161 162 162

… … … … … … … … … … … … … … … … … … …

165 166 172 172 176 179 180 181 181 183 183 183 184 185 186 187 187 187 189

ACCOUNTS AND OPERATIONS OF THE CENTRAL BANK OF SRI LANKA

1-115

7. MONETARY POLICY, MONEY, CREDIT AND INTEREST RATES 7.1 Overview 7.2 Monetary Policy 7.3 Developments in Money and Credit Money Market Liquidity Reserve Money Narrow Money (M1) Broad Money (M2b) Broad Money (M4) 7.4 Interest Rates Money Market Rates Yield Rates on Government Securities Deposit and Lending Rates Yield Rates on Corporate Debt Securities 7.5 Future Developments, Challenges and Outlook

8. FINANCIAL SECTOR Performance AND SYSTEM STABILITY 8.1 Overview 8.2 Performance of the Banking Sector 8.3 Performance of Non-Banking Financial Institutions Registered Finance Companies Specialised Leasing Companies Primary Dealers in Goverments Securities Insurance Companies Unit Trusts Superannuation Funds 8.4 Performance of Financial Markets Money Market The Domestic Foreign Exchange Market Government Securities Market Colombo Stock Market Commercial Paper and Debenture Markets 8.5 Financial Infrastructure Payment and Settlement Systems Regulatory Improvement Credit Information

PART II

PART III MAJOR ADMINISTRATIVE MEASURES ADOPTED BY THE MONETARY BOARD IN 2010

1-112

PART IV MAJOR LEGISLATIVE ENACTMENTS OF 2010 RELATING TO THE FUNCTIONS AND OPERATIONS OF THE CENTRAL BANK AND BANKING INSTITUTIONS IN SRI LANKA STATISTICAL APPENDIX SPECIAL STATISTICAL APPENDIX

1-8

PART I – TABLES

Page

1. ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES 1.1

Gross National Product by Industrial Origin at Constant (2002) Prices

…

1.2

Aggregate Demand and Savings Investment Gap

…

1.3

External Sector Developments

…

1.4

Global Economic Developments and Outlook

…

1.5

Medium Term Macroeconomic Framework

...

…

2. NATIONAL OUTPUT AND EXPENDITURE 2.1

Sectoral Composition and Increase in Gross Domestic Product

by Industrial Origin at Constant (2002) Prices

…

2.2

Agriculture Production Index (1997-2000=100)

…

2.3

Trends in Principal Agricultural Crops

…

2.4

Paddy Sector Statistics

…

2.5

Fish Production

…

2.6

Livestock Sector Statistics

…

2.7

Value Added in Industry (2002 Constant Prices)

…

2.8

Ex-Factory Profit Ratios of Non-BOI Private Sector Industries

…

2.9

Domestic Cost Structure of Non-BOI Private Sector Industries

(As a percentage of total cost of production)

…

2.10 Labour Productivity Index of Non-BOI Private Sector Industries

…

2.11 Aggregate Demand

…

2.12 Composition of Private Consumption Expenditure at Current Market Prices …

…

2.13 Investment and Employment in Enterprises Registered under the Board of

…

2.14 Total Resources and their Uses at Current Market Prices

Investment of Sri Lanka (BOI) and Ministry of Industry and Commerce (MIC) … ...

…

2.15 Consumption, Investment and Savings at Current Market Prices …

…

...

…

3. ECONOMIC AND SOCIAL INFRASTRUCTURE 3.1

Government Investment in Infrastructure

…

....

…

3.2

Growth of Telecommunications and Postal Services

...

…

3.3

Power Sector Performance

…

...

…

3.4

Petroleum Sector Performance

…

...

…

3.5

Salient Features of the Transport Sector

…

...

…

3.6

Performance of Port Services

…

...

…

3.7

Water Supply by National Water Supply and Drainage Board …

…

3.8

Salient Features of Health Services

…

...

…

3.9

Salient Features of General and University Education .

…

...

…

3.10 Samurdhi Welfare Programme - Number of Beneficiary Families

and Value of Grants

4. PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY 4.1

Changes in Price Indices

…

...

…

4.2

Retail Prices of Key Imported and Domestically Produced Items …

…

Page

4.3

Administered Price Revisions of Key Items 2008 - 2010

…

...

…

4.4

Sectoral Deflators and GDP Deflator

…

...

…

4.5

Wage Rate Indices

…

...

…

4.6

Informal Private Sector Daily Wages by Sector and Gender

...

…

4.7

District-wise Population

…

...

…

4.8

Household Population, Labour Force and Labour Force Participation

…

4.9

Employment by Economic Activity

…

...

…

4.10 Status of Employment

…

...

…

4.11 Public Sector Employment

…

...

…

4.12 Unemployment Rate (Unemployed as a percentage of Labour Force)

…

4.13 Departures for Foreign Employment

…

...

…

4.14 Foreign Employment Departures by Destination

…

...

…

4.15 Labour Productivity by Major Economic Sector

…

...

…

4.16 Strikes in Private Sector Industries

…

...

…

5. EXTERNAL SECTOR DEVELOPMENTS AND POLICIES 5.1

Balance of Payments Analytical Presentation

…

101

5.2

Average Import Duty Collection Rate

…

102

5.3

Trade Indices

…

103

5.4

Composition of Exports

…

106

5.5

Composition of Imports

…

108

5.6

Volume of Major Imports

…

109

5.7

Net Services, Income and Current Transfers

…

111

5.8

Tourism Performance

…

112

5.9

Major Projects Financed with Foreign Borrowings during 2010 …

…

119

…

120

5.11 Outstanding External Debt and Banking Sector External Liabilities

…

123

5.12 External Debt Service Payments

…

124

5.13 Exchange Rate Movements

…

125

5.10 External Assets of Sri Lanka

6. FISCAL POLICY AND GOVERNMENT FINANCE 6.1

Summary of Government Fiscal Operations

…

132

6.2

Economic Classification of Revenue

…

133

6.3

Economic Classification of Expenditure and Lending Minus Repayments

…

136

6.4

Functional Classification of Expenditure

…

137

6.5

Sources of Domestic Financing

…

139

6.6

Budget Outturn for Provincial Councils

…

142

6.7

Outstanding Government Debt (as at end-year)

…

143

6.8

Government Debt Service Payments

…

148

6.9

Government Debt Indicators

…

148

7. MONETARY POLICY, MONEY, CREDIT AND INTEREST RATES 7.1

Recent Monetary Policy Measures (2007-2010)

…

150

7.2

Developments in Monetary Aggregates

…

151

7.3

Sources of Reserve Money and Broad Money (M2b)

…

156

7.4

Sectoral Distribution of Loans and Advances granted by Commercial Banks …

…

157

Page

7.5

Sources of Broad Money (M4)

…

158

7.6

Selected Money Market Rates

…

159

7.7

Yield Rates on Government Securities

…

160

7.8

Deposits and Lending Rates

…

161

8. FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY 8.1

Total Assets of the Major Financial Institutions

…

...

…

166

8.2

Distribution of Banks and Bank Branches

...

…

...

…

167

8.3

Credit Card Operations by Licensed Commercial Banks

...

…

...

…

167

8.4

Composition of Assets and Liabilities of the Banking Sector

…

...

…

168

8.5

Composition of Statutory Liquid Assets of the Banking Sector …

...

…

169

8.6

Profit of the Banking Sector

…

...

170

8.7

Composition of Regulatory Capital of the Banking Sector

…

170

8.8

Composition of Assets and Liabilities of RFCs

…

...

172

8.9

Profit of RFCs

…

...

173

8.10 Composition of Assets and Liabilities of SLCs

…

...

177

8.11 Profit of SLCs

…

...

177

8.12 Performance of Primary Dealers in Goverment Securities

…

...

…

179

8.13 Key Financial Indicators of Insurance Companies

…

...

180

8.14 Selected Indicators of the Unit Trust Industry

...

…

...

…

181

8.15 Key Indicators of EPF and ETF

...

…

...

…

183

8.16 Money Market Transactions

...

…

...

…

183

8.17 Market Volumes of Government Securities

...

…

...

…

184

8.18 Market Yield Rates of Government Securities

...

…

...

…

185

8.19 Colombo Stock Market Selected Indicators

...

…

...

…

186

8.20 Transactions Through Payments Systems

...

…

...

…

187

PART I – CHARTS

Page

1. ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES 1.1

Quarterly Growth and Unemployment

…

...

1.2

Inflation

…

...

1.3

Savings and Investment (as a percentage of GDP)

…

...

1.4

Value of Petroleum Imports and Average Price of Crude Oil Imports

…

...

…

1.5

Balance of Payments

…

...

1.6

Revenue, Expenditure and Overall Fiscal Deficit (as a percentage of GDP) …

…

1.7

Government Debt (as a percentage of GDP)

…

...

1.8

Central Bank Policy Rates and Selected Market Interest Rates …

…

1.9

Money,Credit and Interest Rates

…

...

…

...

…

2. NATIONAL OUTPUT AND EXPENDITURE 2.1

Annual Growth Rate

…

2.2

Rice: Supply and Demand

…

...

2.3

Composition of Value Added in Industry – 2010 (2002 Constant Prices)

…

...

…

2.4

Investment in Approved and Contracted BOI Projects (Including Expanded Projects)

…

...

Number of Projects

…

...

Value of Investment

…

...

…

...

2.5

The Economy in 2010 (at Current Prices)

Supply of Goods and Services

…

Demand for Goods and Services

…

3. ECONOMIC AND SOCIAL INFRASTRUCTURE 3.1

Telephone Density

…

...

3.2

Average Tariff and Cost of Electricity

…

...

3.3

International Crude Oil (Brent) Prices (Monthly Average) 2009/2010

…

...

3.4

Volume of Container Handling and Transshipments

…

...

3.5

Government Expenditure on Health and Education

…

...

3.6

Number of Samurdhi Beneficiary Families and Expenditure

…

...

…

Colombo Consumers’ Price Index (2002=100)

…

...

4.2 Trends in Labour Force and Unemployment 2007–2010 5. EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

…

...

…

4. PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY 4.1

5.1

Balance of Payments

…

100

5.2

Major Sources of Foreign Exchange Earnings

…

100

5.3

Export Performance

…

105

5.4

Exports by Commodities - 2010

…

107

5.5

Import Performance

…

107

5.6

Imports by Commodities - 2010

…

108

5.7

Terms of Trade and Trade Indices

…

110

5.8

Exports by Destinations

…

110

Page

5.9

Imports by Origin

…

111

5.10 Inflows to the Capital and Financial Account

…

118

5.11 Quarterly External Assets

…

120

5.12 External Debt

…

...

122

5.13 Exchange Rate Movements

…

...

125

Exchange Rate Movements - Rupees per US $

…

125

Effective Exchange Rate Indices: 24-currency (2010=100) …

…

125

…

127

5.14 Quarterly Inter-Bank Forward Transaction Volumes 6. FISCAL POLICY AND GOVERNMENT FINANCE 6.1

Composition of Government Revenue – 2010

…

133

6.2

Composition of Government Current Expenditure – 2010

…

136

6.3

Total Expenditure by Function – 2010

…

137

6.4

Major Fiscal Indicators (as a percentage of GDP)

…

139

6.5

Deficit Financing (as a percentage of GDP)

…

139

6.6

Sources of Bank Financing

…

140

6.7

Outstanding Government Debt (as a percentage of GDP)

…

143

6.8

Composition of Outstanding Domestic Debt - 2010

…

143

6.9

Composition of Outstanding Foreign Debt - 2010

…

144

6.10 Currency composition of Total Outstanding Debt - 2010

…

144

6.11 Government Debt Service Payments (as a percentage of GDP) …

…

147

7. MONETARY POLICY, MONEY, CREDIT AND INTEREST RATES 7.1

Inflation and Contribution to Inflation from key Categories

…

151

7.2

Policy Interest Rates and the Average Weighted Call Money Rate

…

153

7.3

Excess Money Market Liquidity absorbed through OMO

…

155

7.4

Growth of Monetory Aggregates

…

156

7.5

Growth of Credit granted to the Private Sector by LCBs, LSBs and RFCs

…

158

7.6

Growth of Broad Money

…

159

7.7

Secondary Market Yield Curve for Government Securities

…

160

7.8 Policy Interest Rates and Deposit and Lending Rates of Commercial Banks … 8. FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

…

161

...

…

168

8.1

Funding Structure of the Banking Sector

8.2

Non-Performing Loans of the Banking Sector

...

…

168

8.3

Liquidity Ratios of the Banking Sector

…

169

8.4

Profipability Indicators of the Banking Sector

…

170

8.5

Capital Adequacy Ratios of the Banking Sector

…

172

8.6

Non-Performing Accommodations of RFCs

…

173

8.7

Profitability Indicators of RFCs

…

174

8.8

Non-Performing Advances of SLCs

…

177

8.9

Profitability Indicators of SLCs

…

177

…

186

8.10 Share Price Indices

...

PART I - BOXES

Page

Sri Lanka’s Graduation to Middle-Income Status from the PRGT Eligible Country List

...

…

The Ease of Doing Business Ranking

…

Doubling Per Capita Income

...

…

Using Nanotechnology for Developing the Industrial Sector

...

…

Voluntary Pension Fund-A Social Security Scheme to Increase Domestic Savings

…

...

Infrastructure for Inclusive Growth

…

...

…

Expanding Opportunities for Higher Education

...

…

...

8. Global Warming and Carbon Credits

…

...

Extreme Weather Conditions and their Impact

…

...

10.

Trends in Global Foreign Direct Investment (FDI) Flows and Prospects for Attracting FDI to Sri Lanka

…

115

11.

Progress of the IMF-SBA Facility

…

...

121

12.

Revision of Effective Exchange Rate Indices

…

...

…

126

13.

Government Debt Sustainability

...

…

...

145

14.

Strengthening the Framework for Monetary Policy

...

…

...

…

152

15.

Role of Banks in Consumer Well-being

...

…

...

171

16.

Regulations for the Microfinance Sector

...

…

...

175

17.

Distress Resolution: The Case of Non-Bank Financial Institiutions

…

...

178

18.

Investments by the Employees’ Provident Fund in the Stock Market

…

...

182

19.

Value Chain Approach: An Alternative Way of Small Enterprise Development

…

...

188

20.

Major Economic Policy Changes and Measures: 2010

…

...

191

...

…

STATISTICAL APPENDIX

Table

NATIONAL OUTPUT AND EXPENDITURE

Gross National Product by Industrial Origin at Current Prices of Major Economic Activities …

…

Gross National Product by Industrial Origin at Constant (2002) Prices of Major Economic Activities

…

Gross National Product by Industrial Origin of Major Economic Activities

…

Provincial Gross Domestic Product by Industrial Origin at Current Prices (2005-2009)

…

Resources and their Utilisation

…

Reconciliation of Key Aggregates at Current Market Prices

…

Gross Domestic Capital Formation at Current Market Prices

…

Composition of Private Consumption Expenditure at Current Market Prices

…

Expenditure on Gross National Product at Current Market Prices …

…

Gross Domestic Expenditure and Availability of Resources

…

Investment and Savings at Current Market Prices

…

Real National Income

…

Trends in Principal Agricultural Crops

…

Production of Tea, Rubber, Coconut and Export Agriculture Crops …

…

Annual Rainfall and Rainy Days

…

District-wise Performance of the Paddy Sector

…

Paddy Production

…

Performance of Other Field Crops

…

Statistics on the Sugar Sector

…

Annual Usage of Fertiliser by Crop

…

Statistics on the Forestry Sector

…

Value Added in Industry (2002 Constant Prices)

…

Value Added in Industry (Current Prices)

…

Investment Approvals in Industry by the Board of Investment of Sri Lanka

…

Realised Investments in the Board of Investment (BOI) Enterprises …

…

Relative Composition of Private and Public Sector Industries

…

Capacity Utilisation in Industry

…

Performance of State Owned Enterprises

…

Employment in State Owned Enterprises

…

Regional Distribution of Industrial Enterprises

…

Private Sector Industrial Production Volume Index

…

ECONOMIC AND SOCIAL INFRASTRUCTURE

Salient Features of Government Health Services

…

Salient Features of General and University Education

…

Telecommunications and Postal Services

…

Energy Sector Performance

…

Salient Features of the Transport Sector

…

Performance of the Port Services

…

Land Cultivated under the Mahaweli Development Programme

…

Table

PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

Movement of the Colombo Consumers’ Price Index

…

Colombo Consumers’ Price Index (1952=100)

…

Colombo Consumers’ Price Index (2002=100)

…

Wholesale Price Index

…

Average Retail Prices of Selected Food Items by Province 2009-2010

…

Wholesale Prices of Selected Commodities

…

Wage Rate Indices

…

Average Daily Wages in the Informal Sector

…

Average Daily Wages of Informal Sector by Province 2009-2010 …

…

Demography

…

Population by District

…

Labour Force Participation Rate

…

Status of Employment

…

Employment by Economic Activity

…

Labour Force Trends

…

Public Sector Employment

…

Foreign Employment

…

Employees’ Provident Fund

…

Employees’ Trust Fund

…

Strikes in Private Sector Industries

…

EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

Central Bank Trade Indices – Value

…

Central Bank Trade Indices – Volume

…

Central Bank Trade Indices – Unit Value

…

Foreign Trade

…

Exports

…

Tea Exports, Sales and Prices

…

Volume and Value of Tea Exports

…

Country Classification of Tea Exports

…

Rubber Exports and Prices

…

Country Classification of Rubber Exports

…

Country Classification of Garment Exports

…

Major Coconut Products, Exports and Prices

…

Volume and Value of Exports of Other Agricultural Products

…

Selected Industrial and Mineral Exports

…

Imports by Major Categories

…

Imports and Exports of Major Commodities

…

Expenditure on Imports

…

Direction of Trade - Exports

…

Direction of Trade - Imports

...

Tourism Performance

…

Some Indicators of Regional Distribution of Tourist Trade

…

Balance of Payments

…

Balance of Payments - Standard Presentation under BPM 5

...

…

80A

Table

Services, Income and Transfers

…

Workers’ Remittances

…

External Resources and Their Uses

…

Financing of the External Resources Gap

…

External Debt Outstanding and Banking Sector External Liabilities ...

…

End of Period Exchange Rates

…

Average Exchange Rates of Major Currencies and Monthly Indices of Nominal Effective

…

Exchange Rate (NEER) and Real Effective Exchange Rate (REER) …

…

...

…

Interbank Forward Market Transactions

…

Absorption and Supply of Foreign Exchange by the Central Bank …

…

FISCAL POLICY AND GOVERNMENT FINANCE

Summary of Government Fiscal Operations

…

Government Revenue

…

Payments of the Government of Sri Lanka

…

Voted Expenditure of the Government of Sri Lanka – 2010

…

Voted Expenditure of the Government of Sri Lanka – 2011

…

Current Transfers to Public Corporations and Institutions

…

Capital Transfers to Public Corporations and Institutions

…

Acquisition of Financial Assets (Loan Outlays)

…

Financing of the Government Net Cash Deficit

…

Economic Classification of Government Revenue

…

Economic Classification of Government Expenditure and Lending Minus Repayments

…

100

Economic Classification of Government Fiscal Operations

…

101

…

Composition of Outstanding Government Debt

…

102

Ownership of Government Debt (as at end of the year)

…

103

Ownership of Treasury Bills

…

104

Ownership of Treasury Bonds

…

105

Ownership of Rupee Loans

…

106

Ownership of Outstanding Foreign Debt

…

107

Foreign Loans – 2010

…

...

108

Net Receipts of Foreign Assistance

…

109

Outstanding Central Government Debt (as at end of the year)

…

110

Budget Outturn for Provincial Councils

…

111

MONETARY POLICY, MONEY, CREDIT AND INTEREST RATES

Monetary Aggregates – M1 and M2

…

112

Currency Issue by the Central Bank (by Denomination)

…

113

Monetary Survey (Domestic Banking Units) – M2

…

114

Consolidated Monetary Survey (inclusive of Offshore Banking Units) – M2b

…

115

Financial Survey – M4

…

116

…

Monetary Aggregates

…

117

Reserve Position of Commercial Banks

…

118

Money Rates

…

119

Money Rates: Savings and Long-Term Credit Institutions

…

120

Yield Rates on Government Securities

…

121

Table

Commercial Banks’ Loans and Advances by Type of Security (at end December) …

…

122

Commercial Banks’ Loans and Advances to the Private Sector

…

123-I

Commercial Banks’ Loans and Advances by Purpose and Maturity …

…

123-II

…

124

FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Assets and Liabilities of the Central Bank

…

Assets and Liabilities of Commercial Banks

…

125

Assets and Liabilities of Offshore Banking Units (OBUs)

…

126

Assets and Liabilities of Registered Finance Companies

…

127

Savings and Fixed Deposits of Commercial Banks and Other Licensed Non-Commercial

Bank Financial Institutions

Insurance Activities

…

128

…

129

Share Market Developments

…

130

Debentures Listed on the CSE in 2010

…

131

Total Cultivation Loans Granted by the Lending Banks (Position as at 31 December 2010) …

…

132

New Comprehensive Rural Credit Scheme – Loans Granted for Subsidiary Food Crops by

…

...

133

(Position as at 31 December 2010)

…

134

…

...

135

…

136

Deposits and Advances of District Co-operative Rural Banks (2000 – 2010)

the Lending Banks (Position as at 31 December 2010)

Operations of the Crop Insurance Programme – Paddy Sector

and District-wise Classification for 2010

…

Deposits and Advances of District Co-operative Rural Banks’ Unions (2002 – 2010)

and District-wise Classification for 2010

…

SPECIAL STATISTICAL APPENDIX

Table

1. Real Sector: 1948 – 2010

Population and Labour Force National Output and Prices

… …

... ...

1 2

… …

… ...

... ...

3 4

… …

... ...

5 6

… …

... ...

7 8

Key Socio-economic Indicators in Sri Lanka ... Key Socio-economic Indicators by Province - 2003/04 ... Key Socio-economic Indicators by Sector - 2006/07 & 2009/10 ...

... … ...

... ... ...

9 10 11

2. External Sector: 1950 - 2010

Balance of Payments External Assets, External Debt and Exchange Rates

3. Fiscal Sector: 1950 - 2010

Government Fiscal Operations Government Debt

4. Financial Sector: 1950 - 2010

Monetary Survey (M2) Interest Rates

5. Socio-economic Conditions: 1953 – 2009/10

List of Acronyms ACU AD ADB ADSL AITC ALDL ALFEA APMA APO APTA ARM ASPI ATF ATM AWCMR AWDR AWFDR AWLR AWPR BCP BIA BIADP BIMST-EC BIS BIS BOC BOI BOP BOT BPO CAARP CAR CARAMELS CBG CBSL CCB CCPI CDA CDD CDCPI CDO CDM CDMA CEA CEB

Asian Clearing Union Aggregate Demand Asian Development Bank Asymmetric Digital Subscriber Line Apparel Innovation and Training Centre Agro-Livestock Development Loan Scheme Association of Licensed Foreign Employment Agencies Agriculture Product Marketing Board Asian Productivity Organisation Asia-Pacific Trade Agreement Adjustable Rate Mortgages All Share Price Index Agreement on Trade Facilitation Automated Teller Machine Average Weighted Call Money Rate Average Weighted Deposit Rate Average Weighted Fixed Deposit Rate Average Weighted Lending Rate Average Weighted Prime Lending Rate Business Continuity Plan Bandaranaike International Airport Bandaranaike International Airport Development Project Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation Bank for International Settlement Bureau of Indian Standards Bank of Ceylon Board of Investment Balance of Payments Build Operate and Transfer Business Process Outsourcing Conflict Affected Area Rehabilitation Project Capital Adequacy Ratio Capital, Assets, Reinsurance, Actural, Management, Earnings, Liquidity, Solvency - Rating System Criteria Based Grant Central Bank of Sri Lanka Coconut Cultivation Board Colombo Consumers’ Price Index Coconut Development Authority Customer Due Diligence Colombo District Consumers’ Price Index Collateralised Debt Obligations Clean Development Mechanism Code Division Multiple Access Central Environment Authority Ceylon Electricity Board

CEN CEPA CFC CFL CFS CIDA CIT CIS CLPL COLA CP CPC CPEP CPF CPI CPO CRI CRIB CRIMS CSE CTA CTC CWDCS DBU DA DA DC DCS DFCC DHF DMU DOA DOP DRS DvP ECB EDB EDI EDRS EEZ EFTPOS EIA EIB EPF ESC ESDFP

Central Environmental Authority Comprehensive Economic Partnership Agreement Ceylon Fisheries Corporation Compact Fluorescent Light Consumer Finance and Socio-Economic Survey Canadian International Development Agency Cheque Imaging and Truncation Commonwealth of Independent States Cairn Lanka Private Limited Cost of Living Allowance Commercial Paper Ceylon Petroleum Corporation Colombo Port Expansion Project Contributory Pension Fund Consumer Price Index Central Project Office Coconut Research Institute Credit Information Bureau Credit Information Management Systems Colombo Stock Exchange Colombo Tea Auction Cut, Tear and Curl Country Wide Data Collection System Domestic Banking Unit Document against Acceptance Document of Acceptance Desiccated Coconut Department of Census and Statistics Development Finance Corporation of Ceylon Dengue Haemorrhagic Fever Diesel Multiple Unit Department of Agriculture Department of Posts Disaster Recovery Site Delivery versus Payment External Commercial Borrowings Export Development Board Electronic Data Interchange Export Development Reward Scheme Exclusive Economic Zone Electronic Fund Transfer Facilities at the Point of Sale Environment Impact Assessment European Investment Bank Employees’ Provident Fund Economic Service Charge Education Sector Development Framework and Programme

ETF EU FAC FAO FC FC FCA FCCISL FCS FDI FMEP FMRP FTAs FTM FX swaps G-8 GAMS GAP GDE GDP GMP GNP GPRS GSM GSP GSP+ GSTP GTH GWG HACCP HDFC HDI HIES HP HSDPA IAS IBSL ICT ICTAD IDB IDD IDP IFAD IFC IFF IFRS ILF ILO

Employees’ Trust Fund European Union Fuel Adjustment Charge Food and Agriculture Organisation Finance Company Finance Commission Finance Companies Act Federation of Chambers of Commerce and Industries of Sri Lanka Forward Sale Contract Foreign Direct Investment Fiscal Management Efficiency Project Fiscal Management Reform Programme Free Trade Agreements Fair Trade Movement Foreign Exchange SWAPs Group of Eight (Canada, France, Germany, Italy, Japan, Russia, UK and US) Government Asset Management System Good Agricultural Practices Gross Domestic Expenditure Gross Domestic Product Good Manufacturing Practices Gross National Product General Packet Radio Service Global System Mobile Generalised System of Preferences Genaralised System of Preferences Plus Global System of Trade Preferences Global Telecommunications Holdings Garments Without Guilt Hazard Analysis Critical Control Point Housing Development Finance Corporation Bank Human Development Index Household Income and Expenditure Survey Hire Purchase High Speed Downlink Packet Access International Accounting Standards Insurance Board of Sri Lanka Information and Communication Technology Institute for Construction Training and Development Industrial Development Board International Direct Dialling Internally Displaced Persons International Fund for Agricultural Development International Finance Corporation Investor Facilitation Forum International Financial Reporting Standards Intra-day Liquidity Facility International Labour Organization

IMF IOR-ARC IP IPP IPO IPHT IPVPN IRB IRD IRIC ISFTA IT ITE ITES JBIC JCT JICA JAAF KEI KPO LC LCB LCPL LDB LDC LFPR LFSB LG LIOC LIBOR LMFI LNG LP LSB MBIs MBSs MC MDGs MFA MFI MFN MID MIMT MLCPI MLGPC MLP MOFP MOH MOP MOP MPCC

International Monetary Fund Indian Ocean Rim Association for Regional Cooperation Internet Protocol Independent Power Producers Initial Public Offer Institute of Harvest Technology Internet Protocol Virtual Private Network Internal Ratings Based Inland Revenue Department Inter Regulatory Institutions Council Indo-Sri Lanka Free Trade Agreement Information Technology Intra-group Transaction and Exposure Information Technology Enabled Services Japan Bank for International Co-operation Jaya Container Terminal Japanese International Cooperation Agency Joint Apparel Association Forum Knowledge Economy Index Knowledge Process Outsourcing Letters of Credit Licensed Commercial Bank LankaClear (Pvt) Ltd. Lankaputhra Development Board Least Developed Countries Labour Force Participation Rate Lanka Financial Services Bureau Local Government Lanka Indian Oil Company London Inter-Bank Offered Rates Licensed Micro Finance Institution Liquid Natural Gas Liquid Petroleum Licensed Specialised Bank Market Based Instruments Mortgage – Backed Securities Municipal Council Millennium Development Goals Multi-Fibre Arrangement Micro Finance Institution Most Favoured Nation Ministry of Industrial Development MAS Institute of Management Technologies Matale District Consumer Price Index Ministry of Local Government and Provincial Councils Marginal Labor Productivity Ministry of Finance & Planning Medical Officer of Health Margin of Preferences Muriate of Potash Monetary Policy Consultative Committee

MPI MRA MRCPI MSL MTMFF NAMA NAQDA NAV NBT NCCSL NCDs NCG NCP NCRCS NCRE NCSD NDA NDB NDF NDTF NEC NECCDP NEDA NEER NFA NFF NFIA NFIDC NGJA NHDA NLDB NPC NRCP NPL NRFC NSB NSDS NTT NVQ NWS&DB OBU OFC OMO OTC PAFMIS PAL PAMP PAMPRFS

Milanka Price Index Master Repurchase Agreement Matara District Consumer Price Index Mean Sea Level Medium Term Macro Fiscal Framework Non-Agricultural Market Access National Agriculture Development Authority Net Assets Value Nation Building Tax National Chamber of Commerce of Sri Lanka Non-Communicable Diseases Net Credit to the Government North Central Province New Comprehensive Rural Credit Scheme Non-Conventional Renewable Energy National Council for Sustainable Development Net Domestic Assets National Development Bank Net Domestic Financing National Development Trust Fund National Economic Council North East Coastal Community Development Project National Enterprises Development Authority Nominal Effective Exchange Rate Net Foreign Assets Net Foreign Financing Net Factor Income from Abroad Net-Food Importing Developing Country National Gem & Jewellery Authority National Housing Development Authority National Livestock Development Board National Payment Council North Road Connectivity Project Non Performing Loan Non Resident Foreign Currency (Account) National Savings Bank National Sustainable Development Strategy Nippon Telecommunication and Telegraphs Ltd. National Vocational Qualifications National Water Supply and Drainage Board Offshore Banking Unit Other Field Crops Open Market Operations Over The Counter Public Accounting and Fiscal Management Information System Port and Airport Development Levy Poverty Alleviation Microfinance Project Poverty Alleviation Microfinance Programme Revolving Fund Scheme

PB PC PCB PCE PD PDD PDO PFI PPA PPF PPP PRGT PS PSPF PSDG PSFTA PSDP PUCSL

Peopleâ&#x20AC;&#x2122;s Bank Provincial Council Printed Circuit Board Private Consumption Expenditure Primary Dealer Public Debt Department Project District Office Participating Financial Institutions Power Purchase Agreements Private Provident Fund Public-Private Partnership Poverty Reduction and Growth Trust Pradesheeya Sabha Public Sector Provident Fund Province Specific Development Grant Pakistan-Sri Lanka Free Trade Agreement Province Specific Development Projects Public Utilities Commission of Sri Lanka

QLFS RADA RAMIS R&D RDA RDB RDD REEL REER RFC RFSDP RIDL RNNFC ROA ROE ROO RPI RPPF RRI RSDP RTGS RWCAR SAARC SAFTA SAGT SAPTA SBA SBL SBRP SCL SDR SEA SEA

Quarterly Labour Force Survey Reconstruction and Development Agency Revenue Administration Information System Research and Development Road Development Authority Regional Development Bank Rubber Development Department Real Estate Exchange Ltd Real Effective Exchange Rate Registered Finance Company Rural Financial Sector Development Project Regional Infrastructure Development Levy Resident Non National Foreign Currency Deposits Return on Assets Return on Equity Rules of Origin Retail Price Index Road Projects Preparatory Facility Rubber Research Institute Road Sector Development Project Real Time Gross Settlement Risk Weighted Capital Adequacy Ratio South Asian Association for Regional Co-operation South Asian Free Trade Agreement South Asia Gateway Terminals Ltd. South Asian Preferential Trade Agreement Stand-By Arrangement Single Borrower Limit Small Business Revival Project Special Commodity Levy Special Drawing Rights Sustainable Energy Authority Strategic Environmental Assessment

SEC SEMA SFLCP SHG SLCSI SIRUP SLA SLAPMA SLBA SLBFE SLC SLC SLCPI SLDB SLECIC SLEDB SLIBOR SLIIT SLIPS SLINTec SLNBB SLPA SLR SLSI SLSPC SLT SLTB SLTDA SLTB SME SNG SNBFI SOE SPCDRF SRA SRC SRI SRL SRR SSS System SSDS STAART SVAR

Securities and Exchange Commission Strategic Enterprise Management Agency Small Farmers and Landless Credit Project Self Help Group Sri Lanka Chamber of Small Industries Small Scale Infrastructure Rehabilitation and Upgrading Project SriLankan Airlines Sri Lanka Agricultural Products Marketing Authority Sri Lanka Banks’ Association Sri Lanka Bureau of Foreign Employment Specialised Leasing Company Sri Lanka Customs Sri Lanka Consumers’ Price Index Sri Lanka Development Bond Sri Lanka Export Credit Insurance Corporation Sri Lanka Export Development Board Sri Lanka Inter-Bank Offered Rate Sri Lanka Institute of Information Technology Sri Lanka Inter-bank Payment System Sri Lanka Institute of Nanotechnology Sri Lanka Nation Building Bond Sri Lanka Ports Authority Sri Lanka Railways Sri Lanka Standards Institute Sri Lanka State Plantation Corporation Sri Lanka Telecom Ltd. Sri Lanka Tea Board Sri Lanka Tourism Development Authority Sri Lanka Transport Board Small and Medium Enterprises Sub National Government Supervision of Non-Bank Financial Institutions State Owned Enterprise Second Perennial Crop Development Project Revolving Fund Sovereign Rating Advisor Sovereign Rating Committee Sugar Research Institute Social Responsibility Levy Statutory Reserve Ratio Scripless Securities Settlement System Scripless Securities Depository System Sri Lanka Tsunami Affected Areas Recovery and Take-Off Project Structural Vector Auto Regression

TAARP TAAR TB TCCS TD-PRF TERP TEUs TIFA TRC TRIPS TRQ TSP TVEC TVET TYV UAE UBIS UC UCSC UDA UGC UK UNEP UNICEF UNIDO USA/US USDA USGSP VAT VCC VCF VET VRI VRS WBP WHO WiMAX WPI WPC WTP WTO

Tsunami Affected Areas Rehabilitation Programme Rehabilitation of Roads in Tsunami Affected Areas Tuberculosis Thrift and Credit Co-operative Society Tea Development Project Revolving Fund Tsunami Emergency Recovery Programme Twenty Foot Equivalent Container Units Trade Investment Framework Agreement Telecommunication Regulatory Commission Trade Related Aspects of Intellectual Property Rights Tariff Rate Quota Triple Super Phosphate Tertiary and Vocational Education Commission Technical and Vocational Education and Training Ten Year Vision United Arab Emirates Unemployment Benefit Insurance Scheme Urban Council University of Colombo School of Computing Urban Development Authority University Grants Commission United Kingdom United Nations Environmental Programme United Nations International Children’s Education Fund United Nations Industrial Development Organization United States of America US Department of Agriculture U.S. Generalised System of Preferences Value Added Tax Venture Capital Companies Venture Capital Firm Vocational Education and Training Veterinary Research Institute Voluntary Retirement Scheme Weak Bridge Programme World Health Organisation Worldwide Interoperability for Microwave Access Wholesale Price Index Western Provincial Council Water Treatment Plant World Trade Organisation

Key Economic Indicators 2000

2005

2006

2007

2008

2009

20,217 1.0 322 8,082 (e) 49.5 (e) 5.4 (e)

20,450 1.1 326 8,074 (e) 48.7 (e) 5.8 (e)

2010 (a)

DEMOGRAPHY Mid-year population (‘000 persons) (b) Growth of population (per cent) (b) Population density (persons per sq.km.) (b) Labour force (‘000 persons) Labour force participation rate (per cent) Unemployment rate (per cent of labour force)

19,102 1.3 305 6,827 50.3 7.6

OUTPUT (f) GDP at current market prices (Rs. billion) GNP at current market prices (Rs. billion) Per capita GDP at market prices (Rs.) Per capita GNP at market prices (Rs.) Per capita GDP at market prices (US$) Per capita GNP at market prices (US$)

1,258 1,233 68,102 66,790 899 881

2,453 2,423 124,709 123,181 1,241 1,226

2,939 2,898 147,776 145,744 1,421 1,402

3,579 3,540 178,845 176,893 1,617 1,599

4,411 4,306 218,167 212,972 2,014 1,966

4,835 4,779 236,445 233,716 2,057 2,033

5,602 5,530 271,259 267,780 2,399 2,368

5.8 6.0

6.0 6.2

7.5 7.7

7.1 6.8

4.6 6.0

4.8 3.5

7.9 8.0

1.8 7.5 7.0

1.8 8.0 6.4

6.3 8.1 7.7

3.4 7.6 7.1

7.5 5.9 5.6

3.2 4.2 3.3

7.0 8.4 8.0

82.6 72.1 10.5 28.0 24.8 3.3 -10.6 39.0 49.6 17.4 4.0 21.5

82.1 69.0 13.1 26.8 22.4 4.4 -8.9 32.3 41.3 17.9 5.9 23.8

83.0 67.7 15.4 28.0 23.9 4.1 -11.0 30.1 41.1 17.0 5.4 22.3

82.4 67.2 15.3 28.0 22.6 5.4 -11.3 23.6 34.9 17.6 5.8 23.3

86.1 70.0 16.2 27.6 21.1 6.5 -14.7 19.9 34.6 13.9 3.9 17.8

82.1 64.4 17.6 24.4 17.9 6.6 -7.4 16.8 24.3 17.9 5.8 23.7

81.3 65.8 15.6 27.8 21.6 6.2 -10.5 16.7 27.2 18.7 6.0 24.7

6.2 - - 1.7 6.7 6.7 2.3 8.3

11.6 11.0 7.4 11.5 10.4 10.4 7.8 29.1

13.7 10.0 13.5 11.7 11.3 11.3 2.1 30.3

17.5 15.8 18.8 24.4 14.0 14.0 21.4 21.5

- 22.6 14.4 24.9 16.3 16.3 25.6 7.5

- 3.4 4.8 -4.2 5.9 5.9 4.9 9.4

5.9 6.9 11.2 7.3 7.3 32.0 3.3

-1,798 5,522 7,320 -6.1 1.5 8.1 18.3 12.9

-2,516 6,347 8,863 -4.2 3.3 7.8 6.7 2.7

-3,370 6,883 10,253 -3.5 4.2 8.0 4.1 7.1

-3,657 7,640 11,296 -1.0 4.8 5.9 7.3 4.1

-5,981 8,111 14,091 -11.8 5.8 20.0 0.4 4.0

-3,122 7,085 10,207 24.0 -0.4 -19.7 -12.3 -9.8

-5,205 8,307 13,512 -5.3 10.9 17.2 5.7 13.0

EXTERNAL FINANCE (US$ million) Services and income account (net) -266 38 -132 -56 -571 Current private transfers (net) 974 1,736 1,904 2,214 2,565 Current official transfers (net) 24 93 101 97 101 Current account balance -1,066 -650 -1,499 -1,402 -3,886 Overall balance -522 501 204 531 -1,385

-97 2,927 77 -214 2,725

126 3,608 52 -1,418 921

REAL OUTPUT (percentage change) (f) GNP GDP Sectoral classification of GDP Agriculture Industry Services AGGREGATE DEMAND AND SAVINGS (per cent of GDP) (f) Consumption Private Government Investment Private Government Net exports of goods & services Exports of goods & services Imports of goods & services Domestic savings Net factor income from abroad (g) National savings

PRICES AND WAGES (percentage change) Colombo Consumers’ Price Index (1952 = 100) - Annual Average (h) Colombo Consumers’ Price Index (2002 = 100) - Annual Average Colombo Consumers’ Price Index (2002 = 100) - Year-on-Year - end period Wholesale Price Index (1974 = 100) - Annual Average GNP deflator (f) GDP deflator (f) Nominal wage rate index for workers in all wages boards Nominal wage rate index for central government employees

EXTERNAL TRADE Trade balance (US$ million) Exports (i) Imports (i) Terms of trade (percentage change) Export unit value index (1997 = 100) (percentage change) Import unit value index (1997 = 100) (percentage change) Export volume index (1997=100) (percentage change) Import volume index (1997=100) (percentage change)

(a) Provisional (b) As reported by the Registrar General’s Department (c) Quarterly Labour Force Survey (QLFS) was conducted as a one - off survey in August 2005. (d) Data excluding both Northern and Eastern Provinces. (e) Data excluding Northern Province.

19,668 19,886 20,010 1.0 1.1 1.1 314 317 319 7,312 (c)(d) 7,599 (d) 7,489 (d) 49.3 (c)(d) 51.2 (d) 49.8 (d) 7.2 (c)(d) 6.5 (d) 6.0 (d)

20,653 1.0 329 8,108 (e) 48.1 (e) 4.9 (e)

(f) From 2003, data are based on GDP estimates compiled by the Department of Census and Statistics (DCS). (g) Includes workers’ remittances. (h) Discontinued from May 2008. (i) Excludes re-exports and re-imports from 2007 onwards.

Key Economic Indicators (contd.)

2000

2005

2006

2007

2008

2009 2010 (a)

Current account balance (per cent of GDP) (f) -6.4 -2.7 -5.3 -4.3 -9.5 -0.5 -2.9 Total external assets (months of same year imports) (j) 3.5 5.7 4.7 5.3 3.1 8.3 7.7 Official external assets (months of same year imports) (j) 1.7 3.7 3.3 3.7 2.0 6.3 6.4 Overall debt service ratio As a percentage of export of goods and services 14.7 7.9 12.7 13.1 15.1 19.0 15.2 As a percentage of current receipts 12.2 6.3 9.8 10.0 11.7 13.7 10.7 Total external debt and liabilities (per cent of GDP) (f) 61.0 53.3 49.4 51.0 43.7 49.7 50.1

EXCHANGE RATES Annual average Rs/US$ 75.78 100.50 103.96 110.62 108.33 114.94 113.06 Rs/SDR (k) 99.90 148.45 153.00 169.37 171.24 177.22 172.50 NEER (2010 = 100) (24 - currency basket) (l) - 115.11 100.94 98.96 100.06 99.85 100.00 REER (2010 = 100) (24 - currency basket) (l) (m) - 79.00 81.02 81.03 95.64 97.75 100.00 Year end Rs/US$ 80.06 102.12 107.71 108.72 113.14 114.38 110.95 Rs/SDR (k) 104.31 145.95 162.03 171.57 174.27 178.67 170.84 GOVERNMENT FINANCE (per cent of GDP) (f) Revenue and grants 17.2 16.8 17.3 16.6 15.6 15.0 14.9 Revenue 16.8 15.5 16.3 15.8 14.9 14.5 14.6 o/w Tax revenue 14.5 13.7 14.6 14.2 13.3 12.8 13.0 Grants 0.4 1.3 1.0 0.9 0.7 0.5 0.3 Expenditure and net lending 26.7 23.8 24.3 23.5 22.6 24.9 22.9 Current expenditure 20.2 18.1 18.6 17.4 16.9 18.2 16.7 Capital expenditure and net lending 6.5 5.8 5.6 6.1 5.7 6.7 6.1 Current account deficit (-) / surplus (+) -3.4 -2.6 -2.4 -1.6 -2.0 -3.7 -2.1 Primary deficit (-) / surplus (+) -3.8 -2.1 -1.9 -1.8 -2.2 -3.5 -1.7 Overall deficit (-) / surplus (+) (n) -9.5 -7.0 -7.0 -6.9 -7.0 -9.9 -7.9 Deficit financing 9.5 7.0 7.0 6.9 7.0 9.9 7.9 Foreign 0.1 1.9 1.4 2.8 -0.1 4.8 4.4 Domestic 9.4 5.1 5.6 4.1 7.1 5.1 3.6 Government debt 96.9 90.6 87.8 85.0 81.4 86.2 81.9 Foreign 43.1 39.0 37.5 37.1 32.8 36.5 36.1 Domestic 53.8 51.6 50.3 47.9 48.5 49.8 45.8 MONETARY AGGREGATES (year-on-year percentage change) Reserve money 4.7 15.8 21.2 10.2 1.5 13.1 18.8 Narrow money (M1) (o) 9.1 22.4 12.6 2.7 4.0 21.4 20.9 Broad money (M2b) (o) 12.9 19.1 17.8 16.6 8.5 18.6 15.8 Net foreign assets of the banking system -31.9 20.3 -15.0 33.2 -65.9 417.2 -6.1 Net domestic assets of the banking system 26.9 18.7 25.9 13.8 22.9 -2.8 22.1 Domestic credit from the banking system to Government (net) (p) 56.8 11.9 43.2 4.7 55.8 9.9 -2.1 Public corporations 193.2 -59.5 89.3 55.8 -4.4 55.8 93.2 Private sector 11.8 21.5 24.0 19.3 7.0 -5.8 25.1 Money multiplier for M2b (end year) 4.60 5.16 5.02 5.31 5.67 5.95 5.80 Velocity of M2b (average for the year) (f) 2.80 2.63 2.66 2.73 3.01 2.90 2.92 INTEREST RATES (per cent per annum at year end) Repurchase rate (overnight) 17.00 8.75 10.00 10.50 10.50 7.50 7.25 Reverse Repurchase rate (overnight) 20.00 10.25 11.50 12.00 12.00 9.75 9.00 Treasury bill yield rates 91 days 17.77 10.10 12.76 21.30 17.33 7.73 7.24 364 days 18.22 10.37 12.96 19.96 19.12 9.33 7.55 Deposit rates Commercial banks’ average weighted deposit rate (AWDR) 9.89 6.24 7.60 10.31 11.63 8.01 6.23 Commercial banks’ 12 month fixed deposit rate (max.) 15.00 11.50 14.00 20.00 20.25 19.00 17.00 NSB savings rate 8.40 5.00 5.00 5.00 5.00 5.00 5.00 NSB 12 month fixed deposit rate 15.00 9.00 11.00 15.00 15.00 9.50 8.50 Lending rates Commercial banks’ average weighted prime lending rate (AWPR) 21.46 12.24 15.19 17.95 18.50 10.91 9.29 Commercial banks’ average weighted lending rate (AWLR) 19.30 15.40 16.60 18.10 20.20 17.41 14.80 CAPITAL MARKET All share price index (ASPI) (1985 = 100) 447.6 1,922.2 2,722.4 2,541.0 1,503.0 3,385.6 6,635.9 Milanka price index (MPI) (1998 Dec =1,000) 698.5 2,451.1 3,711.8 3,291.9 1,631.3 3,849.4 7,061.5 Value of shares traded (Rs. million) 10,624 114,599 105,154 104,985 110,454 142,463 570,327 Net purchases by non nationals (Rs. million) -3,365 6,145 5,377 11,254 13,951 -789 -26,335 Market capitalisation (Rs. billion) 88.8 584.0 834.8 820.7 488.8 1,092.1 2,210.5 (j) Includes Asian Clearing Union receipts (n) Grants are classified as a revenue item. (k) Special Drawing Rights (SDR), the unit of account of the International (o) Includes assests/ liabilities of National Development Bank, which merged with Monetary Fund (IMF). NDB Bank Ltd. with effect from August 2005. However, figures for the National Development Bank have not been included when calculating the year-on-year growth (l) The exchange rates have been defined in terms of indices so that the for 2005. appreciation/depreciation of the rupee relative to other currencies is directly reflected by a rise/fall in the values of the effective exchange rates indices. (p) Restructuring bonds worth Rs.19.4 billion, which were issued by the government to the two state banks, have been converted to Treasury bonds upon their maturity in October (m) CCPI is used for the computation of the Real Effective Exchange Rate 2006. This amount, which previously appeared under other assets, has been included in (REER). The REER is computed by adjusting the Nominal Effective Exchange net credit to government since October 2006. Rate (NEER) for inflation differentials with the countries whose currencies are included in the basket.

Key social Indicators PHYSICAL FEATURES AND CLIMATE Location Between 5° 55’ & 9° 50’ North Latitude Between 79° 42’ & 81° 53’ East Longitude 432 km (270 miles) North to South 224 km (140 miles) West to East Highest elevation : 2,524 meters (8,281 ft.) Area Total area : Land area : Inland waters :

65,610 62,705 2,905

Government employees (‘000) (2010) State sector Provincial public sector Semi government sector

PHYSICAL AND SOCIAL INFRASTRUCTURE FACILITIES Transport Length of national roads (A & B) Length of railway route

sq.km. sq.km. sq.km.

Climate Low country : min. 24.4° C - max. 31.9°C Hill country : min. 18.6° C - max. 27.0°C Annual Rainfall (average) mm : (2009) 1,711 (2010) 1,992 Number of Rainy days : (2009) 85 (2010) 88

: 1,299 : 55.8% : 23.3% : 20.9%

: 11,923 km : 1,640 km

Unit Water Supply & Sanitation Access to safe drinking water per cent (b) Access to pipe borne water per cent Electricity

2010 87.3 39

per cent 90.0 Electrification Level Per capita electricity consumption kWh 448.75 Communications POPULATION AND VITAL STATISTICS (a) Telephone density Mid-year population (‘000) in 2010 : 20,653 Fixed lines per 100 persons 17.3 Age distribution (‘000) 2010 Including cellular phones per 100 persons 100.8 0 -14 yrs : 5,431 per 1,000 persons 20.8 15-64 yrs : 13,921 Internet and e-mail (f) Average population served 65 years and over : 1,301 Population density (2010) : 329 persons per sq.km. by a post office number 4,355 Crude birth rate (2010) : 17.6 per 1,000 Public Health Crude death rate (2010) : 6.2 per 1,000 Hospital beds per 1,000 persons 3.4 Rate of natural increase (2010) : 11.4 per 1,000 Persons per doctor number 1,462 Infant mortality rate (2007) : 8.5 per 1,000 live births Nurses per 10,000 persons 13.3 Dependency ratio (2010) : 48.4 % Government expenditure on health per cent of GDP (g) 1.3 Average household size (2009/2010)(b) : 4.0 Expectation of life at birth (2007) Male : 70.3 years

Female

: 77.9 years

Literacy rate (2009) (c) Average : 91.4 % Male : 92.8 % Female : 90.0 %

Income distribution (b) Gini coefficient of household income (2009/2010) : 0.47 Mean household income (2009/2010) : Rs. 35,495 per month Median household income (2009/2010) : Rs. 24,106 per month Poverty Average daily calorie intake (2006/2007) (d) : 2,118 Poverty Head Count Index: (2002) 22.7 (2006/2007) 15.2 (2009/2010) 7.6 (b) Prosperity Index (2007) : 52.7 Human Development Index (2010) : 0.658 Rank among 169 countries : 91 Employment (e) Employed persons (’000) (2010) : 7,707 Agriculture : 32.7% Industry : 24.2% Services : 43.1%

(a) Registrar General-DCS Statistical Branch (b) Based on first three months data of Household Income and Expenditure Survey - 2009/2010 published by DCS. (c) Based on Sri Lanka Labour Force Survey - 2009 conducted by the DCS. (d) Based on Household Income and Expenditure Survey 2006/2007.

General Education (h) School density (area covered by a school) (2010) sq. km. Student/teacher ratio (government schools) (2010) number Age specific enrolment ratio (2007) per cent Primary net enrolment ratio (2007) per cent University Education Student/teacher ratio Age specific enrolment ratio (age 20-24 yrs) Progression to university from GCE (A/L) Eligible for university admission Admission as a percentage of eligible Government expenditure on education

6.3 18 71.5 89.9

number

16.1

per cent

4.2

per cent 61.0 per cent 17.2 per cent of GDP (g) (i) 1.9

Financial Institutions Banks Branches of LCBs number 2,342 Branches of LSBs number 569 Credit cards in use per 100,000 persons 3,770 Banking density no. of bank branches per 100,000 persons 14 Other Financial Institutions Branches of RFCs number 376 Branches of SLCs number 224 ATMs per 100,000 persons 11 (e) (f) (g) (h) (i)

Sources: Relevant Institutions and Human Development Report 2010 Data excluding Nothern Province. Including mobile broadband services Based on GDP estimates compiled by the DCS. Ministry of Education-DCS Statistical Branch Government expenditure on general and higher education

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

1.1 Overview

ri Lankaâ&#x20AC;&#x2122;s economy grew by an impressive 8.0 per cent in 2010, reflecting a fast recovery from the setback suffered in 2009 and moved to a high and sustainable growth path. All key sectors of the economy demonstrated a commendable performance in 2010, underpinned by the peaceful domestic environment, improved investor confidence, favourable macroeconomic conditions and gradual recovery of the global economy from one of the deepest recessions in history. Benign inflation and the favourable inflation outlook enabled the Central Bank to continue its accommodative monetary policy stance with further moderation of interest rates in all market segments supporting economic activity. The fiscal situation improved considerably, mainly reflecting the improvement in revenue performance as well as the containment of recurrent expenditure. The external sector, which made a remarkable turnaround since the second quarter of 2009, continued to improve in

2010. Both exports and imports recovered strongly, while increased earnings from the tourism industry and higher inward remittances offset the widening trade deficit to a great extent, reducing the external current account deficit. Increased capital and financial flows resulted in the balance of payments (BOP) recording a surplus in 2010, further strengthening external reserves of the country. Supported by the favourable macroeconomic environment and the supportive regulatory and supervisory framework, the financial sector displayed improved performance and financial system stability strengthened. Inflation continued to remain low at around mid-single digit levels and the benign outlook for inflation enabled the Central Bank to ease its monetary policy stance further in 2010. While significant demand pressures were absent, improved domestic supply conditions, downward adjustments of certain administered prices and the reduction of import duties on several

Central Bank of Sri Lanka Annual Report - 2010

7 6 5 4 3

Unemployment (per cent)

Growth (per cent)

10 9 8

2 1 0 2 0 10 Q4

2 0 10 Q3

2 0 10 Q2

2 0 10 Q1

2 0 0 9 Q4

2 0 0 9 Q3

2 0 0 9 Q2

2 0 0 9 Q1

Quarterly Growth (left axis)

Unemployment (right axis)

consumer items had a favourable impact on prices. The Central Bank reduced its policy interest rates; the Repurchase rate and the Reverse Repurchase rate, by 25 basis points each, in July 2010 and the Reverse Repurchase rate by a further 50 basis points in August 2010 with a view to supporting economic activity further. Market interest rates continued to adjust downwards in line with the policy rate reductions and the overall growth of monetary aggregates remained consistent with the envisaged path. The growth of broad money (M2b) gradually decelerated to 13.6 per cent by September 2010, before picking up to 15.8 per cent by end 2010. This growth was driven by the increase in commercial banksâ&#x20AC;&#x2122; credit to the private sector, which gradually rose to record a year-on-year growth of 25.1 per cent by end 2010 from a negative 5.8 per cent at end 2009, reflecting the broadbased demand for credit with the recovery in domestic economic C hart 1.2: C ons umer P ric e Inflation activity as well as increased post-conflict capacity Inflation

Chart 1.2 30 25 20 15 10 5

Year-on-year Inflation (CCPI, base=2002) Annual Average Inflation (CCPI, base=2002)

J ul-10

J an-10

J ul-09

J an-09

J ul-08

J an-08

J ul-07

J an-07

J ul-06

J an-06

J ul-05

0 J an-05

Per cent

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

Quarterly Growth and Unemployment Chart 1.1 Quarterly Growth and Unemployment

expansion. However, monetary management could be challenging in the period ahead owing to possible continued high growth in domestic credit as well as a possible increase in capital inflows, thus requiring close monitoring of macroeconomic developments and formulating appropriate demand management policies to prevent the build-up of excessive demand pressures. An encouraging improvement in the overall fiscal situation was witnessed in 2010 with the recovery in government revenue supported by the expansion of economic activity, the addressing of certain persistent structural issues in the tax system, as well as the containment of recurrent expenditure. The overall deficit was reduced to 7.9 per cent of GDP in 2010 from 9.9 per cent in 2009. The government has affirmed its ongoing commitment to fiscal consolidation by reducing the budget deficit to 6.8 per cent in 2011 and to below 5 per cent in the medium term. In line with the recommendations of the Presidential Commission on Taxation, several vital revisions were introduced to the tax structure focusing on the simplification of the tax system, rationalising exemptions, improving tax compliance and strengthening tax administration. In addition, steps were taken to streamline the tax concessions granted under the Board of Investment (BOI) Act focusing on larger and strategic investments. The continued fiscal consolidation efforts would reinforce the conduct of monetary policy in achieving economic and price stability. With favourable macroeconomic conditions and the recovery in economic activity, the performance and stability of the financial sector strengthened in 2010. This improved performance was reflected in all prudential indicators. Credit flows significantly recovered, profitability improved, capital adequacy further increased above the threshold and the ratio of non performing loans declined, while provisions for loan losses increased. The performance of finance companies in distress also improved rapidly, while financial markets continued to remain liquid. The branch network of banks and other financial institutions expanded,

Central Bank of Sri Lanka Annual Report - 2010

Sri Lanka’s Graduation to Middle-Income Status the PRGT Eligible Country List Extreme Weather Conditions and its from Impact

Sri Lanka was graduated to middle-income status from the list of Poverty Reduction and Growth Trust (PRGT) eligible countries, in January 2010 by the International Monetary Fund (IMF). The decision to graduate Sri Lanka into middle-income status came after its Executive Board approved a new eligibility framework for countries that use the IMF’s concessional financial resources under PRGT.1 A country is graduated from the PRGT eligibility category if it (a) has enjoyed income per capita well above the International Development Association (IDA) threshold for a sustainable period; (b) has the capacity for durable and substantial access to international financial markets; and (c) does not face serious short-term vulnerabilities, such as a sharp drop in per capita income, loss of market access, etc.2 The specific factors that have been considered by IMF in graduating Sri Lanka include, mainly: (a) the strong economic performance in recent years has lifted Sri Lanka’s per capita income 1 However, the World Bank classification of income groups are as follows; low income (less than US dollars 995); low-middle income (US dollars 996 - 3,945); upper-middle income (US dollars 3,946 - 12,195); and high income (US dollars 12,196 or more). 2 See IMF’s Public Information Notice (PIN), No.10/16 (February 2010). http://www. imf.org/external/np/sec/pn/2010/pn1016.htm.

particularly with the measures taken by the Central Bank to promote financial service delivery to the Northern and Eastern provinces. Improvements to the payments system continued. A mandatory deposit insurance scheme was introduced in 2010 for licensed banks and finance companies to protect small depositors. However, intermediation costs that still remain high, as reflected by high interest rate margins, and the sluggish development in the corporate debt securities market continue to remain areas of major concern. In terms of raising the social welfare of people, the ultimate goal of macroeconomic policy, the decline in poverty that surpasses the target set under Millennium Development Goals (MDGs) and the continuous decline in unemployment are commendable achievements. The Poverty Headcount Index halved from 15.2 per

substantially, reaching US dollars 2,014 by 2008,3 well above the prevailing IDA threshold and has been on a steady upward trend for, at least, the last 5 years; (b) gradual decline of projected external debt over the medium term, ensuring a sustainable level of public debt with timely implementation of fiscal consolidation; and, (c)

benefits accrued from increased access to capital markets in recent years, thus meeting the market access criterion of IMF, as reflected, for instance, in heavily oversubscription of the five-year international sovereign bond issued in 2009.4

Following this graduation to middle-income status, Sri Lanka projected strongly in international financial markets and it will continue to do so, further opening up for international financial markets, thereby attracting more investments, in the coming years. 3 Sri Lanka’s per capita GDP increased to US dollars 2,399 in 2010 from US dollars 2,057 in 2009. 4 Sri Lanka raised US dollars 1 billion from the international sovereign bond issue in 2010, with a ten-year maturity at a very competitive rate.

cent in 2006/07 to 7.6 per cent according to the first-round information from the Household Income and Expenditure Survey 2009/10 conducted by the Department of Census and Statistics, while the improvements were more prominent in the rural and estate sectors. By 2010, the unemployment rate (excluding the Northern and Eastern provinces), which was 8.8 per cent in 2002 had declined to 4.9 per cent. However, further progress is required, especially in raising employment opportunities for and the living standards of people in the Northern and Eastern provinces. In 2010, the first full year of operation subsequent to the ending of the three-decade long conflict, the economy of Sri Lanka has displayed its true potential, with impressive macroeconomic achievements. The challenge for policymakers today is to sustain these

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

BOX 1

Central Bank of Sri Lanka Annual Report - 2010

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

achievements with macroeconomic stability in the face of more frequent internal and external shocks. While appropriate demand management policies are required to maintain low and stable inflation, effective addressing of supply-side impediments is also needed. The continuous advancement of productivity, the adoption of new technology and human capital development would reduce the pressure on the labour market, while improvements to physical infrastructure and appropriate changes to the regulatory framework need to be pursued to facilitate greater labour mobility as well as greater labour availability to maintain the expected high growth. The diversification of exports, in terms of products and markets, is needed to increase the resilience of the economy to external disturbances, and to this end, the effective utilisation of existing bilateral and multilateral treaties and actively persuing the establishment of further trade relations with emerging regional markets as well as promoting private sector investment and strengthening the â&#x20AC;&#x153;Doing Businessâ&#x20AC;? environment are necessary. The impact of disturbances arising from adverse external developments including price movements of commodities such as crude oil, could also be lessened through the implementation of necessary reforms to the institutional framework of key public enterprises to operate them more efficiently and in a commercially sustainable way to reflect market conditions. These changes will support the ongoing fiscal consolidation process, which would in turn strengthen demand management policies.

1.2 Macroeconomic Developments, Stability and Policy Responses in 2010 Real Sector Developments In 2010, the Sri Lankan economy recorded an impressive growth of 8.0 per cent, the highest annual rate of growth reported in the last three decades.1 This far exceeds the average annual growth of 4.9 per cent recorded since the liberalisation of the economy in 1977. Previously Sri Lanka has recorded an economic growth of 8.2 per cent in 1968 and 1978.

This remarkable performance was supported by the restoration of permanent peace, which created an environment conducive for the expansion in economic activity, the strong macroeconomic environment, increased domestic demand, the development of infrastructure facilities, improved external demand with the gradual recovery in the global economy and favourable domestic weather conditions. The improved performance in all key sectors of the economy contributed towards the high economic growth in 2010. The Agriculture sector, which contributed around 11.9 per cent of the GDP in 2010, grew by 7.0 per cent, compared to 3.2 per cent in 2009, mainly driven by the increased production of paddy, tea, rubber and minor export crops along with significant improvements in the fisheries sector output. However, coconut production declined by 19 per cent, mainly reflecting the lag effect of adverse weather conditions. The Industry sector grew by 8.4 per cent supported by increased domestic and external demand with enhanced investor and consumer confidence. Improved performance in industries, such as food and beverages, rubber based products, textiles and garments coupled with increased performance in the construction sector and increased hydropower generation contributed to this growth. The share of the Industry sector in total GDP increased marginally to 28.7 per cent in 2010. The Services sector grew by 8.0 per cent in 2010. The wholesale and retail sub sector, which accounts for the largest share in the Services sector, grew by 7.5 per cent with enhanced performance in both domestic and external trading activity. The hotels and restaurants sub sector grew sharply by about 39.8 per cent underpinned by the strong performance in tourism. Other major sub sectors such as transport and communications, and banking, insurance and real estate also recorded significantly higher growth rates compared to 2009. Reflecting the increased availability of employment opportunities alongside enhanced economic activity, the unemployment rate, which increased marginally to 5.8 per cent with the slowing down of economic activity in 2009,

Central Bank of Sri Lanka Annual Report - 2010

Sector

Gross National Product by Industrial Origin at Constant (2002) Prices

Value (Rs. million) 2009 (a)

Agriculture

Agriculture, Livestock and Forestry Fishing

Industry

Mining and Quarrying Manufacturing Electricity, Gas and Water Construction

Services

Wholesale and Retail Trade Hotels and Restaurants Transport and Communication Banking, Insurance and Real Estate etc. Ownership of Dwellings Government Services Private Services

Gross Domestic Product Net Factor Income from Abroad Gross National Product

295,097 266,208 28,888 701,129 52,030 427,334 58,974 162,790 1,452,988 570,698 9,901 329,578 217,819 74,051 191,778 59,164 2,449,214 -28,262 2,420,952

2010 (b)

As a Share of GDP (%) 2009 (a)

2010 (b)

315,644 12.0 11.9 283,236 10.9 10.7 32,407 1.2 1.2 760,219 28.6 28.7 60,079 2.1 2.3 458,660 17.4 17.3 63,567 2.4 2.4 177,912 6.6 6.7 1,569,569 59.3 59.3 613,320 23.3 23.2 13,845 0.4 0.5 368,653 13.5 13.9 234,255 8.9 8.9 74,692 3.0 2.8 202,187 7.8 7.6 62,617 2.4 2.4 2,645,432 100.0 100.0 -33,931 2,611,500

(a) Revised (b) Provisional

declined even below the 2008 level to 4.9 per cent in 2010. While the labour force participation rate declined marginally from 48.7 per cent in 2009 to 48.1 per cent in 2010, the number of employed persons increased by 1.4 per cent to 7.71 million in 2010. The share of the Services sector in total employment increased from 42.3 per cent in 2009 to 43.1 per cent in 2010, and that of the Industry sector declined from 25.1 per cent to 24.2 per cent in 2010. In terms of employment status, the share of own account workers increased in 2010. However, relatively high unemployment among youth, in particular among educated youth, remains a concern. Both export and domestic agriculture contributed to the improved performance in the Agriculture sector. Benefiting from favourable weather conditions, the tea sub sector registered the highest ever annual production of 329 million kg compared to the distressed output in 2009, while rubber production also continued to increase. Export agricultural crops such as cloves, pepper and cinnamon contributed positively to the improved performance in the Agriculture sector. Within domestic agriculture, paddy production recorded an impressive growth in 2010 due to increased

Rate of Change (%)

Contribution to Change (%) 2009 (a)

2010 (b)

2009 (a)

2010 (b)

3.2 2.8 6.9 4.2 8.2 3.3 3.7 5.6 3.3 -0.2 13.3 6.3 5.7 1.3 5.9 5.8 3.5 49.8 4.8

7.0 11.0 10.5 6.4 8.8 8.7 12.2 2.2 1.8 8.4 33.9 30.1 15.5 4.7 4.1 7.3 16.3 16.0 7.8 2.5 2.3 9.3 10.3 7.7 8.0 55.2 59.4 7.5 -1.4 21.7 39.8 1.4 2.0 11.9 23.4 19.9 7.5 14.1 8.4 0.9 1.1 0.3 5.4 12.8 5.3 5.8 3.9 1.8 8.0 100.0 100.0 -20.1 7.9 Source: Department of Census and Statistics

extent of cultivation particularly in the Northern and Eastern provinces, favourable weather conditions and the continuation of agriculture support schemes. Coconut production declined significantly by 19 per cent in 2010, and sugar production also recorded a marginal decline. The significant expansion in fishery activities in the Northern and Eastern provinces largely contributed to the increase in fish production by 12 per cent in 2010, while domestic milk production increased notably with the committed efforts to enhance domestic milk production. Prices of key agricultural crops remained high in 2010. Tea prices at the Colombo tea auction recorded historic high levels with increased demand for Sri Lankan tea. The average prices of all varieties of rubber increased due to the severe supply shortages of natural rubber in the international market and increased demand due to global economic recovery and high crude oil prices. The decline in the coconut production together with an increased demand for industrial usage led coconut prices to rise significantly. Despite the increased paddy production in both seasons, prices remained stable assisted by the intervention of the government through its paddy purchasing 5

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

Table 1.1

Central Bank of Sri Lanka Annual Report - 2010

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

programme. The average producer price for liquid milk increased to encourage dairy production. Several measures were taken by the government during 2010 to promote agriculture. To encourage tea re-planting and new planting, the subsidy for tea smallholders was increased while extending the subsidy for coconut re-planting and new planting as well. Despite the high fiscal outlay, the fertiliser support scheme was continued and extended to cover coconut and other field crops from 2011. With a view to promoting supply of high quality seeds, a three-year seed farm development programme was proposed under public-private partnership basis. The output of the Industrial sector recorded a commendable growth of 8.4 per cent in 2010 compared to 4.2 per cent in the previous year. Factory industry, which contributed approximately 54.6 per cent to the total industry output, recorded a 7.5 per cent growth during 2010. The textile, wearing apparel and leather products category, which was adversely affected by the global economic crisis, showed signs of recovery during the last quarter of the year despite the withdrawal of GSP+ concessions effective from August 2010. The apparel industry remained competitive through increased productivity, improved quality, diversification and gradual recovery in external demand. The high growth in food, beverages and tobacco products category, which accounts for nearly 48.0 per cent of the total factory industry output, was driven by the expansion in domestic demand particularly from the Northern and Eastern provinces and increased tourism-related activity during the year. The major contributors to the increased output in export market oriented industries were ship building and repairing and transport equipment and machinery. The non metallic mineral products category also performed well during the year with high demand for cement and building materials. The substantial improvement in hydropower generation raised value addition from the electricity sector, while the construction sector expanded by 9.3 per cent with the continuation of major infrastructure development projects as well as increased construction activity in the private sector. 6

The recovery in both domestic and external demand and favourable macroeconomic environment supported industrial sector growth during 2010. The recovery in domestic economic activity with increased demand from the Northern and Eastern provinces, low interest rates, low inflation and increasing business and consumer confidence created a conducive economic environment for growth in domestic market oriented industries. The export market oriented industries benefitted from increased demand from major trading partner countries with the gradual recovery of the global economy, improved productivity, branding strategies, market diversification strategies and the expansion in product portfolios. The government has taken various measures to foster the development of the industrial sector and regionalise the industrial base by developing industrial estates in various parts of the country, promoting small- and mediumscale enterprise (SME) sector and providing fiscal incentives to promote industries with higher domestic value addition. The Services sector, which contributed 59.3 per cent of the GDP, grew at an encouraging 8.0 per cent, compared to 3.3 per cent in 2009. The wholesale and retail trade sector, displayed an impressive growth following a negative growth in 2009, due to increased external trade with the gradual recovery of the global economy and domestic trade with the restoration of peace. The hotel and restaurant sub sector showed an impressive growth with a rebound in tourist arrivals and increased domestic travel. The transport and telecommunications sector grew with the improved performance in transport, cargo handling, aviation and telecommunications sectors. The banking, insurance and real estate sub sector expanded with increased income from investments and lending activities, foreign exchange operations and widened financial services through the expansion of bank branches and other service outlets. Reflecting the recovery in economic activity, consumption expenditure increased by 14.9 per cent in 2010, while savings and investment of the country also recovered. As a percentage

Central Bank of Sri Lanka Annual Report - 2010 Aggregate Demand and Savings Investment Gap Rs. billion

Item

2009 (a)

2010 (b)

Growth % 2009 (a)

2010 (b)

As a percentage of GDP 2009 (a)

1. Domestic Demand 5,149.2 6,114.1 2.7 18.7 106.5 1.1 Consumption 3,967.8 4,557.3 4.4 14.9 82.1 Private 3,116.2 3,684.7 1.0 18.2 64.4 Public 851.5 872.6 19.3 2.5 17.6 1.2 Investment (Gross Domestic Capital Formation) 1,181.4 1,556.8 -2.8 31.8 24.4 Private 863.5 1,209.6 -7.1 40.1 17.9 Public 318.0 347.2 11.1 9.2 6.6 2. Net External Demand -313.9 -511.8 48.0 -63.0 -6.5 Exports of Goods and Services 1,031.3 1,215.0 -5.9 17.8 21.3 Imports of Goods and Services 1,345.2 1,726.8 -20.8 28.4 27.8 3. Total Demand (GDP) (1 + 2) 4,835.3 5,602.3 9.6 15.9 100.0 4. Domestic Savings (3 - 1.1) 867.5 1,045.0 41.8 20.5 17.9 Private 1,047.5 1,163.8 49.6 11.1 21.7 Public -179.9 -118.9 -103.3 33.9 -3.7 5. Net Factor Income from Abroad -55.8 -71.9 46.9 -28.8 -1.2 6. Net Private Current Transfers 336.6 408.0 21.2 21.2 7.0 7. National Savings (4 + 5 + 6) 1,148.3 1,381.1 46.4 20.3 23.7 8. Savings Investment Gap Domestic Savings - Investment (4 - 1.2) -313.9 -511.8 -6.5 National Savings - Investment (7 - 1.2) -33.1 -175.7 -0.7 9. External Current Account Deficit without -33.1 -175.7 -0.7 Official Grants (2 + 5 + 6) (c) (a) Revised (b) Provisional (c) The difference with the BOP estimates is due to the time lag in compilation.

of GDP, private consumption increased from 64.4 per cent in 2009 to 65.8 per cent in 2010, while government consumption declined from a high level of 17.6 per cent to 15.6 per cent. Both domestic savings and national savings increased, from 17.9 per cent of GDP and 23.7 per cent of GDP, respectively, in 2009, to 18.7 per cent and 24.7 per cent, respectively. Private investment recovered from 17.9 per cent of GDP in 2009 to 21.6 per cent in 2010, while public investment declined marginally from 6.6 per cent of GDP in 2009 to 6.2 per cent in 2010, and as a result, total investment Savings and Investment

Savings and Investment Chart 1.3 (as a percentage of GDP) 30 25

Per cent

20 15

109.1 81.3 65.8 15.6 27.8 21.6 6.2 -9.1 21.7 30.8 100.0 18.7 20.7 -2.1 -1.3 7.3 24.7 -9.1 -3.1 -3.1

Sources: Department of Census and Statistics Central Bank of Sri Lanka

as a percentage of GDP in 2010 increased to 27.8 per cent. The recovery in total investment resulted in widening the national savings and investment gap to 3.1 per cent of GDP, which was reflected in a higher deficit in the external current account. Consumer price inflation continued to remain at mid-single digit levels in 2010, with the annual average increase of the Colombo Consumers’ Price Index (CCPI, 2002=100) and its year-onyear change recording 5.9 per cent and 6.9 per cent, respectively, by end 2010. The relatively low and stable inflation during the year was mainly due to improved domestic supply conditions, supportive fiscal policies aided by the adjustment in import duties and downward revisions to administered prices as well as the prudent monetary policy stance of the Central Bank.

External Sector Developments

10 5 0

2010 (b)

2006

2007 Gross Investment

2008

2009

2010

Gross Domestic Savings

The external sector of the country further improved in 2010 with favourable developments on both domestic and external fronts. Sri Lanka’s graduation to the status of a “middle-income

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

Table 1.2

Central Bank of Sri Lanka Annual Report - 2010

External trade rebounded strongly in 2010, reversing the sharp contraction observed during the global recession of 2009. Earnings from exports increased by 17.3 per cent, reflecting higher earnings from the industrial and agricultural sectors. Expenditure on imports grew by 32.8 per cent, led by intermediate goods imports. As a result, the trade deficit expanded to US dollars 5,205 million in 2010. Although export earnings were volatile in the early part of the year amidst uncertainties regarding the global recovery, they improved towards the latter part of the year, indicating a new growth path, despite the withdrawal of GSP+ concessions. This reflected the peace dividend and the dynamism of local exporters. Meanwhile, international commodity prices rose due to the global economic recovery, higher demand for commodities from emerging economies, and global supply constraints. Consequently, agricultural exports continued to Value of Petroleum Imports and Average Price of Crude Oil Imports

Chart 1.4 Value of Petroleum Imports and Average Price of Crude Oil Imports

3.5

120

3.0

100

2.5

2.0

1.5 40

1.0

0.5 0

2006

2007

Value (left axis)

2008

2009

2010

Average Price (right axis)

US $/ barrel

Chart 1.4

US$ billion

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

economy” by the International Monetary Fund (IMF) in January 2010, enabled the country to project itself strongly in international financial markets. Upgrading of the sovereign credit rating of the country by international rating agencies, the successful continuation of the Stand-by Arrangement (SBA) with the IMF, increased long term capital flows to the government including the successful issuance of the third international sovereign bond in October 2010 as well as increased inflows to the private sector helped strengthen the performance of the external sector. Further relaxation of restrictions on foreign exchange transactions also helped improve investor confidence and the external sector.

fetch high prices in the international market. Higher commodity prices, particularly crude oil prices, caused expenditure on imports to increase in 2010. Imports of consumer durables, such as personal motor vehicles and electronic goods also increased following the tariff reductions and the increase in domestic economic activity. Similarly, imports of investment goods also increased in 2010, led by higher expenditure on imports of machinery and transport equipment. External trade in services improved significantly generating a higher surplus during 2010, while the income account continued to record a deficit. All sub sectors of the services account, mainly transportation, travel, computer and information, construction and insurance services, performed well during the year. Net income from transportation and travel services grew substantially due to higher income from ports and aviation industries and a sharp increase in tourist arrivals. Meanwhile, the deficit in the income account increased to US dollars 572 million in 2010 as outflows on account of repatriation of profits and dividends exceeded the interest earned on investments and profits earned on trading of foreign currency and foreign securities. A substantial increase in inward workers’ remittances to US dollars 4.1 billion helped offset the trade deficit to a great extent in 2010. Establishing collective agreements with overseas employers for higher wages and salaries, the expansion of the exchange houses network by commercial banks, an increase in the number of persons taking up high-end jobs overseas, the government’s ongoing initiative to promote inward remittances through formal channels and opening of new bank branches in the Northern and Eastern provinces were instrumental in attracting a higher level of workers’ remittances. The external current account recorded a deficit of US dollars 1,498 million or 2.9 per cent of GDP in 2010. The current account deficit widened due to a large trade deficit, as a result of an increase in import demand supported by the

Central Bank of Sri Lanka Annual Report - 2010

Item Exports

Agricultural Products Industrial Products Mineral Exports Other Exports

Imports Consumer Goods Intermediate Goods Investment Goods Other

Trade Balance Services (net) Receipts Payments Income (net) Receipts Payments Current Transfers (net) Private Transfers (net) Receipts Payments Official Transfers (net)

Current Account

US dollars million

% Change

2009 (a)

2010 (b)

7,085 1,690 5,305 89 -

8,307 2,041 6,173 93 -

17.3 20.8 16.4 4.4 -

10,207 1,972 5,669 2,451 115

13,512 2,870 7,496 2,970 176

32.4 45.6 32.2 21.2 53.2

-3,122

-5,205

66.7

391 1,892 1,501

698 2,468 1,770

78.5 30.5 18.0

-488 116 603

-572 323 895

17.2 178.7 48.5

3,005 2,927 3,330 403 77

3,660 3,608 4,116 508 52

21.8 23.3 23.6 26.1 -31.9

-214

-1,418

562.8

233

164

-29.7

2,361

14.9 13.3 18.2 112.5 88.0 48.6 38.6 113.8 38.2 -29.3 -36.4 3,728.9 -61.2

Capital Account

Financial Account

Overall Balance

2,725

2,713 435 478 43 149 580 431 1,796 2,460 665 -198 -230 531 -537 921

Gross Official Reserves (c) Months of Imports Total External Reserves (c) Months of Imports Export Price Index Import Price Index Terms of Trade

5,097 6.0 6,770 8.0 112.5 109.1 103.1

6,610 5.9 8,035 7.1 124.9 127.9 97.6

Direct Investment (net) 384 Inflows 404 Outflows 20 Private, Long Term (net) 79 Inflows 390 Outflows 311 Government, Long Term (net) 840 Inflows 1,780 Outflows 940 Private, Short Term (net) -311 of which:Portfolio Investment (net) -6 Government, Short Term (net) 1,369 Errors and Omissions 346

Exchange Rates (Average) Rs./US dollar Rs./Japanese yen Rs./Euro Rs./ Pound sterling

of 0.5 per cent of GDP, reflecting weak external and domestic demand in the context of the global recession.

External Sector Developments

114.94 1.23 160.21 179.87

App(+)/Dep(-) 113.06 1.29 150.10 174.81

1.7 -4.6 6.7 2.9

Source: Central Bank of Sri Lanka (a) Revised (b) Provisional (c) Excluding Asian Clearing Union (ACU) receipts

recovery of domestic demand and expansion of economic activity. However, this was well below the average deficit of the previous few years, with the exception of 2009, which recorded a deficit

Inflows to the capital and financial account exceeded the current account deficit. The medium and long term loan inflows to the government increased during 2010 compared to 2009, mainly due to faster disbursement of foreign loans to finance major infrastructure development projects. The third international sovereign bond of US dollars 1 billion with a tenor of 10 years was successfully issued in October 2010. However, foreign direct investments (FDIs), including loans to BOI enterprises, decreased further to US dollars 516 million in 2010, mainly due to the impact of the global financial crisis on foreign financial flows. Net foreign inflows to the government rupee securities market declined in 2010, as the outstanding value of government securities issued to foreigners reached the maximum allowed limit of 10 per cent of the total outstanding value of government securities. Meanwhile, foreign loan inflows to the private sector increased in 2010, whereas short term net capital outflows reduced, largely due to the decline in foreign assets and the increase in foreign liabilities of commercial banks during 2010, despite the repayment of substantially high oil import bills by the Ceylon Petroleum Corporation (CPC) during 2010. In 2010, the BOP recorded a surplus of US dollars 921 million, following a significantly higher surplus of US dollars 2,725 million in 2009. Higher inflows to the capital and financial account, which exceeded the current account deficit generated the surplus in the overall balance of the BOP. The financial inflows to the government as well as to the private sector for long term investment contributed to the surplus in the BOP. The external reserves of the country further improved to record its highest level in 2010. By end 2010, gross official reserves (excluding ACU receipts) increased to a record high level of US dollars 6,610 million (equivalent to 5.9 months of imports) compared to US dollars 5,097 million

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

Table 1.3

Central Bank of Sri Lanka Annual Report - 2010 Chart 1.5

US$ billion

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

exchange, in order to mitigate excessive volatility in the exchange rate and to further strengthen the reserve position. However, during the last quarter of 2010, the Central Bank had to supply foreign exchange to the market to ensure adequate foreign exchange liquidity in the face of substantial outflows arising from the settlement of petroleum bills.

Balance of Payments

Chart Balance 1.5 of Payments 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 2006

Trade Balance

2007

2008

Current Account Balance

2009

2010

Overall Balance

at end 2009. Higher disbursements of project financing, continuation of the IMF-SBA facility, the proceeds from the third international sovereign bond issue, and the absorption of foreign exchange from the domestic foreign exchange market contributed to the buildup of reserves. Meanwhile, total external assets (excluding ACU receipts) increased by 19 per cent to US dollars 8,035 million by end 2010 (equivalent to 7.1 months of imports), compared to US dollars 6,770 million at end 2009. The total external debt of the country as a percentage of GDP moderated to 43.3 per cent in 2010. Higher foreign inflows to the government including the proceeds from the sovereign bond issue to finance infrastructure development projects, and disbursements under the IMF-SBA facility, which is managed by the Central Bank, were the major factors that contributed to the increase in the outstanding external debt stock. Of the medium to long term debt, the government debt accounted for 85.9 per cent, while the remainder represented borrowings of the private sector and public corporations, and debt obligations to the IMF. The total foreign debt service payments, consisting of amortisation and interest payments as a percentage of exports of goods and services, declined from the unusually high ratio of 19.0 per cent in 2009 owing to crisis-affected level of exports of goods and services, to 15.2 per cent in 2010. The exchange rate policy in 2010 focused mainly on maintaining stability in the domestic foreign exchange market. In the face of continued foreign exchange inflows into the domestic market, the Central Bank regularly absorbed foreign 10

Fiscal Sector Developments Significant improvements in fiscal operations in 2010 helped contain the overall fiscal deficit at 7.9 per cent of GDP from 9.9 per cent in the previous year. For the first seven months of the year, fiscal operations were conducted initially under a Vote on Account framework and then under the provisions of paragraph 3 of Article 150 of the Constitution by a Presidential Decree. The budget for 2010 was approved by the Parliament in July 2010. Despite the delay in presenting the budget and the limited scope for introducing new revenue and expenditure measures, the overall fiscal deficit was maintained within the original target of 8 per cent of GDP. The pickup in domestic economic activity and the strong recovery in imports increased government revenue in nominal terms above the original target set in the budget for 2010. Revenue as a percentage of GDP increased to 14.6 per cent in 2010 from 14.5 per cent in the previous year. The rationalisation of the tariff structure to four bands and the removal of the import duty surcharge as well as the reduction of effective taxes on various major imports, including motor vehicles, caused a surge in import demand and a resultant increase in revenue collection from import related taxes. However, to mitigate the impact of rising international commodity prices on the domestic market, the government revised taxes on several key commodities, including petrol and diesel. In addition, the government provided various tax concessions to assist industries affected by the global economic and financial crisis and to support certain identified industries. Government expenditure was maintained within the original budgetary targets for 2010 with the strict monitoring of recurrent expenditure, while maintaining capital

Central Bank of Sri Lanka Annual Report - 2010

C hart 1. 6

Revenue, Expenditure and Overall Fiscal Deficit (as a percentage of GDP)

-2

-4

-6

-8

Per cent

enue, E xpenditure and O v erall F is cal Deficit ChartR ev 1.6

-10

-12

2006

Expenditure (left axis)

2007

2008

Revenue and Grants (left axis)

2009

2010

Overall Deficit (right axis)

60 50 40 30 20 10 0

2006

2007

Domestic

2008

2009

2010

Foreign

in government securities (0.9 per cent of GDP). Meanwhile, the outstanding government debt to GDP ratio declined from 86.2 per cent in 2009 to 81.9 per cent in 2010 mainly due to a lower budget deficit and higher growth in nominal GDP.

Monetary Sector Developments The Central Bank eased its monetary policy stance further in 2010 by reducing the policy interest rates in the second half of 2010 with a view to stimulate credit growth to support economic activity. The continuous deceleration in money supply growth during the first three quarters of 2010 reflected subdued demand pressures, while the benign outlook for domestic consumer prices prompted the Central Bank to continue its accommodative monetary policy stance during the year. With the reduction in both the Repurchase rate and the Reverse Repurchase rate by 25 basis points in July, and a further reduction of the latter by 50 basis points in August, the policy rate corridor was narrowed, and by end 2010, the Repurchase rate was 7.25 per cent, while the Reverse Repurchase rate was 9.00 per cent. Policy rates were reduced again in January 2011, narrowing the corridor further, which has since remained bounded by the Repurchase rate of 7.00 per cent and the Reverse Repurchase rate of 8.50 per cent. Following the turnaround in rupee liquidity in the domestic money market from mid 2009, the money market liquidity continued to be in excess in 2010. The build-up of excess liquidity was largely due to the absorption of foreign exchange inflows to the country by the Central Bank with a 11

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

The government relied more on external sources to finance the fiscal deficit, thus reducing pressure on the domestic market and interest rates. Improved investor confidence and the favourable borrowing conditions that prevailed in international financial markets enabled the government to issue a 10-year international sovereign bond at a lower rate of interest of 6.25 per cent, attracting an order book of six times the value of the bond and to issue Sri Lanka Development Bonds (SLDBs) with extended tenor at lower interest rates. In financing the deficit through domestic sources, the government reduced its reliance on bank financing, thus releasing resources to the private sector and easing pressure on domestic interest rates. Total net domestic financing in 2010 amounted to 3.6 per cent of GDP, while net foreign financing was 4.4 per cent of GDP, which consisted of foreign loans (3.5 per cent of GDP) and foreign investments

Debt C hartGovernment 1. 7 (as percentage GDP) G ov ernment Debt as a a percentage of of G DP

Chart 1.7

Per cent

expenditure for the accelerated implementation of planned infrastructure projects. Total expenditure and net lending declined from 24.9 per cent of GDP in 2009 to 22.9 per cent of GDP in 2010. The reduction of total expenditure and net lending by 2 percentage points was the combined outcome of a reduction in recurrent expenditure by 1.5 percentage points and capital and net lending by 0.5 percentage points. Concerted efforts taken to rationalise recurrent expenditure enabled government expenditure to be contained within the original budgetary allocations, while the public investment programme was carried out largely unhindered.

Central Bank of Sri Lanka Annual Report - 2010

Chart 1. ... Selected Market Interest Rates

Per cent

Jul-10

Jul-09

Jan-10

Jul-08

Jan-09

Jul-07

Jan-08

Jul-06

Jan-07

Jul-05

Jan-06

Jul-04

Jan-05

Jul-03

Jan-04

Jul-02

Jan-03

Jul-01

Jan-02

Jul-00

Jan-01

Jan-00

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

liquidity with the Central Bank through the standing facility. By end 2010, the overall excess liquidity in the money market amounted to Rs. 124.3 billion compared to Rs. 159.6 billion at end 2009.

Central Bank Policy Rates and Selected Market Interest Rates

Chart 1.8

Repurchase Rate Reverse Repurchase Rate Penal Rate on Reverse Repo Transactions Primary Market Yield on 364-day Treasury bills Average Weighted Prime Lending Rate (Monthly) Average Weighted Deposit Rate

view to preventing an undue appreciation of the rupee. The issue of the sovereign bond in October to international investors, net foreign investments in Treasury bonds and Treasury bills, and other inflows of foreign funds to both the government and the private sector, resulted in the excess of foreign exchange in the domestic foreign exchange market during the first three quarters of the year. The Central Bank continued its efforts to manage liquidity, thereby stabilising interest rates and guiding reserve money along the targeted path. As the stock of government securities held by the Central Bank depleted, the Bank issued its own securities to absorb liquidity on overnight and term bases. Foreign exchange swap agreements, adopted under open market operations (OMO) in 2009, were also utilised to absorb a portion of the excess liquidity. In October 2010, the Central Bank implemented a bond-borrowing programme and the borrowed bonds were used for OMO in the latter part of the year to absorb the excess liquidity in the market. Meanwhile, from 20 October 2010, the overnight and term auctions under OMO were discontinued as the primary market yield rate on three-month Treasury bills declined to levels below the Bank’s Repurchase rate, an outcome of intense competition among banks, who had a large volume of excess liquidity, to acquire short term government securities to manage their portfolios. Accordingly, market participants continued to place their excess 12

The monetary operations of the Central Bank continued within a monetary targeting framework and were guided by its monetary programme, which is prepared taking into account the projected key macroeconomic developments. Accordingly, broad money (M2b) continued to be the intermediate target for monetary policy, while reserve money, which is linked to broad money through a multiplier, remained the Bank’s operating target for monetary policy. The Central Bank’s monetary programme was initially prepared stipulating the targets for annual average growth of broad money and reserve money at 14.5 per cent each. Subsequently however, the Bank revised the monetary programme for the year as it became evident by mid-year that the domestic economy was expanding at a higher rate in 2010 than originally projected, and it was necessary to include information from the government's budget for 2010, which was presented to the Parliament in June 2010. Accordingly, the targeted growth of broad money in 2010 was revised upward to 15 per cent in July 2010. Meanwhile, a notable increase in the ‘currency held by the public’ component within the money supply, particularly in view of the restoration of economic activity in the Northern and Eastern provinces, led to an increase in the currency to deposit ratio, in turn leading to a decline in the money multiplier. Taking into account these developments, the target for year-on-year growth of annual average reserve money was raised to 21.2 per cent in July 2010, consistent with the upward revision to the broad money target. Year-on-year growth of daily average reserve money in 2010 was at a level consistent with the target stipulated in the revised monetary programme for 2010. Viewed from the source side, the expansion of reserve money during the year 2010 was entirely due to the increase in net foreign assets (NFA) of the Central Bank. NFA expanded mainly as the government used a part of

Central Bank of Sri Lanka Annual Report - 2010

Annual average growth of broad money (M2b) was 15.3 per cent in 2010, remaining consistent with the targeted growth of 15 per cent. On the use side, the growth of broad money was reflected in the increases in both currency held by the public as well as deposits, particularly demand deposits. Interest bearing deposits, that is, savings and time deposits (Quasi money) held by the public with commercial banks increased at a slower pace of 14.6 per cent, year-on-year, in 2010, compared to the growth of 18.0 per cent in 2009. The expansion of broad money was driven by the increase in NDA of the banking system as NFA contracted during the year. The NDA expanded largely due to the substantial increase in credit obtained by the private sector from commercial banks, which rebounded strongly in 2010 recording a year-on-year growth of 25.1 per cent compared to a negative growth of 5.8 per cent in 2009. The decline in lending rates along with Cha rt 1. ... Money, Credit a nd Interes t R a tes

25 20 15

10 9

Average Weighted Lending Rate of LCBs (left axis) Credit granted to the Private Sector by LCBs (right axis) M2b (right axis)

2010 Q 4

2010 Q 3

2010 Q 2

2010 Q 1

2009 Q 4

2009 Q 3

2009 Q 2

2009 Q 1

2008 Q 4

2008 Q 3

2008 Q 2

2008 Q 1

-10 2007 Q 4

0 2007 Q 3

-5

2007 Q 2

2007 Q 1

Per cent

Year-on-year Change (Per cent)

Money, Credit and Interest Rates

Chart 1.9

factors, such as improved post-conflict economic conditions, enhanced business confidence and the recovery under way in the global economy helped spur credit flows to the private sector. Credit granted to public corporations, particularly to the CPC, also increased during the year, thereby contributing to the monetary expansion in 2010. However, net credit granted to the government (NCG) declined during the year. Meanwhile, NFA of commercial banks declined partly due to the decline in placements overseas by commercial banks, along with an increase in their investments in Sri Lanka Development Bonds (SLDBs) during the year and supplying foreign exchange to the CPC to settle oil bills. Following the reduction of the Central Bankâ&#x20AC;&#x2122;s policy interest rates, market interest rates adjusted further downwards in 2010, providing additional impetus to economic activity. During the year, the average weighted call money rate (AWCMR) continued to hover around the middle of the policy interest rate corridor, thus contributing to the effective transmission of monetary policy. Also, yields on government securities declined during the year. Meanwhile, the secondary market yield curve for government securities, which shifted downward, extended to longer maturities in 2010. This downward shift in the rate structure can also be attributed to the continued excess liquidity in the money market as well as the benign outlook for inflation that prevailed. Commercial banks reduced their deposits and lending rates gradually during 2010 in response to the easing of the monetary policy stance by the Central Bank. The declining trend in interest rates continued into 2011, as the Central Bank reduced its policy interest rates further in January 2011.

Financial Sector Performance and System Stability The performance of the overall financial sector improved in 2010, leading to a strengthening of the stability of the country's financial system. In addition to the continued supervisory measures relating to examination and 13

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

the funds (US dollars 492 million) it raised by issuing a sovereign bond in international markets to retire Treasury bills held by the Bank amounting to Rs. 55 billion and sold a further US dollars 386 million thus raised to the Central Bank. Meanwhile, net domestic assets (NDA) of the Central Bank decreased as a result of the substantial decline in the amount of Treasury bills held by the Bank.

Central Bank of Sri Lanka Annual Report - 2010

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

problem resolution, several regulatory measures were introduced to further strengthen the stability of the financial sector, thereby enhancing public confidence. The improved performance, which was reflected in all leading indicators of financial institutions, markets, payment systems and safety nets, was recorded amidst the resolution of concerns and stresses that had arisen in 2008 and 2009 due to certain domestic and external shocks adversely impacting on the public and investor confidence and business operations. Both bank and non bank financial institutions displayed improved performance in 2010, reflecting the increase in financial transactions to facilitate the growing economy. The banking sector, which is the most dominant and systemically important sector in the financial system, grew at a high rate, while recording a significantly high level of profitability. Capital adequacy ratios and liquidity ratios in the banking sector remained well above the statutory limits. With regard to non bank financial institutions, the registered finance companies (RFC) sector gradually recovered in 2010 after experiencing liquidity problems in 2009. Timely measures implemented by the Central Bank restored depositor confidence in RFCs. Specialised leasing companies (SLCs) continued to grow in 2010 with an improvement in credit quality and favourable provisioning for bad and doubtful accommodations. Key financial indicators of the primary dealers in government securities improved during 2010, while risk management indicators were maintained within prudent levels. The insurance sector also reported improved performance in 2010. The expansion of the branch network of financial institutions continued during 2010. The banking network further expanded with the establishment of 85 branches, 97 extension offices and 130 automated teller machines (ATMs). Out of the new banking outlets, 67 branches and 77 extension offices were outside the Western province, including 48 outlets in the Northern and Eastern provinces. Along with the issuance of two new licences, the total number of RFCs increased to 37, while their branch network increased by 14

98 during the year. The branch network of SLCs further expanded with the opening of 44 branches, of which, 15 were opened in the Northern and Eastern provinces. The Central Bank further strengthened its supervisory and regulatory framework to improve the soundness and risk management systems of banks. The new regulatory measures introduced included the increase in the minimum capital that is required to be maintained by licensed commercial banks (LCBs) and licensed specialised banks (LSBs), on an annually staggered basis from 2010 to 2015; the implementation of a mandatory deposit insurance scheme, relaxation of classification of loans as non performing loans; the reduction of the required level of general loan loss provisions; the application of the assessment of the fitness and propriety to officers performing executive functions; the requirement for unlisted locally incorporated private banks to obtain a listing on the Colombo Stock Exchange (CSE) by 31 December 2011; and the issuing of Directions on outsourcing of activities. Regulations were issued stipulating maximum rates of interest that can be offered by RFCs in order to prevent unhealthy competition among deposit taking institutions and to secure public confidence and sustainability. The drafting of the Finance Business Act to replace the current Finance Companies Act was finalised with the approval of the Cabinet of Ministers and the Bill is to be presented to the Parliament in 2011. In relation to SLCs, to facilitate their future growth with prudence, the required minimum core capital and the required minimum capital for a public company to qualify for registration were increased on a staggered basis. During the year, efforts were made to rehabilitate the RFCs affected by the liquidity crisis. The major measures included the appointment of a managing agent, attracting new investors to infuse capital and taking over the management, converting deposit liabilities and debt into equity, rescheduling of deposits and interest, disposing of real estate properties and fast tracking the recovery of non performing assets. In addition, the Central Bank Credit Guarantee Scheme was

Central Bank of Sri Lanka Annual Report - 2010

Action was taken to strengthen the regulatory framework for insurance companies. The proposed amendments to the Regulation of Insurance Industry Act to strengthen prudential regulation and supervision in order to protect the interest of policyholders were presented to the Parliament in 2010. All insurance companies will be required to list on the stock exchange. The removal of the war risk premium for Sri Lanka by the London Joint Cargo Committee in June 2010 and the reduction of the premia for terrorism cover by the National Insurance Trust Fund by 75 per cent in April 2010 will reduce the cost of insurance to policyholders. Improvements to the payment and settlement systems continued in 2010. The procedure of granting intra-day liquidity facility (ILF) to institutions under the real time gross settlement (RTGS) system was upgraded to enable them to obtain ILF at their discretion, deviating from providing ILF only on their request. SLIPS was upgraded to provide online connectivity to participating institutions. To eliminate the time lag associated with the movement of physical cheques to LankaClear (Pvt) Ltd, participating banks were instructed to capture the cheque images directly at the branch level and submit those images to LankaClear (Pvt) Ltd.

The activity at the CSE rose to historically high levels in 2010, and the CSE became one of the best performing stock exchanges in the world with all indicators recording high performance. The All Share Price Index (ASPI) rose by 96 per cent and the Milanka Price Index (MPI) increased by 83 per cent in 2010, while all the sub sector price indices increased. The number of shares traded increased four-fold and the average daily turnover rose more than three-fold. The market price earnings ratio increased further and the market capitalisation of the CSE reached Rs. 2.2 trillion by end 2010. Net foreign sales increased driven by the realisation of capital gains amidst high price increases of many stocks, and more local investors engaged in the market. There were 10 initial public offers (IPOs) in 2010 and all were significantly oversubscribed, while 31 companies made rights issues.

1.3 Global Economic Environment and Outlook2 The global economy gradually recovered in 2010 from its deepest recession since the 1930s. The global recovery could be largely attributed to the pickup in private demand and policies taken towards fiscal consolidation and external rebalancing, although it was weakened by high unemployment and systemic risks and renewed stresses in the financial sector. According to the World Economic Outlook (WEO) of the IMF, the world economy is estimated to have expanded by 5.0 per cent in 2010 compared to its contraction by 0.6 per cent in 2009. Being the less affected by the financial turmoil that preceded the recession in 2009, emerging economies continued to be the engine of economic recovery in 2010. Advanced economies, which were worst hit by the economic downturn in 2009, were estimated to have expanded by 3.0 per cent. This modest growth is primarily a result of the weak private domestic demand in advanced economies, mainly due to the prevailing high unemployment levels. The Japanese economy expanded by a The analysis in this section is based on the World Economic Outlook of the IMF, October 2010 and January 2011 (update), and publications by the World Bank and the Asian Development Bank.

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

in place to support the granting of credit to RFCs by licensed banks. Accordingly, three RFCs were able to commence normal business operations, while managing agents of two RFCs have been discontinued. Strategic investors were identified for two RFCs, while prospective investors for other RFCs were under the review and due diligence process. All distressed RFCs will be able to revive their businesses fully during 2011. Investigations into institutions allegedly engaged in finance business without authorisation were continued, while assisting courts with respect to pending litigation. Parallel public awareness programmes, such as country wide seminars/workshops were conducted and advertisements were placed in national newspapers to educate the public on the risks of investing in unauthorised institutions.

Central Bank of Sri Lanka Annual Report - 2010

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

TABLE 1.4

Global Economic Development and Outlook (a)

Item

Actual 2008

2009

Projections 2010

World Output 2.8 -0.6 5.0 Advanced Economies 0.2 -3.4 3.0 United States 0.0 -2.6 2.8 Euro Area 0.5 -4.1 1.8 United Kingdom -0.1 -4.9 1.7 Japan -1.2 -6.3 4.3 Emerging and Developing Economies 6.0 2.6 7.1 Developing Asia 7.7 7.0 9.3 China 9.6 9.2 10.3 India 6.4 5.7 9.7 World Trade Volume (Goods and services) 2.9 -10.7 12.0 Imports Advanced Economies 0.4 -12.4 11.1 Emerging and Developing Economies 9.0 -8.0 13.8 Exports Advanced Economies 1.9 -11.9 11.4 Emerging and Developing Economies 4.6 -7.5 12.8 Price Movements Consumer Prices Advanced Economies 3.4 0.1 1.5 Emerging and Developing Economies 9.2 5.2 6.3 Commodity Prices (US dollars) Oil 36.4 -36.3 27.8 Non fuel 7.5 -18.7 23.0 Six-month London Interbank Offered Rate (LIBOR) on US dollar Deposits (per cent) 3.0 1.1 0.6 (a) Annual percentage change unless otherwise indicated.

2011 4.4 2.5 3.0 1.5 2.0 1.6 6.5 8.4 9.6 8.4 7.1 5.5 9.3 6.2 9.2 1.6 6.0 13.4 11.0 0.7

Source: World Economic Outlook (January 2011 & October 2010), IMF

notable 4.3 per cent in 2010 after a contraction of 6.3 per cent in 2009. The recovery of the Euro region economies was affected by regional fiscal instability and vulnerabilities in financial linkages and therefore the region recorded only a modest growth of around 1.8 per cent in 2010. Fuelled by the gradual increase in global demand, emerging and developing economies expanded by 7.1 per cent in 2010 while developing Asia expanded at an estimated 9.3 per cent. With the gradual recovery of global demand, commodity prices also increased particularly towards the latter half of 2010. Inflation in advanced economies increased from 0.1 per cent in 2009 to 1.5 per cent during 2010, while in emerging and developing economies, inflation increased from 5.2 per cent in 2009 to 6.3 per cent in 2010. In the midst of increasing global demand, there were several supply-side shocks raising commodity prices further. The adverse weather conditions in 16

several major food commodity producing countries caused food prices to increase, while geopolitical instability during the latter part of 2010 resulted in higher crude oil prices. The Food and Agriculture Organisationâ&#x20AC;&#x2122;s (FAO) food price index increased by 25.1 per cent from 177.9 in 2009 to 222.6 in 2010. Meanwhile, the average Brent crude oil price of US dollars 61.83 per barrel in 2009 increased to US dollars 79.97 per barrel in 2010. Short term interest rates continued to remain low in 2010 in response to the continuation of a relaxed monetary policy stance in many advanced and emerging economies. The large policy rate cuts by major central banks in the previous year have resulted in the policy interest rates remaining close to zero in many advanced economies. However, during the latter part of 2010, with looming inflationary pressures, several economies took measures to curb the rise in price levels, by raising interest rates. Several other advanced economies, including the United States and some emerging economies that were still recovering from the recession in 2009, resorted to a range of unconventional measures to further ease financial conditions during 2010 as room for further rate cuts had already been exhausted. Such stimuli included quantitative easing,3 credit easing and expansionary fiscal policy to boost demand and lower uncertainty and systemic risk in financial markets. Heightened volatility in the currency markets was observed in many economies. Central banks around the world intervened, in varying degree, in the foreign exchange markets to dampen rapid appreciations of local currencies. This intensified during the first half of 2010 as global financial turbulence led to sharp currency movements. The pound sterling and the euro depreciated sharply against the US dollar during the first half of 2010 due to the sovereign debt crisis in the European region. However, during the latter part of 2010, Chinaâ&#x20AC;&#x2122;s Quantitative easing refers to the action by a central bank to increase the size of its balance sheet through buying assets from the market in order to increase liquidity in the money market, thereby stimulating the economy and mitigating the threat of deflation. This was made popular by the use of it as an unconventional monetary policy measure, primarily by the US Federal Reserve and the Bank of England, along with the Bank of Japan, during the recent global financial crisis, as policy interest rates of these countries were at or near zero, thus being unavailable to use as an instrument of monetary policy. 3

Central Bank of Sri Lanka Annual Report - 2010

Equity and debt markets in many emerging and developing economies improved with increased foreign investment flows during 2010. However, losses were reported in many equity markets in the European region due to concerns about sustainability of the recovery. The sovereign debt crisis that surfaced during the first quarter of 2010 as a result of unsustainable fiscal policies in some Euro member economies hindered the growth prospects of the region. As a result, investors moved away from several European economies, and the IMF and the European Central Bank (ECB) continued their efforts to bring stability to the European sovereign debt market. Unprecedented liquidity and credit support and substantial fiscal action in affected countries arrested the financial turmoil, moderating its adverse impact on Europeâ&#x20AC;&#x2122;s economic activity. Towards the latter part of 2010, there were signs of improvements in global financial conditions, especially in advanced economies. The bank lending conditions in advanced economies improved while risk spreads continued to tighten. It is unlikely that there would be an early reversal of quantitative easing policies by monetary authorities in advanced economies, as the recovery is still under way and unemployment rates are still high, although deflationary concerns have subsided. For many emerging market economies, the result of quantitative easing in advanced economies, has been substantial inflows of foreign capital and appreciation of their exchange rates. Sterilisation action by central

banks in order to mitigate the impact on export competitiveness through excessive appreciation of their currencies has resulted in significant sterilisation costs to prevent the excess liquidity in domestic money markets of these emerging market economies, and these economies have taken steps to slowdown capital flows through taxing inflows and outflows, introducing caps on investments, while strengthening their financial systems. In response to various policy measures adopted, the economic growth in 2011 is expected to be encouraging, though several downside risks remain. Thus far, the economic recovery in the Asian region has been rapid and strong. It is expected that the growth in the emerging economies would drive the global economic recovery in the short to medium term. In its latest forecast, the IMF has projected the global growth in 2011 to be around 4.4 per cent, led by emerging and developing economies, which are expected to grow at around 6.5 per cent in 2011. The growth in advanced economies is projected to be around 2.5 per cent in 2011. However, the prevailing high unemployment rate, high fiscal deficits, financial imbalances, as well as geopolitical developments in the Northern African and Middle Eastern regions as well as more recent developments in Japan caused by natural disasters still pose challenges to global economic recovery. The demand for energy, mainly in the form of petroleum products and coal, would increase over the medium term as the global economy is poised to recover. However, safety concerns at the Japanese nuclear reactors at Fukushima are unlikely to exert pressure on the demand for petroleum products and coal as alternate energy sources for nuclear energy in the short term. Given the increased demand as a result of expanding economic activity, supply-side shocks due to adverse weather conditions and geopolitical instability, commodity prices are expected to remain above 2010 levels. The IMF has projected the consumer prices in advanced economies to marginally increase to around 1.6 per cent, and in emerging and developing economies, to stabilise at around 6.0 per cent.

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

diversification of its foreign assets resulted in the appreciation of the Japanese yen, Korean won and the euro. Coupled with continued current account surpluses in Japan, the yen appreciated sharply, prompting the Japanese authorities to intervene in the foreign exchange market. China, subsequent to a marginal revaluation of the currency, too allowed the renminbi depreciate marginally to preserve competitiveness. Quantitative easing announced by the Bank of Japan and the move by the US Federal Reserve to purchase up to US dollars 600 billion worth of long term government bonds had an impact on currency movements.

Central Bank of Sri Lanka Annual Report - 2010

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

1.4 Medium Term Macroeconomic Outlook, Challenges and Policies Supported by post-conflict optimism and strengthening global demand, the medium term outlook for Sri Lankaâ&#x20AC;&#x2122;s economy is encouraging. Following the 8.0 per cent real growth in the economy in 2010, in the medium term, the economy is expected to grow by 8 - 9 per cent per annum. Greater capacity utilisation with the development of infrastructure facilities, expansion in the agriculture sector with a larger contribution coming from the Northern and Eastern provinces, improved productivity, product and market diversification and expansion of industries, expansion of trade and services sectors including tourism, ports, transportation, banking and insurance, are expected to provide the required impetus for realising such higher growth prospects. Further, the opening up of new investment opportunities with the dawn of peace, together with the commitment shown by the government by implementing necessary changes to the tax system as well as improving operations of public enterprises will help achieve higher growth levels in the medium term, while ensuring overall macroeconomic stability. Meanwhile, in order to maintain higher economic growth, investment will need to be gradually augmented to a level close to 35 per cent of GDP, while domestic savings requires to be brought up to at least 25 per cent of GDP to support the envisaged level of investment in the medium term. While credit flows to the private sector is expected to continue, these flows, together with claims of the banking system on the government and public corporations, will be closely monitored to contain the build-up of excessive demand pressures. Supply-side improvements are expected to continue, and along with prudent demand management policies, inflation in the medium term is expected to be maintained at a mid single digit level. Meanwhile, the fiscal strategy will continue to focus on a gradual reduction of the overall fiscal deficit and public debt,

as envisaged in the Medium Term Macro Fiscal Framework. This will be achieved through a higher tax revenue collection, supported by a simplified tax structure, a broadened tax base, the rationalisation of government recurrent expenditure and prudent public debt management, while maintaining public investment at a level that can facilitate higher economic growth. The external sector is expected to remain strong in the medium term, enabling the maintenance of an international reserve position that is adequate to finance over 5 months of imports. Given the gradual recovery in the global economy, improved productivity and enhanced product quality of domestic enterprises, exports are expected to maintain its upward momentum in the forthcoming years. Agricultural exports are expected to grow, lured by the attractive prices fetched in the international markets, which has propelled cultivation of marginal lands and the hitherto unutilised lands in the Northern and Eastern provinces. Growth in industrial exports is also expected to accelerate with the emergence of new industries and higher levels of value addition in existing industries. The apparel industry has made significant strides in the international value chain by incorporating design aspects, catering to reputed international brands and expanding to hitherto untapped markets. Exports of food and beverages, rubber products and machinery and equipment could also be developed through higher levels of value addition and the development of new products. The expenditure on imports would also increase with the development projects around the country, reconstruction activities in the Northern and Eastern provinces, the development of the tourism industry and other export oriented industries. Imports of consumer durables are also expected to increase with the improved living standards of the people. With the commissioning of the coal power plant, expenditure on petroleum products is expected to be offset to some extent by the imports of coal, which is relatively cheaper. The geopolitical tensions in the oil producing regions, are likely to exert pressure on international crude oil prices as well as Sri Lankaâ&#x20AC;&#x2122;s oil import bill, and thereby on the trade deficit, particularly, in 2011. A key development

Central Bank of Sri Lanka Annual Report - 2010

The relaxation of exchange controls, focused fiscal incentives and improved macroeconomic environment are expected to attract higher Table 1.5

Indicator

Medium Term Macroeconomic Framework (a) Projections Unit

2009 (b)

2010 (c)

2011

2012

2013

Real Sector GDP at Market Prices Rs. bn 4,835 5,602 6,440 7,405 8,513 Real GDP Growth % 3.5 8.0 8.5 9.0 9.5 GDP Deflator % 5.9 7.3 6.0 5.5 5.0 Per Capita GDP US$ 2,057 2,399 2,794 3,200 3,660 Total Investment % of GDP 24.4 27.8 29.5 32.0 33.0 Domestic Savings % of GDP 17.9 18.7 19.9 23.2 25.0 National Savings % of GDP 23.7 24.7 25.8 29.1 30.7 External Sector Trade Gap US$ mn -3,122 -5,205 -6,762 -7,399 -7,993 Exports US$ mn 7,085 8,307 9,626 10,876 12,341 Imports US$ mn 10,207 13,512 16,389 18,275 20,334 Services (net) US$ mn 391 698 1,148 1,487 1,778 Current Account Balance US$ mn -214 -1,418 -2,140 -1,953 -1,738 Current Account Balance % of GDP -0.5 -2.9 -3.7 -2.9 -2.2 Overall Balance US$ mn 2,725 921 775 525 825 External Official Reserves (d) (e) US$ mn 5,097 6,610 8,004 8,938 9,668 Debt Service Ratio (f) % 18.9 14.6 13.5 16.2 12.6 Fiscal Sector Total Revenue and Grants % of GDP 15.0 14.9 15.6 16.3 16.6 Total Revenue % of GDP 14.5 14.6 15.2 16.0 16.5 Grants % of GDP 0.5 0.3 0.4 0.3 0.2 Expenditure and Net Lending % of GDP 24.9 22.9 22.4 21.5 21.3 Current Account Balance % of GDP -3.7 -2.1 -0.8 1.0 1.7 Overall Budget Deficit % of GDP -9.9 -7.9 -6.8 -5.2 -4.8 Domestic Financing % of GDP 5.1 3.6 4.6 4.2 3.9 Government Debt % of GDP 86.2 81.9 80.0 75.0 71.0 Financial Sector (g) Reserve Money Growth % 13.1 18.8 14.5 14.5 14.5 % 18.6 15.8 14.5 14.5 14.5 Broad Money Growth (M 2b) Change in Credit to Government Rs. bn 57.4 -13.1 42.0 32.4 25.0 Change in Credit to Private Sector Rs. bn -73.4 300.0 281.3 303.1 340.1 Growth in Credit to Private Sector % -5.8 25.1 18.8 17.1 16.4 (a) Based on the information available by mid March 2011 (b) Revised (c) Provisional (d) Excluding receipts of Asian Clearing Union (e) External official reserves include the proceeds from the IMF Stand-by Arrangement facility-2009. (f) Total debt service payments as a percentage of earnings from exports of goods and services (g) Year-on-year growth in end year values

2014 9,790 9.5 5.0 4,190 34.0 27.0 32.3 -8,531 14,027 22,558 2,209 -1,500 -1.7 1,325 10,281 14.3 16.7 16.5 0.2 21.5 1.6 -4.8 3.9 67.0 14.5 14.5 0.0 383.7 15.9

Sources: Ministry of Finance and Planning Department of Census and Statistics Central Bank of Sri Lanka

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

levels of foreign inflows to the government and to the private sector including FDIs in 2011 and beyond. By end 2010, the government had a cumulative financial commitment of around US dollars 7.1 billion from Sri Lankaâ&#x20AC;&#x2122;s development partners, in comparison to US dollars 6.6 billion at end 2009. The project implementation duration for these commitments is in the range of 2-5 years and is mostly for infrastructure projects, which would facilitate the development process and earnings sources of people. In addition, more FDIs are expected to be realised with continued development work in the Northern and Eastern provinces, especially in the tourism sector including hotels, telecommunication, ports, property development, agricultural and manufacturing sectors.

with regard to the BOP would be that earnings from services would record significant increases in the medium term, supported by increased earnings from tourism, port and airport related activities and information technology. It is expected that the political tensions in the Middle East would not have a major impact on inward remittances by expatriate workers, which is likely to remain a significant source of foreign exchange receipts that would continue to lower the deficit in the current account. Supported by higher financial flows to the government and private sector including FDI inflows, the BOP is expected to record a surplus over the medium term.

Central Bank of Sri Lanka Annual Report - 2010

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

The key challenge facing the economy in the coming years is to maintain the significant macroeconomic improvements that were achieved in 2010. In 2010, economic growth rebounded with notable positive contributions from all key sectors while inflation was kept under control. The external sector performed remarkably and official reserves were maintained at a comfortable level, while fiscal consolidation efforts displayed tangible results. Supported by these developments, market interest rates declined and the flow of credit to the private sector increased. These macroeconomic achievements are by no means trivial, and Sri Lanka’s ability to record these in a single year when the major economies and regional economies continue to battle with various economic imbalances, is impressive. Maintaining and building on these achievements in the medium term will be the challenge faced by policymakers, amidst internal and external shocks, and possible demand pressures. Appropriate demand management policies as well as addressing supplyside bottlenecks effectively would be imperative to sustaining macroeconomic stability. Sri Lanka’s current and expected high growth momentum has posed new questions about tightening of the labour market conditions. The key indications of tightening are, first, that Sri Lanka’s unemployment rate (excluding the Northern and Eastern provinces) has gradually declined from 8.8 per cent in 2002 to 4.9 per cent by 2010, and second, in terms of the number of hours worked per week, the percentage of the 40 plus hours category has increased from 60.9 per cent in 2002 to 67.6 per cent by the third quarter of 2010. However, other labour market indicators point towards the possible availability of a pool of labour that could be absorbed into the labour force without having a significant impact on wages. In particular, the labour force participation rate, i.e., the economically active population as a percentage of the working age population, has declined from 50.6 per cent in 2002 to 48.1 per cent in 2010, a trend that could reverse with market conditions, increasing the availability of labour. While the Industry sector and the Services sector employ 24.2 per cent and 43.1 per cent of the 20

employed, respectively, the percentage employed in the Agriculture sector is still as high as 32.7 per cent. While the increase in hours worked signals a reduction in underemployment, it still remains a serious concern particularly in the Agriculture sector. The ongoing improvements to agricultural productivity including mechanisation are expected to push a large proportion of the current agricultural labour force away from agriculture, while ongoing infrastructure developments, in particular, the improvements to the road network, are expected to facilitate greater labour mobility. Although Sri Lanka’s archaic labour regulations were updated early in the current decade, labour flexibility still remains low due to legal and social barriers as well as the mismatch between the available skills and the skills required. Some possible policy measures that could facilitate greater labour mobility as well as greater labour availability are, encouraging the adoption of new technology including computerisation to reduce labour requirements while increasing availability of employment domestically through introducing flexible working hours, promoting part time work, facilitating working parents by providing high quality day care and after-school care facilities for children, strengthening social security nets, the continuation of improvements to infrastructure, in particular, intercity and intracity transport services, as well as the possible reduction in departures for foreign employment. Improvements in the standards of education, in terms of quality and relevance to the market needs, through regular updating of school and tertiary education curricula will also enhance labour mobility. With the end of the conflict in mid-2009, the economy swiftly moved to a high growth trajectory and the excess capacity in the economy, i.e., the negative output gap, started to narrow gradually. During the conflict, Sri Lanka’s productive capacity and productive resources were highly under-utilised as a result of both the direct and the indirect impact of the adverse security situation. However, since mid-2009, land and marine resources, especially in the Northern and Eastern provinces, labour, particularly by way of reduced need for military personnel and greater

Central Bank of Sri Lanka Annual Report - 2010

The government displayed its commitment to fiscal consolidation by reducing the overall budget deficit from 9.9 per cent of GDP in 2009 to 7.9 per cent of GDP in 2010, with improvements in both revenue collection and expenditure management. The government also reduced its exposure to the banking sector with the retirement of a large portion of Treasury bills held by the Central Bank and the repayment of some high cost borrowings from commercial banks, reducing crowding out of private investment. With credit to the private sector rebounding, fiscal consolidation assisted the Bank to keep overall monetary expansion on track in 2010, although credit to public corporations increased, raising a concern. The challenge in the years ahead is to continue the fiscal consolidation process without slippages. In this respect, the absence of sudden financial needs by the government that existed during the years of conflict stands supportive of better expenditure planning by fiscal authorities. At the same time, the government has taken bold steps to address the lingering problems in the tax system through introducing changes that would enhance revenue collection in the medium term by simplifying and broadening the tax base, rationalising the tax concession regime and strengthening the tax administration. It is expected that the overall budget deficit would reduce further to 6.8 per cent of GDP in 2011 and to below 5 per cent in the medium term, and the net domestic financing of the budget deficit

would remain as planned. The fiscal consolidation process would support the effective conduct of monetary policy and help the containment of demand-driven inflationary pressures. Improvements in the performance of public enterprises also need to be continued and strengthened to ease the pressure on government fiscal operations and prevent excessive monetary expansion. With their exposure to the fluctuations in international crude oil prices and their direct impact on domestic price movements, the CPC and the Ceylon Electricity Board (CEB) have historically been focal points in institutional reform. While some strategic improvements have occurred in relation to the CEB with lower expected reliance on high cost petroleum for power generation, the continuation of planned improvements will reduce its burden on the government budget. The CPC, which is directly impacted by frequent fluctuations in international crude oil prices and the sluggish and delayed adjustment of domestic prices, requires urgent improvements to its institutional framework to make domestic prices adjust more flexibly to reflect international market conditions, and any non adjustment of prices should only be to ironout short term fluctuations. In addition to the CPC and the CEB, there are several other state owned enterprises (SOEs) that either operate with a low level of efficiency or are non operative. These SOEs need to be revitalised without further delay to make them viable either under the government or with private sector participation in order to eliminate their excessive burden on the public. Another key challenge in managing strategic enterprises is the lack of expertise and management skills, which highlights the need for human capital development through reforms to the system of education. The movements in international commodity prices during the latter part of 2010 and so far during 2011, in particular, those of crude oil, once again highlight the possible challenges to macroeconomic stability. The geopolitical disturbances in several Northern African and Middle Eastern oil producing countries and the natural 21

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

inter-regional mobility, and capital, through the optimal utilisation of existing capital, the end to destruction of physical infrastructure and through lower crowding-out of private investment, are being utilised more productively for economic activity. While narrowing of the output gap could signal inflationary pressures wafting into the economy, the greater availability of resources is expected to push the production possibility frontier outwards and raising potential output, marking a significant structural break in Sri Lankaâ&#x20AC;&#x2122;s growth record. Managing the simultaneous improvements in actual and potential output in the medium term is another key challenge faced by the economy in order to avoid volatility in the general price level.

Central Bank of Sri Lanka Annual Report - 2010

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

calamities more recently in Japan and several other countries have raised international crude oil prices that averaged around US dollars 80 per barrel in 2010, to over US dollars 110 by March 2011. While with the expected recovery in global demand in 2011 some increase in energy prices was anticipated, the current trends show that the projections of energy prices by international agencies early this year are unlikely to hold. While there would be a one-off increase in the domestic price level if these unanticipated increases are passed on to the consumer, the adverse consequences would be greater and more persistent if absorbed by the government or the CPC. The pass-through of changes in energy prices to the end user also ensures that economic decisions reflect more realistic input prices. Current efforts to promote the use of alternative energy sources and conservation of energy, by the use of hybrid vehicles, better road discipline and improved road conditions, better public transport, and introducing new public transportation systems, need to be strengthened and expedited to lessen the impact on the economy arising from high international crude oil prices. With domestic peace and global economic recovery under way, Sri Lanka’s exports have the potential to reach a new growth trajectory, with significant levels of value addition, the development of a range of new products and the diversification of export markets. With skilled labour, certain industries have immense potential to move further up the value chain, in order to offer value added products and services to the global market through the infusion of modern technologies and greater foreign investment. Ease of doing business and improved macroeconomic environment could attract more investments from the expatriate community as well as foreign investors. Sri Lanka could also strive to capture the market for high quality components of products, which ultimately are imported, assembled and re-exported by other countries. The recent increase in electrical equipment exports reflects a portion of this niche market. While diversification of exports improves the resilience of the economy to external disturbances, the recent

trends in global growth patterns underscore the availability of untapped markets particularly within emerging Asia. For centuries under foreign rule and thereafter, Sri Lanka’s exports and foreign trade have been oriented towards the Western markets. Hence, it would require special efforts to diversify trade towards emerging markets in Asia. In this regard, the existing bilateral and multilateral trade agreements need to be strengthened and renegotiated to remove policy and non policy obstacles to trade. It is imperative that traders are well informed of the benefits of trade agreements, so that these are optimally utilised to improve trade. This would raise the standard of living of the people of member countries as it enables them to enjoy a wider range of products and services at lower costs. Trade promotion should be made more market and information specific to capture global supply chains that have direct access to the consumers. It is necessary for Sri Lanka to attract more non debt creating foreign investment flows if it is to increase the level of investment required to maintain the envisaged economic growth path, given the shortfall in domestic savings. Creating a business friendly environment is needed to improve investor confidence and attract foreign investments. While the recent relaxation of exchange control regulations, a strengthened macroeconomic environment as well as the re-establishment of peace in the country incentivise investment, further steps need to be taken to encourage foreign investments. Currently, Sri Lanka’s ranking in the Doing Business Index is 102 and the government has targeted to improve the ranking to 30 by 2014. The government has already established a working group to recommend required changes to operations of key institutions to rectify existing weaknesses and reduce bureaucratic barriers and costs at each stage of running a business enterprise, and the Central Bank coordinates this process of improvement with relevant institutions and the World Bank group. The Bank published “A Step by Step Guide to Doing Business in Sri Lanka” in October 2010 to provide information to investors. Executing the required reforms as planned and

Central Bank of Sri Lanka Annual Report - 2010

The Ease of Doingand Business Ranking Extreme Weather Conditions its Impact

It is widely accepted that the corporate sector plays a key role in economic development. Therefore, governments seeking rapid development need to focus attention on creating a conducive regulatory framework that governs the corporate sector in the country. Economic activities require good rules including those that establish and clarify property rights, reduce the cost of solving disputes, increase the predictability of economic interaction and provide contractual partners with provisions against abuse. The existence of conducive rules not only increases the dynamism of business but also its resilience during economic and financial crisis. The Doing Business project was initiated 9 years ago by the World Bank and International Finance Corporation (IFC). Its main goal is to provide an objective basis for understanding and improving the regulatory environment for business. “Doing Business 2011: Making a Difference for Entrepreneurs” is the eighth in a series of annual reports investigating regulations that enhance business activity and those that constrain it. Doing Business presents quantitative indicators on business regulations and the protection Table B 2.1

of property rights that can be compared across 183 economies, from Afghanistan to Zimbabwe, over time. A set of regulations affecting 9 stages of a business’s life are measured: starting a business, dealing with construction permits, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts and closing a business. Data in Doing Business 2011 are current as of 01 June 2010. All topics are given equal weight and the overall index is calculated as the ranking on the simple average of percentile rankings on each of the 9 topics. Two types of data are considered for each stage of business. The first type is based on laws and regulations, while the second is on time and motion indicators. The indicators considered for each stage of business are summarised in Table B 2.1. The data for the Doing Business ranking is collected through a questionnaire designed by the “Doing Business Team” of the World Bank together with academic advisers. The respondents to this questionnaire (typically) include local experts, such as lawyers, business consultants, accountants and

Doing Business Indicators 2011

1 Starting a Business

Procedures, time, cost and paid-minimum capital to open a new business

2 Dealing with Construction Permits

Number of tax payments, time to prepare and file tax returns and to pay taxes, total taxes as a share of profit before all taxes borne

Procedures, time and cost to obtain construction permits, inspections and utility connections

3 Registering Property

Strength of legal rights index, depth of credit information index

Trading across Borders Documents, time and cost to export and import

Procedure, time and cost to transfer commercial real estate

4 Getting Credit

Paying Taxes

Enforcing Contracts Procedures, time and cost to resolve a commercial dispute

Closing a Business Recovery rate in bankruptcy

5 Protecting Investors Strength of investor protection index: extent of disclosure index, extent of director liability index and ease of shareholder suits index Source: http://www.doingbusiness.org

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

BOX 2

Central Bank of Sri Lanka Annual Report - 2010

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

government officials of the relevant country. Several interactions are conducted by the compilers of the ranking, and these responses and data are tested for robustness before the rankings are finalised. The ranking of a particular country can change not only when it implements reforms but also when other countries implement reforms, when new countries are introduced to the ranking and when there are methodological changes in the ranking criteria. According to the ranking for 2011, the highest ranking (No. 1) was achieved by Singapore while Sri Lanka was ranked 102 out of 183 economies. The worst performing country was Chad (No. 183). Limitations of the Doing Business Ranking There are, however, several limitations in this ranking. It is very important to note that the ranking captures only a few of the large number of factors that matter to firms or investors or impact on competitiveness. Macroeconomic stability, security, strength of institutions, quality of infrastructure, size of domestic market, corruption and skills of the labour force are some of the factors not considered. In particular, it does not consider the strength of the financial sector, which could be considered a serious shortcoming in view of the fact that the fragility of the financial sector was one of the main causes of the recent financial crisis. Although it measures the regulatory environment, it does not measure all regulatory goals in an economy. Even in the stages of business considered, it does not cover all regulations. Another limitation is that it is only relevant to the situation faced by a corporate that exists in the country’s largest business city and pertains only to a specific form of business (domestic small and medium limited liability companies), and therefore, is not reflective of the situation that exists in other forms of business (sole proprietorships, partnerships, etc.). Also, a certain amount of judgment is involved in the ranking. An underlying assumption made when computing the ranking is that entrepreneurs have all the required information with them and do not need to spend time to search for the same. In actual fact, this is not the case and search for information involves considerable effort. Benefits of Improving the Doing Business Ranking Despite its shortcomings, the Doing Business ranking is very useful for benchmarking. The ranking assesses the regulatory environment in selected areas. A 24

conducive regulatory environment aids the growth of the formal sector in an economy, whereas an onerous regulatory environment forces businesses to remain in the informal sector. Formal sector firms tend to grow faster, be more productive, employ more workers and have better access to credit, and thereby bring greater benefits to the economy. In the area of trade, the quality of a country’s contracting environment is a source of comparative advantage, while in the area of credit, greater information sharing through credit bureaus is associated with high bank profitability and lower bank risks. Although Doing Business ranking does not focus on regulations specific to foreign investment, the ranking is one of the indicators considered by foreign investors before deciding to invest in a particular country. Therefore, improving the country’s ranking will tend to attract more foreign investment. Sri Lanka’s Doing Business Ranking In “Doing Business 2011”, Sri Lanka’s ranking was 102 out of 183 economies. Its rankings in the 9 stages of business evaluated in the 2011 report are given in Table B 2.2. It is clear that Sri Lanka’s performance in the different stages varies considerably. Its performance in the stages of Dealing with Construction Permits, Registering Property, Paying of Taxes and Enforcing Contracts is particularly weak as it ranks below 100 of the 183 economies considered and therefore, Sri Lanka’s Ranking in Doing Business 2011 Compared with the Table B 2.2 Best and Worst Performing Economies Indicator

Doing Business 2011 Rank Singapore Sri Lanka Chad

Ease of Doing Business 1 Starting a Business 4 Dealing with Construction Permits 2 Registering Property 15 Getting Credit 6 Protecting Investors 2 Paying Taxes 4 Trading Across Borders 1 Enforcing Contracts 13 Closing a Business 2

102 34 169 155 72 74 166 72 137 43

183 182 101 137 152 154 179 171 164 183

Source: http://www.doingbusiness.org

Central Bank of Sri Lanka Annual Report - 2010

180 160

Doing Business Ranking

140 120

171

167

148 147 142 134 121

116 107

100

102 85 83

79 78

60 40 21 19

16 02 01

Laos Afghanistan Philippines Cambodia Bhutan India Indonesia Nepal Bangaladesh Sri Lanka Maldives Pakistan China Vietnam Mongolia Malaysia Thailand South Korea Hong Kong Singapore

Country

pulls down the country’s overall ranking. In fact, in the areas of Dealing with Construction Permits and Registering Property, it fares worse than the worst performing country, Chad. Any reform strategy should focus on these areas. Chart B 2.1 compares Sri Lanka with selected Asian economies. Out of the economies considered, Sri Lanka’s performance falls below 10, namely Singapore, Hong Kong, South Korea, Thailand, Malaysia, Mongolia, Vietnam, China and even the South Asian countries like Pakistan and Maldives. As some of Sri Lanka’s competitors in trade are included in this group, it is a matter of concern that Sri Lanka performs worse than them. credibly achieving the targeted rankings in the interim years are necessary to boost the investment climate and realise the full growth potential of the economy. The government has planned to transform Sri Lanka into a strategically important economic centre by developing five strategic hubs; a knowledge hub, a commercial hub, a naval/ maritime hub, an aviation hub and an energy

Improving Sri Lanka’s Doing Business Ranking His Excellency the President in his address to the United Nations General Assembly has stated that Sri Lanka aims at improving its Doing Business ranking to 30 by 2014. This is a huge challenge and needs the hard work and commitment of all stakeholders. Most countries use the Doing Business ranking to identify better performing economies with similar characteristics and model their laws and regulations according to those countries. In Sri Lanka, the Central Bank of Sri Lanka (CBSL) together with the Ministry of Economic Development is coordinating the strategy to achieve the goal articulated by his Excellency the President. The Budget for 2011 has already made significant strides to simplify taxation, and thereby improve the ranking in the area of “Paying Taxes.” There is also ample scope for eliminating a large number of “procedures” involved in various areas by establishing “one stop shops” where an entrepreneur needs to submit required documents at one point only and all the necessary formalities and clearances are undertaken by the agency concerned. This could be effectively done in the area of Dealing with Construction Permits and Trading across Borders. In the area of land registration, introduction of title registration could reduce time involved substantially. Court procedure also has to be closely studied in order to devise a method to reduce the delay and improve the ranking in Enforcement of Contracts. The CBSL will be looking at other aspects also to facilitate business. In particular, to reduce the time and effort spent on searching for information, CBSL has already produced a booklet “A Step by Step Guide to Doing Business”, which contains necessary information needed by an entrepreneur during each stage of operation of his/her business. hub, taking advantage of Sri Lanka’s strategic location and resources. The main elements of a knowledge hub are to generate knowledge, to transfer knowledge to sites of application and to transmit knowledge to others through education and training. The initial focus of the knowledge hub in Sri Lanka has been in the area of information technology. The tremendous progress that has already been made in this area and the availability of a highly skilled workforce in related fields, make this

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

Doing Business Ranking: Sri Lanka Compared to Selected Asian Economies

Chart B 2.1

Central Bank of Sri Lanka Annual Report - 2010

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES Economic and Social Infrastructure

an ideal starting point for setting up the knowledge hub in Sri Lanka. Implementing the commercial hub and naval/maritime hub include, developing the Port of Colombo into a major transshipment hub, Galle as a tourist port, Trincomalee as an industrial port, Oluvil as a fisheries harbour and Hambantota as a logistic centre and developing the country as a shipping, trading and finance centre. Developing Sri Lanka as an aviation hub includes, modernising the Bandaranaike International Airport and constructing a second international airport at Mattala, improving domestic airports and developing the aviation industry. Developing Sri Lanka as an energy hub would involve developing new energy sources, developing new refineries and acquiring the technical know-how to conduct international trade in oil. While taking steps to harness the potential benefits of the strategic location of the country by promoting these hubs is commendable, it is important to formulate a national policy for the effective and early establishment of each of the hubs. To implement these hubs it would be necessary to set up a central point to coordinate the various activities that need to be carried out by different institutions in order to ensure that all players work together towards the establishment of the five hubs. One of the major constraints to developing these five hubs is the lack of skilled personnel. Part of the strategy to developing Sri Lanka as a knowledge hub should include training persons in the skills required for the jobs that would be created with the establishment of these hubs. Parallel to the improvements to state education, it is important to promote non state education and training provision to develop the human capital base of the country to provide the skills required by the market. This would entail teaming up with the universities to commence degree programmes to develop the necessary knowledge and skills required by the respective hubs. Recognising that the tourism sector could be a key driver of economic activity and considering the vast income generation potential of the industry, tourism related infrastructure and facilities around the country would need to be expanded to cater to the 26

2.5 million tourist arrivals envisaged in 2016. Activities in the periphery of the main tourism attractions would ensure tourists spend more time and money in these areas. A Tourism Master Plan is of essence to expedite tourism related projects and prevent haphazard development. In this respect, the government and the private sector would need to work together in partnership to promote the country’s diverse array of tourist attractions. While the government’s role should focus on developing tourism related infrastructure and institutions, capturing markets, and creating a conducive environment for investment by the private sector, the private sector should take the lead in product development aspects. Human resources would also need to be developed among the various stakeholders of the tourist sector to ensure the provision of quality service to tourists, thus helping promote the wealth of attractions in Sri Lanka, through positive publicity. As tourists are attracted by diversity and seek interactive experiences to understand and appreciate the procedures taken to develop goods to the consumable level, the way forward in the tourism arena is to diversify the range of products to cater to different groups of tourists. Although all tourism related projects are expected to generate income and employment and provide a fillip to economic growth prospects of the country, the environmental and socio-cultural factors would also need to be considered in order to ensure that the development of tourism resources occur in a sustainable manner. Recent international evidence has reaffirmed that countries that suffered financial system crises had deeper recessions than those countries that did not undergo financial system crises, and thus confirming the importance of strengthening the financial system stability.4 A troubled financial system is shown to reduce the efficiency of financial intermediation as well as the monetary transmission mechanism. While supporting reforms to the global monetary and financial order 4 See Stanley Fischer, “Central Bank Lessons from the Global Crisis”, RBI Monthly Bulletin, March 2011, pp. 281-290, and Carman Reinhart and Kenneth Rogoff, This Time is Different, Princeton: Princeton University Press, 2009.

Central Bank of Sri Lanka Annual Report - 2010

While 2010 has seen significant improvements to the Northern and Eastern provinces in terms of reconstruction, physical, social and financial infrastructure development and livelihood development, it is necessary to continue this process. Developments to the physical infrastructure, especially to the road and railway network would enhance connectivity with other regions. In terms of agricultural development, introducing land usage policies that would improve agricultural productivity, supporting agricultural research that could introduce new crops to these regions, the continuous improvements to fishery harbours and facilitating deep sea fishing, resolving the issues relating to South Indian and Sri Lankan fishermen amicably, would raise the supply of agricultural produce in the economy, while transmitting the financial benefits to the producers in the Northern and Eastern provinces. Promoting

private sector-led agri-based industries, small- and medium-scale enterprises, as well as revitalising large-scale industries need to continue. Further developments to the Services sector, through facilitating tourism related activity, developing Trincomalee as an industrial port that could potentially serve as a supply hub to the broader Indian subcontinent, and promoting health and education services through greater private sector investment are required. More essentially, in addition to rapid developments to the road and rail network, making sea and air routes to the Northern and Eastern provinces available to the tourist industry and the general public would strengthen integration and distributing the benefits of development across the entire economy. The vision of the Government of Sri Lanka to double the country’s per capita income to US dollars 4,000 by 2016 and to turn Sri Lanka into the “Wonder of Asia”, requires a growth rate of around 8.0 per cent to be maintained over the years ahead. While the past year saw the acceleration of the country’s economic growth rate and the return to a high growth trajectory in line with expectations, inflation remained at a stable low level supported by appropriate demand management policies. The key challenge in the years ahead is to create an enabling environment for private sector investment and to facilitate the ongoing infrastructure and reconstruction projects that are needed to sustain the growth momentum of the economy, while continuing to maintain a low and stable rate of inflation. Although the ongoing growth process could give rise to short term price pressures through greater demand for domestic resources, it would lead to long term stability by enhancing the country’s resilience to adverse domestic and external demand and supply shocks.

1 ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

to reduce the effects of contagion, the ongoing improvements to financial surveillance domestically, strengthening the coordination between regulators, strengthening macroprudential regulation, raising public awareness through various publications and other forms of communication, and including financial sector analysis within the dual approach to monetary policy analysis recently adopted by the Central Bank are expected to strengthen financial system stability further. Meanwhile, the contribution of the financial sector to raise private sector investment, particularly in terms of higher lending to small- and medium-scale enterprises, increased long term lending, expanding the outreach of the financial sector to include economically backward regions of the country in the development process, and the adoption of cutting-edge technology and financial sector innovation need to be actively encouraged and supported.

Central Bank of Sri Lanka Annual Report - 2010

National Output and Expenditure

2.1 Overview

ri Lankaâ&#x20AC;&#x2122;s Gross Domestic Product (GDP) grew by an impressive 8.0 per cent in 2010 over a relatively low growth of 3.5 per cent in 2009. This was the second highest growth rate witnessed during the past six decades and the highest growth rate reported during the past three decades. The domestic economy, which slowed down in 2009 after four consecutive years of 6 per cent or higher annual growth, recovered in the backdrop of the peaceful domestic environment and improved domestic and external conditions conducive for economic growth. Further, the gradual recovery in the global economy together with favourable weather conditions also contributed positively towards a high growth in 2010. Economic growth during 2010 was broad-based with all major sectors contributing positively towards overall economic growth. Value added growth in the Agriculture sector increased by 7.0 per cent during 2010 supported mainly by the favourable performance

in domestic agriculture with the bumper paddy harvest and increased output in vegetables and highland crops together with the significant increase in fish production. Within export agriculture, tea production, which declined in 2009 contributed favourably towards growth in 2010 along with the favourable performance in minor export crops. The Industry sector recorded a growth of 8.4 per cent in 2010 with the higher growth in all sub-sectors. Output in factory industry sub-sector increased at a higher rate along with the significant growth in construction, mining and quarrying and electricity sub-sectors. The Services sector, which slowed down considerably in 2009 with the contraction in external trade activities recovered in 2010 to record an impressive growth of 8.0 per cent. The wholesale and retail trade sub-sector grew with increased domestic demand and gradual recovery in the global economy. Transportation activity expanded with increased economic activity while financial services also grew at a higher rate during the year.

Central Bank of Sri Lanka Annual Report - 2010 Sectoral Composition and Increase in Gross Domestic Product by Industrial Origin at Constant (2002) Prices

Table 2.1

Sector Agriculture

Contribution to Change in GDP (%)

Share of GDP (%)

2009(a) 2010(b)

3.2

7.0

11.0

10.5

12.0

11.9

2.8 - 8.4 7.9 5.3 5.2 - 5.1 6.2 7.0 5.2 5.9 5.1

6.4 13.1 12.7 - 14.3 37.6 17.5 2.9 4.4 5.4 3.1 7.6

8.8 - 2.8 0.5 2.0 0.7 - 2.7 1.5 7.5 0.4 1.0 0.5

8.7 1.7 0.4 - 2.4 2.1 3.7 0.3 2.1 0.2 0.2 0.4

10.9 1.0 0.3 1.4 0.5 1.7 0.9 3.9 0.3 0.6 0.4

10.7 1.1 0.3 1.1 0.6 1.8 0.8 3.8 0.3 0.6 0.4

2. Fishing

6.9

12.2

2.2

1.8

1.2

Industry

4.2

8.4

33.9

30.1

28.6

28.7

3. Mining and Quarrying

8.2

15.5

4.7

4.1

2.1

2.3

4. Manufacturing 4.1 Processing (Tea, Rubber and Coconut) 4.2 Factory Industry 4.3 Cottage Industry

3.3 0.7 3.4 3.3

7.3 5.8 7.5 5.5

16.3 0.1 15.2 1.0

16.0 0.4 14.8 0.7

17.4 0.6 15.8 1.1

17.3 0.6 15.7 1.1

5.1 Electricity 5.2 Gas 5.3 Water

3.7 3.7 5.4 2.9

7.8 8.2 4.6 4.5

2.5 2.2 0.3 0.1

2.3 2.2 0.1 0.1

2.4 2.1 0.2 0.1

6. Construction

5.6

9.3

10.3

7.7

6.6

6.7

Services

3.3

8.0

55.2

59.4

59.3

- 0.2 - 8.2 - 2.2 7.3

7.5 9.5 3.4 7.6

- 1.4 - 20.8 - 2.7 22.1

21.7 9.4 1.8 10.5

23.3 8.0 4.2 11.1

23.2 8.1 4.0 11.1

13.3

39.8

1.4

2.0

0.4

0.5

6.3 5.9 0.4 11.7

11.9 11.4 16.8 13.2

23.4 18.1 0.1 5.2

19.9 15.8 1.4 2.8

13.5 11.1 0.7 1.7

13.9 11.5 0.7 1.8

10. Banking, Insurance and Real Estate etc.

5.7

7.5

14.1

8.4

8.9

11. Ownership of Dwellings

1.3

0.9

1.1

0.3

3.0

2.8

12. Government Services

5.9

5.4

12.8

5.3

7.8

7.6

13. Private Services

5.8

3.9

1.8

2.4

Gross Domestic Product

3.5

8.0

100.0

49.8

-20.1

4.8

7.9

Economic andOutput Socialand Infrastructure National Expenditure

Rate of Change (%)

Agriculture, Livestock and Forestry 1.1 Tea 1.2 Rubber 1.3 Coconut 1.4 Minor Export Crops 1.5 Paddy 1.6 Livestock 1.7 Other Food Crops 1.8 Plantation Development 1.9 Firewood and Forestry 1.10 Other Agricultural Crops

Electricity, Gas and Water

Wholesale and Retail Trade 7.1 Import Trade 7.2 Export Trade 7.3 Domestic Trade

8. Hotels and Restaurants

9. Transport and Communication

9.1 Transport 9.2 Cargo Handling-Ports and Civil Aviation 9.3 Post and Telecommunication

Net Factor Income from Abroad

Gross National Product (a) Revised (b) Provisional

The higher growth of 10.2 per cent in domestic demand during 2010 when compared to the growth of 3.2 per cent in 2009 indicates the contribution of domestic economic activity in achieving the overall growth. Domestic consumption demand grew at a higher rate of 8.4 per cent in comparison to the growth of 3.6 per cent in 2009, and the increase in consumer demand could be attributed to 30

Source: Department of Census and Statistics

the overall improvement in economic activity, particularly with livelihoods affected by the war returning back to normalcy. Further, expenditure on investment grew at a significant rate of 15.5 per cent in 2010 with higher growth momentum, which would be an essential ingredient in achieving a higher growth in the medium term. The external trade sector, which contracted in 2009 with the global economic slowdown in

Central Bank of Sri Lanka Annual Report - 2010

Per capita GDP (PCGDP) is a measure of material living standard of the population in a country. It is estimated as the GDP valued at market prices divided by the mid-year population of the country.1 For international comparison it is usually expressed in US dollar (USD) terms. In 19602, PCGDP in Sri Lanka was estimated at USD 142 and it took another 15 years to double to USD 281 in 1975. Again 1991 and 2004 were milestone years in terms of PCGDP, which doubled to reach USD 547 and USD 1,062 after 16 years and 13 years, respectively. However, in an environment of higher growth rates of over six per cent with stable macroeconomic conditions, PCGDP doubled in a relatively short time span of four years (between 2004 and 2008) to USD 2,014 in 2008. Further, Sri Lanka has been categorised by the World Bank as a lower middle income country.3 Chart B 3.1

Per Capita GDP: 1960 â&#x20AC;&#x201C; 2010 (US dollars)

2,500

2,000

1,500

Table B 3.1

Time Taken to Double Per Capita GDP (1960 â&#x20AC;&#x201C; 2008)

Year

1960

1975

1991

2004

2008

Per Capita GDP in USD

142

281

547

1,062

2,014

No. of Years to Double (approximately)

The growth potential of the country has improved immensely with the end of the three decades long conflict, increased investor confidence, major infrastructure development drive raising production capacity of the country and recovery in the global economy. With improved domestic agriculture and appropriate demand management policies, significant price pressure is not expected in the years ahead. Also the fiscal consolidation process would contribute towards demand management while improved investor confidence would induce the flow of foreign investment, which would contribute towards exchange rate stability. Given this scenario in the macroeconomic environment, the country would be able to attain a higher real growth rate of over 8 per cent in the medium term. PCGDP estimates for the period 2011-2014 are presented in the following table. The assumptions used for this purpose are given in Table 1.5.

1,000

500

2010

2000

1990

1980

1970

1960

Table B 3.2 GDP (At Current Market Prices) Mid-Year Population

PCGDP =

Central Bank commenced publication of GDP from 1959.

3 According to the World Bank classification, income groups are expressed as low income (less than $995), lower middle income ($996-$3,945), upper middle income ($ 3,946-$12,195) and high income ($ 12,196 or more) based on Gross National Income per capita.

terms of both imports and exports, grew in 2010. Consequently, net external demand widened due to the higher demand on imports with increased domestic demand. Gross National Product (GNP), which is defined as GDP adjusted for Net Factor Income from Abroad (NFIA) grew by 7.9 per cent in 2010. NFIA, which improved in 2009

Projections of Per Capita GDP

Year

2011

2012

2013

2014

Projected Per Capita GDP in USD

2,794

3,200

3,660

4,190

declined in 2010 resulting in the lower growth in GNP when compared to the growth in GDP. Although both the receipts and payments of factor income from aboard grew during 2010, the latter recorded a higher growth resulting in the negative developments in NFIA. Per capita GDP increased from Rs. 236,445 in 2009 to Rs. 271,259 in 2010 or by 14.7 per cent, 31

2 National Output and Expenditure

Doubling Per Capita Extreme Weather Conditions and itsIncome Impact

BOX 3

Central Bank of Sri Lanka Annual Report - 2010

this growth. The net private transfers, in 2010 increased to Rs. 408 billion from Rs. 337 billion in 2009. Accordingly, the national savings ratio stood at 24.7 per cent in 2010 over the corresponding figure of 23.7 per cent in the previous year.

Annual Chart 2.1 Growth Rate Annual Growth Rate

9 8 7

Per cent

Economic andOutput Socialand Infrastructure National Expenditure

2.2 Sectoral Output, Policies, Institutional Support and Issues

5 4 3

Agriculture

2 1 0

2006 Agriculture

2007

2008 Industry

2009 Services

2 0 10 GDP

surpassing the inflation rate (5.9 per cent). In US dollar terms the per capita income increased by 16.6 per cent to US dollars 2,399 from US dollars 2,057 in 2009. At current market prices, GDP expanded by 15.9 per cent to Rs. 5,602 billion (US dollars 49.5 billion) in 2010. The nominal growth in GDP comprises the real GDP growth of 8.0 per cent and the increase in general price levels measured by the GDP deflator, which was 7.3 per cent compared to 5.9 per cent in 2009. Domestic savings grew at a lower rate of 20.5 per cent during 2010 when compared to the growth of 41.8 per cent in 2009 and is estimated at Rs. 1,045 billion. The lower growth in domestic savings could be attributed to the increased demand for imported goods due to increased growth in consumption expenditure. The value of imports of goods, which include consumption, intermediate and investment goods grew by 30.2 per cent in rupee terms during 2010 over a contraction of 23.1 per cent in 2009. Meanwhile, domestic savings ratio, which was 17.9 per cent in 2009 increased to 18.7 per cent in 2010. National savings were estimated at Rs. 1,381 billion in 2010 which was a growth of 20.3 per cent over 2009. Although the growth in net private current transfers by 21.2 per cent contributed positively to national savings, the deterioration in NFIA dampened 32

The Agriculture sector grew by 7.0 per cent in 2010 compared to a 3.2 per cent growth in the previous year. This was mainly due to the favourable growth in paddy, tea, and minor export crops along with the significant improvement in the fisheries sector. However, lower than expected coconut and livestock production slowed down the growth momentum of the sector to some extent. Meanwhile, the share of the Agriculture sector in the GDP decreased marginally to 11.9 per cent in manifestation of the growth thrust of other sectors in the economy.

Export Crops Total tea production in 2010 registered the highest ever annual production growing by 13 per cent to 329 million kg. This manifested a significant recovery from distressed output in 2009 due to the dry weather conditions in the first quarter of 2009. At the same time, the national average yield per ha has increased from 1,435 kg per ha in 2008 to 1,484 kg per ha in 2010. The growth in 2010 was largely attributable to the favourable weather conditions that prevailed in all tea growing districts except during the last two months of the year. This was supplemented by higher prices that continued from the previous year, which induced growers to focus more on better agriculture and processing practices. The continuation of the fertiliser support programme for tea smallholders also helped increase the productivity. The largest contribution of 60 per cent to the national production of tea came from low grown tea, which grew by 13 per cent to 196 million kg in 2010. Meanwhile, medium grown and high grown tea production grew by 22 per cent and 7 per cent to 55 million kg and 78 million kg,

Central Bank of Sri Lanka Annual Report - 2010

Item Agriculture and Fishing 1 Agriculture 1.1 Agriculture Crops Tea Rubber Coconut Paddy Other Crops 1.2 Livestock 2 Fishing (a) Revised (b) Provisional

Agriculture Production Index (1997-2000 =100) 2009 (a) 122.4 122.1 119.3 101.4 141.9 102.7 137.0 122.5 146.6 124.4

2010 (b) 131.6 130.3 128.1 114.7 158.7 83.4 161.4 129.1 150.3 139.7

Change(%) 2009/10 7.5 6.8 7.3 13.1 11.8 -18.8 17.8 5.4 2.6 12.3

Source: Central Bank of Sri Lanka

respectively. Tea smallholder sector continued to play a major role in total tea production in Sri Lanka contributing 76.4 per cent to the total tea production in 2010. In 2010, the Colombo Tea Auction (CTA) recorded the highest prices compared to all other international tea auctions. The annual average of all tea prices at CTA in 2010 increased by 3 per cent to Rs.372 per kg in 2010 from Rs.361 per kg in 2009 while the annual average export price increased by 5 per cent to Rs.494 per kg. The increase in tea prices in 2010 was largely due to the increasing trend of international demand for Sri Lankan origin orthodox teas, which fetched premium prices amidst shortage of global supply of black tea. The rubber production in 2010 reached 153 million kg registering 12 per cent growth over the previous year. Despite the torrential rainfall during the second and fourth quarters, the production increased consistently largely due to the attractive prices fetched for all varieties of rubber throughout the year. Further, the growth in rubber smallholders sector, which consists of around 127,200 smallholders and 54 per cent of total rubber extent in the country, largely reflects their quick response to higher natural rubber prices. Furthermore, increased extent of tapping rubber plantation in recent times has also been contributing to the growth in production. As a result, national yield of rubber increased by 11.8 per cent to 1,607 kg per ha in 2010. Higher growth is also

due to better agriculture practices, such as fertiliser usage, improved techniques of latex tapping and use of rain guards adopted by growers in response to favourable prices. This was further supplemented by the improved extension services of the relevant authorities such as Rubber Development Department and Rubber Research Institute. The average prices of all rubber varieties remained high in 2010. The annual average price of RSS 1 increased by 91 per cent to Rs.403 per kg, while that of Crepe Rubber No.1 also increased by 113 per cent to Rs.453 per kg, compared to 2009. Meanwhile, the domestic consumption of natural rubber increased to 107,225 mt in 2010 (70 per cent of the total production) from 84,941 mt in 2009 due to increased production of rubber based products. The significant supply shortage of natural rubber in the international market due to adverse weather conditions in major rubber producing countries like Thailand and strong international demand with the global economic recovery and higher oil prices largely helped natural rubber prices to surge. The coconut production showed a sharp decline by 19 per cent to 2,317 million nuts in 2010. The decline in coconut production has been largely due to the lag effect of low rainfall in 2009 in major coconut growing areas. The decline in coconut production was substantial especially in the last quarter of 2010 where the production declined by 32 per cent to 429 million nuts as against the corresponding quarter of 2009. The use of fertiliser for coconut has also shown a decline in the recent years especially among the smallholder sector, which represents around 80 per cent of the total extent of coconut in the country. Of the total production in the coconut triangle (Puttalam, Gampaha and Kurunegala) in 2010, the highest decline in production (34 per cent) was reported from the Puttalam district where the lowest rainfall was reported in 2009. Further, total coconut production in Kurunegala and Gampaha districts also declined by 24 per cent in 2010. The factors such as decline in productivity resulting from degradation of top soil of many estates and smallholdersâ&#x20AC;&#x2122; lands, less fertiliser usage, 33

2 National Output and Expenditure

Table 2.2

Central Bank of Sri Lanka Annual Report - 2010

Economic andOutput Socialand Infrastructure National Expenditure

edible oil market. Resultantly, the average price at the Colombo Coconut Auction (CCA) increased to Rs.41 per nut in December 2010 Category Unit 2009(a) 2010(b) compared to that of Rs.23.50 in December 1.Tea 1.1 Production (c) kg mn 291.0 329.0 2009, which compelled the government to take 1.2 Total Extent hectares ‘000 222 222 measures to arrest further escalation of coconut 1.3 Extent Bearing hectares ‘000 192 190 1.4 Cost of Production (d) Rs/kg 269.01 313.17 prices. Accordingly, the government reduced the 1.5 Average Price - Colombo Auction Rs/kg 360.85 371.54 tariff on import of edible oil to Rs.15 per kg in - Export (f.o.b.) Rs/kg 470.11 494.39 1.6 Replanting hectares 1,126 1,274 November 2010 in addition to raising the cess 1.7 New Planting hectares 12 3 on exports of coconuts in raw form up to Rs.30 1.8 Value added as % of GDP (e) 1.7 1.6 per nut from Rs.2 per nut. Also, the government 2.Rubber 2.1 Production kg mn 136.9 153.0 took a decision to expand the fertiliser support hectares ‘000 124 126 2.2 Total Extent (f) hectares ‘000 95 95 2.3 Area under Tapping (f) scheme to the coconut sector irrespective of the 2.4 Cost of Production Rs/kg 115.50 119.83 extent to enhance coconut production. 2.5 Average Price Table 2.3

Trends in Principal Agricultural Crops

- Colombo Auction (RSS 1) Rs/kg 211.65 403.02 - Export (f.o.b) Rs/kg 202.23 373.87 The production of many export agriculture 2.6 Replanting (g) hectares 1,002 1,493 2.7 New Planting (g) hectares 715 1,537 crops showed a positive trend in 2010. The 2.8 Value added as % of GDP (e) 0.5 1.0 production of clove increased significantly by 3.Coconut 215 per cent while pepper also increased by 10 3.1 Production nuts mn 2,853 2,317 3.2 Total Extent hectares ‘000 395 395 per cent during the year. The clove production in 3.3 Cost of Production Rs/nut 9.53 11.27 3.4 Average Price 2010 recorded the highest ever production with - Producer Price Rs/nut 18.28 23.82 - Export (f.o.b.) (h) Rs/nut 18.23 25.67 the support of favourable weather conditions in 3.5 Replanting / Under Planting (j) hectares 3,545 2,684 2009 during the flowering period of clove. Major 3.6 New Planting (j) hectares 3,998 2,920 3.7 Value added as % of GDP (e) 1.4 1.4 (a) Revised. (b) Provisional. (c) Including green tea. (d) Includes green leaf supplier’s profit margin. (e) In growing and processing only. (f) Based on rubber land survey -2003 conducted by the Dept. of Census and Statistics & Rubber Development Department. (g) Extents covered by cultivation assistance schemes of the Rubber Development Department. (h) Three major coconut kernel products only (i) Extents covered by cultivation assistance schemes of the CCB.

Sources: Sri Lanka Tea Board Tea Small Holdings Development Authority Department of Census and Statistics Rubber Development Department Coconut Cultivation Board Coconut Development Authority Ministry of Coconut Development and Janatha Estate Development Plantation Companies Sri Lanka Customs Central Bank of Sri Lanka

spreading diseases and fragmentation of coconut lands for alternative land uses appear to have contributed to this decline in national coconut production. The declined coconut production in 2010 resulted in a severe shortage of nuts for consumption as well as industrial usage and soaring prices to unprecedented level. The coconut oil production declined by 14 per cent to 65,130 mt in 2010. However, the demand for coconut from coconut oil millers remained high in the year partly due to decline in palm oil imports owing to high import duty supported by continuing bullish trend in the international 34

harvesting season of pepper in major pepper producing districts was delayed from July 2009 to January-February 2010 due to unfavourable weather conditions, thereby increasing pepper production in 2010. Meanwhile, increased average farm gate price by 19 per cent and average auction price by 24 per cent of pepper also helped to sustain the growth in pepper production in 2010. The cinnamon production also increased by 4 per cent induced by increased farm gate prices and auction prices. Notably, cinnamon bark oil exports have increased from 16.8 mt in 2009 to 26 mt in 2010. Further, during the year, Export Agriculture Department implemented several projects to expand export agriculture crops in the Northern and the Eastern provinces through the expansion of their technical services and providing subsidies.

Domestic Agriculture Total paddy production grew by 17.8 per cent to 4.3 million mt in 2010 compared to 2009. The 2009/2010 Maha production increased by 10 per cent to 2.6 million mt while 2010 Yala

Central Bank of Sri Lanka Annual Report - 2010

Item

2009(a)

Unit

Gross Extent Sown Gross Extent Harvested Net Extent Harvested Production Yield (c) Credit Granted Rice Imports Paddy Equivalent of Imports

Maha Yala Total

hectares ‘000 632 345 hectares ‘000 605 338 hectares ‘000 539 303 mt ‘000 2,384 1,268 bushels ‘000 114,241 60,763 kg/hectare 4,421 4,187 Rs.mn. 1,158 760 mt ‘000 mt ‘000

(a) Revised. (b) Provisional (c) Yield per hectare for Maha and Yala are calculated using data from the Department of Census and Statistics which are based on crop cutting surveys while total yield is calculated by dividing total production by the net extent harvested.

production increased by 31.8 per cent to 1.6 million mt. The increase in paddy production in 2010 is attributed to the increased extent in the Northern and the Eastern provinces and sufficient rainfall and timely release of water for cultivation, and the government policy to bring fallow lands under cultivation. Meanwhile, the paddy production in 2010 was further sustained by the continuation of the fertiliser support scheme and paddy purchasing scheme of the government. Although increased production in both seasons in 2010 resulted in average farm gate paddy prices to decline compared to that of 2009, the intervention by the government through its paddy purchasing programme helped stabilise paddy prices. The government

3 ,2 0 0

2 ,8 0 0

2 ,4 0 0

2 ,0 0 0

1,6 0 0

1,2 0 0

800

400

2006

2007

2008

2009

2 0 10

Price (Rs/kg)

Quantity (MT ‘000)

Rice : Supply Rice: Supply and Demand Chart 2.2 and Demand

Domestic Supply of Rice

Average Retail Price of Rice

Total Supply of Rice

Average Producer Price of Paddy

Total Demand for Rice

2010(b) Maha

Yala

978 646 419 943 643 416 842 574 376 3,652 2,630 1,671 175,004 126,029 80,074 4,336 4,583 4,444 1,918 1,402 1,139 52 76

Total 1,065 1,060 950 4,301 206,103 4,528 2,541 126 185

Sources: Department of Census and Statistics Sri Lanka Customs Central Bank of Sri Lanka

purchased 182,000 mt of paddy at the rate of Rs.28 per kg for Nadu and Rs.30 per kg for Samba during both Maha and Yala seasons. Further, a stock of rice amounting to 125,780 mt imported to meet any shortage of rice in 2009 was also available in the market in 2010. The production of Other Field Crops showed a mixed performance during 2010. The production of maize increased by 25 per cent to 161,694 mt in 2010 due to assured market and prices through forward contracts, government commitment to protect local maize growers through increased cess on imports of maize, and introduction of import licensing requirement on maize. Meanwhile, the production of red onion, soya beans, chillies (green) and black gram increased by 34 per cent (61,811 mt), 97 per cent (7,521 mt), 6 per cent (49,003 mt) and 41 per cent (9,991 mt), respectively. However, the production of potatoes, big onion and cowpea decreased by 16 per cent (51,933 mt), 28 per cent (58,930 mt), and 14 per cent (11,609 mt), respectively. The significant increase in cultivation in Puttalam and Jaffna districts largely contributed to the increase in production of red onion while big onion production declined largely due to the reduction in extent under big onion in Matale district, as heavy rainfall caused growers to shift to paddy in the district during the Yala season. The increased production of soya beans has shown the effect of remunerative prices for soya bean in recent times 35

2 National Output and Expenditure

Paddy Sector Statistics

Table 2.4

Central Bank of Sri Lanka Annual Report - 2010

Economic andOutput Socialand Infrastructure National Expenditure

with the emerging demand from soya based product manufactures. In fact, the government also intervened through the Paddy Marketing Board (PMB) to purchase soya bean in 2010 to stabilise soya bean prices due to the excess production. The decline in potato production in the country during the year was caused largely by the shortage of quality potato seeds during the time of cultivation and increase in prices of imported potato seeds. Sugar production marginally declined by 2.6 per cent to 31,335 mt in 2010. This was mainly due to the decline in the extent under sugar cane cultivation by around 2 per cent in 2010, as the farmers shifted to other crops such as paddy and banana. The present domestic sugar production would be sufficient only to meet 6 per cent of the annual sugar requirement of the country. Presently, the defunct Hingurana Sugar factory is in the process of being revitalised and sugar cane cultivation has commenced while commercial operations is expected to start in 2012. It is necessary that sugar cane growers adopt improved agricultural practices including planting high yielding seed cane and fertiliser application to increase the productivity. Three high yielding sugar cane varieties were released by the Sugar Cane Research Institute in 2010.

Fishing Fish production in 2010 increased by 12 per cent to 381,630 mt. Marine fish sector contributed to 87 per cent in the total fish production and the balance came from the inland fishing sector. Marine fish production grew by 13 per cent and inland fishery by 10 per cent during the year. Off shore fish production in 2010 was lower than the expected growth due to the impact of adverse weather conditions in the deep sea and slow growth of targeted deep sea fishing fleet. However, significant increase in the fishery activity in the Northern and the Eastern provinces largely contributed to increase the marine fish production in 2010. Fish production in the Northern and the Eastern provinces together increased by 40 per cent to 125,840 mt in 2010. The large number of fishery programmes including distribution of boats and fishing gear and skill development of fishermen 36

Table 2.5

Fish Production Metric Tons ’000

Sub-Sector Marine (c) Aquaculture and Inland Fisheries

2009(a) 293 47

2010(b) 330 51

381 Total 340 Source: Ministry of Fisheries and Aquatic (a) Revised Resources (b) Provisional (c) Coastal and deep sea sector

under “Nagenahira Navodaya (Eastern Revival)” and “Waddakkil Vasantham (North Spring)” helped speedy recovery of the fishery sector in these provinces. The proper management of reservoirs with community participation, establishment of community based mini-hatcheries, increase of fish seed production and free issue of fingerlings during the year helped to increase the inland and aquaculture fishing in 2010. Despite the increase in total fish production, the average prices of many fish varieties were high in 2010 mainly due to lower than expected performance in the Southern, Western and North Western provinces due to adverse weather conditions and increased fish consumption in the country.

Livestock Total milk production showed an increase by around 6 per cent to 247 million litres in 2010. The milk collection of major milk product manufactures in the country increased by 10 per cent to 137.6 million litres in 2010 from 125.4 million litres in 2009 supported by the increase in milk collection centres in the country from 2,673 in 2009 to 2,895 in 2010. Moreover, the increase in the number of chilling centres of major milk product manufactures during the post-conflict period, the increase in the number of places of production of value added milk products in the country, the increase in the liquid milk sales outlets of both the government and private sector also reflected the recent progress in the dairy sector. Accordingly, domestic milk production as a percentage of total national requirement of milk increased to 30 per cent in 2010 from that of 28 per cent in 2009. The government’s target is to reach self-sufficiency in milk production by 2020.

Central Bank of Sri Lanka Annual Report - 2010

Livestock Sector Statistics 2009(a)

Sub-Sector 1. National Herd (No.) (mn) Neat Cattle Baffalo 2. National Milk Production (mn litres) Cow Milk Baffalo Milk 3. Milk Products (mn litres) 4. Producer Price - Cow Milk (Rs./litre) 5. National Egg Production (No) (mn) 6. National Poultry Meat Production (mt ‘000) (a) Revised (b) Provisional

1.5 1.1 0.4 233.4 184.1 49.3 23.3 29.53 1,142.2 99.28

2010(b) 1.6 1.2 0.4 247.6 191.9 55.6 17.8 32.48 1,139.9 104.16

Source: Ministry of Livestock Development

The average producer price of liquid milk was Rs.32.50 per litre (Fat/SNF=3.8/8.3) in 2010 compared to that of Rs.29.50 per litre in 2009, which also helped encourage milk production. In 2010, chicken meat production increased by around 5 per cent while egg production slightly declined by 0.2 per cent. The cost of production of chicken meat and eggs increased with higher feed prices, as maize prices rose due to the shortage of maize supply in 2009 Yala season amidst restriction on maize imports. As prices of chicken meat and eggs increased substantially, around ten million eggs and 500 mt of chicken meat were imported by “Lak Sathosa” in the middle of festive demand in December 2010 and January 2011 to stabilise the prices.

Forestry The total forest cover by end 2010 in Sri Lanka was 1,934,062 ha as identified by the Forest Department. The identified mangroves extent was 15,545 ha in 2010 compared to 8,815 ha in 2009. During the year, the Forest Department carried out reforestation in 873 ha. Moreover, the assisted re-planting programme under the World Food Programme, which commenced in 2009 continued successfully in 2010. Accordingly, home garden development, agro forestry woodlots, canal bank planting, tank catchment rehabilitation and the rehabilitation of degraded mangrove forest were carried out under this programme in Ampara, Trincomalee, Vavuniya and Batticaloa districts.

The government policy on the agriculture as envisaged in the “Mahinda Chinthana Vision for Future” focuses on several targets. These include achieving food security of the people, ensuring higher and sustainable income and remunerative prices for farmers, uninterrupted access to competitive markets both in Sri Lanka and abroad, farm mechanisation, expanding the extent under cultivation, reducing wastage in transit and ensuring environmental conservation, introducing efficient farm management techniques and using high yielding seeds and improved water management. In line with this policy, the government has identified several strategies and programmes, which include promoting paddy as a national crop, achieving self-sufficiency in other field crops, exploring the full potential of fruits and vegetables and exporting preserved fruits and vegetables, establishing best quality production centres for floriculture products and herbal farms for better health, strengthening input delivery system, farmer friendly agriculture lending, links between producers and consumers and crop diversification through multiple cropping and inter-cropping, promoting low cost locally produced fertiliser and promoting natural drinks. In 2010, the activities of Sri Lanka Tea Board (SLTB), Tea Research Institute (TRI) and Tea Small Holdings Development Authority (TSHDA) were directed mainly on improvement of productivity, quality and value addition of Sri Lanka tea. With a view to increasing tea production, new planting, re-planting and re-filling by corporate and smallholder sectors were promoted and the fertiliser subsidy for smallholders was continued. In order to encourage tea re-planting and new planting, the subsidy was increased by Rs.50,000 per ha to smallholder tea growers. Meanwhile, under the tea smallholders land rehabilitation programme, tea re-plantations were carried out in 1,972 ha during the year. Under SLTB, a fund for tea promotion and marketing was established in November 2010 to promote Sri Lanka tea globally and funds will be raised through a specific levy of Rs.3.50 per kg introduced by SLTB. With a view to increasing high value added tea exports under 37

2 National Output and Expenditure

Table 2.6

Central Bank of Sri Lanka Annual Report - 2010

Economic andOutput Socialand Infrastructure National Expenditure

Sri Lankan brand names, the cess on export of bulk tea was also increased to Rs.10 per kg from Rs.4 per kg. Action has also been taken to utilise a large area of tea lands for re-plantation under regional plantation companies. Coconut Research Institute (CRI), Coconut Development Authority (CDA) and Coconut Cultivation Board (CCB) continued their developmental activities in the coconut sector in 2010. The emergence of an incurable disease namely, Weligama Coconut Leaf Wilt Disease (WCLWD) in the Southern province has created an alarming situation as a possible threat to country’s coconut industry. In this connection, 18,109 affected coconut palms were destroyed during the year and at the same time, arrangements were made to distribute seedlings in WCLWD affected areas as a first step to introduce resistant / tolerant coconut varieties. A new division for oil palm research was established at CRI to help the plantation companies growing oil palm. This would encourage the oil palm cultivation domestically to bridge the gap between demand and supply of edible oil. Minimum land size required for the coconut plantation subsidy scheme was reduced from half an acre to quarter acre. In the meantime, in order to enhance the coconut cultivation in identified 70,000 acres in the Northern and the Eastern provinces, steps have been taken to establish a seed garden in Kilinochchi. Further, to ensure the coconut sector development, the government has established a new Cabinet Ministry. Meanwhile, with a view to raising coconut production to 3,500 million nuts per year over the medium term from the current level, measures such as subsidies for replanting and new planting, promoting inter-cropping and productivity improvements in the coconut sector were taken during the year. Seedling production at the government farms has also been planned to increase up to 4 million to facilitate this target. “Kapruka Village Society” is another step introduced to increase awareness about coconut cultivation and products among the people. Rubber Research Institute (RRI) implemented several measures to improve the production and productivity during the year. After assessing 38

current clonal composition in the country, RRI took measures to cultivate high yielding clones with improved secondary characters such as high timber volume and disease resistance. In order to expand the rubber cultivation to non-traditional areas, pilot projects on rubber cultivation were initiated in Vavuniya, Mullaitivu and Kilinochchi districts and a new sub-station was established at Monaragala to facilitate Uva-Wellassa rubber growers. Meanwhile effective, close and continuous extension services were carried out throughout the year. The subsidy for re-planting and new planting for rubber has also increased promoting rubber cultivation in areas like Monaragala, Vavuniya and Mullaitivu districts. To encourage the value added exports of rubber, the export cess on raw rubber was also increased from Rs.4 per Kg to Rs.8 per Kg in 2010. Several measures were introduced in the government Budget 2011 to increase the supply of high quality seeds and planting material. Accordingly, it was proposed to develop the existing nineteen government seed farms and all unutilised lands in agricultural research centres as a national priority under a three year seed farm development programme from 2011 under PublicPrivate Partnership (PPP) basis. Further, in order to promote floriculture, particularly in Avissawella, Gampaha and Kegalle districts, it was proposed to establish a special incentive package to establish nurseries to produce high quality flowers and ornamental plants. National campaign on agriculture “Api Wawamu Rata Nagamu” which was introduced in 2007 successfully continued for the third consecutive year in 2010. In 2010, a total of 18,511 acres of fallow lands were brought under paddy cultivation in addition to 75,752 acres of fallow lands cultivated in 2009. In 2010, under the home gardening development programme 375,000 home gardens were developed. Under the community based seed development programme, 42,325 kg of other field crop seeds such as maize, red onion, cowpea, and chillies were distributed among the farmers in 2010. The present post-harvest losses of vegetables and

Central Bank of Sri Lanka Annual Report - 2010

During the year, institutions under the Department of Agriculture (DOA) continued to conduct programmes in line with the the government policy to improve the domestic agriculture sector in the country. During the year, Rice Research Institute (RRI) introduced two new high yielding rice varieties namely, BG 366 and LD 408 with realisable yield potential of 9 mt per ha and 7 mt per ha, respectively, which are more resistant to pests and diseases. Since chemical control is costly and pollutes the environment, developing resistance varieties for pests and diseases is the best option as it is environmentally friendly and no additional cost is involved in managing such incidents. In the Other Field Crop sector, release of new potato variety (golden star) tolerant to diseases such as â&#x20AC;&#x153;late brightâ&#x20AC;? was one of the significant improvements reported in the year. Further, in the horticulture sector, a cherry type new tomato variety (lanka cherry) and a new banana variety (millewa selection) were also released for commercial cultivation. Further, seed paddy production programmes under DOA also showed a significant improvement in 2010, which further supported the expansion of agriculture in 2010. Accordingly, the seed paddy production under DOA improved up to 4,476 mt in 2010 compared to that of 2,900 mt in 2009. Improving of the dairy sector has been a priority area in the agriculture policy of the government. The expenditure on the import of milk and milk products increased to US dollars 258.75 million (76,010 mt) in 2010 from US dollars 165.67 million (65,246 mt) in 2009 mainly due to

the increase in international market prices. On this background, the government increased the producer price of milk by Rs.3 to Rs.33 per litre with effect from June 2010 to encourage the domestic milk production. In March 2011, Milco increased its purchase price to Rs.50 per litre which would provide strong support to boost the milk collection in the country. Further, during 2010, some amendments were brought to the Animal Act No. 29 of 1958 to deal with matters pertaining to animal identification, animal welfare, animal transportation, etc. In addition, removal of tariffs on the importation of dairy animals for breeding purposes and dairy equipment in relation to milk processing were also implemented in line with the government policy to strengthen the dairy sector. The activities such as rounding up displaced cattle in the conflict affected areas and handing over such animals to farmers in those areas, expansion of dairy villages and increase in artificial insemination and pasture development programmes helped to increase the dairy animal population in the country. A total of 190,771 artificial inseminations were carried out in cattle and buffaloes in 2010, which is 10 per cent increase from that of 2009. The national cattle population increased by 3 per cent to 1,169,670 in 2010 from 1,136,860 in 2009. The Agriculture sector in the country requires special attention in several areas to accelerate its growth. Measures to increase the competitiveness of the Agriculture sector through improvement in the productivity and increase in value addition in both domestic and export agriculture are necessary in anticipation of further integration of the country with the world through trade agreements in future. In this regard, the adoption of improved agriculture and manufacture practices, the adoption of capital intensive methods where possible, the reduction of post-harvest losses and the provision of appropriate technical services could be identified as areas for improvement. Moreover, it is imperative to introduce measures to encourage private sector investment in large scale farming, which would also promote investments in the food processing industry. 39

2 National Output and Expenditure

fruits are as high as 30 to 40 per cent in Sri Lanka. In order to reduce this post harvest loss, a total of 142,500 plastic crates were distributed among the farmers, traders and collectors during the last three years at subsidised rates including 20,700 of such crates distributed in 2010. Furthermore, there was a significant improvement in the production of organic fertiliser in 2010 largely due to extensive training / awareness programmes by the relevant authorities and remunerative prices for such fertiliser in the year.

Central Bank of Sri Lanka Annual Report - 2010

Economic andOutput Socialand Infrastructure National Expenditure

Industry The Industry sector recorded the highest sectoral growth of 8.4 per cent in 2010 over the moderate growth of 4.2 per cent in the previous year. All sub-sectors contributed favourably towards this impressive performance in the Industry sector. The higher growth in factory industry subsector together with the expansion in construction were the major contributors to growth in the sector. The share of the Industry sector in the total GDP increased marginally to 28.7 per cent in 2010 from 28.6 per cent in 2009. The factory industry, accounting for approximately 55 per cent of the total industry output, recorded a growth of 7.5 per cent during 2010 compared to 3.4 per cent in 2009. This growth was achieved from improved performance in all categories of factory industry resulting from enhanced economic activity in both domestic and international markets. Increased demand from post-conflict Northern and Eastern provinces, considerably lower interest rates, low inflation and enhanced business and consumer confidence created a conducive economic environment for growth in domestic market oriented industries. Export market oriented industries benefited from increased demand from major trading partner economies with the gradual recovery of the global economy, expansion in product portfolios, well articulated branding and market diversification strategies. These competitive measures adopted by export market oriented industrialists assisted them to retain the existing market share as well as to capture new market segments in international markets. Within the export market oriented industries, textile, wearing apparel and leather products category, was able to face the withdrawal of GSP+ concession from August 2010, by way of adopting productivity improvement and cost saving strategies. The growth in factory industry output was reflected in both domestic and export market oriented industries. Growth in food, beverages and tobacco products category, which accounts for nearly 48 per cent of the total factory industry output 40

was driven by expansion of markets in post-conflict Northern and Eastern provinces and increased tourism activity during the year. The non-metallic mineral products category was also a main driver of output growth with high demand for cement and building materials. Several other domestic market oriented industries, comprising glass, ceramic based products, cables, wires, iron, steel sheets and paints reflected favourable growth rates during 2010. The growth in export market oriented industries was driven by textile, apparel, petroleum, rubber, machinery and equipment sub-categories. Textile, wearing apparel and leather products category, which took longer than anticipated to recover from the global economic crisis, showed signs of recovery from the fourth quarter of 2010. Other major contributors to the increased output in export market oriented industries were tableware, floor and wall tiles, ship building and repairing, transport equipment and machinery. The food, beverages and tobacco products category, which benefited from the expansion in domestic market, recorded a growth of 6.8 per cent in 2010 compared to 5.9 per cent in 2009. The main industries that contributed towards the growth included, processed food, beverages, bakery products and poultry feed. Increase in production capacity in the private sector was initiated by manufacturers in the dairy, sugar and salt sectors. Value added tea production also recorded a substantial growth boosted by record high prices for â&#x20AC;&#x2DC;Ceylon Teaâ&#x20AC;&#x2122; in international markets during 2010. Sri Lankan tea manufacturers continued shifting to value added tea by supplying large quantities of tea bags, packets, instant tea powder, green tea and flavoured tea to international markets. The processed food manufacturing subcategory played a major role in the growth of food, beverages and tobacco products category. Expansion in the export market was boosted by higher output in processed food comprising tropical fruits, vegetables, grains, spices, condiments and sea food. The domestic processed food market also benefited from increased tourist activity, changing

Central Bank of Sri Lanka Annual Report - 2010 Value Added in Industry (2002 Constant Prices) Rs. million

Category

2009

Change %

2010(a) 2009

2010(a)

1. Food, beverages and tobacco products 2. Textile, wearing apparel and leather products 3. Wood and wood products 4. Paper products, publishing and printing 5. Chemical, petroleum, coal, rubber and plastic products 6. Non-metallic mineral products 7. Basic metal products 8. Fabricated metal products, machinery and transport equipment 9. Manufactured products not elsewhere specified

185,142 197,731 5.9

2,138 5.1

6.7

Total

385,927 414,925 3.4

7.5

(a) Provisional

87,762 92,293 0.6 1,125 1,193 3.7 1,635 1,742 2.3

6.8 5.2 6.0 6.5

59,706 66,990 1.8 14,794 16,328 -3.3 965 1,028 0.7

12.2 10.4 6.5

32,794 35,482 3.4

8.2

2,004

Source: Department of Census and Statistics

consumption patterns and expansion of major supermarket chains and retail outlets island wide. Food processing industries continued to attract international buyers by obtaining internationally recognised safety and hygienic standards and by providing training for technical grade employees. Even though Sri Lanka is the largest supplier of cinnamon and many other spices to the world market, value addition of spices remained at considerably low levels. However, the industry continued to expand into new markets in Europe, Japan and USA by adopting innovations such as mechanised drying and grinding in value added processing of spices. The textile, wearing apparel and leather products category grew by 5.2 per cent during 2010 compared to 0.6 per cent in 2009. Despite numerous challenges to this industry, such as, high level of competition from regional manufacturers, withdrawal of GSP+ concession, high cost of skilled labour and imported raw materials, the industry remained competitive in export markets by producing high quality state-of-the-art products to major Western clothing brands. The strategies adopted by launching campaigns on the themes of ‘Ethically Manufactured Garments’, ‘Garments without Guilt Certification’ and ‘Sustainable Environmental Friendly Manufacturing’ assisted major textile manufacturing industries to maintain its reputation for supplying high quality finished products to the international market.

Increased focus on improved management skills, high productivity and quality were the primary drivers for the growth in the textile, wearing apparel and leather products category during 2010. Apparel industry also focused on exploring niche markets in the Asian region in order to diversify their export destinations. New innovations in the apparel industry included the launching of Re-Engineered Design (RED) products by using waste fabric of local apparel industries, up-cycling and converting them into a fashionable clothing line catering to Western clothing brands. Although, there was a concern that exports would be negatively affected with the withdrawal of the GSP+ concession from August 2010, a significant increase in export earnings from textile and apparel category was observed with the European and US clothing retailers placing increased orders in the last quarter of 2010. The chemical, petroleum, coal, rubber and plastic products category recorded a growth of 12.2 per cent in 2010 compared to 1.8 per cent in 2009. The rubber based industry, recorded a high growth during the year with increased demand for natural and synthetic rubber based products. The recovery in the automobile industry in developed and emerging markets had a direct impact on the price of natural rubber in the world market. Recovery in the European and US economies also contributed towards a significant growth in solid tyre manufacturing. The PVC and paint industries benefited from increased construction activity in the domestic market during the year. The output of the non-metallic mineral products category increased by 10.4 per cent in 2010 compared to a negative growth of 3.3 per cent in 2009. Growth in cement, tile and roofing sub-categories was driven by increased construction in the private sector as well as continuation of government infrastructure projects, coupled with rehabilitation and reconstruction projects in the Northern and Eastern provinces. Export demand for high quality porcelain products and tiles increased with the gradual recovery in economic activity of major export destinations in 41

2 National Output and Expenditure

Table 2.7

Composition of Value Added in Industry 2010 Central Bank of Sri Lanka Annual Report - 2010 (2002 Constant Prices) manufactured commercial and leisure boats, small Composition of Value Added in

Economic andOutput Socialand Infrastructure National Expenditure

Chart 2.3

Industry - 2010 (2002 Constant Prices)

Chemical, petroleum, coal, rubber and plastic products 16% Textile, wearing apparel and leather products 22% Food, beverages and tobacco products 48%

Non-metallic mineral products 4% Fabricated metal products, machinery and transport equipment 9% Other 1%

European and US markets. Tableware exporters further strengthened their position in the international market with the introduction of premium products such as â&#x20AC;&#x2DC;Bone China Tablewareâ&#x20AC;&#x2122;, which is considered as the most expensive tableware in the world. Porcelain manufacturers further enhanced their production line by commissioning international tableware designers to develop new surface designs and shapes. Growth in tourism activity coupled with refurbishment of existing hotels and construction of new hotels contributed towards increasing the demand for high quality tableware products in the domestic market. Increased demand for beverages, mainly from the conflict affected provinces, resulted in an increase in glass manufacturing in 2010. The fabricated metal products, machinery and transport equipment category registered a growth of 8.2 per cent during 2010 compared to 3.4 per cent in 2009. The ship and boat building sub-category, which accounts for a significant portion within the fabricated metal products category, recorded a high growth despite the continuing recession in the global shipping industry during 2010. Sri Lankan ship and boat builders were able to cater to a large number of international orders within the year, particularly in supplying medium scale vessels. Furthermore, they were able to construct ocean passenger vessels and ventured into construction and repairing of tug-supply vessels, dredgers and multi-purpose vessels in 2010. The boat building industry showed signs of recovery with the opening up of the Northern and Eastern sea fronts. Demand for locally 42

and medium scale luxury yachts increased during 2010. Key leisure boat manufacturers continued their presence in international markets particularly in Europe, Mauritius, Solomon Islands, Singapore and the Middle East. The emerging tourism industry, mainly in the sea fronts of Northern and Eastern provinces, is expected to generate an increasing demand for leisure boats as well as vessels for sea excursions. The public sector industrial output declined further mainly due to the low production of Ceylon Petroleum Corporation (CPC), which contributed to more than 95 per cent of the public sector output in 2010. The production of CPC declined by 13 per cent owing to prescheduled closure of its refinery for two months. The production of Lanka Mineral Sands Ltd. increased by 53 per cent within the year to reach 39 per cent of total capacity. Lanka Salt Ltd. and Lanka Phosphate Ltd. also recorded positive growth rates during 2010. Other state enterprises that recorded negative growth rates included, Sri Lanka Rubber Manufacturing and Export Corporation Ltd., National Paper Company Ltd. and Sri Lanka Ayurvedic Drugs Corporation. The State Resources and Enterprise Development Ministry has already taken measures to streamline several loss making and defunct state owned enterprises into viable ventures through structural improvements.

The ex-factory profit ratio of non-BOI private sector industries increased by 2.1 per cent in 2010 compared to a decline in the previous year. The increase in profitability was mainly attributed to the conducive business environment that prevailed during 2010. Increased sales resulting from favourable domestic factors contributed towards higher sales revenue, while the reduction in interest cost, use of alternative energy sources and increase in productivity contributed positively towards improving the ex-factory profit ratio. Cost of both imported and domestic raw materials increased resulting from increased domestic and international demand. A notable decline was observed in interest cost from 3.3 per cent in 2009 to

Central Bank of Sri Lanka Annual Report - 2010 Ex - Factory Profit Ratios of Non - BOI Private Sector Industries (a)

Category

Total Cost of Production (Rs. million) 2009 (b)

2010 (c)

1. Food, beverages and tobacco products 132,956 146,456 2. Textile, wearing apparel and leather products 36,214 41,236 3. Wood and wood products 2,835 3,205 4. Paper products, publishing and printing 9,123 10,273 5. Chemical, petroleum, coal, rubber and plastic products 72,273 83,398 6. Non-metallic mineral products 45,628 53,621 7. Basic metal products 4,498 5,042 8. Fabricated metal products, machinery and transport equipment 28,206 32,356 9. Manufactured products not elsewhere specified 5,514 6,411 337,247 381,998 Total

Total Value of Production (Rs. million)

Factory Profit Ratio (percentage)

2009 (b)

2010 (c)

2009(b)

155,992 40,885 3,216 10,415 85,106 52,747 5,220 32,678 6,295

172,283 46,965 3,642 11,742 98,563 62,161 5,864 37,578 7,335

14.8 11.4 11.8 12.4 15.1 13.5 13.8 13.7 12.4

15.0 12.2 12.0 12.5 15.4 13.7 14.0 13.9 12.6

392,554 446,133

14.1

14.4

2010 (c)

(a) Based on information received from 510 non-BOI private sector firms (b) Revised (c) Provisional

2.6 per cent in 2010. The decline in productivity due to low demand during 2009 in the textile, wearing apparel and leather products category witnessed a recovery with majority of textile factories operating at full capacity during the last quarter of 2010. The government continued its commitment towards the development of regional industries through the “Gamata Karmantha” programme providing incentives to industries located in regional areas. The Ministry of Industry and Commerce (MIC) continued with this programme creating employment in rural areas and avoiding further concentration of industries in Colombo and Gampaha districts. The Domestic Industries Approval Committee (DIAC) of MIC approved 111 projects during 2010 of which, 58 industries were in commercial operation and 11 projects were in different stages of implementation. The Industrial Estate Development programme of MIC continued in 2010 to promote local investments in regional areas. During 2010, 451 plots from a total of 608 plots were allocated, of which 270 industries were in commercial operation and 33 factories were under construction. The development work of Industrial Estates in Buttala, Embilipitiya and Galigamuwa was completed to commence new ventures, while construction of Industrial Estates in Pallegodawatta and Madampe was in progress. Further, preliminary work was commenced on proposed Industrial Estates at Katana, Pallekele and Kurunegala. This programme

also aims to develop the Northern and Eastern provinces parallel to the “Nagenahira Navodaya” (Eastern Revival) and “Wadakkil Wasantham” (Northern Spring) programmes and has initiated preliminary construction work on proposed Industrial Estates in Batticaloa, Mannar and Vavuniya, while construction of six model factory buildings was nearing completion at Trincomalee (Kappalthurei) Industrial Estate. The Board of Investment (BOI) continued with the “Nipayum Sri Lanka - 300 Enterprises Programme” during 2010 focusing on regionalising the industrial base of the country. Under this programme, 260 projects have received approvals out of which, agreements were signed for 224 projects. Further, 132 projects have commenced commercial operations while 36 projects were under construction. Majority of investments were in the tourism, wearing apparel and textile product categories. The government continued its efforts to promote the Small and Medium Enterprise (SME) sector creating employment and income generating opportunities. The National Enterprise Development Authority (NEDA), continued its efforts in formulating policies for the development of this sector. The World Bank continued to support in strengthening the SME sector under the ‘Pilot Crisis Response Facility' (PCRF) during 2010. The PCRF scheme facilitates licensed commercial banks in offering SME sector financing through 43

National Output and Expenditure

Table 2.8

Central Bank of Sri Lanka Annual Report - 2010

Domestic Cost Structure of Non - BOI Private Sector Industries (a) (As a percentage of total cost of production)

Table 2.9

Category

Economic andOutput Socialand Infrastructure National Expenditure

1. 2. 3. 4. 5. 6. 7. 8. 9.

Food, beverages and tobacco products Textile, wearing apparel and leather products Wood and wood products Paper products, publishing and printing Chemical, petroleum, coal, rubber and plastic products Non-metallic mineral products Basic metal products Fabricated metal products, machinery and transport equipment Manufactured products not elsewhere specified

Total

Power & Fuel

Wage

2009 2010 (b) 3.8 5.2 10.2 4.9 7.1 21.4 10.3 5.7 5.8

Raw Material

2009 2010 (b)

3.8 5.4 10.5 5.1 7.3 21.6 10.6 5.8 6.0

10.7 15.5 16.7 13.3 13.9 15.5 11.1 12.9 12.2

7.0 7.2

10.8 15.6 17.2 13.6 14.3 15.9 11.4 13.0 12.3

12.8 13.0

Interest

2009 2010 (b) 40.8 13.8 33.6 20.2 31.5 30.1 36.4 27.6 35.0

2009 2010 (b)

41.2 14.1 34.0 20.7 32.3 31.0 36.8 29.2 35.3

2.1 3.4 5.0 4.2 4.4 4.5 2.9 5.2 2.1

33.5 33.8

1.6 2.8 3.8 3.2 3.0 3.0 1.9 3.4 1.5

3.3 2.6

(a) Based on information received from 510 non-BOI private sector firms (b) Provisional

refinancing, partial credit guarantee of loans and technical assistance. Budget 2011 has also proposed to provide relief to SMEs that were adversely affected during the global financial crisis by exempting SMEs operating on sub-contract basis from Economic Service Charge (ESC) and by providing a concessionary income tax rate of 10 per cent. Several incentives were proposed from the Budget 2011, to major foreign exchange earning industries, which significantly contribute towards value addition in the factory industry sub-sector. Machinery and equipment used in the manufacture of textile, leather, footwear and bags and manufacture of grain mixed bakery products were exempt from import duties and Value Added Tax (VAT), while customs duty on selected raw materials of bakery products was reduced. Incentives were also given to promote entrepot trade involving import, processing and re-export as well as transshipment activity. To facilitate continuous growth in the apparel sector, leading buyers in the textile industry were encouraged to establish their headquarters in Sri Lanka by exempting their foreign exchange earnings from income tax. Budget 2011 also proposed incentives to encourage local brand names and high domestic value addition industries while various other incentives were provided for economically important and emerging industries. It was proposed to impose a cess on all exports in raw 44

and semi-processed form to encourage value added exports from Sri Lanka, while export of finished goods was exempt from cess. Income tax was lowered from 15 per cent to 10 per cent for industries with domestic value addition in excess of 65 per cent and Sri Lankan brand names with patent rights reserved in Sri Lanka. Customs duty on certain glass and plastic bottles used for packing pharmaceutical products including Ayurvedic preparations was reduced, while import of raw materials for manufacture of pharmaceutical products was exempt from Nation Building Tax (NBT). However, tax on profit of firms engaged in manufacture and distribution of tobacco and liquor products was increased to 40 per cent. Several institutional reforms were proposed to improve ease of doing business in the country. The government proposed to modernise Table 2.10

Labour Productivity Index of Non-BOI Private Sector Industries (a) 1995 =100

Category

2009 2010 (b) Change (%)

159.4 165.6 123.8 127.3 110.8 113.6

3.9 2.8 2.5

139.1 122.9

3.7 2.2

134.7 138.8 3.0

Total

(a) Based on information received from 510 non-BOI private sector firms (b) Provisional

146.0 127.6 114.0 114.0

150.1 132.2 117.1 116.8

144.2 125.9

2.8 3.6 2.7 2.5

Central Bank of Sri Lanka Annual Report - 2010

Using Nanotechnology for Developing the Industrial Sector

Nanotechnology is a new invention, which has the ability to produce unique products with new features by changing the existing form of such products. This involves the manipulation of matter on the scale of atoms and molecules by changing the inherent features of material through re-engineering the composition at the molecular level. Likewise, nanotechnology applications can be found in many areas in the Industrial sector.

Examples of nano applications Today many countries use nanotechnology in the development of the industrial sector to manufacture new and innovative products in a cost effective manner. For example, with the use of nanotechnology, ordinary textile and fabric are converted into textile that do not absorb liquids and other substances giving it the unique feature of resistance from spills and stains. Similarly, the very high water repellency found on the Lotus flower, known as the lotus effect is seen developed in paints with the use of nanotechnology ensuring dust and water repellent properties in keeping walls of buildings clean for longer periods. Likewise, the difficulty of cleaning windows of sky scrapers is solved by using nanotechnology to produce glass with self-cleaning coating surfaces that do not accumulate dust and other tiny particles. These are only a few examples of how nanotechnology can be applied in the Industrial sector.

The national nanotechnology initiative The government considering the importance of nanotechnology in industrial development, decided to build a nanotechnology Park in 2007. This initiative is aimed at facilitating research to take advantage of the Nanotechnology that was creating a revolutionary breakthrough around the world. In 2008, the private sector, having identified the potential benefits of early exploitation of this technology showed a keen interest in investing in this field and as a result, partnered with the government to establish the Sri Lanka Institute of Nanotechnology (SLINTec). The SLINTec as a public-private partnership, is committed to undertake sustainable research focusing on projects that are economically, environmentally and socially sustainable. In its first year of operations, SLINTec has been able to acquire 5 international patents compared with Sri Lanka’s past record rate of 1-1.5 international patents per year. International Patents acquired in 2010 include carbon nanotubes, nano

fertiliser and nano rubber while field testing has already commenced as the first step to commercialising some of these products. The areas of research and development carried out were in the sectors of textile and apparel products, rubber based products, fertilisers and mineral products such as graphite and ilmenite.

Potential nano applications and their progress The textile and wearing apparel sector, which is the major export oriented factory industry, promise immense potential in making revolutionary gains with the use of nanotechnology in its products as well as in the production mechanism. Accordingly, research and development was carried out on nano textiles to be manufactured in Sri Lanka, where some products are currently being developed to the commercialisation stage. The use of nanotechnology in reducing the carbon footprint of garment manufacturing and also in garments' dyeing processes, are also currently in the stage of development for commercialisation, which promise considerable value addition to the “Green Garments” attached to Sri Lankan apparel exports. Another typical use of nanotechnology that demonstrates a favourable economic impact to Sri Lanka is nano fertiliser which can be used in commercial crops. Nano fertiliser which is currently being field tested has a unique characteristic of high absorption efficiency which would result in lower fertiliser quantities required per arable unit of land. Similarly, the exportation of nano carbon tubes and nano titanium dioxide in place of the raw minerals that are exported currently, promise a notable increase of our export earnings. Rubber based products industry, which is Sri Lanka’s second largest export oriented factory industry, also has immense potential to increase its foreign exchange earnings by inculcating nano rubber to its products such as solid tyres and rubber gloves.

The way forward One of the main drawbacks encountered in going forward with this venture is the lack of funds. However, the high initial investment required to put up nanotechnology plants could be justified by the high economic benefits and shorter pay back periods. Hence, private sector participation is largely encouraged to make correct and timely investments. The formation of public-private partnerships may help minimise burden on government budget and expedite commercialisation of research findings in going forward with this venture.

2 National Output and Expenditure

BOX 4

Central Bank of Sri Lanka Annual Report - 2010

Economic andOutput Socialand Infrastructure National Expenditure

the Board of Investment (BOI) registration process by establishing an electronic data interchange system. Likewise, BOI set up a ‘one stop shop facility’ and ‘sector teams’ to identified thrust sectors to provide a sector-wise guidance for investors as well as to fast track the approval process and the commencement of businesses, moving away from its previous policy of country based investments to sector based investments.

research and development on projects which are environmentally, economically and socially viable, harnessing the talents of researchers to acquire intellectual property rights. Budget 2011 also provides incentives for industries with local patent rights by reducing the income tax rate from 15 per cent to 10 per cent, while targeting to increase the national research and development expenditure in both public and private sectors to 2 per cent of GDP.

The government continued to implement its industrial policy during 2010 through various line ministries and proposed several policy reforms from the Budget 2011. Initiatives were taken by the government to attract new investments through the BOI towards efficient utilisation of existing Export Processing Zones (EPZs). Accordingly, in allocating vacant positions in the 12 existing EPZs, preference was given to value added, large scale investments in priority sectors. Meanwhile, foreign companies and Sri Lankan companies were granted permission to borrow from foreign sources from November 2010.

The Export Development Board (EDB) along with other government and private institutions actively took part in promoting industrial exports of Sri Lankan manufacturers. Industry promotions in the export markets focused on adding value through branding of processed food items on propositions of ‘Ethically Processed’, ‘Rain Forest Alliance’, ‘Ozone Friendly’ and ‘Geographical Indicator’ schemes to attract niche markets. The EDB continued to promote locally manufactured products through ‘Trade Fair Participations’ and ‘Contact Buyer Seller Investor Meetings’, while the BOI and other government ministries organised foreign investment promotion missions as well as hosting and facilitating foreign delegations visiting Sri Lanka.

The government, along with many institutions, carried out various measures to facilitate innovative industrial products to the international market. Some of these measures include, environmentally friendly industrial development policies to promote green products as well as emphasis on obtaining local and international patents. The government launched the “Haritha Lanka” programme under which industries were required to be resource efficient, environmentally friendly and socially responsible. The government also signed the ‘Green Industry Declaration’ in order to be competitive in the global market. The Ceylon Chamber of Commerce (CCC) continued with its ‘Switch Asia’ project to promote Sustainable Consumption and Production of SMEs in the food and beverages industry category. The government, with the participation of the private sector, has taken initial measures to set up a nanotechnology park by establishing the Sri Lanka Institute of Nanotechnology (SLINTec). SLINTec follows a policy of carrying out 46

Mining and quarrying sub-sector grew by 15.5 per cent in 2010 compared to a lower growth of 8.2 per cent in the previous year. The growth in both gem and other mining contributed towards the expansion in the sector. The continued growth in other mining sub-sector by 17.5 per cent over the growth of 18.1 per cent in 2009 was the major contribution towards growth in this sector. The demand emanating from increased construction activity sustained the higher growth while the increased output from mineral sands, graphite and phosphate was also reflected in the growth in other mining activity. Meanwhile, the gem mining sub-sector, which contracted by 17.2 per cent in 2009, grew by 7.9 per cent in 2010. This was supported by the recovery in the demand for gems in the international market as reflected by a growth of 2.6 per cent in the volume of gem exports.

Central Bank of Sri Lanka Annual Report - 2010

The growth rate of cottage industry subsector stood at 5.5 per cent in 2010 as against 3.3 per cent in 2009. The growth in the subsector could be attributed to increased demand for paddy milling with higher paddy output, improved demand for small scale building material products and expansion in self-employment activity. Electricity, gas and water sub-sector recorded a higher growth of 7.8 per cent in 2010 as against the 3.7 per cent growth in 2009. This notable growth was gained with the acceleration of activity in all three sub-sectors. Electricity, which is the largest contributor in this sub-sector, grew by 8.2 per cent as increased hydro power generation, made possible by the improved weather conditions lowered the demand for thermal power generation. This performance was evidenced in the increase in the share of hydro power to 52.6 per cent of total electricity in 2010 compared to the corresponding figure of 39.3 per cent in the previous year. Meanwhile, the demand for electricity from domestic, commercial and industrial sectors increased indicating the growing economic activities of the economy. The gas sub-sector recorded a 4.6 per cent of growth in 2010 over a 5.4 per cent expansion in 2009. The water sub-sector, which grew by 2.9 per cent in 2009 continued to grow by 4.5 per cent in 2010. The construction sector expanded significantly by 9.3 per cent in value added terms in 2010 compared to a lower growth of 5.6 per cent in 2009. Increased activity in construction was depicted by the growth in domestic production of building material by 12.0 per cent during the year.

Further, cement availability grew by 18.1 per cent in 2010 compared to a contraction of 11.1 per cent in the previous year. The increased involvement in the private sector was reflected in the growth of private sector credit for construction purposes by 19.3 per cent during the year. Meanwhile, government construction projects related to roads, ports, power sector, irrigation and water resources and housing together with other small scale construction also contributed favourably to the growth in value added in the construction sector. The construction sector expanded with the acceleration of the ongoing road development projects such as expressways, interregional national highways and mega power projects initiated to meet the rising demand for electricity. Further, port development projects together with construction of houses and reconstruction work done in newly liberated areas boosted construction activity.

Services The Services sector recorded a growth of 8.0 per cent in 2010 and accounted for 59.3 per cent of total GDP. The higher growth in the sector was supported mainly by the recovery in trade activities from the contraction in 2009. Meanwhile, hotels and restaurants and transportation sub-sectors also recorded impressive growth during the year. The expansion in wholesale and retail trade activities was evidenced by the growth of 7.5 per cent during the year. The sector, which had a negative contribution to growth in the previous year rebounded in 2010 with a 21.7 per cent contribution to GDP growth. The acceleration in export and import activities with the gradual recovery in international markets after the setback in the previous year, as well as the growth in domestic trade, positively impacted towards the improvement in the sector. Import trade recorded a higher growth of 9.5 per cent in value added terms in 2010 compared to the contraction of 8.2 per cent in 2009. This was indicated by the volume growth of 20.6 per cent of consumer goods category, which includes food items and other consumer goods such as 47

2 National Output and Expenditure

Processing sub-sector showed a positive growth of 5.8 per cent in 2010 compared to a marginal growth of 0.7 per cent in 2009. This was largely due to the improvement in tea production particularly during the first nine months of 2010, which impacted favourably on the value added growth in the processing subsector together with the increased output in rubber production. But the contraction in coconut production impacted negatively on its growth.

Central Bank of Sri Lanka Annual Report - 2010

Economic andOutput Socialand Infrastructure National Expenditure

motor vehicles. The growth rate of intermediate goods category stood at 13.0 per cent despite the decline in textile and crude oil imports. The growth in this category was supported by the increase in imports of fertiliser, other petroleum and other imports during the year. Meanwhile, investment goods imports grew by 7.3 per cent in volume terms with the contribution of transport and machinery equipment imports during the year. The export sub-sector grew by 3.4 per cent in 2010 over the contraction of 2.2 per cent in the previous year benefiting from the developments in the international market. In this sub-sector agricultural exports grew by 9.7 per cent in volume terms mainly due to the expansion of exports in tea and other agricultural products, which grew by 11.4 per cent and 20.1 per cent, respectively. The growth in industrial exports was sustained by petroleum and other industrial products while textile and garment exports declined in volume terms during the year. Further, mineral exports expanded by 3.0 per cent in volume terms compared to the contraction of 8.8 per cent in the previous year. Domestic trade activity registered a healthy growth of 7.6 per cent in 2010 compared to a growth of 7.3 per cent in the previous year. This was a result of the acceleration of domestic demand in the environment of emerging economic activity throughout all regions with the restoration of peace in the country. Hotels and restaurants sector recorded a significant growth rate of 39.8 per cent in 2010 as against 13.3 per cent growth in 2009 consequent to the peaceful environment that prevailed in the country. Local and foreign tourist activity accelerated as reflected in tourism industry related indicators such as tourist arrivals, which increased by 46.1 per cent in 2010 as against a marginal increase of 2.1 per cent in 2009. Further, total guest nights, which include both foreign and local tourists, also rose by 42.3 per cent in 2010. Transport and communication sector recorded a 11.9 per cent of growth in 2010, compared to 6.3 per cent growth in the previous year. A healthy 48

growth was evident in all three sub-sectors namely, transport, cargo handling-ports and civil aviation, and post and telecommunications. The growth in the transport sub-sector was 11.4 per cent in 2010, which is the highest growth rate recorded by the sector during the last three years. This significant growth was reflected in the expansion shown in passenger kilometres operated by cluster bus companies. Fuel consumption grew with increased demand for transport services amidst relatively stable prices that prevailed during the year. This was reflected by the increase in petrol sales by 14.3 per cent and diesel sales by 1.2 per cent in 2010. Meanwhile, new vehicle registration also rose by 76.0 per cent in 2010 as a result of downward revision in the government tariff on vehicle importation. Air travel sub-sector also spurred by the significant upturn in the tourism sector. The cargo handling-ports and civil aviation sub-sector expanded substantially with a growth of 16.8 per cent in contrast to the marginal growth of 0.4 per cent registered in the previous year. This expansion was backed by the increase in both transshipment and cargo handling, which grew by 18.0 per cent and 26.7 per cent, respectively, during 2010. Further, the Colombo port handled the highest recorded volume of 4.1 million Twenty-Foot Equivalent Container Units (TEUs) during the year. Post and telecommunication sector grew by 13.2 per cent in 2010 continuing its favourable contribution towards overall growth. This growth was reflected by the expansion in telecommunication subscriber-base by 17.6 per cent in 2010. Fixed access subscriber-base, which includes CDMA connections grew by 3.9 per cent, while the mobile subscriber-base increased by 20.9 per cent to 17.2 million denoting the improvement of accessibility and affordability owing to the expansion of the sector. Meanwhile, the activity in postal services declined during the year with the development of new technology in other communication services.

Central Bank of Sri Lanka Annual Report - 2010

The government services sub-sector registered a moderate growth of 5.4 per cent compared to the growth of 5.9 per cent in 2009. Improvement and expansion of government services mainly contributed to the growth in the sector. The private services sub-sector recorded a 5.8 per cent growth as in the previous year. The growth of the sector emanated mainly from areas of private education and health services while other private sector services also emerged with the revival of economic activity.

Gross Domestic Expenditure (GDE), which measures the aggregate demand generated by domestic economic activity, in terms of consumption and investment, was estimated at Rs. 6,114 billion for 2010. The total demand represented by GDE grew by 18.7 per cent in 2010 over a growth of 2.7 per cent in 2009. The higher growth momentum in GDE indicates the improvement in economic activities during 2010 over the slowdown in both consumption and investment activities in the previous year. The positive impact of the peaceful environment together with the pent-up demand from liberated areas in terms of both consumption and investment expenditure can be attributed to the expansion in domestic demand. GDP at market prices given by GDE adjusted for net exports was estimated at Rs. 5,602 billion in 2010, an increase of 15.9 per cent compared to 2009. This increase in GDP comprised the real growth of 8.0 per cent and the price growth of 7.3 per cent, as measured by the implicit deflator for GDP.

Consumption Consumption expenditure, which includes both the private and public sector, grew by 14.9 per cent to Rs. 4,557 billion in 2010. The higher

Aggregate Demand

Table 2.11

2.3 Expenditure

Item

Current Market Prices (Rs.mn) 2008

2009(a)

2010(b)

Constant (2002) Prices (Rs.mn) 2008 2009(a)

A. Domestic demand

Consumption ( % Change ) Gross domestic capital formation ( % Change )

Total domestic demand ( % Change )

2010(b)

3,799,084 3,967,770 4,557,348 1,922,863 1,992,820 2,160,814 28.8 4.4 14.9 7.9 3.6 8.4 1,215,247 1,181,449 1,556,769 657,377 671,191 775,400 21.5 -2.8 31.8 4.2 2.1 15.5 5,014,331 5,149,220 6,114,117 2,580,240 2,664,011 2,936,214 26.9 2.7 18.7 6.9 3.2 10.2

B. External demand Exports of goods and services ( % Change ) Imports of goods and services ( % Change ) Net external demand

1,095,679 5.2 1,699,328 20.2 -603,649

1,031,289 -5.9 1,345,216 -20.8 -313,927

1,215,007 17.8 1,726,803 28.4 -511,796

C. Total demand ( % Change )

4,410,682 4,835,293 5,602,321 23.2 9.6 15.9

758,972 665,575 0.4 -12.3 973,711 880,372 4.0 -9.6 -214,739 -214,797

(a) Revised (b) Provisional

703,917 5.8 994,699 13.0 -290,782

2,365,501 2,449,214 2,645,432 6.0 3.5 8.0 Sources: Department of Census and Statistics Central Bank of Sri Lanka

2 National Output and Expenditure

The banking, insurance and real estate subsector expanded by 7.5 per cent over the growth of 5.7 per cent in 2009. The increase in profitability through income from loans and advances and other investments owing to the moderate interest rates and consequently, rebounded credit flows to the private sector during the year supported the sectoral growth along with the better performance shown in foreign exchange market activities in the banking sector. Moreover, widening of financial services through opening up new branches and service outlets and other services continued. Meanwhile, insurance and leasing sector also grew substantially in line with the developments in areas such as new vehicle registration. The real estate activity retained its competitive position during the period.

Central Bank of Sri Lanka Annual Report - 2010

Economic andOutput Socialand Infrastructure National Expenditure

growth in consumption expenditure reflected the recovery in economic activity from the set-back in 2009 that saw a nominal growth of 4.4 per cent in total consumption expenditure. Meanwhile, private and public consumption expenditure grew by 18.2 per cent and 2.5 per cent in 2010, respectively. Meanwhile, Private Consumption Expenditure (PCE) as a percentage of GDP accounted for 65.8 per cent, which was an increase from 64.4 per cent in 2009. Consequently, government consumption expenditure, which constituted 17.6 per cent of GDP declined to 15.6 per cent in 2010 indicating a higher growth momentum in the private sector. The largest consumption category within PCE is food, beverages and tobacco, which accounted for a share of 39.6 per cent in 2010. Further, spending on this category grew by 22.6 per cent in 2010 compared to a growth of 2.1 per cent in the previous year. The increased demand could be particularly attributed to the pent-up demand from the Northern and the Eastern provinces. Further, the average price increase in this consumption category as indicated by the CCPI sub-index was 6.8 per cent during the year compared to a relatively lower growth of 2.8 per cent in 2009. Meanwhile, expenditure on clothing and footwear also increased by 26.2 per cent recovering from the contraction of 1.1 per cent in 2009.

Meanwhile, expenditure on furnishings, household equipment and routine maintenance of the house grew by 3.9 per cent in nominal terms compared to the increase of 3.6 per cent in the previous year. The expenditure share of this consumption category was 5.2 per cent, which was a marginal decline over that of 5.9 per cent in 2009. PCE on health and education grew by 7.9 per cent and 12.3 per cent, respectively, during 2010 compared to a growth of 21.0 per cent and 9.9 per cent in 2009. Meanwhile, the share of both health and education expenditure categories remained low at 2.0 per cent and 0.1 per cent, respectively, indicating the higher contribution of the public sector in providing these services to the public. Expenditure on transport activities accounted for a share of 21.2 per cent of total PCE in 2010, which was a marginal improvement from the previous year. Expenditure on transport activities

Composition of Private Consumption Expenditure at Current Market Prices

Table 2.12

Private expenditure on housing, water, electricity, gas and other fuels increased by 10.7 per cent in 2010 over the contraction of 4.7 per cent in the previous year. Together with the increased demand due to overall recovery in economic activity, prices also grew by 3.4 per cent according to the CCPI sub-index. The domestic prices of most items such as fuel and electricity remained stable during the year.

Item

Share of Total PCE (%)

09/08

10/09

1. Food, Beverages and Tobacco 37.8 38.2 39.6 2.1 2. Clothing and Footwear 5.7 5.6 6.0 -1.1 3. Housing, Water, Electricity, Gas and Other Fuels 12.7 12.0 11.2 -4.7 4. Furnishings, Household Equipment and Routine Maintenance of the House 5.8 5.9 5.2 3.6 5. Health 1.8 2.2 2.0 21.0 6. Transport 21.8 21.1 21.2 -2.1 7. Leisure, Entertainment and Culture 3.6 2.9 2.5 -18.1 8. Education 0.1 0.1 0.1 9.9 9. Hotels, Cafes and Restaurants 1.5 1.5 1.3 2.7 10. Miscellaneous Goods and Services 4.9 5.5 4.8 14.4 11. Expenditure Abroad of Residents 7.7 8.1 9.2 5.9 12. Less: Expenditure of Non-Residents 3.3 3.1 3.1 -5.0 Total Private Consumption Expenditure 100.0 100.0 100.0 1.0

22.6 26.2 10.7 3.9 7.9 19.0 0.9 12.3 4.7 3.0 34.8 20.8

(a) Revised (b) Provisional

2008

2009(a)

2010(b)

Rate of Change (%)

18.2

Source: Department of Census and Statistics

Central Bank of Sri Lanka Annual Report - 2010

2010 compared to a growth of 2.1 per cent in 2009. Consequently, investment ratio, which expresses nominal investment expenditure as a percentage of GDP improved to 27.8 per cent from a value of 24.4 per cent in the previous year. Private investment activity that suffered a considerable contraction of 7.1 per cent in 2009 recovered with a nominal growth of 40.1 per cent in 2010. Private sector investment expenditure, which includes public corporations accounted for a share of 77.7 per cent of total investment in 2010. Private investment, which contracted in 2009 due to unfavourable conditions in both the domestic and international economy rebounded in 2010 amidst the conducive environment, which induced higher involvement in investment activities by the private sector. This was reflected in credit to the private sector, which grew rapidly during the latter part of the year, and also the growth in investment goods imports to US dollars 2,970 million.

Public sector consumption expenditure grew by 2.5 per cent in 2010 as compared to the growth of 19.3 per cent in 2009. This was mainly due to the contraction of other recurrent expenditure with the rationalisation of government expenditure while expenditure on salaries and wage bill increased.

Investment During 2010, expenditure on investment (Gross Domestic Capital Formation) recovered from a contraction of 2.8 per cent in the previous year to expand by 31.8 per cent in nominal terms. Investment expenditure, which was estimated at Rs.1,181 billion in 2009 expanded to Rs.1,557 billion in 2010. The favourable economic environment supported the higher growth in investment activity which slowed down in the previous year. The recovery in investment activity could be witnessed in real terms as well, with the growth at 15.5 per cent in Table 2.13 Table 2.13

Foreign Direct Investments (FDI) of BOI enterprises declined by 14 per cent to US dollars 516 million in 2010 compared to US dollars 601 million in 2009. This FDI commitment was mainly attributed to the manufacturing, agriculture and infrastructure sectors where the manufacturing sector accounted for more than 31 per cent of total FDIs. Within the manufacturing sector, majority of investments were for chemical, petroleum, coal,

Investment and Employment in Enterprises Registered Under Board of Investment of Sri Lanka (BOI) and Ministry of Industry and Commerce (MIC)

2009(a) 2010(b)

BOI (Under Act No.4 of 1978) Projects Approved Under Section 17 (c) Under Section 16 Projects Contracted Under Section 17 (c) Realised Investment Under Section 17 (d) Commercial Operations (d) Under Section 17 (c)(d) Under Section 16 (d)

422 427 384 353 38 74 182 262 2,283 1,991 2,633 2,587 1,848 1,830 785 757

Employment (No.)

Envisaged and Actual Investment (Rs.million)

No. of projects Foreign

2009(a) 2010(b) Local

Total

Foreign

Local

2009(a) 2010(b)

Total

454,896 110,138 565,033 87,155 211,605 298,760 441,004 109,582 550,586 82,604 211,289 293,893 13,892 556 14,447 4,551 316 4,867 374,029 48,875 422,904 55,318 166,336 221,654 495,506 278,762 774,268 533,312 327,766 861,078 264,899 3,913,854 4,178,755 267,702 3,923,546 4,191,247 245,383 3,903,491 4,148,875 248,417 3,913,263 4,161,680 19,516 10,363 29,880 19,285 10,283 29,567

130,294 55,866 128,465 54,125 1,829 1,741 109,382 33,099 477,530 461,813 405,991 390,242 368,846 354,144 37,145 36,098

MIC

Projects Registered (d)

(a) Revised (b) Provisional (c) Includes expanded projects (d) Cumulative as at end of year

1,876 1,940

139,120

145,295

292,168 294,242

Sources: Board of Investment of Sri Lanka Ministry of Industry and Commerce

2 National Output and Expenditure

rebounded from the contraction of 2.1 per cent in 2009 to expand by 19.0 per cent in 2010. Since the price impact on transportation activities was marginal with public transportation and fuel prices remaining unchanged during the year, the growth in the sector could be attributed to the real increase in transportation activities with the peaceful environment in the country.

Central Bank of Sri Lanka Annual Report - 2010

Chart 2.4

Investment in Approved and Contracted BOI Projects (Including Expanded Projects) Number of Projects Number of Projects Number of Projects

700 600 700

Number of Projects

400 500 300 400 200 300 100 200 0 100

2006

2007

2008

2007

2008

Approved

2009

2010

Contracted

Value of Investment Value of Investment 700

Value of Investment

600 700 500 600 Rs. billion

Economic andOutput Socialand Infrastructure National Expenditure

500 600

400 500 300 400 200 300 100 200 0 100

2006(a)

2007 Approved 2007

2008

2009 Contracted 2009

2010

(a) Excluding local investment on Mihin Lanka (Pvt) Ltd.

plastic products category and textile, wearing apparel and leather products category. Majority of FDIs were from India with a value of US dollars 110 million. Other significant investments were from United Arab Emirates, Malaysia, United Kingdom, Singapore and Hong Kong. The accumulated realised investment of the BOI by end 2010 was Rs. 861 billion. The BOI approved 427 projects under Section 17 and Section 16 of the BOI Act during 2010 compared to 422 approved projects in the previous year. Out of the total approved projects in 2010, 135 projects were fully foreign owned and 183 projects were locally owned. The total estimated investment of the approved projects amounted to Rs. 299 billion during the year compared to Rs. 565 billion in 2009. Services sector continued to attract majority of investments with 266 projects, 52

while within the manufacturing sub-sector food, beverages, and tobacco products continued to be the main investment category. BOI continued to sign agreements under Section 17 of the BOI Act with foreign and local investors, while a number of projects located in the EPZs commenced commercial operations during 2010. Contracted investment during 2010 under Section 17 of the BOI Act amounted to a total investment commitment of Rs. 222 billion with 262 projects, compared to Rs. 423 billion with 182 projects in 2009. Majority of investments were for the services sector, which recorded an increase in the number of projects by 64 per cent to 141 projects in 2010. Within the manufacturing sub-sector, textile, wearing apparel and leather products category and fabricated metal, machinery and transport equipment category were the main contributors with an estimated investment of Rs. 11 billion. Total value of projects in commercial operation under Section 17 of the BOI Act increased to Rs. 4,162 billion by end 2010 compared to Rs. 4,149 billion by end 2009. Industries registered under MIC as at end 2010 increased to 1,940 from 1,876 in 2009, whereas, total investment increased to Rs. 145 billion from Rs.139 billion by end 2009. This includes enterprises located in all districts of the country while the largest investment was from Colombo and Gampaha districts creating more than 88 per cent of employment and attracting approximately 90 per cent of total investments. Government investment increased by 9.2 per cent in 2010. The main impetus was the continued growth in ongoing mega projects to enhance physical infrastructure in the sectors such as transport, irrigation, power and energy and water supply. These include Colombo - Katunayake Expressway, Colombo Outer Circular Road Project, and Southern Highway Projects. A number of projects were implemented in line with the rehabilitation programmes in the Northern part of the country. In addition, small scale development projects including “Maganaguma” and “Gamanaguma”

Central Bank of Sri Lanka Annual Report - 2010

Availability and Utilisation of Resources The resource availability of the country grew by 18.6 per cent in nominal terms to Rs. 7,329 billion during 2010 compared to a relatively low growth of 1.2 per cent in 2009. Further, the availability of resources is measured as the sum of domestic resources given by GDP and foreign resources, which is given by the value of imports of goods and services. Domestic resources estimated at Rs. 5,602 billion accounted for a share of 76.4 per cent of total resources. This was a decline of around two percentage points when compared to 2009 indicating the higher demand for foreign resources with improved economic activity during 2010. Consequently, foreign resources increased to a share of 23.6 per cent of total resources from a share of 21.8 per cent in 2009. Further, total resource availability increased in real terms by 9.3 per cent in 2010 recovering from the contraction of 0.3 per cent in 2009. The favourable development in resource availability was supported by both the increase in domestic output and imports in real terms during the year. Of the available resources, the largest share was utilised for consumption in 2010 as in the previous years. The share of consumption in total utilisation was 62.2 per cent when compared to a share of 64.2 per cent in 2009. The decline in the consumption share in total utilisation could be attributed to the expansion in the share of fixed capital formation during 2010 to 19.8 per cent from 18.6 per cent in the previous year. Further, the share of exports of goods and services accounted for 16.6 per cent of resource utilisation in 2010. Of the total supply of goods and services, domestic resources contributed for a share of around 76.4 per cent during 2010. Domestic

Table 2.14

A. Resources

Total Resources and Their Uses at Current Market Prices Percentage Share Percentage Growth

Item

2009(a) 2010 (b)

Gross Domestic Product Imports of Goods and Services

Total

78.2 76.4 21.8 23.6 100.0 100.0

2009(a) 2010 (b) 9.6 15.9 -20.8 28.4 1.2 18.6

B. Utilisation Consumption Gross Domestic Fixed Capital Formation Private Government Change in Stocks Export of Goods and Services

64.2

62.2

4.4

14.9

18.6 19.8 2.9 26.5 13.6 15.4 -1.7 34.5 5.0 4.4 17.6 4.9 0.6 1.4 -66.0 208.1 16.7 16.6 -5.9 17.8 100.0 100.0 1.2 18.6

Total (a) Revised (b) Provisional

Sources: Department of Census and Statistics Central Bank of Sri Lanka

goods, which account for a share of 32.3 per cent grew by 15.5 per cent during the year while domestic services, which account for 44.2 per cent recorded a growth of 16.1 per cent in nominal terms. The remaining 23.6 per cent of the total supply was provided by imports, of which goods constituted 20.8 per cent while services imports accounted for the remaining 2.7 per cent during the year.

Chart 2.5

The Economy in 2010 (at Current Prices) Supply of Goods and Services

2 National Output and Expenditure

programmes, which are aimed at achieving balanced regional development also continued. Social infrastructure projects also increased, including projects in sectors such as education, health and environment, which aim to enhance the productivity of the human resources in the country while improving the living standards of the people.

Supply o (Rs Supply of Goods (Rs. 7,329

(Rs. 7,329 billion)

Electricity, gas and water 1.7% Manufacturing 13.8%

Construction 5.8%

Mining and quarrying 1.2% Fishing 1.3% Agriculture, livestock and forestry 8.5% Imports of services 2.7% Imports of goods 20.8%

Services 44.2% Services 44.2%

Wholesale and retail trade 15.0% Hotels and restaurants 0.5% Transport and communication 9.7% Banking, insurance and real estate etc. 8.2% Ownership of dwellings 2.3% Government services 6.8% Private services 1.7%

Demand for Goods and Services (Rs. 7,329 billion)

Government consumption 11.9%

Private investment 16.5% Government investment 4.7% Exports of goods 12.8%

Private consumption 50.3%

Exports of services 3.8%

Dem

Central Bank of Sri Lanka Annual Report - 2010

Economic andOutput Socialand Infrastructure National Expenditure

Consumption, Investment and Savings at Current Market Prices

Table 2.15

Item 1. Gross Domestic Product at Market Prices 2. Consumption Expenditure Private Government 3. Investment Private Government 4. Domestic Savings Private Government 5. Domestic Savings - Investment gap 6. Net Factor Income from Abroad 7. Net Private Current Transfers from Abroad 8. National Savings (a) Revised (b) Provisional

Rs. million

% Change

As a per cent of GDP

2009(a) 2010(b) 2009(a) 2010(b) 2009(a) 2010(b) 4,835,293 3,967,770 3,116,221 851,549 1,181,449 863,485 317,964 867,523 1,047,454 -179,931 -313,927 -55,795 336,578 1,148,306

5,602,321 4,557,348 3,684,738 872,610 1,556,769 1,209,551 347,218 1,044,973 1,163,847 -118,874 -511,796 -71,858 407,967 1,381,082

9.6 4.4 1.0 19.3 -2.8 -7.1 11.1 41.8 49.6 -103.4 48.0 46.9 21.2 46.4

15.9 14.9 18.2 2.5 31.8 40.1 9.2 20.5 11.1 33.9 -63.0 -28.8 21.2 20.3

100.0 82.1 64.4 17.6 24.4 17.9 6.6 17.9 21.7 -3.7 -6.5 -1.2 7.0 23.7

100.0 81.3 65.8 15.6 27.8 21.6 6.2 18.7 20.8 -2.1 -9.1 -1.3 7.3 24.7

Sources: Department of Census and Statistics Central Bank of Sri Lanka

The growth momentum on the demand side improved in 2010 with consumption, investment and exports all recording higher growth rates than in the previous year. Consumption demand grew by 14.9 per cent during the year with the growth in both private and public consumption. Meanwhile, investment demand also grew by 31.8 per cent recovering from the set-back in 2009. Exports of goods and services also recovered from the contraction of 5.9 per cent in the previous year to record a nominal growth of 17.8 per cent during 2010.

Domestic savings, which grew by 41.8 per cent in 2009 recorded a lower growth of 20.5 per cent in 2010. Further, total domestic savings, which include both private and government savings, was estimated at Rs. 1,045 billion in 2010. Although government savings, which is defined as the current account balance of the government budget, remained negative during the year, it improved to 2.1 per cent of GDP from 3.7 per cent in 2009 and contributed favourably towards the growth in domestic savings. Meanwhile, domestic savings ratio (domestic savings as a percentage of GDP) was 18.7 per cent during the year.

Savings

National savings grew by 20.3 per cent to Rs. 1,381 billion in 2010. The growth in national savings was also dampened in 2010 when compared to the high growth of 46.4 per cent in the previous year. This slowdown in national savings is attributed to the worsening of net factor income from abroad while the 21.2 per cent growth in net private current transfers from abroad assisted in securing the growth in national savings during the year. Meanwhile, national savings ratio increased to 24.7 per cent during 2010 from 23.7 per cent in the previous year.

The growth in savings slowed down during 2010 when compared to that of the previous year. During 2009, savings improved due to the slowdown in domestic expenditure and the relatively low commodity prices in the international market. The recovery in economic activity, spurred by growth in consumption demand, dampened the growth in both domestic and national savings. Consequently, the resource gap widened from 6.5 per cent in 2009 to 9.1 per cent in 2010.

Central Bank of Sri Lanka Annual Report - 2010

Voluntary Pension Fund â&#x20AC;&#x201C; A Social Security Scheme to Increase Domestic Savings

A pension scheme is a form of social security which provides financial security and stability to the members of the scheme while contributing to raise the level of savings. In that context, the existing pension and superannuation schemes in Sri Lanka do not cover a large segment of the working population in the informal sector who are engaged in small business and self-employment activities. In order to address this long felt need for a social security scheme with a wider coverage, the Government has decided to establish a Voluntary Pension Fund (VPF) as a key policy initiative to introduce a social security scheme for the small business and those who are self-employed to save for their old age. The proposed VPF is open for all Sri Lankans, especially for those who are not members of any other social security fund. It will be managed by the Monetary Board of the Central Bank and will be operated through a simple and low cost electronic infrastructure which uses mobile phone technology for registrations, member contributions and the payment of monthly pensions. The VPF will be structured to serve dual purposes. First, the VPF will provide social security and financial stability to its members throughout their post-retirement life cycle. Needless to say, a monthly pension will significantly contribute to meet the pensionersâ&#x20AC;&#x2122; daily expenses and health care needs, so that they would not be a burden to society or the Government. Second, the VPF will serve to improve the savings habits of our people. The domestic savings rate in Sri Lanka was 18.7 per cent of the GDP in 2010. The national savings rate which includes domestic savings plus net factor income and net private transfers from abroad, was 24.7 per cent of the GDP in 2010. At

the same time, in order to reach a per capita GDP income level of USD 4,000 before 2016, the national savings should be increased up to about 30 per cent. Although such investment deficit may be covered by foreign borrowings and investments, the costs and risks associated with funds raised from foreign sources could be considerably higher compared to domestic savings. It is now estimated that there would be about 4 million small business, self- employed informal sector workers who could join and benefit from this scheme. Therefore, the VPF will be targeted at a wide range of occupations such as drivers, carpenters, mechanics, vendors, farmers, fishermen, migrant workers, etc. In addition, private sector casual employees who, presently, do not contribute to any form of social security funds, such as construction workers, housemaids, child care helpers, NGO workers and self-employed professionals such as lawyers, architects, consultants, advisors, journalists, musicians, entertainers, sports persons, beauticians, etc. too could greatly benefit from this scheme. A common feature of the small business and selfemployed persons is that they have a low saving habit, and hence they often become victims of the consequences of unsecured retirement life. Hence, the implementation of the VPF will be an important policy initiative to expand the opportunities for the small business and self-employed persons to save for their retirement. In addition, the VPF being a long-term fund, will be able to invest in a sufficiently diverse portfolio of long-term assets that incorporates the particular investment objectives and risk tolerance of the Fund, leading to the VPF being able to effectively contribute to the increase of the domestic savings, and thereby supporting the development of the country.

2 National Output and Expenditure

BOX 5

Economic and Social Infrastructure

3.1 Overview

he massive infrastructure development drive currently in progress is expected to support the country to maintain a high and sustainable growth in the medium term, which will raise the living standards of the people. Timely development of economic infrastructure will help increase economic efficiency while expanding the production capacity of the economy, facilitate productivity enhancement and reduction of regional disparity. Robust social infrastructure is also important in the development of a dynamic human capital base which is essential for the economy to transform into a knowledge based economy. In 2010, the economic infrastructure development programme of the government focused on all areas of infrastructure; development of roads, energy, water supply and sanitation, ports and aviation, transport and rural infrastructure. Several major infrastructure development projects launched by the government during the last few years were nearing completion by

end 2010. The construction work of phase I of Norochcholai Coal Power Plant and phase I of Hambantota Port Development Project were completed in 2010 while the Southern Expressway, the Upper Kotmale Hydro Power Project were nearing completion. Government investment on infrastructure development increased to Rs. 337 billion in 2010. Meanwhile, â&#x20AC;&#x153;Maga Neguma" rural road development programme, rural electrification projects, expansion of telecommunication network, minor irrigation projects and community based water supply projects continued to empower the rural economy, supporting a regionally balanced economic growth. As reflected in social indicators, the key social infrastructure facilities in the country continued to be satisfactory. In 2010, measures were taken to develop physical infrastructure facilities and the human capital base of the health sector. The education sector has also seen numerous improvements

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure

with a renewed focus on enhancing the quality of education provided by schools Island-wide. Steps were taken to initiate the drafting of a new Education Act with the view to revitalizing and re-designing the current education policy. Despite the various measures taken to improve the outcomes of the education sector, the mismatch between demand for and supply of labour continued to exist. Therefore, it is important to take measures to strengthen the education policies in line with the medium and long-term development objectives of the country. Though Sri Lanka has achieved significant progress in social development compared to many other countries in the region, these achievements are presently being challenged by demographic and epidemiological transitions and the structural changes that are taking place in the economy. Issues pertaining to the ageing population, the high prevelence of Non-Communicable Diseases (NCDs), and the re-emergence of communicable diseases, need to be addressed by re-aligning the health care system in the country. With the rapid growth in demand for high quality services globally, Sri Lanka has a potential to be an exporter of high quality health, education and other professional services. The existing competitive advantages such as strategic location, competitive prices coupled with a competent workforce are strong settings that can attract foreign demand for such services. If this potential is harnessed appropriately, these Government Investment in Infrastructure

Table 3.1

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (c)

Economic Services Rs. bn

% of GDP (a) 54.9 3.9 51.7 3.4 58.7 3.2 61.3 2.9 77.5 3.2 106.8 3.6 141.2 3.9 168.9 3.8 256.4 5.3 280.8 5.0

Social Services Rs. bn

% of GDP (a) 14.6 1.0 15.7 1.0 19.2 1.1 29.0 1.4 60.4(b) 2.5 48.4 1.6 55.0 1.5 60.2 1.4 53.9 1.1 56.2 1.0

Total Rs. bn

% of GDP (a) 69.5 4.9 67.4 4.4 77.9 4.3 90.3 4.3 137.9 5.7 155.2 5.3 196.2 5.5 229.1 5.2 310.3 6.4 337.0 6.0

(a) From 2003, data based on GDP Sources: Ministry of Finance and Planning Central Bank of Sri Lanka estimates compiled by the Department of Census and Statistics (b) Inclusive of Tsunami related capital expenditure (c) Provisional

services can become a significant source of foreign exchange for the country. While the commitment of the government to improve the infrastructure base of the country is commendable, it is important to ensure long-term viability of key public sector institutions which provide utility services by improving financial management and pricing. Less dependence of these entities on the government budget and the banking system to finance their operating losses is important to reduce the likely macroeconomic implications. In order to address such issues, the government has initiated action towards improving the operational efficiency of State Owned Enterprises (SOEs). The focus was on improving performance through management reforms and thereby transforming SOEs into entities which can provide the government with a dividend income while carrying out their social responsibilities. SOEs are encouraged to explore innovative financing, professional boardroom practices and governance, effective corporate planning and increased public accountability to enhance the performance of these enterprises. The Ministry of State Resources and Enterprise Development was established with the aim of restructuring and revitalizing SOEs through appropriate and tailor-made restructuring plans. Public Private Partnerships (PPPs) were also encouraged, as private sector participation is important to instigate dynamism and efficiency in the operations and management of SOEs. The continuation of these efforts is critical to make SOEs financially viable in the long run and to improve the quality of their service delivery.

3.2 Economic Infrastructure, Policies, Institutional Framework and Performance Communication Services The growth momentum in the telecommunications sector continued in 2010 reflecting the increased demand mainly from the Northern and Eastern provinces. The number of mobile connections has recorded a growth of 20.9 per cent to 17.2 million while a

Central Bank of Sri Lanka Annual Report - 2010

Chart 3.1 3.1

Telephone Density

120

Telephones per 100 persons

100 80 60 40 20 0

2006

2007

Fixed Access

2008

2009

2010

Total (including Cellular phones)

Several measures have been taken by the TRC to ensure the efficient provision and development of Information and Communication Technology (ICT) services. The TRC enforced floor prices and interconnection rates for mobile phones. This has helped ensure fair pricing and competition for market players by preventing unnecessary price competition. This facilitates the telecommunications industry to invest in research, development and expansion. A benchmarking process was initiated for Asymmetric Digital Subscriber Line (ADSL) and Worldwide Interoperability for Microwave Access (WiMAX) services to monitor the quality and speed of each service provider. A sophisticated telecommunications sector is a prerequisite for Sri Lanka to emerge as a commercial and a knowledge hub. A modern telecommunication infrastructure contributes to the improvement of efficiency and productivity of all the other sectors of the economy by way of reducing transaction costs. Sri Lanka owns one of the most modern telecommunications industries in the region and has been the first to introduce latest technologies, such as Global System for Mobile Communication (GSM), Code Division Multiple Access (CDMA) fixed wireless telephone services, General Packet Radio Service Table 3.2

3 Economic and Social Infrastructure

growth of 3.9 per cent was recorded in the fixed telephone connections which increased to 3.6 million. Accordingly, the telecommunications sector experienced an overall growth of 17.6 per cent to 20.8 million connections in 2010. The growth was largely fuelled by the expansion and strengthening of network coverage in the Northern and Eastern provinces provided by mobile service providers. Also, the provision of attractive calling charges and value added services at competitive prices in mobile phone connections, has stunted the growth in the fixed access telephone connections. Increase in mobile connections has led to a significant increase in mobile penetration (mobile connections as a per cent of total population) to 83.5 per cent in 2010 from 69.8 per cent in 2009. With these developments, telephone density (telephones per 100 persons including cellular phones) increased to 100.8 in 2010 from 86.6 in 2009 reflecting that, on average, each person has a telephone. As at end 2010, the telecommunications sector consisted of multiple telephone service providers including 4 fixed line operators, 5 mobile operators, 33 external gateway operators, and 8 internet service providers, making the industry more competitive. However, the level of internet penetration remains at 2.1 per cent. Existing operators face the challenge of expanding broadband penetration in the country up to at least 10 per cent within the next two years. The Telecommunications Regulatory Commission (TRC) has suggested that newcomers may be allowed to operate in the market if the said target is not met.

Growth of Telecommunications and Postal Services Growth Rate (%)

Item 2009

2010(a) 2009 2010(a)

1. Telecommunications services 1.1 Fixed access services (No.) (â&#x20AC;&#x2DC;000) Wireline telephones in service 872 897 -6.6(b) 2.9 Wireless local loop telephones 2,564 2,674 2.0 4.3 1.2 Cellular phones (No.) (â&#x20AC;&#x2DC;000) 14,264 17,247 28.7 20.9 Telephone density (Telephones per 100 persons including cellular phones) 86.6 100.8 20.4 16.4 1.3 Other services Public pay phones (No.) 7,378 7,054 -0.5 -4.4 Internet & e-mail (No.) (â&#x20AC;&#x2DC;000) 240 430 (c) 2.6 79.2 2. Postal service Delivery areas (No.) 6,729 6,729 0.0 0.0 Post offices (No.) 4,738 4,742 0.0 0.1 Public 4,054 4,058 0.0 0.1 Private 684 684 0.0 0.0 Area served by a post office (Sq.km) 14 14 1.4 0.0 Population served by a post office (No.) 4,316 4,355 0.1 0.9 Letters per inhabitant (No.) 20 17 -4.8 -15.0 Sources: Telecommunications Regulatory (a) Provisional Commission of Sri Lanka (b) Wireline telephones declined in 2009 Department of Posts due to shift of some subscribers to cellular phones (c) Including mobile broadband services

Value of Investment 700 600 500 400

3.3 International Crude Oil (Brent) Prices (Monthly Average) 2008

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure

(GPRS), ADSL, WiMAX, High Speed Downlink Packet Access (HSDPA) and 3.5G services. Also, the market hosts a number of players, leading to increased competition, which in turn, fast tracked technological developments and increased market penetration. However, in line with the vision to become services so as to enhance the productive capacity of the economy and the countryâ&#x20AC;&#x2122;s attractiveness to foreign investment. Postal services registered a mixed performance during the year. The postal service consisted of 4,742 post offices, including 648 main post offices, 3,410 sub post offices, 156 rural agency post offices and 65 estate and 463 agency post offices. The average population served by a post office is around 4,355 persons in 2010. The initiatives taken by the Department of Posts (DOP) in 2007 to provide certain other revenue generating services such as banking facilities and selling pre-paid phone cards were continued in 2010. The DOP has earned around Rs. 21 million as commissions for these services carried out during the year. DOP launched a four hour express courier service in 2010, in Colombo and suburbs to cater to the emerging demand from the private sector. In 2010, the DOP adopted several strategies such as penetrating into more income generating areas and adopting cost rationalization methods to transform itself into a self-financing venture. The DOP continued to report operating losses in 2010. The operating loss of DOP remained high, at Rs. 3,008 million in 2010. The total revenue of the DOP decreased to Rs. 4,322 million while the operating expenditure increased by 3.1 per cent to Rs. 7,330 million, leading to an increase in operating losses. Hence, it is important for DOP to continue with the efforts taken to generate other sources of income and vigorously follow cost rationalization methods to transform it to a self-financing venture.

Energy In 2010, international oil prices were largely influenced by the global economic recovery. Since the pace of recovery in the global economy 60

was slower than expected, increase in oil prices were subdued during the first nine months of 2010. Over this period, oil prices hovered largely in the range of US dollars 70 â&#x20AC;&#x201C; 80 per barrel. By the end of the year, prices started to increase rapidly and touched US dollars 90 levels as the US economy showed signs of growth. In 2010, the annual average price of crude oil (Brent) had increased to US dollars 80 per barrel as compared to US dollars 62 per barrel in the previous year. An upward price pressure is expected to persist in 2011 due to increased demand from emerging countries and the geo-political tensions in the Middle East. The annual average import price of crude oil (C&F) by Ceylon Petroleum Corporation (CPC) stood at US dollars 79.52 per barrel reflecting an increase of 24.4 per cent when compared to that of the previous year. Though the international oil price was high, the increased hydropower generation cushioned the pressure of high oil prices on the external sector. The electricity sector benefitted from the high rainfall which prevailed in catchment areas throughout the year. The construction of low cost coal power plants enabling the country to change its energy mix and measures taken to implement renewable energy projects would reduce the countryâ&#x20AC;&#x2122;s vulnerability to high oil prices in the long run.

Electricity Electricity generation increased by 8.4 per cent to 10,714 GWh in 2010 reflecting the growth in economic activities and the lower base in 2009. The share of hydro power in total power generation increased to 52.6 per cent from 39.3 per cent in the previous year reflecting the high rainfall which prevailed throughout the year in catchment areas. As a result, thermal power generation decreased by 16.4 per cent to 4,995 GWh. The system loss, as a percentage of total generation, declined from 14.6 per cent to 13.5 per cent in 2010. The share of Ceylon Electricity Board (CEB) in total electricity generation increased to 60 per cent in 2010 from 55 per cent in 2009, reducing the share of the power produced by the private sector to 40 per cent.

Central Bank of Sri Lanka Annual Report - 2010 Power Sector Performance Growth Rate (%) Item

2009

2010(a)

Installed capacity (MW) (b) Hydro Thermal Other

2,684 1,379 1,290 15

Units generated (GWh) (b) Hydro Thermal Other

9,882 3,881 5,975 26

Total sales by CEB (GWh) Domestic and religious Industrial General purpose and hotel Bulk sales to LECO Street lighting

8,441 2,927 2,518 1,768 1,120 108

9,268 3,186 2,870 1,903 1,201 108

0.3 4.6 -6.0 3.8 -0.9 0.0

9.8 8.8 14.0 7.6 7.2 0.0

LECO sales (GWh) Domestic and religious Industrial General purpose and hotel Street lighting

1,050 486 208 331 25

1,123 -2.0 510 1.3 229 -12.2 363 1.2 21 -7.4

7.0 4.9 10.1 9.7 -16.0

Overall system loss of CEB (%) Number of consumers (â&#x20AC;&#x2DC;000) (c) o/w Domestic and religious Industrial General purpose and hotel (a) Provisional (b) Inclusive of Independent Power Producers (IPPs) (c) Inclusive of LECO consumers

2,817 1,382 1,390 45

2009 1.5 2.5 0.4 0.0

5.0 0.2 7.8 200.0

10,714 -0.2 5,636 -6.0 4,995 3.7 83 188.9

8.4 45.2 -16.4 219.2

14.6

13.5

-2.7

-7.5

4,749 4,207 46 491

4,958 4,392 48 513

4.5 4.5 4.5 3.8

4.4 4.4 4.3 4.5

Sources: Ceylon Electricity Board Lanka Electricity Company (Pvt.) Ltd

The sale of electricity, excluding system losses from total generation, increased significantly by 9.8 per cent to 9,268 GWh in 2010. The electricity consumption of the household, general purposes and hotel categories increased by 8.8 per cent, 7.1 per cent and 13.7 per cent, respectively, in 2010. Meanwhile, electricity consumption by the industrial sector increased significantly by 14 per cent, reflecting the growth in industrial activities. The financial position of CEB improved during the year. CEB recorded an operating profit of Rs. 5 billion in 2010 compared to a loss of Rs. 11 billion reported in 2009. The less dependence on high cost thermal power generation helped mitigate the pressure on the cash flow of CEB. At the same time, the availability of furnace oil at a highly subsidised rate has also helped improve the financial position of CEB, though it was a burden on CPC. Meanwhile, measures taken by CEB to curtail costs also helped improved its financial performance

in 2010. The fuel bill of CEB decreased by 34.9 per cent to Rs. 16.4 billion in 2010. On average CEB incurred Rs. 4.33 to generate a unit of electricity in 2010. The average purchase price of power per unit from the private sector amounted to Rs.15.25 in 2010. However, the exemption of Fuel Adjustment Charge (FAC) granted to the industrial category and changes to the tariff structure to provide further relief to low income households under the fiscal stimulus package of the government, adversely affected the financial position of CEB. The average cost of electricity generation decreased to Rs. 13.01 per unit while the average tariff of a unit was at Rs. 13.16 in 2010. CEBâ&#x20AC;&#x2122;s short-term borrowings from banks and other outstanding liabilities to CPC and to Independent Power Producers (IPPs) amounted to Rs. 87.9 billion by end 2010. Several changes were introduced to the electricity tariff with effect from January 2011. The average tariff was increased by 8 per cent with the new tariff revision. The tariff applicable to households which consume less than 120 units was kept unchanged as a relief measure to lowincome consumers. At the same time, the tariff applicable to the industrial and commercial sectors was increased and tariff based on the time of use was made mandatory for large scale hotels and industries. The FAC of 30 per cent applicable on some categories which were not given concessions under the fiscal stimulus was removed with effect from January 2011.Though the measures taken to maintain the tariff applicable to domestic users at the same level and the exemption of FAC will ease the cost of living of domestic users, their long-term adverse effect on CEB would be significant. Concessionary tariff may result in lack of power conservation by the public. Also, with the already high tariffs prevailing in the country, increase in the tariff applicable to the industrial and general purpose categories may affect the cost of production of industries and thereby, on external competitiveness. However, the addition of low cost power plants, especially coal power, would bring down the cost of power generation, thereby creating room to maintain the electricity tariff at a competitive level in the medium term. 61

3 Economic and Social Infrastructure

Table 3.3

Central Bank of Sri Lanka Annual Report - 2010

The first electricity tariff filing by the Public Utilities Commission of Sri Lanka (PUCSL), which was established to regulate the major utilities in Sri Lanka, was carried out in 2010. Public hearing and stakeholder consultations were conducted before the revision of the general tariff structure. Non-Conventional Renewable Energy (NCRE) based electricity purchase tariffs were also introduced in order to increase the transparency of the process. Meanwhile, the Multi-Year Tariff review methodology was introduced during the year and licensees were informed on the methodology related to allowed charges. The capacity limitation which was inherent to the electricity sector for several years has been successfully addressed with the construction Chart 3.2

ChartTariff 3.2 and Cost of Electricity Average

Average Tariff and Cost of Electricity

20 18 16 Rs./ unit

Economic and Social Infrastructure

The CEB has significantly expanded its distribution network and has taken steps to improve its transmission efficiency. The electrification level in Sri Lanka is substantially high compared to many other countries in the region. With the ongoing rural electrification projects, it is expected to achieve 100 per cent electrification by end 2012. To achieve this target, the government launched several rural electrification projects islandwide such as Conflict Affected Area Rehabilitation Rural Electrification Project, Rural Electrification Project 4 and Rural Electrification Project 8. With these efforts, the electrification level which stood at 86 per cent in 2009 increased to 90 per cent by end 2010.

14 12 10 8 6 4 2 0 2006

2007

Domestic Tariff Average Cost

2008 Industry Tariff Average Tariff

2009

2010

General Purpose Tariff

of several new power projects. The second phase of the Kerawalapitiya Combined Cycle Power Plant (100 MW), which was previously in the testing phase, was added to the national grid on a permanent basis in May 2010. The construction of the first phase of the Norochcholai Coal Power Plant (300 MW) was completed by end 2010 and was added to the national grid by end March 2011. The second phase of the Norochcolai Coal Power Plant will add another 600 MW to the national grid by 2014. The construction of Upper Kothmale Hydro Power Plant (150 MW) was also in progress in 2010. The Upper Kothmale Hydro Power Plant is expected to be added to the national grid by end 2011. The Uma Oya Hydro Power Plant, which is at the initial stages of construction, is also expected to add another 120 MW to the national grid. Meanwhile, agreements are being finalized for the construction of a 500 MW coal power plant in Trincomalee. With the addition of these new power plants to the national grid, the total installed capacity of the country will increase by around 62 per cent. Fast implementation of these projects will help to improve the resilience of the economy to face future oil price shocks. At the same time, emphasis has also been placed on the development of appropriate renewable energy and other low cost energy sources such as Liquefied Natural Gas (LNG), and the promotion of energy conservation in the country in the medium term. Three wind power plants of 10 MW each were added to the national grid in 2010. These wind plants are located in the Puttalam district and two plants were connected to the national grid in May and the other plant in July 2010. The energy labelling programme carried out by the Sustainable Energy Authority (SEA) was successful and the penetration of Compact Florescent Lights (CFLs) has supported the achievement of an annual energy saving of 22 GWh. The SEA has planned to extend the energy labelling programme to other products as well. The estimated annual energy saving due to enhanced use of energy efficient equipment through the labelling programme is 240 GWh. Simultaneously, measures are being taken to promote renewable energy sources such as wind and solar power.

Central Bank of Sri Lanka Annual Report - 2010

International crude oil prices remained high in 2010 compared to lower prices in the previous year. The average international crude oil (Brent) price increased to US dollars 80 per barrel in 2010 from US dollars 62 per barrel in 2009, reflecting an increase of 29 per cent. International crude oil prices which were in the range of US dollars 7080 during the first half of the year increased up to US dollars 92 by the end of 2010 mainly due to strong global demand and geo-political instability in certain oil producing regions. The average cost and freight (C&F) price of crude oil imported by CPC increased by 24.4 per cent to US dollars 79.52 per barrel in 2010. The consumption of petroleum products increased during 2010 reflecting increased demand for passenger and goods transportation in the country. The total sales of major petroleum products namely petrol, diesel and kerosene by CPC and Lanka IOC (LIOC) PLC increased by 4.7 per cent, in 2010 compared to that of the previous year. Petrol sales have increased by 14.3 per cent and diesel sales increased marginally by 1.2 per cent reflecting the lower demand for thermal power generation. The sale of kerosene increased by 9.6 per cent reflecting an increased demand from Northern and Eastern provinces' increased fishing activities and industrial activities. A duty waiver of Rs. 20 was granted on petrol with effect from November 2010 to compensate the losses made by oil companies due to increased international prices. Domestic International Crude Oil (Brent) Prices (Monthly Average) 2009/2010 International Crude Oil (Brent) Prices (Monthly Average) 2008/2009

Chart 3.3 3.3 100 90

US$/bbl

80 70 60 50 40 30

09’ Jan

Mar

May

Jul

Sep

Nov

10’ Jan

Mar

May

Jul

Sep

Nov

retail prices of petroleum products were not revised during the year. Prices have remained the same since December 2009 and continue to shelter consumers from high prices which prevailed in the international market in 2010. At the same time, Social Responsibility Levy (SRL) and Value Added Tax (VAT) on import of petrol were also removed. CPC also increased the price of furnace oil, previously sold to CEB at a subsidized price of Rs. 25, to Rs. 40 per litre with effect from September 2010. Table 3.4

Petroleum Sector Performance

Item Quantity imported (Mt ‘000) Crude oil Refined products (b) L.P. gas Domestic L.P. gas production (Mt ‘000)

Growth Rate % 2009 2,066 2,135 146 24

2010(a) 1,819 2,936 163 23

2009 2010(a) 11.5 1.5 1.4 50.0

Value of imports (C&F) Crude oil (Rs. mn) 111,715 120,180 -22.0 (US dollars mn) 973 1,064 -26.5 Refined products (Rs. mn) 126,111 200,634 -37.2 (US dollars mn) 1,093 1,775 -41.0 L.P. gas (Rs. mn.) 11,298 16,049 -26.5 (US dollars mn) 98 142 -31.0 Average price of crude oil (C&F) (Rs./barrel) 7,343 8,985 -30.0 (US dollars/barrel) 63.93 79.52 -34.1

Quantity of exports (Mt ‘000) Value of exports (Rs. mn) (US dollars mn) Local sales (Mt ‘000) o/w Petrol (90 Octane) Petrol (95 Octane) Auto diesel Super diesel Kerosene Furnace oil Avtur Naphtha L.P. Gas

268 340 -13.5 15,484 24,403 -43.8 135 216 -47.1 3,919 3,951 5.9 518 595 5.7 22 22 -24.1 1,681 1,699 4.7 9 12 0.0 151 165 0.0 1,110 1,004 11.1 229 275 21.2 111 82 -21.8 194 209 11.5

Local Price (end period) (Rs./litre) Petrol (90 Octane) Petrol (95 Octane) Auto diesel Super diesel Kerosene Furnace Oil 500 Seconds 800 Seconds 1,000 Seconds 1,500 Seconds 3,500 Seconds L.P. Gas (Rs./kg) Litro Gas (c) Laugfs Gas

115.00 115.00 133.00 133.00 73.00 73.00 88.30 88.30 51.00 51.00

-12.0 37.5 11.6 -4.2 7.6 9.4 59.1 62.4 42.1 44.9 22.4 24.4 26.9 57.6 60.0 0.8 14.9 0.0 1.1 33.3 9.3 -9.5 20.1 -26.1 7.7

-4.2 0.0 4.3 3.5 2.0

0.0 0.0 0.0 0.0 0.0

0.0 2.9 0.0 3.2 4.0

0.0 0.0 0.0 0.0 0.0

124.01 132.16 -13.2 118.48 121.60 8.1

6.6 2.6

54.30 34.90 52.70 32.70 26.00

Sources: Ceylon Petroleum Corporation (a) Provisional Lanka IOC PLC (b) Imports by Ceylon Petroleum Corporation, Lanka Marine Services (Pvt.) Ltd Lanka IOC PLC and Lanka Marine Litro Gas Lanka Limited Services (Pvt.) Ltd Laugfs Gas Limited (c) On 04 November 2010, the government Sri Lanka Customs purchased remaining 51% stake of Shell Gas Lanka Limited and took over the management and decision making powers. It was later renamed as Litro Gas Lanka Ltd.

3 Economic and Social Infrastructure

Petroleum

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure

Despite this, the government continues to provide kerosene subsidy stamps as an additional financial support for Samurdhi recipients. The CPC’s financial position eroded further during the year. The CPC reported an operational loss of Rs. 28.6 billion in 2010 compared to Rs. 26.2 billion in 2009. The main contributory factors for the financial losses of CPC were the provision of heavy fuel at a highly subsidised rate to CEB and Individual Power Producers (IPPs), a subsidy granted on kerosene and the non-adjustment of prices in line with international oil prices during the year. Continuous operational losses of CPC has resulted in a significant loss in tax revenue to the government as well as high borrowing from the banking system by the CPC to undertake their financial operations. The CPC’s net borrowing increased by Rs. 68.4 billion from the banking system for their working capital requirements during the year. The refinery modernization and expansion project is in the pipe line. The existing capacity of the oil refinery is 50,000 barrels per day and is sufficient to meet approximately 45 per cent of the total demand for petroleum products of the country. With the expansion and modernization of the oil refinery, the capacity will increase by another 50,000 barrels a day. The final report of the feasibility study of the refinery modernization expansion project was completed in October 2010. Land acquisition for the refinery was in progress. The preparation of the Environment Impact Assessment (EIA) report and obtaining approval of the Central Environment Authority for the project is under way. The refinery modernization will increase the quality of the end product and bring it on par with international standards.

Oil Exploration Oil exploration in the Mannar Basin was in progress in 2010. Cairn Lanka Private Limited (CLPL), the contractor for block No. 2 of the Mannar Basin, acquired Three Dimensional (3D) seismic data for 1,750 Sq km within the block, in March 2010. An oceanographic and meteorological survey to collect data on ocean currents and wave heights has already been completed by the CLPL. 64

CLPL plans to commence drilling 3 exploration wells in 2011. In addition to the remaining blocks in the Mannar Basin, blocks identified for exploration in the Cauvery and Southern Offshore Basins are expected to be offered for oil exploration in the next licensing round.

Transportation The transportation sector demonstrated a noticeable improvement in 2010. This improvement was seen predominantly in the road development sector. Construction of highways, expressways, bridges, rehabilitation of existing roads with special focus on roads in the Northern and Eastern provinces, and construction of rural roads under the "Maga Neguma" programme continued in 2010. Road passenger transportation, rail and bus transportation, port services and air transportation also recorded impressive performance, reflecting the recovery in economic activities.

Road Development Road development in the country, which was left behind during the last few decades, has been given prominence under the “Randora” Infrastructure Development Programme of the government. The National Road Master Plan has been prepared to direct the government’s policy on road development. The National Road Master Plan focused on the construction of expressways and highways, widening of highways, reduction of traffic congestion, road maintenance and rehabilitation, bridge rehabilitation and reconstruction, land acquisition and resettlement of people where necessary. Since the development of road infrastructure is crucial for balanced regional development, and the poor condition of the road network is a major detrimental factor in attracting new investment to the regional areas of the country, emphasis has been given to the construction of several roads, to connect provinces with the centre. Concurrently, under the "Maga Neguma" Programme, the government has taken action to improve the conditions of rural level roads in order to improve the connectivity between regional and urban areas.

Central Bank of Sri Lanka Annual Report - 2010

Construction activities of major road development projects continued in 2010. Around 83 per cent of the first three sections of the Southern Expressway was completed by end 2010. It is expected to be open to the public by mid-2011. The fourth section of the project, from Pinnaduwa to Matara, is to be awarded to a consortium of local contractors upon the completion of the first three sections. Land acquisition for Stage I of the Colombo Outer Circular Highway was nearing completion by end 2010 and construction work was in progress. For the construction of Stage II of the Outer Circular Highway, land acquisition was commenced and for Stage III, 60 per cent of the detailed design study was completed by end 2010. Furthermore, construction of the Colombo-Katunayake Expressway Project was in progress during the year. Field surveys of the Colombo-Kandy Expressway are nearing completion and the preliminary design and land acquisition were in progress. Under the Weak

Bridge Programme (WBP), 169 bridges were identified, of which 15 bridges were rehabilitated in 2010 and the construction of 32 bridges is under way. The rehabilitation of the Kantale-Trincomalee and Ambepussa-Dambulla roads were at the initial stages. Meanwhile, rehabilitation of rural roads under the "Maga Neguma" Rural Road Rehabilitation Programme continued in 2010 throughout the country. The fund allocation for the "Maga Neguma" Programme for the year 2010 stood at Rs.3 billion. During the year, a total of 703 km of roads were improved or reconstructed under this programme. The liberation of the North and East has created new opportunities to link these two provinces with the rest of the country, for which an efficient road network is essential. Recognizing this, the Conflict Affected Area Rehabilitation Project (CAARP), was commenced to reconstruct 190 km of roads in the Northern and Eastern Provinces. As at the end of 2010, 83 km of national highways have been completed under this project. A further 170 km of national roads in the North Central and Northern Provinces and 140 km of provincial roads in the Northern Province will be rehabilitated under the North Road Connectivity Project (NRCP). The initial work for the rehabilitation of the Kandy-Jaffna (A9) road project, and the Rehabilitation of Northern Roads Project has commenced. Under this project, a total of 512 km of roads in the Northern Province will be rehabilitated. The Sanguppidi Bridge that connects the Jaffna Peninsula to the mainland was opened in January 2011. This 288 metre long two-way bridge situated on the A32 (Colombo - Pooneryn) road will reduce the distance to Jaffna by nearly 80 kilometres and help cut down travel time to Jaffna by roughly three hours.

Road Passenger Transportation Public passenger transportation showed mixed performance in 2010. The total operated kilometreage of the Sri Lanka Transport Board (SLTB) increased by 2.7 per cent while total passenger kilometreage increased by 7.6 per cent, during the year. Though SLTB owned a fleet 65

3 Economic and Social Infrastructure

The current road density of Sri Lanka, at 1.6 km of roads per every square kilometre, is high when compared to that of other countries in the South Asian region. The network of National Highways consisted of 4,219 km of Trunk (A class) and 7,704 km of Main (B class) roads and 4,213 bridges as at end 2010. The road density will further increase with the completion of planned road development activities. However, the economic planning process is in need of proactive assessment of capacity requirements, given the expected high economic growth and the need for increased mobility within the regions. This is essential to gradually bring down the transportation cost per kilometre to levels similar to that of developed countries and thereby, help improve competiveness. High traffic volumes and poor road maintenance has contributed to congestion cost of Rs. 32 billion per year in Sri Lanka (The World Bank, 2009). Further, proper coordination and planning between other service providers like CEB, National Water Supply and Drainage Board (NWS&DB) and Telecom Service Providers, can help to eliminate the duplication of work, wastage and reduce maintenance costs caused by the expansion of these utility services along the roads.

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure

of 7,746 buses, the operated average number of buses in 2010 was 4,441 per day compared to the requirement of 7,131 buses. Refurbishment of buses and adding them to the fleet was a progressive step taken by SLTB to maintain the operative bus fleet. The number of buses owned by private operators increased by 6.1 per cent to 19, 805 while the operated average number of buses increased to 15, 884 in 2010. The total operated kilometreage by private operators increased by 21.6 per cent while total passenger kilometreage increased by 21.6 per cent, during the year. Several projects were carried out to address weaknesses in the road passenger transportation sector during the year. The ‘Nisi Seriya’ night time bus service, ‘Sisu Seriya’ school bus service, and ‘Gami Seriya’ to provide transport facilities in uneconomic routes and remote areas continued during the year. The Treasury provided Rs. 1,662 million to cover losses on account of operations on uneconomic routes, season subsidies and the operation of “Nisi Seriya” and “Sisu Seriya” during the year. Bus fares were not revised as per the national bus fare policy during the year as there was no significant change in the cost elements linked to fare revision. Several measures were taken to improve the efficiency of the state owned bus services. In order to improve the productivity of SLTB, a broad network was established between the head office, regional offices and depots, to exchange information. A pilot project was carried out to introduce electronic ticket machines with GPRS facilities. The financial position of the SLTB continued to remain weak in 2010. The total passenger revenue of the SLTB increased to Rs.15.2 billion while the operating expenditure amounted to Rs.23.6 billion. As a result, the operating loss amounted to Rs. 8.4 billion in 2010. The subsidy payment of the government to the SLTB on other services amounted to Rs. 5 billion during the year. The weak financial position of the SLTB highlights the importance of continuing efforts to make state owned passenger transportation entities run efficiently without burdening the government budget. 66

Reflecting the recovery in economic activities, the number of vehicle registrations increased significantly during the year. The number of vehicles registered increased by 76 per cent to 359,243 during the year. The number of buses registered increased by 237 per cent during the year. The number of motor cars registered increased by 300 per cent, reflecting the reduction of import duties and increased income levels.

Railway Transportation Sri Lanka Railways (SLR) registered a mixed performance in 2010. Passenger kilometreage decreased by 4.7 per cent mainly due to the closure of the coastal railway line between Galle and Matara for rail track upgrading. Meanwhile, goods kilometreage increased substantially by 44 per cent, reflecting increased utilization of railway for oil transportation, which helped SLR to reduce its operating losses by 33.5 per cent to Rs. 3,173 million in 2010. The substantial reduction of operating expenditure by Rs. 1.6 billion in 2010 also helped to curtail the operating loss. SLR contributes only to about 5 per cent of passengers and 2 per cent of freight transportation via its 1,640 kms of rail network. The railway network coverage, reliability and the service delivery should be improved in line with the emerging transport demand of the country. With the view to improving the efficiency of railway transportation, SLR initiated several fleet upgrading measures and continued with railway infrastructure development projects in 2010. In order to increase the punctuality and reliability of the railway service, measures were taken to expedite maintenance of locomotives thereby increasing their availability for services. With this initiative, SLR was able to make available the daily requirement of 60 locomotives. Steps have also been taken by SLR to import 20 Diesel Multiple Units (DMUs) and 3 Locomotives in two phases to strengthen the rolling stock position of SLR. Out of the 13 DMUs to be delivered in 2011, 2 are luxury units which are to be specifically used for tourism purposes while others would be used to strengthen operations in the hill country and Kelani Valley railway lines. In order to increase the

Central Bank of Sri Lanka Annual Report - 2010 Salient Features of the Transport Sector

Item 1. New registrations of motor vehicles (No.) Buses Private cars Three wheelers Dual purpose vehicles Motor cycles Goods transport vehicles Land vehicles

Growth Rate(%) 2009

2010(a)

2009

2010(a)

204,075 359,243 -23.0 739 2,491 -37.4 5,762 23,072 -71.5 37,364 85,648 -16.6 1,280 11,712 -55.2 135,421 204,811 -13.2 8,225 11,845 -41.4 15,284 19,664 -41.5

76.0 237.1 300.4 129.2 815.0 51.2 44.0 28.7

2. Sri Lanka Railways

Operated kilometers (‘000) Passenger kilometers (mn) Freight ton kilometers (mn) Total revenue (Rs.mn) Operating expenditure (Rs.mn) Operating loss (Rs.mn)

9,545 4,568 113 4,020 8,788 4,768

9,723 4,353 163 4,018 7,191 3,173

3.5 -2.2 -6.6 9.5 6.8 4.7

1.9 -4.7 44.2 0.0 -18.2 -33.5

3. Sri Lanka Transport Board

Operated kilometers (mn) Passenger kilometers (mn) Total revenue (Rs.mn) Operating expenditure (Rs.mn) Operating loss (Rs.mn)

332 15,131 13,979 22,005 8,026

341 16,274 15,200 23,616 8,416

6.1 0.3 -2.7 6.7 28.2

2.7 7.6 8.7 7.3 4.9

4. SriLankan Airlines

Hours flown Passenger kilometers flown (mn) Passenger load factor (%) Weight load factor (%) Freight (Mt. ‘000) Employment (No.)

(a) Provisional

54,228 7,851 76 58 69 4,664 Sources:

62,694 -20.0 9,400 -14.4 78 2.7 55 -1.7 83 -20.7 4,969 -4.3

15.6 19.7 2.6 -5.2 20.3 6.5

Department of Motor Traffic Sri Lanka Railways Sri Lanka Transport Board National Transport Commission Civil Aviation Authority of Sri Lanka Sri Lankan Airlines

efficiency of operations, the duplication of tracks from Ragama to Negombo and Kalutara South to Payagala continued during the year. The upgrading of the costal line railway to increase the speed level up to 100 kmph will help reduce travel time between Colombo and Matara. Construction of the Matara-Galle section of the track was completed by mid-February 2011. Contracts were awarded for relaying the rail track from Omantai to Pallai, Pallai to Kankesanturai, Madawachiya to Madu, and Madu to Talaimannar in 2010. With the liberation of the Northern and the Eastern provinces, SLR recommenced operations to those areas. SLR extended the operation of ‘Yal Devi’ and ‘Rajarata Rajina’ trains up to the Thandikulam railway station in 2010. The service on the Eastern railway sector was improved by introducing a Rail-Bus service. Joint actions were

taken by SLTB and SLR to ensure better rail-road coordination at several main stations. Meanwhile, special train services were introduced during the festive seasons to meet the transport demand of the public.

Civil Aviation Gradual recovery in the global economy, coupled with the post-conflict improvement in the tourism sector, resulted in a notable increase in air passenger and freight transportation. The passenger traffic carried by SriLankan Airlines (SLA) increased by 24.5 per cent in 2010. Bandaranaike International Airport (BIA) handled the highest ever transshipment freight of 26,445 metric tonnes in 2010 recording an increase of 43 per cent compared to the previous year. The total air cargo handled, also increased by 20.3 per cent compared to the previous year. The air cargo handling capacity was doubled during the year with the addition of a new export terminal. The current capacity stands at 300,000 metric tonnes of cargo per annum. Domestic air travel activities declined during the year due to a significant decrease in domestic passengers travelling to North and East by air, since alternative modes of transport are now available at a lower cost. The financial performance of the aviation sector was favourable in 2010. The revenue realized by SLA increased by 26.3 per cent to Rs. 67,835 million, while the operating cost increased by 12.4 per cent to Rs.74,107 million resulting in an operating loss of Rs. 6,272 million which was a decrease of 49 per cent compared to the previous year. The increase in revenue and the implementation of stringent cost control measures contributed to the reduction of the operating loss of SLA. Meanwhile, Mihin Lanka recorded an operating profit of Rs. 416 million in 2010 compared to the operating loss of Rs. 666 million incurred in 2009. The government has declared its intention to develop the country as a regional aviation hub. Given its geographical location, coupled with the modernization of BIA and construction of a 67

3 Economic and Social Infrastructure

Table 3.5

Central Bank of Sri Lanka Annual Report - 2010

The construction work of several aviation development projects were in progress. The construction work of the Mattala International Airport was in progress in 2010 and phase I would be completed by 2013. The BIA expansion project also was in progress. This includes expansion of the transit area, construction of a new baggage re-claim area, multi-storey car park and widening of the existing runway. The feasibility study for the second runway of the BIA commenced in 2010. Development of the domestic airport network is also planned and priority was given to Koggala, Ampara and Palali airports.

Port Services With the gradual recovery in international trade, the performance of port operations increased significantly in 2010. The Colombo 68

Port achieved a new record of 4.1 million containers supported by steadfast growth in both import-export and transshipment cargo. Total container handling throughput increased by 19.4 per cent to 4.1 million TEUs in 2010. This also reflects a 10.8 per cent increase compared to the total of 3.7 million TEUs in 2008, the highest-ever performance before the global recession. Transshipment handling increased by 18 per cent, while the cargo handling at the port of Colombo increased by 26.7 per cent in 2010. The global economic recovery has helped the Sri Lanka Ports Authority (SLPA) to improve its financial performance. The revenue of the SLPA increased by 21.2 per cent to Rs. 28.3 billion, while the operating expenditure increased by 11.7 per cent to Rs. 23.9 billion. The operating profit of the SLPA increased by 126 per cent to Rs. 4.4 billion in 2010. The capital expenditure incurred by the SLPA during the year increased to Rs. 6.1 billion compared to Rs. 3.8 billion in 2009. The development of port infrastructure and services is at the forefront of the governmentâ&#x20AC;&#x2122;s infrastructure development agenda. Phase 1 of the Mahinda Rajapaksa Port in Magampura was inaugurated in November 2010. The port is expected to initially function as a service and industrial port. It will later be developed to handle transshipment cargo, specifically from the Indian Sub-Continent, East Africa and other neighbouring regions. Construction work of Phase II of the Port Chart 3.4

Volume of Container Handling and Transshipments

Chart 3.4 Volume of Container Handling and Transshipments 4,500 4,000 3,500

TEUs (â&#x20AC;&#x2DC;000)

Economic and Social Infrastructure

second international airport, the airline industry in the country could grow rapidly with the potential to emerge as a highly competitive regional hub. Also, bilateral air services with more than 60 countries, the presence of domestic land aerodromes, and potential for water aerodromes and recreational aviation facilities can help the country exploit the tourism potential associated with the aviation hub. However, it is essential to align government agencies and industry partners to bring about certain infrastructure improvements so as to create a competitive business environment which will contribute to increased growth and efficiency of the aviation industry. Issues related to the human resources of the aviation industry need to be addressed via setting up of specialized training centres and introduction of appropriate specialized curricula at all education levels so as to build an industry oriented human resource base. Furthermore, in order to emerge as a successful aviation hub, greater collaboration, information sharing and efficient use of existing technologies across the aviation value chain is needed. This can help streamline airport processes and improve service delivery and customer satisfaction. Encouraging the private sector to play an active role can help fast track the countryâ&#x20AC;&#x2122;s transformation into an aviation hub in an efficient and sustainable manner.

3,000 2,500 2,000 1,500 1,000 500 0

2006

2007 Container Handling

2008

2009 Transshipments

2010

Central Bank of Sri Lanka Annual Report - 2010 Performance of Port Services

Item 1 Vessels arrived (No.) Colombo Galle Trincomalee

Growth Rate (%) 2009 4,456 4,114 32 310

2010(a)

2009

2010(a)

4,067 -7.4 -8.7 3,910 -7.0 -5.0 48 -52.9 50.0 109 -3.7 -64.8

2 Total cargo handled (Mt ‘000) Colombo Galle Trincomalee

48,778 61,240 -3.6 46,373 58,768 -3.3 167 318 -63.6 2,238 2,154 3.5

3 Total container traffic (TEUs ‘000) (b)

25.6 26.7 90.4 -3.8

3,464

4,137

-6.0

19.4

4 Transshipment container (TEUs ‘000) (b) 2,712

3,205

-2.6

18.2

5 Employment (No.) (c) 13,367 12,828 -2.5 -4.0 Colombo 12,263 11,747 -2.3 -4.2 Galle 513 480 -7.2 -6.4 Trincomalee 591 601 -3.7 1.7 Source: Sri Lanka Ports Authority (a) Provisional (b) TEUs = Twenty-foot equivalent container units (c) Only for Sri Lanka Ports Authority

is under way at an estimated cost of US dollars 800 million. Construction of bunkering facilities and a Tank Farm with 14 Tanks with a total storage capacity of 80,000 cubic metres of petroleum products is scheduled to be completed by October 2011. The supply of bunkers at the port is expected to commence in 2011. Upon completion, the Mahinda Rajapaksa Port will be the largest port in South Asia. Meanwhile, 48 per cent of the construction work of the breakwater was completed in the Colombo South Port by end 2010. The construction work of the 1st terminal is expected to commence in early 2011 and is expected to be ready for operation in 2013. The South Terminal of the Colombo South Port project is designed as a Public Private Partnership (PPP) project on Build, Operate and Transfer (BOT) basis. The Colombo South Port project with three terminals, and each terminal having the capacity of 2.4 million TEUs per annum, will increase the capacity of the Colombo Port by 160 per cent upon completion. Construction work of the Port of Oluvil is expected to be completed by mid-2011. Construction work at the Galle and Trincomalee ports were under way in 2010. The government has declared its intention to develop the country as a regional shipping hub. Sri Lanka’s strategic location within close proximity to the East West maritime route used for international trade, the growing trade in the Indian

sub-continent and the increased level of integration with the rest of the world, has helped Sri Lanka to emerge as a shipping hub in the region.The SLPA has been proactively involved in addressing the capacity limitations of the port sector and the modernization of port operations through infusion of new technology to make Sri Lanka a shipping hub in the region. Sri Lanka has a massive potential to develop the port and shipping industry into one of the prime sectors of the economy, which would help generate foreign exchange and a range of direct and indirect employment opportunities in the medium term. The SLPA has taken several measures to improve productivity and efficiency of port operations. It is necessary for Sri Lanka to differentiate itself as a unique, high quality and timely service provider to emerge as a shipping hub. Separate bays have been planned within the Port of Colombo to facilitate importers and their representatives to clear cargo with minimum delay. Facilities at the Jaye Container Terminal of the Port of Colombo are being upgraded to enhance efficiency and productivity. Steps were taken to set up a “Cargo Village” at Peliyagoda on a land with road and rail connectivity. Also, an electronic documentation transfer system is to be introduced for importers and exporters to submit shipping documents without visiting the port. An online payment system will also be made available for port users. Although, Sri Lanka is strategically positioned on a popular maritime route, the ports sector faces competition from counterparts in the region. Hence, to maintain the competitiveness, it is essential to continuously focus on improving the infrastructure of the ports. While many measures are under way, less importance has been placed on the development of an effective inter-modal transport system. It is important to improve the road and rail connectivity to and from the port to ensure cost-effective transportation within the country. Further, there is an urgent need to implement the planned port information systems and to develop information systems linking with other key ports in the region. 69

3 Economic and Social Infrastructure

Table 3.6

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure

It is also necessary for the SLPA to engage in cooperative ventures with ports in countries such as China, India and those in Africa. This can help SLPA to gain expertise related to the development and management of state-of-the-art ports. This will also provide an opportunity for SLPA to forge partnerships with major shipping lines.

Water Supply and Irrigation The demand for pipe borne water is growing continuously with the increased level of urbanization, change in lifestyles and expansion of commercial and industrial activities. To meet the increasing demand, the National Water Supply and Drainage Board (NWS&DB) provided 87,245 new connections during the year. The total number of connections has reached a total of 1.35 million with new additions, reflecting a 6.9 per cent increase during the year. The unaccounted water losses of the NWS&DB are still at a high level due to various reasons. These include high incidence of leakages as a result of the decayed distribution network, illegal connections and shortcomings in meter readings. In 2010, unaccounted water increased to 31.5 per cent from 31.3 per cent in the Greater Colombo area and to 26.6 per cent from 25.1 per cent in other regions. The financial position of the NWS&DB was satisfactory in 2010. The total revenue of the NWS&DB increased by 10 per cent in 2010 mainly due to the increased number of connections during the year and the operational and maintenance costs increased by 10 per cent. The NWS&DB recorded an operational profit of Rs.11 million during the year. The financial performance of the NWS&DB are hindered by a high level of unaccounted water losses due to various reasons. The NWS&DB implemented several water supply development projects in 2010, of which some were completed during the year. The Nuwara Eliya District Group Town Project, Rehabilitation & Augmentation of Kirindioya Water Supply Project, Water Treatment Plant (WTP) - Moratuwa, Ambatale and in Negombo, Augmentation of Nawalapitiya, Ampara, and 70

Table 3.7

Item

Water Supply by National Water Supply & Drainage Board Growth Rate (%) 2009

2010(a)

2009 2010(a)

Total number of water supply schemes (b) 312 315 1.0 Total number of new connections given during the period 79,395 87,245 -26.5 Total number of connections (b) 1,266,328 1,353,573 6.7 Total water production (Mn. Cu. Mtr.) 449 469 2.0 Unaccounted water (%) Greater Colombo 31.3 31.5 -17.4 Regions 25.1 26.6 0.8 (a) Provisional (b) As at year end

1.0 9.9 6.9 4.5 0.6 6.0

Source: National Water Supply and Drainage Board

Koggala projects were completed during the year at a cost of Rs.12 billion. The Towns South of Kandy Project will be completed in 2011 at a cost of Rs. 9,626 million and will address the water requirements of 360,000 people. To build a proper waste water disposal and sewage disposal facility, several projects were initiated in the Central and Western provinces at a total cost of Rs. 28.4 billion. New water supply projects initiated and planned for 2011 include, the Rehabilitation & Augmentation of Labugama - Kalatuwawa WTP, the Greater Ratnapura Integrated Water Supply Project - Phase I, Jaffna Peninsula Water Supply & Sanitation Project, Kolonna and Balangoda Water Supply Project, Ruhunupura Water Supply Development, Energy Conservation Project at Ambatale WTP and Greater Kurunegala Water Supply & Sanitation Project at a total cost of Rs.70.8 billion. Several major irrigation projects were in progress in 2010. The Uma Oya Multipurpose Development Project was in progress and is expected to irrigate 5,000 ha of new lands and provide for the drinking and industrial water requirements of the South East dry zone. Some of the other projects implemented by the Irrigation Department include the Deduru Oya Reservoir Project, the Rambukkan Oya Reservoir Project, Weheragala Reservoir Project and the Lower Uva Minor Irrigation Project. These projects will facilitate around 23,670 ha of land extent. Under the Eastern Revival Programme, several irrigation schemes were commenced in the Ampara, Batticaloa and Trincomalee districts at a total cost of Rs.1,190

Central Bank of Sri Lanka Annual Report - 2010

The status of the health and education achievements of a country reflects the nature of the human capital endowment, which is a critical factor in the overall economic progress. The long standing government policy on universally free health and education to facilitate human development and the implementation of generous welfare schemes in Sri Lanka has delivered abundant results in the areas of education and health and has facilitated the improvement of the living conditions of the people. However, achievements by both the education and health sector in Sri Lanka are now being challenged by demographic and epidemiological transitions and the structural changes that are taking place in the economy. Meanwhile, reduction of regional disparities in health and education outcomes, to bring about “spatial blindness” in basic human development, continue to remain a challenge which is to be addressed in the socio-economic policy front.

Health Sri Lanka’s health sector standards continued to improve though achievements are now being challenged by newly emerging issues. The country’s health indicators show a steady improvement over the recent decades, particularly, in maternal and infant mortality, and life expectancy. Though post neo-natal mortality has declined significantly, there has been less success in pre-natal and neo-natal mortality. A neo-natal mortality rate of 8.4 per 1,000 live births suggests the need for special attention. Further, nutritional status remains a serious problem especially among the poor and vulnerable

3.0 2.5 2.0 1.5 1.0 0.5 0.0

2006

2007 Education/GDP

2008

2009

2010

Health/GDP

groups. Sri Lanka’s malnutrition is puzzling in the presence of its relatively high income level and its extraordinary achievements in female literacy. It is being recognized that, the improvement of nutritional status of the people should be a coordinated effort of all the stakeholders. Therefore, measures were taken to rally the support of all stakeholders, with a prominent role being played by the Ministry of Health. The re-emergence of certain communicable diseases, and a rising trend in Non-Communicable Diseases (NCDs), are also threatening the achievements of the health sector. The rising instances of NCDs suggest the need for a mass scale national awareness campaign to change the lifestyle of the people and to discourage unhealthy food patterns. Sri Lanka has an extensive network of different types of primary level health care institutions that provide community health services, out-patient and in-patient care. However, a study carried out by the Ministry of Health has revealed that, though community health services are well utilized, primary level government curative health care facilities are underutilized, while services provided by secondary and tertiary care institutions are over-burdened. Bypassing of primary care needs provided by peripheral health care institutions and there being addressed at higher level hospitals or by private specialists increases the cost of health care to the government as well as to patients. This urges the importance of establishing a proper referral system with continuous medical education for service providers operating at the peripheral level. 71

Economic and Social Infrastructure

3.3 Social Infrastructure Policies, Institutional Framework and Performance

Government Chart 3.5 Expenditure on Health and Education Government Expenditure on Health and Education

Chart 3.5

% of GDP

million. A total of 14,457 ha will be cultivable under these schemes and a total of 14,300 families will be benefitted. Under the Northern Spring ("Vadakkil Vasantham") programme, several irrigation schemes commenced in the Vavuniya and Mannar districts at an estimated cost of Rs. 947 million. The total land extent of 14,270 ha will be made cultivable when these irrigation schemes in the North become operational.

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure

BOX 6

Infrastructure for Inclusive Growth Extreme Weather Conditions and its Impact

Introduction Inclusive growth refers to a rapid pace of sustainable growth which is broad based across sectors. At the same time, there should be enhanced opportunities in terms of access to markets, resources and social protection. Inclusive growth encompasses both the pace and pattern of growth which are critical in providing opportunities for many who are excluded from the growth process so that all members of the society could contribute to and benefit from growth. Inclusive growth is not simply income redistribution. The emphasis of inclusive growth is on improving the productive capacity of individuals and creating a conducive business environment for employment rather than income redistribution (Ianchovichina and Lundstrom, 2009). The most pressing obstacle to achieving inclusive growth is the lack of adequate economic, social and financial infrastructure (Rauniyar and Kanbur, 2009). Inclusive Growth – Why for Sri Lanka? As the Sri Lankan economy progresses on the high growth path, policy responses are required to promote inclusive growth. At present, a significant proportion of the population remains outside the ambit of basic physical, social and financial infrastructure, lacking the opportunity to contribute to this growth momentum. This urgent need for policies to be growth oriented has been recognized in the “Mahinda Chintana” (The Development Policy Framework of the Government). “The development strategy relies not only on promoting investments on infrastructure based on commercial and economic returns but also on the creation of equitable access to such infrastructure development to enable people to engage in gainful activities.” Therein, the infrastructure development agenda of the government encompasses policies which are focused on transforming the nature of the economic growth into one which is broad-based, faster and inclusive so as to effectively reduce inequality and improve socio-economic progress. Hence, the government’s infrastructure drive comprises of emphasis on regional infrastructure development to achieve a regionally balanced growth. It is equally important to identify public policy priorities to improve economic, social and financial infrastructure to achieve inclusive growth and increased spatial equity. Economic Infrastructure for Inclusive Growth Economic infrastructure includes transport, energy, information and communication technology, and

irrigation. Investment in economic infrastructure is important to expand the production base, enhance competitiveness and the generation of employment. Furthermore, economic infrastructure enhances trade potential between provinces while raising growth and productivity and increasing the efficiency of resource utilization. Therefore, physically connecting leading and lagging areas with better infrastructure such as transport, roads and telecommunication services can reduce the cost of transport, create a market for agricultural products produced in lagging areas and thereby generate more employment opportunities. The “Maga Neguma” rural road development programme has laid the foundation for connecting peripheral areas with the centre. Meanwhile, investments made to develop inter-regional highways and railroads, to promote mobility of people and goods, under the Government’s national level infrastructure development programme are expected to deliver tangible economic returns in the near future. With the development of economic infrastructure, market forces would emerge to change the economic structure of lagging areas. In case of failure of market forces, integrated interventions may be needed to change the economic structure of those lagging areas allowing people to actively participate in the growth process. Social Infrastructure for Inclusive Growth Social infrastructure relates to the facilities and mechanisms which ensure education, health care, community development and social welfare. There is a strong linkage between the attainment of economic prosperity and the associated enrichment of the quality of life, seen in indicators such as health, literacy and environmental sustainability. Improvements in the social infrastructure of a country will influence the creation of a more productive and more skilled workforce capable of meeting the demands brought forth by economic growth and ensuring that the country is also able to mature into one which is conducive for further well-paced economic growth and development. Education and health have been identified as key aspects of social infrastructure which can directly contribute to inclusive growth. Sri Lanka’s universally free education and health has helped the geographical balancing of access to education and health services. However, improvements in the educational standards (in terms of quality and relevance to the market needs) can help provide people in lagging areas with the ability

Central Bank of Sri Lanka Annual Report - 2010

financial infrastructure (Ianchovichina and Lundstrom, 2009). In addition, geographic obstacles are a key hindrance on both the demand and supply side.

The health of the population of a country makes an important contribution to the efficiency and productivity of human capital. In this regard, Sri Lanka’s public health service coverage is commendable with 3.2 beds per 1,000 people and a doctor for every 1,462 people. While it has performed higher than its regional counterparts in this aspect, ground reality is highly skewed in terms of distribution of key health personnel. Colombo has the highest health personnel-to-population ratio for doctors, nurses and midwives, while remote provinces suffer from the lowest. The health sector has to focus on targeted intervention to overcome malnutrition and micro nutrition deficiencies which are significant in lagging areas and to introduce tailored policies to overcome area specific health needs.

Inclusive growth focuses on both the pace and pattern of growth, which enable economic growth which is not only high but is also of an inclusive nature. Though public policies implemented in Sri Lanka for several decades have delivered abundant results, halving the country’s poverty, helping the integration of the country economically, and allowing access to public services in all the provinces in Sri Lanka’s journey towards a upper middle income country, it has to focus more on socio-economic policies which strive to improve living standards of people across provinces. For the benefits of accelerating growth to spread across the country, let alone households and income levels, it is important for policy makers to be more concerned on reshaping the economic geography, improving the human capital base through re-aligning health and education policies, enabling people access to credit, and improving social safety nets.

Financial Infrastructure for Inclusive Growth Financial infrastructure is the set of institutions that enable effective operation of financial intermediaries. It also encompasses the existing legal and regulatory framework for financial sector operations. For financial infrastructure to contribute to inclusive growth, it is not only important to improve access to credit but also make available affordable credit facilities, safe and secure savings and payment products, insurance products, international remittances and access to financial advice. In the context of Sri Lanka, the lack of access to credit is one of the major bottlenecks for inclusive growth. There are demand and supply constraints for access to credit. On the demand side, insufficient collateral hinders the ability of the poor to access credit services. They also lack the financial literacy to open a bank account and to access credit services. On the supply side, banks may consider it costly and not worth to work with poor and rural clients due to high transaction costs and inadequate

While measures are being taken by the Sri Lankan government to achieve full financial inclusion by 2015, banks have to play a proactive role in coming forward and exploiting this opportunity. Hindrances to financial inclusion are poor awareness of financial products and inflexibility of such products. Also, the non-availability of appropriate banking technology due to lack of proper physical and financial infrastructure in rural areas such as low penetration of broadband services, continues to be a challenge to financial inclusion. The development of financial infrastructure can help address both demand and supply side constraints which hinder inclusive growth.

References Ianchovichina, E. and S. Lundstrom, (2009), ‘Inclusive Growth Analytics: Framework and Application’, Economic Policy and Debt Department, The World Bank, Washington, D.C. McKay, A., (2008), ‘Economic Growth, Inequality and Poverty Reduction: Does Pro-Poor Growth Matter?’, IDS in Focus, No. 3. Rauniyar, G. and R. Kanbur, (2009), ‘Inclusive Growth and Inclusive Development: A Review and Synthesis of Asian Development Bank Literature’, Asian Development Bank (ADB), Manila, Philippines. The World Bank, (2010), Reshaping Economic Geography, Connecting People to Prosperity.

3 Economic and Social Infrastructure

to enter labour markets in dynamic places. This will help enhance labour mobility and thereby reduce poverty in lagging provinces. Compared to many of Sri Lanka’s international counterparts, investment in education particularly in higher education and vocational training, is comparatively low. Hence, the current move to encourage private sector participation is to be welcomed. Improving access to high quality education is a vital step in inclusive growth as lagging areas are home to a large portion of labour whose potential has not been tapped into, due to lack of basic skills and knowledge in areas ranging from Ordinary Level Mathematics and English to ICT skills. Further, entrepreneurial skill development is another important area that the education system in Sri Lanka still lacks. Limited investment in human capital particularly skills and entrepreneurship training, is a constraint for inclusive growth (McKay, 2008).

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure

which 96 per cent was utilized. There were specific health projects implemented in the Northern and Eastern provinces in 2010, with a total estimated expenditure of Rs. 1,055 million on the Jaffna 2009 Item 2010(a) Government hospital development project. In addition to physical Hospitals (practicing western medicine) (No.) 555 568 infrastructure development programmes, measures Beds (No.) 68,897 69,501 Primary Health Care Units (No.) 475 476 were taken to strengthen the human capital base of Doctors (No.) 13,633 14,125 (b) the health sector. Accordingly, 1,700 nurses were Assistant medical practitioners (No.) 1,198 1,158 Nurses (No.) 25,549 27,494 appointed to the Health service and 1,075 persons Attendants (No.) 8,301 8,189 Ayurvedic were recruited for professions supplementary to Ayurvedic physicians (No.) (c) 19,529 20,004 Medicine, paramedical services and technical Total government expenditure on health (Rs.bn) 71.5 73.8 service categories during the year. Table 3.8

Salient Features of Health Services

Current expenditure Capital expenditure

(a) Provisional (b) Including Intern Medical Officers (c) Registered with the Department of Ayurvedic Commisioner

58.8 12.7

60.5 13.3

Sources: Ministry of Health Department of Ayurveda Ministry of Finance and Planning Central Bank of Sri Lanka

Health care financing has become more challenging in the wake of the rising cost of health care, demand for quality health care and changing demographic and epidemiological patterns of the country. In Sri Lanka, around 49 per cent of total health care expenditure is financed by the government budget, through the central and provincial ministries of health. Around 4.9 per cent of the expenditure is financed by voluntary health insurance schemes and only 0.1 per cent is financed by social health insurance. Around 43.6 per cent of the total health expenditure is financed through out-of-pocket payments or household expenditure (WHO, 2009). It is important to recognize that the current level of high out-of-pocket expenditure may affect vulnerable communities. Hence, it is important to rationalize government expenditure for the better use of health care provisioning and at the same time, to explore alternative health financing mechanisms for affordable groups to ensure free health for needy people. Also, measures are being taken by the government to implement Senaka Bibileâ&#x20AC;&#x2122;s drug policy to prescribe drugs by their generic names to increase access to reasonably priced health care. The Ministry of Health carried out several programmes in 2010 to further improve health care delivery. In 2010, a total of Rs. 2.4 billion was allocated for the development of infrastructure facilities in the health sector, out of 74

The potential for promoting health tourism in Sri Lanka is significant. Looking at the existing competitive advantages of the industry, such as the highly skilled and trained workforce, strategic location, competitive prices and hospitality, there are opportunities to attract foreign demand for health services and transform the health sector into a high value added source of foreign exchange earnings for the country. In promoting Sri Lanka as a health tourism destination, it is important to develop new strategies, especially in relation to service delivery, quality, and pricing.

Education The education system plays a vital role in creating a productive workforce, which possesses appropriate knowledge and skills. Recognizing the importance of a dynamic education sector which can meet the requirement of the changing needs of the labour market, a series of changes has been initiated by the government. In doing so, the strengthening of capacity, improvement of quality and relevance of primary, secondary and higher education sectors have been identified. At the same time, the need to improve technical and vocational training to fill the knowledge gaps has also been recognized. In reshaping the education sector, it should be noted that the education policy, in general, has to be closely linked with the labour demand and economic policy of the country. Several measures were taken to address the issue of regional disparity in general education. The Ministry of Education has identified 150 schools

Central Bank of Sri Lanka Annual Report - 2010

a. Schools (No.) Government schools o/w National schools Other schools Private (c) Pirivena b. Students (No.) (‘000) c. New admissions (No.) (‘000) (d) d. Teachers (No.) (‘000) e. Student/Teacher ratio (government schools) f. Total govt. expenditure on education (Rs. bn) (e) Current expenditure Capital expenditure

It has been recognized that the general education system requires substantial modernization to create the human capital foundation of the country needed to emerge as a knowledge hub. With the aim of re-designing the education policy, steps have been initiated to draft a new Education Act. It is envisaged that this new legislation would ensure accelerated and optimally qualitative educational development. At the same time, measures are also being taken to introduce reforms to the general education system such as moving towards a competency based curriculum from an examination oriented, content based curriculum, promoting English and IT in education and providing opportunities for children to gain life skills.

Sources: Ministry of Education (a) Provisional University Grants Commission (b) All government schools in Mullaitivu and Ministry of Finance and Planning Kilinochchi districts and some govt. schools in Central Bank of Sri Lanka Mannar and Vavuniya districts were temporarily closed at the census date due to war situation (c) Private schools approved by the government and schools for children with special needs (This figure excludes international schools which are registered under the Companies Act) (d) Government schools only (e) Includes government expenditure on higher education (f) In all Universities, excluding the Open University of Sri Lanka

Sri Lanka ranks at 82 out of 149 countries in the Knowledge Economy Index (KEI) prepared by the World Bank (2009). The knowledge economy is one that creates, disseminates and uses knowledge to enhance growth and development in a country. A successful knowledge economy is characterized by close links between science and technology, greater importance placed on innovation for economic growth and competitiveness, increased significance of education, greater investment in R&D, information technology, and education. Since Sri Lanka is

Table 3.9

Salient Features of General and University Education

Item

2009

2010(a)

1. General education 10,205 9,410 (b) 334 795 98 697 4,038 330 226 18 100.5 82.4 18.1

10,492 9,675 340 817 98 719 4,112 332 228 18 104.2 85.2 19.0

2. University education a. Universities (No.) b. Students (No.) (f) c. Lecturers (No.) d. Number Graduating (f) Arts and Oriental studies Commerce & Management studies Law Engineering Medicine Science Other e. New admissions for basic degrees (No.) (f)

15 68,768 4,735 13,952 4,830 2,705 425 1,157 943 2,504 1,388 20,846

15 66,305 4,918 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 21,547

poised to realize faster growth and thereby move into the upper middle income status, the country needs to formulate robust “Knowledge Economy” oriented strategies and reform appropriate sectors at the national level. Since the improvement that has so far been made is limited, it is important to focus on improving the country’s rank in the areas of ICT, innovation, and economic incentive regime. Sri Lanka has consistently remained at a low level with regard to patents, journal publications and research. University education in Sri Lanka, which is mainly a public sector monopoly, suffers from both, the inability to meet demand and failure 75

3 Economic and Social Infrastructure

as “Isuru Schools” with the objective of developing these schools to the level of national schools for secondary education in selected divisional secretariat areas to ease the high demand for admission into national schools. It is expected to increase the number of “Isuru Schools” to 325 by end 2012. Further, the government has taken measures to develop 1,000 full-fledged secondary schools island-wide, with the establishment of a primary school network as a measure to ensure quality education for all. Measures are being taken to establish “Teacher Villages” for teachers to facilitate their livelihood in remote areas so as to effectively address the shortage of teachers in those areas. At the same time, several measures are being taken to broaden opportunities for education in Information and Communication Technology (ICT) for schools in remote areas.

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure

BOX 7

Expanding Opportunities for Higher Education

With the rising of income levels, there has been a rapid growth in demand for high quality services such as health and education. While there has been rather wide choice available for people who wish to avail of health services in the country, the choices available for higher education have been limited as the state had been the monopoly provider. To cater to the increased demand for high quality higher education, it has been widely acknowledged that there is a strong need to increase the opportunities available domestically. At present, in Sri Lanka, the public university system faces a severe capacity constraint to accommodate all those aspiring for university education. In 2010, although 61 per cent of the students who sat the GCE Advanced Level examination were eligible for admission to a university, only 17.2 per cent (21,547 students) were in fact admitted, due to capacity limitations. This serious limitation locally has led to local students seeking admission in universities in developed and developing countries, including neighbouring countries such as India, Nepal and Bangladesh at a significant cost. Despite the prevalence of this serious capacity limitation, private sector participation in higher education in Sri Lanka was not permitted, on the misguided view that such a policy will deny the opportunity for higher education for low income students. Unfortunately, however, the outcome of this policy was that, due to inadequate placements in the public university system, those with financial affordability had to secure placements in foreign to supply a quality education compatible with labour market requirements. Private sector participation in higher education was opposed for several decades, on the ground, that it will deny the opportunity for higher education for low income students. However, due to inadequate placements in the public university system of Sri Lanka, those with financial affordability, have left to foreign universities resulting in an outflow of a large volume of foreign exchange. In this context, the government has clearly stated that participation in the higher education system will be opened up to the non-state sector, allowing foreign 76

universities at a significantly high cost, while the opportunities for the poorer sections of society were, limited by the number of available positions in the state sector universities. In the meantime, the expansion of the middle class’ affordability led to further increase in demand for higher education, since parents of students who could not secure opportunities domestically, search for opportunities elsewhere to educate their children. In this context, by opening the higher education sector for non-state universities, Sri Lanka will be able to expand the opportunities and choices available for Sri Lankan students for higher education. It has also been noted that the viability of this option is enhanced by the availability of competitive advantages such as the strategic geographical location of the country, the service culture of the workforce and the intellectual capacity of local academia. This policy will therefore result in Sri Lanka being able to provide education on par with international institutions, at a lower cost and in turn, open up venues to “export” higher education services in the near future. Since in the past, investment in this sector had been artificially restricted, this new move can also stimulate the higher education sector in the areas of research and development as well as capacity building. This initiative will also prompt more efficient resource mobilisation, and serve to improve the quality of education with increased competition amongst universities. Such increased competition, in turn, will act as an incentive to improve quality, which will probably serve to rectify the supply and demand “mismatch” in the domestic labour market. universities to set up affiliated universities in Sri Lanka. The attraction of renowned universities with appropriate regulations and accreditation policies in place would also enable Sri Lanka to attract foreign students to these universities. While promoting foreign investment in the higher education sector in the country, it is important to improve the existing university education system. In doing so, due to the limited fiscal space, it is important to explore alternative sources of funding for higher education of a greater quality. For this purpose, the existing administrative

Central Bank of Sri Lanka Annual Report - 2010

Organization (ILO) Sri Lankan branch, designed a customized policy framework especially for the provision of skills training for vulnerable groups. A Vocational Education and Training (VET) Plan was developed for the Eastern province. In addition to this, Industry specific VET Plans were developed for the leather and ICT sectors, in collaboration with the Industrial Development Board (IDB) and the University of Colombo School of Computing (UCSC). Under National Vocational Qualifications (NVQ) programme there were 13,249 NVQ certificates issued during the year from a total of 736 accredited courses. A Technical and Vocational Education and Training (TVET) Rationalization Programme was implemented by the Ministry of Youth Affairs and Skills Development, in association with the TVEC, to streamline TVET delivery by public sector training institutions. Nine Technical Colleges in nine provinces have been upgraded to Colleges of Technologies which offered National Diplomas in 2010.

The University Grants Commission (UGC) executed several measures during the year to improve the quality of the higher education sector in Sri Lanka. The UGC streamlined the process to recognise postgraduate courses by adopting a new format for the application and evaluation procedure, with the assistance of the Quality Assurance and Accreditation Council of the UGC. Further, the UGC also executed measures to regularise the external degree programmes and external courses with the intention of improving the quality of the respective courses. Further, to regularise and to facilitate private sector participation in the higher education sector, guidelines were published to grant degree awarding status for state and non-state higher degree awarding institutions. Meanwhile, the Quality Assurance Programme of the higher education sector was continued in 2010.

Housing and Urban Development

The technical and vocational education sector continued to expand during the year. The National Policy Framework on Higher Education and Technical and Vocational Education was finalized during the year and the policy implementation plan was presented in December 2010. Tertiary and Vocational Education Commission (TVEC), with the association of the International Labour

The government has taken many steps to cope with the housing and urban infrastructure demand resulting from urbanization. Amidst scarcity of lands, the government is now focused on urban development with a view to increasing quality of life and facilitating commercial activities in the centre of cities. Severe flooding after torrential rains in many areas of the country including the capital, Colombo, highlighted the importance of urban planning. The primary reason for flooding within the Colombo city was the unauthorized construction of buildings within the city. Such unauthorized construction has also given rise to the increased incidence of health hazards such as dengue and other serious environmental issues. In 2010, the Urban Development Authority (UDA) played a proactive role in urban development. It has been recognized that Colombo, being the major administration city, requires strategic development to boost both commercial and housing activities in an environment friendly and effective manner. The Development Plan, formulated by the UDA, focuses on development issues in the City of Colombo that have emerged as a result of rapid 77

3 Economic and Social Infrastructure

and financial regulations would need to be reviewed and suitably amended without compromising academic standards, quality and examination integrity. Though public universities enjoy a considerable level of autonomy, administrative constraints could result in reducing revenue generated through consultancy, research activities and study programmes. Entrepreneurial orientation of university education is another possible avenue for alternative financing as well as attracting foreign students from other countries. Even with the expansion of the private general education system in the country, proper criteria are yet to be set up to admit students of private education institutions into public universities via a suitable cost sharing mechanism. Simultaneously, it is important to introduce a quality assurance rating system to make public universities competitive which in turn would spur academic and research excellence in public universities.

The housing finance market faces several issues, which inhibit its growth. The failure to include low and middle income groups and other self-employed categories in the formal housing sector, due to various reasons, takes a significant toll on the physical infrastructure of developing urban areas such as Colombo. The maturity mismatch characteristic of lending institutions, legal and other institutional issues, problems relating to land titles, high cost of construction materials and lack of skilled labour inhibits the growth in the housing sector. However, it should be noted that the cost of housing financing has reduced with the reduction of interest rate charged on housing loans in 2010.

Safety Nets and Poverty Alleviation The incidence of poverty declined significantly in Sri Lanka during last few years.

2005 2006 2007 2008 2009 2010 (a) (b) (c)

11,000

1,900

10,500

1,800

10,000

1,700

9,500

1,600

9,000

1,500

8,500 2006

2007

2008

2009

2010

Number of Families (Left Axis) Total Expenditure (Right Axis)

The Poverty Head Count Index (percentage of population below the poverty line) has come down to 7.6 per cent from 15.2 per cent in 2006/ 2007 as per the first round data of the 2009/2010 Household Income and Expenditure Survey. Decline in poverty is significant in the estate and rural sectors while decline in urban poverty is moderate. This indicates the success of public policies in levelling social welfare. The governmentâ&#x20AC;&#x2122;s policy to ensure that basic infrastructure is improved despite the conflict, has allowed benefits to trickle down to low income households. However, it should be noted that the identification of disparities in poverty, among different geographical locations, is needed. These have to be then assessed through a proper poverty mapping exercise to improve targeting of poverty alleviation programmes. Various poverty alleviation programmes continued under the Department of Commissioner General of Samurdhi in 2010.

Income Supplementary Programme Number of Families (b)

Value (Rs.mn)

Nutrition Programme

Dry Ration Programme Number of Families (b) Value (Rs.mn)

1,960,664 9,244 1,916,594 10,570 1,844,660 9,423 1,631,133 9,967 (c) 1,600,786 9,274 (c) 1,572,129 9,241 (c)

Number of Families (b)

98,223 1,142 122,269 1,359 105,105 1,234 102,662 1,457 173,450 2,860 30,320 1,016

Number of famillies decreased in 2008, 2009 and 2010 due to improvement in targeting and increase in income levels As at year end Including the kerosene subsidy

Rs. million

2,000

Samurdhi Welfare Programme Number of Beneficiary Families and Value of Grants (a)

Table 3.10

Year

(â&#x20AC;&#x2DC;000)

Economic and Social Infrastructure

urbanization. A comprehensive planning approach, including all urban issues, has been taken to address the current and future infrastructural needs of the city. The UDA implemented urban development projects and urban renewal projects for under-served settlements to improve their living standards. This project will release nearly 250 ha of land within the city of Colombo and its suburbs for investments targeted at urban development. The UDA carried out urban development projects worth Rs. 3.1 billion in 2010. At the same time, the UDA made a self-financing debenture issue of Rs.10 billion to provide a low-income housing scheme for shanty dwellers in the Colombo metropolitan city limit.

Central Bank of Sri Lanka Annual Report - 2010 Chart 3.6 Number of Samurdhi Benficiary Families and Number of Samurdhi Beneficiary Exprnditure Chart 3.6 Families and Expenditure

122,186 186,211 102,020 86,480 71,762 61,495

Value (Rs.mn) 250 576 594 386 505 388

Sources: Department of the Commissioner General of Samurdhi Ministry of Finance and Planning

Central Bank of Sri Lanka Annual Report - 2010

The Samurdhi Authority of Sri Lanka launched various income generation programmes, community development programmes as well as capacity building programmes in 2010 to enable the Samurdhi beneficiaries to escape from poverty. The Samurdhi social security programme was launched with the view to preventing poor families from falling into the lowest depths of poverty due to unexpected incidents such as deaths, hospitalisation and childbirth. These disbursements amounted to Rs. 33.8 million during the year. Under the social development programmes, programmes on prevention of drug abuse and uplifting moral values were conducted on the Divisional Secretariat level.

Environment A sustainable balance needs to be maintained between high economic growth and its impact on environment. Sri Lanka has ratified a range of international conventions, agreements and protocols related to the environment. Although this has helped to keep Sri Lanka away from serious environmental hazards, the country

continues to face several challenges in preserving the environment. These include forest cover depletion, land degradation, haphazard waste disposal, depletion of biodiversity, air pollution, climate change, unsustainable utilization of natural resources and pollution of inland waters and marine and coastal ecosystems. These environmental problems are a result of the growing needs of the population pressurizing the natural environment. In turn, this has caused many parts of the island’s natural environment to be converted for human uses such as settlements and agricultural lands. The Ministry of Environment has played a proactive role in designing and implementing measures focused on the sustainable and efficient use of natural resources. The “Haritha (Green) Lanka” programme, initiated in 2009, continued in 2010. The “Dayata Sevana” programme was initiated in 2010 in line with the “Green Country” theme outlined in the government’s policy. Under this programme, 1.1 million trees were planted across the country. Steps have also been taken to improve and maintain the quality of water in key water bodies, to a level suitable for human use. Under the “Pavithra Ganga” programme, the Ministry has collaborated with the Central Environment Authority (CEA) and the NWS&DB to monitor the quality of the river water on a bi-weekly basis. Climate change has also been recognized as a challenge, and in this regard, the Ministry in collaboration with UN Habitat has prepared and finalized the National Climate Change Policy Framework and adopted the SAARC three year Action Plan on Climate Change, in 2010. The “Green Circle Project” was implemented to introduce the development of wetlands while conserving resources and providing recreation space to promote the sustainable tourism industry. A variety of awareness programmes such as “Parisara Paagamana” (eco-march), tree planting campaigns and green awards ceremony were also conducted in 2010. The CEA also implemented several measures to protect the environment. The CEA commenced a Strategic Environmental Assessment (SEA) 79

3 Economic and Social Infrastructure

Such major programmes were the Samurdhi subsidy programme, nutrition allowance programme, dry rations for Internally Displaced Persons (IDPs), Samurdhi social security programme and kerosene subsidy stamp programme. However, the existing food rations programme needs to be reviewed through follow up work to outline specific steps for geographic, poverty and age targeting to improve the programme’s cost effectiveness and its potential impact on nutrition in the future. The potential for linking some of these food programmes with community-driven development programmes needs to be explored as malnutrition in the country could challenge social development. In addition to these food programmes and income supportive schemes, community development programmes were also carried out by the Samurdhi Authority of Sri Lanka. A total number of 1.6 million families benefited from the Samurdhi subsidy programme in 2010. The total expenditure amounted to Rs. 9,241 million during this period.

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure

BOX 8

Warming and and Carbon Credits ExtremeGlobal Weather Conditions its Impact

Global warming and the resultant climate change are among the most serious environment problems facing the world community. The repercussions of climate change already are being felt worldwide. The impact will be seen on a broad array of human and natural systems, with consequences for human health, food production, water supplies, and many other areas vital to economic and social well-being. While certain effects may in the nearer term prove beneficial to some, in the long-term, these will be largely detrimental. Adapting to these changes in order to minimize their human and environmental consequences has become a significant challenge to the world. The Kyoto Protocol, a ‘modus operandi’ to the International Framework Convention on the reduction of greenhouse gas emissions, is an amendment to the United Nations Framework Convention on Climate Change (UNFCCC), an international treaty to unite countries to reduce global warming and the resultant climate change. It was formulated to tackle global warming by setting target levels for countries to reduce greenhouse gas emissions worldwide. While targets tend to vary between regions and countries, the initial worldwide target is the reduction of greenhouse gas emissions to 5.2 per cent below base levels (1990 levels) during the ‘commitment period’ ranging from 2008 – 2010. While the convention covers all greenhouse gases, the prime focus of the Kyoto Protocol is on the reduction in the levels of Carbon Dioxide (CO2), Methane (CH4), Nitrous Oxide (N2O), Hydrofluorocarbons (HFCs), Perflurocarbons (PFCs) and Sulfur Hexafluoride (SF6). The carbon trading scheme as a whole aims to provide a means of reducing greenhouse effect emissions on an industrial scale by capping total annual emissions and then assigning a monetary value to the shortfall via trading. The credits can be exchanged among businesses or traded at market prices prevailing in international markets. The carbon market valued at in the Northern and Southern provinces. In the Southern province, land has been identified as suitable for development projects such as airport, seaport, cricket stadium, industrial estates and for tourism. The Northern province SEA is expected to facilitate development activities while preserving the environment. Further, the CEA has also developed 80

USD 10.9 billion in 2005 is known to have grown at compound annual growth rate of 89 per cent to reach USD 139 billion in 2009. It is expected that the global carbon trading market will experience a high growth after 2012 and may reach USD 1.2 trillion by 2020. However, of recent times, it has been recognized that the Clean Development Mechanism of Carbon Trading has failed to incorporate the “Polluter Pays” principle. As countries realize that the prices of carbon credits have not acted as a disincentive to pollution and now introduce higher floor prices, consumers of products of energy intensive industries seem to have been hit hard. The pass-through of the environmental externalities of economic activities by the producers has increased the costs of production causing consumers to bear higher costs. The phenomenon has extended to one where the polluter pays and passes down to consumers, thereby creating little or no benefit to consumers or to the world as a whole. In turn, the issue may be magnified to encompass the fact that countries which sell carbon credits or less pollutant may, in turn, have to bear higher costs when they import from countries which have added the costs of pollution in order to set off the costs associated with buying carbon credits from low polluting countries. Hence, countries which have not polluted may actually be poorly benefitted by reducing their pollution levels, as they may have to purchase final products or services from high polluting countries by paying more to set off the cost incurred by them to buy carbon credits. Therefore, it seems as if the mechanism in itself has initiated a vicious cycle where the aim of curbing emission remains unfulfilled. Hence, the only solution which will compel a commitment of countries to curb their pollution without causing costs to consumers, is for them to refrain from any activities which will cause them to go beyond the pollution level targets set for their respective countries. an Environmental Resource Information System containing all environment and socio-economic data of Sri Lanka up to the Grama Niladhari level. This spatial database will play a vital role in environmental assessment, management, monitoring and identification of development sites and in the disaster management planning.

PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

4.1 Overview

nflation continued to remain at mid-single digit levels in 2010. The annual average inflation as measured by the Colombo Consumersâ&#x20AC;&#x2122; Price Index (CCPI) (2002=100), which had decelerated since November 2008, reaching a low of 3.1 per cent in February 2010, moved upward gradually to 5.9 per cent in December 2010. Year-on-year inflation decelerated to 4.3 per cent in July 2010 from 6.5 per cent recorded in January 2010 but followed an increasing trend thereafter, moving gradually to reach 6.9 per cent in December 2010. The relatively low and stable level of inflation during the year was mainly attributable to the improved domestic supply conditions and supportive fiscal policies aided by the adjustment in import duties, and downward revisions in administered prices as well as the prudent monetary policy stance. In addition, the relatively stable exchange rate and improved productivity also helped lower price pressures during the year. Meanwhile, the core inflation, which is derived by excluding food and

energy items from the CCPI basket, followed a decelerating path both in terms of annual average and yearon-year bases in 2010. Nominal wages of employees in both the public and private sectors increased in 2010, with a substantial increase in wages in the formal private sector. There was no upward revision in the wages of public sector employees during 2010. Employees in the public sector enjoyed higher nominal wages in 2010 when compared to 2009, entirely due to the adjustment in the Cost of Living Allowance (COLA) in November 2009. As a result, the overall nominal wage rate index of the central government employees increased by 3.3 per cent in 2010. There was a slight drop in real wage rate indices of all categories of public sector employees in 2010, as against the significant real wage increase enjoyed by them in 2009. The minimum wages for all three major categories of the formal private sector, namely, Agriculture, Industry and Commerce, and Services

Central Bank of Sri Lanka Annual Report - 2010

The rate of unemployment, which had been decelerating over the past few years, (except in 2009 when a temporary set-back occurred due to the global financial turmoil), declined further to 4.9 per cent in 2010 from 5.8 per cent in 2009, indicating the resurgence of the economy with the growing economic activities and gradual recovery in the global economy. Meanwhile, there was a change in the composition of employment among the major industry groups, with the increasing shares of the Services and Agriculture sectors and the declining share of the Industry sector in total employment. The Services sector, which made the largest contribution to overall economic growth during the last few years, continued to dominate the generation of more employment opportunities in 2010 too. Meanwhile, the number of employers and self-employed workers grew during the year. However, a decline was observed in the number of public sector employees, private sector employees and unpaid family workers as compared to 2009. The implementation of various infrastructure Colombo Consumersâ&#x20AC;&#x2122; Price Index (2002=100)

Chart 4.1 Colombo Consumers' Price Index (2002=100)

Chart 4.1

30 25 20 15 10 5

Annual Average Change %

Year-on-Year Change %

Nov - 10

Jul - 10

Sep - 10

May - 10

Jan - 10

Mar - 10

Nov - 09

Jul - 09

Sep - 09

Mar - 09

May - 09

Jan - 09

Nov - 08

Jul - 08

Sep - 08

May - 08

Jan - 08

0 Mar - 08

Per cent

Economic and SocialAND Infrastructure PRICES, WAGES, EMPLOYMENT PRODUCTIVITY

sectors governed by the Wages Boards increased, raising the overall nominal wage rate index for the whole sector by 32.0 per cent in 2010 over the previous year. This sharp rise was led by the substantial increase in minimum wages of workers in the Agriculture sector, granted in January 2010. Formal private sector employees enjoyed increases in their real wages in 2010. Both the nominal and real wages of informal sector workers also increased in 2010.

development projects; increased level of livelihood activities and creation of self-employment opportunities; and increased activities in the Services sector, particularly in the tourism industry with the dawn of peace, would have generated more employment opportunities. Meanwhile, the improvement in labour productivity observed during the last few years continued in 2010 as well. At the same time, departures for foreign employment, which continued to be a major source of foreign exchange earnings for the country, also increased significantly during 2010.

4.2 Prices Price Movements and Contributory Factors Colombo Consumersâ&#x20AC;&#x2122; Price Index (CCPI) In 2010, the CCPI, the official consumer price index of the country, recorded a 5.9 per cent increase on an annual average basis and a 6.9 per cent increase on an year-on-year basis, by year end. The annual average inflation rate gradually increased from a low level of 3.1 per cent in January to 5.9 per cent by end 2010. Overall, the Index rose by 14.8 index points from 213.5 in December 2009 to 228.3 in December 2010. During the course of 2010, the year-on-year change in the index recorded a marginal increase from 6.5 per cent in January 2010 to 6.9 per cent in February 2010 but decreased steadily thereafter to reach 4.3 per cent in July, before registering an upward movement since then to reach 6.9 per cent in December 2010. Price increases in domestically produced goods largely impacted on inflation during the year. The contribution from domestically produced goods to the annual average inflation was 85.2 per cent in 2010, while that from imported items was 14.8 per cent. A similar trend was followed in the case of year-on-year inflation as well. Despite the contribution from domestically produced goods to inflation being yet dominant in the CCPI, its relative significance has been decelerating since March 2010.

Central Bank of Sri Lanka Annual Report - 2010 Changes in Price Indices

CCPI (2002=100) WPI GDP Deflator

Annual Average Percentage Change

Year-on-Year Percentage Change

Average Index Index 2008

2009

2010 (a)

Dec. 2009/ Dec. 2008

Dec. 2010/ Dec. 2009 (a)

2009/2008

199.9 3,653.6 298.3

206.8 3,500.9 315.8 (b)

219.1 3,893.0 338.8

4.8 13.3 -

6.9 17.6 -

3.4 -4.2 5.9

(a) Provisional (b) Revised

2010/2009 (a) 5.9 11.2 7.3

Sources: Department of Census and Statistics Central Bank of Sri Lanka

The major contribution to inflation came from the Food and non-alcoholic beverages sub-index, which has the highest weight of 46.7 per cent in the CCPI. The annual average change in the Food sub-index increased continuously from 2.6 per cent at the beginning of the year to 6.8 per cent in December 2010. Overall inflation moved almost in line with the Food sub-index due to its dominance in the overall index. The Food sub-index contributed to 56.9 per cent of the annual average change in the overall CCPI during the year. The year-on-year increase of the Food sub-index was 10.0 per cent as at end 2010. The price increases of key items such as fish, vegetables, fruits, bread, sugar, egg, meat and meat products, coconut, coconut oil and condiments contributed to the increase in the Food sub-index.

curtail the increases in rice prices in December 2010 contributed to lower the average price

The improved domestic supply conditions as well as the measures taken by the government to

on average, declined by 4.5 per cent during 2010

Table 4.2

Item

of rice. Although the price of rice was relatively higher at the beginning of the year compared to 2009, mainly due to lower supply that prevailed in the market, it began to decline gradually thereafter as reaping of the bumper paddy harvest in the Maha season, especially in the Eastern Province commenced. However, prices of rice moved upward from October 2010 again, partly due to the increased demand for rice that resulted from the substitution effect caused by the high prices of wheat flour and bread. However, the price ceiling on rice imposed by the government w.e.f. 10 December 2010 helped curtail increases in prices. As a result of these developments, the price of rice, compared to 2009.

Retail Prices of Key Imported and Domestically Produced Items

Unit

Percentage Change

Price - Rs.

CCPI (2002=100) Weight %

Annual Average 2008

2009

2010 (a)

Dec. 2008

Dec. 2009

Dec. 2010 (a)

Annual Average 2009/ 2008

Year-on-year

2010/ Dec. 2009/ Dec. 2010/ 2009 (a) Dec. 2008 Dec. 2009 (a)

Domestic

Rice - Samba Rice - Kekulu (Red) Rice - Kekulu (White) Rice - Nadu Coconut (medium) Fish - Kelawalla Beans Brinjals Eggs

1kg 1kg 1kg 1kg nut 1kg 1kg 1kg each

2.8 0.9 0.6 0.5 5.4 1.1 0.5 0.2 0.4

73.99 72.66 72.05 74.17 77.54 65.73 62.53 60.10 64.96 65.55 63.55 61.74 54.33 64.02 63.19 65.16 63.53 60.81 66.95 67.88 29.56 26.01 33.64 24.85 29.64 486.48 523.43 599.67 521.02 523.33 119.60 114.99 137.22 109.66 134.22 86.05 76.25 87.12 93.13 103.70 9.33 10.75 13.60 10.53 15.19

72.30 59.19 57.93 60.95 47.18 639.43 157.17 105.75 16.53

-1.8 -4.9 -2.8 -2.5 -12.0 7.6 -3.9 -11.4 15.2

-0.8 -3.9 -12.0 -4.3 29.3 14.6 19.3 14.3 26.5

4.5 0.9 -1.3 1.4 19.3 0.4 22.4 11.3 44.3

-6.8 -9.7 -8.3 -10.2 59.2 22.2 17.1 2.0 8.8

Imports

Sugar Milk Powder - Anchor Red Dhal Wheat Flour

1kg 400g 1kg 1kg

1.1 3.8 0.8 0.2

63.03 81.97 93.74 274.46 251.73 234.35 190.73 199.70 165.63 73.18 70.84 69.61

99.61 244.00 168.32 82.43

30.0 -8.3 4.7 -3.2

14.4 -6.9 -17.1 -1.7

37.3 -16.2 -14.0 3.6

12.6 8.4 -5.1 15.0

(a) Provisional

64.45 88.50 268.57 225.00 206.23 177.33 69.15 71.67

Source: Department of Census and Statistics

PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

Table 4.1

Central Bank of Sri Lanka Annual Report - 2010

Economic and SocialAND Infrastructure PRICES, WAGES, EMPLOYMENT PRODUCTIVITY

The average price of most varieties of vegetables increased substantially towards the end of 2010, on account of lower supply from the main producing areas, as a consequence of the adverse weather conditions. The average prices of coconut and coconut oil increased by 28.9 per cent and 24.0 per cent, respectively, in 2010 compared to 2009 due to the sharp drop in coconut production. The domestic prices of big onion, red onion and potato, on average, also increased moderately by 4.3 per cent, 3.3 per cent and 2.9 per cent, respectively, in 2010 compared to the previous year. Prices of fish and seafood also remained high compared to the previous year recording an increase of 10.2 per cent, on average, largely due to increased demand and supply fluctuations. Despite the production of fish recording an average growth of 12.0 per cent during 2010, the price of most varieties of fish recorded increases in the range of 0.9-18.9 per cent in 2010, compared to 2009. Meanwhile, prices of Table 4.3

Item

chicken and eggs increased by 13.8 per cent and 28.0 per cent, respectively, in 2010. Despite the price ceiling, the price of chicken fluctuated and reached a peak level in May 2010, but recorded a downward movement towards the end of the year with the reduction of the import duty on chicken. The impact of increases in international commodity prices on domestic prices of key consumer items was mitigated to a certain extent by the reduction of imports related taxes. The average import price of crude oil decreased gradually from US dollars 77.79 per barrel in January 2010 to US dollars 73.53 per barrel in August, but increased rapidly thereafter to reach US dollars 90.37 per barrel in December 2010. Meanwhile, there were several duty revisions on fuel w.e.f. 23 November 2010. Accordingly, import or supply of petrol was exempted from Value Added Tax (VAT). Further, the full customs duty waivers, which had been granted on the importation of petrol and diesel, were reduced to Rs. 20 per litre (applicable duty rate is Rs. 15 per

Administered Price Revisions of Key Items 2008 - 2010

Unit

Price (Dec.) - Rs.

2009/2008

2010/2009

70.00 50.00 120.00 1,619.00 1,403.00 52.70 31.70 25.00

73.00 51.00 115.00 1,550.00 1,421.00 52.70 32.70 26.00

73.00 51.00 115.00 1,652.00 1,540.00 52.70 32.70 26.00

4.3 2.0 -4.2 -4.3 1.3 0.0 3.2 0.0

0.0 0.0 0.0 6.6 8.4 0.0 0.0 0.0

First 30 units 31 - 60 units 61 - 90 units 91 - 180 units Above 180 units

60.00 90.00 120.00 180.00 240.00

0.0 0.0 0.0 0.0 0.0

Electricity - Unit Charges Tariff Block First 30 units 31 - 60 units 61 - 90 units 91 - 180 units Above 180 units

3.00 4.70 7.50 16.00 25.00

0.0 0.0 0.0 0.0 0.0

Water - Unit Charges Tariff Block 00 to 05 units 06 to 10 units 11 to 15 units 16 to 20 units 21 to 25 units 26 to 30 units Bus Fare

1.25 1.25 2.50 8.50 30.00 50.00 -

3.00 7.00 15.00 30.00 50.00 75.00 -

140.0 460.0 500.0 252.9 66.7 50.0 5.3

0.0 0.0 0.0 0.0 0.0 0.0 0.0

Diesel Kerosene Petrol Gas - Shell/Litro (a) Gas - Laugfs Furnace Oil (1000) Furnace Oil (1500) Furnace Oil (3500) Electricity - Fixed Charges Tariff Block

1 ltr. 1 ltr. 1 ltr. 12.5 kg 12.5 kg 1 ltr. 1 ltr. 1 ltr.

(a) Prices of 2010 denotes those of Litro.

2008

2009

Percentage Change 2010

Source: Central Bank of Sri Lanka

Central Bank of Sri Lanka Annual Report - 2010

Extreme Weather Conditions and their Impact

A number of countries including Sri Lanka suffered from unusual weather conditions particularly during the latter part of 2010 and the early part of 2011. The floods and landslides that occurred during this period as a result of unusually heavy rains over Sri Lanka have caused significant damages to the houses, infrastructure facilities, agricultural crops and loss of human lives. Damages in countries like Australia, Brazil and Philippines were severe and are among the most costly natural disasters in those countries. Some experts are of the view that the “La Niña” condition which prevailed during this period may have had a relationship with these weather anomalies. La Niña is typically defined as the below normal sea surface temperature in the central and eastern tropical Pacific Ocean. It is not typical for La Niña phenomenon to impact a country as far west to the Pacific Ocean as Sri Lanka. However, its impact upon weather patterns over the island is not totally rejected either, as the strong winds created by La Niña could interact with the normal northeast monsoon in Sri Lanka.

9 February 2011, more than 3,700 houses were fully damaged while more than 23,000 were partially damaged. In addition to the loss of lives, more than 140,000 people were displaced. The economic impact of this natural disaster was significant in terms of crops and cultivated lands, requiring a significant amount of funds to recover from these damages. Rebuilding process of the damaged infrastructure system also required a lot of resources. The government allocated the required funds from the existing budgetary resources to provide relief to the affected people and to meet the Heavy Rainfall in early 2011, Compared with 30 year Average

Chart B 9.1 1,400

Tatal Rainfall 1-20 January 2011 (mm) 30 year Average Rainfall for 1-20 January (mm)

1,200 1,000 800 600 400 200

Kurunegala

Vavuniya

Anuradhapura

Maha Illuppallama

Mihinthale

Badulla

Ampara

Pottuvil

Trincomalee

Batticaloa

Total Rainfall 1-6 February 2011 (mm) 600

30 year Average Rainfall for the month of February (mm)

500 400 300 200 100

Kurunegala

Monaragala

Pottuvil

Maha Illuppallama

Anuradhapura

Vavuniya

Mihinthale

Badulla

Ampara

Trincomalee

0 Batticaloa

The Eastern and North Central provinces were badly affected by floods due to the heavy precipitation and the hill country was affected by severe landslides in January 2011. There were losses of human lives, majority of which was from the districts of Batticaloa, Ampara and Kandy1. A second spell of heavy precipitation was reported in the first week of February 2011. More than one million people were affected in the Eastern and North Central provinces and the total number of affected people throughout the country was beyond 1.2 million. As reported on

Polonnaruwa

During the month of January and early February of 2011, several parts of the country recorded significantly high levels of rainfall and the eastern region suffered from severe floods. Almost all the tanks and reservoirs in that area were at spill levels and some were breached. Another abnormal phenomenon was the very low temperatures that were recorded in the country during January. In regions such as Batticaloa and Kurunegala, the temperatures fell below 18ºC.

Source: Department of Meteorology

1 As per the Situation Report of the Disaster Management Centre, dated 23 January 2011.

4 PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

BOX 9

Central Bank of Sri Lanka Annual Report - 2010

°C

Economic and SocialAND Infrastructure PRICES, WAGES, EMPLOYMENT PRODUCTIVITY

Low Temperature in Batticaloa During Early 2011, Compared with the Lowest Four Temperature Values Recorded Since 1901

Chart B 9.2 18.2 18.0 17.8 17.6 17.4 17.2 17.0 16.8 16.6 16.4 16.2

17 Feb 1918 17.7

4 Nov 1927 18.0 14 Feb 1953 17.4

27 Jan 1945 17.1

1901

1911

1921

1931

1941

13 Jan 2011 16.9

1951

1961

1971

Year

cost of urgent rehabilitation work to restore normalcy in order to bring back normal life to the people. The government’s emergency relief and rehabilitation programme was greatly successful, particularly in providing food, shelter and sanitation to the affected families. Paddy cultivation in Ampara, Polonnaruwa, Anuradhapura and Batticaloa districts has been severely affected by the floods. In addition to the damage caused by the floods, the cold weather which persisted in most of the districts over the same period would degrade the paddy harvest and as a result, the 2010/11 Maha season crop would be lower. Other subsidiary food crops also suffered damages. The drop in harvest, destruction of food stocks and transportation difficulties impacted on food prices, particularly vegetable prices. Therefore, handling any short supply of food items and stabilizing the resulting increases in price levels is a challenge, in the context of escalating world food prices and shortage of world supply of food due to bad weather conditions experienced by many countries. The government acted swiftly to restore normalcy in the affected areas and decided to earmark Rs. 33 billion for the proposed rehabilitation programme. Further,

litre) and Rs.11 per litre (applicable duty rate is Rs. 4 per litre), respectively. However, these duty revisions on fuel did not have a direct impact on the CCPI, as there was no corresponding revision of retail prices during the course of the year. Therefore, the stable fuel prices that prevailed in the domestic market throughout the year helped contain the overall cost structure and thereby inflation in the economy to a greater extent. 86

1981

1991

2001

2011

Source: Department of Meteorology

it was decided to suspend all supplementary budget programmes in 2011, to use existing programmes by line ministries and agencies on the rehabilitation programme, to accelerate the food production drive including one million home gardens, to provide seeds free of charge and to extend the fertilizer subsidy scheme to growers of vegetables and all other crops. In addition, a task force was appointed to direct and monitor the implementation of a well coordinated and effective programme for restoration activities. The adverse impact of these extreme weather conditions experienced in late 2010 and early 2011 created an extra burden to the government, and the government was confronted with new challenges of consolidating fiscal and macro economic achievements of the recent past. The success of facing these challenges would reflect in the level of economic resilience of the country. References www.disasmin.gov.lk; Ministry of Disaster Management, Sri Lanka. www.dmc.gov.lk; Disaster Management Centre, Ministry of Disaster Management, Sri Lanka. www.noaa.org; National Oceanic and Atmospheric Administration. The revision of import duty pertaining to key food items during the year also had an impact on the CCPI. The reduction of import duties on wheat flour by Rs. 10 per kg w.e.f. 22 December 2009 and milk powder by Rs. 50 per kg w.e.f. 01 December 2009 led to a decline in their domestic prices in 2010. Meanwhile, the import duty on wheat flour was revised upward on two occasions in April and June 2010. The total recoverable taxes

Central Bank of Sri Lanka Annual Report - 2010

Other significant contributions to the increase in the index came from the sub-indices of Housing, water, electricity, gas and other fuels; Health, and Education. These sub-indices contributed 11.6 per cent, 11.3 per cent and 9.1 per cent, respectively, to the annual average increase in 2010. The increase in the sub-index of Housing, water, electricity, gas and other fuels resulted from the increase in LP gas prices during the year. LP gas prices increased, on average, by 11.3 per cent in 2010. The increase in the Health sub-group was mainly attributable to the price increases in the services provided by private hospitals, pharmaceuticals and specialist consultations. Increases in tuition fees caused the sub-index of Education to move upward. Meanwhile, all the other sub-groups of Clothing and footwear; Transport; Communication; Furnishing, household equipment and routine household maintenance; Recreation and culture; and Miscellaneous goods and services; provided contributions ranging from 0.9 per cent to 2.8 per cent to the annual average inflation.

The annual average core inflation, which is derived by excluding food and energy items from the CCPI basket, declined gradually from 8.6 per cent in January to 6.3 per cent in December, 2010. The year-on-year core inflation too declined from 7.9 per cent in January 2010 to 5.6 per cent in December 2010. In the core inflation, the contribution of Education and Health sub-groups significantly increased, on average, during 2010 due to the increase in tuition fees and charges for private medical services including medicine, and medical consultation fees. In order to reflect changes in household consumption patterns owing to the improvement in income levels and the changes in consumer tastes and preferences, the base year of CCPI is expected to be revised from 2002 to 2006/07 in 2011. The Department of Census and Statistics (DCS) has completed the work relating to the revised CCPI, based on the Household Income and Expenditure Survey (HIES) conducted in 2006/07. The rebased CCPI is expected to replace the current 2002 based CCPI in mid-2011.

Wholesale Price Index (WPI) Inflation at the primary market level, as measured by the WPI, showed a declining trend on an year-on-year basis during the first nine months of the year and reached 5.2 per cent in September 2010. However, it reversed its trend thereafter and increased substantially to record a 17.6 per cent increase by year end. On an annual average basis, the WPI continued to move on an increasing path during the year reaching 11.2 per cent in December 2010 from a negative 2.5 per cent in January 2010. The annual average increase of the subindex for the Food category was 10.1 per cent. The sub-indices for Textile and footwear; Chemical and chemical products; Metal products; and Electrical appliances, declined on an annual average basis by 2.4 per cent, 13.6 per cent, 1.1 per cent and 0.4 per cent, respectively, in 2010. When the sector-wise classification of the 87

4 PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

on importation of milk powder was reduced from Rs. 100 to Rs. 50 per kg w.e.f. 16 February 2010 while the price of the same increased by Rs. 19 per 400g in mid-2010. The average price of sugar increased substantially by 15.5 per cent in 2010, owing to the increase in the international price and an increase in the import duty by Rs. 4 per kg w.e.f. 21 June 2010. Similarly, the domestic price of dhal decreased considerably as a result of the price declines in the international market, in spite of the increase in the Special Commodity Levy (SCL) on the importation of dhal, w.e.f. 10 August 2010. The net impact of the above international price developments and duty changes led to a decrease in the average prices of dhal, milk powder and wheat flour in the domestic market by 17.4 per cent, 6.7 per cent and 1.7 per cent, respectively, in 2010 compared to 2009. Import and other duty revisions pertaining to red onion, big onion, potato, egg, meat of fowl and edible oil, during the year also had an impact on the CCPI. In addition, the slight appreciation of the rupee has had a favourable impact on the prices of imported items.

Central Bank of Sri Lanka Annual Report - 2010

Economic and SocialAND Infrastructure PRICES, WAGES, EMPLOYMENT PRODUCTIVITY

WPI is considered, prices in the Domestic and Export categories increased by 3.0 per cent and 28.7 per cent, respectively, on an annual average basis during the year, while prices in the Import category recorded a decline of 0.9 per cent. Price increases in cocoa, rubber products, cardamom, coconut, coconut oil, cinnamon and tea caused the increase in the Export group. When the enduse classification of the WPI is considered, prices in all three categories namely, Consumer, Intermediate and Investment increased by 9.9 per cent, 17.7 per cent and 0.9 per cent, respectively, on an annual average basis, by year end. Of these categories, the increases in the price of green gram, coconut, coconut oil, egg, sugar, fruits and vegetables contributed heavily to the increase in the Consumer category while the price increases of cocoa, rubber, cardamom and cinnamon contributed to the increase in the Intermediate category.

Table 4.4

Sector

Sectoral Deflators and GDP Deflator

Index

Percentage Change

2008 2009 (a) 2010 (b)

2009/2008 (a) 2010/2009 (b)

Agriculture

342.2 344.8

376.5

0.8

9.2

Industry

304.0 323.0

342.4

6.3

6.0

Services

285.1 304.7

327.6

6.9

7.5

GDP

298.3 315.8

338.8

5.9

7.3

(a) Revised (b) Provisional

Sources: Department of Census and Statistics Central Bank of Sri Lanka

sector employees during 2010, the annual average nominal wages registered an increase of 3.3 per cent in 2010, as a result of the adjustment in the COLA in November 2009. A decline in the real wage rate indices of all categories of the public sector employees was observed in 2010, as nominal wage increases were not sufficient to compensate for the increase in the price level in 2010.

Public Sector Wages

4.3 Wages

The nominal wage rate indices of public sector employees recorded a modest increase in 2010. The last increase of the monthly COLA by Rs. 750 payable to employees in the Public Service, Provincial Public Service and Armed Forces was in November 2009. Accordingly, the monthly COLA payable to the public sector employees remained unchanged at Rs. 5,250 throughout 2010. Consequent to the increase in the monthly COLA in November 2009, the overall nominal wage rate index of the central government employees increased by 3.3 per cent compared to 9.4 per cent in 2009. Nominal wage rate indices of non-executive officers, minor employees and government school teachers rose by 3.1 per cent, 3.5 per cent and 3.3 per cent, respectively, in 2010 when compared to increases in the range of 8.9-10.0 per cent in 2009.

The nominal wages of both the public and private sector employees increased in 2010. Within the private sector, employees in both the formal and informal private sectors enjoyed increases in wages both in nominal and real terms. This increase was substantial among the employees in the formal private sector, whose wages are governed by the Wages Boards. Though there was no upward revision in the wages of public

When the nominal wages were adjusted for inflation, there was a slight drop in real wage rate indices of all categories of public sector employees in 2010, as against the significant real wage increases enjoyed by them in 2009. Accordingly, non-executive officers, minor employees and government school teachers suffered real wage erosions of 2.6 per cent, 2.3 per cent and 2.5 per cent, respectively, in 2010

GDP Deflator The overall price change in the economy, as measured by the GDP deflator, rose by 7.3 per cent in 2010 compared with 5.9 per cent recorded in 2009. Both the Agriculture and Services sectors recorded relatively higher inflation rates of 9.2 per cent and 7.5 per cent, respectively, during the year, compared to the last year. The inflation in the Agriculture sector is considerably higher when compared to the lowest growth recorded in 2009. The lowest rate of inflation of 6.0 per cent during the year was in the Industry sector, in which inflation decelerated marginally from 6.3 per cent in 2009.

Central Bank of Sri Lanka Annual Report - 2010 Wage Rate Indices (December 1978=100) Index Employment Category

Percentage Change

Nominal 2008

2009

Real (a) 2010 (b)

2008

2009

Nominal 2010 (b)

Real (a)

2008 2009 2010 (b)

2008

2009 2010 2010 (b) (b)

1. Government employees Central government employees

4,116.1 4,502.8 4,651.6

150.4 159.0

155.1

7.5

9.4

3.3

-12.4

5.7

-2.5

Non-executives Minor employees Government school teachers

3,749.5 4,082.4 4,210.4 4,494.7 4,943.5 5,116.1 2,938.6 3,215.3 3,321.7

137.0 144.2 164.2 174.6 107.4 113.5

140.4 170.6 110.7

7.3 7.7 7.2

8.9 10.0 9.4

3.1 3.5 3.3

-12.5 -12.2 -12.5

5.2 6.3 5.7

-2.6 -2.3 -2.5

2. Workers in Wages Boards Trades All Wages Boards Trades

2,070.4 2,171.4 2,865.3

75.5

76.7

95.5

25.6

4.9

32.0

2.7

1.5

24.5

Workers in agriculture Workers in industry and commerce Workers in services

2,286.6 2,349.4 3,327.6 1,877.5 2,054.0 2,198.9 1,370.8 1,545.8 1,673.3

83.5 68.5 49.9

83.0 72.5 54.6

110.9 73.2 55.7

25.5 23.3 29.7

2.7 9.4 12.8

41.6 7.1 8.2

2.6 0.9 6.0

-0.6 5.9 9.3

33.7 0.9 2.0

(a) Real wage rate indices are based on CCPI (2002=100). (b) Provisional

as against real wage increases enjoyed by them in the range of 5.2-6.3 per cent in 2009. Consequently, the overall real wage rate index of central government employees recorded a decrease of 2.5 per cent over that of the previous year.

Formal Private Sector Wages Nominal wages of the organised private sector as measured by the minimum wage rate indices of employees whose wages are regulated by Wages Boards increased substantially during 2010. The minimum wage rate indices in the three major categories of the formal private sector, namely, Agriculture, Industry and Commerce, and Services increased in nominal terms by 41.6 per cent, 7.1 per cent and 8.2 per cent, respectively, in 2010. The increase was mainly attributable to the substantial increase in the minimum wage rate index of workers in the Agriculture sector, by 41.3 per cent granted in January 2010. Meanwhile, there were increases in nominal wage rate indices of the Agriculture sector (by 0.5 per cent) in July 2010, the Industry and Commerce sector (by 16.9 per cent), and the Services sector (by 19.8 per cent) in August 2010. As a combined outcome of the above mentioned developments during 2010, the overall wage rate index for the organised private sector recorded an increase of 32.0 per cent in 2010 over the previous year. When the nominal wage rate indices were adjusted for inflation, the formal private sector

Sources: Department of Labour Central Bank of Sri Lanka

employees in all three major categories enjoyed increases in their real wages in 2010, with the Agriculture sector in particular registering a significant wage increase in real terms. Accordingly, minimum wage rate indices of the Agriculture, Industry and Commerce, and Services sectors increased in real terms by 33.7 per cent, 0.9 per cent and 2.0 per cent, respectively, in 2010. As a result, the overall real wage rate index for employees under the purview of the Wages Boards, on average, increased by 24.5 per cent in 2010, in real terms compared to 1.5 per cent increase in the previous year.

Informal Private Sector Wages Information on the daily wages of the informal private sector revealed upward movements, at varied rates, in nominal terms. Wages in the informal private sector, which fall outside the public and formal private sector, are collected under a regular survey carried out under the Country Wide Data Collection System (CWDCS), pertaining to the agriculture and building construction sectors. Generally, wages in the informal private sector tend to get adjusted to reflect both demand and supply conditions in the economy and the level of the reservation wage of labour. Accordingly, informal sector wages in the Agriculture and Construction sectors increased by 9.1 per cent and 7.3 per cent, respectively, in 2010 when compared to the previous year. Within the Agriculture sector, the average daily wages of 89

PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

Table 4.5

Central Bank of Sri Lanka Annual Report - 2010

Economic and SocialAND Infrastructure PRICES, WAGES, EMPLOYMENT PRODUCTIVITY

Table 4.6

Informal Private Sector Daily Wages by Sector and Gender

Annual Average (Rs.) Sector

2008 (a)

2009 (a)

Percentage Change

2010 (b)(d)

Real(c)(c) Real

Nominal 2009

2010 (d)

2009 2009

2010 2010(d) (d)

1. Agriculture Sector Tea Male Female Rubber Male Female Coconut (e) Male Paddy Male Female

440 305

488 356

543 391

10.9 16.5

11.3 9.9

7.2 12.6

5.0 3.7

500 377

532 416

588 463

6.5 10.1

10.5 11.4

2.9 6.4

4.3 5.2

590

651

699

10.4

7.4

6.7

1.3

562 395

613 423

658 453

9.1 7.0

7.3 7.1

5.5 3.5

1.3 1.1

844 558

934 615

1,002 657

10.6 10.2

7.3 6.8

6.9 6.5

1.3 0.8

837 561

925 623

995 669

10.5 11.1

7.6 7.4

6.8 7.3

1.5 1.4

2. Construction Sector (e) Carpentry Master Carpenter - Male Skilled and Unskilled Helper - Male Masonry Master Mason - Male Skilled and Unskilled Helper - Male (a) (b) (c) (d) (e)

Wage information were based on monthly wages from 90 data collection centres. Wage information for 2010 were based on monthly wages from 102 data collection centres. Real wage percentage changes are based on CCPI (2002=100). Provisional Female participation is minimal in the Coconut and Construction sectors.

sub-categories of Rubber, Tea, Coconut and Paddy increased by 11.0 per cent, 10.7 per cent, 7.9 per cent and 7.3 per cent, respectively, in 2010 against 2009. The increases were relatively higher among the Tea and Rubber sub-sectors, probably due to the increased export prices in the international market, which enabled the producers to make higher payment to the respective workers, and the sharp increase in wages of workers in the formal sector plantations. Gains in the real wages of the employees in all the sub-categories in the Agriculture and Construction sectors were recorded in 2010. Accordingly, the daily real wages of Rubber, Tea, Coconut and Paddy sub-sectors in the Agriculture sector, on average, increased by 4.7 per cent, 4.5 per cent, 1.8 per cent and 1.3 per cent, respectively. Meanwhile, the real wages of masonry and carpentry in the Construction sector recorded lower increases of around 1.5 per cent and 1.1 per cent, respectively. Overall, both the Agriculture and Construction sectors recorded lower increases in real wages around 3.0 per cent and 1.3 per 90

Source: Central Bank of Sri Lanka

cent, respectively, in 2010 compared to real wage increases of 8.2 per cent and 6.9 per cent, recorded in 2009.

4.4 Population, Labour Force and Employment Population The mid-year population is estimated at 20.65 million in 2010, an increase of 1.0 per cent compared with 1.1 per cent growth recorded in 2009. Except in Mulaitivu, population in all districts increased in 2010. High increases in population were recorded in Colombo, Kandy, Kurunegala, Ratnapura, Badulla, Gampaha, Galle, Anuradhapura and Ampara Districts, which together contributed to over 60 per cent of the overall growth in population in 2010.

Labour Force According to the QLFS, the labour force, which is defined as the economically active population aged 10 years and above, increased marginally to 8.11 million in 2010 from 8.07

Central Bank of Sri Lanka Annual Report - 2010

of the labour force to the total population aged 10 years and above, further decreased to 48.1 per cent in 2010 from 48.7 per cent in the previous year. This decrease was attributable to the appreciable decline in the female LFPR, which was estimated at 31.2 per cent in 2010 compared to 32.8 per cent in the previous year. Meanwhile, there was a marginal increase in the male LFPRs to 67.1 per cent in 2010 compared to 66.6 per cent in the previous year. Sector-wise LFPRs indicated that the rural sector participation was higher than that in the urban sector while the female participation in the urban sector was significantly lower than that of males. Similarly, the gender analysis of the LFPRs over the years had shown that the participation rate of males has been more than twice that of females, throughout the recent past, and female labour force participation has been declining over the last few years.

District-wise Population ‘000 Persons 2009

2010 (a)

Change (a)

Percentage Change (a)

Colombo

2,521

2,553

1.3

Kandy

1,415

1,431

1.1

Ratnapura

1,113

1,125

1.1

874

886

1.4

Kurunegala

1,550

1,563

0.8

Gampaha

2,165

2,177

0.6

Galle

1,074

1,084

0.9

820

830

1.2

1,128

1,135

0.6

Matara

831

839

1.0

Nuwara Eliya

755

761

0.8

Ampara

634

644

1.6

Batticaloa

537

543

1.1

Puttalam

770

779

1.2

Jaffna

607

611

0.7

Matale

490

497

1.4

Trincomalee

368

374

1.6

Hambantota

565

571

1.1

Moneragala

435

440

1.1

Polonnnaruwa

405

410

1.2

Mulaitivu

154

148

-6

-3.9

Kilinochchi

154

156

1.3

Vavuniya

169

174

3.0

Kegalle

813

818

0.6

District

Badulla

Anuradhapura Kalutara

Mannar

Total (a) Provisional

103

104

1.0

20,450

20,653

203

1.0

Employment According to the QLFS, the number of employed persons increased marginally by 1.4 per cent to 7.71 million in 2010 as compared to 7.60 million in 2009.2 This could be attributed to the growing demand for employment consequent to the improved performance in all three major sectors of the economy.

Source: Registrar General’s Department

million in the previous year.1 The total labour force comprised of 7.71 million employed and 0.40 million unemployed persons. Meanwhile, the labour force participation rate (LFPR), which is the ratio Table 4.8

Item

Household Population, Labour Force and Labour Force Participation

2008 (a) 2008 (b) 2009 (a) 2009 (b)

Household Population (c) ‘000 Persons 15,079 Labour Force ‘000 Persons Employed Unemployed

16,320 15,398 8,082 7,648 434

7,572 7,140 433

8,074 7,602 471

Labour Force Participation Rate (d) per cent 50.2 Male 67.9 Female 34.3

49.5 67.8 33.2

49.2 66.7 33.7

48.7 66.6 32.8

2010 (b) Q4

Annual

7,678 7,557 7,445 7,762 7,610 7,287 7,146 7,092 7,418 7,236 390 411 353 344 375 49.1 67.8 32.7

48.5 67.6 31.6

Annual Q4 Annual

47.7 67.1 30.4

49.3 66.7 33.7

48.6 67.3 32.1

8,130 8,051 7,972 8,279 8,108 7,726 7,613 7,578 7,909 7,707 404 437 394 369 401 48.2 67.3 31.6

47.9 67.3 30.8

47.4 67.1 29.8

48.8 66.9 32.6

48.1 67.1 31.2

Source: Department of Census and Statistics

Data exclude both Northern and Eastern provinces. Data exclude Northern Province. Aged 10 years and above. Labour force as a percentage of household population aged 10 years and above.

The levels and trends of labour force, employment and unemployment in Sri Lanka are based on the Quarterly Labour Force Survey (QLFS) conducted by the DCS. The coverage of the QLFS was extended to the Eastern Province in the first quarter of 2008. Though the DCS plans to expand its sample coverage to the entire country, the Northern Province was not covered fully by the QLFS during the last few years. Accordingly, the labour force data excluding the Northern Province has been used in the analysis, unless otherwise stated.

16,578 15,640 15,586 15,619 15,755 15,650 16,851 16,810 16,816 16,969 16,862

7,569 7,175 394

(a) (b) (c) (d)

2010 (a) Q2

The QLFS conducted by the DCS defines an employed person as one who is engaged in some kind of work for pay, profit or family gain (unpaid) during the survey period. According to the status of employment, persons working as paid employees, employers, own account workers (self-employed), or unpaid family workers during the survey period were considered as employed persons in the QLFS. This includes persons with a job but not at work during the survey period. Employees absent from work due to illness, bad weather or labour disputes are also considered as employed.

4 PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

Table 4.7

Central Bank of Sri Lanka Annual Report - 2010

Economic and SocialAND Infrastructure PRICES, WAGES, EMPLOYMENT PRODUCTIVITY

Employment by Economic Activity

Table 4.9

â&#x20AC;&#x2DC;000 Persons Sector

2009 (a)

Agriculture Industry Manufacturing Construction (c)

2009 (b)

Percentage of Total Employment

2010 (a) Q1

2010 (b) Q4

Annual

2009 (a)

2009 (b)

2010 (a)

2010 (b)

2,319 2,476 2,456 2,299 2,197 2,462 2,354 2,600 2,439 2,367 2,672 2,520 1,823 1,910 1,835 1,696 1,756 1,821 1,777 1,911 1,795 1,850 1,910 1,867 1,301 1,348 1,321 1,222 1,251 1,287 1,270 1,356 1,274 1,301 1,342 1,318 522 562 514 474 506 534 507 555 521 549 568 548

32.5 32.6 32.5 32.7 25.5 25.1 24.6 24.2 18.2 17.7 17.6 17.1 7.3 7.4 7.0 7.1

Services 2,999 3,216 2,996 3,150 3,139 3,134 3,105 3,214 3,379 3,360 3,327 3,320 Trade and hotels, etc. 1,047 1,119 1,082 1,096 1,201 1,121 1,125 1,149 1,183 1,262 1,192 1,196 Transport, storage and communication 420 445 451 480 454 465 463 471 506 474 486 484 Finance, insurance and real estate 221 227 231 240 285 268 256 237 245 295 281 264 Personal services and other 1,311 1,426 1,232 1,333 1,199 1,281 1,261 1,357 1,445 1,330 1,367 1,375

42.0 42.3 42.9 43.1 14.7 14.7 15.5 15.5 5.9 5.9 6.4 6.3 3.1 3.0 3.5 3.4 18.4 18.8 17.4 17.9

Total employment

7,140 7,603 7,287 7,146 7,092 7,418 7,236 7,726 7,613 7,578 7,909 7,707 100.0 100.0 100.0 100.0

Percentage of Labour Force

94.3

94.2

94.9

94.6

95.3

95.6

(a) Data exclude both Northern and Eastern provinces. (b) Data exclude Northern Province. (c) Mining and quarrying, electricity, gas and water categorised under Construction.

There was a change in the composition of the employed population, among the major industry groups between these two periods. Accordingly, the shares of the Agriculture and Services sectors in total employment recorded increases in 2010 while that of the Industry sector recorded a contraction. The Services sector, which made the largest contribution to the overall economic growth during the last few years, continued to dominate in generating more employment opportunities in 2010 as well. Accordingly, the share of the Services sector in total employment Status of Employment

Table 4.10

Per cent Period 2008 (a) 2008 (b) 2009 (a) 2009 (b) 2010 (Annual) (a) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 2010 (Annual) (b) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Public Private Unpaid SelfSector Sector EmplFamily Employees Employees oyers Employed Workers 14.9 15.2 15.2 15.5 13.9 13.5 13.9 14.1 14.0 14.3 14.2 14.1 14.6 14.2

41.1 41.2 42.1 42.1 41.3 41.5 42.3 41.2 40.2 41.2 41.4 42.2 41.1 40.2

(a) Data exclude both Northern and Eastern provinces. (b) Data exclude Northern Province.

3.0 2.9 2.7 2.6 2.7 2.4 2.7 3.2 2.4 2.6 2.4 2.6 3.1 2.4

30.2 30.3 29.0 29.2 31.5 31.6 30.4 31.8 32.0 31.5 31.4 30.7 31.7 32.1

10.8 10.5 11.0 10.6 10.7 11.0 10.6 9.8 11.4 10.4 10.7 10.3 9.5 11.1

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Source: Department of Census & Statistics

95.1

95.0

94.6

95.1

95.5

95.0

Source: Department of Census and Statistics

increased to 43.1 per cent in 2010 from 42.3 per cent in the previous year. Within the Services sector, the increase in employment came mainly from the Personal Services and Other sector, primarily supported by the expansion of economic activity. Meanwhile, the share of employment in the Agriculture sector increased to 32.7 per cent in 2010 from 32.6 per cent in 2009, and that of the Industry sector decreased to 24.2 per cent in 2010 from 25.1 per cent in 2009. The drop in the share of employment in the Industry sector to the total employment was observed in both the Manufacturing and Construction sectors. In terms of employment status, the share of own account workers increased in 2010, while that of employers remained at the same level as in 2009. However, the shares of the public sector employees, private sector employees and unpaid family workers declined, when compared to 2009. Despite the share of employment in the private sector declining in 2010, it continued to maintain its dominance, registering the major share of 41.2 per cent as against 14.3 per cent by the public sector. Meanwhile, in the self-employment category, which has been the second most prominent category, the number of employment opportunities generated was higher during the year. The growth in the number of employers and self-employed categories signifies

Central Bank of Sri Lanka Annual Report - 2010

2008

2009

2010 (a)

Percentage Change

Government (b) 990,410 1,047,041 1,027,179 Semi-government (c) 261,318 266,543 271,923 Public Sector 1,251,728 1,313,584 1,299,102 (a) (b) (c)

Provisional Central Government, Local Government and Provincial Councils State Corporations, Statutory Boards and State Authorities

2009/ 2008

5.7 2.0 4.9

2010/ 2009 (a)

-1.9 2.0 -1.1

The unemployment rate was high among the age group of 15â&#x20AC;&#x201C;29 years as observed during the last few years. However, according to the estimates of the QLFS, the unemployment rate among this age group decreased to 14.8 per cent in 2010 from 16.1 per cent in 2009. More precisely, the youth unemployment among the age group of 1519 years and 20-29 years dropped to 20.3 per cent and 13.8 per cent, respectively, in 2010, from those of 20.9 per cent and 15.4 per cent, respectively, in 2009. The unemployment rate of 21.7 per cent recorded among young females was higher than that of 10.9 per cent among young males in 2010. However, both unemployment rates were lower than those of the previous year.

Source: Central Bank of Sri Lanka

the post-conflict increase in investorsâ&#x20AC;&#x2122; confidence and growing opportunities in the economy.

Unemployment According to the QLFS, the unemployment rate decreased to 4.9 per cent in 2010 as compared to 5.8 per cent recorded in 2009, in line with the broad based growth in all the key sectors of the economy. The total number unemployed was estimated at 401,000 in 2010, compared to 471,000 in the previous year.

Foreign Employment

However, the continued youth unemployment, especially among educated youth, remains a matter of concern. This problem was even more acute among educated females than educated males. In terms of the unemployment rate by level of education, the highest unemployment rate of 11.6 per cent was among those with qualifications of GCE (A/L) and above, followed by those with GCE (O/L) qualifications (6.9 per cent). The increasing

Unemployment Rate (Unemployed as a percentage of Labour Force)

Table 4.12 Category

Overseas job opportunities for Sri Lankans recovered well from the temporary set-back in 2009 and continued to be a major source of employment in 2010. Following the usual pattern, there was a continued increase in departures for foreign employment during the first three successive quarters of 2010 while a slight slowdown was registered in the last quarter of

2008 (a) 2008 (b) 2009 (a) 2009 (b)

2010 (b)

2010 (a) Q1

Q4 Annual

Q3 Q4Q4

Annual Annual

All

5.2

5.4

5.7

5.8

5.1

5.4

4.7

4.9

5.0

5.4

4.9

4.5

4.9

By Gender Male Female

3.6 8.0

3.7 8.4

4.3 8.2

4.3 8.6

3.5 7.9

4.2 7.7

3.4 7.4

2.9 7.2

3.5 7.5

3.4 7.9

4.1 8.0

3.6 7.7

2.9 7.3

3.5 7.7

20.6 13.2 3.1 1.2

20.8 13.7 3.1 1.2

21.2 15.1 3.6 1.4

20.9 15.4 3.7 1.4

21.6 14.5 2.9 1.0

24.2 14.9 3.2 1.2

18.7 13.1 3.0 1.2

19.8 12.2 3.4 0.8

21.1 13.7 3.1 1.0

20.2 14.3 2.8 1.0

22.1 14.9 3.1 1.2

18.2 13.8 3.1 1.2

20.5 12.3 3.4 0.8

20.3 13.8 3.1 1.0

Grade 4/Year 5 and below 1.1 - Grade 5-9/Year 6-10 4.5 4.5 GCE (O/L)/NCGE 7.4 7.8 GCE (A/L)/HNCE and above 9.9 10.5 Data exclude both Northern and Eastern provinces. Data exclude Northern Province.

- 4.9 8.1 10.8

- 5.0 8.5 11.2

- 3.6 7.3 11.9

- 3.8 8.0 12.3

- 3.5 7.0 10.6

- 3.4 5.6 10.6

- 3.6 6.9 11.3

- 3.5 7.0 12.0

- 4.0 7.8 12.3

- 3.5 7.5 11.1

- 3.5 5.6 10.8

3.6 6.9 11.6

By Age Group

15 - 19 20 - 29 30 - 39 40 and above

By Educational Level (a) (b)

Source: Department of Census and Statistics

4 PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

Sector

trend in unemployment among those with GCE (A/L) and higher qualifications since 2008 is indeed an unfavourable development. The persistent mismatches between job opportunities in the market and aspirations and skills of the unemployed have partly caused this problem.

Public Sector Employment

Table 4.11

Central Bank of Sri Lanka Annual Report - 2010 Trends in Labour Force & Unemployment 2007-2010

Chart 4.2 Chart 4.2Trends in Labour Force & Unemployment 2006-2010 10

7 49

Per cent

5 4

Labour Force Participation Rate (Left Axis)

2010 - Q4

2010 - Q3

2010 - Q2

2009 - Q4

2010 - Q1

2009 - Q3

2009 - Q2

2009 - Q1

2008 - Q4

2008 - Q3

2008 - Q2

2008 - Q1

2007 - Q4

2007 - Q3

2007 - Q2

47 2007 - Q1

Economic and SocialAND Infrastructure PRICES, WAGES, EMPLOYMENT PRODUCTIVITY

Unemployment Rate (Right Axis)

Note: 2007 unemployment rate excludes Northern and Eastern provinces.

2010. The total number of departures for foreign employment in 2010 increased by 7.8 per cent to 266,445 compared to 247,126 departures in 2009. A decline in departures for overseas employment was observed in the categories of semi-skilled workers and housemaids. Meanwhile, a noticeable growth in migration for foreign employment was registered for professionals, middle level, clerical and related workers, and skilled labour as well as for unskilled labour categories. A number of policy measures were introduced by the relevant authorities in 2010 to attract more foreign employment opportunities, while enhancing the protection and welfare of Sri Lankan migrant workers and their families left behind. Accordingly, a National Labour Migration Policy was developed in consultation

In addition to the compulsory training programmes being conducted for female migrant employees, the SLBFE has commenced a five day compulsory male training programme for capacity building of male workers. More importantly, a computer network has also been developed to maintain links with the head office and its district and regional offices and Sri Lankan Missions in labour receiving countries and local recruitment agents. Further, taking into consideration the valuable services being rendered by the recruitment agencies in deploying migrant workers for overseas jobs, the SLBFE organised a grading scheme, with the technical assistance of the Sri Lanka Standards Institution,

Departures for Foreign Employment

Table 4.13

Employment

with the International Labour Organization (ILO), addressing major issues that relate to labour migration. The policy was mainly aimed at providing better governance and regulation of labour migration, effective protection and services for Sri Lankan foreign employees and, mobilising more contribution in terms of remittances and reintegration of returnees. Further, with a view to facilitating international relations with regard to migrant labour through bilateral agreements, MOUs, influencing policy making on migrant labour in host countries and better coordination of migrant labour affairs through Sri Lankan missions overseas, the Sri Lanka Bureau of Foreign Employment (SLBFE) was placed under the purview of the Ministry of External Affairs.

2008 Number

2009 Per cent

2010 (a)

Number

Per cent

Number

Per Percent cent

Total Placement By Source

250,499

100.0

247,126

100.0

266,445

100.0

160,973 89,526

64.3 35.7

156,567 90,559

63.3 36.7

160,700 105,748

60.3 39.7

128,232 122,267

51.1 48.9

119,381 127,745

48.3 51.7

135,502 130,946

50.9 49.1

2,835 8,727 6,791 59,718 5,326 59,239 107,923

1.1 3.5 2.7 23.8 2.1 23.6 43.1

2,832 6,388 6,719 61,321 6,015 50,173 113,678

1.1 2.6 2.7 24.8 2.4 20.3 46.0

2,974 6,720 7,795 71,114 4,857 59,898 113,087

1.1 2.5 2.9 26.7 1.8 22.5 42.4

Licensed Agents Other

By Gender

Male Female

By Manpower Category

Professional Middle Level Clerical & Related Skilled Labour Semi Skilled Labour Unskilled Labour Housemaid

(a) Provisional

Source: Sri Lanka Bureau of Foreign Employment

Central Bank of Sri Lanka Annual Report - 2010

The concerted efforts made by relevant authorities for more employment opportunities in countries outside the traditional markets and encouraging Sri Lankans to take up technically skilled employment resulted in changes in departures for foreign employment by the manpower category in 2010. With these developments, the departure of housemaids, who continued to dominate the Sri Lankan foreign employment industry decreased further slightly by 0.5 per cent to 113,087 in 2010. Similarly, the relative significance of housemaids in the total departures for foreign employment also decreased to 42.4 per cent in 2010 from 46.0 per cent in 2009. However, the skilled as well as unskilled labour, and clerical and related worker groups recorded increases in the relative share of each manpower category as compared to 2009. In addition, there were remarkable increases in the number of departures in respect of skilled labour (by 9,793) and unskilled labour (by 9,725). However, the semi-skilled labour category decreased by 1,158 between the two years. Despite the increase in departures of the middle level employees, its relative significance in the total departures declined marginally during the year. However, there was an increase in male migration in 2010, against the temporary decline observed in 2009. Accordingly, male migration increased to 51 per cent in 2010 from 48 per cent of total departures in 2009. As a result, the gender composition of male to female departures registered a ratio of 51:49 in 2010 compared to that of 48:52, last year.

The Middle Eastern region continued to dominate the foreign employment market, accounting for more than 90 per cent of the departures for foreign employment, with the majority consisting of housemaids. Within the Middle East region, Saudi Arabia, Qatar, Kuwait and UAE accounted for 80.6 per cent of the total departures for foreign employment in 2010. Of these countries, departures to Saudi Arabia and Qatar, which alone contributed to 49.2 per cent of the total migrant workers in 2009, declined to 46.7 per cent in 2010, entirely due to the decrease in departures of migrant workers to Saudi Arabia. Accordingly, the substantial increase in departures to Qatar by 22.6 per cent in 2010 was partially offset by the decline in departures to Saudi Arabia by 8.9 per cent. Migration to Kuwait and UAE reported increases of 13.5 per cent and 6.3 per cent, respectively, in 2010, when compared to 2009. The bilateral agreements and MOUs entered into by the Ministry of Foreign Employment Promotion and Welfare with labour receiving countries namely, Kuwait, Oman, Jordan, Libya, Qatar, Bahrain and UAE for enhancing welfare and protection of migrant employees would make foreign employment more attractive. In addition, development of information sharing networks with different stakeholders in the industry and government to government recruitment systems will further improve the future employment opportunities overseas. Foreign employment continued to be an important and stable source of foreign currency inflows to the country. As a result of the developments in migrant worker population, total foreign remittances received in 2010 increased Table 4.14

Country Qatar Saudi Arabia U A E Kuwait Other

Total (a) Provisional

Foreign Employment Departures by Destination 2009

2010 (a)

Number

43,744 77,826 39,586 42,400 43,563

17.7 31.5 16.0 17.2 17.6

247,119 100.0

Number 53,632 70,890 42,069 48,105 51,749

Change (a) Number Per cent

20.1 26.6 15.8 18.1 19.4

9,888 -6,936 2,483 5,705 8,186

22.6 -8.9 6.3 13.5 18.8

266,445 100.0

19,326

7.8

Source: Sri Lanka Bureau of Foreign Employment

4 PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

to evaluate the performance of licensed foreign employment agencies and grant them with National Recognition. Further, the Ministry of Foreign Employment Promotion and Welfare has signed several bilateral agreements with some Arabian countries, such as Jordan, Libya, Qatar, Bahrain and United Arab Emirates (UAE), with the objective of enhancing protection and welfare of Sri Lankan migrant workers. These new measures along with many other welfare and protection schemes that are in place will have a positive impact on foreign employment in the future.

Central Bank of Sri Lanka Annual Report - 2010

Economic and SocialAND Infrastructure PRICES, WAGES, EMPLOYMENT PRODUCTIVITY

by 23.6 per cent to US dollars 4,116 million, compared to US dollars 3,330 million received during the previous year. The efforts to explore new market opportunities in non-traditional markets, amendments to the relevant law to eradicate malpractices of the industry while safeguarding the interest of migrant workers, and implementation of other protection and welfare policy measures would lead to further improvements in overseas job opportunities and foreign exchange remittances to the country.

Labour Productivity Overall labour productivity continued to improve in 2010, following the trend observed over the last few years. Labour productivity, measured in terms of GDP per worker (at constant prices of 2002) increased by 6.6 per cent in 2010 over the previous year, to Rs. 343,300 per worker. The increase in productivity was attributed to the growth in productivity in the three key sectors of the economy, namely, the Industry sector (by 10.9 per cent), Agriculture sector (by 5.1 per cent) and Services sector (by 4.6 per cent) during the year. Enhancing productivity in all three major sectors of the economy would be important to achieve a higher economic growth, while containing inflationary pressures in the economy. There is further room to increase the productivity in the Agriculture sector through use of improved seed varieties, new technologies and innovations, and mechanisation, which could be promoted through farmer awareness by way of an effective extension service. In addition, increasing Table 4.15

Labour Productivity by Major Economic Sector 2008

2009

2010 2010(a)(a)

GDP at Constant(2002) Prices, Rs.million 2,365,501 2,449,214 2,645,432 Agriculture 285,897 295,097 315,644 Industry 672,791 701,129 760,219 Services 1,406,813 1,452,988 1,569,569 Labour Productivity, Rs.â&#x20AC;&#x2122;000 per person (b) 309.3 322.2 343.3 Agriculture 114.8 119.2 125.3 Industry 335.6 367.1 407.2 Services 446.1 451.8 472.8 (a) Provisional (b) Based on employment data excluding Northern Province.

Sources: Department of Census & Statistics Central Bank of Sri Lanka

value addition by promoting agro-based processing industries, improving awareness on proper usage of fertilizer, rehabilitation of irrigation networks, and infrastructure facilities would also help increase the productivity in the Agriculture sector. Taking into account the contribution by the Industry sector to the national economy, the improvement of productivity in the Industry sector should also be given high priority. To make Sri Lanka globally competitive, the Industry sector needs to be upgraded with new technology and be diverted towards value added niche products. Also, there should be an increased emphasis on research development and innovation, and improved infrastructure facilities, particularly the provision of uninterrupted power supply to eliminate nonproductive time of machinery and reliable transport facilities to minimise unproductive worker time. Maintaining industrial peace is also important in this context. Given the plan to transform Sri Lanka into a major regional hub for Naval, Aviation, Commercial, Energy and Knowledge, it would be necessary to improve productivity in the Services sector on an urgent basis. For this purpose, at the very basic level it would be necessary to amend the school curriculum to ensure that students are equipped with Information Technology (IT), Language and other soft skills as well as knowledge on areas such as Accountancy when they leave school. For this purpose, capacity building of teachers is essential. A certification system should be introduced to ensure that private training facilities in IT are up to standard and obtaining of international qualifications by school leavers in this area should be encouraged, as the attracting of high value Business Process Outsourcing (BPO) activities will be constrained by the lack of skilled manpower. In the rapidly expanding tourism sector, emphasis should also be placed on capacity building of all stakeholders. For this purpose, it will be necessary to set up large scale training facilities for the hospitality industry. These measures are expected to improve the productivity in key sectors of the economy, and thereby contribute to a balanced economic growth.

Central Bank of Sri Lanka Annual Report - 2010

Plantation Year

Other Other(a) (a)

Total

No. of Strikes

Workers Involved

Man ManDays Days Lost Lost

8 34

1,468 34,014

6,089 41,525

17 17

6,079 3,917

36,109 24,130

25 51

7,547 37,931

42,198 65,655

2009

300

4,720

7,365

5,020

7,665

2 - - -

300 - - -

3 3 - -

3,095 1,625 - -

6,190 1,175 - -

5 3 - -

3,395 1,625 - -

6,490 1,175 -

2007 2008 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

2010 (b)

No. No.ofof Workers Workers Man Days Strikes Strikes Involved Involved Lost Lost

3,185

23,037

1,923

2,034

1st Quarter 3 804 2 449 2nd Quarter 2 332 3rd Quarter 2 1,600 4th Quarter (a) Includes semi-government institutions and all other private institutions. (b) Provisional

14,220 6,009 1,208 1,600

3 1 2 -

369 218 1,336 -

408 218 1,408 -

Labour Relations and Labour Market Reforms Maintaining better relationships and dialogue among parties at the workplace are important to improve industrial harmony. Although, the number of strikes exceeded the number reported in 2009, 2010 is still the year with the second lowest number of strikes reported since 2000. The private sector reported 15 strikes in 2010, as a result of an increase in the number of strikes in the plantation sector. Total man-days lost also increased to 25,071 in 2010 compared to 7,665 in 2009. An increase in the industrial disputes in the plantation sector was the main reason that led to the higher number of strikes in 2010. There was also an increase in both the number of man-days lost and number of workers involved in the strikes in the plantation sector. Accordingly, the number of man-days lost

No. No.ofof Strikes Strikes

Workers Workers Man Days Involved Involved Lost

5,108

25,071

6 3 4 2

1,173 667 1,668 1,600

14,628 6,227 2,616 1,600

Source: Department of Labour

in the plantation sector increased to 23,037 in 2010 compared to 300 in 2009 while the total workers involved in the strikes increased to 3,185 in 2010 compared to 300 in 2009. The increase was mainly observed during the first quarter of the year, which reported 3 strikes involving 804 workers leading to 14,220 losses in man-days. The number of strikes in the rest of the private sector remained at 6, similar to that of the previous year. However, both the number of workers involved and the man-days lost by the rest of the private sector decreased substantially in 2010. Accordingly, total workers involved in these strikes decreased to 1,923 in 2010 from 4,720 in 2009 while man-days lost decreased to 2,034 from 7,365. This favourable development in the rest of the private sector is commendable. The continuing maintenance of a sound working environment is essential to improve industrial harmony, and to thereby increase investment and productivity in the country.

4 PRICES, WAGES, EMPLOYMENT AND PRODUCTIVITY

Strikes in Private Sector Industries

Table 4.16

EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

5.1 Overview

he external sector performed well during 2010, underpinned by the gradual recovery of the global economy, improved international financial market conditions and enhanced investor confidence brought about by the stable domestic macroeconomic environment. External trade rebounded strongly in 2010, reversing the sharp contraction observed in 2009. Supported by the improved investment climate, attractive prices and the gradual recovery of the global economy, the earnings from exports reached a record high, surpassing the previous peak performance in 2008. Despite the withdrawal of the Generalised System of Preferences Plus (GSP+) concessions since August 2010, exports to all major destinations increased. Imports also recovered strongly with significant contributions from consumer and intermediate goods reflecting tariff reductions, higher commodity prices and the strong growth in the domestic economy. As a result, the trade deficit expanded in 2010 subsequent to the sharp contraction in 2009

in view of the lower domestic and global demand. Inward workers’ remittances increased substantially and continued to be the foremost foreign exchange earner in 2010. Sri Lanka’s travel and tourism industry, which suffered immensely due to the protracted internal conflict, staged a remarkable recovery during the year. The current account deficit in 2010 stood at 2.9 per cent of GDP compared to the 10-year average of 3.5 per cent. Increased inflows to the financial account supported the Balance of Payments (BOP) to record a significantly high surplus. Sri Lanka’s graduation to ‘middleincome' economy status by the International Monetary Fund (IMF) in January 2010, from the previously listed category of Poverty Reduction and Growth Trust (PRGT) eligible countries, enabled the country to project itself strongly in international financial markets. The continuation of IMF Stand-By Arrangement (SBA) facility helped strengthen the already positive investor sentiment to a greater extent. Moreover, the

Central Bank of Sri Lanka Annual Report - 2010

4,000

3,500

0 3 6 9

3,000 2,500 2,000 1,500 1,000

500

2006

Trade Balance

2007

2008

2009

Current Account Balance

2010

Overall Balance

international rating agencies raised their ratings of Sri Lanka. The third international sovereign bond issued in October 2010 was oversubscribed by more than 6 times, and the interest rate was substantially lower, compared to previous issues. Owing to these favourable developments, coupled with long-term capital flows to the government and the private sector, the BOP recorded a surplus of US dollars 921 million by end December 2010, while the gross official reserves (excluding the receipts of the Asian Clearing Union-ACU) reached US dollars 6,610 million, which was equivalent to 5.9 months of imports. Exchange rate policy in 2010 focused on maintaining stability in the domestic foreign exchange market. The rupee continued to appreciate gradually against the US dollar in the face of significant inflows during the first nine months of the year. The Central Bank purchased foreign exchange from the domestic foreign exchange market to avoid excessive rupee appreciation, and to build up reserves. However, in the last quarter of 2010, the Central Bank supplied foreign exchange to the domestic foreign exchange market, to ensure adequate foreign exchange liquidity in the face of large outflows arising from the settlement of petroleum bills. The external sector is expected to strengthen further in 2011 with the gradual recovery in the global economy and improved growth prospects of the domestic economy. Several measures were taken towards diversifying the export product portfolio and markets, by focusing more on value added and finished goods, penetrating into emerging markets and strengthening international trade ties. Further, measures were taken to promote tourism 100

Major Sources of Foreign Exchange Earnings

4,500

US $ million

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

Chart 5.2

Major Sources of Foreign Exchange Earnings

Chart 5.2

Balance of Payments

% of GDP

Chart 5.1 Chart 5.1

2006

2007

Garments & Textiles

2008

Workers' Remittances

2009

2010

Tea

Tourism

and foreign employment, which would attract more foreign exchange into the economy. Precautionary measures need to be in place to maintain resilience of the BOP to any external shock that could emanate from unanticipated commodity price fluctuations and volatility in short-term financial flows. These measures should focus on attracting long-term capital flows, particularly, Foreign Direct Investments (FDI) and non-debt creating financial flows in the context of gradual improvements of macroeconomic conditions. Towards this end, the recent moves announced by the Central Bank to implement major relaxations of foreign exchange controls would help promote financial openness, thereby attracting more financing and investments for the private sector and enhancing the overall competitiveness of the economy.

5.2 External Sector Policies and Institutional Support External sector policies in 2010 focused on promoting trade through diversifying its export product base and markets. Sri Lanka’s potential to achieve its policy targets was demonstrated by the commendations received from the 153 countries at the World Trade Organisation (WTO) during the Third Trade Policy Review of Sri Lanka in 2010 for the efforts taken to double per capita GDP despite the protracted internal strife and the global economic crisis. Continuing the drive towards rapid economic growth, the government took decisive steps to encourage exports of value added and finished goods and to minimise the adverse impact of supply constraints and price increases in international markets on the domestic market.

Central Bank of Sri Lanka Annual Report - 2010

Item

Rs. million

US dollars million

2006

2007

2008

2009

2010 (b)

Trade Balance Exports Imports

-3,370 6,883 10,253

-3,657 7,640 11,296

-5,981 8,111 14,091

-3,122 7,085 10,207

-5,205 8,307 13,512

Services (net) Receipts Payments

257 1,625 1,368

302 1,775 1,472

401 2,004 1,603

391 1,892 1,501

698 2,468 1,770

26,660 168,802 142,142

33,357 196,249 162,892

43,557 217,180 173,623

44,780 217,378 172,598

78,760 278,959 200,199

Income (net) Receipts Payments

-389 311 700

-358 449 807

-972 -32 940

-488 116 603

-572 323 895

-40,424 32,457 72,881

-39,054 50,213 89,267

-105,032 -3,133 101,899

-55,814 13,551 69,365

-64,650 36,508 101,158

Goods, Services and Income (net)

-3,503

-3,712

-6,552

-3,219

-5,079

-363,874

-410,401

-708,681

-369,740

-574,757

Current transfers (net) Private Transfers (net) Receipts Payments Official Transfers (net)

2,004 1,904 2,161 257 101

2,311 2,214 2,502 288 97

2,666 2,565 2,918 353 101

3,005 2,927 3,330 403 77

3,660 3,608 4,116 508 52

208,385 197,861 224,678 26,817 10,524

255,684 245,006 276,814 31,808 10,677

288,639 277,711 316,091 38,380 10,928

345,498 336,578 382,818 46,240 8,920

413,885 407,967 465,166 57,199 5,918

Current Account

-1,499

-1,402

-3,886

-214

-1,418

-155,489

-154,717

-420,042

-24,242

-160,872

1,808

2,097

1,773

2,594

2,876

190,768

230,978

193,713

299,381

322,022

291 291 299 8

269 269 278 10

291 291 303 12

233 233 247 14

164 164 182 19

30,292 30,292 31,171 879

29,669 29,669 30,735 1,066

31,456 31,456 32,774 1,319

26,832 26,832 28,465 1,633

18,521 18,521 20,599 2,078

Financial Account 1,517 Long-term: 907 Direct Investment 451 Foreign Direct Investment (net) 451 Private Long-term (net) -35 Inflows 139 Outflows 174 Government, Long-term (net) 491 Inflows 932 441 Outflows Short-term: 610 Portfolio Investment (net) 51 Private Short-term (net) -30 Commercial Bank Assets (net) 297 Commercial Bank Liabilities (net) 293 - Government Short-term (net)

1,828 1,251 548 548 31 199 168 672 1,290 618 577 101 20 -281 364 372

1,483 1,016 691 691 74 265 191 252 1,059 807 466 60 594 210 -185 -213

2,361 1,304 384 384 79 390 311 840 1,780 940 1,058 -6 228 -435 -98 1,369

2,713 2,379 435 435 149 580 431 1,796 2,460 665 334 -230 -1,032 249 815 531

160,477 95,089 46,985 46,985 -3,590 14,469 18,058 51,694 97,690 45,996 65,387 5,377 -3,066 23,789 39,287 -

201,309 140,054 60,768 60,768 3,314 22,033 18,719 75,971 144,146 68,175 61,256 11,249 1,868 -31,352 38,746 40,744

162,258 109,174 74,837 74,837 7,768 28,693 20,925 26,568 114,658 88,090 53,084 6,460 63,987 17,889 -11,858 -23,395

272,550 149,772 44,112 44,112 9,105 44,795 35,691 96,555 204,435 107,880 122,777 -785 26,108 -51,298 -8,836 157,588

303,501 268,214 49,008 49,008 17,555 65,934 48,379 201,650 276,582 74,932 35,287 -26,010 -116,655 33,343 84,356 60,252

- - -165 531 -531

- - 728 -1,385 1,385

508 - 346 2,725 -2,725

- - -537 921 -921

- - -1,756 33,523 -33,523

- - -16,259 60,002 -60,002

- - 80,534 -145,795 145,795

58,353 - 40,082 315,221 -315,221

-73,176 87,974 -87,974

Annual Average Exchange Rate Rs./US$ 103.96 110.62 108.33 114.94 Ratio to GDP in Percentages (e) Trade Account -11.9 -11.3 -14.7 -7.4 -10.5 -11.9 -11.3 -14.7 -7.4 Current Account -5.3 -4.3 -9.5 -0.5 -2.9 -5.3 -4.3 -9.5 -0.5 Current Account without Grants -5.7 -4.6 -9.8 -0.7 -3.0 -5.7 -4.6 -9.8 -0.7

113.06

Capital and Financial Account

Capital Account Capital Transfers (net) Receipts Payments

Allocation of SDRs (c) Valuation Adjustments Errors and Omissions Overall Balance (d) Monetary Movements (d)

- - -105 204 -204

2006

2007

-350,110 -404,703 716,579 845,683 1,066,689 1,250,386

2008

2009

-647,207 -358,707 878,499 813,911 1,525,705 1,172,618

(a) This presentation conforms as far as possible to the Balance of Payments Manual, 5th Edition (1993) of the International Monetary Fund (IMF). In addition, beginning 1994, Offshore Banking Units have been treated as a part of the domestic banking system. (b) Provisional (c) General and special allocations of Special Drawings Rights (SDRs) by the IMF. (d) US dollar values are converted into rupee values using period average exchange rates. (e) Based on GDP at current market prices published by the Department of Census and Statistics.

2010 (b)

-588,867 937,737 1,526,604

-10.5 -2.9 -3.0

Source: Central Bank of Sri Lanka

101

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

Balance of Payments Analytical Presentation (a)

Table 5.1

Central Bank of Sri Lanka Annual Report - 2010

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

Table 5.2

Average Import Duty Collection Rate (a) percentage (%)

Item

2006 2007 2008 2009 2010 (b)

Consumer Goods 11.2 12.4 12.6 19.4 12.6 Food and beverages 10.7 13.5 14.8 26.8 12.1 Rice 23.4 3.1 3.1 5.4 2.1 Flour 33.7 31.9 22.6 22.6 40.8 Sugar 1.9 23.9 32.8 26.5 4.0 Wheat and Meslin 5.6 6.3 6.7 32.2 12.4 Milk and Milk products 9.6 7.7 2.0 29.2 6.4 Dried Fish 5.0 2.9 9.4 10.9 12.2 Other Fish Products 7.8 4.9 8.7 18.3 25.0 Other 24.2 20.8 24.2 27.2 19.6 Non-Food Consumer Goods 11.7 11.2 8.4 6.7 13.3 Motor Cars & Cycles 18.3 16.3 7.7 6.2 18.4 Radio Receivers - Television Sets 7.1 7.7 6.3 7.1 20.0 Rubber Tyres & Tubes 19.2 22.4 19.2 20.1 21.6 Pharmaceutical Products 0.3 0.4 0.4 0.4 0.3 Other 10.3 10.6 13.0 8.6 9.7 Intermediate Goods 1.5 1.5 2.2 5.0 1.7 Fertiliser 2.5 2.7 2.5 2.5 1.0 Crude Oil 0.0 0.0 0.0 0.0 0.0 Other Petroleum Products 2.3 1.6 4.7 19.0 3.2 Chemical Elements and Compounds 1.8 1.9 1.8 1.9 1.1 Dyeing,Tanning and Colouring 2.6 2.5 2.1 2.1 2.1 Paper and Paper Boards 2.4 2.2 2.0 2.1 1.8 Textiles 0.1 0.1 0.2 0.2 0.1 Other Intermediate Goods 3.3 3.3 2.9 4.9 3.2 Investment Goods 5.2 4.8 5.3 4.4 4.8 Building Materials 9.2 7.2 7.2 8.2 5.9 Transport Equipment 7.0 7.1 7.1 3.7 7.6 Machinery and Equipment 3.2 2.7 3.1 2.5 2.8 Other Investment Goods 3.4 4.2 3.9 3.3 4.0

Average Import Duty Collection Rate

4.3

(a) Actual import duty collection (including Special Commodity Levy wherever applicable) as a percentage of total imports (c.i.f. values ). (b) Provisional

4.1

4.6

7.8

5.0

Source: Sri Lanka Customs

The main trade policy instrument since 2004, the five band customs duty structure was simplified. The tariff bands of 0, 2.5, 6, 15 and 28 per cent, were reduced to a four band customs duty structure of 0, 5, 15, and 30 per cent, with effect from 1 June 2010. This revision was congruent to the overall policy stance of supporting local

Import tariffs were substantially revised to mitigate the impact of external supply shortfalls on consumers, promote trade and support small and medium industries. The customs duty and Special Commodity Levy (SCL) applicable on selected consumer and intermediate goods such as petrol, diesel, milk powder, maize, palm oil, wheat grain, malt extract and PVC leather cloths, were reduced to stabilise price fluctuations in the domestic economy. Customs duties on the import of gold were also removed with effect from 1 March 2010. It is envisaged that this will facilitate more imports through formal channels and boost jewellery manufacturing and exports. The 15 per cent surcharge on customs duty payable on imported goods, was removed with effect from 1 June 2010, while import duties on motor vehicles were reduced by 50 per cent. In order to promote Sri Lanka as an attractive shopping destination and improve the living standards of the people, import duties on electronic goods and internationally branded products, such as mobile phones, wristwatches and cameras were reduced by 90 per cent. The Budget 2011 supported the efforts to move towards the export of value added and finished goods from the traditional primary products. Accordingly, a Cess was imposed on all exports of raw and semi-processed items while exports of finished goods were exempted. Further, duties and taxes on machinery, equipment and raw materials were reduced to enable enterprises to have more affordable access to world class

industries to increase production for export and

technologies

domestic markets. The 2.5 per cent customs duty

production. Income tax was reduced from 15 per

of the earlier five band structure, which was mostly

cent to 10 per cent for industries with domestic

applicable on importation of raw materials and

value addition in excess of 65 per cent and Sri

machinery, was abolished and these items were

Lankan brand names with patent rights reserved in

placed at the zero band. Intermediate and finished

Sri Lanka. Several tariff concessions were granted

goods were placed on the middle and upper rates

to promote export industries such as gem and

of 5, 15 and 30 per cent. The average import duty

jewellery, apparel, leather and footwear. Further, in

rate, calculated based on total imports and customs

a move to encourage exports in general, income

duties, decreased to 5.0 per cent in 2010 from 7.8

tax applicable on all export companies was reduced

per cent in 2009.

from 15 per cent to 12 per cent.

102

and

thereby

increase

domestic

Central Bank of Sri Lanka Annual Report - 2010

Authority (NGJA) embarked on a three pronged strategy in 2010, comprising of supply and demand development and capacity building, to achieve the export target of US dollars 1 billion by year 2016 for gem and jewellery. This is supported by the Budget 2011 proposal to increase the foreign exchange allowances for imports of raw gem stones from US dollars 10,000 to US dollars 50,000 per person with effect from November 2010. Sri Lanka continued strengthening its trade ties by actively engaging in negotiations at multilateral, regional and bilateral levels. At the multilateral level, Sri Lanka continued its active engagement in the current negotiations of the Doha

Trade Indices (a)

Table 5.3

1997=100 2009 Category

Value Index

Volume Index

Unit Price Index

Value Volume Unit Price Index Index Index

Value Index

159.1 164.4 125.4 141.3 165.8

122.7 114.8 89.0 119.2 182.8

129.7 143.2 140.9 118.6 90.7

192.2 190.8 216.6 147.6 222.0

134.5 127.9 83.8 104.1 219.5

142.8 149.1 258.4 141.8 101.1

20.8 16.1 72.8 4.4 33.9

9.7 11.4 -5.8 -12.7 20.1

Industrial Exports

154.1 143.7 138.4 177.8

139.7 148.4 55.0 129.0

110.3 96.8 251.4 137.9

179.3 153.7 222.1 230.0

146.3 141.6 68.2 163.4

122.6 108.6 325.7 140.8

16.3 7.0 60.5 29.3

4.7 -4.6 23.9 26.7

11.2 12.2 29.6 2.1

Mineral Exports

99.3 83.0 314.1

122.4 111.8 262.1

81.1 74.2 119.8

103.7 84.6 354.4

126.1 114.7 276.1

82.2 73.8 128.4

4.4 1.9 12.8

3.0 2.6 5.3

1.4 -0.6 7.1

Total Exports

152.4

135.4

112.5

178.7

143.2

124.9

17.3

5.7

10.9

158.0 153.8 164.2

185.2 140.7 249.7

85.3 109.3 65.8

241.1 215.7 278.0

223.3 157.3 319.2

108.0 137.1 87.1

52.6 40.3 69.3

20.6 11.8 27.8

26.5 25.5 32.4

Intermediate Goods

183.2 291.4 368.2 433.6 229.8 188.2 104.0 131.9 195.7 160.2

133.0 135.8 114.1 128.3 176.6 130.0 132.5 120.2 96.9 181.4

137.8 214.7 322.7 337.9 130.1 144.7 78.5 109.7 201.9 88.3

239.6 362.3 402.6 710.1 286.7 186.7 124.9 190.8 206.2 217.5

150.2 160.5 100.3 182.4 199.6 132.6 131.7 158.1 93.8 237.2

159.5 225.7 401.4 389.2 143.6 140.8 94.8 120.7 219.9 91.7

30.8 24.3 9.4 63.7 24.8 -0.8 20.1 44.6 5.4 35.8

13.0 18.2 -12.1 42.2 13.0 2.0 -0.6 31.5 -3.3 30.7

15.8 5.1 24.4 15.2 10.4 -2.7 20.8 10.0 8.9 3.9

Investment Goods

184.8 262.9 209.7 136.2 279.1

202.9 186.9 98.0 243.9 161.7

91.1 140.7 214.0 55.9 172.6

223.9 297.9 308.6 162.2 303.0

217.8 183.9 109.4 267.6 166.5

102.8 162.0 282.0 60.6 182.0

21.2 13.3 47.2 19.1 8.6

7.3 -1.6 11.7 9.7 2.9

12.9 15.2 31.8 8.5 5.5

Total Imports

174.0

159.4

109.1

230.4

180.1

127.9

32.4

13.0

17.2

97.6

-5.3

EXPORTS Agricultural Exports

Tea Rubber Coconut Other Agricultural Exports Textiles and Garments Petroleum Products Other Industrial Exports

Gems Other Mineral Exports

Growth Rate (b)

2010 (b)

IMPORTS Consumer Goods

Food and Beverages Other Consumer Goods Fertiliser Crude Oil Other Petroleum Chemical Elements and Compounds Wheat and Meslin Textiles (Including Clothing) Plastics Diamonds Other Intermediate Goods Building Materials Transport Equipment Machinery and Equipment Other Investment Goods

Terms of Trade (a) In terms of US dollars (b) Provisional

103.1

Volume Unit Price Index Index 10.1 4.2 83.3 19.6 11.5

Sources: Sri Lanka Customs Central Bank of Sri Lanka

103

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

Trade promotion activities were targeted at improving both, demand and supply side issues that were hindering the rapid growth of trade. Integrated supply chain development programmes which focus on improving stakeholder coordination and all stages of the export process were initiated by the Export Development board (EDB) for key agricultural and industrial exports and professional services. Further, the EDB continued the Simplified Value Added Tax scheme (SVAT) which helps reduce cash flow difficulties of nonapparel sector exporters, generating an estimated benefit of Rs. 18 billion to 740 registered direct and indirect exporters. The National Gem and Jewellery

Central Bank of Sri Lanka Annual Report - 2010

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

Development Round in the World Trade Organisation (WTO), which members committed to conclude in 2011. Negotiations were held on agriculture and Non-Agricultural Market Access (NAMA), aimed at ensuring flexibilities for Sri Lanka as a Net-Food Importing Developing Country (NFIDC) and improved market access through lowering of high tariffs prevalent in key markets for main exports, particularly in the garments and fisheries sectors. With regard to NAMA, Sri Lanka remained exempted from having to undertake tariff reduction commitments. Increased protection for geographical indications, traditional knowledge and biodiversity resources were negotiated under Trade related aspects of Intellectual Property Rights (TRIPS). Sri Lanka continued to participate in negotiations on a new Agreement on Trade Facilitation (ATF), aimed at harmonising customs and other trade facilitation procedures and regulations. The third round of the Global System of Trade Preferences (GSTP) initiated to increase South–South Trade and Economic Cooperation, concluded in 2010 with the signing of the Sao Paulo Round Protocol. However, due to the similarities in the current structure of exports, many developing countries are effectively competitors. Further, since many countries have regional or bilateral trade agreements with major trading partners in the GSTP, they already enjoy lower tariffs than offered under the GSTP. Thus, only 22 members out of 43 members have shown interest in engaging in ongoing negotiations. Sri Lanka engaged in advancing its interests in the rules of origin negotiations in the third round and is currently reviewing the option to join the Protocol. Sri Lanka’s exports remained resilient despite the withdrawal of the GSP+ scheme. On 15 February 2010, EU member states announced the temporary withdrawal of preferential tariff benefits that Sri Lanka received under the GSP+ scheme. Sri Lankan authorities were engaged in a dialogue with the European Commission relating to the suspension of the scheme since February 2010. However, the EU withdrew the concessions with effect from 15 August 2010, resulting in exporters accessing the EU market under the general GSP scheme, which is nevertheless below the Most 104

Favoured Nation (MFN) rates. The focused, longterm preparations to face global competition sans GSP+ benefits, such as firm level actions taken towards differentiating and diversifying products as well as markets, improving the quality of products, branding products, negotiating with buyers, enhancing productivity and reducing finance and input costs together with, changes in global supply and improving macroeconomic conditions ensured a relatively smooth transition for exports from GSP+ access to general GSP access. As a result, Sri Lankan exporters were able to record higher than projected earnings from key export industries. Asia-Pacific Trade Agreement (APTA), which is the only trade agreement that links Sri Lanka to East Asia, reaped expected results as trade, especially exports to China and South Korea, increased due to the preferential access it provided. It is important to increase the utilisation of this agreement as it will provide preferential market access at 40 per cent margin of preference (MOP) on 40 per cent of the tariff lines, to emerging markets such as China, India and South Korea upon the full implementation of the fourth round of negotiations. Sri Lanka is however exempted from making the above commitments along with the least developed countries (LDCs) as it is a smaller trading nation compared to China, India and South Korea. given that APTA is the only trade agreement that jointly links Sri Lanka with foremost emerging economies, there is immense potential for it to expand trade with these large markets which have rapidly growing buying power. The first phase of reducing negative lists and customs duties under the trade liberalisation programme under the South Asian Free Trade Agreement (SAFTA) was implemented with effect from November 2010. Negotiations on the reduction of negative lists by 20 per cent by each member continued and Sri Lanka will reduce customs duties to 0 – 5 per cent in six equal instalments by 2014 for products from the other member states. However, utilisation of the SAFTA and South Asian Preferential Trade Agreement

Central Bank of Sri Lanka Annual Report - 2010

As Sri Lanka is a member of several trade agreements, it is important to consider if access gained is fully utilised and advanced. Lack of knowledge regarding access provided and benefits to exporters and importers stands as a key obstacle to widening the usage of tariff concessions and liberalised trade between trading partners. Thus, extensive and comprehensive awareness programmes regarding the opportunities created by these agreements must be implemented in all member countries. This would be beneficial as international trade would enable people to consume better quality products and services at lower prices and increase export earnings which will, in turn, raise the standards of living in member countries.

Export Performance

Earnings from exports increased by 17.3 per cent to US dollars 8,307 million in 2010 compared to that of 2009. External trade, which was affected by the global economic crisis in 2009, rebounded strongly during 2010 with the better investment climate, attractive prices, gradual recovery in external demand and the removal of the marine war risk premium on re-insurance. Although earnings were relatively low during the early part of the year amidst the slow global recovery, it recovered strongly towards the latter part of the year. The largest contribution to the growth in earnings came from industrial exports (70.9 per cent), followed by the agricultural exports (28.7 per cent). Earnings from industrial exports increased by 16.4 per cent to US dollars 6,173 million in 2010, reflecting growth in all sub-sectors, mainly due to the recovery of global demand. The largest contribution to the growth in industrial exports came from textiles and garments, rubber products and machinery and equipment. Earnings from exports of food and beverages, and petroleum products also performed well. Earnings from textile and garments exports amounted to US dollars 3,504 million in 2010, reflecting a 7.0 per cent growth during the year, and accounted for nearly 42 per cent of total export proceeds. In view of the impending withdrawal of the GSP+ benefits, many Chart 5.3Export

5.3 Export Performance (2008 - 2010)

Export Performance

1,000 900

800 700 600 500 400 Jan

Feb

Mar

Apr

May

2008

Jun

Jul

Aug

2009

Sep

Oct

Nov

Dec

2010

105

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

Trade under bilateral agreements demonstrated a significant improvement in 2010. Trade with india and thus, under the India-Sri Lanka Free Trade Agreement (ISFTA), recovered considerably after a decline in 2009 due to the impact of the global economic slowdown. Interest in the Pakistan-Sri Lanka Free Trade Agreement (PSFTA), which came into force in 2005, is gradually gaining momentum as exporters in both countries have identified its potential. In order to strengthen the present bilateral economic relations with India and Pakistan, Sri Lanka is in the process of negotiating Comprehensive Economic Partnership Agreements (CEPA) with both countries. In addition to trade in goods, the CEPA framework encompasses trade in services, investment and economic cooperation.

5.3 Trade in Goods, Trade Balance and Terms of Trade

US $ million

(SAPTA) has been slow as Sri Lanka’s foremost regional trading partners, India and Pakistan, trade mainly under separate bilateral agreements with Sri Lanka. Supporting the significant increase in trade in services, the South Asian Association for Regional Co-operation (SAARC) Framework Agreement on Trade in Services was signed at the 16th SAARC Summit in April 2010. Sri Lanka, India and Bangladesh have already ratified the agreement. Negotiations on the schedules of commitments under the agreement are expected to begin to enable its implementation.

Central Bank of Sri Lanka Annual Report - 2010

Table 5.4

2010 (a)

2009 Value US dollars million 1,690.3

Change in Value (a) US dollars million

Growth Rate (a) %

Contribution to Growth (a) %

23.9

Value US dollars million 2,041.4

24.6

351.1

20.8

28.7

Tea Rubber Coconut Kernel Products Other Other Agricultural Products

1,185.1 98.6 166.2 58.2 108.0 240.4

16.7 1.4 2.4 0.8 1.5 3.4

1,375.4 170.4 173.6 55.4 118.2 322.0

16.6 2.1 2.1 0.7 1.4 3.9

190.3 71.8 7.4 -2.8 10.1 81.6

16.1 72.8 4.4 -4.7 9.4 33.9

15.6 5.9 0.6 -0.2 0.8 6.7

Industrial Exports

5,305.4

74.9

6,172.8

74.3

867.3

16.4

70.9

406.1 3,274.2 134.7 384.7 36.4 13.6 330.3 329.8 395.6

5.7 46.2 1.9 5.4 0.5 0.2 4.7 4.7 5.6

503.4 3,504.1 216.3 567.6 39.1 17.1 487.8 334.7 502.7

6.1 42.2 2.6 6.8 0.5 0.2 5.9 4.0 6.1

97.3 229.9 81.5 182.9 2.7 3.6 157.5 4.9 107.1

24.0 7.0 60.5 47.5 7.3 26.3 47.7 1.5 27.1

8.0 18.8 6.7 15.0 0.2 0.3 12.9 0.4 8.8

Mineral Exports

88.7

1.3

92.6

1.1

3.9

4.4

0.3

68.9 19.8

1.0 0.3

70.3 22.4

0.9 0.3

1.3 2.6

1.9 12.8

0.1 0.2

Category Agricultural exports

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

Composition of Exports

Food, Beverages and Tobacco Textiles and Garments Petroleum Products Rubber Products Ceramic Products Leather, Travel Goods and Footwear Machinery and Equipment Diamond and Jewellery Other Industrial Exports Gems Other Mineral Exports

Unclassified

Share %

0.0

0.3

0.0

0.2

...

0.0

Total exports (b)(c)

7,084.5

100.0

8,307.0

100.0

1,222.5

17.3

100.0

Annual Average Exchange Rate (d)

114.94

113.06

(a) Provisional (b) Excludes re-exports (c) Adjusted (d) Rs. / Us dollar exchange rate

manufacturers improved the quality of their products and enhanced productivity enabling them to face the new competition. They achieved higher levels of value addition by incorporating design aspects into the production process, focusing on branded products and catering to the high end customers. As a result, garments exports to EU, which constituted approximately 50.7 per cent of total apparel exports, increased by 3.0 per cent to US dollars 1,678 million in 2010. garments exports to USA, Sri Lankaâ&#x20AC;&#x2122;s second largest market, increased by 5.5 per cent to US dollars 1,356 million in 2010. Earnings from other categories of industrial exports such as rubber products, food, beverages and tobacco, machinery and equipment, and diamonds and jewellery increased during 2010. Rubber product exports increased by 47.5 per cent in 2010 to US dollars 568 million and consisted mainly of solid tyres and rubber gloves. Earnings from exports of food, beverages and tobacco category increased by 24.0 per cent to US dollars 503 million, in 2010, 106

Sources: Sri Lanka Customs Ceylon Petroleum Corporation and Other Exporters of Petroleum

National Gem and Jewellery Authority Central Bank of Sri Lanka

which comprised mainly of fish (US dollars 163 million), animal fodder (US dollars 76 million) and processed fruits and vegetables (US dollars 30 million). Machinery and equipment exports, which comprised mainly of transport equipment such as boats and bicycles, and electrical equipment such as transformers, static converters, inductors and insulated cables increased by 47.7 per cent to US dollars 488 million in 2010. Exports of processed diamonds and jewellery increased by 1.5 per cent to US dollars 335 million in 2010. Earnings from mineral exports increased by 4.4 per cent in 2010 to US dollars 93 million led by precious and semiprecious stones. Earnings from agricultural exports increased by 20.8 per cent to US dollars 2,041 million in 2010 mainly due to the high prices that prevailed in the international market throughout the year. The contribution of tea exports to total export growth was 15.6 per cent followed by minor agricultural products (6.7 per cent), rubber (5.9 per cent) and coconut (0.6 per cent).

Central Bank of Sri Lanka Annual Report - 2010

Other 1%

Textiles and garments 42%

Agricultural 25% Industrial 74%

Other Industrial 6% Petroleum products 3%

Machinery and Equipment 6% Rubber Products 7% Diamond and Jewellery 4% Food, Beverages and Tobacco 6%

Earnings from tea exports increased by 16.1 per cent to US dollars 1,375 million, due to both the increased volumes and high prices. Ceylon tea continued to fetch the highest prices in the major auction centres of the world in 2010 mainly due to the fine quality of Ceylon tea and the high international demand for orthodox tea. The average export price of tea rose by 7.0 per cent to US dollars 4.38 per kg in 2010. There was a shortage of black tea in the international market due to drought conditions and high local consumption in other major tea producing countries. However, in Sri Lanka, tea production surpassed historically high levels in 2010, owing to overall good weather, timely application of fertiliser and good agricultural practices. As a result, export volume of tea increased by 8.5 per cent to 314 million kg in 2010. Sri Lanka remained the third largest tea exporter in the world after Kenya and China. The Middle Eastern countries and the Commonwealth of Independent States (CIS) continued to be major destinations for Ceylon tea exports in 2010. To encourage high value added tea exports, government increased the Cess on bulk tea to Rs.10 per kg with effect from 23 November 2010. Earnings from minor agricultural exports, rubber, and coconut showed a healthy growth in 2010. Earnings from minor agricultural exports grew by 33.9 per cent to US dollars 322 million in 2010 due to higher international prices fetched by cocoa products, cardomons and essential oil and increased export volumes of sesame seeds, cocoa products and pepper. Increased export earnings of certain spices, such as cloves, nutmeg and mace, were due to both, higher volumes and

prices. Earnings from rubber exports increased significantly by 72.8 per cent in 2010 to US dollars 170 million. Lower production in major natural rubber producing countries due to adverse weather conditions and higher demand for natural rubber from China and India exerted upward pressure on rubber prices throughout the year. As a result, export prices of rubber reached historically high levels in 2010. The average export price of rubber increased by 87.9 per cent to US dollars 3.31 per kg in 2010. Despite the higher export prices, export volume of rubber decreased by 8.1 per cent in 2010 since most of the rubber production was absorbed by domestic industries to produce value added exports. To encourage value added rubber exports, the government increased the Cess on the export of raw rubber from Rs. 4 per kg to Rs. 8 per kg with effect from 23 November 2010. Earnings from coconut exports increased by 4.4 per cent to US dollars 174 million in 2010 due to the high values fetched by coconut based products such as coconut oil and coir fibre products.

Import Performance Expenditure on imports grew by 32.4 per cent, year-on-year, to US dollars 13,512 million in 2010 compared to US dollars 10,207 million in 2009, reflecting the high international commodity prices and increased import volumes led by the upsurge in domestic economic activities. All major categories of imports, consumer, intermediate and investment goods increased during the year. The largest contribution to the growth in imports of 55.3 per cent came from intermediate goods while the contributions from consumer goods and investment goods were 27.2 per cent and 15.7 per cent, respectively. Chart 5.5 (2008 - 2010) 5.5 Import Performance

Import Performance

1,600 1,400 1,200 1,000

800 600 400

Jan

Feb

Mar

Apr

May

2008

Jun

Jul

2009

Aug

Sep

Oct

Nov

Dec

2010

107

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

5.4

Exports by Commodities - 2010

US $ million

Chart 5.4

Table 5.5

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

Central Bank of Sri Lanka Annual Report - 2010

Consumer Goods

Composition of Imports

2009 Category

Food and Beverages Rice Sugar Wheat Other Other Consumer Goods

Value US dollars million 1,971.8 1,246.2 22.9 218.7 259.3 745.4 725.6

Intermediate Goods

Petroleum Fertiliser Chemicals Textiles and Clothing Other Intermediate Goods

5,669.2 2,166.6 193.4 312.5 1,442.0 1,554.7

Investment Goods

Machinery and Equipment Transport Equipment Building Materials Other Investment Goods

2,450.8 1,012.8 436.3 714.5 287.3

2010 (a) Share %

Change in Value (a) US dollars million

Growth Rate (a) %

2,870.3

21.2

898.5 395.6 36.1 144.6 -2.0 217.0 502.9

45.6

31.7 158.1 66.1 -0.8 29.1 69.3

27.2

55.5

7,495.9

55.5

1,826.7

32.2

55.3

24.0

2,969.6

22.0

518.7

21.2

15.7

Value US dollars million

19.3

Share %

12.2 0.2 2.1 2.5 7.3 7.1

1,641.8 59.0 363.3 257.2 962.3 1,228.5

21.2 1.9 3.1 14.1 15.2

3,018.7 240.5 389.9 1,732.3 2,114.5

9.9 4.3 7.0 2.8

1,205.9 642.2 809.6 311.9

12.2 0.4 2.7 1.9 7.1 9.1 22.3 1.8 2.9 12.8 15.6 8.9 4.8 6.0 2.3

852.1 47.1 77.4 290.3 559.9

193.1 205.9 95.1 24.6

39.3 24.3 24.8 20.1 36.0

19.1 47.2 13.3 8.6

Contribution to Growth (a) %

12.0 1.1 4.4 -0.1 6.6 15.2 25.8 1.4 2.3 8.8 16.9 5.8 6.2 2.9 0.7

Unclassified Imports

114.8

1.1

175.9

1.3

61.1

53.2

1.9

Total Imports (b)(c)

10,206.6

100

13,511.7

100.0

3,305.0

32.4

100.0

114.94

113.06

Annual Average Exchange Rate (d) (a) (b) (c) (d)

Sources: Sri Lanka Customs Ceylon Petroleum Corporation Lanka IOC PLC Prima Ceylon Limited Serendib Flour Mills (Pvt) Ltd Central Bank of Sri Lanka

Provisional Excludes re-imports Adjusted Rs. / Us dollar exchange rate

Expenditure on imports of intermediate goods increased by 32.2 per cent to US dollars 7,496 million in 2010, led by higher petroleum imports. The price of crude oil in the international market which rose towards the end of 2009 along with the global economic recovery, continued to increase in 2010. The average import price of crude oil increased by 24.4 per cent to US dollars 79.52 per barrel during the year, compared to US dollars 63.93 per barrel in 2009. As a result, the expenditure on petroleum imports rose by 39.3 per cent to US dollars 3,019 million in 2010. Imports of textiles and clothing, which amounted to US dollars 1,732 million, recorded a 20.1 per cent increase over that of 2009, reflecting the growth potential in apparel exports. Meanwhile, the expenditure on fertiliser imports increased by 24.3 per cent to US dollars 240 million in 2010, led by higher prices and increased import volumes. Urea, which is used extensively for paddy cultivation, accounted for over 63 per cent of the fertiliser imports in 2010. Imports of other intermediate goods, such as chemicals and paper, also increased during the year. 108

Expenditure on imports of consumer goods increased by 45.6 per cent in 2010 to US dollars 2,870 million, with non-food imports contributing more than 15.2 per cent to this increase. The nonfood consumer goods category comprised mainly of motor cars and motor cycles which recorded a significant growth of 246.9 per cent in 2010. This was mainly due to improved economic activity and the reduction in taxes on imports of personal motor vehicles. Imports of rubber tyres and tubes also increased by 49.9 per cent in 2010. Chart 5.6

Imports by Commodities - 2010

5.6 Other 2%

Crude Oil 8%

Investment Goods 22%

Paper & Paper Boards 2%

Fertiliser 2%

Consumer Goods 21% Intermediate Goods 55%

Other Petroleum 14%

Textiles 13%

Other Intermediate 16%

Central Bank of Sri Lanka Annual Report - 2010

owing

the

higher

Table 5.6

expenditure

Volume of Major Imports (a)

incurred on imports of sugar and milk products. International sugar prices reached historical highs in 2010 amidst supply constraints in major sugar producing countries. The average import price of sugar rose by 38.6 per cent, as a result of which, expenditure on sugar imports increased by 66.1 per cent to US dollars 363 million in 2010. Expenditure on milk product imports increased by 56.2 per cent to US dollars 259 million in 2010, reflecting high international prices. However, expenditure on wheat imports decreased marginally in 2010 compared to 2009. Imports of investment goods increased by 21.2 per cent to US dollars 2,970 million in 2010, led by higher expenditure incurred on imports of transport equipment and machinery. Expenditure on transport equipment imports grew by 47.2 per cent, mainly due to increased economic activities. Transport equipment imports comprised of motor vehicles for transport of goods and passengers and

'000 mt

Item

2006

2007

2008

3 2 3 4

4 7 3 74

41 28 11 4

3 3 2 44

1,200

952

919

287 321 331 261

204 388 274 87

272 312 153 182

288 229 220 289

352 171 292 236

525

481

575

467

112 137 127 149

112 138 118 113

163 131 167 114

123 110 142 92

559 145 156 154 104

2,151

1,938

1,853

592 535 582 442

272 557 559 550

229 525 544 555

2,302

2,314

2,386

540 587 479 696

597 646 517 554

778 583 465 560

409 605 564 576

786 879 504 703

633

569

772

501

166 203 119 146

62 171 131 205

125 223 216 208

46 109 123 223

649 88 238 165 158

Rice

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Wheat

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Sugar

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Petroleum (Crude Oil)

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Refined Petroleum 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

and electrical transformers. However, expenditure incurred on imports of building materials such as portland cement, iron bars and rods and asbestos increased by 13.3 per cent to US dollars 810 million during the year reflecting expansion in construction activities.

Trade Balance The accelerated growth in expenditure on imports relative to earnings from exports contributed to the expansion in the trade deficit in 2010. Subsequent to the sharp contraction in 2009, the overall trade deficit expanded by 66.7 per cent in 2010 to US dollars 5,205 million from US dollars 3,122 million in 2009. As a percentage of GDP, the trade deficit was 10.5 per cent in 2010.

559 417 416 674

Fertiliser

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

(a) Adjusted (b) Provisional

332 541 541 405

2,154 2,873

equipment increased by 19.1 per cent to US dollars data processing machines, transmission apparatus,

2,066 1,819

126 121 2 2 1

1,026 1,052

related vehicle parts. Imports of machinery and 1,206 million. This comprised mainly of automatic

2009 2010 (b)

Sources: Sri Lanka Customs Ceylon Petroleum Corporation Lanka IOC PLC Prima Ceylon Limited Serendib Flour Mills (Pvt) Ltd Central Bank of Si Lanka

Terms of Trade The terms of trade weakened by 5.3 per cent in 2010 due to the significant increase in import prices, over export prices. Commodity export prices in the international market increased substantially in 2010 with the gradual recovery of the global economy. As a result, the price index of exports grew by 10.9 per cent in 2010. The export price index of rubber increased by 83.3 per cent due to exceptionally high international and local demand. The tea export price index increased further by 4.2 per cent in 2010. Industrial export price index also increased by 11.2 per cent in 2010, reflecting price increases in all sub-categories, especially the textile and garment sub-category where prices increased by 12.2 per cent. The price index of imports grew at a higher rate of 17.2 per cent in 2010 reflecting price increases in all major import categories. Among 109

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

Food imports increased by 31.7 per cent mainly

Central Bank of Sri Lanka Annual Report - 2010 Terms of Trade and Trade Indices

Chart 5.8 5.8 Other 19%

180 170

Index Points (1997=100)

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

Chart 5.7 5.7

Exports by Destinations 2005

UK 12% Belgium 5%

160 150

Middle East 5%

140

Germany 4%

130 120

Asia 15%

110 100 80 70

2006

2007

2008

2009

Imports-Volume

Imports-Unit Value

Exports-Volume

Exports-Unit Value

2010

2010 Other 16%

Terms of Trade

consumer goods, the import price index of food and consumer durables increased significantly by 25.5 per cent and 32.4 per cent, respectively. The import price index of intermediate goods increased by 15.8 per cent mainly due to the 24.4 per cent increase in crude oil prices. The price index of fertiliser imports also rose by 5.1 per cent in 2010. In line with this trend, price indices of almost all other sub-categories of intermediate goods also increased. Import price index of investment goods also increased by 12.9 per cent in 2010, reflecting increases in prices of nearly all sub-categories.

Direction of Trade The western countries continued to be Sri Lanka’s major export destinations despite their weakened economies in 2010 while India, Singapore and China were the foremost importoriginating countries in 2010. India emerged as the largest trading partner in 2010 by accounting for nearly 20 per cent of Sri Lanka's imports and 5.6 per cent of its total exports. USA, which is the major export market for Sri Lanka, accounted for 21.1 per cent of exports, followed by UK and India. Garments remained the largest export to USA and UK. The major exports to India were rubber and rubber products, and animal fodder. Exports to EU countries accounted for 35.0 per cent of total exports in 2010. Among these, UK, Italy, Germany and Belgium remained the main destinations representing 12.3 per cent, 110

EU-Other 9%

USA 31%

UK 12% Belgium 5%

Middle East 12% Asia 16% USA 21%

Germany 5%

EU-Other 13%

5.6 per cent, 4.8 per cent and 4.8 per cent of total exports, respectively. Nearly 16.3 per cent of the country’s garments were exported to Germany and Italy and approximately 72.6 per cent of Sri Lanka’s processed diamonds were exported to Belgium. Russia and Iran, which accounted for nearly 15.9 per cent and 10.1 per cent of total tea exports, respectively, continued to be the major destinations for tea in 2010. The Middle Eastern region was the foremost export destination for Sri Lanka’s tea, accounting for 48.1 per cent of total tea exports. India, which continued to be the largest source of imports, accounted for nearly 19.0 per cent of imports in 2010. The main imports from India included refined petroleum products, motorcycles and auto-trishaws. Singapore and China followed as the second and third largest import source countries. Main imports from Singapore comprised of petroleum products, milk and milk products while the major imports from China were machinery, mechanical appliances and cotton. Iran and Japan remained the fourth and fifth largest import source countries for Sri Lanka. The major import from Iran was crude oil while that of Japan was motor vehicles.

Central Bank of Sri Lanka Annual Report - 2010

5.9 5.9

Imports by Origin 2005

Other 16%

EU 14% USA 2%

Middle East 8% India 21% Asia-Other 24%

China 7% Other 16%

previous year. This growth was attributed to the increase in the number of passengers travelling to Sri Lanka, increase in freight charges collected and improvement in port and airport related other business services. Meanwhile, outflows on account of transportation services increased by 30 per cent during 2010 compared to the previous year, with increased international trade and expenditure by Sri Lankans on foreign travel.

Singapore 8%

2010

EU 11% USA 1%

Middle East 14%

India 19%

Asia-Other 18%

China 9%

Singapore 12%

5.4 Trade in Services, Income, Current Transfers and Current Account Balance Trade in Services With the expansion of economic activity and recovery of the global economy, trade in services recorded a significantly higher surplus during 2010. The services account, mainly consisting of transportation, travel, communications, computer and information, construction and insurance services registered a surplus of US dollars 698 million during 2010. All sub-sectors of the services account performed remarkably well during the year showing the countryâ&#x20AC;&#x2122;s potential to achieve a steady growth in coming years.

Transportation Services Transportation services, the main contributor to the services account, performed well during the year. The gross inflows on account of transportation services consisting of passenger fares, freight charges, port and airport related activities increased at a higher rate of 33.6 per cent to US dollars 1,156 million compared to the

Gross inflows on account of passenger fares increased by 15.8 per cent to US dollars 468 million in 2010 compared to the previous year. Gross inflows improved as a result of the increase in the number of passengers travelling to Sri Lanka for both business and leisure, and the increase in airfare by the national carrier, SriLankan Airlines, mainly due to the fuel surcharge imposed in 2010. SriLankan Airlines purchased two new aircraft in 2010 and plans to purchase more in the future to increase its current fleet of aircraft from 14 to 20 by 2012. Inflows are expected to improve further over the medium term as a result of the planned acquisition of new aircraft, expansion of flight destinations and the increase in frequency of flights by the national carrier. Table 5.7

Item

Net Services, Income and Current Transfers (a) US dollars million

Rs. million

2009 2010 (b)

1. Transportation Services 235 2. Travel -61 3. Communications Services 26 4. Computer and Information Services 245 5. Construction Services 34 6. Insurance Services 28 7. Other Business Services -100 8. Government Expenditure n.i.e. -16

336 123 27 265 36 31 -102 -17

26,822 37,963 -7,094 13,778 3,004 3,106 28,161 29,962 3,936 4,037 3,247 3,481 -11,450 -11,591 -1,846 -1,976

Total Net Services

391

698

44,780 78,760

1. Compensation of Employees 2. Direct Investment 3. Interest and Other Charges

-11 -223 -254

-11 -377 -184

-1,233 -1,235 -25,573 -42,603 -29,007 -20,812

Total Net Income

-488

-572

-55,814 -64,650

1. Private 2. General Government

2,927 77

3,608 52

336,578 407,967 8,920 5,918

Total Net Current Transfers

3,005

3,660

345,498 413,885

Source: Central Bank of Sri Lanka

(a) This presentation conforms as far as possible to the Balance of Payments Manual, 5th Edition (1993) of the International Monetary Fund. (b) Provisional

111

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

Chart 5.9

Central Bank of Sri Lanka Annual Report - 2010

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

Gross inflows on account of freight, port and airport related services increased by 49.2 per cent to US dollars 688 million during 2010. The growth was primarily led by the significant increase in container handling at the Port of Colombo, particularly the substantial increase in transshipment container handling, which resulted from the increase in international trade volumes in the region. With the expected enhancement of capacity of local ports and the improvement in external trade, it is expected that this sector will improve further in 2011 and beyond.

Travel and Tourism Sri Lanka’s tourism industry rebounded strongly in 2010 due to post-conflict peaceful environment. Tourist arrivals increased to 654,476 in 2010, surpassing the previous record of 566,202 in 2004. The relaxation of travel advisories issued by major tourist originating countries such as USA, UK, Germany, Australia and Japan in view of the improved security situation in the country and the accolades Sri Lanka received as one of the best travel destinations resulted in this sharp rise in the number of arrivals. The largest number of arrivals was recorded from India (126,882) followed by UK (105,496), Germany (45,727), the Maldives (35,791), Australia (33,456) and France (31,285). Tourist arrivals from Middle Eastern countries also increased. Nearly 78.9 per cent of tourists arrived in Sri Lanka for holiday

Earnings from tourism increased by 64.6 per cent to US dollars 576 million in 2010, compared to US dollars 350 million in 2009. Sri Lanka Tourism has earmarked 2011 as the “Visit Sri Lanka” year and launched a promotional campaign comprising "12 tourism themes for 12 months" to showcase the country's diverse attractions. The Sri Lanka Tourism Development Authority (SLtDA) initiated a programme to fast-track infrastructure development programmes in some of the most popular tourist locations such as Passikudah, Arugam Bay, Trincomalee, Nilaveli, Vakarai, Verugal and Kalkudah. Furthermore, SLtDA also approved a number of internationally acclaimed hotels to be set up within Colombo as well as in the periphery and is in the process of attracting several other world renowned hotel chains. To complement proposals to position Sri Lanka as an attractive shopping destination, a Chinese enterprise is expected to invest in a large scale hotel/shopping complex in the heart of Colombo. Several measures were taken to expedite investments further to cater to the 2.5 million tourist arrivals anticipated in 2016. SLtDA has set

Tourism Performance

Table 5.8

purposes, 12.7 per cent for business purposes, 5.4 per cent for visiting friends and relatives, while 1 per cent arrived for conventions and meetings and 0.8 per cent for religious and cultural purposes.

Item 2006 2007 2008 2009

Tourist Arrivals (No.) Pleasure Business Other

Growth Rate (%)

2010 (a)

2009

2010 (a)

559,603 392,766 96,981 69,856

494,008 331,238 52,116 110,654

438,475 321,079 37,261 80,135

447,890 358,188 38,473 51,229

654,476 516,538 83,270 54,668

2.1 11.6 3.3 -36.1

Tourist Guest Nights (‘000)

5,794

4,940

4,166

4,076

6,548

-2.2

60.7

Room Occupancy Rate (%)

47.8

46.2

43.9

48.4

70.1

10.3

44.8

Gross Tourist Receipts (Rs. million)

42,586

42,571

37,094

40,133

65,018

8.2

Per Capita Tourist Receipts (Rs.)

76,100

86,175

84,598

89,605

99,344

5.9

133,558 55,649 77,909

145,238 60,516 84,722

123,134 51,306 71,828

124,970 52,071 72,899

132,055 55,023 77,032

1.5 1.5 1.5

Total Employment (No.) Direct Indirect (a) Provisional

112

46.1 44.2 116.4 6.7

62.0

10.9 5.7 5.7 5.7

Sources: Sri Lanka Tourism Development Authority Central Bank of Sri Lanka

Central Bank of Sri Lanka Annual Report - 2010

Communications Services Communications services sector reflected improved performance during the year. Gross foreign exchange inflows on account of communications services increased by 3.8 per cent to US dollars 83 million during the year. This was driven by the increase in earnings on International Direct Dialling (IDD) for voice calls and increase in rental receipts for data transmission through leased circuits. Due to rapid expansion of communications services with improved technology, the usage of broadband internet connections, satellite and cable TV have improved notably during 2010. Further, lower call rates offered by both mobile and fixed line operators for IDD have encouraged generation of more IDD calls from Sri Lanka, resulting in outflows on account of communications services to increase at a parallel rate.

Computer and Information Services Computer and information services subsector showed a satisfactory improvement in 2010. Gross inflows on account of exports of software, Business Process Outsourcing (BPO) and other IT enabled services (ITES) increased by 8.2 per cent to US dollars 265 million during 2010. Meanwhile, inflows on account of Knowledge Process Outsourcing (KPO) which is classified under ‘other business services’ of the services account, also increased substantially during the year. Given the continuous improvement of macroeconomic conditions, Sri Lanka is being increasingly recognised as one of the leading outsourcing hubs and hence, the ITES, BPO and KPO industries have been identified as sectors with high growth potential. The government also has taken a number of initiatives to fast track the development and expansion of the sector by providing fiscal and other incentives. The stable political, legal and economic environment coupled with the availability of skilled human capital is highly conducive for the establishment of niche competent BPO-KPO centres and promoting Sri Lanka as a site for disaster recovery and business continuity for other regional countries.

Inflows and Outflows of Income The income account recorded a deficit of US dollars 572 million during 2010, compared to the deficit of US dollars 488 million recorded in 2009. Despite the low international interest rates, interest earned from the investment of higher level of reserves and profits earned on trading of foreign currency, foreign securities and gold contributed to the inflows in the income account. The inflows on account of interest and other charges increased three fold to US dollars 307 million in 2010. However, this was offset by the substantial increase in the interest payments on foreign loans of the government and private sector. Of the interest payments on foreign loans of US dollars 491 million, interest paid on long and medium term loans by the government, the private sector companies and public corporations accounted for around 70 per cent. Given the increase in net foreign liabilities 113

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

up a one-stop-shop, where all tourism development applications are processed by a special team and approved within two to three weeks provided there are no environmental issues. In order to improve the institutional framework by devolving the powers of the SLtDA at the center to the provinces, to enhance localised tourism related infrastructure services in the Eastern Province, to extend the product content and develop supply chains ensuring that they are aligned with sustainable tourism, the SLtDA together with the Ministry of Tourism embarked on a Sustainable Tourism Development Project, funded by the World Bank. Since the end of the conflict, several airlines have resumed flights to Colombo and a number of new airlines and cruise operators have expressed interest in developing closer relations with Sri Lanka. Sri Lanka’s tourism industry, which was highly dependent on the tour operators for business during times of conflict, is now relying more on direct advertising to reach out to tourists via internet and other mass media. However, if Sri Lanka is to live up to its tag line, ‘The Wonder of Asia’, the Government and the private sector would need to work together in partnership to promote the diverse array of tourist attractions in post conflict Sri Lanka.

Central Bank of Sri Lanka Annual Report - 2010

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

of commercial banks, the net interest payments on foreign financial liabilities of commercial banks increased significantly during the year. Meanwhile, outflows on account of direct investments increased by 67.8 per cent to US dollars 386 million, mainly due to the repatriation of profits and dividends by the foreign enterprises. However, a substantial portion of the repatriated profits and dividends have been reinvested by foreign enterprises for the expansion of existing operations.

Current Transfers The net current transfers in 2010 increased significantly to US dollars 3,660 million from US dollars 3,005 million in 2009. The inward workers’ remittances continued to be the foremost foreign exchange earner in 2010. The inward workers’ remittances which account for a larger portion of current transfers, increased significantly by 23.6 per cent to US dollars 4,116 million, compared to US dollars 3,330 million in 2009. Sri Lankan authorities entering into collective agreements with employers for higher wages and salaries, expansion of the exchange houses network by commercial banks, encouragement for skilled labour migration to take up high-earning overseas jobs, government’s on-going initiative to promote inward remittances through formal channels and financial penetration in the Northern and Eastern Provinces through the opening up of new bank branches, were instrumental in attracting a higher level of workers’ remittances. Further, remittances inflows for reconstruction and establishment of new livelihoods in the Northern and Eastern provinces contributed to the notable increase in inward workers’ remittances. The economic recovery in several key remittance-originating countries, especially in the Middle Eastern region, resulted in an increase in the demand for migrant workers in 2010.

Current Account The current account recorded a deficit of US dollars 1,418 million or 2.9 per cent of gDp in 2010. The current account deficit widened due to a larger trade deficit, as a result of increased import demand supported by the recovery of domestic 114

demand and expansion of economic activity. Particularly, the demand for investment goods for infrastructure projects increased during the year. Meanwhile, substantial inflows to the current account in the form of services and private transfers helped curtail the deficit in the current account. As a percentage of GDP, the current account deficit of 2.9 per cent in 2010 was well below the average deficit of the previous few years, with the exception of 2009, which recorded a deficit of 0.5 per cent of GDP, reflecting weak global and domestic demand in the context of the global recession.

5.5 Capital and Financial Flows and Balance of Payments Foreign Direct Investment (FDI) The FDI, including loans, during 2010 decreased to US dollars 516 million from US dollars 601 million in 2009. As FDI is long-term in nature, the impact of the global financial crisis on foreign equity and debt inflows continued to have an effect on the FDI. However, the increase in the reinvestment of retained earnings indicates signs of recovery in FDI. Highest FDI inflows amounting to US dollars 110 million were recorded from India followed by Malaysia and the United Arab Emirates (U.A.E) amounting to US dollars 72 million and US dollars 66 million, respectively. Further, as observed in the previous years, the telecommunications industry has attracted most of the FDI inflows during 2010. The FDI inflows in 2010 consisted of equity capital of US dollars 44 million, loans and advances of US dollars 112 million by the shareholders, intra-company borrowings of US dollars 126 million, foreign loans of US dollars 39 million and reinvestment of retained earnings of US dollars 195 million by the existing companies. Meanwhile, FDI outflows increased to US dollars 43 million in 2010 from US dollars 20 million in 2009. Consequently, the net FDI inflows during 2010 declined to US dollars 473 million from US dollars 581 million recorded in 2009. Investment commitment of contracted projects has increased in 2010 compared to 2009 along with the increase in the number of projects contracted, indicating future prospects for realisation of new FDIs.

Central Bank of Sri Lanka Annual Report - 2010

Trends in Global Foreign Direct Investment (FDI) Flows and Extreme Weatherfor Conditions Prospects Attractingand FDI its to Impact Sri Lanka

United Nations Conference on Trade and Development.

2000 1500 1000 500 0 2000

2001

2002

2003

Emerging E conomies

2004

2005

2006

Developing E conomies

2007

2008

2009

Developed E conomies

Source: UNCTAD FDI Statistics Database (http://www.unctad.org/fdistatistcs)

flows (mainly intra-company loans). Particularly, equity investments squeezed due to weak crossborder mergers and acquisitions (M&As) during 2009, reflecting the curtailment of financing following the collapse of financial markets. Also, reinvested earnings declined due to substantial contraction of profits of transnational corporations (TNCs), thus draining their internal resources. Further, the decline in FDI inflows in 2009 was apparent not only in industries more sensitive to business cycles (such as automobile and chemical industries), but all sectors, across primary, manufacturing and services.2 Meanwhile, FDI inflows to Sri Lanka during 2010, has fallen by about 14 per cent to US dollars 516 million, from US dollars 601 million during 2009. Such a reduction may not entirely be unexpected given the adverse effects of the financial crisis on global financial flows. Data on Sri Lankaâ&#x20AC;&#x2122;s FDI inflows in 2010 reveals that about 59 per cent came into infrastructure development projects, while manufacturing and services sectors attracted about 31 per cent and 9 per cent, respectively, and that in agriculture was marginal (Chart B 10.2). Chart B 10.2

Sector-wise Composition of FDI in Sri Lanka, 2010

8.6%

30.9%

Services Infrastructure Agriculture

1.3%

According to the World Investment Report (2010), the sharp decline in FDI inflows in 2009 was evident in all FDI components, which consisted of equity investments, reinvested earnings, and other capital 1

FDI Inflows by Groups of Economies, 2000-2009

2500

Trends in Global FDI Flows During the past decade, FDI flows gathered momentum as a key channel of global economic integration. This surge in capital flows is attributed, mainly, to strong global economic growth; favourable financial conditions supported by ample global liquidity due to sustained low interest rates; rising commodity prices; and market oriented economic reforms by FDI recipient countries. In 2007, that is, prior to the peak of the global financial crisis, there has been an unprecedented increase in global FDI inflows amounting to US dollars 2.1 trillion, which is an increase of about 50 per cent compared to global FDI inflows during 2000. Further, the last decade witnessed an impressive growth in emerging markets, resulting in a rapid expansion of FDI linkages across the globe. FDI flows from these emerging economies constituted a substantial share of inflows to developing economies, albeit advanced economies continued to play a major role in determining global FDI flows. However, on the onset of the global financial crisis which hindered economic activity in all major advanced economies, the increasing trend of FDI flows was reversed drastically. For instance, according to the UNCTAD1 statistics, global FDI flows have declined by 16 per cent to US dollars 1.8 trillion in 2008, and by some 37 per cent to US dollars 1.1 trillion in 2009. As Chart B 10.1 depicts, FDI inflows have declined sharply in 2009 in all major groupings, namely, developed, developing, and emerging economies, reflecting weak economic performance across the world owing to the global financial crisis.

C hart 1: F DI Inflows by G roups of E conomies , 2000-2009

Chart B 10.1

59.2%

Manufacturing

Source: Board of Investment of Sri Lanka.

The primary sector includes agriculture, fishing, mining, forestry, quarrying and petroleum etc. 2

115

EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

Foreign Direct Investment (FDI) is a long-term and non-debt creating financial flow that helps to increase aggregate investment of a country. Unlike other capital flows, FDI embodies many desirable features such as transfer of technology and development in human capital through transferring managerial and marketing skills etc. Further, FDI helps facilitate global integration, infrastructure development, and technology innovation, while creating employment opportunities and new markets.

US dollras billion

BOX 10

Central Bank of Sri Lanka Annual Report - 2010

During the past few years, FDI flows to the developed economies fell sharply, while developing and emerging economies fared relatively better (Chart B 10.3). For instance, FDI flows to developed economies recorded a staggering 44 per cent drop in 2009, while developing and emerging economies recorded a decline of only 24 per cent. A relatively smaller decline in FDI flows to developing and emerging economies could be attributed, mainly, to increasing growth prospects over the years and market-oriented reforms towards increased financial openness. According to UNCTAD data, developing and emerging economies collectively accounted for nearly half of global FDI inflows, during 2009 (Chart B 10.4). Further, some developing and transition economies have been able to rank among the top 20 FDI recipients in global rankings by 2009, in which, China was the second most popular FDI destination, while the US topped the list (Chart B 10.5). Also, the presence of India, Brazil, Russian Federation, Singapore and Hong Kong among the largest FDI destinations confirmed the emergence of developing and emerging economies, while the rankings of some European countries slide in 2009. Another interesting development observed during the past few years was that investors from emerging economies tend to prefer investing in other emerging economies. For instance, over 50 per cent of emerging economiesâ&#x20AC;&#x2122; capital flows (in terms of M&As) have been directed at other emerging economies during the first half of 2010 (OECD Investment News -Nov 2010). Recent data suggests that global FDI flows started bottoming out since the latter half of 2009, supported by a modest recovery in the world economy. Rising corporate profits, improvements in global stock C hart 3: S hares in G lobal F DI Inflows 2000-2009

Shares in Global FDI Inflows 2000-2009

Chart B 10.3

P er cent

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

Rising of Developing and Emerging Economies as Major FDI Recipients

90 80 70 60 50 40 30 20 10 0 2000

2001

2002

2003

2004

2005

Developed Economies Developing Economies Emerging Economies

116

2006

2007

2008

2009

Shares Global 4: Shares of Global FDIof Inflows 2009 FDI Inflows Chart BC hart 10.4 2009 50.8%

Developed Economies 42.9%

Emerging Economies Developing Economies

6.3%

C hart 5: G lobal F DI Inflows , T op 20 R ecipients 2008-2009*

Global FDI Inflows, Top 20 Recipients 2008-2009*

Chart B 10.5

US dollras billion. 0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

Unit ed St at es China France China, Hong Kong Unit ed Kingdom Russian Federat ion Germany Saudi Arabia India Belgium It aly Luxembourg Net herlands Brazil Brit ish Virgin Islands Ir eland Aust ralia Canada Singapore Spain

2008

2009

Source: UNCTAD FDI Statistics Database (http://www.unctad.org/fdistatistcs) * Ranked on the basis of 2009 FDI Inflow data.

market performance, and implementation of policies promoting financial openness contributed towards this development. According to the World Investment Report (2010), global FDI inflows are estimated to have picked up to US dollars 1.1-1.3 trillion, and the projections for 2011 and 2012, are US dollars 1.3-1.5 trillion and US dollars 1.6-2.0 trillion, respectively. Importantly, the global trends observed during the pre-crisis period are expected to continue over the next few years. In particular, developing and emerging economies are expected to be major FDI destinations, with China, Brazil and India leading the way, among others. Further, the BRIC economies (Brazil, Russia, India and China), being host countries as well as home countries, contribute substantially towards recovery of global FDI flows. According to the World Investment Prospects Survey - 2010/2012, developing countries are set to attract more FDI, mainly in the developing Asia and Latin America, while the FDI growth prospects are considered to be higher for primary and services sectors, than for the manufacturing sector.

Central Bank of Sri Lanka Annual Report - 2010

Sri Lanka has substantial scope for improvement of FDI inflows into the services and agriculture sectors, in the context of recovering trends in global FDI flows. As the World Investment Prospects Survey - 2010/2012 highlights, the FDI growth prospects are higher for primary and services sectors in coming years. As Sri Lanka has already embarked on a programme to promote tourism in the post-conflict era, tourism related FDI needs to be strengthened further. In the meantime, more FDI needs to be attracted to areas such as education and, research and development (R&D) in order to ensure sustainable economic growth over the medium- to long-term. The agriculture sector seems to have been largely unexplored, so far, as a potential investment area in Sri Lanka. There is growing interest among the international organizations in promoting investment opportunities in the agriculture sector, as they begin to foresee some likely threats, given the forecasts of the United Nations on world population growth (reaching 7 billion by 2012 and 9 billion by 2050). Such projections of the world population growth point towards toughest policy challenges in feeding the world, particularly, in the context of increasing scarcity in land and water, let alone any adverse effects due to climate change. Meanwhile, potential in the manufacturing sector could also be enhanced, by directing FDI towards more focused areas such as information and communication technology, and low-carbon industries; not only because there is growing interest among transnational companies into these areas, but also these can facilitate the expansion of productive capacity and upgrade export competitiveness, which are key to achieving sustainable economic growth. The essential requirements towards realisation of these FDI prospects seem to be already in

Medium and Long-term Capital to the Government The medium and long-term loan inflows to the government increased during 2010 compared to 2009. The long-term loan inflows to the government, excluding the proceeds of the sovereign bond of US dollars 1 billion and grants,

place, supported by, on one hand, benign growth prospects of the world economy, rising corporate profits of TNCs and improved global equity market performance, and; on the other hand, strengthening macroeconomic environment domestically, coupled with policy initiatives taken to further liberalise the investment regime. Sri Lanka has taken several progressive measures in order to promote financial openness and to enhance the investment climate, moving beyond more conventional measures such as offering costly tax concessions, supplying of unskilled labour at low cost etc. Policy focus has shifted towards implementing proper investment promotion strategy, underpinned by various factors such as political and social stability, improved infrastructure, low tax regime, skilled labour, and efficient government institutions. Especially, the Central Bank announced some major relaxation of foreign exchange transactions recently, while various legislation are in the pipeline to facilitate an investment friendly climate, such as strategic investment law. However, there still are some concerns over FDI prospects across the globe because of the fragility in global economic recovery. Further, while the liberalisation policies may certainly help attract FDI inflows, the fiercely competitive environment among FDI recipient countries, would be a challenge. As such, emphasis is needed on continous basis to strengthen the macroeconomic performance of all sectors of the economy, leading to a sustainable economic growth over the medium to long-term. References World Investment Report (2010), United Nations Conference on Trade and Development, United Nations. World Investment Prospects Survey - 2010/2012 (2010), United Nations Conference on Trade and Development, United Nations. OECD Investment News (2010), Organization for Economic Co-operation and Development, November, Issue 14.

increased to US dollars 1,460 million in 2010 from US dollars 1,280 million in 2009. The higher foreign loan inflows in 2010 reflect the faster disbursement for ongoing projects during the year and as a result, the foreign aid utilisation rate1 increased marginally in 2010 to 24.8 per cent from 24.1 per cent in 2009. 1

The foreign aid utilisation rate is the ratio of disbursements during

2010 to committed undisbursed balance as at end June 2010.

117

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

FDI Prospects for Sri Lanka

Central Bank of Sri Lanka Annual Report - 2010

Short-term Capital to the Government The net foreign inflows on account of Treasury bills and bonds in 2010 were US dollars 531 million. The outstanding value of government securities issued to foreigners reached its maximum level of 10 per cent of the total outstanding value of the government securities. All inflows on Treasury bills and bonds were absorbed by the Central Bank to cushion and facilitate any sudden withdrawals by the foreign investors, in order to avoid any undue pressure on the domestic foreign exchange market.

Long-term Capital to the Private Sector and Public Corporations Foreign loan inflows to the private sector increased significantly by 48.7 per cent to US dollars 580 million in 2010. This was mainly due to the inflows from Exim Bank of China to Lanka Coal Company Limited amounting to around US dollars 450 million for the Puttalam Coal Power Project. However, foreign loan inflows to the Board of Investment (BOI) companies decreased to US dollars 39 million during 2010 as compared to US dollars 197 million in 2009, reflecting the decrease in FDI. The foreign borrowings by the private sector in 2010 were mainly for investment in telecommunication, power and energy sectors. The gradual recovery of the global economy and positive investor sentiments are expected to provide impetus for greater foreign inflows to the private sector in 2011 and beyond. 118

Inflows to the Capital and Financial Account

Chart 5.10 5,000 4,500 4,000 3,500

US$ million

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

The loan inflows were mostly directed towards the continuation of infrastructure projects such as the Mahinda Rajapaksa Port in Magampura, Colombo Port Expansion Project and Southern Highway Construction Project. Sri Lankaâ&#x20AC;&#x2122;s third international sovereign bond to the value of US dollars 1 billion was successfully issued in October 2010. The oversubscription of the offering by more than six times reflected the confidence placed by foreign investors on the economy of Sri Lanka. The total receipt of grants, consisting of both current and capital in nature, decreased to US dollars 150 million in 2010 from US dollars 221 million in 2009.

3,000 2,500 2,000 1,500 1,000 500 0

2006

2007

Foreign Direct Investment (FDI) Inflows (Excluding loans)

2008

2009

Inflows to the Private Sector (excluding FDI)

2010

Inflows to the Government

Short-term Capital to the Private Sector and Public Corporations short-term capital flows to the private sector consisted of portfolio investments, trade credits and changes in assets and liabilities of commercial banks. The short-term net capital outflows decreased substantially to US dollars 198 million in 2010, from US dollars 311 million in 2009. This was largely due to the decrease in foreign assets and increase in foreign liabilities of the commercial banks during 2010, irrespective of the repayment of large oil import credits by Ceylon Petroleum Corporation (CPC) during 2010. CPC received net trade credits of US dollars 1,490 million including US dollars 968 million of Iranian line of credit for oil imports in 2010 compared to US dollars 1,582 million received in 2009, and settled around US dollars 1,300 million during 2010. Despite increased gross foreign inflows to the Colombo Stock Exchange (CSE) during 2010 of US dollars 819 million compared to US dollars 375 million in 2009, the net portfolio investment recorded a net outflow of US dollars 230 million in 2010 as compared to US dollars 6 million in 2009. This was mainly due to the higher sales of shares by foreigners to gain profits from rising stock prices and the impact of one-off selling by an international investment fund.

Central Bank of Sri Lanka Annual Report - 2010 Major Projects Financed with Foreign Borrowings during 2010 Amount Disbursed US dollars million

Lender and Project AB Svensk Export Credit Corporation of which; Ratmalana & Ja-Ela Wastewater Treatment Facilities Project

Asian Development Bank of which; Colombo Port Expansion Project Financial Markets for Private Sector Development Project National Highways Sector Project Southern Transport Development Project - Supplementary

Calyon Credit Agricole CIB of which; Rehabilitation of Wimalasurendra and New Laxapana Power Stations Project

28.5 19.0 306.3 72.3 40.0 35.4 18.7 17.1 17.1

China Development Bank Corporation of which; Rehabilitation and Improvement of Priority Roads Project

152.8 152.8

Export-Import Bank of China of which; Puttalam Coal Power Project - Phase II Hambantota Port Development Project Supply of 13 Nos. Diesel Multiple Units to Sri Lanka Railway Project Bunkering Facility & Tank Farm Project at Hambantota Colombo - Katunayake Expressway (CKE) Section A1 Colombo - Katunayake Expressway (CKE) Section A4 Colombo - Katunayake Expressway (CKE) Section A2

692.2 451.5 115.0

Government of France of which; Trincomalee Integrated Infrastructure Project [TIIP] Government of Japan of which; Upper Kotmale Hydro Power Project Greater Colombo Transport Development Project Water Sector Development Project Southern Highway Construction Project (II) Colombo City Electricity Distribution Development Project Pro-poor Economic Advancement & Community Enhancement (PEACE) Project Pro-poor Eastern Infrastructure Development Project Government of the Republic of Korea of which; Ruhunupura Water Supply Development Project

Government of the Peopleâ&#x20AC;&#x2122;s Republic of China of which; Puttalam Coal Power Project - Buyerâ&#x20AC;&#x2122;s Credit Facility

30.3 26.8 19.4 18.5 17.6 50.2 35.4 302.9 58.4 52.0 45.8 30.4 24.8 18.4 14.0 36.7 15.4 103.7 103.7

HSBC Bank PLC (United Kingdom) of which; Emergency Purchase of Container Handling Equipment - Jaya Terminal Development of the Dikkowita Fisheries Harbour Regional Bridge Project

77.4

International Development Association of which; Emergency Northern Recovery Project Additional Financing for North-East Housing Reconstruction Project Provincial Roads Project Second Community Development and Livelihood Improvement Project

144.5 23.4

Nordea Bank Denmark A/S of which; Oluvil Port Development Project

35.0 23.0 16.9

17.4 15.3 15.2 30.8 19.0

Source: External Resources Department

Foreign assets of commercial banks decreased by US dollars 249 million in 2010 compared to an increase of US dollars 435 million in 2009. Meanwhile, foreign liabilities of commercial banks increased by US dollars 815 million during 2010 from a decrease of US dollars 98 million in 2009. Accordingly, the decrease in foreign assets

and increase in foreign liabilities have resulted in net foreign liabilities of the commercial banks to increase by US dollars 1,064 million to US dollars 1,154 million in 2010. The increase in net foreign liabilities of commercial banks during the year was mainly due to the conversion of foreign assets and increase in foreign liabilities, to generate foreign exchange to finance domestic foreign currency lending to CPC by around US dollars 450 million, and other private sector enterprises, as well as to finance the investment in Sri Lanka Development Bonds.

Balance of Payments The overall balance in BOP in 2010 recorded a surplus of US dollars 921 million, following an unprecedented surplus of US dollars 2,725 million, in 2009. despite the increase in the current account deficit due to the widened trade deficit, higher inflows to the capital and financial account resulted in BOP recording a surplus. The financial inflows to the government from the third international sovereign bond issue of US dollars 1 billion in October 2010 and increase in private long-term investments, contributed to the surplus in the BOP. The gradual recovery of the global economy, improved financial market conditions and increased investor confidence brought about by the stable macroeconomic environment helped attracting higher inflows to the capital and financial account. To strengthen BOP in the medium to longterm, non-debt creating and long-term financial flows such as FDI need to be encouraged. Towards this end, progressive measures have already been taken to promote financial openness and enhance the investment climate, which include adoption of an investment promotion strategy by the BOI and relaxation of foreign exchange transactions.

External Reserves The gross official reserves (excluding ACU receipts) increased substantially and recorded US dollars 6,610 million by end 2010, compared to US dollars 5,097 million at end 2009. Disbursements under the foreign funded projects, 119

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

Table 5.9

Central Bank of Sri Lanka Annual Report - 2010

US dollars million (b) 2006

2007

128 2,709 2,837 1,169 4,005

99 3,409 3,508 1,448 4,956

113 5,244 5,357 1,673 7,030

3.3 2.9

3.7 3.3

2.0 1.8

6.3 5.5

6.4 5.7

4.7 4.1

5.3 4.7

3.1 2.8

8.3 7.2

7.7 6.8

88 7,109 7,196 1,424 8,621

2006 13,789 291,747 305,536 125,867 431,403

2007

2008

10,768 370,640 381,408 157,454 538,862

11,411 260,297 271,708 140,075 411,783

120

9,747 788,722 798,469 158,031 956,500

In January 2010, Sri Lanka graduated to 'middle-income' economy status from the previously listed category of PRGT eligible countries (Box1). This helped foster investor confidence in international financial markets. The third sovereign bond of US dollars 1 billion of 10year tenure was oversubscribed by over 6 times, indicating a strong investor confidence in the Sri Quarterly External Assets

Chart 5.9 Chart 5.11

Quarterly External Assets

9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000

Total External Assets

Gross Official Assets

10/Q4

10/Q3

10/Q2

10/Q1

09/Q4

09/Q3

09/Q2

08/Q3

08/Q2

08/Q1

07/Q4

07/Q3

07/Q2

07/Q1

06/Q4

06/Q3

1,000 06/Q2

Under the IMF-SBA facility, a total of SDR 1.65 billion (approximately US dollars 2.6 billion) was approved in July 2009. The first two tranches amounting to US dollars 652 million were received in July and November 2009. Following the completion

12,920 599,880 612,799 191,373 804,173

of the second and third reviews of the SBA facility in June 2010, the programme period was extended by another year, and the future disbursements were re-phased to be in seven equal tranches. Thus, during 2010, three tranches amounting to US dollars 620 million were received. Meanwhile, the sixth tranche of US dollars 217 million was received in February, 2011 (Box 11).

06/Q1

the receipt of three tranches under the IMF-SBA facility, the proceeds of the third international sovereign bond and inflows to the private sector contributed mainly in building up foreign reserves in 2010. On October 4, 2010, gross official reserves reached a record high level of US dollars 7,173 million which was equivalent to 6.7 months of imports. However, in the last quarter of 2010, official reserves declined slightly as the Central Bank supplied foreign exchange to the domestic foreign exchange market to ensure adequate foreign exchange for settling the high level of petroleum bills and to prevent any undue volatility in the exchange rate. Accordingly, as of end 2010, gross official reserves excluding ACU receipts, stood at US dollars 6,610 million, which is equivalent to 5.9 months of imports. Meanwhile, total external assets excluding ACU receipts increased to US dollars 8,035 million in 2010 (equivalent to 7.1 months of imports), compared to US dollars 6,770 million in 2009.

Source: Central Bank of Sri Lanka

(a) Calculated at market value and includes Asian Clearing Union receipts. (b) Converted at the following year end rates, except for certain items in the International Reserves of the Central Bank of Sri Lanka which were converted at the representative rate agreed with the International Monetary Fund. Year 2006 2007 2008 2009 2010 Rs. per US dollar (year end) 107.71 108.72 113.14 114.38 110.95 (c) Excludes foreign exchange agreements (FX Swaps) outstanding as at end December 2009 and 2010 amounting to US dollars 245 million and US dollars 97 million, respectively. (d) Provisional

09/Q1

1. Government 2. Central Bank 3. Total Official Assets (1+2) 4. Commercial Banks 5. Total External Assets (3+4) 6. Gross Official Assets in Months of 6.1 Import of Goods 6.2 Import of Goods and Services 7.Total Assets in Months of 7.1 Import of Goods 7.2 Import of Goods and Services

Rs. million

08/Q4

Ownership

US$ million

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

External Assets of Sri Lanka (a)

Table 5.10

Central Bank of Sri Lanka Annual Report - 2010

Progress of the IMF-SBA Extreme Weather Conditions and itsFacility Impact

IMF approved a 20-month Stand-By Arrangement (SBA) facility of SDR 1.65 billion (approximately US dollars 2.6 billion) on 24 July 2009 to Sri Lanka, as a Balance of Payments (BOP) support. This accounts for 400 per cent of the country’s current quota with the Fund and is the highest ever facility offered by the IMF to Sri Lanka. The facility was originally planned to be disbursed in 8 equal instalments of approximately SDR 206.7 million each (Box Article 9: Stand-By Arrangements Facility, Central Bank Annual Report 2009).

The SBA facility has progressed successfully, within its framework. Thus far, IMF has conducted six quarterly reviews and released six tranches under the SBA facility totalling US dollars 1.5 billion. A staff mission from IMF visited Colombo in February 2011 to conduct the sixth review of the SBA Facility. Accordingly, the seventh tranche is expected in April 2011. The seventh review is expected in May 2011.

Timeline of the Reviews and Disbursements of the SBA Facility

Table B 11.1 Date of the Board Meeting

Review No.

24 July 2009

06 November 2009

First

28 June 2010 (a) 24 September 2010 02 February 2011

Tranche No.

Amount SDR mn.

USD mn.

First

206.7

322.0

Second

206.7

329.0

Second & Third

Third & Fourth

275.6

407.8

Fourth

Fifth

137.8

212.5

Fifth

Sixth

137.8

216.6

964.6

1487.9

Total

(a) The programme was extended by one-year and the future disbursements were rephased into seven equal instalments of SDR 137.8 million each.

Lankan economy. The coupon rate of this bond was 6.25 per cent per annum, which is substantially lower, compared to previous sovereign bond issues (i.e., 7.4 per cent per annum in 2009 and 8.25 per cent per annum in 2007, each amounting to US dollars 500 million with a 5-year tenure). While Sri Lanka will continue to receive funding from the World Bank’s concessional arm, the International Development Association (IDA), the graduation of Sri Lanka to middle-income status and the latest creditworthiness assessment of the World Bank has confirmed Sri Lanka’s eligibility to receive financing from its non-concessional International Bank for Reconstruction and Development (IBRD) window, as well. The larger pool of resources that would be available to Sri Lanka would help raise investment to a level required to sustain a high growth momentum.

International rating agencies raised their ratings of the country in 2010. The Standard & Poor’s (S&P) raised the long-term foreign currency rating to ‘B+’ from ‘B’ and the local-currency rating to ‘BB-’ from ‘B+’. The Fitch Ratings Agency has affirmed long-term foreign and local currency Issuer Default Rate at ‘B+’ and revised the outlook to ‘Positive’ from ‘Stable’, while Moody’s Investor Services, covering Sri Lanka for the first time, assigned ‘B1’ sovereign rating with a ‘Stable’ outlook. The reserve adequacy as measured by the ratio of gross official reserves to short-term liabilities increased to 95.2 per cent by end 2010, from 81 per cent, recorded at end 2009. This is due to the increased reserve levels, supported by the financial inflows to the country, over the increase in short-term debt. The absorption of foreign 121

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

BOX 11

Central Bank of Sri Lanka Annual Report - 2010

External Debt The total external debt of the country, which consists of medium and long-term, and shortterm debt decreased to 43.3 per cent of GDP in 2010 from 44.4 per cent in 2009. However, in US dollar terms, the total external debt increased by 14.9 per cent to US dollars 21.4 billion in 2010 from US dollars 18.7 billion in 2009. While the increase in medium and long-term debt amounted to approximately, US dollars 3.3 billion, the increase in the total outstanding debt moderated owing to the decline in short-term debt. The reduction in shortterm debt was primarily due to the settlement of trade credits of CPC during the year. Meanwhile, the medium and long-term debt increased mainly 122

External Debt

Chart 5.12

5.10 External Debt US $ Mn.

23,000

21,000

19,000 50

17,000 15,000

5.6 External Debt and Debt Service

A major share of external debt was accounted for by the government. Of the medium to long-term debt, the government debt accounted for 85.4 per cent, while the remainder represented borrowings of the private sector and public corporations and debt obligations to IMF. Out of the total government external debt outstanding, the concessional debt accounted for 71 per cent by end 2010, compared to 81 per cent by end 2009. Access to concessional loans from multinational institutions has declined with the categorisation of Sri Lanka as a middle-

% of GDP

With the expectation of improving investor confidence and stabilising the foreign exchange market, the Central Bank decided to relax certain restrictions, gradually, on foreign exchange transactions. Accordingly, opening and maintaining bank accounts abroad for certain specific reasons were permitted; provisions to enter into forward contracts in foreign currency to cover foreign exchange transactions were granted; margin requirements against advance payments on selected imports were removed; suspension of prepayment of import bills was lifted and unification of different investor accounts maintained by nonresidents in commercial banks was allowed, with effect from March 11, 2010. Meanwhile, with effect from November 22, 2010, a range of relaxations were implemented, which mainly include, permission for foreigners to invest in Rupee Denominated Debentures issued by local companies, permission for foreign companies to open places of business in Sri Lanka, approval for companies to borrow from foreign sources. Moving forward, further relaxations were announced to be made effective from January 1, 2011, such as permission to Sri Lankan resident individuals, corporate and unincorporated bodies to invest in equity of overseas companies.

due to the higher level of inflows to the government, including US dollars 1 billion sovereign bond, and disbursements under IMF-SBA facility, and inflows to the private sector, particularly, on account of Puttalam Coal Power Project. On the currency composition of total external debt outstanding, SDR and US dollar shares were 31.4 per cent and 29.8 per cent, respectively, while 27.9 per cent was denominated in Japanese yen. The banking sector external liabilities have increased, substantially, by about 51 per cent to US dollars 3.4 billion by end 2010. This was mainly due to the increase of commercial bank liabilities to US dollars 2.6 billion by end 2010, compared to US dollars 1.8 billion by end 2009, as a result of increased import credits by commercial banks to corporate borrowers, particularly the CPC. Meanwhile, the ACU liabilities increased to US dollars 586 million by end 2010, from US dollars 261 million by end 2009, owing to deferred settlement by the year end. Accordingly, the total external debt and liabilities as a percentage of GDP increased marginally to 50.1 per cent by end 2010, from 49.7 per cent in 2009.

US$ million

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

inflows to the government securities market by the Central Bank into official reserves has facilitated in improving the reserve adequacy ratio.

13,000

11,000 35

9,000 7,000

2006

Short-term

2007

2008

Medium and Long-term

2009

2010

Total External Debt as a % of GDP (Right Axis)

Central Bank of Sri Lanka Annual Report - 2010

Table 5.11

Outstanding External Debt and Banking Sector External Liabilities

Item

US dollars million 2006

2007

2008

Rs. million

2009 2010 (a)

2006

2007

2008

2009

2010 (a)

11,347 12,879 13,646 15,564 18,823 1,222,175 1,400,883 1,543,952 1,780,313 2,088,449 1.1 Government 10,245 11,744 12,593 13,769 16,076 1,103,418 1,276,846 1,424,729 1,574,933 1,783,729 1.2 Public Corporations and Private Sector with Government Guarantee 465 345 251 110 517 50,065 37,501 28,429 12,608 57,398 1.3 Public Corporations and Private Sector without Government Guarantee 393 539 634 967 919 42,376 58,553 71,715 110,570 101,913 1.4 IMF Drawings (b) 244 251 169 719 1,311 26,316 27,933 19,079 82,201 145,410

2. Short-term Debt 2.1 Government (c) 2.2 Other (d)

634 - 634

1,111 1,460 3,098 457 212 1,622 654 1,248 1,476

2,615 2,171 444

68,286 120,748 - 49,641 68,286 71,107

165,207 24,006 141,201

354,341 185,534 168,808

290,150 240,856 49,294

1,994 3 1,681 311

2,493 2,669 2,251 2 1 227 2,046 1,861 1,763 446 808 261

3,393 228 2,578 586

214,802 271,063 284 219 181,040 222,389 33,478 48,454

301,950 64 210,531 91,355

257,575 26,042 201,696 29,837

376,418 25,322 286,052 65,044

3. Banking Sector External Liabilities 3.1 Central Bank (e) 3.2 Commercial Banks (f) 3.3 ACU Liabilities

4. Total External Debt (1+2)

11,981 13,989 15,107 18,662 21,438 1,290,461 1,521,581 1,709,159 2,134,654 2,378,599

5. Total External Debt and Liabilities (1+2+3)

13,976 16,483 17,775 20,913 24,830 1,505,263 1,792,643 2,011,109 2,392,229 2,755,017

MEMORANDUM ITEMS Medium and Long-term Debt

Project Loans Non-Project Loans Suppliersâ&#x20AC;&#x2122; Credits IMF Drawings (b) Other Loans (g)

Short-term Debt and Banking Sector External Liabilities

9,087 10,002 11,148 11,914 13,174 867 1,064 740 708 1,516 435 679 705 1,146 1,838 244 251 169 719 1,311 718 884 885 1,077 985

978,356 1,087,359 1,261,304 1,362,806 1,461,729 93,331 115,697 83,703 81,025 168,151 46,877 73,790 79,722 131,103 203,889 26,316 27,933 19,079 82,201 145,410 77,295 96,054 100,145 123,178 109,271

2,628

283,088 391,811

3,604 4,129 5,349

6,008

Total External Debt Total Banking Sector External Liabilities Total External Debt and Liabilities Short-term Debt Short-term Debt and Banking Sector External Liabilities

467,157

611,916

666,567

As a Percentage of GDP (h) 42.4 7.1 49.4 2.2

43.2 7.7 51.0 3.4

37.1 6.6 43.7 3.6

44.4 5.4 49.7 7.4

43.3 6.8 50.1 5.3

43.9 7.3 51.2 2.3

42.4 7.6 50.1 3.4

38.8 6.8 45.6 3.7

44.1 5.3 49.5 7.3

42.5 6.7 49.2 5.2

9.3

11.1

10.1

12.7

12.1

9.6

10.9

10.6

12.7

11.9

14.8 10.8 57.8

10.5 13.7 36.3

As a Percentage of Total Debt and Liabilities

Short-term Debt Short-term Liabilities

Short-term Debt as a Percentage of Official Reserves (a) (b) (c) (d) (e) (f) (g) (h)

4.5 14.3 22.4

6.7 15.1 31.7

8.2 15.0 60.8

14.8 10.8 57.8

10.5 13.7 36.3

Provisional Includes drawings under the International Monetary Fund (IMF) Stand-by Arrangement facility of 2009. Includes outstanding Treasury bills and Bonds issued to non-residents. Includes Iranian line of credit of the Ceylon Petroleum Corporation and other trade credits. Includes currency Swaps of US dollars 200 mn from 2009. Foreign liabilities of commercial banks including those of Offshore Banking Units. Includes long-term loans of public corporations and private sector institutions. Based on GDP at current market prices published by the Department of Census and Statistics.

income country. Nonetheless, Sri Lanka will continue to receive funding from the World Bankâ&#x20AC;&#x2122;s concessional arm, IDA. Further, the ratio of shortterm to total debt declined to 12.2 per cent by end 2010, compared to 16.6 per cent by end 2009, mainly due to the reduction in trade credits of the CPC.

Foreign Debt Service Payments The total foreign debt service payments, consisting of amortisation and interest payments, declined in nominal terms to US

4.5 14.3 22.4

6.7 15.1 31.7

8.2 15.0 60.8

Sources: External Resources Department Central Bank of Sri Lanka

dollars 1,633 million in 2010 from US dollars 1,702 million in 2009. Further, as a percentage of export of goods and services, total foreign debt service payments decreased to 15.2 per cent in 2010, compared to 19 per cent in 2009. The higher debt service ratio in 2009 was due to the settlement of syndicated loans of US dollars 225 million, whereas in 2010 the syndicated loan settlements were only US dollars 25 million. Also, the full settlement of the rescheduled loan obligation due to moratorium granted after the tsunami in 2004, has resulted in lower debt service ratio, in 2010. 123

EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

1. Medium and Long-term Debt

Central Bank of Sri Lanka Annual Report - 2010

15 Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

External Debt Service Payments

Table 5.12

US dollars million

Item

Rs. million

2006

2007

2008

2009

1. Debt Service Payments 1.1 Amortization (i) To IMF (ii) To Others 1.2 Interest Payments (i) To IMF (ii) To Others

1,080 759 144 615 321 14 307

1,232 791 5 786 441 14 427

1,525 1,075 77 998 450 11 440

1,702 1,346 95 1,251 357 6 351

1,633 1,142 46 1,096 491 7 484

2. Earnings from Exports of Goods and Services

8,508

9,415 10,115

8,977

10,775

2010 (a)

2006

2007

112,670 136,521 79,227 87,731 15,276 789 63,952 86,942 33,443 48,790 1,452 1,509 31,991 47,281

2008 165,511 116,702 8,582 108,120 48,809 1,173 47,636

2009 195,727 154,713 10,941 143,772 41,014 644 40,370

2010 (a) 184,610 129,121 5,238 123,883 55,490 803 54,687

885,380 1,041,932 1,095,679 1,031,289 1,216,697

3. Receipts from Export of Goods, 10,980 12,365 13,001 12,423 15,215 1,142,515 1,368,959 1,408,637 1,427,658 1,718,370 Services, Income and Private Transfers

4. Debt Service Ratio (b) 4.1 As a Percentage of 2 above (i) Overall Ratio 12.7 13.1 15.1 19.0 15.2 12.7 13.1 15.1 (ii) Excluding IMF Transactions 10.8 12.9 14.2 17.8 14.7 10.8 12.9 14.2

19.0 17.9

15.2 14.7

4.2 As a percentage of 3 above (i) Overall Ratio 9.8 10.0 11.7 13.7 10.7 9.9 10.0 11.7 (ii) Excluding IMF Transactions 8.4 9.8 11.1 12.9 10.4 8.4 9.8 11.1

13.7 12.9

10.7 10.4

5. Government Debt Service Payments 5.1 Government Debt Service Payments (c) 610 813 1,066 1,166 922 63,368 89,924 115,508 5.2 As a Percentage of 1 above 56.4 66.0 69.9 68.5 56.5 56.2 65.9 69.8

134,019 68.5

104,240 56.5

(a) Provisional (b) Debt service ratios calculated in rupee values and US dollar values differ due to variations in exchange rates during the year. (c) Excludes transactions with the International Monetary Fund (IMF).

5.7 Exchange Rate Regime and Exchange Rate Movements Exchange rate policy in 2010 focused on maintaining stability in the domestic foreign exchange market. Amidst the favourable developments in the external environment and improved investor confidence, the resulting appreciating trend in the exchange rate subsequent to the dawning of peace in the country in May 2009, continued during 2010. The recovery of commodity prices in the international markets resulted in the US dollar losing its value during the second half of 2010. Supported by steady foreign currency inflows from services sector, workersâ&#x20AC;&#x2122; remittances and financial flows from the third international sovereign bond issue and short-term investments in Treasury bills and bonds, the rupee appreciated gradually by 3.09 per cent to Rs. 110.95 per US dollar during 2010. Meanwhile, the annual average exchange rate in 2010 was Rs. 113.06 against the US dollar compared to Rs. 114.94 in 2009. In the face of continued foreign exchange inflows into the domestic market, the 124

Source: Central Bank of Sri Lanka

Central Bank regularly absorbed foreign exchange to mitigate excessive volatility in the exchange rate and to ensure that the competitiveness of the export sector is unaffected by an undue appreciation of the rupee, while strengthening the reserve position. However, during the last quarter of 2010, the Central Bank supplied foreign exchange to the domestic market to ensure adequate foreign exchange liquidity in the face of large outflows arising from the settlement of petroleum bills. Accordingly, during 2010 the Central Bank purchased US dollars 753 million from the domestic foreign exchange market while supplying US dollars 820 million, leading to a net supply of US dollars 67 million. The rupee appreciated at a relatively higher rate against some other major currencies during 2010. It appreciated against the Euro (10.95 per cent) and pound sterling (6.03 per cent). However, the rupee depreciated against the Japanese yen (8.80 per cent) and Indian rupee (0.73 per cent). meanwhile, several international currencies depreciated due to measures taken by respective countries to boost exports. Accordingly, reflecting

Central Bank of Sri Lanka Annual Report - 2010 Exchange Rate Movements

Chart 5.13

Effective Exchange Rate Indices 24 - currency (2010=100) Effective Exchange Rate Indices: 24 - Currency (2010=100)

Exchange Rate Movements - Rupees per US$ Exchange Rate Movements Rupees per US$ 110

the movements of major currencies against the US dollar in the international markets, the rupee appreciated against the SDR by 4.58 per cent during 2010.

Nominal and Real Effective Exchange Rates During 2010, both the Nominal Effective Exchange Rate and the Real Effective Exchange Rate appreciated, reversing the depreciating trend observed in 2009. Reflecting a nominal

End Year Rate

End Year

Nov-10

Annual Average

2009

2010

2008

2009

2010

2009

2010

2009

2010

159.45 2.36 1.25 163.28 113.14 174.27

163.72 2.46 1.24 181.75 114.38 178.67

147.56 2.48 1.36 171.41 110.95 170.84

159.32 2.52 1.05 200.73 108.33 171.24

160.21 2.39 1.23 179.87 114.94 177.22

150.10 2.49 1.29 174.81 113.06 172.50

-2.60 -4.13 0.89 -10.16 -1.09 -2.46

10.95 -0.73 -8.80 6.03 3.09 4.58

-0.56 5.52 -14.60 11.60 -5.75 -3.37

6.73 -3.91 -4.55 2.90 1.66 2.73

Monthly Index

Percentage Change over Previous Year

Annual Average

Monthly Index Dec. 2008

NEER - 24 currencies REER - 24 currencies (d)

Annual Average Rate

2008

Effective Exchange Rate Indices (b) (c) (2010=100)

Sep-10

Percentage Change over Previous Year (a)

In Rupees per unit of Foreign Currency Currency

Euro Indian Rupee Japanese Yen Pound Sterling US Dollar SDR

Jul-10

appreciation of the Sri Lanka rupee against most of the major currencies in the currency baskets, the nominal effective exchange rate (NEER) of the Sri Lanka rupee, based on the 5-currency basket, (which includes the US dollar, Pound sterling, Euro, Japanese yen and Indian rupee) appreciated by 4.1 per cent, while the NEER based on the nominal exchange rates of 24 trading partners and competitors appreciated by 2.4 per cent. The higher nominal appreciation of the rupee and the relatively high domestic inflation as compared to that of trading partners and competitors, resulted

Exchange Rate Movements

Table 5.13

REER

101.85 99.35

Dec. 2009 Dec. 2010 98.12 97.57

100.49 102.82

2008

2009

2010

2009

2010

2009

2010

100.06 95.64

99.85 97.75

100.00 100.00

-3.67 -1.79

2.42 5.38

-0.21 2.20

0.16 2.32

(a) Changes computed on the basis of foreign currency equivalent of Sri Lanka rupees. A minus sign indicates depreciation. (b) The Nominal Effective Exhange Rate (NEER) is a weighted average of nominal exchange rates of 24 trading partner and competitor countries. Weights are based on the trade shares reflecting the relative importance of each currency in each of the currency baskets. The Real Effective Exchange Rate (REER) is computed by adjusting the NEER for inflation differentials with the countries whose currencies are included in the basket. A minus sign indicates depreciation. (c) The exchange rates have been defined in terms of indices so that the appreciation/depreciation of the rupee relative to other currencies is directly reflected by a rise/fall in the values of the effective exchange rate indices. (d) CCPI was used for REER computation.

Source: Central Bank of Sri Lanka

125

EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

NEER

May-10

Mar-10

Jan-10

Nov-09

Sep-09

Jul -10

Oct -10

Jan -10

Apr -10

Oct -09

Jul -09

Jan -09

Apr -09

Jul -08

Oct -08

Jan -08

Apr -08

Jul -07

Oct -07

Jan -07

Apr -07

106

Jul-09

110

100

May-09

114

105

Mar-09

Rs./US$

118

Jan-09

Index Point No.

122

Central Bank of Sri Lanka Annual Report - 2010

Economic Social Infrastructure EXTERNAL SECTOR and DEVELOPMENTS AND POLICIES

Revision of Effective Exchange Indices Extreme Weather Conditions and itsRate Impact

BOX 12 Effective Exchange Rate Indices

The Central Bank has been preparing NEER and REER indices based on a 5-currency basket and a 24-currency basket since 1989. The recent series of these indices were prepared with the base year as 2006.2 Rather than observing the movements of the exchange rate against one foreign currency only, this would enable market participants to track the movement of the Sri Lanka rupee against a basket of currencies. A rise in the NEER index value implies an appreciation of the rupee relative to other countries, and vice versa. The REER index is used as an indicator of export competitiveness or currency misalignment.

The exchange rate measures the value of a reference currency in terms of the other. The effective exchange rate assesses the value of a currency against a group of other currencies and is generally expressed as an index.1 Usually the group of foreign currencies represents the major trading partners of the reference country. The Central Bank of Sri Lanka prepares two effective exchange rate indices, namely the Nominal Effective Exchange Rate (NEER) and the Real Effective Exchange Rate (REER). The NEER is the weighted geometric average of major bilateral nominal exchange rates, with weights based on the proportion of bilateral trade to Sri Lanka’s total foreign trade. The REER is obtained by adjusting the NEER for inflation differentials between domestic and respective foreign countries and used as an indicator of the country’s external competitiveness

Revision of the Effective Exchange Rate Indices The trade patterns change over time. The importance of some countries could diminish, while trading with some other countries could increase. Hence, the effective exchange rate indices are revised regularly to capture new developments once in every 4-5 years. Accordingly, the base year of the 5-currency indices and 24-currency indices are revised to the year 2010. The 5-currency NEER and REER indices capture the

NEER NEER is the weighted geometric average of the bilateral nominal exchange rates of the domestic currency in terms of a basket of foreign currencies.

n wi NEER = ∏(e/ei) i=1

where e: Exchange rate of the Sri Lankan rupee against the US dollar (US dollars per rupee in indexed form) ei: Exchange rates of currency i against the US dollar (US dollars per currency i in indexed form) wi: Weights attached to the country/currency i in the index

REER REER is the inflation adjusted NEER.

n wi REER = ∏[(e/ei)(P/Pi)] i=1

where P: Consumer Price Index (CPI) of Sri Lanka compared to the base period index Pi: CPI of country i

1 A detailed description of exchange rates, exchange rate regimes, effective exchange rate indices and compilation methodology are available in the Pamphlet Series No3: Exchange Rates, published by the Central Bank of Sri Lanka, 2006.

126

Table B 12.1

Revised Trade Weights (per cent)

Country United States India United Kingdom China Germany Japan Italy Belgium Hong Kong France Malaysia Russia Thailand Netherlands Canada Pakistan Singapore Indonesia Turkey Taiwan Korea Australia Bangladesh Kenya

New Weight 19.74 15.57 9.86 6.41 5.88 4.99 4.83 4.45 3.63 2.93 2.36 2.18 2.15 2.11 1.96 1.80 1.79 1.73 1.52 1.51 1.17 0.97 0.36 0.10 100.00

2 The methodology of the computation of NEER and REER since January 2000 by the Central Bank is available in the Box 16 of the Central Bank of Sri Lanka Annual Report, 2003.

Central Bank of Sri Lanka Annual Report - 2010

1,800 1,500 1,200 900 600

10/Q4

10/Q3

10/Q2

10/Q1

09/Q4

09/Q3

09/Q2

09/Q1

08/Q4

08/Q3

08/Q2

08/Q1

07/Q4

300

has increased only marginally to US dollars 11,065 million during 2010 from US dollars 10,959 million during 2009. The forward premia for one-month, threemonth and six-month remained slightly lower than the interest rate differentials throughout 2010. This indicates the market expectation of continued future inflows into the domestic foreign exchange market in the shortterm. Despite declining domestic interest rates, it being comparatively higher than the international benchmark interest rates, has resulted in higher interest rate differentials. Coupled with the increased investor confidence in the domestic economy, the higher interest rate differential further supplemented in attracting foreign investment into the domestic Treasury bill and bond market.

127

5 EXTERNAL SECTOR DEVELOPMENTS AND POLICIES

Quarterly Inter - Bank Forward Transaction Volumes Quarterly Inter- Bank Forward Transaction Volumes

07/Q3

The domestic foreign exchange market expanded in 2010 amidst the mixed impact from the developments in the external sector. Given the expansion in trade, steady inflows into the domestic foreign exchange market from export proceeds, increased workersâ&#x20AC;&#x2122; remittances inflows, and the stability in the exchange rate, the total volume of spot transactions increased to around US dollars 7,416 million in 2010 (67 per cent of total transactions), compared to US dollars 6,335 million recorded during 2009. However, the total volume of forward transactions has deviated from the trend seen in the spot market with the transaction volume decreasing to US dollars 3,649 million during 2010 compared to US dollars 4,624 million recorded during 2009. The relatively stable spot market exchange rates as well as the expectations of steady inflows into the market have reduced the demand for forward booking of foreign exchange requirements. Accordingly, the total inter-bank foreign exchange transaction volume

Chart 5.12

07/Q2

Developments in the Domestic Foreign Exchange Market

Chart 5.14

07/Q1

in the real effective exchange rate (REER) based on both 5-currency and 24-currency baskets, appreciating by 7.4 per cent and 5.4 per cent, respectively, during 2010.

remains unchanged. The price index used in the computation of REER should ideally be the measure of producer prices of respective countries. However, due to practical considerations such as non availability of all countries in the basket and differences in preparation, CPI is used as a proxy for the REER calculation. Given the time lag in obtaining consumer price indices from all countries, the REER index based on actual data is published with an eight week time lag. In order to ensure up to date information, the NEER and REER indices have already been published in the Central Bank of Sri Lanka web site. The newly computed NEER and REER indices are also published in Table 5.13 and Statistical Appendix Table 87.

US$ million

movement of the value of the rupee against five major currencies; the US dollar, Euro, Pound sterling, Japanese yen and Indian rupee. The weights derived from relative importance of trading currencies to Sri Lanka in terms of both exports and imports have been normalised in computing 5-currency NEER and REER indices. Similarly, the 24-currency NEER and REER indices are now being computed with some new trading partners reflecting recent developments in the external sector. Accordingly, from the 2006 basket of countries, Denmark, the Philippines, South Africa and Sweden have been replaced by Australia, Pakistan, Russia and Turkey in creating the 2010 basket of countries, based on the importance of trade with those countries. The computational methodology

Fiscal Policy and GOVERNMENT FINANCE

6.1 Overview

iscal operations improved significantly in 2010 with revenue performance exceeding expectations and expenditure being contained within the budgetary allocations. The pickup in domestic economic activity and the gradual recovery in international trade contributed to the turnaround in revenue collection during the year. In addition, measures were taken to rationalise recurrent expenditure, while directing capital expenditure to strategic infrastructure development programmes in line with the governmentâ&#x20AC;&#x2122;s commitment to sustaining a high growth momentum and encouraging more inclusive growth through several regional development programmes. In view of the Presidential and Parliamentary elections held in early 2010, there was a delay in presenting the budget for 2010. During the period January to April 2010, fiscal operations were conducted under a Vote on Account framework. Fiscal operations for the period May to July 2010 were conducted under the provisions

of Section 3 of Article 150 of the Constitution by a Presidential decree. The budget for 2010 was presented to Parliament in June 2010 and was approved in July 2010. Despite the delay in presenting the budget for 2010 and the limited scope for introducing new revenue and expenditure measures, the overall fiscal deficit was maintained within the original budgetary target of 8 per cent of GDP. Improved investor confidence and favourable conditions in international financial markets enabled the government to raise funds from external sources to finance the fiscal deficit, thus reducing the domestic borrowing requirement. The government was able to raise funds through the issue of a ten year international sovereign bond at a competitive rate and by issuing Sri Lanka Development Bonds (SLDBs) with longer maturities and low yield margins, while continuing to secure foreign investments in government securities. Particularly noteworthy during the year was the reduced reliance on bank financing

Central Bank of Sri Lanka Annual Report - 2010

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

6 1

to bridge the governmentâ&#x20AC;&#x2122;s resource gap. The reduced financing requirement of the government from domestic sources significantly eased the pressure on domestic interest rates, while making available more funds to the private sector.

6.2. Fiscal Policy Direction and Measures The focus of fiscal policy in 2010 continued to be on achieving a sustainable fiscal deficit and reducing the public debt burden, while maintaining expenditure on public investment at a level that would support high economic growth. Fiscal operations during the first four months of the year were conducted under a Vote on Account framework and in the following three months under a Presidential decree, until the budget for 2010 was approved in Parliament in July 2010. The delay in presenting the budget for 2010, limited the scope for introducing new fiscal measures during the year. Despite the delay in presenting the budget for 2010, the government took several measures to simplify the tax system and improve revenue generation from taxes. The tariff structure was simplified by abolishing some taxes, such as the import duty surcharge of 15 per cent and the Regional Infrastructure Development Levy (RIDL) and by reducing the number of customs duty bands from five (0, 2.5, 6, 15 and 28 per cent) to four (0, 5, 15 and 30 per cent). The significant reduction in taxes on certain categories of imports, including motor vehicles and consumer durables, and the sharp rise in those imports, reflecting the pent up demand, increased the revenue generated from taxes on imports substantially. The government revised several taxes to mitigate the impact of rising international commodity prices on the domestic market. A full customs duty waiver was granted on the import of petrol and diesel at the beginning of the year due to rising crude oil prices in international markets. Customs duties were subsequently reapplied at reduced rates in November 2010 when international crude oil prices declined. In addition, the import or 130

supply of petrol was exempted from Value Added Taxes (VAT) in November 2010 to prevent an increase in domestic fuel prices. Customs duty waivers were granted on the import of milk powder and certain categories of edible oils to reduce the impact of rising international prices. Customs duties on the import of wheat grain were also revised during the year to stabilise the consumer and producer price of staple foods. A customs duty waiver was also granted on the importation of maize in order to support domestic animal feed production. Further, the Special Commodity Levy (SCL) applied on the import of selected food items was also revised periodically during the year to stabilise prices in the domestic market. In addition, the excise duty on LP gas was revised several times during the year to mitigate the impact of fluctuating international prices on domestic prices. All taxes relating to the import of eggs, egg yolk and chicks for breeding and other purposes were removed, while taxes on the importation of meat of fowls were either entirely removed or reduced to address supply shortages in the domestic market. Several taxes were revised during the year to support selected industries. Imports of certain categories of machinery and equipment for the leather and footwear industry, high-tech medical, laboratory and educational equipment, agricultural machinery and parts, electrical equipment, and high-tech equipment for use in the telecommunication industry were exempted from VAT. The customs duty of 2.5 per cent, which was mostly applied on the importation of raw materials and machinery was abolished to support domestic industries that were adversely affected by the global economic and financial crisis. In addition, all taxes and levies relating to the importation of gold have been removed to promote the jewellery industry. Further, several taxes were removed on imports of electrical items and parts of these electrical items in order to promote Sri Lanka as an international shopping destination. The Presidential Commission on Taxation submitted its report to the President in October 2010, making several recommendations

Central Bank of Sri Lanka Annual Report - 2010

Emphasis continued to be placed on the need to modernise Sri Lankaâ&#x20AC;&#x2122;s revenue administration and expenditure management to create fiscal space to support the governmentâ&#x20AC;&#x2122;s public investment programme. The Fiscal Management Efficiency Project (FMEP) which aims at a comprehensive Fiscal Management Reform Programme (FMRP) to enhance revenue collection and improve expenditure management continued in 2010. Modernising revenue administration processes by introducing and upgrading the information technology systems in the revenue collection departments was a key component of this project. An integrated treasury management information system is being set up to improve the financial management of line ministries, spending agencies and other public sector institutions. As part of the programme to build and strengthen the financial management capacity of the public sector, an Academy of Financial Studies has been set up to enhance the skills of officers in the Ministry of Finance and Planning, including officers in the revenue collecting agencies. Concerted efforts to manage the operational expenditure of the government and strict monitoring helped contain recurrent expenditure within the original budgetary allocations. Due to the delay in presenting the budget for 2010, expenditure in the first seven

months of 2010 was based on the allocations for 2009. The reformulation of duties and functions of ministries was a major initiative taken by the government to encourage ministries to focus on their core objectives and to restrict expenditure within their budgetary allocations. Co-ordination of policy implementation was strengthened, while expertise from the private sector was introduced into public sector institutions to improve the performance of these institutions. A Cabinet Sub Committee was appointed to make necessary recommendations to simplify administrative and regulatory procedures, practices and related laws with a view to creating a more modern and efficient administrative system. In addition, all line ministries were requested to identify areas which could be opened to the private sector with a view to enhancing the productive use of idle assets. The public investment programme was directed at accelerating several strategic infrastructure projects to support high growth, while allocating funds to develop rural infrastructure to ensure a more regionally balanced development. To facilitate this growth, several large scale irrigation projects, such as the Moragahakanda and Kaluganga Development Project, river diversions, such as Gin/Nilwala Diversion Project, power projects, such as the Upper Kotmale Hydro Power Project, road sector development projects, such as the Southern Expressway, the Colombo-Katunayake Expressway, the Outer Circular Highway and the Colombo-Kandy Highway as well as port development projects, such as the South Colombo Harbour Development Project, the Hambantota Port Development Project (Phase II), the Oluvil Port Development Project and the Galle Port Development Project are currently underway. In addition, the government initiated several regional development programmes in each of the provinces to address rural urban imbalances. Two regional programmes, 'Negenahira Navodaya' and 'Uthuru Wasanthaya' in the Northern and the Eastern provinces, respectively were continued in 2010 to expedite

131

6 Fiscal Policy and gOVERNMENT FINANCE

regarding the rationalisation of the tax system. The mandate of the Commission was to design a buoyant tax system that would facilitate accelerated economic growth, while addressing the decline in the tax to GDP ratio that has been observed in the last two decades. This decline in revenue collection and the greater involvement of the government in development and social welfare programmes necessitated revenue buoyancy measures. In order to achieve the above targets, the commission examined various taxes collected at different levels of government and proposed measures to broaden the tax base and simplify the tax system, while recommending various administrative improvements in the revenue collecting agencies.

Central Bank of Sri Lanka Annual Report - 2010

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

6 1

rehabilitation and reconstruction activities. Special projects have been implemented under these programmes to re-establish civil administration, to redevelop infrastructure facilities and to restore the livelihoods of the people in conflict affected areas. The governmentâ&#x20AC;&#x2122;s strategy to reform state owned enterprises (SOEs) has been to focus on improving the management and efficiency of these entities so that they would become commercially viable and financially independent. The Ministry of Public Management Reforms was established in 2010 to modernise public management, while the Ministry of State Resources and Enterprise Development was set up to address the issues of underperforming and loss making SOEs. State enterprises are being re-engineered to generate surpluses by utilising their resources to the optimum level, thus reducing dependence on the national budget. SOEs are also being encouraged to explore Public Private Partnerships (PPPs), while small scale SOEs that are not viable are being merged or amalgamated to create commercially viable entities. SOEs will continue to operate in areas of strategic importance and to engage in operations which would not be undertaken by the private sector due to their scale, risk or technological complexity. Although social considerations may necessitate the provision of some services that have economic and social benefits to the country but may not necessarily be financially beneficial to the enterprise, it is important to ensure that these services are properly targeted, so that the burden on the national budget is minimised. The government resorted to low cost external borrowings during the year taking advantage of the favourable conditions prevailing in international financial markets and the improved investor confidence. A third international sovereign bond of US dollars 1 billion with a coupon rate of 6.25 per cent was successfully issued in October 2010. The issue attracted an order book of more than six times the value of the bond, reflecting the improved investor confidence. 132

The proceeds from the bond issue were used to repay some high cost domestic borrowings. Foreign investments in government securities continued up to the maximum limit allowed for non residents of 10 per cent of the total outstanding stock of Treasury bills and Treasury bonds. Consequently, external sources became the dominant source of deficit financing in 2010. In Summary of Government Fiscal Operations

Table 6.1

2011

2010

2009

Item

Approved Estimates

Provi- Approved sional Estimates

Rs. million Total revenue and grants Total revenue Tax revenue Non tax revenue Grants

725,566 699,644 618,933 80,711 25,922

840,716 817,516 728,744 88,772 23,200

835,129 818,220 725,671 92,549 16,909

985,920 963,320 861,943 101,377 22,600

Expenditure and lending minus repayments Current Capital and net lending o/w Public investment

1,201,927 1,279,553 1,280,205 1,419,664 879,575 928,339 937,094 1,017,155 322,352 351,214 343,111 402,509 330,448 361,214 356,519 413,546

Current account surplus (+)/deficit (-) -179,931 -110,824 -118,874 -53,835 Primary account surplus (+)/deficit (-) -166,686 -101,630 -92,485 -79,816 Overall budget surplus (+)/deficit (-) -476,361 -438,837 -445,076 -433,744 Total financing Foreign financing (a) Domestic financing Market borrowings Non bank Bank Monetary Authority Commercial banks Non-market borrowings

476,361 230,807 245,554 234,274 185,247 49,027 -109,241 158,268 11,280

438,837 158,000 280,837 280,837 235,837 45,000 n.a. n.a. -

445,076 243,788 201,288 191,999 193,891 -1,892 -32,112 30,220 9,289

433,744 143,750 289,994 289,994 247,994 42,000 n.a. n.a. -

As a percentage of GDP Total revenue and grants Total revenue Tax revenue Non tax revenue Grants Expenditure and lending minus repayments Current Capital and net lending o/w Public investment

15.0 14.5 12.8 1.7 0.5

15.3 14.9 13.3 1.6 0.4

14.9 14.6 13.0 1.7 0.3

15.6 15.2 13.6 1.6 0.4

24.9 18.2 6.7 6.8

23.3 16.9 6.4 6.6

22.9 16.7 6.1 6.4

22.4 16.1 6.4 6.5

Current account surplus (+)/deficit (-) Primary account surplus (+)/deficit (-) Overall budget surplus (+)/deficit (-)

-3.7 -3.5 -9.9

-2.0 -1.8 -8.0

-2.1 -1.7 -7.9

-0.8 -1.3 -6.8

Total financing Foreign financing (a) Domestic financing Market borrowings Non bank Bank Monetary Authority Commercial banks Non-market borrowings

9.9 4.8 5.1 4.9 3.8 1.0 -2.3 3.3 0.2

8.0 2.9 5.1 5.1 4.3 0.8 n.a. n.a. -

7.9 4.4 3.6 3.4 3.5 ... -0.6 0.5 0.2

6.8 2.3 4.6 4.6 3.9 0.7 n.a. n.a. -

(a) Includes rupee denominated Treasury bonds and Treasury bills issued to foreign investors, the Sri Lankan diaspora and migrant workers.

Source: Ministry of Finance and Planning

Central Bank of Sri Lanka Annual Report - 2010

The improved macroeconomic environment and improved investor confidence were also reflected in the sovereign ratings assigned by the three rating agencies. Standard and Poor’s upgraded Sri Lanka’s long term foreign currency sovereign rating to B+ with stable outlook, while Fitch affirmed Sri Lanka’s long term foreign currency rating of B+, while upgrading the outlook to positive. Moody’s Investor Service assigned a B1 foreign currency issuer rating with a stable outlook. A Sovereign Rating Committee (SRC) with representatives from the government and the private sector was appointed to operationalise the strategy to upgrade the country’s rating to an investment grade of BBBby 2014. In order to facilitate this process, three Sovereign Rating Advisors (SRAs) were appointed to strengthen the co-ordination between the authorities and the rating agencies.

6.3 Government Budgetary Operations Revenue and Grants Revenue Total government revenue collection in 2010 improved substantially with the picking up of domestic economic activity and the gradual rebounding of external trade. In nominal terms, total revenue increased by 16.9 per cent to Rs. 818.2 billion in 2010 and exceeded the original budgetary estimate of Rs. 817.5 billion, while as a percentage of GDP, total revenue increased to 14.6 per cent in 2010 from 14.5 per cent in 2009. The declining trend observed in the revenue to GDP ratio during the last three years was reversed in 2010 with a higher mobilisation of both tax and non tax revenue. Tax revenue as a percentage of GDP increased to 13 per cent from 12.8 per cent in 2009. The improved performance in tax revenue collection was mainly due to an increase in revenue collection from VAT, Nation Building Tax (NBT) and

Chart 6.1 6.2

Composition of Government Revenue - 2010 Tax Revenue 89%

VAT 27%

Profits and Dividends 4%

Other Taxes 21% Other 3% Income Taxes 17% Fees and Charges 3%

Excise Duties 16% Import Duties 8%

Interest Income 1% Non Tax Revenue 11%

the Port and Airport Development Levy (PAL), as well as from higher revenue collection from excise taxes. Non tax revenue as a percentage of GDP remained at 1.7 per cent, although in nominal terms it increased by 14.7 per cent to Rs. 92.5 billion in 2010 due to higher transfer of profits and dividends from public institutions. Tax revenue collection in 2010 amounted to Rs. 725.7 billion, an increase of 17.2 per cent over the previous year. The share of tax collection in total revenue remained at 89 per cent in 2010 as in 2009. The main source of tax revenue collection was consumption based taxes accounting for 81.3 per cent of total tax collection. The proportion of taxes from international trade was 39.4 per cent, Table 6.2

Economic Classification of Revenue 2009

2010

Item

Approved Estimates

2011 Provisional

Approved Estimates

Rs. million Tax revenue Income taxes VAT Excise taxes Import duties Other taxes Non tax revenue Total revenue

618,933 139,558 171,510 97,604 79,560 130,701 80,711

728,744 160,344 206,750 120,768 84,837 156,045 88,772

725,671 135,623 220,168 129,749 64,369 175,763 92,549

861,943 154,883 238,390 152,250 92,803 223,617 101,377

699,644

817,516

818,220 963,320

As a percentage of GDP

Tax revenue Income taxes VAT Excise taxes Import duties Other taxes Non tax revenue

12.8 2.9 3.6 2.0 1.6 2.7 1.7

13.3 2.9 3.8 2.2 1.5 2.8 1.6

13.0 2.4 3.9 2.3 1.1 3.1 1.7

13.6 2.4 3.8 2.4 1.5 3.5 1.6

Total revenue

14.5

14.9

14.6

15.2

Source: Ministry of Finance and Planning

133

6 Fiscal Policy and gOVERNMENT FINANCE

addition, SLDBs were issued with longer maturities and lower yield margins taking advantage of the positive investor sentiment.

Central Bank of Sri Lanka Annual Report - 2010

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

6 1

while the share of taxes from domestic goods and services was 41.9 per cent. Revenue from income taxes as a percentage of GDP declined to 2.4 per cent in 2010 from 2.9 per cent in 2009 as a result of the sharp decline in the withholding taxes on interest income. Revenue from withholding taxes declined as a percentage of GDP to 0.5 per cent in 2010 from 0.9 per cent in 2009 and in nominal terms by 34 per cent to Rs. 29.4 billion in 2010, mainly due to the reduction in interest rates in 2010. Consequently, the share of income taxes in total taxes declined to 18.7 per cent in 2010 from 22.5 per cent in 2009. Revenue collection from corporate income tax increased by 12.7 per cent to Rs. 75.2 billion in 2010, although as a percentage of GDP it declined marginally to 1.3 per cent in 2010. Higher tax payments by the banking sector, which accounted for around 24 per cent of total corporate income taxes, mainly contributed to the increase in corporate tax revenue. Non corporate tax also increased by 9.8 per cent to Rs. 31 billion in 2010, maintaining the ratio of non corporate tax as a percentage of GDP at 0.6 per cent as in 2009. The increase in corporate and non corporate tax revenue was mainly due to the pickup in domestic economic activity as well as the efforts taken to broaden the tax base and to improve tax compliance. Revenue collection from VAT as a percentage of GDP increased to 3.9 per cent in 2010 from 3.6 per cent in 2009 due to the rebound of domestic economic activity and higher imports. In nominal terms, revenue from VAT increased by 28.4 per cent to Rs. 220.2 billion in 2010 exceeding the budgetary estimate of Rs. 206.8 billion. Consequently, the share of VAT in total tax revenue increased to 30.3 per cent in 2010 from 27.7 per cent in 2009. Revenue collection from VAT on imports increased by 47.5 per cent to Rs. 99.8 billion as a result of a sharp increase in imports, including the import of motor vehicles and petroleum products. VAT on domestic goods and services increased by 15.9 per cent to Rs. 120.4 billion in 2010 as a result of higher 134

domestic economic activity. The main sources of VAT from domestic goods and services were tobacco and alcohol, telecommunication services and insurance. Excise duty collection as a percentage of GDP increased to 2.3 per cent in 2010 from 2 per cent mainly due to the higher revenue generated from excise taxes on imports of motor vehicles. In nominal terms, revenue from excise taxes increased by 32.9 per cent to Rs. 129.7 billion exceeding the budgetary target for 2010 of Rs. 120.8 billion. The share of excise taxes in total tax revenue also increased to 17.9 per cent in 2010 from 15.8 per cent in 2009. Revenue from excise duties on motor vehicles increased significantly to Rs. 21.2 billion from Rs. 3.2 billion in 2009 as a result of a sharp rise in motor vehicle imports during the year. Revenue from excise duties on liquor increased by 28.5 per cent to Rs. 36.6 billion due to the periodic scaling up of excise duty rates (around 35 per cent in 2010) and the increase in hard and malt liquor production by 20 per cent and 28.6 per cent, respectively during the year. Revenue collection from excise duties on cigarettes increased by 8.2 per cent to Rs. 40.7 billion during the year over 2009, due to the upward revision of excise tax rates by around 18 per cent and an increase in cigarette sales by 2.1 per cent with the opening of new markets in the Northern and Eastern provinces. Revenue collection from excise duties on petroleum increased by 21.8 per cent to Rs. 28 billion mainly on account of the increase in the volume of petroleum imports during the year. Revenue collection from import duties and the SCL as a percentage of GDP declined sharply to 1.3 per cent in 2010 from 2 per cent in 2009 due to the reduction in import duties and the granting of duty concessions on several items. Revenue from import duties declined by 19.1 per cent in 2010 to Rs. 64.4 billion (1.1 per cent of GDP), with the share of import duties in total tax revenue falling to 8.9 per cent in 2010 from 12.9 per cent in 2009. The removal of the import duty surcharge of 15 per cent at the beginning

Central Bank of Sri Lanka Annual Report - 2010

Revenue collection from NBT and PAL increased significantly, while revenue collection from Cess levies increased only marginally. NBT collection as a percentage of GDP increased to 0.8 per cent in 2010 from 0.6 per cent in 2009 mainly due to the recovery of imports and the increase in turnover from manufacturing and services in 2010. In nominal terms, revenue from NBT increased significantly by 69.4 per cent to Rs. 46.1 billion in 2010. This was due to the full impact of the upward revision of the NBT rate to 3 per cent in May 2009 and the significant increase in the turnover from imports, manufacturing and services. Revenue from PAL increased as a percentage of GDP to 0.9 per cent in 2010 from 0.8 per cent in 2009 and in nominal terms by 36.8 per cent to Rs. 49.7 billion in 2010 mainly as a result of higher imports. Revenue collection from Cess levies as a percentage of GDP declined marginally to 0.5 per cent in 2010 from 0.6 per cent in 2009, although in nominal terms it increased by 3.5 per cent to Rs. 27.9 billion in 2010. This was mainly due to the removal of the Cess levied on selected imports and the reduction in the Cess levy on imports of raw materials for the construction sector, including cement.

Non tax revenue increased by 14.7 per cent over 2009 to Rs. 92.5 billion in 2010, mainly due to an increase in the transfer of profits and dividends from public institutions. Non tax revenue from profits and dividends increased by 44.7 per cent in 2010 compared to 2009, increasing the share of profits and dividends in total non tax revenue to 50 per cent in 2010 from 39.6 per cent in 2009. Interest income declined by 11.3 per cent to Rs. 8 billion in 2010 due to the low interest rates that prevailed in 2010.

Grants Continuing the declining trend, foreign grant receipts fell by 34.8 per cent to Rs.16.9 billion in 2010. The gradual move of Sri Lanka towards middle income country status and the lower grant receipts from European countries due to the fiscal problems in many of those countries contributed to the decline in foreign grants in 2010. Foreign grants were mainly from multilateral donors, accounting for 67.1 per cent of total grant receipts in 2010.

Expenditure and Net Lending Total expenditure and net lending declined to 22.9 per cent of GDP in 2010 from 24.9 per cent of GDP in 2009 due to the efforts by the government to curtail recurrent expenditure, while maintaining capital expenditure at the desired level. The reduction of total expenditure and net lending by 2 percentage points was the combined outcome of a reduction in recurrent expenditure by 1.5 percentage points and capital expenditure and net lending by 0.5 percentage points. However, in nominal terms total expenditure and net lending increased by 6.5 per cent to Rs. 1,280.2 billion in 2010. Recurrent expenditure, as a percentage of GDP declined significantly to 16.7 per cent in 2010 from 18.2 per cent in 2009, reflecting the governmentâ&#x20AC;&#x2122;s effort to rationalise recurrent expenditure. In nominal terms, recurrent expenditure increased by 6.5 per cent to Rs. 937.1 billion in 2010 due to an increase in salaries and wages, pension payments and interest payments. 135

6 Fiscal Policy and gOVERNMENT FINANCE

of 2010, the full customs duty waiver on petrol and diesel effective throughout the year and the customs duty waiver on wheat grain during the first half of the year, as well as the reduction of taxes on the import of milk powder were the main reasons for the decline in import duty collection during the year. Revenue from the SCL declined sharply by 46.4 per cent to Rs. 10.2 billion in 2010 reducing the share of the SCL in total tax revenue to 1.4 per cent in 2010 from 3.1 per cent in 2009. The removal of the SCL on rice during the first quarter of the year and the reduction of the SCL on big onions and potatoes during the latter part of the year were the main reasons for the decline in revenue collection from SCL. The average customs duty rate, including SCL, declined to 5 per cent in 2010 from 7.8 per cent in 2009, reflecting the reduction in customs duties, the granting of customs duty waivers, the removal of the import duty surcharge, and the zero rate applied on imports under trade agreements with India and Pakistan as well as the revisions to SCL during the year.

Central Bank of Sri Lanka Annual Report - 2010

6 1

Table 6.3

Economic Classification of Expenditure and Lending Minus Repayments 2009

Item

2010 Approved Estimates

2011 Provisional

Approved Estimates

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

Rs. million Current expenditure Expenditure on goods and services o/w Salaries and wages Interest payments Foreign Domestic Current transfers and subsidies o/w To households and other sectors Samurdhi Pensions Fertiliser subsidy Other Capital expenditure Acquisition of real assets Capital transfers Provision for under expenditure Lending minus repayments

879,575 928,339 379,731 388,246 271,229 296,710 309,675 337,207 35,698 40,480 273,978 296,727 190,168 202,886 148,993 160,561 9,267 9,300 85,139 93,000 26,935 30,000 27,652 28,261 277,416 304,307 143,590 170,249 133,826 143,482 - -9,424 44,936 46,907

937,094 1,017,155 388,286 455,686 300,558 344,023 352,592 353,928 55,464 44,528 297,127 309,400 196,216 207,541 156,194 165,182 9,241 9,300 90,995 98,000 26,028 20,000 29,931 37,882 302,087 351,899 158,488 199,579 143,599 168,975 - -16,654 41,025 50,609

Total expenditure and net lending 1,201,927 1,279,553 1,280,205 1,419,663 As a percentage of GDP Current expenditure 18.2 16.9 Expenditure on goods and services 7.9 7.1 o/w Salaries and wages 5.6 5.4 Interest payments 6.4 6.1 Foreign 0.7 0.7 Domestic 5.7 5.4 Current transfers and subsidies 3.9 3.7 o/w To households and other sectors 3.1 2.9 Samurdhi 0.2 0.2 Pensions 1.8 1.7 Fertiliser subsidy 0.6 0.5 Other 0.6 0.5 Capital expenditure 5.7 5.5 Acquisition of real assets 3.0 3.1 Capital transfers 2.8 2.6 Provision for under expenditure - -0.2 Lending minus repayments 0.9 0.9

16.7 6.9 5.4 6.3 1.0 5.3 3.5 2.8 0.2 1.6 0.5 0.5 5.4 2.8 2.6 - 0.7

16.1 7.2 5.4 5.6 0.7 4.9 3.3 2.6 0.1 1.5 0.3 0.6 5.6 3.1 2.7 -0.3 0.8

Total expenditure and net lending

22.9

22.4

24.9

23.3

Source: Ministry of Finance and Planning

The reduction in defence related procurement expenditure helped restrict the nominal increase in recurrent expenditure to the minimum. Composition of Government Current Expenditure - 2010

Chart 6.2 6.3

Interest Payments 38%

Transfers to Households 17 %

Public Institutions and Corporations 4% Pensions 10%

Other 3% Other Goods and Services 9%

Fertiliser Subsidy 3% Samurdhi 1% Salaries 32%

136

Expenditure on salaries and wages for public servants including those attached to the provincial councils increased by 10.8 per cent to Rs. 300.6 billion in 2010. However, as a percentage of GDP it declined to 5.4 per cent in 2010 from 5.6 per cent in 2009. The share of salaries and wages in total recurrent expenditure was 32 per cent in 2010, marginally higher than 31 per cent in 2009. The increase in the monthly cost of living allowance (COLA) of public sector employees by Rs.750 to Rs. 5,250 with effect from January 2010, the special payment of Rs. 1,000 per month for security personnel and the extension of the operational risk allowance to all security personnel with effect from November 2009, contributed to the nominal increase in salaries and wages in 2010. Although in nominal terms interest expenditure increased by 13.9 per cent to Rs. 352.6 billion in 2010, this was significantly lower than the increase of 45.7 per cent recorded in 2009. Consequently, interest expenditure as a percentage of GDP declined to 6.3 per cent in 2010 from 6.4 per cent in the previous year. The declining yield rates on government securities coupled with initiatives taken by the government to restructure its debt stock by shifting from high cost domestic debt to low cost foreign debt helped contain interest expenditure during the year. Interest payments on domestic debt increased by 8.4 per cent to Rs. 297.1 billion in 2010 due to the increase in the outstanding domestic debt stock by 12 per cent in 2009, although the average interest rate on domestic debt declined to 12.4 per cent in 2010 from 12.8 per cent in the previous year. Interest payments on domestic debt accounted for 84 per cent of total interest payments. Meanwhile, interest payments on foreign debt increased by 55.4 per cent to Rs. 55.5 billion in 2010. This was due to the increase in the foreign debt stock by 22 per cent in 2009 and the increase in the average interest rate on foreign debt to 3.2 per cent in 2010 from 2.5 per cent in the previous year, on account of the higher share of foreign commercial debt in the total foreign debt stock in 2009.

Central Bank of Sri Lanka Annual Report - 2010

2010

2009

Item

Approved Estimates

2011 Provisional

Approved Estimates

Rs. million Current expenditure General public services Civil administration Defence Public order and safety Social services Education Health Welfare Community services Economic services Agriculture and irrigation Energy and water supply Transport and communication Other Other o/w Interest payments

879,575 224,281 37,123 144,884 42,274 260,071 82,414 58,789 105,017 13,852 85,188 43,967 3,429 31,068 6,724 310,035 309,675

928,339 225,766 39,440 142,348 43,978 274,668 84,876 60,802 114,091 14,899 87,496 45,402 3,599 31,517 6,978 340,409 337,207

937,094 1,017,155 228,136 256,745 37,895 42,236 145,243 163,486 44,998 51,024 267,636 306,506 85,195 99,278 60,506 70,788 107,690 121,172 14,245 15,269 85,440 97,476 44,081 51,678 3,492 4,125 31,246 33,856 6,621 7,817 355,882 356,427 352,592 353,928

Capital expenditure and lending

330,448

361,213

356,519

413,546

General public services Civil administration Public order and safety Social services Education Health Housing Community services Economic services Agriculture and irrigation Energy and water supply Transport and communication Other Other Under expenditure

20,094 18,686 1,409 53,938 18,092 12,664 5,291 17,891 256,411 22,105 59,983 139,104 35,219 5 -

22,474 21,133 1,341 60,393 19,000 14,146 6,106 21,141 287,670 30,090 67,909 164,360 25,312 100 -9,424

21,510 20,212 1,298 56,205 19,053 13,329 5,489 18,334 278,803 24,865 66,569 165,505 21,804 1 -

24,897 23,657 1,240 69,122 21,129 16,939 9,237 21,817 335,721 40,521 75,537 182,781 36,881 460 -16,654

Total expenditure and lending

1,210,023 1,289,553 1,293,613 1,430,701

As a percentage of GDP Source: Ministry of Finance and Planning

General public services Social services Economic services Other o/w Interest payments Total expenditure and lending

5.1 6.5 7.1 6.4 6.4

4.5 6.1 6.8 6.2 6.1

4.5 5.8 6.5 6.4 6.3

4.4 5.9 6.8 5.6 5.6

25.1

23.5

23.1

22.6

account for 58 per cent of the transfers to households increased by 7 per cent to Rs. 91 billion in 2010 due to the increase in the monthly COLA to pensioners by Rs. 375 to Rs. 2,375 with effect from January 2010 and the addition of about 16,366 new pensioners during the year. The fertiliser subsidy (Rs. 26 billion), the Samurdhi programme (Rs. 9 billion), welfare programmes for disabled soldiers (Rs.10 billion) as well as programmes targeting school children such as providing free school text books and uniforms as well as the school nutritional food programme were the other major transfers to households by the government during the year. Current transfers to public institutions increased by 2.3 per cent to Rs. 27.7 billion in 2010, accounting for 14 per cent of total current transfers in 2010. Transfers to public institutions engaged in economic services and social services, especially in the areas of education, health and community services, increased, while transfers to public institutions engaged in civil administration declined marginally. Current transfers to public corporations declined by 12.5 per cent to Rs. 12.4 billion in 2010 and accounted for 6 per cent of the total current transfers in 2010. The reduction in the operating loss of the Department of Sri Lanka Railways as a result of the rationalisation of maintenance costs, mainly contributed to the decline in transfers to public corporations. Capital expenditure and net lending increased by 6.4 per cent to Rs. 343.1 billion in 2010, reflecting the governmentâ&#x20AC;&#x2122;s commitment Chart6.3 6.3

Source: Ministry of Finance and Planning

Current transfers and subsidies increased by 3.2 per cent to Rs. 196.2 billion in 2010 due to an increase in transfers to households and public institutions, although transfers to public corporations declined. As a percentage of GDP, current transfers and subsidies declined to 3.5 per cent in 2010 from 3.9 per cent in 2009. Current transfers to households, which account for 80 per cent of total current transfers in 2010 increased by 4.8 per cent to Rs. 156.2 billion. Pension payments, which

Total Expenditure by Function - 2010 Economic Services and Other 29%

General Public Services 19% Welfare 8%

Transport and Communication 15%

Education 8%

Energy and Water Supply 5% Agriculture and Irrigation 5%

Health 6% Housing and Community Services 3%

Other 4% Interest Payments 27%

Social Services 25%

137

6 Fiscal Policy and gOVERNMENT FINANCE

Functional Classification of Expenditure

Table 6.4

Central Bank of Sri Lanka Annual Report - 2010

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

6 1

to expediting infrastructure development projects. Public investment increased by 7.9 per cent to Rs. 356.5 billion in 2010, although as a percentage of GDP it declined to 6.4 per cent during the year compared to 6.8 per cent in 2009. Accordingly, the momentum gained in public investment in recent years continued as there was a strong commitment by the government to maintain expenditure on public investment considering its long term benefits to the national economy. Expenditure on the acquisition of real assets increased by 10.4 per cent to Rs. 158.5 billion in 2010, while capital transfers increased by 7.3 per cent to Rs. 143.6 billion in 2010 mainly due to the increase in transfers to public institutions (9.8 per cent). The public investment programme in 2010 was directed towards strategically important infrastructure development projects as well as projects to reduce the rural-urban divide. Public investment in economic services continued to be the main component of the government’s investment programme amounting to Rs. 278.8 billion in 2010, an 8.7 per cent increase compared to that of the previous year. This included investment in ports, transportation, communication, energy, water supply, agriculture and irrigation. The government’s policy is to give the highest priority to improving the road network in the country as it contributes to accelerated economic growth and balanced regional development, while opening up opportunities for national integration. Hence key public investment programmes in transportation, such as the Colombo-Katunayake Expressway, the Outer Circular Highway, the Southern Transport Development Project, the Trincomalee Integrated Infrastructure Project, the National Highway Sector Project, maintenance of roads and bridges programme and the 'Maga Neguma' Rural Road Development Programme were some of the projects carried out in 2010 to develop the road network. In line with the government’s policy to improve transport services, investments were made to extend and rehabilitate railway lines and purchase Diesel Multiple Units, locomotives and carriages to upgrade the railway system in the country. As part 138

of the government’s vision to position Sri Lanka as a naval/maritime hub, several significant investments were made in 2010 to develop the ports, such as the Hambantota Port Project and the Colombo South Harbour Development Project. Public investment in social services increased by 4.2 per cent to Rs. 56.2 billion in 2010, of which, Rs. 19.1 billion was on account of education, while Rs. 13.3 billion was in relation to expenditure on health related services. The investment in education was directed towards the improvement and rehabilitation of educational infrastructure, modernisation of secondary education, training and capacity building, developing identified schools, including the Defence Services School, improving relevance and quality of undergraduate education, and enhancing and upgrading advanced technological education. Public investment in the health sector was mainly directed towards hospital rehabilitation and development, health promotion and disease prevention, as well as controlling communicable and non communicable diseases. The government continued its commitment towards balanced regional development in 2010. Various development programmes were conducted under the Ministry of Economic Development in this regard. Expenditure on key public investment initiatives, such as the 'Gama Neguma' programme and infrastructure development programmes in lagging regions amounted to Rs. 13 billion and Rs. 8 billion, respectively. Further, identifying the uniqueness of each region, their diverse resources and potential, specific regional development initiatives were undertaken in each of the provinces in the country.

Key Fiscal Balances Reflecting the improvement in the fiscal sector the overall deficit declined to 7.9 per cent of GDP in 2010, within the original estimate of 8 per cent of GDP, and below the deficit of 9.9 per cent recorded in the previous year. Improvements in both revenue

Central Bank of Sri Lanka Annual Report - 2010 Major Fiscal Indicators (as a percentage of GDP)

6.4

100

-2

80 60

-6 40

-8

-10 -12

Per cent

-4

2006

2007

2008

Outstanding Debt (right axis) Primary Deficit (left axis)

2009

2010 Pro.

Current Account Deficit (left axis) Overall Deficit (left axis)

and expenditure contributed to this noteworthy achievement. Government revenue exceeded the target, while expenditure was maintained within the original budgetary allocation, narrowing the government’s resource gap and reducing the government’s financing requirement. The favourable developments in the fiscal sector were also reflected in other fiscal indicators. The current account deficit, which reflects government dis-savings, narrowed to 2.1 per cent of GDP in 2010 from 3.7 per cent of GDP in 2009, marginally above the targeted level of 2 per cent in the original budget estimate for 2010. Further, the primary deficit, which reflects the current fiscal deficit, as interest payments are determined by the size of previous fiscal deficits, declined to 1.7 per cent of GDP in 2010 from 3.5 per cent in the previous year and below the target of 1.8 per cent.

from the domestic market in 2010. Accordingly, foreign funds contributed around 55 per cent of the total financing requirement in 2010, while the balance was financed through domestic sources. Consequently, foreign financing amounted to Rs. 243.8 billion compared to the original estimate of Rs. 158 billion, while domestic financing amounted to Rs. 201.3 billion compared to the original estimate of Rs. 280.8 billion. Considering the composition of net domestic financing (NDF), the government relied almost entirely on non bank financing in 2010. Accordingly, total borrowings from the non bank sector were Rs. 203.2 billion compared to the original estimate of Rs. 235.8 billion and the borrowings of Rs. 196.5 billion from the non bank sector in 2009. There was a net repayment of Rs. 1.9 billion to the banking sector in 2010 compared to the original borrowing estimate of Rs. 45 billion, and the borrowing of Rs. 49 billion from the banking sector in 2009. The net repayment to the banking system in 2010 was the combined outcome of a repayment of Rs. 32.1 billion to the Central Bank and a net borrowing of Rs. 30.2 billion from commercial banks. The government was able to repay some of the high cost borrowings from the banking sector with the proceeds of the international sovereign bond issue. Accordingly, US dollar denominated borrowings from the OBU of the Bank of Ceylon (BOC)

Financing the Budget Deficit

Table 6.5

The greater availability of external resources to finance the fiscal deficit, reduced borrowings

Rs. billion

Deficit Financing (As a per cent of GDP)

Deficit Financing (as a percentage of GDP)

Chart 6.5

5 4

Per cent

Item By Instrument

3 2

Treasury bonds (a) Treasury bills (b) Rupee loans Sri Lanka Development Bonds Central Bank provisional advances Other

By Source

1 0 -1

Sources of Domestic Financing

2006

2007

2008

2009

2010 Pro.

-2

Domestic Non Bank & Other

Domestic Bank Borrowings

Foreign Loans

2007

2008

2009

2010 Provisional

127.7 314.3 245.6 52.8 192.4 201.9 37.1 69.8 49.0 10.3 -1.5 -17.7 23.6 65.5 7.6 11.7 15.6 -2.4 -7.8 -27.5 7.1 127.7 314.3 245.6 15.8 195.2 49.0 112.0 119.0 196.5

201.3 140.4 82.8 -24.6 11.1 4.0 -12.4 201.3 -1.9 203.2

Bank Non bank

(a) (b)

Sources: Ministry of Finance and Excludes rupee denominated Treasury bonds Planning issued to foreign investors since 2007 and to the Central Bank of Sri Lanka Sri Lankan diaspora and migrant workers since 2009. Excludes rupee denominated Treasury bills issued to foreign investors since 2008 and to the Sri Lankan diaspora and migrant workers since 2009.

139

6 Fiscal Policy and gOVERNMENT FINANCE

Chart Chart 6.4

Central Bank of Sri Lanka Annual Report - 2010

180

borrowing from OBUs during 2010. Accordingly, the net value of foreign currency denominated domestic borrowings during the year was Rs. 4.3 billion (US dollars 37.5 million).

130

Rs.bn

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

6 1

Sources of Bank Financing Chart 6.6 Sources of Bank Financing

80 30 -20 -70

-120

2006

2007

Central Bank

2008

2009

2010 P ro.

Commercial Banks

(Rs. 4.7 billion) and outstanding government import bills with the BOC (Rs. 8.6 billion) were repaid, while a part of the government’s outstanding overdraft with the two state commercial banks (Rs. 43.1 billion) was settled. In addition, the Central Bank’s holdings of Treasury bills amounting to Rs. 55.1 billion were retired with the proceeds from the international sovereign bond. The shift away from bank financing is a positive development as it reduces the inflationary impact of deficit financing. As part of the government’s borrowing strategy of moving towards more market oriented debt instruments for domestic financing, the government relied more on Treasury bills and Treasury bonds as in previous years. Accordingly, net borrowings by way of Treasury bills amounted to Rs. 82.8 billion and net borrowings by way of Treasury bonds amounted to Rs. 140.4 billion, while a net repayment of Rupee loans of Rs. 24.6 billion was recorded during the year. Borrowing from SLDBs amounted to Rs. 11.1 billion. There was a net repayment of Rs. 8.4 billion to other borrowing sources with the repayment of some short term high cost borrowings. Foreign currency denominated domestic borrowings increased in 2010, due to favourable investor sentiments, in contrast to the net repayment recorded in 2009. Gross borrowings from SLDBs were Rs. 71.2 billion (US dollars 628 million), while repayments amounted to Rs. 60.1 billion (US dollars 530 million). The government repaid Rs.6.8 billion (US dollars 60.5 million) of borrowing to OBUs, while there was no new 140

The contribution of foreign sources to finance the budget deficit increased to 55 per cent in 2010 from 48 per cent in 2009. Accordingly, total gross borrowings from external sources amounted to Rs. 328 billion (US dollars 2,913 million), while total net foreign financing was Rs. 244 billion in 2010. Of the total gross borrowings 17.8 per cent (Rs. 58.4 billion) was on concessional terms compared to 21.7 per cent (Rs. 77 billion) in the previous year, while the balance was obtained on non concessional terms. The funds raised from the international sovereign bond issue was Rs. 112 billion (US dollars 1,000 million), while gross financing from foreign investments in Treasury bills and Treasury bonds amounted to Rs. 15.8 billion (US dollars 140 million) and Rs. 36.2 billion (US dollars 320 million), respectively. Project loans received from bilateral and multilateral development partners accounted for 50 per cent of total foreign financing. The Asian Development Bank (ADB), Japan and China were the major sources of project financing. The increase in foreign financing helped reduce the pressure on the domestic market arising from budgetary financing and increase the resources available to the private sector.

6.4 Budgetary Operations in Sub National Governments Policy Direction and Measures of Sub National Governments The Ministry of Local Government and Provincial Councils continued to work in close coordination with the sub national governments in 2010. The Sub National Government (SNG) system in Sri Lanka consists of Provincial Councils (PCs) and Local Governments (LGs). There are nine PCs established under the 13th Amendment to the Constitution. As at end 2010, the LG system constituted 330 institutions, which were made up

Central Bank of Sri Lanka Annual Report - 2010

In line with the objective of providing guidance and support to PCs and LGs, the Ministry of Local Government and Provincial Councils implemented various programmes in PCs and LGs in 2010 covering areas of management, development and reform. Drafting amendments to legislation governing local government, presenting a Local Authorities Election Ordinance to Parliament, initiating programmes to improve provincial and local government administration, enhancing infrastructure in the provinces, providing legal support, promoting services, such as solid waste management, antidengue campaigns and fire and rescue services were some of the initiatives taken by the Ministry of Local Government and Provincial Councils during the year. Further special assistance was extended to backward local authorities in the areas of finance, management and institutional support. Road sector development was the key area facilitated by the Ministry of Local Government and Provincial Councils in 2010. In addition to providing assistance to major road sector development projects, the Ministry initiated a special project to prepare detailed designs and to obtain the required funding for provincial road development. Further, small and medium scale city development projects were carried out in 2010 with the technical and advisory support from the Urban Development Authority (UDA) and Sri Lanka Land Reclamation and Development Corporation. The Sri Lanka Institute of Local Governance continued to engage in programmes to strengthen local authorities in 2010 by developing human resources required for enhancing efficiency and ensuring good governance of local authorities. The Finance Commission continued its operations in 2010 with a close dialogue with

PCs and other stakeholders with the objective of achieving a balanced regional development. The Finance Commission has initiated an institutional capacity development programme in 2010 to implement Results Based Planning and Monitoring within the Provincial Councils with a view to integrating the National Policy Framework into the provincial development plans. The necessary guidelines were issued during the year to implement this system. LGs continued their operations as important institutions of governance in the country impacting the lives of people at the grass roots level. The revenue sources of LGs include income from assessment rates, licence fees, taxes on businesses, assigned revenue (stamp duty and court fines), and Central Government transfers. PCs worked as the agent for LGs in collecting the two sources of devolved revenue, namely stamp duty and court fines, as assigned under the 13th Amendment to the Constitution. The outlays of LGs comprised personal emoluments, other current expenses and capital expenses. The revenue structure of the PCs was changed from January 2011. The turnover tax, which was imposed on wholesale and retail trade and collected by the PCs, was abolished and the coverage of the NBT was widened to cover those activities. One third of the revenue collected from the NBT by the Central Government will be transferred to the Provincial Councilsâ&#x20AC;&#x2122; revenue account. In addition, the entire stamp duty collected and 70 per cent of the total revenue generated from motor vehicle registration fees will be transferred to this account.

Budgetary Operations in Provincial Councils The overall budgetary performance of PCs in 2010 improved compared to the previous year. Total revenue collection of PCs increased by 24 per cent to Rs. 36.5 billion in 2010. Revenue from turnover taxes, licence fees and stamp duties increased due to the recovery in domestic economic activity. As in previous years, the 141

6 Fiscal Policy and gOVERNMENT FINANCE

of 18 Municipal Councils (MCs), 42 Urban Councils (UCs) and 270 Pradesheeya Sabhas (PSs). As in previous years, grants were provided by the Central Government on the recommendation of the Finance Commission to meet the budgetary requirements of the SNGs.

Central Bank of Sri Lanka Annual Report - 2010

Table 6.6

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

6 1

Budget Outturn for Provincial Councils Rs. million

Item

2007

2008

2009

2010 Provisional

Total revenue

25,868

31,368 29,433

36,474

21,473 4,395

25,992 5,376

24,907 4,526

30,825 5,650

Tax revenue Non tax revenue

Total expenditure

113,067 120,011 130,260

140,531

Current expenditure o/w Personal emoluments Capital expenditure

92,721 103,199 111,336 74,711 79,717 86,547 20,346 16,812 18,924

116,843 91,433 23,688

Central government transfers

88,317

88,942 93,999

107,032

Block grants 70,742 Criteria based grants 1,208 Matching grants 205 PSDGs (a) 6,995 Foreign grants for special projects 9,167

76,773 77,386 2,304 2,276 - - 7,262 10,945 2,603 3,393

85,299 2,612 11,683 7,439

(a) Province Specific Development Grants

Sources: Ministry of Local Government and Provincial Councils Central Bank of Sri Lanka

Western Provincial Council continued to be the major contributor to the revenue collection of PCs accounting for 63 per cent of the total revenue collection of PCs in 2010. The Western Province was followed by the Southern, the Central and the North Western provinces each accounting for around 8 per cent of the total revenue collection. Recurrent expenditure of PCs increased by 5 per cent to Rs. 116.8 billion in 2010. The increase in recurrent expenditure was mainly due to the increase in personal emoluments as a result of the increase in the COLA of public sector employees at the beginning of the year. Personal emoluments accounted for 78 per cent of the total recurrent expenditure of PCs in 2010, with salaries and wages in the education and health sectors accounting for a large proportion of this expenditure. The balance recurrent expenditure was on account of other expenses in relation to the purchase of goods and services. The total capital expenditure of PCs increased by 25 per cent to Rs. 23.7 billion in 2010. The investment programmes of PCs mainly consisted of Province Specific Development Projects (PSDPs), foreign funded special projects and projects funded by Criteria Based Grants (CBGs). A special programme named Regional Development Initiatives under PSDGs was carried out in 2010 with the objective of enhancing 142

economic growth in the provinces with greater public private partnership. Under this programme the Sabaragamuwa Provincial Council has initiated the Ma-Oya Area Development Project, which aims to develop the area around the Pinnawala Elephant Orphanage and to develop agriculture and livestock activity in the project area. Provinces were also provided with donor funding from international development agencies, such as the Asian Development Bank (ADB), the Japan International Cooperation Agency (JICA) and the World Bank to develop rural roads and improve community livelihood in 2010, in addition to the funds allocated under PSDGs for such activities. In 2010, Central Government transfers to PCs increased by 14 per cent to Rs. 107 billion. These transfers were in the form of block grants to fund recurrent expenditure, CBGs to fund discretionary expenditure requirements, PSDGs to continue Province Specific Development Projects and grants for special projects. As in previous years, a major portion of government transfers, amounting to 80 per cent of total transfers, were in the form of block grants.

6.5 Government Debt and Debt Service Payments Government Debt Government debt as a percentage of GDP declined to 81.9 per cent in 2010 from 86.2 per cent in the previous year due to improvements in fiscal operations. Higher revenue collection which reduced the borrowing requirement, the reduction in the discount factor (which is the net difference in the book value and the face value of issues and maturities of Treasury bills and Treasury bonds) as a result of declining yield rates in government securities and the appreciation of the rupee vis-Ă -vis major foreign currencies, as well as higher economic growth contributed to the reduction in the debt to GDP ratio. In nominal terms, the total outstanding government debt increased by 10.3 per cent to Rs. 4,590 billion as at end 2010. As a percentage of GDP domestic debt declined significantly to 45.8 per cent of GDP in 2010 from

Central Bank of Sri Lanka Annual Report - 2010 Debt (as a percentage of GDP)

6.8Chart 6.8

100

Composition of Outstanding Domestic Debt - 2010 Sri Lanka Development Bonds 7%

90 80

Per cent

37.5

37.1

32.8

36.5

50.3

47.9

48.5

49.8

36.1

Central Bank Provisional Advances 3%

50 40 30 20

45.8

10 0

2006

2007

2008

2009

2010 P ro.

49.8 per cent of GDP in 2009, while foreign debt declined to 36.1 per cent of GDP in 2010 from 36.5 per cent of GDP in the previous year. The share of domestic debt in total government debt declined further in 2010 to 56 per cent from 58 per cent in 2009. Repayment of high cost domestic borrowings with the proceeds of the international sovereign bond and the increase in availability of foreign funds reduced the share of domestic debt in the total debt stock. The share of medium to long term debt to total domestic debt stock declined Outstanding Government Debt (As at end year) Rs. million 2009

2010 Provisional

Total government debt 3,041,686 3,588,962 4,161,422 Domestic debt (a) 1,715,199 2,140,228 2,400,955 By maturity period Short term 363,199 516,365 560,646 Medium and long term 1,351,999 1,623,863 1,840,309 By institution Bank (b) 415,318 657,424 705,765 1,299,779 1,482,704 1,695,089 Non bank Foreign debt 1,326,487 1,448,734 1,760,467 By type Concessional loans 1,099,911 1,227,222 1,271,142 Non concessional loans 45,308 57,491 78,649 Commercial 181,268 164,020 410,677 By currency SDR 508,241 531,849 567,502 US dollars 266,645 280,435 330,842 Japanese yen 338,621 445,596 452,758 Euro 121,460 132,047 143,566 Other 91,520 58,807 265,799 71,646 117,785 23,114 Memo: Exchange rate variation

4,590,245 2,565,662

Item

(a) (b)

Other 3% Rupee Loans 3% Treasury Bills 20%

Domestic

Foreign

Table 6.7

Treasury Bonds 64%

2007

2008

619,549 1,946,113 691,716 1,873,845 2,024,583 1,266,910 147,240 610,433 572,354 476,490 508,802 142,371 324,566 -4,653

Excludes Treasury bonds amounting Source: Ministry of Finance and Planning Central Bank of Sri Lanka to Rs. 4,397 million issued to commercial banks on behalf of CWE in November 2003. Includes outstanding balance to OBUs.

marginally to 76 per cent in 2010 from 77 per cent in the previous year, while 84 per cent of medium to long term domestic debt comprised Treasury bonds. The share of Treasury bills in short term debt, increased to 83 per cent in 2010 from 79 per cent in the previous year. The outstanding stock of Rupee loans continued to decline to Rs. 88 billion in 2010 from Rs. 112 billion in 2009, due to the repayment and non issuance of Rupee loans during the year, as the debt management strategy has been to move towards more market oriented debt instruments. Reflecting the increasing reliance on non bank borrowings, the outstanding debt held by the non bank sector increased by 10.5 per cent to Rs. 1,873.8 billion in 2010. Accordingly, the outstanding stock of Treasury bills and Treasury bonds held by the non bank sector increased by 19.5 per cent and 12 per cent, respectively, in 2010. The EPF and NSB continued to be the major investors in government securities, accounting for 46 per cent and 15 per cent, respectively of the outstanding debt stock held by the non bank sector. The outstanding debt obligations of the government to the domestic banking system declined by 2 per cent to Rs. 691.7 billion in 2010. The outstanding debt held by the Central Bank declined by Rs. 31.2 billion to Rs. 78.4 billion, while outstanding government debt held by commercial banks increased by Rs. 17.2 billion to Rs. 613.3 billion in 2010. Consequently, the share of banking sector debt in the total domestic debt stock declined to 27 per cent in 2010 from 29 per cent in 143

6 Fiscal Policy and gOVERNMENT FINANCE

Outstanding Outstanding Debt (As a per centGovernment of GDP) ChartGovernment 6.7

Central Bank of Sri Lanka Annual Report - 2010

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

6 1

2009. Retirement of the Central Bankâ&#x20AC;&#x2122;s holdings of Treasury bills reduced the government debt outstanding to the Central Bank. While, Treasury bill holdings of commercial banks increased by Rs.60 billion to Rs. 220 billion, Treasury bond holdings of the commercial banks declined by Rs. 26 billion to Rs. 162 billion, reflecting the appetite of investors for short term instruments. Further, other outstanding government debt held by commercial banks declined to Rs. 230.8 billion in 2010 from Rs. 247.5 billion in 2009.

6.9 Chart 6.9

Composition of Outstanding Foreign Debt - 2010 Non Resident Investments in Treasury Bonds & Bills 12%

Bilateral 33%

International Sovereign Bond 11% Multilateral 30%

Other 6% Bilateral 4% Multilateral 4%

Although there was an increase in foreign currency denominated domestic debt in US dollar terms, the rupee value of these debts declined marginally due to the appreciation of the Sri Lanka rupee against the US dollar. The outstanding domestic debt denominated in foreign currency declined to Rs.190.5 billion (US dollars 1,717 million) by end 2010 from Rs.191.8 billion (US dollars 1,676 million) at end 2009. This comprised outstanding OBU borrowings of Rs.16.6 billion (US dollars 150 million) and SLDBs amounting to Rs.173.9 billion (US dollars 1,567 million). Total outstanding foreign debt increased by 15 per cent to Rs. 2,024.6 billion in 2010, although as a percentage of GDP it declined to 36.1 per cent in 2010 from 36.5 per cent in 2009. The share of concessional debt in the total foreign debt stock declined further to 63 per cent in 2010 from 72 per cent in 2009 as a result of a marginal decline in concessional borrowing together with an increase in non concessional financing in 2010. Non concessional debt increased by 55 per cent to Rs. 758 billion, raising the share of non concessional debt in the total foreign debt stock to 37 per cent at end 2010 from 28 per cent at end 2009. The increase in non concessional debt was mainly due to higher foreign commercial borrowing, which increased by 49 per cent to Rs.610 billion in 2010. The gradual move of Sri Lanka towards middle income country status reduced the availability of concessional foreign financing. However, the favourable environment in international financial markets as well as the improvement in investor 144

Concessional 63%

Non Concessional 37%

confidence enabled the government to raise funds from non concessional external sources to finance the overall deficit. The rupee value of outstanding debt declined by Rs. 4.7 billion due to the impact of the variation in the exchange rate. The rupee value of US dollar denominated domestic debt (FCBUs and SLDBs) declined as result of the appreciation of the Sri Lanka rupee vis-Ă -vis the US dollar by 3.1 per cent in 2010. The appreciation of the Sri Lanka rupee against other currencies, such as the Special Drawing Rights (SDR) and the euro by 4.6 per cent and 10.9 per cent, respectively in 2010 also contributed to reduce the outstanding foreign debt stock, since about 59 per cent of the total foreign debt stock is denominated in SDR (28.3 per cent), US dollars (23.5 per cent) and euro (7 per cent). However, since around 25 per cent of the foreign outstanding debt stock is denominated 6.10

Chart 6.10

Currency Composition of Total Outstanding Debt - 2010 Other 2% Euro 3% Japanese Yen 11%

SDR 12% LKR 57%

USD 15%

Central Bank of Sri Lanka Annual Report - 2010

Government Debt Extreme Weather Conditions andSustainability its Impact

What is Debt Sustainability? ‘Debt Sustainability’ refers to the ability of a country to meet its current and future debt obligations without resorting to debt rescheduling and without the need for any major fiscal adjustment. Maintaining debt at a sustainable level is important, as a high and rising debt level can reduce the effectiveness of fiscal policy and monetary policy. For instance, countercyclical fiscal policies, such as expansionary fiscal policy during a slowdown in economic growth may not have the desired impact, if a country already has a high outstanding public debt, as economic agents would expect a higher tax burden in the future to service the debt. For a country to maintain its government debt at a sustainable level, the future primary balances of the government, which is the difference between total government revenue and total government expenditure, excluding interest payments, should be large enough to meet all its debt obligations. Accordingly, if a government runs a primary deficit, it implies that government expenditure, excluding interest payments, is higher than revenue collection and this shortfall would need to be financed through borrowings. This indicates that the total debt stock of the government in the current year would be equal to last year’s debt stock, plus interest payments on that debt stock, minus the primary balance of the current year, which can be presented as follows: Dt = Dt-1 + iDt-1 - PBt where, Dt is the debt stock of the current year, Dt-1 is the previous year’s debt stock, i is the effective interest rate on debt and PBt is the primary balance. Accordingly, a primary deficit (PBt<0) or higher interest rates will result in increasing the current year’s debt stock. If the primary balance is zero (PBt=0), that is if government revenue is sufficient to meet its total expenditure, excluding interest payments, the borrowing in the current year would be necessary only to service the past debt stock. Moreover, if the government is able to achieve a primary surplus (PBt>0), those savings could be

utilised to service past debt, thus reducing the need for additional borrowing in the current year. How to Assess Debt Sustainability? There are a number of methodologies developed to assess debt sustainability. According to these approaches, debt sustainability depends on the real interest rate, the primary balance, the real exchange rate and the rate of economic growth. A high real interest rate will lead to higher debt servicing costs, while a primary deficit will lead to additional borrowings for budgetary financing. For an open economy, the exchange rate is also a key variable which affects the outstanding public debt, since the depreciation of the domestic currency vis-à-vis a foreign currency would result in an increase in the debt stock denominated in that currency. The debt to GDP ratio is one of the major indicators of government debt sustainability. A high debt to GDP ratio makes a country more vulnerable to shocks and crises in the future. However, there isn’t a particular level of debt to GDP which can be used as a threshold to assess the debt sustainability of a country as this would vary from country to country based on the economic characteristics of each country. The law of motion of the government’s debt-to GDP ratio1 is a commonly used tool to assess the debt sustainability of a country. Accordingly, the change in the debt stock of a country in the current year can be represented by combining the key variables which affect the debt stock, such that, r-g Dt-1 PBt Dt =( ) Yt 1+g Yt-1 Yt where, D is debt stock, Y is GDP , r is the real interest rate, g is the rate of economic growth and PB is the primary balance (the exchange rate is ignored in this analysis for simplicity). Accordingly, if the real interest rate is higher than the growth rate it indicates that the interest burden on the existing debt stock would Developed by IMF and World Bank. See Croce, Enzo, and V. Hugo Juan – Ramón, 2003, “Assessing Fiscal Sustainability: A Cross Country Comparison,” IMF Working Paper No. WP/03/145, International Monetary Fund, Washington D.C.

145

6 Fiscal Policy and gOVERNMENT FINANCE

BOX 13

Central Bank of Sri Lanka Annual Report - 2010

However, if the government can maintain a primary balance which is sufficient to meet the interest cost under a given growth rate (a stabilising primary balance), then the debt to GDP ratio will stabilise at the existing level since there is no need for new borrowing. Further, if the primary balance is higher than the stabilising primary balance, the outstanding government debt would fall over time. Similarly, if the real interest rate is equal to the growth rate, then the primary balance required for debt sustainability will remain constant. However, if the real interest rate is higher than the growth rate, then the actual primary balance required for debt sustainability will increase over time.

In the baseline scenario, if the medium term growth projections are realised and the zero primary balance in 2012 continues until 2016, the targeted debt level of 60 per cent of GDP can be achieved in 2016, provided the real interest rate remains at around 3 to 4 per cent during the medium term. It would be possible to maintain the debt to GDP ratio as expected by 2016, even with an increase in the real interest rate, as the favourable developments in the fiscal sector as reflected by a zero primary balance and the higher growth momentum will mitigate the negative impact of an increasing interest rate on the outstanding debt stock (see Chart B 13.1). Assuming there are no further developments in the monetary, real and fiscal sectors, that is all the variables remain at the 2010 level over the medium term, the debt to GDP ratio will continue to decline, although at a slower rate than envisaged under the baseline scenario, provided the rate of economic growth is above the real interest rate, implying that

Debt Sustainability in Sri Lanka There has been much debate regarding the sustainability of government debt in Sri Lanka. The debt burden in Sri Lanka during the period 2000 to 2004 was about 102 per cent of GDP on average. The trend was reversed in 2005 and it declined gradually to 81.4 per cent of GDP by 2008. However, the debt to GDP ratio increased in 2009 due to the decline in revenue, slower growth in GDP with the impact of global economic recession and a rise in expenditure with the intensification of the war and post war resettlement and development activities. This situation turned favourable in 2010 with the improvement in the fiscal sector. Baseline Scenario

Chart B 13.1

All Variables Prevail at 2010 Level

Chart B 13.2

-4

2011

2010 P ro.

2016

2015

2014

2016 2013

2015 2012

2014 2011

2013 2010 P ro.

GDP G rowth(right (rightaxis axis) ) Real Interes t Rate Primary BalanceofasGDP a Debt as a percentage percentage of GDP (right axis ) (left axis )

-2

-4

GDP G rowth (right Real axis ) Interes t Rate (right axis ) as a percentage of GDP Primary Balance as Debt a (left axis percentage of GDP (right axis) )

(right axis axis)) Real GDP InteresGt rowth Rate (right Balance of asGDP a Debt Primary as a percentage percentage of GDP (right axis ) (left axis )

2016

2015

2014

-2

2016

2013

-2

2015 2012

2012

2011

2010 P ro.

2014

2011

2013 2010 P ro.

P er cent

2012

P er cent

Real Interes t Rate (right axis ) Debt as a percentage of GDP (left axis )

146

Figure 2 Figure 2 If all variables prevail at 2010 level If all variables prevail at 2010 level

GDP G rowth (right axis ) Primary Balance as a percentage of GDP (right axis )

P er cent

Figure 1 Baseline Scenario

P er cent

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

6 1

According to the medium term macroeconomic projections, the debt to GDP ratio in Sri Lanka is expected to decline to 80 per cent of GDP in 2011 and reach 60 per cent of GDP by 2016. As envisaged in the Fiscal Management Report 2011, the primary deficit is projected to decline to 1.3 per cent of GDP in 2011 and record a zero primary balance by 2012. Further, GDP is projected to grow above 8 per cent in the medium term. Given these projections, the possibility of achieving the targeted debt path can be determined using the law of motion of the governmentâ&#x20AC;&#x2122;s debt-to-GDP ratio assuming that the exchange rate remains stable over the medium term.

increase, while the debt stock as a percentage of GDP would also increase. Similarly, if the government borrows for financing expenditure other than for servicing the debt stock (that is the government runs a primary deficit) the debt burden as measured by the debt to GDP ratio would increase.

Central Bank of Sri Lanka Annual Report - 2010

Category

Classification of Countries under DSF Implication

Low risk

All debt indicators are well below the relevant thresholds

Moderate Risk

Under the baseline scenario there is no breach of threshold but alternative scenarios or stress tests result in breaches.

High risk

Breaches the threshold under the baseline scenario but the country does not face any payment difficulty at present

Debt distress

Country is already in arrears

the growth in GDP can mitigate the pressure on debt arising from developments in the monetary and fiscal sectors (see Chart B 13.2). The IMF and World Bank have also developed a Debt Sustainability Framework (DSF) which can be used as a tool to assess the external debt sustainability of low income countries. Under this framework, countries are classified by comparing the projected public debt indicators with specific thresholds under a baseline scenario, alternative scenarios and stress tests. Accordingly, countries are classified as low risk, moderate risk, high risk and debt distress (see Table B 13.1 for details). Based on an analysis conducted by the IMF and World Bank in 2009 to assess debt sustainability, Sri Lanka was upgraded to the moderate risk category. However, this study was based on several assumptions made regarding the key macroeconomic variables,

in Japanese yen, the depreciation of the Sri Lanka rupee against the Japanese yen by 8.8 per cent had a negative impact on the outstanding debt stock.

such as export growth, GDP growth and the exchange rate. According to the latest projections of the Central Bank, all these macroeconomic variables are expected to be more favourable than assumed by the IMF and World Bank when they undertook this sustainability analysis in July 2009. Conclusion The Governmentâ&#x20AC;&#x2122;s debt portfolio has been restructured by moving to more market oriented debt instruments with medium to long term maturities at lowest possible cost in order to reduce the rollover risk and interest burden. Bank borrowings have also been declining gradually reducing the inflationary impact of budgetary financing. Similarly, various measures have been taken on the fiscal front to increase government revenue and rationalise expenditure, thus improving the key fiscal balances. Continuing the governmentâ&#x20AC;&#x2122;s fiscal consolidation process is expected to further improve the primary balance over the medium term. Improved investor confidence and lower inflationary expectations will help to maintain the interest rate at the required level. Further, increasing foreign exchange inflows will support a stable exchange rate. The economy is also expected to grow at a faster rate benefiting from the policies which are currently being implemented. Given these developments, both external and domestic debt can be expected to remain at a sustainable level, enabling the government to meet its future debt obligations.

maintaining a high economic growth would be required to reduce the outstanding debt stock to the targeted level of 60 per cent by 2016. Government Debt Service Payments

Chart 6.11 Payments (As(as Debt Service a per cent of GDP) a percentage of GDP) 18 16 14

Per cent

The improvement in public debt indicators signals a decline in the future debt burden. The improvement in the fiscal sector, lower interest rates and the appreciation of the rupee vis-Ă -vis major foreign currencies together with the high economic growth reduced the debt to GDP ratio in 2010. The debt to GDP ratio in 2010 fell below the targeted level set in the Medium Term Macro Fiscal Framework of 84 per cent of GDP by 2010. Continuing the fiscal consolidation process and

5.1

6.4 5.1

4.8

8.9

8.6

2007

2008

6.3

8 6 4

10.0

10.7

8.3

2 0 2006

Interest

2009

2010 P ro.

Amortisation

147

6 Fiscal Policy and gOVERNMENT FINANCE

Table B 13.1

Central Bank of Sri Lanka Annual Report - 2010

Fiscal Economic Policy and and Social gOVERNMENT Infrastructure FINANCE

6 1

Table 6.8

Government Debt Service Payments

Rs. million Item

2007

Debt service payments 500,514 Domestic 415,089 Foreign 85,425 Amortisation payments 317,833 Domestic 253,719 Foreign 64,114 Interest payments 182,681 Domestic 161,370 Short term 53,874 Medium and long term 107,496 Foreign 21,311

2008 592,804 440,918 151,886 380,330 258,720 121,609 212,475 182,198 65,364 116,834 30,277

2009 825,687 675,274 150,414 516,012 401,296 114,716 309,675 273,978 72,364 201,613 35,698

2010 Provisional 820,448 686,800 133,648 467,856 389,672 78,184 352,592 297,127 58,943 238,185 55,464

Sources: Ministry of Finance and Planning Central Bank of Sri Lanka

Debt Service Payments Total debt service payments declined by Rs. 5.2 billion to Rs.820.4 billion in 2010 due to lower amortisation payments, as interest payments increased during the year. Total amortisation payments, which accounts for 57 per cent of total debt service payments, declined by 9.3 per cent to Rs. 467.9 billion. Of the total amortisation payments, Rs. 389.7 billion was made to domestic sources and Rs. 78.2 billion to foreign sources, including deferred repayments on defence loans. A decline in the maturing debt stock in 2010 and the appreciation of the rupee, which reduced the rupee value of foreign debt repayments, mainly contributed to the decline in amortisation payments to external sources. Total interest payments increased by 13.9 per cent to Rs. 352.6 billion in 2010. Although domestic interest payments increased by 8.4 per cent over the last year, this was well below the 50.4 per cent increase in interest payments recorded in the previous year. The main reason for the lower growth in domestic interest payments in 2010 compared to 2009 was the declining yield rates on government securities in

148

Table 6.9

Government Debt Indicators

Indicator Government debt/GDP Domestic debt/GDP Foreign debt/GDP Total foreign debt/exports (a) Total debt service/GDP Total debt service/government revenue (b) o/w Domestic debt service/ government revenue (b) Total debt service/government expenditure (c) o/w Domestic debt service/ government expenditure (c) Foreign debt service/exports (a) Total interest/GDP Domestic interest/GDP Domestic interest/Government current expenditure Foreign interest/exports (a)

2007

2008

2009

85.0 47.9 37.1 127.3 14.0

81.4 48.5 32.8 132.2 13.4

86.2 49.8 36.5 170.7 17.1

81.9 45.8 36.1 166.4 14.6

88.6

90.5

118.0

100.3

73.5

67.3

96.5

83.9

43.2

43.1

48.1

46.9

35.8 8.2 5.1 4.5

32.0 13.9 4.8 4.1

39.3 14.6 6.4 5.3

39.3 11.0 6.3 5.3

25.9 2.0

24.5 2.8

31.1 3.5

31.7 4.6

2010

Provisional

Sources: Ministry of Finance & Planning (a) Export of goods and services Department of Census and Statistics (b) Government revenue is in economic Central Bank of Sri Lanka format (c) Government expenditure includes amortisation payments

2010. Interest payments on foreign debt increased by 55.4 per cent, mainly due the increase in non concessional foreign borrowings. Debt indicators improved in 2010 reversing the unfavourable trend recorded in the previous year. The ratio of debt service payments to revenue declined to 100.3 per cent from 118 per cent in 2009 with the increase in revenue collection and the decline in debt servicing costs. The higher GDP growth in 2010 together with the decline in debt servicing costs contributed to the decline in the total debt service to GDP ratio to 14.6 per cent in 2010 from 17.1 per cent in 2009. Total interest payments to GDP also declined to 6.3 per cent in 2010 from 6.4 per cent in 2009. Further, the ratio of foreign debt to earnings from the export of goods and services declined to 166.4 per cent in 2010 from 170.7 per cent in 2009 due to higher export growth in 2010.

Monetary Policy, Money, Credit and Interest Rates

7.1 Overview

he Central Bank of Sri Lanka eased its monetary policy stance further in 2010. Broad money expansion continued to moderate during the first three quarters of 2010, indicating subdued demand pressures. Supply-side developments meanwhile, were also favourable, as domestic supplies increased during the year, while commodity prices in international markets including petroleum prices moderated towards mid-2010. The outlook for prices therefore was benign, supporting a further relaxation of the monetary policy stance to promote economic activity. Accordingly, policy interest rates of the Central Bank were reduced further, in July and August 2010. The targeted growth of broad money in 2010 was also revised upward in July 2010, in order to facilitate the smooth functioning of economic activity, as it became evident by mid-year that the domestic economy was expanding at a higher rate in 2010 than originally projected. Following the reduction of the Central Bankâ&#x20AC;&#x2122;s policy interest rates, market interest rates adjusted further downwards during the second half of

2010, providing additional impetus to economic activity. This declining trend in interest rates continued into 2011 as well, as the Bank reduced its policy interest rates further in January 2011. Credit obtained by the private sector regained momentum during the year 2010 in view of the improved outlook for economic activity and the continued accommodative monetary policy stance of the Central Bank. Yearon-year growth of credit granted by commercial banks to the private sector, which was at a negative 5.8 per cent at end 2009, turned positive in March 2010, and thereafter continued to increase at a robust rate to reach 25 per cent in December 2010. This expansion was reflected in credit flows to all sectors of the economy. Nevertheless, average growth of broad money (M2b) during the year 2010 remained around the targeted level of 15 per cent by yearend, as net foreign assets of the banking system declined gradually during the year along with increased

Central Bank of Sri Lanka Annual Report - 2010

Economic Social Monetary Policy, Money,and Credit andInfrastructure Interest Rates

financing of imports, while net credit obtained by the government from the banking system also declined towards the end of the year. Year-on-year growth of daily average reserve money in 2010 was also consistent with the target stipulated in the monetary programme for 2010.

economic activity, by enabling the private sector to raise funds in international markets. More diverse sources of financing would also promote deepening of domestic financial markets.

Persistently high rupee liquidity was a challenge in conducting monetary policy in 2010. Mainly as a result of foreign capital inflows to both the government and the private sector and subsequent purchases by the Central Bank, the money market continued to have excess liquidity in 2010. Hence, the Central Bank continued to absorb the excess liquidity through open market operations in order to ensure that interest rates remain stable and that reserve money would remain at targeted levels.

The Central Bank of Sri Lanka continued to operate within a monetary targeting framework in conducting monetary policy. Accordingly, broad money (M2b) continued to be the intermediate target for monetary policy while reserve money, which is linked to broad money through a multiplier, remained the Bankâ&#x20AC;&#x2122;s operating target for monetary policy. In implementing monetary policy, the policy rate corridor formed by the Repurchase rate and the Reverse Repurchase rate was the primary monetary policy instrument used by the Bank to signal its monetary policy stance and maintain stability in short-term interest rates at an appropriate level within the corridor by conducting open market operations (OMO), in order to achieve monetary policy targets. Further, the statutory reserve ratio (SRR) applicable to all rupee deposit liabilities of commercial banks was maintained at 7 per cent since early 2009, as this level was considered compatible with the Bankâ&#x20AC;&#x2122;s monetary policy stance. Moral suasion meanwhile, was used to encourage

Measures being taken by the Central Bank to strengthen financial system stability, meanwhile, will enhance monetary policy transmission in the years ahead. As has been the case with central banks the world over in the period following the recent global financial crisis, the Central Bank of Sri Lanka too has taken steps to strengthen regulation of financial institutions operating in the country, their governance as well as the legal framework within which they operate. These measures, while helping to strengthen financial system stability, are also likely to help stabilise economic activity along business cycles, and thereby help prevent sharp fluctuations in credit conditions including market interest rates, over time, which in turn, would help enhance economic stability. Recent fiscal measures relating to financial services, including those aimed at facilitating long-term funding of viable economic activity, meanwhile, would raise the effectiveness of financial intermediaries, improve monetary policy transmission as well as complement other policy measures adopted by the government to accelerate economic development and remove supply bottlenecks, thereby helping reduce supply side pressures on prices. The recent exchange control liberalisation by the Central Bank would also further enhance resource availability for domestic 150

7.2 Monetary Policy

Table 7.1

Recent Monetary Policy Measures (2007-2010)

Per cent per annum Date 23 February 2007 21 November 2007 13 October 2008 25 November 2008 12 January 2009 11 February 2009 24 February 2009 18 March 2009 22 April 2009 21 May 2009 16 June 2009 11 September 2009 18 November 2009 09 July 2010 20 August 2010

Repurchase Reverse Rate Repurchase Rate 10.50 - - - - 10.25 - - 9.00 - 8.50 8.00 (f) 7.50 7.25 (f) -

12.00 - - - - 11.75 - - - 11.50 11.00 10.50 (f) 9.75 9.50 (f) 9.00

Statutory Penal Rate Reserve on Reverse Ratio (a) Repos - - 19.00 (b) 9.25 (c) 7.75 (d) - 17.00 - 16.50 7.00 (e) - 14.75 - 13.00 - Removed - - - - -

Source: Central Bank of Sri Lanka

(a) To be maintained as a percentage of rupee deposit liabilities. (b) Effective from 03 December 2007. (c) Effective from the reserve week commencing 17 October 2008. (d) Effective from the reserve week commencing 28 November 2008. (e) Effective from the reserve week commencing 27 February 2009. (f) Effective from the close of business.

Central Bank of Sri Lanka Annual Report - 2010 Inflation and Contribution to Inflation from Key Categories

Chart 7.1 Chart 7.1 Inflation and Contribution to Inflation from Key Categories 30 25

Per cent

Percent

The Bank’s monetary programme was initially prepared stipulating the targets for annual average growth of broad money and reserve money at 14.5 per cent each. Subsequently, the Central Bank revised the monetary programme for the year taking into account several new developments. Projections pointed to a higher rate of growth of economic activity in 2010 than originally expected. The need to include information from the national budget for 2010, which was presented to the Parliament in June 2010, also necessitated a revision to the monetary programme. Accordingly, the targeted growth of broad money in 2010 was revised upward to 15 per cent in July 2010. Meanwhile, a notable increase in the ‘currency held by the public’ component within the money supply, particularly in view of the restoration of economic activity in the Northern and Eastern provinces, led to an increase in the currency to deposit ratio, in turn leading to a decline in the money multiplier. Taking into account this development, the target for year-on-year growth of daily average reserve

15 10 5

Jul-10

Oct-10

Jan-10

Apr-10

Jul-09

Other

Oct-09

Jan-09

Apr-09

Jul-08

Transport

Oct-08

Jan-08

Apr-08

Jul-07

Oct-07

Jan-07

Food and Non-Alcoholic Beverages

Apr-07

Jul-06

Oct-06

Jan-06

-5

Apr-06

Inflation, y-o-y (CCPI, base=2002)

money was raised to 21.2 per cent, in July 2010, parallel to the upward revision to the targeted level of broad money. Following the favourable price developments in 2009, inflation was broadly stable in 2010. Inflation, as measured by the year-on-year change in the Colombo Consumers’ Price Index (base=2002) was at 6.9 per cent by end 2010, in comparison to 4.8 per cent a year earlier. Annual average inflation increased gradually during the year to reach 5.9 per cent by year-end from 3.4 per cent in the previous year. While there were no signs of significant demand pressures in the economy, the favourable supply-side developments helped contain inflationary pressures in the economy.

Developments in Monetary Aggregates

Table 7.2

Rs. billion Item 1. 2. 3.

Currency Outstanding 1.1 Currency held by the Public 1.2 Currency with Commercial Banks Commercial Banks’ Deposits with the Central Bank Government Agencies’ Deposits with the Central Bank

End 2009

End 2010 (a)

Change 2009 Amount

2010 Amount

217.4 181.8 35.6 86.1 …

255.7 216.5 39.1 104.9 …

31.3 26.8 4.5 3.8 …

16.8 17.3 14.5 4.6 …

38.2 34.7 3.5 18.8 …

17.6 19.1 9.9 21.8 …

4. Reserve Money (1+2+3)

303.5

360.5

35.1

13.1

57.0

18.8

5. Demand Deposits held by the Public with Commercial Banks

154.9

190.6

32.6

26.6

35.8

23.1

6. Narrow Money Supply, M1

336.7

407.2

59.4

21.4

70.5

20.9

(1.1+5)

7. Time and Savings Deposits held by the Public with Commercial Banks

1,200.0

1,405.8

195.2

19.4

205.8

17.1

8. Broad Money Supply, M2

1,536.8

1,813.0

254.6

19.9

276.2

18.0

(6+7)

9. Foreign Currency Deposits (b)

10. Consolidated Broad Money Supply, M2b (8+9)

269.4

278.4

28.8

12.0

9.0

3.3

1,806.2

2,091.4

283.4

18.6

285.2

15.8

Money Multiplier, M2b Velocity, M2b (c)

(a) (b) (c)

Provisional Includes deposits of resident category of Offshore Banking Units and a part of foreign currency deposits with Domestic Banking Units. During the year

5.95 2.90

5.80 2.92 Source: Central Bank of Sri Lanka

151

Monetary Policy, Money, Credit and Interest Rates

banks to fall in line with policy rate adjustments by reducing their lending rates and extending credit to the private sector. The Bank’s monetary operations continued to be guided by its monetary programme, which is prepared taking into account the projected key macroeconomic developments.

Central Bank of Sri Lanka Annual Report - 2010

Economic Social Monetary Policy, Money,and Credit andInfrastructure Interest Rates

BOX 14

Strengthening the Framework forImpact Monetary Policy Extreme Weather Conditions and its

The Central Bank of Sri Lanka has conducted its monetary policy within a monetary targeting framework since the 1980s. While demand for money in Sri Lanka has remained broadly stable1, broad money aggregates computed for Sri Lanka help predict domestic inflation. Hence, the Bank has been able to continue its monetary operations within a monetary targeting framework. Accordingly, the Bank attempts to achieve price stability, the final objective of monetary policy, by guiding reserve money, its operational target, along a path that is compatible with the targeted growth of broad money, the intermediate target for monetary policy. The monetary programme, which guides the Bankâ&#x20AC;&#x2122;s monetary policy, sets out the annual targets for broad money and reserve money. The target for broad money is determined on the basis of the projected growth of economic activity and a desirable rate of increase in the general price level, as measured by the GDP deflator. The target for reserve money is thereafter derived on the basis of the projected money multiplier for the period under consideration. This framework has served the Bank well in its endeavour to secure price stability, particularly as the Bank has continued to take measures to strengthen its operations within this policy framework. In an economy undergoing significant changes, monetary policy responses to price developments would need to be carefully calibrated. The implications of expected economic developments for domestic prices need to be taken into consideration in formulating monetary policy. The implications of expected developments in the economy for monetary policy transmission, including the relative effectiveness of different channels of monetary policy transmission, also need to be given due consideration in formulating monetary policy. In view of these considerations, the approach to monetary policy formulation has been further strengthened, taking two perspectives into account. The Bank now carries out more in-depth analyses of economic and monetary developments in 1 If the velocity with which money changes hands in the economy remains broadly stable, that indicates stability of demand for money balances. Demand for real money balances (real money balances are derived by adjusting nominal money balances so as to remove the effect of inflation) generally depends on i) the level of economic activity, as reflected by the real gross domestic product, as money is required to carry out various transactions; and ii) the opportunity cost of holding money, which could be approximated by a representative market interest rate adjusted for expected inflation.

152

order to ensure that relevant information is taken into consideration in analysing risks to price stability. Economic Analysis The Bankâ&#x20AC;&#x2122;s economic analysis includes an analysis of macroeconomic developments as well as an analysis of developments in the financial sector. Accordingly, a more detailed analysis of the output gap would be undertaken by the Bank. In this regard, the contributory factors in shifts in the potential output would be carefully analysed. Accordingly, developments in the labour market, trends in external demand for different types of goods and services, capacity utilisation in existing industries, the potential of emerging industries as well as the catalytic role played by infrastructure being built or to be built in the ensuing period would be analysed. A comprehensive analysis of the financial sector, meanwhile, would enable the Bank to deduct the implications of emerging trends highlighted by macro-prudential indicators in relation to diverse aspects of financial system stability including capital adequacy, liquidity, profitability and solvency. Further, an analysis of trends in asset prices would help identify market expectations in relation to domestic prices and the value of the Sri Lanka rupee vis-Ă -vis other currencies, in addition to highlighting potential risks to economic stability. The Bank will also carry out a broader analysis of conditions in domestic as well as international markets with a view to identifying emerging price pressures either due to evolving supply-side developments or due to inbuilt structural weaknesses. The domestic economy may also be subject to unforeseen supply-side shocks from time to time. For example, the recent volatility in the international prices of petroleum products due to natural calamities and geo-political tensions in some parts of Africa and the Middle East, if protracted, could impact upon domestic prices. The country may also face supply side shocks that originate domestically. For example, the recent floods that devastated crops resulted in significant increases in vegetable prices. Circumstances arising from supply side shocks such as these would need to be managed primarily through supply-side measures. However, if second round effects are witnessed in prices due to such shocks, the Central Bank would

Central Bank of Sri Lanka Annual Report - 2010

Monetary Analysis Alongside the analysis of economic developments, the Bank will continue to carry out an analysis of monetary developments, with a short-to-mediumterm focus, in order to identify pervasive risks to price stability. Trends in measures of the money supply and their components, help gauge aggregate demand. In Sri Lanka, M2b, that is, broad money, which includes currency held by the public and deposits held by the public with commercial banks, is the measure of money that is used for monetary policy purposes. While M2b is also calculated from the perspective of sources of money, an analysis of trends in net foreign assets, net credit obtained by the government from the banking system, and credit granted to the private sector by the banking system, which comprise broad The Bank reduced the policy interest rates in the second half of 2010 with a view to spurring the growth of credit to support economic activity. The Bank reduced both the Repurchase rate and the Reverse Repurchase rate by 25 basis points in July while the Reverse Repurchase rate was reduced by a further 50 basis points in August. Following these changes, the policy interest rate corridor of the Central Bank narrowed and by the end of the year 2010, the Repurchase rate was at 7.25 per cent while the Reverse Repurchase rate was 9.00 per cent. Policy Chart Interest 7.2.a Rates and the Average

ChartPolicy 7.2Interest Rates of the Central Bank and the Average Chart 7.2a Weighted Call Money Rate Weighted Call Money Rate

19.00

17.00 16.50

13.00

21-Dec-10

21-Nov-10

22-Sep-10

7.25

9.00

22-Oct-10

27-Sep-09

27-Oct-09

29-Jul-09

28-Aug-09

29-Jun-09

30-Apr-09

30-May-09 3

31-Mar-09

30-Jan-09

7.50

24-Jul-10

8.00

23-Aug-10

8.50

9.50

24-Jun-10

9.75

25-Apr-10

9.00

25-May-10 2

10.50

26-Mar-10

11.00

10 10.50 10.25

25-Jan-10

11.50

24-Feb-10

12.00 11.75

26-Dec-09

01-Mar-09

Per cent

14.75

31-Dec-08

Percent

26-Nov-09

Repurchase Rate

Average Weighted Call Money Rate

Reverse Repurchase Rate

Penal Rate on Reverse Repos

money (M2b), help identify sources of a potential buildup of demand pressures. A further disaggregation of these monetary aggregates helps identify evolving economic trends as well as emerging demand pressures in different sectors of the economy. Given that prices respond to monetary policy with time lags which are variable depending on the prevailing macroeconomic conditions, the monetary analysis plays a vital role in monetary policy formulation. Trends in monetary aggregates help identify early, emerging demand pressures in the economy. Conclusion In formulating monetary policy, the broader and more in-depth analyses of economic and monetary developments help the Bank organise, evaluate and cross-check information and examine the inter-play of demand and supply side factors. This process would, in turn, strengthen the Bankâ&#x20AC;&#x2122;s monetary policy formulation. Money market liquidity has continued to be in excess in 2010 and the Central Bank continued with its efforts to manage market liquidity so as to stabilise interest rates and maintain reserve money along the targeted path. Following a turnaround in the liquidity position in the domestic money market around mid-2009, the money market continued to experience an excess liquidity position throughout 2010. The build-up of excess liquidity was largely due to the absorption of foreign exchange inflows to the country by the Central Bank, with a view to preventing undue appreciation of the rupee. Considering the importance of managing market liquidity and maintaining money market interest rates at an appropriate level, to curb potential future inflation, the Central Bank employed several instruments to absorb the excess liquidity. As the stock of government securities held by the Central Bank depleted, the Bank issued its own securities to absorb liquidity on overnight and term bases. The remaining government securities were utilised to enter into overnight repurchase agreements with commercial banks and primary dealers, that is, institutions participating in the monetary operations of the Central Bank. Foreign exchange swap 153

Chart 7.2.b Policy Interest Rates of the Central Bank and the Average Weighted Call Money Rate

7 Monetary Policy, Money, Credit and Interest Rates

need to take monetary policy action. Hence, the economic analysis would also include an analysis of the implications of supply-side shocks.

Central Bank of Sri Lanka Annual Report - 2010

Economic Social Monetary Policy, Money,and Credit andInfrastructure Interest Rates

agreements, adopted under OMO in 2009, were also utilised to absorb a part of the excess liquidity. In October 2010, the Central Bank implemented a bond-borrowing programme and the borrowed bonds were used in the Bank’s OMO during the last three months of the year. Meanwhile, from 20 October 2010, the overnight and term auctions under OMO were discontinued as the primary market yield on three-month Treasury bills declined to levels below the Bank’s Repurchase rate, an outcome of intense competition among banks with a large volume of excess liquidity to acquire short-term government securities to manage their portfolios. Subsequent to the suspension of OMO auctions, the excess money market liquidity has continued to be placed with the Central Bank through its standing facility. The Central Bank views its communication with the general public as an essential aspect of implementing monetary policy successfully. The continued dialogue with key stakeholders in formulating monetary policy, and coherently conveying to the public the rationale for the Bank’s policy actions help bridge the gap between the expectations of the Central Bank and the expectations of the public. Towards this end, the Central Bank has continued to publish its strategies for the upcoming year as well as the medium term at the beginning of each year, in its Road Map. Policy decisions in relation to monetary policy continued to be communicated through regular press releases. The general public is also continually updated on policies and strategies of the Central Bank through statutory and other publications of the Central Bank including its Annual Report and the Recent Economic Developments. Further, the Bank is represented at various fora at which the Bank’s officers update members of the public on economic developments and their implications for monetary policy. During the year, the Central Bank also engaged in regular policy dialogue with its Monetary Policy Consultative Committee to benefit from views and perceptions of a cross-section of the private sector and academia. 154

7.3 Developments in Money and Credit Money Market Liquidity Rupee liquidity in the domestic money market was in surplus throughout the year. The issue of a sovereign bond worth US dollars one billion in October at the international capital market and the sale of a part of the funds thus raised to the Central Bank by the government, so as to be able to settle some of its rupee liabilities to commercial banks, resulted in an increase in rupee liquidity in the market. During the first three quarters of the year, net inflows of foreign funds to both the government and the private sector, including net foreign investments in Treasury bonds and Treasury bills resulted in an excess of foreign exchange in the domestic foreign exchange market, which the Central Bank purchased to prevent any undue appreciation of the rupee. During the last quarter of the year however, the Bank sold foreign exchange to the market, mainly to facilitate the settlement of bills relating to oil imports. Hence, for the year 2010 as a whole, the Bank was a net supplier of foreign exchange to the market, thereby absorbing some liquidity. Meanwhile, there have been occasional purchases of Treasury bills in the primary market by the Central Bank, while the Central Bank transferred its profits to the government, which also added some liquidity to the money market. By end 2010, the overall excess liquidity in the money market amounted to Rs. 124.3 billion compared to Rs. 105.6 billion at end 2009. The Central Bank absorbed the excess market liquidity employing a range of instruments. In addition to repurchase agreements on an overnight basis, with Treasury bills serving as the underlying security, in conducting OMO, the Bank used its own securities extensively to mop up excess liquidity on both overnight and term bases. The Bank’s own securities were used in OMO as the amount of government securities held by the Bank was limited. Accordingly, permanent

Chart Chart 7.3 7.3Chart Chart 7.3 7.3 Excess Money Excess Market Money Liquidity Market absorbed Liquidity absorbed by the Central by Central Bank Excess Money Excess Market Money Liquidity Market absorbed Liquidity absorbed by the by the theBank Bank Central Central Bank of Sri Lanka Annual Central Report - 2010Bank through OMO through OMO through OMO through OMO

FX SWAPs

Central Bank Securities sold on a Term Basis

Term Repos

absorption of liquidity through the sale of government securities was also minimal, totalling Rs. 13.25 billion in 2010. Foreign exchange swap transactions (FX SWAP transactions) were also continued by the Bank to absorb excess liquidity in the money market on a term basis. Meanwhile, government securities borrowed by the Bank under the bond-borrowing programme were also used for the purpose of absorbing excess market liquidity, given the relatively lower absorption cost involved. As the yields on Treasury bills with a shortterm maturity of three months in the primary market fell to levels below the Central Bank’s Repurchase rate by October, the conduct of OMO repo auctions as well as auctions for the sale of Central Bank securities, were discontinued from the 20th of October. Since then, participating institutions continue to place their excess funds with the Central Bank through its standing facility, at the Bank’s Repurchase rate.

Reserve Money Year-on-year growth of daily average reserve money in 2010 was at a level consistent with the target stipulated in the monetary programme revised in July 2010 following revisions to key underlying assumptions.

2323DecDec1010 0808NovNov1010

1010Aug-10 Aug-10

Overnight Repos and Central Bank Securities sold on an Overnight Basis

0808NovNov1010 2424SepSep1010 23- Dec- 10

08- Nov- 10

24Sep10 1010 2424SepSep-

1010Aug-10 Aug-10 2626JunJun1010 10- Aug-10

12- May-10

2626JunJun1010 26Jun10 1212May-10 May-10

In the first few months of the year, currency in circulation increased by a substantially higher rate than in the corresponding months of the previous years, thereby causing reserve money to expand at a higher rate than initially projected. This phenomenon was attributed to the increased transactions demand for money in the domestic economy along with the pick-up in economic activity, particularly in the Northern and Eastern provinces, following the end to the conflict. The result of the higher than expected increase in currency in circulation was a decline in the money multiplier. In July 2010 therefore, the monetary programme was revised, taking into consideration the higher than expected expansion in economic activity and the unexpected decline in the money multiplier, setting the target for year-on-year growth of daily average reserve money at 21.2 per cent. It was observed that the growth of reserve money moved close to the targeted path in the revised monetary programme during the second half of the year, enabling the Bank to achieve its target for reserve money despite the substantially higher annual average growth of currency at about 24 per cent, in 2010. Viewed from the source side, the expansion of reserve money during the year 2010 was entirely due to an increase in Net Foreign Assets (NFA) of the Central Bank. NFA expanded mainly as the government used a part of the funds (US dollars 492 million) it raised by issuing a sovereign bond in international markets to retire Treasury bills held by the Bank amounting to Rs. 55 billion and sold a further US dollars 386 million thus raised to the Central Bank, which enabled it to settle some of its liabilities to commercial banks. During the year, NFA of the Central Bank expanded by about Rs. 93 billion. Net Domestic Assets (NDA) of the Central Bank decreased by about Rs.36 billion in 2010, which reflected largely the retirement of Treasury bills held by the Bank. Government securities on the Bank’s balance sheet decreased from around Rs. 37.5 billion at end 2009 to about Rs. 2 billion by end 2010. Following these developments, reserve money amounted to Rs. 360.5 billion by end 2010, compared to Rs. 303.5 billion at end 2009. 155

7 Monetary Policy, Money, Credit and Interest Rates

1111FebFeb1010

0 0

1212May-10 May-10 2828MarMar1010

0 0

1515Aug-09 Aug-09 0101JulJul0909

25 25 0101JulJul0909

25 25

100

28- Mar- 10

50 50

2828MarMar11Feb10 1010

Rs. billion

50 50

125

1111FebFeb1010 2828DecDec0909

75 75

28- Dec- 09

75 75

150

29- Sep- 09

100 100

2828DecDec0909 1313NovNov13Nov09 0909

100 100

through OMO

175

1313NovNov0909 2929SepSep0909

125 125

15- Aug-09

125 125

Rs. billion

150 150

Rs. Rs.billion billion

150 150

ExcessChart Money Market Liquidity 7.3 Excess Money Market Liquidity absorbed by through the Central Bank absorbed OMO

Chart 7.3

2323DecDec1010

175 175

2929SepSep01Jul09 0909 1515Aug-09 Aug-09

175 175

Central Bank of Sri Lanka Annual Report - 2010

Chart 7.4 35 30

Percent

25 20.9 18.8 18.0 15.8

20 15 10 5 0 -5

Reserve Money

Nov -10

Jul - 10

Sep - 10

May - 10

Jan -10

Mar - 10

Nov - 09

Jul - 09

Sep -09

May - 09

Jan - 09

Mar - 09

Nov - 08

Jul - 08

Sep - 08

May - 08

Jan - 08

-10 Mar - 08

The narrow money supply increased further in 2010 following its increasing trend from the second half of 2009, reflecting the recovery and subsequent expansion of economic activity. Narrow money (M1), which consists of currency and demand deposits held by the public, recorded a 20.9 per cent growth in 2010 in comparison to the growth of 21.4 per cent in 2009. The high growth of M1 could be attributed to the expansion of economic activity. Partly reflecting the relatively higher transactions demand for money in the Northern and Eastern provinces of the country, currency held by the public increased by 19.1 per cent during the year, a higher rate when compared with the 17.3 per cent growth in 2009. Demand deposits held by the public also grew by 23.1 per cent in 2010 as against the growth of 26.6 per cent

Chart 7.4 Growth of Monetary Aggregates Year-on-year Growth of Monetary Aggregares

Per cent (Year-on-year)

Economic Social Monetary Policy, Money,and Credit andInfrastructure Interest Rates

Narrow Money (M1)

M2b

side, the growth of broad money was reflected in the increases in both currency held by the public as well as deposits, particularly demand deposits. Interest bearing deposits, that is, savings and time deposits (quasi money) held by the public with commercial banks increased at a slower pace than in 2009. Quasi money with commercial banks grew by 14.6, year-on-year, in 2010, compared to the growth of 18.0 per cent in 2009.

recorded in 2009.

Broad Money (M2b) Annual average growth of broad money (M2b) was 15.3 per cent in 2010, thus remaining consistent with the targeted growth of 15 per cent. By end-December 2010, M2b recorded a year-on-year growth of 15.8 per cent. On the use

On the source side, the expansion of broad money was driven mainly by the expansion of credit obtained by the private sector from commercial banks. Credit granted to the private

Sources of Reserve Money and Broad Money (M2b)

Table 7.3

(Computed as per the Monetary Survey) Rs. billion Item

Reserve Money

End 2009 (a)

End 2010 (b)

Change 2009 Amount

2010 Amount

303.5

360.5

35.1

13.1

57.0

18.8

412.2 -108.7

505.5 -145.0

264.0 -228.9

178.2 -190.4

93.3 -36.3

22.6 -33.4

1,806.2

2,091.4

283.4

18.6

285.2

15.8

Net Foreign Assets 401.9 Monetary Authorities 412.2 Commercial Banks -10.3 Net Domestic Assets 1,404.3 Domestic Credit 1,907.7 Net Credit to the Government 640.3 Central Bank 109.0 Commercial Banks 531.3 Credit to Public Corporations 73.2 Credit to the Private Sector 1,194.2 Other Items (net) -503.5

377.4 505.5 -128.0

324.2 264.0 60.1

417.2 178.2 85.3

-24.4 93.3 -117.7

-6.1 22.6 -1,140.2

1,714.0 2,262.9 627.2 76.9 550.3 141.5 1,494.2

-40.8 10.2 57.4 -108.3 165.8 26.2 -73.4

-2.8 0.5 9.9 -49.8 45.3 55.8 -5.8

309.7 355.1 -13.1 -32.1 19.0 68.3 300.0

22.1 18.6 -2.1 -29.5 3.6 93.2 25.1

-548.9

-51.0

-11.3

-45.4

-9.0

Net Foreign Assets of the Central Bank Net Domestic Assets of the Central Bank

Broad Money (M2b)

(a) Revised (b) Provisional

156

Source: Central Bank of Sri Lanka

Central Bank of Sri Lanka Annual Report - 2010

way in the global economy helped spur credit flows to the private sector. Furthermore, the aforementioned factors are likely to have helped ease the heightened risk averseness observed among commercial banks during the previous year, thus encouraging lending activities.

NFA of commercial banks accounted entirely for the contraction of NFA of the banking system to Rs. 377.4 billion by end-2010, a contraction of around Rs. 24 billion compared to the previous year. The diminution in NFA of commercial banks was partly a result of the decline in placements overseas by commercial banks, along with an increase in their investments in Sri Lanka Development Bonds (SLDBs) during the year. Contributing to this decline was the foreign currency borrowings by the Ceylon Petroleum Corporation (CPC) from commercial banks to settle its oil import bills. The Central Bank was a net supplier of foreign exchange to the domestic foreign exchange market in 2010, as it made net sales of foreign exchange particularly in the last quarter of the year. However, NFA of the Central Bank improved during the year, following the purchase of foreign currency receipts by the government.

Net credit granted to the government (NCG) by the banking system during the year 2010 took on a negative value of around Rs. 13 billion, although it was expected that NCG would be around Rs. 45 billion in 2010, as per the national budget for 2010. Relatively lower claims of commercial banks on the government in 2010 partly on account of the settlement of a part of the liabilities of the

NDA of the banking system increased significantly when compared with the previous year, along with notable increases in credit granted to the private sector as well as public corporations. Following negative year-on-year growth during the first quarter of 2010, credit flows to the private sector rebounded strongly during the rest of the year and recorded a year-on-year growth of 25.1 per cent by December. In absolute terms, credit granted by commercial banks to the private sector increased by around Rs. 300 billion during the year. Domestic Banking Units (DBUs) accounted for the bulk of this increase, while the contribution of the Offshore Banking Units (OBUs) was trivial. The reduction of lending rates by commercial banks, following the downward revision to policy rates twice during the year, along with factors such as improved post-conflict economic conditions in the country, enhanced business confidence among entrepreneurs and the recovery under

Table 7.4

Sectoral Distribution of Loans and Advances granted by Commercial Banks (a)(b) Rs. billion

Category Agriculture and Fishing

End 2009

End 2010(c)

% Share 2010

% Change 2010

154.0

216.8

14.3

34.3 10.4 2.3 6.9

45.5 14.4 4.7 13.8

3.0 0.9 0.3 0.9

32.4 38.1 103.6 99.5

5.6 2.9

6.9 4.1

0.5 0.3

21.8 42.8

Industry

493.2

547.3

36.2

11.0

of which, Construction Food and Beverages Textiles and Apparel Fabricated Metal Products, Machinery and Transport Equipment

196.4 44.2 88.2

234.2 31.4 85.3

15.5 2.1 5.6

19.3 -28.9 -3.2

33.4

41.8

2.8

24.9

Services

242.9

320.4

21.2

31.9

94.1 30.2

108.4 32.4

7.2 2.1

15.2 7.2

39.0

65.8

4.4

68.5

8.5

11.7

0.8

37.4

Personal Loans and Advances (d)

302.5

404.6

26.7

33.7

of which, Consumer Durables Pawning

34.2 111.0

35.2 166.3

2.3 11.0

3.0 49.9

15.9

23.4

1.5

47.7

1,208.4 1,512.5 100.0

25.2

of which, Tea Rubber Coconut Paddy Vegetable and Fruit Cultivation, and Minor Food Crops Fisheries

of which, Wholesale and Retail Trade Tourism Financial and Business Services Shipping, Aviation and Supply, and Freight Forwarding

Safety Net Scheme Related (e.g., Samurdhi) Total (a) (b) (c) (d)

Includes loans and advances of Offshore Banking Units. Loans and advances include overdrafts and bills discounted and exclude cash items in the process of collection. Provisional Excludes personal housing loans classified under â&#x20AC;&#x2DC;Constructionâ&#x20AC;&#x2122;.

40.8

Source: Central Bank of Sri Lanka

157

7 Monetary Policy, Money, Credit and Interest Rates

sector, which contracted in 2009 with the downturn in economic activity, expanded at a rapid rate during the second half of 2010, making the largest contribution to the growth of broad money in 2010, in the face of the negative contribution made by NFA of the banking system to broad money expansion.

Central Bank of Sri Lanka Annual Report - 2010

Credit granted to public corporations increased during the year, thereby contributing to the monetary expansion in 2010. Credit obtained by public corporations increased from around Rs.73 billion at end 2009 to around Rs.141 billion by end December 2010. Credit granted by OBUs mainly accounted for this increase, on account of credit granted to the Ceylon Petroleum Corporation (CPC).

Broad Money (M4) Growth of broad money (M4), computed on the basis of the financial survey, decelerated during 2010, up to November, before picking up somewhat in December. Year-on-year growth of M4, which was 18.8 per cent in December 2009,

Chart 7.5 Credit granted to the Private Sector by LCBs, LSBs and RFCs

Growth of Credit granted to the Private Sector by LCBs, LSBs and RFCs

Chart 7.5 50 40

Per cent (Year-on-year)

30 20 10 0

LCBs

LSBs

Dec -10

Oct -10

Aug -10

Jun -10

Apr -10

Feb -10

Dec -09

Oct -09

Aug -09

Jun -09

Apr -09

Feb -09

-10 Dec -08

Economic Social Monetary Policy, Money,and Credit andInfrastructure Interest Rates

government to commercial banks using proceeds from the sovereign bond, the retirement of a large portion of the Treasury bills held by the Central Bank, as well as an increase in the balances of a government-held deposit in a commercial bank following the receipt of proceeds from the sale of a plot of land for a hotel project, resulted in NCG taking on a negative value by the end of the year. While NCG from the Central Bank decreased by around Rs. 32 billion during the year, NCG from commercial banks increased by around Rs.19 billion with DBUs increasing their holdings of Treasury bills, and also with an increase in the overdraft facilities extended to the government. OBUs of commercial banks meanwhile, also contributed to the increase in NCG by commercial banks, by increasing their holding of SLDBs.

RFCs

declined to 14.3 per cent by November 2010 and thereafter picked up, to 15.6 per cent in December. Given the decline in NFA of the banking system, this growth was entirely due to an increase in the NDA of the banking system and Registered Finance Companies (RFCs), on account of an increase in their claims on both the private sector and the government. Credit granted to the private sector increased rapidly during the second half of 2010, following a period of negative growth from May 2009 to February 2010. Year-on-year growth of credit granted to the private sector increased to 24.3 per cent by end 2010 from the negative growth of 3.7 per cent recorded at end 2009. Credit extended by RFCs to the private sector increased notably during 2010, contributing to about 13 per cent of the year-on-year increase in M4. Claims of Licensed Specialised Banks (LSBs) on the government meanwhile, accounted for about 9 per cent of the year-on-year increase in M4.

Sources of Broad Money (M4)

Table 7.5

(Computed as per the Financial Survey) Rs. billion Change

End 2009(a)

End 2010(b)

Broad Money (M4)

2,280.0

2,636.0

361.3

18.8

356.0

15.6

Net Foreign Assets Net Domestic Assets Domestic Credit Net Credit to the Government Credit to Public Corporations Credit to the Private Sector Other Items (net)

378.1 1,901.8 2,513.9 911.5 73.2 1,529.1 -612.1

354.5 2,282.0 2,973.9 932.4 141.5 1,900.0 -691.9

322.0 39.3 84.5 116.9 26.2 -58.7 -45.1

573.0 2.1 3.5 14.7 55.8 -3.7 -8.0

-23.6 380.1 460.0 20.9 68.3 370.9 -79.9

-6.2 20.0 18.3 2.3 93.2 24.3 -13.1

Item

(a) Revised (b) Provisional

158

2009 Amount

2010 Amount

Source: Central Bank of Sri Lanka

Central Bank of Sri Lanka Annual Report - 2010

to the effective transmission of monetary policy. The Sri Lanka Inter-Bank Offered Rates (SLIBOR), which reflect the rates offered by commercial banks when borrowing in the inter-bank call money market, moved parallel to the call money market rates.

Money

Per cent (Year-on-year)

21 19 17

15.8 15.6

15 13 11 9

M2b

Dee c-10

Dee c-09

Dee c-08

Dee c-07

De c-06

Dee c-05

D e c-04

Dee c-03

Dee c-02

Dee c-01

Dee c-00

D e c-99

Viewed from the use side, it is observed that savings and time deposits of the public held with RFCs expanded at a high rate of around 22 per cent, year-on-year, by December 2010. With respect to LSBs, there was a gradual deceleration in the expansion of deposits, in 2010. Deposits held by the public with LSBs recorded an increase of 13.5 per cent, year-on-year, by December 2010, whereas by end 2009, the increase recorded was 20.2 per cent.

7.4 Interest Rates Market interest rates adjusted downwards in 2010 in response to the easing of the Central Bankâ&#x20AC;&#x2122;s monetary policy stance. Following the significant downward adjustment of its policy rates in 2009, the Bank relaxed its monetary policy stance further in July and August 2010, with a view to providing further impetus to reviving economic activity. The Repurchase rate and the Reverse Repurchase rate were reduced by 25 basis points each in July 2010. The Reverse Repurchase rate was reduced by a further 50 basis points in August 2010. In turn, benchmark yield rates on Treasury bills adjusted downwards, leading other market interest rates on a downward sloping path.

Money Market Rates Inter-bank rates declined in 2010, having responded positively to the reduction of policy interest rates by the Central Bank. During the year, the average weighted call money rate (AWCMR) continued to hover around the middle of the policy interest rate corridor, thus contributing

As there was excess liquidity in the money market, the average weighted yield rate at the daily OMO repo auctions of the Central Bank remained closer to the lower bound of the policy rate corridor of the Central Bank until these auctions were discontinued in October 2010. It was at 7.68 per cent at the last auction held on 19 October 2010. Auctions under OMO to absorb excess market liquidity were discontinued from 20 October 2010 as it was observed that, by then, the primary market yields on 91-day Treasury bills had declined to a level below the Bank`s Repurchase rate. Since then, commercial banks have placed their excess liquidity with the Central Bank through its standing facility at the Bankâ&#x20AC;&#x2122;s Repurchase rate. Several auctions were held under open market operations for the outright sale of Treasury bills during the first ten months of the year 2010, to absorb excess liquidity on a permanent basis, while auctions for the sale of Central Bank securities with term maturities were also continued during this period. At the last OMO auction for the outright sale of Treasury bills, held on 12 October 2010, Treasury bills amounting to Rs. 1 billion with a remaining maturity of 16 days were auctioned. At this auction, the weighted average yield rate determined was 7.85 per cent. The last OMO auction for the sale of Central Bank securities with a term maturity was Table 7.6

Selected Money Market Rates Per cent per annum

Period Dec-08 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

Weighted Average Repo Auction Rate 10.96 8.24 8.13 8.18 7.86 - (a)

Average Weighted Call Money Rate

SLIBOROvernight

End Average for Period the Month

14.66 9.07 9.05 8.89 7.97 8.03

13.74 9.03 9.07 9.07 8.80 8.15

(a) CBSL discontinued Repo auctions from 20 October 2010.

15.13 9.00 9.13 9.00 8.41 8.13

15.57 9.10 9.15 9.06 8.83 8.17

Source: Central Bank of Sri Lanka

159

7 Monetary Policy, Money, Credit and Interest Rates

of Broad Chart 7.6 7 Growth 6 Year-on-year Growth of Broad Money

Chart 7.6

Central Bank of Sri Lanka Annual Report - 2010

held on 13 October 2010. While Central Bank securities amounting to Rs. 4.1 billion, with a maturity of 28 days were auctioned, the average weighted yield rate determined at this auction was 7.96 per cent (8.84 per cent with tax).

Economic Social Monetary Policy, Money,and Credit andInfrastructure Interest Rates

FX SWAPs continued to be an instrument used by the Central Bank for mopping up excess money market liquidity, following their introduction in November 2009. FX SWAPs outstanding by end 2010 amounted to Rs. 4.4 billion. On a weighted average basis, the swap cost payable by the Central Bank on the last FX SWAP transaction done in December 2010 was 15 basis points, in comparison to the weighted average swap cost of 50 basis points incurred in January 2010.

Yield Rates on Government Securities

Table 7.7

Yield Rates on Government Securities Per cent per annum

End 2009 Primary Market Treasury Bills Instrument

91 days 182 days 364 days

Treasury Bonds 2 years 3 years 4 years

Rupee Securities

7.73 8.73 9.33

End 2010

7.24 7.35 7.55

9.55 12.83 (b) 9.78

8.27 (a) 8.15 8.60

12.60 (c)

Secondary Market Treasury Bills 91 days 182 days 364 days

7.78 8.78 9.58

7.26 7.36 7.55

Treasury Bonds 2 years 3 years 4 years (a) The last auction for 2-year Treasury Bonds was held in August 2010. (b) The last auction for 3-year Treasury Bonds was held in July 2009. (c) Rupee Securities issued in March 2009.

10.00 10.88 11.08

7.65 8.03 8.78

Source: Central Bank of Sri Lanka

Following the easing of the Central Bankâ&#x20AC;&#x2122;s monetary policy stance, benchmark yields on government securities declined during the year 2010, although there was some increase in the yield rates during the first four months of the year. The primary market yields on 91-day, 182-day and 364-day Treasury bills were 7.24 per cent, 7.35 per cent, and 7.55 per cent, respectively, by the end of the year, having declined by 49 basis points, 138 basis points and 178 basis points, respectively, during the year. Secondary Chart 7.7 Market Yield Curve for Government Securities

Chart 7.7 Market Yield Curve for Government Securities Secondary 22 20

Per cent

Percent

18 16 14 12 10 8 6 0

End Dec 2008

160

4 6 Maturity - Years

End Dec 2009

End Dec 2010

Yield rates pertaining to government securities with longer maturities also displayed a declining trend in 2010. The primary market yield on 2-year Treasury bonds declined from 9.55 per cent at end 2009 to 8.27 per cent by end 2010. Similar movements were seen in yield rates pertaining to Treasury bonds of other maturities as well. Treasury bonds with long-term maturities of nine and ten years were also issued during the second half of 2010. The average weighted yield on 10-year Treasury bonds issued on 13 September 2010 was 9.30 per cent. The secondary market yield curve for government securities, whilst shifting downward, extended to longer maturities in 2010. Secondary market yields on government securities, which were in a range of 7.78 per cent to 12.07 per cent at the beginning of the year, decreased significantly to a range of 7.26 per cent to 9.45 per cent by end 2010. This downward shift in the rate structure can be attributed to the relaxation of the monetary policy stance of the Central Bank, the continued excess liquidity in the money market as well as the benign outlook for inflation that prevailed.

Central Bank of Sri Lanka Annual Report - 2010 Chart 7.8 Policy Interest Rates of theInterest Central Bank and Policy Rates

Deposit and Lending Rates

and Deposit and Lending Rates of Commercial Banks

Chart 7.8 Deposit and Lending Rates of Commercial Banks

Table 7.8

Institution

Deposit and Lending Rates (a) Per cent per annum End End 2009 2010

Commercial Banks Interest Rates on Deposits

One year Fixed Deposits 7.25-19.00 Savings Deposits 1.50-10.50 Average Weighted Deposit Rate (AWDR) 8.01 Average Weighted Fixed Deposit Rate (AWFDR) 10.91

Interest Rates on Lending Average Weighted Prime Lending Rate (AWPR) 11.12 Average Weighted Lending Rate (AWLR) 17.41

5.05-17.00 (b) 1.50-9.50 6.23 8.20 9.27 14.80

Other Financial Institutions Interest Rates on Deposits National Savings Bank Savings Deposits 5.00 5.00 One year Fixed Deposits 9.50 8.50 State Mortgage and Investment Bank One year Fixed Deposits 10.00 8.50 DFCC Bank One year Fixed Deposits 9.50 8.50 Interest Rates on Lending National Savings Bank (c) 12.00-15.00 11.00-14.00 State Mortgage and Investment Bank (c) 16.50-20.00 12.00-14.00 DFCC Bank 14.00-16.00 9.00-11.50 National Housing Development Authority (c) 11.00 11.00 (a) Based on the rates quoted by commercial Source: Central Bank of Sri Lanka banks and other selected financial institutions. (b) Maximum rate is a special rate offered by certain commercial banks. (c) Lending for housing purposes only.

Repurchase Rate Reverse Repurchase Rate Penal Rate on Reverse Repos

2010 Q3

2010 Q1

2009 Q3

2009 Q1

2008 Q3

2008 Q1

2007 Q3

2007 Q1

2006 Q3

2006 Q1

2005 Q3

2005 Q1

2004 Q3

2004 Q1

2003 Q3

2003 Q1

2002 Q3

2002 Q1

2001 Q3

2001 Q1

2000 Q3

2000 Q1

Average Weighted Deposit Rate (AWDR) Average Weighted Lending Rate (AWLR)

end of each year, reflected the decline in market interest rates1. The Legal Rate and the Market Rate applicable for the year 2011 are 7.26 per cent, each. As they are computed to be equal to the weighted average interest rate applicable to all interest bearing deposits held by the public with commercial banks, during the twelve months immediately preceding, they declined by 407 basis points from the respective rates applicable to the previous year. As the cost of funds of commercial banks declined, lending rates were also brought down gradually by commercial banks. The average weighted lending rate (AWLR), which reflects the movement of interest rates pertaining to all loans and advances granted by commercial banks to the private sector, declined significantly by 261 basis points to 14.8 per cent by end 2010. The monthly average weighted prime lending rate (AWPR) which reflects the rates applicable to loans and advances granted by commercial banks to their prime customers, declined by 185 basis points to 9.27 per cent by December 2010 from 11.12 per cent in December 2009. The declining trend in the interest 1 The Legal Rate is defined under the Civil Procedure Code (Amendment) Act No. 6 of 1990 and is applicable to any action for the recovery of a sum of money. The Market Rate is defined under the Debt Recovery (Special Provision) Act No. 2 of 1990 and applies only in relation to actions instituted by lending institutions for the recovery of debt exceeding Rs. 150,000 arising out of commercial transactions, where there is no agreed rate of interest.

161

Monetary Policy, Money, Credit and Interest Rates

The Legal Rate and the Market Rate, which are determined by the Monetary Board and published in the Government Gazette at the

Per cent

Commercial banks reduced their deposit rates gradually during the year 2010 in response to the easing of the monetary policy stance by the Central Bank. The average weighted deposit rate (AWDR), which reflects the movement of interest rates pertaining to all interest bearing deposits held by the public with commercial banks, declined by 178 basis points during the year, that is, from 8.01 per cent in December 2009 to 6.23 per cent in December 2010. A sharp decline was witnessed in the average weighted fixed deposit rate (AWFDR) in 2010, which is computed in respect of fixed deposits maintained by the public with commercial banks. The AWFDR declined by 271 basis points during the year, that is, from 10.91 per cent in December 2009 to 8.20 per cent in December 2010.

Central Bank of Sri Lanka Annual Report - 2010

Economic Social Monetary Policy, Money,and Credit andInfrastructure Interest Rates

rates charged by long-term lending institutions also continued in 2010. Meanwhile, the Central Bank requested all banks to take appropriate measures to reduce interest rates pertaining to housing loans to a level not exceeding 14 per cent, while they were also requested to bring down the penal rates of interest charged on the outstanding balances in respect of credit cards to a level not exceeding 24 per cent, by the end of October 2010. Interest rates applicable to foreign currency denominated deposits held with commercial banks in 2010 remained at low levels as the low interest rate regimes in the major economies continued. Interest rates applicable to US dollar denominated savings deposits were in a range of 0.1 per cent to 2.66 per cent by end 2010, compared to a range of 0.1 per cent to 2.64 per cent by end 2009. By end 2010, depositors holding US dollar denominated time deposits were paid interest at rates ranging from 0.1 per cent to 5.6 per cent by commercial banks. Corresponding rates were in a range of 0.2 per cent to 5.6 per cent by end 2009.

Yield Rates on Corporate Debt Securities Debt instruments issued by the corporate sector also carried lower rates of interest in 2010, following the sharp decline in market interest rates during 2009. Accordingly, interest rates pertaining to commercial paper, a shortterm debt instrument, also declined. Interest rates pertaining to commercial paper issued by banks during the last quarter of 2010 were in a range of 7.30 - 13.15 per cent. They were in a range of 9.52 - 15.75 per cent during the last quarter of 2009. There were two listings of corporate debentures in 2010. While these debentures, both with a maturity period of 5 years, were issued in June and October 2010, investors were given several options with regard to the yield from these bonds. The fixed rates of interest, payable annually, pertaining to these two bonds were 11.00 per cent and 11.50 per cent, respectively. 162

7.5 Future Developments, Challenges and Outlook Along with accelerated growth and development, aggregate demand would pick up. The Bankâ&#x20AC;&#x2122;s monetary policy therefore, would be designed to hold in check any undue build-up of demand pressures, while facilitating the realisation of the economyâ&#x20AC;&#x2122;s potential. In the global economy, recent geo-political tensions in some parts of the Middle East and Africa and natural calamities have led to volatility as well as uncertainty with regard to international commodity prices, trade and capital flows. Spillover effects of these developments on the domestic economy will continue to be closely monitored by the Bank, in order to discern implications for monetary policy, if any. Continued foreign exchange inflows, while helping the Central Bank to build up a healthy level of foreign currency reserves, have increased domestic money market liquidity to a historic high. While the resultant excess liquidity in the money market provides room for further expansion of private sector credit, persistent excess liquidity could lead to unwarranted interest rate volatility and excessive credit growth, posing a threat to monetary and financial system stability. Hence, the Bank will continue to manage the excess liquidity so as to be able to achieve its monetary targets as well as maintain interest rate stability. The ongoing fiscal consolidation efforts have created further room for private sector expansion, while impacting favourably on inflation expectations. Crowding out of private investment has become significantly less through both greater availability of credit and lower interest rates. However, the fiscal sector improvements need to be supported and sustained, for fiscal consolidation to have a long-term impact on inflation expectations as well as real activity.

Central Bank of Sri Lanka Annual Report - 2010

expectations. Also, a greater understanding of the impact of monetary policy changes on other sectors of the economy, for example, downward nominal rigidities in wholesale and retail sectors, wage behaviour in formal and informal sectors, working of the wage-price spiral â&#x20AC;&#x201C; areas that could directly affect the transmission process â&#x20AC;&#x201C; is required. The new approach is expected to supplement the existing monetary targeting framework and strengthen the control over demand driven inflationary pressures.

163

7 Monetary Policy, Money, Credit and Interest Rates

The Central Bank will continue to make further improvements to its framework for monetary policy. At the beginning of 2011, the Bank adopted a more dynamic dual approach to its monetary policy analysis. The Bank now carries out a broader and more in-depth analysis of economic developments parallel to its analysis of monetary developments. With the structural changes that are taking place in the economy, it is imperative that policy decisions are based on expected developments and aimed at influencing

FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

8.1 Overview

n 2010, reflecting the expansion of economic activity and supportive regulatory and supervisory measures, the financial sector showed improved performance, which in turn led to further strengthening financial system stability in the country. The financial sector performed well while resolving concerns and stresses that had arisen in 2008 and 2009 due to certain domestic and external shocks adversely impacting on public and investor confidence and business operations. The improved performance was reflected in all leading indicators of financial institutions, markets, payments systems and safety nets. With regard to financial institutions, the expansion of business operations supported by the recovery in credit/accommodation, improved profitability, enhanced capital adequacy and the reduced non-performing loan position with increased loan loss provision point to their better performance. Financial markets operated with high liquidity, and improved investor sentiment was reflected in the increased

volume of operations. Rising stock prices resulting in higher capital gains, declining interest rates/yield rates and an appreciation of the rupee against the US dollar with greater stability in the exchange rate were the key market outcomes. Use of the payments systems expanded while the payments system infrastructure was upgraded. The financial safety net was further strengthened with the introduction of a mandatory deposit insurance scheme for licensed banks and finance companies to protect small depositors, the implementation of a number of regulations to encourage prudence in operations of financial institutions, several rules for stock trading in the Colombo Stock Exchange to promote healthy trading and resolution action on a number of distressed financial institutions. As a result of the improved performance of the financial sector, supported by macroeconomic recovery and an enhanced safety net mechanism, no major issues concerning financial system stability remained unresolved.

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

However, a number of concerns and issues relating to performance of certain individual institutions and the sector as a whole requiring attention of the regulators and other stakeholders continued to prevail. Amongst these issues are the high intermediation cost (as reflected in high interest margins of banks), excess liquidity in relation to certain commercial banking institutions, recovering of bad assets and the effective implementation of deposit repayment plans in respect of distressed-finance companies to boost confidence, combating Ponzi schemes operated through fraudulent investment proposals and prohibited schemes operated under the mask of multi-level marketing, the sustainability of the current stock price boom, marginal level of activity and primitive status of the corporate debt securities market, lack of initiatives taken by derivatives market participants for their further development, monitoring international capital flows to promote economically healthy flows of foreign capital and the conduct of suitable programmes to enhance financial literacy of the general public. The stakeholders of the financial sector need to understand several key challenges to promote the financial sector with stability, especially in view of the lessons learned from various financial crises up to the global financial crisis of 2007-2009. First, possible emergence of financial institutions and conglomerates that would be too-big-to-fail should be managed prudently to prevent systemic stresses in the future. Therefore, the tendency or desire of financial institutions to expand in pursuit of economies of scale needs to be followed up with adequate caution. Second, the possible expansion of the segment of population consisting of middle-income earners and the expansion of financial markets will encourage commercial banks to diversify business into investment banking/ proprietary trading devices that are widely believed to be immediate sources of systemic risks. Third, market initiatives should emerge for setting up exchange-based derivatives markets in view of their role in promoting liquidity, price discovery and market risk management so as to facilitate further development of markets. Fourth, financial institutions 166

Table 8.1

Total Assets of the Major Financial Institutions 2009

Banking Sector Central Bank Licensed Commercial Banks Licensed Specialised Banks

2010(a)

Share in Share in Rs. bn Rs. bn Total % Total % 3,835.2 68.3 4,533.2 67.7 821.9 14.6 985.4 14.7 2,506.6 44.7 2,969.3 44.4 506.7 9.0 578.5 8.6

Other Deposit Taking Financial Institutions 315.7 Registered Finance Companies 185.3 Co-operative Rural Banks 124.5 Thrift and Credit Co-operative Societies 5.9

5.6 3.3 2.2 0.1

400.9 233.6 160.6 6.7

6.0 3.5 2.4 0.1

Other Specialised Financial Institutions Specialised Leasing Companies Primary Dealers Stock Broking Companies Unit Trusts / Unit Trust Management Companies Market Intermediaries (b) Venture Capital Companies Credit Rating Agencies

257.4 111.8 99.8 6.4

4.6 2.0 1.8 0.1

354.8 154.1 125.8 13.2

5.3 2.3 1.9 0.2

10.6 27.1 1.5 0.2

0.2 0.5 0.0 0.0

23.0 37.0 1.6 0.1

0.3 0.6 0.0 0.0

Contractual Savings Institutions Insurance Companies Employees' Provident Fund Employees' Trust Fund Approved Private Provident Funds Public Service Provident Fund

1,205.5 21.5 1,401.5 181.0 3.2 221.7 772.0 13.8 902.0 107.3 1.9 125.9 121.9 2.2 126.2 23.3 0.4 25.7

21.0 3.3 13.5 1.9 1.9 0.4

Total

5,613.8 100.0 6,690.4 100.0

(a) Provisional Source: Central Bank of Sri Lanka (b) Excluding the assets of Licensed Banks, Registered Finance Companies and Specialised Leasing Comapnies which are registered as Market Intermediaries.

should re-position themselves for financial innovation in products for intermediation, payments and fund transfers, financial market services, investments as well as fund management, to facilitate emerging economic activity without compromising consumer rights and protection, financial due-diligence and prudential regulations. Finally, the shadow banking system (i.e., non-banking financial intermediaries which may or may not be regulated) should be monitered and streamlined to prevent banking regulatory arbitrage that could lead to systemic risks.

8.2 Performance of the Banking Sector Beign the most dominant and systermatically important sector in the financial system, the banking sector carried out an increased volume of transactions to facilitate the highest growth of the economy. The year 2010 was a high performance year in the last decade. Its high performance was reflected in the high rate of business growth,

Central Bank of Sri Lanka Annual Report - 2010

Business Growth (a) Outreach: As at end of the year, the number of banks stood at 31 (reduced from 36 in 2009) comprising 22 licensed commercial banks (LCBs) and 9 licensed specialised banks (LSBs). The reduction was due to the vesting of the businesses of the state owned six Regional Development Banks with another newly incorporated state bank, Pradeshiya Sanwardana Bank. During the year, the Distribution of Banks and Bank Branches

Table 8.2

Category

End 2009(a) End 2010(b)

Licensed Commercial Banks (LCBs) I.Total No.of LCBs 22 Domestic banks 11 Foreign banks 11 II.Total No.of LCB Branches and Other Outlets Branches Domestic Bank Branches Foreign Bank Branches Extension Offices Domestic Banks Foreign Banks Student Savings Units and Other Outlets Automated Teller Machines

22 11 11

5,002 1,382 1,338 44 832 662 170 2,788 1,757

5,119 1,432 1,386 46 898 728 170 2,789 1,848

Licensed Specialised Banks (LSBs) I. Total No. of LSBs 14 Regional Development Banks (c) 6 National Savings Bank 2 Long-term Lending Institutions 2 Housing Finance Institutions 2 Private Savings and Development Banks 2

9 1 2 2 2 2

II. Total No. of LSB Branches and Other Outlets Branches Regional Development Banks National Savings Bank Long-term Lending Institutions Housing Finance Institutions Private Savings and Development Banks Extension Offices Student Savings Units and Other Outlets Automated Teller Machines

676 465 226 147 21 28 43 36 175 119

755 500 230 173 23 28 46 67 188 158

Total No. of Bank Branches and Other Outlets

5,678

5,874

Total No. of Automated Teller Machines (ATMâ&#x20AC;&#x2122;s)

1,876

2,006

Total No. of Electronic Fund Transfer Facilities at the Point of Sale Machines (EFTPOS)

24,977

27,588

Banking Density: No. of Bank Branches Per 100,000 Persons

9.13

9.35

(a) Revised Source: Central Bank of Sri Lanka (b) Provisional (b) During 2010, businesses of 06 Regional Development Banks were vested with a new national level Bank

banking network further expanded with the opening of 85 branches, 97 extension offices and 130 automated teller machines (ATMs). Accordingly, there were 1,932 branches, 965 extension offices, 2,977 other banking outlets and 2,006 ATMs by the end of 2010. Out of the new banking outlets, 67 branches and 77 extension offices were opened outside the Western Province, which included 21 and 27 banking outlets in the Northern and Eastern provinces, respectively. Accordingly, banking density remained at 9 branches per 100,000 persons during the year 2010. (b) Assets: Total assets of the banking sector recorded a growth of 18 per cent by the end of 2010 in comparison to a somewhat lower growth of 12 per cent in 2009. This was mainly the result of the significant growth in loans by 23 per cent compared to the negative growth of 2 per cent in 2009. The growth of loans was mainly in respect of the agriculture, consumption, infrastructure, trade and construction sectors, with annual growth of 60 per cent, 36 per cent, 29 per cent, 28 per cent and 23 per cent, respectively. The negative growth of credit card advances continued and was at a negative 3 per cent (negative 7 per cent in 2009) while advances against pawning indicated a significant growth of 40 per cent (18 per cent in 2009). Further, overdrafts and term loans including housing loans recovered from the negative growth of 14 per cent and 11 per cent, respectively, reported in 2009 to a significant growth of 35 per cent and 24 per cent, respectively, by the end of 2010. The growth in Table 8.3

Credit Card Operations by Licensed Commercial Banks 2009

2010 (a)

% Change

Total Number of Credit Cards in use 840,509 778,549 (7.4) Accepted only locally 58,302 58,771 0.8 Accepted globally 782,207 719,778 (8.0) Outstanding Credit at end-year (Rs. mn) 32,159 31,168 (3.1) Interest rates charged from customers (%) for Cash 33.00-48.00 21.96-36.00 for Credit 30.00-48.00 21.96-26.60 Commission from Dealers (%) 1.5-4.0 1.7-4.0

(a) Provisional

Source: Central Bank of Sri Lanka

167

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

improved credit quality with favourable credit-loss provision coverage, a high level of profitability, and the maintenance of capital adequacy ratios and liquidity ratios well above the statutory limits.

Central Bank of Sri Lanka Annual Report - 2010

Table 8.4 Item

2010 (a) %%ofof Rs.Rs.bnbn Total Total

2009 % of Total

Rs. bn

% Change 2010

2009

Assets Loans Investments Others

1,596 53.0 1,959 55.2 (2.3) 22.7 929 30.8 1,081 30.5 38.0 16.4 488 16.2 508 14.3 25.1 4.1

Liabilities Deposits Borrowings Capital Funds Other

2,232 74.1 2,587 72.9 18.8 15.9 389 12.8 497 14.0 (15.0) 27.7 243 8.1 293 8.3 11.2 20.5 149 5.0 171 4.8 4.9 14.8

Total Assets/Liabilities 3,013 100.0

3,548 100.0

11.7

17.7

Source: Central Bank of Sri Lanka

(a) Provisional

investments decelerated from 38 per cent in 2009 to 16 per cent in 2010. Overall, the composition of assets changed marginally where the share of loans improved from 53 per cent in 2009 to 55 per cent in 2010 and the share of investments remained at 31 per cent. (c) Liabilities: The growth of funds raised through deposit products declined from 19 per cent in 2009 to 16 per cent in 2010. However, deposits remained the main funding source accounting for 73 per cent of total liabilities. Total borrowing recorded a significant growth of 28 per cent in 2010 against the negative growth of 15 per cent in 2009 and the share of borrowings in total funds increased marginally from 13 per cent to 14 per cent. Capital funds also recorded a significant growth of 21 per cent by end 2010. However, the share of Capital funds in the total liabilities remained unchanged at 8 per cent. Funding Structure of the Chart 8.1 Chart 8.1: Funding StructureBanking Sector 100

3.0

4.9

5.3

5.0

4.8

18.1

17.5

17.0

12.9

14.0

(d) Off-balance Sheet Exposures: The offbalance sheet exposures (contingencies and commitments) increased by 19 per cent against a negative growth of 4 per cent recorded in 2009, mainly due to the recovery in foreign trading activities. Consequently, the exposure of the offbalance sheet items as a percentage of total assets increased marginally from 37 per cent in 2009 to 38 per cent by end 2010. Forward sales and purchases of foreign exchange, guarantees, bonds and letters of credit were the most demanded types of off-balance sheet facilities.

Risk Management (a) Credit Risk: Credit quality improved significantly as reflected in the decline in nonperforming loans (NPLs). The amount of gross NPLs (without interest in suspense) declined from Rs. 136 billion in 2009 to Rs. 105 billion in 2010, a fall of 23 per cent by end 2010, against the significant increase of 31 per cent in 2009. The improvement was also indicated in the NPL ratios (the ratio of NPLs to total loans) where the gross NPL ratio and net NPL ratio (net of loan loss provision) declined from 8 per cent and 5 per cent, respectively, in 2009 to 5 per cent and 3 per cent, respectively, in 2010. The share of NPLs in the loss category increased from 47 per cent in 2009 to 56 per cent in 2010 where as a corresponding decline was recorded in the share of NPLs in the substandard category, which declined from 23 per cent in 2009 to 13 per cent in 2010. Further, the loan loss provision coverage improved from 53 per cent Chart 8.2

Non-Performing Loans of the Banking Sector Chart 8.2: Non Performing Loans

160 8.5

69.8

69.6

69.5

74.1

72.9

9.1 2006 Capital Funds

168

5.6

8.0 2007 Deposits

8.1 2008

8.1 2009 Borrowings

8.3 2010 Others

120

6.3 5.2

5.0 3.4

5.3 80 3.0

2.4

2.3

2.4

70.7

72.6

79.1

103.3

135.6

104.7

2005

2006

2007

2008

2009

2010

7.1

Gross NPL Volume (Rs. billion) Net NPL Ratio (Per cent)

Gross NPL Ratio (Per cent)

Rs. billion

Per cent

As a percentage of Total Assets

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Composition of Assets and Liabilities of the Banking Sector

Central Bank of Sri Lanka Annual Report - 2010

(c) Liquidity Risk: Liquidity risk was not a major concern in the banking sector in 2010. The cumulative gap between assets and liabilities based on the contractual maturity as a percentage of the cumulative liabilities, a key liquidity risk indicator, showed a negative gap (maturity of assets longer than the maturity of funds/liabilities) for all maturities up to 5 years indicating the fundamental liquidity risk involved in financial intermediation. Further, the negative gap widened towards the period of six months. However, this gap remained unchanged at around 19 per cent for maturity periods up to one year.

Treasury Bills Treasury Bonds Sri Lanka Development Bonds Cash Money at Call Balances with banks abroad Other

Total Liquid Assets

% Change 2010 (a) % of 2009 2010 Total

Rs. bn

269.2 25.3 375.0 33.8 60.8 39.3 319.1 30.0 350.5 31.6 75.4 9.9 160.8 15.1 106.8 9.6 96.1 (33.6) 39.5 3.7 47.3 4.3 12.8 19.7 37.5 3.5 53.0 4.8 (14.8) 41.4 98.2 9.2 90.3 8.1 22.9 (8.1) 140.0 13.2 86.4 7.8 19.2 (38.3)

1,064.4 100.0 1,109.3 100.0

39.4

4.2

Source: Central Bank of Sri Lanka

(a) Provisional

overall statutory liquid asset ratio of the banking system was well above the stipulated minimum requirement (20 per cent of non-capital liabilities). This ratio was high at 36.6 per cent as at end 2010, although it tended to decline due to the increased utilisation of funds for lending business. The liquidity ratio in the specialised banking sector was excessively high due to the dominance of the National Savings Bank (NSB), which is required to invest a minimum of 60 per cent of its deposits in government securities. Investments in government securities by the banking sector accounted for nearly 76 per cent of the liquid assets consisting of investments in Treasury bills (34 per cent), Treasury bonds (32 per cent) and Sri Lanka Development Bonds (10 per cent). The balances with banks abroad (Nostro accounts) accounted for 8 per cent of liquid assets. Overall, liquid assets represented a larger share of 31 per cent in the total asset/liability base of the banking sector, which is above the cumulative negative gap at any maturity period. Accordingly, the banking system operated with a high capacity to meet any sudden liquidity requirements during the year 2010. Chart 8.3

Liquidity Ratios of the Banking Sector

Chart 8.3: Liquidity Ra os

71.1

69.4 63.6

31.7

30.4

61.0

61.9

30.4

31.3

39.2 33.0

In addition, liquid assets maintained to meet financial obligations were at high levels. The

2009 % of Rs. bn Total

Item

24.2

2005

23.9

2006

ALL LCB

25.6

24.8

2007

2008

ALL LSB

2009

74.3

36.6 29.4

2010

Industry

169

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

(b) Market Risk: The movements of interest rates have not had a significant impact on the earnings of the banking sector during the year 2010. Despite the declining interest rates in the economy, the interest margin (net interest income as a per cent of average assets) of the banking sector remained unchanged at 4.6 per cent. As regards the foreign exchange risk, the banksâ&#x20AC;&#x2122; exposure was low with the foreign currency assets and liabilities remaining low around 11 per cent and 13 per cent (net liability position of 2 per cent), respectively, of total assets and liabilities. Meanwhile, commercial banks, as authorised dealers in foreign currency, maintained a low level in relation to the over-sold position in foreign currency, with a ratio of net open position to capital base of 1.2 per cent by end 2010 expecting an appreciation of the rupee against the US dollar. Accordingly, with an appreciation of the rupee by 3.1 per cent in 2010, commercial banks were able to report foreign exchange gains (net) of Rs. 12 billion accounting for 24 per cent of total noninterest income.

Composition of Statutory Liquid Assets of the Banking Sector

Table 8.5

Per cent

in 2009 to 60 per cent in 2010. The decline in the ratio of net NPLs to capital from 26 per cent in 2009 to 14 per cent by end 2010 indicated a desirable movement of credit risk absorption capacity of the banking sector. Further, about 90 per cent of the investments of the banking industry were in the government securities, indicating a low credit risk in respect of investments.

Central Bank of Sri Lanka Annual Report - 2010

(b) Capital: Overall capital funds of the banking sector improved, thus increasing the cushion available for absorbing risks. Total capital funds grew by 21 per cent from Rs. 243 billion as at end December 2009 to Rs. 293 billion by end December 2010. Internally generated capital (Rs. 10 billion) and fresh capital infusions in several banks (Rs. 7 billion) contributed to this increase. The ratio of capital funds to assets (leverage ratio)

5 4 3

16.4

Growth 2010 2009 Amount Amount 2009 2010 (a) (Rs.bn) % (Rs.bn) %

364.3 326.1 234.0 178.7

20.5 5.3

Net Interest Income

130.3 147.4

15.2 13.2

Non-Interest Income Non-Interest Expenses Staff Cost Loan Loss Provisions (net) VAT

59.2 96.6 44.9 21.5 19.2

Profit before Corporate Tax

52.2

88.7

Profit after Corporate Tax

27.2

57.5

(a) Provisional

170

66.8 103.1 45.6 (6.4) 28.6

6.0 (38.2) (10.5) 2.3 (55.3) (23.6)

17.1

13.1

4.7 8.7 7.6 12.9 7.6 8.6 6.5 6.7 5.3 13.5 0.7 1.6 9.7 82.6 (27.9) (129.6) 3.3 20.6 9.4 48.7

1.8

3.5

(0.5) (1.9)

36.5

14.0

2 1 0

69.9

30.3 111.1

Source: Central Bank of Sri Lanka

4.4

4.6

20 15

15.2

13.4

11.8 1.8

1.2 2005

1.2

1.1

2006

2007

ROA (Left Axis)

1.1 2008

1.0 2009

Interest Margin (Left Axis)

2010

ROE (Right Axis)

improved from 8 per cent in 2009 to 9 per cent in 2010, which was a considerably higher level compared with the 4 per cent regulatory minimum applied in some countries. Further, the Regulatory Capital Adequacy ratio (CAR) remained high at 15 per cent, well above the minimum requirement of 10 per cent, as at end 2010. As a result of high growth in loans, the CAR reported a decline from 16 per cent in the previous year, since the risk weighted assets against which capital should be maintained increased by 17 per cent compared to a reduction of 2.8 per cent in 2009. Meanwhile, the Core Capital ratio was at 13 per cent, well above the minimum requirement of 5 per cent. The composition of the regulatory capital in 2010 indicated a notable change where the share of retained profit in core capital increased from 28 per cent in 2009 to 30 per cent in 2010 and the share of general provisions in Tier II capital increased from 6 per cent in 2009 to 39 per cent in 2010. However, the share of subordinated term Table 8.7

Profit of the Banking Sector

Interest Income Interest Expenses

4.4

21.6

Amount (Rs.bn) Item

4.4

4.1

Per cent

(a) Profitability: The banking industry achieved a considerably high level of profits in 2010. The profit after tax amounted to Rs. 57.5 billion during the year 2010, a 111 per cent growth in comparison to a profit of Rs. 27.2 billion in 2009. This was reflected in improved Return on Assets and Return on Equity ratios, which increased from 1.0 per cent and 11.8 per cent, respectively, in end 2009 to 1.8 per cent and 21.6 per cent, respectively, in end 2010. The significant growth in profitability was mainly attributed to a higher increase in fee-based income, a lower increase in non-interest expenses and the reversal of loan loss provisions due to reduced provisioning requirement. The interest margin (net interest income as a percentage of average assets) remained unchanged at 4.6 per cent, whereas the decline in non-interest expense and write-back of provisions contributed to the increased Return on Assets, while Return on Equity significantly improved from 11.8 per cent to 21.6 per cent.

Table 8.6

Profitability Indicators of the Banking Sector Chart 8.4: Profitability Indicators

Chart 8.4

Per cent

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Profitability and Capital

Composition of Regulatory Capital of the Banking Sector

Item Tier I Capital Share Capital Statutory Reserve Funds Retained Profits General and Other Reserves Other Tier II Capital Revaluation Reserves General Provisions Subordinated Term Debt

Total Regulatory Capital Base (a) Provisional

Amount (Rs.bn) 2009

2010 (a)

2009

2010

87.0 34.4 4.9 24.7 23.1 0.0

87.5 33.6 4.5 26.4 19.6 3.0

33 5 13 15

13.0 2.0 0.8 10.1

12.5 1.9 4.9 5.7

265

100.0

215 85 12 61 57 0

232 89 12 70 52 8

32 5 2 25

247

Composition (%)

Source: Central Bank of Sri Lanka

Central Bank of Sri Lanka Annual Report - 2010

Role of Conditions Banks in Consumer Well-Being Extreme Weather and its Impact

Banks play a significant role in facilitating day to day activities of the general public. The general public save their excess funds with banks, they borrow from banks to finance their needs and obtain other services from banks for payment transactions. The business of banks, therefore, crucially depends on trust and customer confidence. In turn, confidence depends on the extent of the safety of transactions, which requires prudence of banking operations as well as protection to customers. Conventionally, regulators have been concerned mainly about prudence, as prudent banking will finally promote customer protection. However, as a result of the recent financial crises, the regulator's attention is also increasingly drawn to explicit customer protection and rights of customers in relation to their transactions with banks. In promting customer protection the following would need to be looked into, • Availability of documents on all products/services, separately: Separate Key Facts Document containing all relevant information in the form of a brochure/leaflet written in plain language for each and every product/service should be available when making an offer or recommendation to a customer. • Clear terms and conditions in all agreements: Clear statements, terms and conditions minimise disputes and help customers take informed decisions. • Sufficient time and complete information for decision making: Sell products/services after providing proper explanations regarding the products/ services and allowing sufficient time for customers to make decisions. • Prior and timely notice before withdrawal/termination of products/services: Withdraw/terminate a product/service already in contract with reasonable notice and exit compensation.

debt in Tier II capital declined significantly from 78 per cent in 2009 to 45 per cent by end 2010. The Core Capital ratio of 13 per cent of risk weighted assets and the share capital (high quality capital

• Ethical advertising in the media: The public generally tends to believe in advertisements and expects the results/benefits in the same manner as revealed in the advertisement. Ethical advertising with actual facts, ultimately enhances public confidence in the bank. • Display information in all banking outlets: Displaying information such as interest rates applicable to deposits and advances, exchange rates and details of the Financial Ombudsman etc. in the branches and other outlets of the bank, can accelerate customers in taking early decisions. • Changes in 'Terms and Conditions' and other transaction details in statements: Timely information on changes in the ‘Terms and Conditions’ and other transaction details (i.e., statements) should be provided to the customers. • Healthy sales promotion and recovery methods by collecting agents: This will protect the integrity of customers, leading to confidence building in relation to the performance of the entire industry. • Proper grievance-resolution mechanism: An efficient and effective internal mechanism to handle customer complaints needs to be established. Regulatory intervention to safeguard customers’ interests

In Sri Lanka, at present, the Financial Ombudsman Scheme helps in resolving customer complaints. Parallel to the development of the banking industry in Sri Lanka, the protection of the customers of banks is also considered to be an area that requires the regulator’s intervention. Accordingly, the Central Bank of Sri Lanka plans to launch a ‘Customer Charter’ with the primary objective of introducing rights and obligations of customers and fair banking practices. The Charter would also mandate banks to develop a Code of Conduct for its officers which could be made available for customers as well.

to absorb unexpected losses) of 5 per cent were already above the prudential limits of 6 per cent and 4.5 per cent respectively, recommended under international standards of Basel III. 171

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

BOX 15

Central Bank of Sri Lanka Annual Report - 2010

Chart 8.5: Capital Adequacy Ra o 2.0

Rs. trillion

1.5

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

8.3 Performance of Non-Banking Financial Institutions

Capital Adequacy Ratios of the Banking Sector

1.0

14.1

14.5

14.1

14.9 13.0

12.6

12.5

1.3

1.6

1.5

2007

2008

2009

0.5 0.0

Registered Finance Companies

20 16.1

15 10

Per cent

Chart 8.5

Risk Weighted Assets (Rs. trillion)

1.8 2010

Capital Adequacy Ratio (Per cent)

Core Capital Ratio (Per cent)

Supervisory and Regulatory Developments During the year, the Central Bank further strengthened its supervisory and regulatory framework to improve the safety net and risk management systems of banks. The details of these measures are given in Part II and Part III of this Report. In addition to the continued supervisory measures through examination and problem resolution, several regulatory measures were introduced. Those included increasing the minimum capital that LCBs and LSBs are required to maintain from Rs. 2.5 billion and Rs. 1.5 billion, respectively, to Rs. 5 billion and Rs. 3 billion, respectively, on a staggered basis from 2010 to 2015, the implementation of a mandatory deposit insurance scheme, the relaxation of classification of loans as non-performing loans, the reduction of the general loan loss provision to be maintained from 1 per cent to 0.5 per cent by 31 December 2011, by reducing at a rate of 0.1 per cent per quarter commencing from the quarter ending 31 December 2010, the application of the assessment of the fitness and propriety to officers performing executive functions, requiring unlisted locally incorporated private banks to list on the Colombo Stock Exchange by 31 December 2011 and the issue of directions on outsourcing of activities. Further, work was in progress in relation to new directions to restrict credit exposure of banks through margin trading of shares, integrated risk management and the customersâ&#x20AC;&#x2122; charter. 172

Registered Finance Companies (RFCs) gradually recovered in 2010 after experiencing liquidity problems since 2009. The growth of accommodations and deposits, improved credit quality and increased profits were the favourable indicators. However, deterioration of capital and shortage of liquidity continued in a few RFCs. The resolution measures implemented by the Central Bank could boost depositor confidence in the sector and investor interest in the liquidity-threatened RFCs.

Business Growth (a) Outreach: As at the end of the year, along with the issuance of two new licences, the total number of RFCs in business increased to 37. Meanwhile, the branch network increased by 98 to 376 during the year. (b) Assets: The asset base increased substantially in 2010. The total assets stood at Rs. 234 billion, showing a growth of 26 per cent compared to the marginal 6 per cent growth reported in 2009. The key contributory factor was the increase in accommodations. Hire purchase, finance lease and pawning were the major sources of accommodations accounting for 35 per cent, 30 per cent and 10 per cent, respectively. The growth of total accommodations was 38 per cent. The increased portfolio of leasing Table 8.8

Item

Composition of Assets and Liabilities of RFCs 2009

2010 (a)

% Change

Rs.bn % of Total Rs.bn % of Total 2009 2010

Assets Loans & Advances Investments Others

113.5 15.2 56.6

61.2 156.2 8.2 20.7 30.6 56.7

66.9 1.5 37.6 8.9 3.8 35.9 24.3 15.2 0.0

Liabilities Deposits Borrowings Capital

119.8 19.2 20.6

64.6 146.1 10.4 34.2 11.1 21.6

62.6 15.8 22.0 14.7 (26.8) 78.2 9.3 (18.4) 4.8

Total Funds

159.6

Others

Total Assets/Liabilities (a) Provisional

25.8

185.4

86.1 202.0

86.5

13.9 31.6

13.5 25.0 22.6

3.0 26.5

100 233.6

100

5.6 26.0

Source: Central Bank of Sri Lanka

Central Bank of Sri Lanka Annual Report - 2010

(a) Credit Risk: A major improvement in credit risk management was not reported during the year. The total amount of non-performing accommodations continued to increase. However, the exposure to non-performing accommodations relative to total accommodations outstanding declined, as shown in the reduction in the ratio of non-performing accommodations to total accommodations from 10 per cent in 2009 to 9 per cent in 2010. When provisions for non-performing accommodations were considered, the net exposure was 5 per cent of total accommodations. Accordingly, the total provision coverage for non-performing accommodations increased from 49 per cent in 2009 to 54 per cent in 2010. The non-performing ratios of leasing and hire purchase were low at 6 per cent and 5 per cent, respectively, whereas nonperforming pawning was almost zero. (b) Market Risk: The movements in interest rates have had a significant favourable impact on the earnings during the year 2010. Despite the declining interest rates in the economy, the interest margin (net interest income as a percentage of total assets) has widened considerably to 5 per cent in 2010 from 3 per cent in 2009. Accordingly, the net

9.3

15 5.5

5.7

5.3

4.8

3.6 5 0

2.0

10 8

6.7 10

12 10.2

6 4

2.5

4.2

5.5

7.6

11.9

15.6

2006

2007

2008

2009

2010

Gross Non-Performing Advances (Rs. billion) Grosss NPA Ratio (Per cent) Net NPA Ratio (Per cent)

interest income of the sector increased by 132 per cent to Rs. 10.6 billion in the year 2010 from Rs. 4.6 billion in 2009. (c) Liquidity Risk: The liquidity position tended to improve, but liquidity shortfalls of several RFCs were reported. The total value of statutory liquid assets by end 2010 indicated a marginal deficit of Rs. 0.1 billion when compared with the amount required for meeting the minimum statutory liquid assets ratios (i.e., 10 per cent of time deposits and certificates of deposits and 15 per cent of savings deposits).

Profitability and Capital (a) Profit: Benefitting from the decline in interest rates in 2010 and improved economic activity, profitability of the RFC sector re-emerged in 2010 with the sector posting a before-tax profit of Rs. 2.2 billion compared to a loss of Rs. 1.2 Table 8.9

Item Interest Income Interest Expenses

Profit of RFCs Amount (Rs.bn)

Growth

2010 2009 Amount Amount % % 2009 2010 (a) (Rs.bn) Change (Rs.bn) Change 22.4 26.0 0.5 2.3 3.6 16.0 17.8 15.4 1.5 9.3 (2.5) (13.8)

Net Interest Income

4.6

Non-Interest Income Non-Interest Expenses Loan Loss Provisions (net)

3.8 5.1 (1.3) (25.4) 1.2 32.3 7.8 10.4 0.3 3.5 2.6 33.2 1.7 3.0 0.9 110.4 1.3 75.2

Profit before Tax Tax

Profit after Tax (a) Provisional

(1.2)

10.6

2.2

(1.0) (18.0)

(3.5) (150.2)

6.1

3.4

132.4

291.5

0.8 2.6 0.1 10.1 1.8 228.2

(2.0)

(0.4)

(3.6) (223.5)

1.6

79.8

Source: Central Bank of Sri Lanka

173

FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Risk Management

Per cent

(c) Liabilities: The increase in the growth of deposits from 16 per cent in 2009 to 22 per cent in 2010 reflected the improved depositor trust in the RFC sector. Deposits were the major source of funding representing 72 per cent of the fund base and 63 per cent of the total liabilities. Deposit mobilisation was primarily through time deposits which accounted for nearly 96 per cent of total deposits. The borrowings also rose significantly by 78 per cent compared to a decline of 27 per cent in 2009, reaching 17 per cent of the funding base. Meanwhile, capital funds increased marginally by 5 per cent reversing the negative growth of 18 per cent reported in the previous year.

Non-Performing Accommodations of RFCs Chart 8.6: Non Performing Advances of RFCs

Chart 8.6

Rs. billion

and hire purchase contributed 57 per cent to this growth. Pawning advances doubled during the year to be the fourth largest category of accommodations. However, there was a 15 per cent decline in loans against real estate.

Central Bank of Sri Lanka Annual Report - 2010

Chart 8.7

Chart 8.7: Profitability Indicators of RFCs 20 15

Per cent

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Profitability Indicators of RFCs

14.7 11.1

10 5 0

6.7 4.3 2.5

4.5 2.0

3.5

1.4

5.0 2.6

1.1

-0.7

-2.2

-5 -10 2006

2007

Interest Margin

2008

ROA

-9.2 2009

2010

ROE

billion in 2009. A considerable increase in net interest income mainly contributed to the increase in profits. The increase in profits was reflected in improved Return on Assets and Return on Equity ratios, which stood at 1 per cent and negative 2 per cent, respectively, in 2010 compared to negative 1 per cent and negative 10 per cent respectively, in 2009. However, profitability of the sector remained at a very low level. The low profitability was a result of 6 distressed RFCs, which accounted for 26 per cent of the total assets of the sector, and thus, is expected to improve in the coming years consequent to the resolution of these companies. (b) Capital: Although capital funds in the balance sheet improved marginally, the regulatory capital defined for the maintenance of capital adequacy ratios continued to erode during the year. Total regulatory capital declined from Rs. 15 billion by end 2009 to Rs. 12 billion as at end 2010. Significant losses posted by distressed companies caused this erosion of funds. However, the statutory capital adequacy ratios mostly remained above the required minimum levels. The ratio of regulatory capital funds to total deposits, which was 16 per cent as at end 2009 declined to 12 per cent as at end 2010 (statutory minimum level of 10 per cent). The core capital ratio (as a percentage of risk weighted assets) declined from 9 per cent to 5 per cent (required minimum is 5 per cent). Meanwhile, the total risk weighted capital ratio deteriorated below the required minimum of 10 per cent to 7 per cent at end 2010.

174

Supervisory and Regulatory Developments (a) New Regulations: In order to prevent unhealthy competition for deposit-taking business and ensure public confidence and sustainability, regulations were issued setting maximum rates of interest to be offered by RFCs. The draft of the Finance Business Act to replace the current Finance Companies Act was finalised with the approval of the Cabinet of Ministers to be presented to the Parliament in 2011. (b) Resolution of Distressed RFCs: During the year, efforts were made to rehabilitate six RFCs affected by the liquidity crisis that erupted at the end of 2008. Major measures included the appointment of a managing agent, new investors to infuse capital and take-over the management, the conversion of deposit liabilities and debt into equity, rescheduling of deposits and interest, the disposal of real estate properties and fast tracking the recovery of nonperforming assets. In addition, the Central Bank Credit Guarantee Scheme was in place to support the granting of credit to RFCs through licensed banks. Accordingly, three RFCs were able to commence normal business operations while the managing agent was released from two RFCs. One RFC concluded the public issue of shares successfully while another has been able to convert deposits into equity as planned. Strategic investors were identified for two RFCs while prospective investors for other RFCs were under the review and due diligence process. All distressed RFCs will be able to revive their businesses fully during 2011. (c) Action against the Conduct of Business without Authority: Investigations into institutions allegedly engaged in finance business without authority were continued while assisting courts with respect to pending litigation. The total number of such institutions and parties was 50 and the number under litigation was 15. Parallel to these measures, public awareness programmes by way of country-wide seminars/workshops as well as advertisements were carried on to educate the public on the risks of investing in unregulated institutions.

Central Bank of Sri Lanka Annual Report - 2010

Regulations for the Microfinance Sector Extreme Weather Conditions and its Impact

Microfinance The microfinance sector comprises of a variety of entities including savings associations, rotating savings clubs, credit associations, funeral or death benefit societies, and other such savings and credit clubs/groups. A microfinance institution has been defined as “a credit methodology that employs effective collateral substitutes to deliver and recover short-term, working capital loans to micro entrepreneurs” and as a poverty reduction strategy (Consultative Group to Assist the Poorest (CGAP), 2003). In terms of operational activities, it provides various financial services; including loans, savings, insurance, remittances and other services (advisory and technical services) that target low income clients, particularly, people living in poverty who were traditionally neglected by the formal banks/financial institutions. As such, microfinance is expected to expand and improve the income generation activities and capacities of the low income earners. The most popular model is the lending through selfhelp groups. This model has been successfully used as a credit delivery mechanism in the microfinance sector. Microfinance Sector in Sri Lanka • The microfinance sector in Sri Lanka consists of a large number of institutions that are different in size, activities, operating areas, operational mechanisms, institutional structures and funding methods adopted. In terms of the legal provisions, Micro Finance Institutions (MFIs) have been registered under various legal statutes, i.e., Finance Companies Act, Finance Leasing Act, Co-operative Societies Law, Samurdhi Authority of Sri Lanka Act, Agrarian Development Act, Companies Act and Voluntary Social Services Organization (Registration and Supervision) Act. • Some MFIs operate as financial intermediaries, mobilizing funds as savings or sometimes as borrowings, mainly from its members or non-members for lending, while others operate only as lending/credit institutions. The lending/credit-only institutions mobilize funds from international or local donors or borrow from the formal sector. In terms of the activities, some operate as profit-making institutions while others

are non-profit oriented. When microfinance institutions engage in deposit-taking in order to mobilize household savings, they become financial intermediaries. These institutions, if not regulated or supervised, pose concerns to the authorities/regulators as there is a responsibility to safeguard the depositors and other creditors and to protect the consumer right of the poor. • Informal or non-institutional microfinance providers include savings associations, rotating savings clubs or credit associations, funeral or death benefit societies, traders, moneylenders, input suppliers and relatives. Importance of Microfinance Most of the low income people lack access to basic financial services. Hence, the challenge of providing financial services to them still remains. Increased access to finance among the low income population would contribute towards income generation activities, and thereby improve savings habits as well as their living standards. Further, “the microfinance services helps people fight poverty on their own terms, in a sustainable way” (CGAP, 2006). Therefore, microfinance is a powerful instrument for the poor, in the form of financial services directed specifically towards poverty reduction, enabling the poor to build assets, increase their income, and reduce their vulnerability to economic stress. As a result, the poor can improve their living conditions, while taking an active role in economic activities. Need for a Regulatory Mechanism for Microfinance • To ensure an effective microfinance sector, it is necessary to have a set of sound MFIs to carry out operations in a sound and professional manner. When any institution mobilizes deposits, such institution should be subject to prudential regulation and supervision in order to safeguard the depositors. With the expansion of such MFIs, the authorities have become more concerned about the safety of the poor people’s savings being mobilized, as these MFIs are currently not subject to proper regulation and supervision under any legal statute. Regulation refers to a set of rules that the MFIs would be subject to and supervision is the process of 175

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

BOX 16

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

enforcing compliance with the rules. Lack of regulation could also be a reason why some donors/funding agencies are reluctant to provide financial assistance to the MFIs as they too believe that effective regulation and supervision is essential, in order to ensure significant outreach of the industry in an effective manner while maintaining sustainability. • As observed in many other countries, the microfinance sector in the country currently suffers from weak corporate governance, poor repayment rates, high lending rates, unethical recovery methods, high transaction costs, recurring losses and significant deficiencies in regulation and supervision. Therefore, the presence of an effective regulatory mechanism which would help streamline the operations of MFIs is essential for transmiting the real benefits accruing from the operations of MFIs to society, effectively. A regulatory mechanism would contribute towards ensuring the soundness of the sector, building up of public confidence and enhancing even wider access to funding sources. This would also discourage the emergence of fraudulent financial activities.

Specialised Leasing Companies Specialised Leasing Companies (SLCs) continued to grow in terms of business in 2010 with improvements in credit quality and favourable provisioning for bad and doubtful accommodations.

Business Growth (a) Outreach: As at the end of 2010, the number of institutions registered under the Finance Leasing Act was 70 of which 15 were licensed banks, 34 were RFCs and 21 were SLCs. The SLC sector’s branch network further expanded to 224 with the opening of 44 branches, compared to 180 in 2009. Of the new branches, 15 were opened in the Northern and Eastern provinces. (b) Assets: During 2010, the total assets of SLCs grew significantly by 38 per cent to Rs. 154 billion compared to a lower growth of 1 per cent in 2009. 176

Proposed Regulatory Mechanism • Under the proposed regulatory mechanism an authority will be established for the regulation and supervision of microfinance businesses, whereas, the Monetary Board of the Central Bank of Sri Lanka will be empowered to set regulations, principles and standards. The Board of the authority will consist of five members; i.e., an officer of the Ministry of Finance nominated by the Secretary to the Treasury, an officer of the Central Bank of Sri Lanka (CBSL) nominated by the Monetary Board of the CBSL, three members appointed by the Minister of Finance, one of whom shall be a person representing a professional accounting body, and the other two from among persons who have academic or professional qualifications in finance, banking, economics, law, management or any other related field together with relevant experience. • The authority would be empowered to grant licences to carry on microfinance business, issue directions to the MFIs (licensed/registered) on capital requirements, liquid assets, granting accommodation and acceptance of deposits. Further, it can call for information and cause examinations of MFIs and take supervisory actions including cancellation of the licenses. The high growth of accommodations, at 32 per cent, compared to the negative growth of 10 per cent reported in 2009, was the key contributory factor. The growth of accommodations was mainly in relation to finance leases and hire purchases which recorded an annual growth of 36 per cent and 50 per cent, respectively. However, the share of accommodations in total assets declined to 68 per cent with a commensurate increase in investments. Three SLCs continued to dominate the sector accounting for 72 per cent of the sector’s total assets. (c) Liabilities: Borrowing, which is the major funding source of SLCs, increased by 42 per cent from Rs. 74 billion in 2009 to Rs. 105 billion in 2010. While debt instruments retained its share in funding, other borrowings increased. Capital funds increased by 29 per cent with its share in total funding reducing marginally to 17 per cent.

Central Bank of Sri Lanka Annual Report - 2010

Item

2009 % of Total

Rs.bn

2010 (a) % of Total

Rs.bn

% Change 2009

80.0 71.7 105.4 68.4 (10.3) 31.9 29.5 26.4 40.2 26.1 (32.7) 36.3 6.3 5.6 16.8 10.9 16.9 166.7 25.3 22.7 31.8 20.7 62.8 26.0

Liabilities Debt Instruments Other Borrowings Capital Funds Other

24.0 21.4 49.9 44.7 20.5 18.4 17.1 15.5

Total Assets/Liabilities 111.5

100 154.1

(a) Provisional

21.2 14.5 46.7 (11.1) 17.2 10.8 14.8 21.4

36.6 44.3 28.9 31.8

100

38.2

1.4

Source: Central Bank of Sri Lanka

Risk Management The exposure to credit risk declined as shown by the reduction in both non-performing accommodations (NPA) volume and ratio. The NPA ratio declined to 5 per cent by end 2010 from 8 per cent at end 2009 while the NPA amount declined to Rs. 5.4 billion from Rs. 6.0 billion. A significant improvement of provisioning from 57 per cent of NPA to 78 per cent was a risk mitigation factor. The exposure to investments was high as investment in shares of subsidiaries/related companies amounted to 53 per cent of capital funds of the sector. The SLC sector benefited from the declining market interest rates as indicated by the improvement in the interest margin from 5 per cent in 2009 to 7 per cent in 2010. The sector maintained liquid assets amounting to Rs. 15 billion as at end December 2010, indicating a marginal increase of 15 per cent, compared to the increase of 127 per cent in 2009. These liquid assets stood at 14 per cent of total borrowings as at end 2010. Chart 8.8

13.4 8.8

Net interest Income Non-Interest Income Profit before Tax Profit after Tax

4.6 3.2 2.6 1.5

3.5

(b) Capital: Capital funds of the sector improved by 29 per cent to Rs. 26 billion from Rs. 21 billion as at end December 2009, mainly on account of retained profits. However, the ratio of capital to assets marginally decreased. When compared with the gearing ratio of 7 times the capital funds required under prudential regulation, maintaining it at 4 times showed the ability to manage risks with a greater level of capital.

1.3

1.8

1.9 1.1

2.3

3.2

4.8

6.0

5.4

2006

2007

2008

2009

2010

Gross Non-Performing Advances (Rs. billion) Gross NPA Ratio (Per cent) Net NPA Ratio (Per cent)

Profitability Indicators of SLCs

3.3

158.1

Chart 8.9: Profitability Indicators of SLCs

5.1

4.1

2.5

(a) Profit: Profitability improved towards the pre-2008 level. The profit after tax increased to Rs. 4 billion during the nine-month period ending December 2010, recording a 167 per cent growth compared to a negative growth in the previous year. The significant growth of profitability was reflected in the ROA (pre-tax) and ROE of 5 per cent and 20 per cent, respectively, in 2010. The ROA and ROE were 3 per cent and 10 per cent, respectively, in 2009.

2 0

Per cent

(2.5)

Profitability and Capital

5.4

4.0 0.0

14.4 (16.2) 72.6 26.0 123.1

Source: Central Bank of Sri Lanka

Chart 8.9

Per cent

Rs. billion

2010 Amount % (Rs.bn)

15.3 (1.5) (9.8) 1.9 7.4 (1.8) (17.0) (1.4) 7.9 0.3 8.0 3.3 4.0 0.6 21.8 0.8 5.8 0.3 12.6 3.2

(a) Provisional

Non-Performing Advances of SLCs 7.6

2009 Amount % 2009 2010 (a) (Rs.bn)

Interest Income Interest Expenses

Chart 8.8: Non Performing Advances of SLCs

Growth

Amount (Rs.bn)

Item

2010

Assets Accommodations Finance Leases Investments Others

32.7 72.0 26.5 22.9

Profit of SLCs

Table 8.11

20.2 17.7 15.2

11.4 10

10.1

6.9 5 3.7 0

2006

4.7

4.5

5.0

3.4

2.8

3.2

2007

Interest Margin

2008

6.6 5.1

2009

ROA

2010

ROE

177

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Composition of Assets and Liabilities of SLCs

Table 8.10

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

BOX 17

Distress Resolution: Case of and Non-bank Financial Institutions Extreme WeatherThe Conditions its Impact

Overview Non-bank financial institutions generally engage in deposit-taking at high rates of interest and offer financial facilities that include hire purchase, leasing and real estate development, which involve a relatively higher risk profile. Beginning November 2008, most in the non-banking sector comprising of 58 institutions (registered finance companies and leasing companies) started confronting depositors’ unrest due to certain shocks that resulted from local and global financial conditions. While a large number of nonbanks were able to cope with the situation prudently, 8 institutions which belonged to two business groups suffered a crisis of outflow of deposits consequent to weak risk management practices that prevailed in those institutions. As usually observed in crisis-affected financial institutions, they started confronting severe liquidity problems and ended up facing insolvency due to large losses and poor recovery of assets. However, the crisis did not have any contagion effect on the financial sector and therefore, the Central Bank as the regulator adopted a specific resolution mechanism to promote customer confidence and rehabilitation of businesses of those institutions. Distress Resolution - Policy and Measures Although the Central Bank had diverse statutory powers to intervene in distressed companies for the purpose of resolution, such as taking over the management and business, reconstitution of the board of directors, suspension of the business and liquidation, it adopted a market-based mechanism to rebuild public confidence and rehabilitate the institutions without resorting to public funds and direct involvement in management. This was specially followed from the lessons the Central Bank learned from its resolution action in relation to thirteen failed finance companies in the early 1990s. Accordingly, the specific measures implemented by the Central Bank to resolve the distressed institutions in 2008-2009 were as follows: • Appointment of Managing Agents with state’s stakes to manage the distressed companies during the interim period in order to regain depositor confidence and to perform as an agent to implement the decisions of the Monetary Board.

178

• Executive powers of directors were removed, while requiring the directors to remain on the boards and making them responsible for their affairs in the past. • The remuneration of employee directors and executives was restricted. • A ceiling on total deposit liabilities was imposed to prevent the transfer of liabilities from related entities which engaged in deposit-taking without authority. • A Stimulus Package was introduced with the help of the Government to enable the companies to raise funds using their marketable assets. • A Credit Guarantee Scheme was launched to provide access to funds from banks. • A panel of four experts representing business and legal professionals was appointed to advise the distressed companies on business restructuring. • In order to improve the capital position and lessen the deposit repayment difficulties, deposits and debts were converted into equity with the consent of the depositors and creditors. • Certain deposits were rescheduled with new repayment periods and reduced interest rates to ease the liquidity problems. • In circumstances where directors were not co-operative and effective, they were removed statutorily where their fitness and propriety to hold positions in the financial sector would be questioned. • Strategic investors were invited to infuse fresh capital and take over the management control. • Once the balance sheet was restructured with deposit/debt conversion into equity, fair valuation of assets, provisions for rebuilding a healthy financial condition and initial capital infusion, new share issues were made to augment capital further. In this regard, the unlisted institutions were required to list their shares on the stock market to facilitate rehabilitation with the participation of new shareholders and strengthen corporate governance. As a result, 3 companies were able to recommence business with new capital and strategic investors. New boards of directors were also appointed to drive the companies towards new business models. Other companies are nearing completion of restructuring as planned.

Central Bank of Sri Lanka Annual Report - 2010

To facilitate future growth with prudence, the required minimum core capital was increased from Rs. 75 million to Rs. 100 million to be effective from 01 January 2012 with further increases to Rs. 150 million, Rs. 200 million, Rs. 250 million and Rs. 300 million in 2013, 2014, 2015 and 2016, respectively. Meanwhile, the minimum capital a public company is required to have to qualify for registration was also increased to Rs. 100 million from 01 January 2011 with an annual increase of Rs. 50 million to reach Rs. 300 million by 01 January 2015. Two new Directions on reporting requirements and opening/closing/ relocating branches/business places were issued. Favourable depreciation allowances in relation to equipment, to be permitted from April 2011 when calculating tax will be beneficial to the leasing business and its profitability.

Primary Dealers in Government Securities Key financial indicators of the primary dealers showed improved performance during 2010. Risk management indicators were also maintained within prudent levels by Primary Dealers.

Assets and Liabilities: Total assets at end of 2010 amounted to Rs. 125.8 billion, which was an increase of 26 per cent over 2009. As government securities in trading, investment in government securities and reverse repos, accounted for almost 98 per cent of total assets Primary Dealers confirmed to their authorised business. The significant increase in the trading portfolio by 76.7 per cent was the main contributory factor in the increase in the total portfolio as both the investment portfolio and the reverse repo portfolio declined by 15.2 per cent and 48.7 per cent, respectively. Repos amounting to Rs.74 billion, which accounted for 73.2 per cent of total liabilities in 2009 and 58.8 per cent of total liabilities in 2010, were their key liability.

Table 8.12

Performance of Primary Dealers in Government Securities Rs. million Annual Growth (%)

Item Total Assets Dealing Securities Investment Securities Reverse Repo Equity and Liabilities Total Capital Repo Profit before Tax Profit after Tax Return on Assets % Return on Equity % Risk Weighted Capital Adequacy Ratio % Leveraging Times Dealings Primary Market Dealings Secondary Market Dealings (a) Provisional

2009

2010(a)

2009 2010

99,810 125,773 18.3 26.0 54,015 95,423 18.8 76.7 17,616 14,943 (7.7) (15.2) 24,976 12,824 56.2 (48.7) 99,810 125,773 18.3 26.0 9,958 13,417 61.9 34.7 73,032 74,001 16.0 1.3 6,215 5,455 266.5 (12.2) 4,594 4,292 308.8 (6.6) 6.2 4.3 4.2 (1.9) 46.4 35.4 27.7 (10.9) 22.4 22.6 7.4 5.5 7,982,339 7,950,922 1,522,649 1,508,645 6,459,690 6,442,277

5.9 0.1 (29.5) (25.2) 15.1 Â (0.4) 20.1 (0.9) 14.0 (0.3)

Source: Central Bank of Sri Lanka

Risk Management (a) Market Risk: Market risk continued to be the main risk as the trading portfolio consisted of 76 per cent of total assets. However, the combined effect of higher capital levels, a shorter duration of the trading portfolio and a downward shift in the yield curve during the second half of the year lowered the market risk. The stress test conducted at end December 2010 revealed that an increase of 100 basis points in yield rates would cause a loss of capital amounting to Rs.1,245 million and a reduction of the capital adequacy ratio by 2.1 per cent. This is an increase in market risk exposure compared to the corresponding results for 2009 (Rs. 853 million in capital and 0.9 per cent reduction in the capital adequacy ratio). (b) Liquidity Risk: Liquidity risk also remained low and manageable. The cumulative negative maturity mismatch for overnight, up to one week and up to one month were 4.4 per cent, 13.5 per cent and 20.1 per cent, respectively, at the end of 2010. When compared with the corresponding levels of 3.2 per cent, 7.4 per cent and 31.5 per cent as at end of 2009, liquidity risk had increased marginally up to the one week category by end 2010. However, the management of liquidity risk of primary dealers poses no concern as 98 per cent of their assets comprise highly liquid government securities. 179

FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Supervisory and Regulatory Developments

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Capital and Profit Risk management was further supported by a high capital cushion.The total capital base stood at Rs. 13.4 billion at the end of the year, recording an increase of 34.7 per cent through retained profits. Accordingly, the risk weighted Capital Adequacy ratio was maintained at a high level of 22.6 per cent, covering the high level of capital required for the increased trading portfolio. While high profitability was recorded during 2008-2009 due to declining and volatile interest rates. In 2010, profitability declined to a moderate level in response to low and stable interest rates. As a result, profits before tax declined to Rs. 5,455 million that is, by 12.2 per cent, from Rs. 6,215 million in 2009. Accordingly, the Return on Assets (ROA) as well as Return on Equity (ROE) declined to 4.3 per cent and 35.4 per cent, respectively, in 2010, from 6.2 per cent and 46.4 per cent, respectively, reported in 2009.

Market Participation During 2010, the primary dealer units of banks reported the highest participation levels in respect of both Treasury bill and Treasury bond auctions, recording 69.1 per cent and 31.5 per cent, respectively, as compared to the participation rates of 60.9 per cent and 41.2 per cent, respectively, in 2009. Participation by non - bank primary dealers declined to 7.6 per cent in relation to Treasury bills and 7.1 per cent in relation to Treasury bonds, in 2010, from the corresponding rates of 12.6 per cent and 17.5 per cent in 2009. Total secondary market dealings remained high and stable at 81 per cent of total dealings.

Insurance Companies The insurance sector, which consisted of 19 insurance companies, 48 insurance broking companies and about 37,000 insurance agents showed improved performance in 2010, as reported by several key indicators. The increase of total assets by 22 per cent, income by 40 per cent and pre-tax profit by 262 per cent shows the expansion of insurance business. The 180

asset composition tended to increase towards equities and cash/deposits while government securities remained to be the dominant asset. While both premium and investment income continued to register considerably high increases, the share of investment income tended to increase considerably from 19 per cent in 2008 to 35 per cent in 2010, with a corresponding decline in the share of premium income. Reflecting the high growth of profit, both return on equity and return on assets increased by 37 per cent and 18 per cent respectively, for general insurance, while, return on assets rose to 2.6 per cent in respect of life insurance.The solvency margin, which measures the adequacy of capital to meet obligations, improved for life insurance, and both insurance business lines complied with the minimum solvency margin requirements. Action was taken to strengthen the regulatory framework of insurance companies. The proposed amendments to the Regulation of Insurance Industry Act to strengthen prudential regulation and supervision, in order to protect the interests of policyholders, was presented to the Parliament in 2010. The Act will empower the Insurance Board of Sri Lanka to stipulate capital requirements for insurance companies and brokers, make rules and determinations in realation to the conduct of insurance business, Key Financial Indicators of Insurance Companies

Table 8.13

Rs. million Item

2008

2009

2010 (a)

Total Assets 155,994 181,045 221,736 Government Securities 64,361 78,083 89,642 Equities 16,352 22,108 32,696 Cash & Deposits 14,168 14,412 25,790 Total Income 71,902 76,213 105,060 Premium Income 58,166 57,252 68,493 Investment Income 13,736 18,961 36,567 Profit Before Tax 2,775 4,994 16,563 Solvency Margin Ratio - Life Insurance 5.0 4.9 5.1 - General Insurance 2.7 2.8 2.6 Retention Ratio (%) - Life Insurance 96.0 96.4 97.0 - General Insurance 70.5 72.7 75.7 Claims Ratio (%) - Life Insurance 26.6 43.6 38.3 - General Insurance 64.9 63.2 61.8 Combined Operating Ratio (%) - Life Insurance 51.1 69.7 60.4 110.4 91.0 86.0 - General Insurance Return on Assets (ROA) (%) - Life Insurance 8.4 2.4 2.6 5.4 4.0 18.1 - General Insurance Return on Equity (ROE) (%) - General Insurance 2.6 8.9 36.9 Underwriting Ratio (%) - General Insurance 18.5 21.0 32.0 (a) Provisional

Source: Insurance Board of Sri Lanka

Central Bank of Sri Lanka Annual Report - 2010

Unit Trusts The unit trust (UT) sector expanded as indicated by three new entrants, a substantial growth in net asset value (NAV), investors and the number of units in issue in 2010. As at end 2010, there were 21 UTs under six management companies. The total number of unit-holders increased by 6.6 per cent to 24,640 with the total number of units in issue almost doubling to 1.16 billion. The NAV grew by 122 per cent to Rs. 22 billion at end 2010. Although considerable increases in investments in equities and government securities were reported, the share of equities in the investment portfolio fell to 53 per cent while the share of government securities increased to 34 per cent. The improved profitability was reflected in the Table 8.14

Details

Selected Indicators of the Unit Trust Industry

2007

2008

2009

2010

No.of Unit Trusts 14 17 18 21 Total No.of Unit Holders 23,191 22,699 23,116 24,640 No.of Units in Issue (Mn.) 470 638 564 1,159 Total Assets (Rs.Mn.) 6,332 6,801 10,004 22,176 Net Asset Value-NAV (Rs.Mn.) 6,295 6,781 9,952 22,060 Investments in Equities (Rs.Mn.) 3,649 2,589 6,036 11,743 % of Total Assets 57.6 38.1 60.3 53.0 Investments in Government Securities (Rs.Mn.) 808 2,575 3,008 7,532 % of Total Assets 12.8 38.0 30.2 34.1 NAV per Unit (Rs.) 13 11 18 19 Dividend per Unit (Weighted Average) (Rs.) 1.33 1.01 0.96 1.21 Source: Unit Trust Association of Sri Lanka

increase in dividends (estimated weighted average) paid to unit holders from Rs. 0.96 to Rs. 1.21. However, the improvement of net asset value per unit was only marginal from Rs. 18 to Rs. 19. One of the budget proposals for 2011 was to exempt foreigners and foreign funds from exchange control restrictions on investments in UTs and, therefore, the UT sector will be another attractive investment avenue in the future.

Superannuation Funds Superannuation funds consisted of three state-managed funds and 170 privately managed approved provident and pension funds. The size of the sector estimated in terms of assets increased by 15 per cent to Rs. 1,180 billion as at end 2010 from Rs. 1,024 billion as at end 2009. The two state funds, Employees’ Provident Fund (EPF) and Employees’ Trust Fund (ETF) operating under specific Acts, accounted for 89 per cent of total assets of the industry. Both funds maintained high profitability to pay interest on member balances at 12.5 per cent, which was well above the market interest rates. The EPF, which is the largest fund accounting for 76 per cent of the total assets recorded a growth of 16 per cent and stood at Rs. 902 billion at end 2010. Total net contribution (contribution less refunds of benefits) continued to improve to Rs. 20 billion in 2010 compared with Rs. 17 billion in 2009. The investment portfolio was predominately held in government securities in view of maintaining long-term safety of the fund and the non-availability of alternative avenues for safe and liquid investments of large scale. The share in government securities at 94.1 per cent as at end 2010 showed a decline, with the EPF increasing its portfolio of equity investments during the year. The overall return on investments marginally declined by 100 basis points due to declining interest rates in the market although the net profit amount available for distribution increased by 9.6 per cent. In line with the decline in return on investment, the interest rate paid on member balances too declined by 125 basis points to 12.5 per cent in 2010. The ETF, which accounted for 11 per cent of the sector also showed 181

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

engage in dispute resolution and prescribe the “fit and proper” criterion for the appointment of directors and brokers. The Act also provides for the requirement in accordance with which long-term and general insurance business are to be conducted by separately incorporated companies, with existing insurers being given time to segregate business. All insurance companies will be required to list on the stock exchange. The removal of the war risk premium for Sri Lanka by the London Joint Cargo Committee in June 2010 and the reduction of the premium for terrorism cover by the National Insurance Trust Fund by 75 per cent in April 2010 will reduce the cost of insurance to policyholders.

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

BOX 18

Investments by Employees’ Provident in the Stock Market Extreme Weather Conditions and itsFund Impact

The Employees’ Provident Fund (EPF) is the largest superannuation fund with an asset base of Rs. 900 billion which accounts for 14 per cent of the total assets of Sri Lanka’s financial system. The investment policy of the EPF continued to be focused on obtaining a positive real return on a sustainable basis to its members while ensuring the safety of the Fund. With the rapid growth of the Fund, the available investment opportunities need to be expanded to enhance the return to its members while managing the risks of such investments. EPF’s Investments in the Stock Market Sri Lanka's stock market recorded substantial gains during the past two years with the end to the threedecade-long conflict in May 2009 and the resulting renewed investor confidence. The price indices of the four major sub-sectors in terms of market capitalization, i.e., Diversified Holdings; Bank, Finance and Insurance; Food, Beverage and Tobacco; and Hotel and Travel sectors have increased significantly during the past two years. Within this milieu, the EPF increased its investments in the equity market during the past two years, by investing in fundamentally sound companies in these sectors. Since a major portion of the equity investments by the EPF were made with a long-term focus, considerable gains are expected to be realized in the future. During 2010, equity investments by the EPF have been able to generate a sizeable income which included both capital gains and dividends. In addition, the EPF also received a substantial amount of unrealized gains from its equity portfolio. As a result of these investments, the EPF members were able to reap the benefits of the stock market boom and at the same time, EPF will continue to be able to pay interest at a higher rate to its members on their balances. Further, a great majority of the public including members of the EPF, do not possess the knowledge or the capacity to invest similar performance. The growth of assets by 17 per cent, a decline in the share of government securities in investments by one percentage point, a decline in the return on investment by 130 basis points and the payment of interest on member balances at 12.5 per cent were the key performance indicators. The Public Service Provident Fund managed by 182

and benefit from share market activity individually. Hence, the EPF’s investments in the share market have enabled its members to indirectly own a stake in some financially stable, fast growing companies and benefit from the country’s economic development. The government has planned to reduce the budget deficit to GDP ratio from 8 per cent in 2010 to 6.8 per cent in 2011. One percentage point reduction in the budget deficit will lower the government borrowing requirement by about Rs.60 billion. Since the budget deficit is expected to decline further in the medium to long-term resulting in reduced borrowing by the government, shifting a part of the funds of the EPF to other profitable investment avenues such as listed and unlisted equities, debentures and mortgage backed securities, is a prudent investment strategy in managing the funds of the EPF. EPF’s Contribution to Capital Market Development The presence of large institutional investors is crucial for the development of our capital market. In many markets, institutional investors such as pension funds, unit trusts and mutual funds, play a significant role in the stock market when compared to individual investors. Unlike the retail investors, large institutions invest with a long-term focus and are not affected by the shortterm price fluctuations. Since their investment capacity is relatively high, institutional investors can correct the stock market inefficiencies such as speculative actions thereby stabilizing the market in the long-run. In addition, the presence of large local institutional investors in the equity market is critically important to build investor confidence among the retail and foreign investors. Hence, as a large institutional investor, the EPF has supported the development of our capital market through its equity investments by creating longterm market stability and building investor confidence. the Department of Pensions for about 242,500 members owned assets amounting to Rs. 26 billion with investments of Rs. 23 billion compared to assets of Rs. 22.7 billion as at end 2009. Total assets of the 170 privately managed approved provident and pension funds covering about 157,500 members increased to Rs. 126 billion from Rs. 122 billion in

Central Bank of Sri Lanka Annual Report - 2010

Details

Key Indicators of EPF and ETF

EPF

ETF

2009(a) 2010(b) 2009(a) 2010(b)

Total Assets (Rs.bn) 772.0 902.0 107.3 125.9 Total Member Balance (Rs.bn) 752.5 869.0 103.1 119.9 Number of Member Accounts (mn) 12.8 13.3 8.9 9.1 Number of Active Member Accounts (mn) 2.1 2.3 2.1 2.1 Number of Employers contributing 61,396 62,000 61,237 62,731 Total Contributions (Rs.bn) 48.7 54.8 8.7 9.8 Total Refunds (Rs.bn) 31.9 34.9 6.4 6.4 Total Investments Portfolio (Rs.bn) 738.1 867.1 101.0 118.9 o/w : Government securities (%) 97.1 94.1 91.4 90.5 Gross Income (Rs.bn) 109.8 121.3 14.5 15.5 Profit Available for Distribution (Rs.bn) 101.7 111.5 14.2 14.6 Return on Investments (%) 16.0 15.0 15.2 13.9 Interest Rate paid on Member Balances (%) 13.8 12.5 13.0 12.5 (a) Revised (b) Provisional

Sources: Central Bank of Sri Lanka Employees’ Trust Fund Board

2009 with investments amounting to Rs. 107 billion at end 2010. The need for the establishment of a regulator for provident and pension funds for the purpose of prudential regulation and supervision to ensure the safety and soundness of these funds has been recognised and appropriate action in their regard will be initiated in the near future.

8.4 Performance of Financial Markets Money Market In 2010, the money market continued to remain highly liquid with excess liquidity in the commercial banking system. At the beginning of the year, the commercial banks’ liquidity surplus stood at around Rs.109 billion and increased to Rs. 124.3 billion towards the end of the year. Accordingly, the total call money transactions volume declined by almost half in 2010 compared to the 6 per cent increase in 2009, while the inter-bank overnight call money rates declined considerably Table 8.16

Market Call Money Inter-bank repo Central Bank repo Central Bank reverse repo Central Bank Securities

to a range of 7.83-9.43 per cent. However, interbank Repo transactions (based on government securities) remained almost unchanged at the 2009 level, but with a noticeable decline in Repo interest rates to a range of 7.05 per cent, to 8.53 per cent, which was lower than the range of call money rates. Further, transactions at the Central Bank’s Repo window rose, due to both the excess liquidity and the Central Bank’s continued action to mop up the excess liquidity. The Central Bank’s Reverse Repo window stayed dormant.

The Domestic Foreign Exchange Market In view of the foreign currency inflows, the Sri Lanka rupee appreciated gradually during the year. The rupee appreciated against the US dollar by 3.09 per cent from Rs. 114.38 to Rs. 110.95. The appreciation of the rupee against the euro and the Sterling pound were at 10.95 per cent and 6.03 per cent, respectively. However, the rupee depreciated against the Indian rupee and the Japanese yen by 0.73 per cent and 8.80 per cent, respectively. The average US dollar buying and selling rates of commercial banks for telegraphic transfers decreased to Rs. 110.20 and Rs. 112.02, respectively, at the end of 2010, from Rs. 113.61 and Rs. 115.15 recorded at the end of 2009. The total inter-bank foreign exchange transactions during 2010 increased to US dollars 11,066 million from US dollars 10,959 million in 2009. The daily average volume was US dollars 46.3 million compared with US dollars 45.4 million in 2009. As in the past, the Central Bank continued to intervene in the domestic foreign

Money Market Transactions

Volume (Rs. billion)

Interest/Yield Rates

2008 2009 2010 2008 2009 2010 1,927 932 851 905 176

2,040 1,162 1,786 907 1,781

996 1,128 10,723 - 1,467

12.52-21.13 12.03-21.76 10.50-15.94 12.00-19.00 10.50-16.25

8.58-15.54 8.29-15.01 7.50-10.90 9.75-19.00 7.50-9.62

7.83-9.43 7.05-8.53 7.25-8.25 9.75 -9.00 7.25-8.85

Source: Central Bank of Sri Lanka

183

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Table 8.15

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

exchange market to prevent any excessive volatility in the exchange rate. During 2010, the Bank bought US dollars 753.2 million from the domestic foreign exchange market. However, the Central Bank had to sell US dollars 819.80 million mainly towards the latter part of the year as a result of the increase in import bills mostly due to oil bills following the rise in crude oil prices in the international market. This resulted in net sales of US dollars 66.6 million in 2010 when compared to the net purchases of US dollars 2,291.9 million in 2009. Reflecting improved foreign investor confidence, the net inflow of foreign investments through defferent financial instruments such as equities, government securities and deposits amounted to Rs. 51.8 billion (US dollars 458 million) in 2010. This position was reflected in inflows and outflows through Securities Investment Accounts (SIAs), which are the rupee accounts required to be maintained under exchange control regulations in order for foreign investors to route their financial investments. These accounts reported an inflow of funds amounting to Rs. 215.9 billion and an outflow of funds for repatriation of investments, dividends/ income, etc., amounting to Rs. 164.1 billion. Several exchange control relaxation measures coupled with prudential safeguards, were implemented in 2010 to further improve the convertibility of the rupee for international transactions. These related to the introduction of Securities Investment Accounts for foreigners to route financial investments, permission for foreign investments in corporate debentures up to 50 per cent, expedited approval for foreign borrowing by companies and sole proprietorships, permission for foreign companies to open places of businesses in Sri Lanka and Sri Lankan companies and partnerships to open places of business outside Sri Lanka, permission for pre-payment of import bills, removal of the 100 per cent margin requirement in respect of imports of selected consumer items, increasing the limit on advance payments for imports from US dollars 10,000 to US dollars 50,000, further relaxation of forward contracts in foreign currency by banks with eligible customers, foreign currency accounts for international service providers and their employees, permission for individuals, companies and partnerships in Sri 184

Lanka to invest in shares of foreign companies and sovereign bonds issued by foreign governments and governmental institutions up to certain annual limits and permission for certain types of Sri Lankan residents such as exporters to maintain accounts with banks outside Sri Lanka. These measures, coupled with surveillance, are expected to promote foreign investor confidence and stable capital flows, which will facilitate the mobilisation of resources competitively from global markets to finance the domestic savings-investment gap to secure a high rate of economic growth.

Government Securities Market The issues of government securities in the primary market as well as trading in the secondary market indicated increased activity. Although the total of Treasury bills and Treasury bonds issued through primary dealers remained almost unchanged at Rs. 1.5 trillion in 2010, with respect to the composition issues of Treasury bills increased as a per cent of the total issues. Secondary market transactions almost doubled to Rs. 41.2 trillion. It was noticed that activity in the secondary market for Treasury bills surpassed that of Treasury bonds. The number of investor accounts at LankaSecure (Depository System) also increased by 13 per cent to 73,396. With the easing of the monetary policy stance and improved market liquidity, yield rates moved downwards in 2010. Further, the range within which the yield rates changed during the year also narrowed significantly. The yield rates of Treasury bills, which were in a range of 7-19 per cent in 2009 declined to a range of 7-9 per cent in 2010. The corresponding Market Volumes of Government Securities

Table 8.17

Rs. billion Item Issued in the Primary Market Treasury bills Tresury bonds Trading in the Secondary Market (as recorded in LankaSecure) Treasury bills Tresury bonds No. of Investor Accounts at LankaSecure

2008

2009

1,268.3 1,522.6 779.6 821.2 488.7 701.4

2010 1,508.6 1,000.1 508.6

17,562.7 20,542.5 41,250.0 7,566.0 8,048.6 21,379.7 9,996.8 12,493.9 19,870.3 56,041 64,680 73,396 Source: Central Bank of Sri Lanka

Central Bank of Sri Lanka Annual Report - 2010 Market Yield Rates of Government Securities Per cent per annum Item

Primary Market 2008

Treasury bills 91 day 16.46-21.30 182 day 17.45-19.99 364 day 18.34-19.96 Treasury bonds 2 yrs 17.79-20.53 3 yrs 16.90-20.34 4 yrs 16.89-19.09 5 yrs 17.00 6 yrs 10 yrs

2009

Secondary Market 2010

2008

2009

2010

7.25-17.31 8.33-18.57 9.17-19.12

7.02-8.52 6.95-9.24 7.10-9.47

16.33-19.33 17.54-19.37 18.35-19.51

7.33-17.70 8.27-18.53 9.12-19.16

6.62-8.57 6.89-9.14 7.06-9.48

9.55-21.00 12.83-20.10 9.78-18.10 10.32-13.00 9.92-16.50 13.09-13.74

8.27-9.60 8.15-9.78 9.09-9.80 8.76-9.90 8.93-9.92 9.30-9.80

17.50-20.86 17.19-20.00 16.21-20.25 16.00-19.74 15.61-19.50 14.63-18.19

9.56-20.25 9.81-19.70 9.69-20.08 9.99-19.67 10.05-19.67 10.08-18.63

7.53-10.68 7.78-11.48 8.18-12.01 8.79-12.05 8.87-12.25 9.04-12.61

Source: Central Bank of Sri Lanka

decline in the rates pertaining to Treasury bonds was from a range of 10-20 per cent in 2009 to a range of 8-13 per cent in 2010. During the year 2010, the government was able to raise US dollars 1,000 million through its third international bond issue which was listed on the Singapore exchange at a comparatively attractive rate of 6.25 per cent. The previous 5-year international sovereign bond was issued at a weighted average yield rate of 7.40 per cent, in 2009. Consequently, the yields of the two previous international sovereign bonds of US dollars 500 million each raised in 2007 and 2009 too declined by about 180 bps. Foreign investment in Treasury bills and Treasury bonds also reached the ceiling of 10 per cent of the total outstanding. Foreign investments in Treasury bills amounted to Rs. 57 billion in while foreign investments in Treasury bonds amounted to Rs. 184 billion by end 2010.

Colombo Stock Market Activity at the Colombo Stock Exchange (CSE) rose to historically high levels in 2010. The CSE thus became one of the best performing stock exchanges in the world. The All Share Price Index (ASPI) rose by 96 per cent and the Milanka Price Index (MPI) increased by 83 per cent in 2010. All sub sector price indices increased contributing to the upward trend of the ASPI and the MPI. The number of shares traded increased by four times and the average daily turnover rose by more than three times.

The market price earnings ratio increased further in 2010 and reached 25.2 as compared to 16.6 in 2009. The market capitalisation of the CSE, which more than doubled in 2009, doubled again in 2010 reaching Rs. 2.2 trillion by end 2010. The five largest sub-sectors in terms of market capitalisation, i.e., (i) Banking, Finance and Insurance, (ii) Diversified Holdings, (iii) Beverage, Food and Tobacco (iv) Hotel and Travel and (v) Telecommunications sectors, which accounts for 74 per cent of the total market capitalisation, were the main contributors to the boom in the stock market during 2010. Net foreign sales increased to Rs. 242.3 billion driven by the realisation of capital gains amidst high price increases of many stocks. New share issues also rose during 2010 with eight new Initial Public Offers (IPOs) being announced which were significantly over-subscribed, reflecting positive investor sentiment. More than Rs. 4.3 billion was raised through IPOs during the year. Further, 28 companies made Rights Issues and raised a total of Rs. 24.3 billion. Several regulatory measures were introduced to facilitate the conduct of stock market activity in a healthier manner. In order to address sharp upward movement in share prices and excessive speculative trading activity, the Securities and Exchange Commission (SEC) imposed a 10 per cent upward and downward “price band” on all stocks in August 2010. This “price band” was replaced in September 2010 by a revised 10 per cent upward and downward “price band” imposed on selected stocks according to a formula based on 185

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Table 8.18

Central Bank of Sri Lanka Annual Report - 2010 Colombo Stock Market Selected Indicators

Item All Share Price Index (a) Year-on-year change (%) Milanka Price Index (a) Year-on-year change (%) Market Capitalisation (Rs.bn.)(a) As a percentage of GDP (%) Market Price Earnings Ratio (a) Turnover to Market Capitalisation (%) Average Daily Turnover (Rs.mn) Value of Shares Traded (Rs.bn.) Number of Shares Traded (mn.) Number of Companies Listed Introductions (b) Number of Initial Public Offers/Offers for Sale (b) Number of Rights Issues Amount Raised through Rights Issues and Initial Public Offers(Rs.mn.) (a) End of the year

Chart 8.10

2008

2009

2010

1,503.0 (40.9) 1,631.3 (50.5) 488.8 11.4 5.4 22.6 465.0 110.4 3,155 235 1

3,385.6 125.3 3,849.4 136.0 1,092.1 22.9 16.5 13.0 593.6 142.5 4,929 231 0

6,635.9 96.0 7,061.5 83.4 2,210.5 39.4 25.2 25.8 2,396.3 570.3 18,489 241 2

2 9

3 14

8 31

4,409

6,205

28,669

Source: Colombo Stock Exchange

(b) There are 3 methods to obtain a listing: i.e an introduction where no public issue is required, an offer for sale where already existing shares are issued to the public and an offer for subscription where new shares are issued to the public.

the price volatility and volume traded of the stock. From January 2011 stockbrokers were prohibited from extending credit beyond T+3 to investors for buying shares and credit beyond T+3 since then can be extended only by margin providers. Stockbrokers were also required to reduce their existing debtor positions by 50 per cent by end March 2011 and by 100 per cent by end June 2011. Further, stockbrokers were mandated to force-sell stocks of investors who are in default of settlement by T+5. The brokers were also mandated to obtain a minimum of 50 per cent of the settlement value upfront from the investors who wish to purchase stocks subject to the price band. The two band fee structure inclusive of brokerage fees and other government levies relating to equity trades, i.e., 1.425 per cent for value of transactions up to Rs. 1 million and 1.225 per cent for value of transactions from Rs. 1 million up to Rs. 100 million, was removed with effect from 30 June 2010. The reduced new fee structure for transactions up to Rs. 50 million is 1.020 per cent and the threshold level for negotiated brokerage was reduced to Rs. 50 million. The tick size, which is the incremental change of the share price that can be quoted when buying or selling, was also reduced to 10 cents with a view to increasing the number of transactions in the market. In the event a listed company is transferred to the Default Board for 186

Share Price Indices

8.10 : Share Market Indices 9,000

Index Value

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

Table 8.19

8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

2006

2007

All Share Price Index

2008

2009

2010

Milanka Price Index

not submitting financial reports/accounts, the directors of such listed company are prohibited from trading in the shares of that company as they have unpublished price sensitive information. With effect from 1 January 2011, all new issues should be in de-mat form and a one year transition period has been permitted for all existing securities.

Commercial Markets

Paper

and

Debenture

Both markets continued to record low activity during the year 2010. The total value of commercial paper issued with the support of banks such as credit lines, declined to Rs. 12 billion in 2010 when compared with Rs. 22 billion in 2009. Interest rates also declined significantly to a range of 7 to 16 per cent from a range of 9 to 36 per cent in 2009. Nearly 97 per cent of the commercial paper had a maturity period up to 3 months. The total outstanding value of commercial paper reduced from Rs. 6 billion as at end December 2009 to Rs. 4 billion as at end December 2010. There were only two issues of debentures during the year 2010, i.e., 5 year debentures issued by Bank of Ceylon for Rs. 5 billion and by the Urban Development Authority for Rs. 10 billion. The trading turnover of debentures listed on the Debt Securities Trading System (DEX) of the CSE declined from Rs.137 million in 2009 to Rs. 72 million in 2010. With a view to broadening the investor base and improving liquidity in the secondary market, exchange control regulations were relaxed to permit foreigners to invest in rupee denominated debentures issued by local companies up to 50 per cent of the issue.

Central Bank of Sri Lanka Annual Report - 2010

Payment and Settlement Systems During the year 2010, the usage of payment systems improved in terms of both volume and value of transactions. The total volume of payments through the Real Time Gross Settlement System (RTGS), the Cheque Imaging and Truncation System (CITS), the Sri Lanka InterBank Payment System (SLIPS), as well as through Credit Cards and Debit Cards increased by 10.8 per cent with a 41.4 per cent increase in the total value of payments. In February 2010, the procedure of granting the Intra-day Liquidity Facility (ILF) to institutions participating in the RTGS was upgraded to providing ILF at their discretion, deviating from providing ILF only on request. Further, a mechanism was introduced to the LankaSettle system to deal with daily transactions in the event of special holidays being declared. SLIPS was upgraded to provide online connectivity to the participating institutions. The upgraded system also enables any participant to transmit multiple outward files to the operator (LankaClear (Pvt) Ltd) during one session, and the usage of digital signatures for authentication of inward and outward files and multiple settlements of net balances through the RTGS. Accordingly, SLIPS was advanced to a payment system with same day settlement (T+0) for transactions submitted to the operator before 12.00 noon. Subsequent to the upgrade, SLIPS has a capacity of handling 1.2 million transactions during a normal business day. To eliminate the time lag associated with the practical issues in the Table 8.20

System Real Time Gross Settlement System Cheque Imaging and Truncation System Sri Lanka Interbank Payment System Credit Cards Debit Cards Total

movement of physical cheques from bank branches to LankaClear regional centers and subsequently transmitting cheque images from regional centers to LankaClear (Pvt) Ltd. and as well as the cost of maintaining such centers, participating banks were instructed to capture the cheque images at the branch level and submit those images to LankaClear (Pvt) Ltd in Compact Discs (CD). All banks were able to successfully implement this CD submission system connecting all their branches online to the head offices. Subsequently, regional centers were terminated in 2010.

Regulatory Improvements Under the Service Providers of Payment Cards Regulations No. 1 of 2009, fourteen licensed commercial banks, two registered finance companies and one licensed specialised bank were issued licences to operate as service providers of payment cards under five categories, namely, card issuer, financial acquirer, operator of payment system, operator of clearing system and operator of settlement system, based on their business activities. Further, Credit Card Operational Guidelines No. 01 of 2010 was issued to payment card service providers who engage in credit card business. Having observed the need to broaden the regulatory framework of payments and settlements systems to ensure safety, efficiency and stability of the emerging electronic fund transfer mechanisms, mobile payments guidelines were prepared and will be released to the banking system in the near future. Further, guidelines for internet payments were also under drafting to be finalised during the second half of 2011.

Transactions Through Payments Systems

Volume (000) 2008

2009

% Change 2010

2009

2010

Value (Rs. billion) 2008

2009

2010

% Change 2009

2010

229 233 247 1.7 6.0 25,131 33,155 47,806 31.9 44.2 44,550 40,637 42,795 (8.8) 5.3 4,693 4,391 5,346 (6.4) 21.7 7,845 9,034 12,530 15.2 38.7 236 279 332 18.2 19.0 18,866 16,627 16,451 (11.9) (1.1) 73 65 75 (11.0) 15.4 2,174 3,309 5,340 52.2 61.4 6 11 16 83.3 45.5 73,664 69,840 77,363 (5.2) 10.8 30,139 37,901 53,575 25.8 41.4 Source: Central Bank of Sri Lanka

187

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

8.5 Financial Infrastructure

Central Bank of Sri Lanka Annual Report - 2010

Economic and Social Infrastructure FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

BOX 19

Value Chain Approach: Extreme Weather Conditions and its Impact An Alternative Way of Small Enterprise Development

Over the years, income generating projects, aimed at increasing the well-being of poor and disadvantaged people, have provided a package for their beneficiaries that includes short-term job oriented training and a loan to commence self-employment. This short-term training is insufficient to develop needed technical and entrepreneurial skills and, furthermore, the poor and disadvantaged are the least able to bear the risk of starting a new venture. Most of these beneficiaries, without market analysis, choose activities such as poultry farming, retailing, food processing and tailoring that have low entry cost. The low rate of return of these activities coupled with the low level of productivity, often fails to uplift the living standards of those self-employed. Recent experiences in poverty reduction strategies implemented all over the developing world have clearly emphasised two realities: Poverty alleviation cannot be sustained in the absence of economic growth, and economic growth cannot be sustained in non-competitive industries. The concept of the value chain approach focuses on industries employing a large number of disadvantaged people and/ or industries with high levels of micro and small enterprise (MSE) participation, with the potential to

Chart B 19.1

become and remain competitive in national and global markets. It is argued by the proponents of the value chain approach that the best way to support the poor, over the long run, is to support the industries in which they participate. A value chain refers to all the activities and services that bring a product (or a service) from conception to end use in a particular industry. It includes input suppliers, producers, processors, wholesalers and retailers that produce, transform, store, transfer and market the product, adding to its value at each step in the chain. The value chain approach views the value chain in the backdrop of the market system in its totality. It comprises the firms that operate in the industry from input suppliers to end market buyers, the support markets that provide technical, business, and financial services to the industry, and the business environment (this includes laws, regulations, policies, international trade agreements and public infrastructure) in which the industry operates (See Figure B 19.1). The value chain approach envisages improving the competitiveness and efficiency of the selected industries, addressing the major opportunities and constraints faced at the various levels of the value chain, in order to increase the well-being of the poor and deprived communities.

Value Chain Structure Global Retailers

Global Enabling Environment National Retailers

National Enabling Environment Exporters

Wholesalers

Sector-specific Providers

Cross-cutting Providers

Processors

Financial providers

Producers Input Suppliers

188

Central Bank of Sri Lanka Annual Report - 2010

Careful identification of appropriate value chains is crucial to achieve the expected advantages from the value chain approach. Having chosen a value chain, it is necessary to analyse the inter-firm relationships to evaluate how and where the development agencies should intervene in order to facilitate production and market efficiencies and to promote the competitiveness in the industry. The value chain approach also examines the other factors influencing the chain’s performance including, the legal, regulatory and policy environment, the availability and quality of support services such as financial services, business

Credit Information Acitivities of the Credit Information Bureau (CRIB) also indicated increased lending by financial Institutions. The CRIB had 89 reporting credit institutions as its members and issued 1,580,782 credit reports in 2010 compared with 864,619 reports in 2009. The CRIB made several improvements in 2010. The on-line Credit Information Management System (CRIMS)

management services and information technology and, the availability of required infrastructure. In conclusion, the final goal of the value chain approach is achieving economic growth through enhanced private sector participation based on the market mechanism while creating opportunities for the poor and disadvantaged people to reap the benefits of economic growth. In 2011, the Central Bank of Sri Lanka will commence activities of the National Agribusiness Development Programme (NADeP), an enterprise development project, funded by the International Fund for the Agricultural Development (IFAD). This programme will use the value chain approach as the strategy to accomplish its objectives. The NADeP will invite reputed firms to work with it, in order to provide opportunities to the MSE sector to work with the organized private sector. The NADeP will assist farmers to processes their products for a market that offers a fair price and a stable demand, thus enabling them to earn a higher income. References www.acdivoca.org wikipidia, the free encyclopedia www.bdsknowledge.org

provided an enhanced service to users. Self Inquiry Reports (iReports) facilitated the prospective borrowers to request their own credit information. The details on “Cheque Returns” were introduced in credit reports. A “Customer Help Desk” was set up to assist the public in applying for credit and interacting with lenders. CRIB also initiated work on establishing a “Secured Transactions Registry” for movable assets which would promote and facilitate lending against movable property.

189

8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY

In some industries, large firms, which have the potential to be competitive or remain competitive in national or global markets, obtain raw materials or semi-processed products from sector and/or employ a large number of poor and disadvantaged people. The value chain growth strategy insists on providing technical assistance and required services to the MSE sector and those employed in these industries in a way that directly meet the requirements of such large firms. This will increase the value of the poor and disadvantaged people as suppliers or employees in the industry.

Central Bank of Sri Lanka Annual Report - 2010

BOX 20

Major Economic Policy Changes and Measures: 20101

21 April 2010

- Post Tsunami Coastal Rehabilitation and Resources Management Programme (PTCRRMP) – “Diyawara Saviya” was launched.

30 April 2010

- The first Dairy Resources Center to facilitate exchange of milch cows among buyers and sellers was inaugurated at Meewanapalana, Horana under the Agro-Livestock Development Loan Scheme (ALDL).

09 December 2010

- Maximum retail prices were imposed on rice to stabilise the price in the market. Accordingly, the maximum retail price of Samba (excluding Keeri Samba and Suduru Samba) was fixed at Rs. 70 and the maximum retail price of Nadu, and red and white raw rice was fixed at Rs. 60.

01 January 2011

- The average electricity tariff was increased by 8 per cent.

Forthcoming - Operations of the National Agri-Business Development Programme, funded by the International Fund for Agricultural Development (IFAD) will commence. External Sector Trade and Tariff 01 January 2010

- The surcharge on the importation of some categories of P.V.C. leather cloth was removed.

- The 15 per cent surcharge levied on customs import duty, both general and preferential, on all imported goods, except those specified in the Extraordinary Gazette, No. 1574/15 dated 06 November 2008, was extended for a period of six months.

19 January 2010

- A full customs duty waiver was granted on the importation of petrol and diesel.

25 January 2010

- A customs duty waiver of 12.5 per cent was granted on the importation of maize. Hence the applicable duty is 2.5 per cent.

10 February 2010

- Special Commodity Levy (SCL) on the importation of dried sprats, potatoes, big onions, peas, chickpeas, green gram, dhal, canned fish, sugar, red onions and garlic was extended for another three months.

14 February 2010

- The partial customs duty waiver of 13 per cent per kg on the importation of some categories of P.V.C. leather cloth was extended.

16 February 2010

- Total recoverable tax rate on the importation of milk powder was reduced from Rs. 100 per kg to Rs. 50 per kg.

18 February 2010

- Customs duty waiver of Rs. 25 per kg was granted on the importation of certain categories of edible oil and their fractions.

- Excise duty of Rs. 200 per litre and Rs. 500 per litre was imposed on the importation of Spirit (Ethyl Alcohol) up to a maximum of 20,000 litres per month and beyond the monthly limit of 20,000 litres, respectively.

25 February 2010

- The full customs duty waiver on the importation of malt extract was extended.

1 This includes major economic policy changes and measures implemented during 2010. Policy changes and measures that have been implemented during the first three months of 2011 and to be implemented in 2011 are also included.

191

Major Economic Policy Changes and Measures: 2010

Real Sector

Central Bank of Sri Lanka Annual Report - 2010

Major Economic Economic Policy Changes and Social andInfrastructure Measures: 2010

01 March 2010

- All taxes and other levies applicable on the importation of gold were removed.

20 March 2010

- SCL on the importation of rice was removed and customs duty and other applicable taxes and levies were re-imposed.

21 March 2010

- SCL of Re. 1 per kg on the importation of sugar was extended for another three months.

01 May 2010

- The full customs duty waiver on the importation of wheat grain was reduced to Rs. 8 per kg. Hence the applicable customs duty is Rs. 2 per kg.

10 May 2010

- SCL on the importation of dried sprats, potatoes, big onions, red onions, peas, chickpeas, dhal, green gram, dried chillies and canned fish was extended for another three months at the previous rates.

01 June 2010

- The five band customs duty structure (0, 2.5, 6, 15 and 28 per cent) was reduced to a four band structure (0, 5, 15, and 30 per cent).

- The 15 per cent surcharge on customs duty on imported goods was removed.

- The 2.5 per cent customs duty, which was mostly applied on the importation of raw materials and machinery, was abolished.

- The Cess levy on the importation of motor vehicles was abolished.

- Excise duty on the importation of motor vehicles was reduced.

- Customs duty on the importation of motor cycles was reduced from 15 per cent to 5 per cent and an excise duty of 25 per cent was imposed on motor cycles.

- Customs duty, Value Added Tax (VAT), Social Responsibility Levy (SRL), Cess and excise duty were removed on the importation of certain categories of electric items and their parts. Thus the liable taxes on these items are only Port and Airport Development Levy (PAL) and Nation Building Tax (NBT).

- Cess on the importation of refrigerators, freezers, dish washing machines, washing machines, wrist watches, pocket watches and other watches and parts thereof was removed.

- Excise duty on the importation of paints and varnishes was abolished.

- Cess on the importation of certain categories of paints and varnishes, and paintersâ&#x20AC;&#x2122; fillings was reduced from Rs. 85 per kg to Rs. 50 per kg.

- Cess on the importation of printing ink was reduced from Rs. 25 per kg to Rs. 15 per kg.

- Cess rates on the importation of certain categories of beauty or make-up preparations and preparations for use on the hair were revised to 35 per cent or Rs. 250 per kg, whichever is higher.

- Cess on industrial monocarboxylic fatty acids, acid oils from refining, and industrial fatty alcohols was removed.

- Cess on the importation of certain categories of resins and cellulose and their chemical derivatives, certain categories of plastics, and polymers of ethylene, propylene, styrene, vinyl chloride, vinyl acetate, acrylic polymers, polyacetals, other polyesters and polyamides in primary forms was reduced from 10 per cent to 5 per cent.

- Cess on the importation of cement was reduced from 10 per cent to 8 per cent.

- Cess on the importation of certain categories of worked monumental or building stones, such as tiles, granite, marble etc. was reduced from 30 per cent or Rs. 50 per kg to 20 per cent or Rs. 30 per kg, whichever is higher.

192

- Cess on the importation of certain categories of products made in iron or non-alloy steel was increased from Rs. 10 per kg to Rs. 15 per kg.

- Cess on the importation of certain categories of wire of iron or non-alloy steel, stainless steel, and certain categories of angles, shapes, and sections (U sections, I sections, H sections etc.) of iron or non-alloy steel was removed.

- VAT, NBT and PAL were removed on the importation of currency notes (HS code 4907.00.90).

21 June 2010

- SCL on the importation of sugar was increased from Re. 1 per kg to Rs. 5 per kg for three months.

- The duty waiver of Rs. 8 per kg on the importation of wheat grain was removed and hence the applicable customs duty was increased to 15 per cent or Rs. 10 per kg, whichever is higher.

08 July 2010

- VAT on the importation of high tech medical equipment was removed.

10 August 2010

- SCL on the importation of red onions and big onions was increased from Rs. 10 per kg to Rs. 25 per kg.

- SCL on the importation of garlic was reduced from Rs. 30 per kg to Rs. 10 per kg.

- SCL on the importation of whole peas and whole chickpeas was reduced from Rs. 15 per kg to Rs. 10 per kg.

- SCL on the importation of whole masoor dhal and split masoor dhal was increased from Re. 1 per kg to Rs. 10 per kg and Rs. 2 per kg to Rs. 15 per kg, respectively.

- SCL on the importation of dried sprats, potatoes, split peas, split chickpeas, green gram, dried chillies and canned fish was extended for another four months at previous rates.

16 August 2010

- VAT on the importation of fruit seeds under HS code 1209.99.10 was removed.

27 August 2010

- A surcharge of Rs. 20 per kg was imposed on potatoes until 09 September 2010.

10 September 2010

- SCL on the importation of potatoes was increased from Rs. 10 per kg to Rs. 30 per kg for another three months.

21 September 2010

- SCL of Rs. 5 per kg on the importation of sugar was extended for another three months.

13 October 2010

- Customs duty, VAT, SRL, Cess, PAL and NBT were removed on the importation of chicks for breeding and other chicks.

- Customs duty, VAT, SRL and Cess were removed on the importation of eggs and egg yolk.

- Customs duty was reduced from 30 per cent to 15 per cent and VAT, SRL and Cess were removed on the importation of meat of fowls.

30 October 2010

- SCL on the importation of big onions was reduced from Rs. 25 per kg to Rs. 10 per kg.

- SCL on the importation of potatoes was reduced from Rs. 30 per kg to Rs. 10 per kg.

- Customs duty waiver of Rs. 45 per kg or 15 per cent was granted on the importation of certain categories of edible oil and their fractions.

23 November 2010

- An import duty waiver of Rs. 150 per kg was granted on the importation of meat of fowls. Hence the applicable duty rate is Rs. 50 per kg.

- A full import duty waiver of Rs. 100 per kg was granted on the importation of birdâ&#x20AC;&#x2122;s eggs.

- Import or supply of petrol, coal and bitumen were exempted from VAT.

- The tax formulae used by Sri Lanka Customs were changed.

193

Major Economic Policy Changes and Measures: 2010

Central Bank of Sri Lanka Annual Report - 2010

Major Economic Economic Policy Changes and Social andInfrastructure Measures: 2010

- The full customs duty waiver granted on the importation of petrol was reduced to Rs. 20 per litre. Hence the applicable duty rate is Rs. 15 per litre.

- The full customs duty waiver granted on the importation of diesel was reduced to Rs. 11 per litre. Hence the applicable duty rate is Rs. 4 per litre.

- Cess of Rs. 600 per kg was imposed on the importation of lottery tickets and telephone cards.

- Pharmaceutical products falling within HS headings 30.01, 30.02, 30.03, 30.04 and 30.06 was exempted from PAL.

- Customs duty and excise duty applicable on the importation of hybrid electric vehicles was revised.

- Customs duty on the importation of electrical machinery and equipment was revised.

- The Special Import Licence Regulations, No. 1 of 1977, published in Gazette Extraordinary, No. 291/7 of 15 November 1977 was amended.

- Customs duty was reduced for Telecom/Information and Communication Technology (ICT)/ Business Process Outsourcing (BPO) sectors, agriculture sector, confectionary and bakery product manufacturing, health, pharmaceuticals and cosmetics (including ayurvedic), tourism and construction industry, shopping for branded products, vehicle assembly industry, instruments and apparatus for health, education and scientific research.

10 December 2010

- SCL on the importation of dried sprats, potatoes, big onions, peas, chickpeas, green gram, dhal, canned fish, sugar, red onions and garlic was extended for another four months at previous rates.

- A full customs duty waiver was granted on the importation of diesel to be effective from 23 November 2010.

22 December 2010

- The Special Import Licence Regulations, No. 1 of 1977, published in Gazette Extraordinary, No. 291/7 of 15 November 1977 was further amended.

01 January 2011

- Import of goods, for any infrastructure development project funded through foreign loans or donations directly to government ministries as approved by the Minister of Finance was excluded from NBT and VAT.

- Import of raw materials exclusively used in manufacturing ayurvedic preparation and packing materials exclusively used for packing of ayurvedic preparations in Sri Lanka (other than cosmetic preparations) as approved by the Minister of Finance was excluded from NBT.

- Import of bitumen falling under HS Code 2713.20 and HS Heading 27.14 and import of tractors falling under HS Codes 8701.10.10, 8701.10.90, 8701.90.10 and 8701.90.20 was excluded from NBT.

- Importation of certain categories of machinery and equipment for leather or footwear industry, high-tech medical, laboratory and educational equipment, taxi meters, agricultural machinery and parts, electrical equipment, articles used for fashion jewellery manufacturing, machinery and high-tech equipment for the use in telecommunication industry and aircraft simulators and parts was exempted from VAT.

11 January 2011

- The customs duty waiver granted on the importation of petrol was increased from Rs. 20 per litre to Rs. 30 per litre. Hence the applicable duty rate is Rs. 5 per litre.

22 January 2011

- A full customs import duty waiver was granted on the importation of milk powder. Hence, only PAL and NBT will be applicable on importation of milk powder.

194

Central Bank of Sri Lanka Annual Report - 2010 Foreign Exchange Management 11 March 2010

- The following categories of resident Sri Lankans were permitted to open and maintain bank accounts abroad:

• a person resident in Sri Lanka who has proceeded outside Sri Lanka temporarily for • an individual or a company or a firm registered in Sri Lanka who provide professional or vocational services outside Sri Lanka while being a resident in Sri Lanka

• an individual or a company or a firm registered in Sri Lanka who has been permitted by the Minister of Finance to invest outside Sri Lanka

• an individual or a company or a firm registered in Sri Lanka who has been permitted by the Central Bank of Sri Lanka to lend foreign currency abroad and,

• an exporter of merchandise goods.

- The existing different investment accounts, namely, Share Investment External Rupee Account (SIERA), Treasury Bond Investment External Rupee Account (TIERA), Treasury bill Investment External Rupee Account (TIERA-2), Treasury bonds/bills Investment External Rupee Account – Deshabhimani (TIERA-D), maintained by non-residents in commercial banks were permitted to be unified. The unified account was renamed as Securities Investment Account (SIA).

- Restrictions on Authorised Dealers entering into forward contracts with their customers to hedge an exposure to exchange risk have been relaxed.

- The 100 per cent margin deposit requirement against advanced payments on the invoiced value of selected imported items was removed.

- The suspension on the pre-payment of import bills was lifted.

- Transfer of funds between Special Foreign Investment Deposit Accounts (SFIDA) of a non-resident and accounts maintained in Offshore Banking Units (OBUs) in Sri Lanka by such non-resident was permitted.

07 May 2010

- Authorised dealers were permitted to open a new foreign currency account titled “Foreign Currency Accounts for International Service Providers and their Employees (FCAISPE)”.

02 June 2010

- The issuance of foreign currency notes as a part of the travel allowance for Sri Lankans travelling abroad was increased to US dollars 2,500 or its equivalent in any other convertible foreign currency from its present level of US dollars 2,000.

22 November 2010

- Foreign companies were permitted to open places of business in Sri Lanka.

- Non-residents were permitted to invest in rupee denominated debentures issued by local companies.

- Advance payment for imports was increased from US dollars 10,000 to US dollars 50,000.

- Foreign diplomatic missions, diplomatic personnel and their family members were permitted to perform certain banking transactions in foreign currency and in Sri Lanka rupees.

- Non-nationals either on temporary visit to Sri Lanka or intending to visit Sri Lanka were permitted to open non-resident non-national foreign currency accounts.

- Importers of Gems and Jewellery were permitted to open accounts in foreign currency.

- Approval was granted for companies to borrow from foreign sources.

01 January 2011

- Individuals resident in Sri Lanka and companies incorporated in Sri Lanka were permitted to invest in shares of foreign companies and sovereign bonds issued by foreign governments.

195

Major Economic Policy Changes and Measures: 2010

business, studies or for medical purposes

Central Bank of Sri Lanka Annual Report - 2010

Major Economic Economic Policy Changes and Social andInfrastructure Measures: 2010

- Sri Lankan companies and partnerships were permitted to open places of business outside the country.

Forthcoming

- Introducing Corporate Credit Cards/Travel Cards.

- Granting a general permission to banks to transfer the funds in NRFC/RFC accounts among banks/individuals.

- Removing the maximum limit on the balance of indirect exporters foreign currency accounts.

- Introducing special foreign currency accounts for travel agents, airlines, local companies who undertake foreign contracts, such as power projects, building constructions etc. abroad and local companies who undertake foreign funded projects in Sri Lanka.

- Relaxing exchange control restrictions on foreigners and foreign fund investments in unit trusts.

- Relaxing restrictions on foreign investments in education, travel agencies and shipping agencies to facilitate such services in line with the current developments.

- Granting a general permission to residents to make payments to non-residents in respect of buying real estate in Sri Lanka from the latter party.

- Granting permission for Sri Lankan students studying abroad to obtain loans from respective countries for the purpose of studies. Fiscal Sector

Government Revenue 01 January 2010

- Excise duty on LP gas was reduced from 5 per cent or Rs. 31.50 per kg to 5 per cent or Rs. 8.70 per kg, whichever is higher.

01 March 2010

- Excise duty on LP gas was removed.

24 June 2010

- Excise duty on cigarettes was increased.

01 September 2010

- Excise duty on LP gas was reintroduced at a rate of Rs. 13.12 per kg.

29 October 2010

- Excise duty on cigarettes was increased.

- Excise duty on LP gas was increased to Rs. 15.66 per kg from Rs. 13.12 per kg.

19 November 2010

- Environment Conservation Levy (ECL) on telecommunication services was removed.

23 November 2010

- SRL on all items other than income tax was removed.

- Excise duty on liquor was increased.

- Annual license fee and security deposit for manufacturing and selling liquor was revised.

- Excise duty on cigarettes was increased.

01 December 2010

- A levy of Rs. 2 per minute was imposed on incoming IDD calls of all telecommunication services.

16 December 2010

- Excise duty on LP gas was removed.

01 January 2011

- The 20 per cent VAT rate was reduced to 12 per cent. Hence, there is only one VAT rate applicable other than the zero rate.

- The NBT rate of 3 per cent was reduced to 2 per cent.

196

- Regional Infrastructure Development Levy (RIDL) was removed.

- A Composite Telecommunications Levy of 20 per cent was introduced replacing the VAT, NBT and Cellular Mobile Subscriberâ&#x20AC;&#x2122;s Levy on telecommunication services.

- A Cess levy of 2 per cent on the annual gross turnover of telecom operators was introduced.

- Turnover Tax (TT) collected by the provincial councils was abolished.

- The Share Transaction Levy was increased from 0.2 per cent to 0.3 per cent.

05 January 2011

- Excise duty on hard liquor (all types of liquor except malt liquor) was increased by Rs. 50 per proof litre.

Forthcoming 01 April 2011

- Increasing the tax free allowance for the computation of personal income taxes from Rs. 300,000 to Rs. 500,000.

- Revising the personal income tax slabs as follows: First Rs 500, 000 (of taxable income) Next Rs. 500, 000 Next Rs. 500, 000 Next Rs. 500,000 Next Rs. 1,000,000 Balance

- 4 per cent - 8 per cent - 12 per cent - 16 per cent - 20 per cent - 24 per cent

- Increasing the tax free allowance from Rs. 500,000 to Rs. 600,000 for the computation of Pay-As-You-Earn (PAYE) taxes.

- Introducing the PAYE tax for government sector employees.

- Treating the tax deducted from employment income (of both government and private sector employees) under the PAYE scheme as final, where employment income is the only source of income.

- Extending the present exemption available to senior citizens for withholding tax on interest income from money deposited in state banks from Rs. 200,000 to Rs. 500,000.

- Extending the first level of assessable income of individuals and charitable institutions for selfdirection purposes of withholding tax from Rs. 300,000 to Rs. 500,000.

- Extending the second level of assessable income for self-direction purposes (for the concessionary rate of 2. 5 per cent) of withholding tax from Rs 1 million to Rs 1.5 million.

- Treating withholding tax on corporate debt securities on par with government securities.

- Removing withholding tax on specified fees.

- Reducing the withholding tax for persons other than companies to 8 per cent.

- Reducing the corporate income tax rate to 28 per cent from 30 per cent, 33 1/3 per cent or 35 per cent applicable to companies or NGOs (other than any person engaged in a business which deals in liquor or tobacco).

- Increasing the corporate income tax rate applicable on any person engaged in manufacturing or importation of liquor or tobacco products to 40 per cent.

- Reducing the concessionary corporate income tax rate of 15 per cent to 12 per cent.

197

Major Economic Policy Changes and Measures: 2010

Central Bank of Sri Lanka Annual Report - 2010

Major Economic Economic Policy Changes and Social andInfrastructure Measures: 2010

- Limiting the maximum corporate income tax rate applicable to any person engaged in an undertaking to manufacture any product, having domestic value addition in excess of 65 per cent and Sri Lankan brand name with patent rights reserved in Sri Lanka.

- Reducing the corporate income tax rate on clubs and associations, undertaking for operation and maintenance of facilities for storage, local software development or supply of labour to 10 per cent.

- Reducing the corporate income tax rate on venture capital companies, petroleum exploration and entertainers or artists to 12 per cent.

- Reducing the corporate income tax rate on the divisible profits of a partnership from 10 per cent to 8 per cent.

- Limiting the maximum corporate income tax rate on the profits and income of any agricultural undertaking referred to in Section 16 of the Inland Revenue Act to 10 per cent.

- Exempting fishing, cultivation and primary processing of agricultural seeds and planting material sectors from corporate income tax for a period of five years reckoned from the year of assessment.

- Exempting foreign exchange earnings from supplies made to foreign buyers, who establish their headquarters in Sri Lanka for management, finance, supply chain and billing, by manufacturers of textile, leather products, and footwear and bags from corporate income tax.

- Exempting SriLankan Airlines Ltd. and Mihin Lanka (Pvt) Ltd. from income taxes from all sources for a period of 10 years. They will be subjected to the payment of a dividend of 25 per cent to the government from their annual gross profits.

- Exempting Ceylon Electricity Board, National Water Supply and Drainage Board, Ceylon Petroleum Corporation and Sri Lanka Ports Authority from income taxes from all sources for a period of 5 years. They will be subjected to the payment of a dividend of 25 per cent to the government from their annual gross profits.

- Exempting the turnover of distributors as defined in the Economic Service Charge Act, dealers in lottery, unit trusts or mutual funds and all airlines and shipping lines from the Economic Service Charge (ESC).

- Increasing the present threshold of ESC from Rs. 7.5 mn to Rs. 25 mn per quarter.

- Converting the present submission of returns on a quarterly basis for ESC to annual returns, while the existing quarterly payments will remain.

- Simplifying the existing rates schedule of ESC from a five band structure (0.05, 0.1, 0.25, 0.5 and 1 per cent) to a four band structure (0.1, 0.25, 0.5, and 1 per cent).

- Removing the Debits tax.

- Removing the SRL on income taxes.

- Offering a five year tax holiday for any company, which carries on a new undertaking, with a minimum investment of not less than US dollars 3 million (but not more than US dollars 10 million) or an amount equal to such amount in rupees in such activities as specified by the Minister of Finance and Planning from time to time, by order published in the Gazette having regard to the development of the national economy.

- Removing the concessionary NBT rate of 1.5 per cent applicable on the liable turnover from the sale of rice manufactured from locally procured paddy.

198

Central Bank of Sri Lanka Annual Report - 2010

01 January 2010

- The cost of living allowance (COLA) of public sector employees was increased by Rs. 750 to Rs. 5,250 per month, while COLA of pensioners was increased by Rs. 375 to Rs. 2,375 per month.

01 January 2011

- All public servants were given a special allowance equivalent to 5 per cent of their basic salary.

- The COLA of public sector employees in the non staff grade category was increased by Rs. 600 to Rs. 5,850 per month.

- The COLA of pensioners was increased by Rs. 300 to Rs. 2,675 per month.

- The ‘Academic Allowance’ paid to university academic staff, the ‘Personal Allowance’ paid to the members of the judiciary coming under the purview of the Judicial Services Commission, and the ‘On-Call Allowance’ paid to doctors was increased by 25 per cent.

Forthcoming

- Increasing the current COLA of public sector employees in the staff grade category with effect from July 2011by Rs. 600 to Rs. 5,850 per month.

- Giving an increase of Rs. 750 per month and Rs. 250 per month to pensioners who retired prior to 01 January 2004 and to pensioners who retired during the period 01 January 2004 to 31 December 2005, respectively with effect from July 2011.

Debt Management 21 May 2010

- A Sovereign Rating Committee (SRC) was appointed in order to encourage the active participation of public and private sector stakeholders in the country’s sovereign rating process which aims to achieve a sovereign rating of an investment grade of BBB - or higher by 2014.

30 June 2010

- The marketing operations of government securities by the outlets of LankaClear were ceased.

9 July 2010

- Having considered the need for strengthening the sovereign rating process, three Sovereign Rating Advisors (SRAs) namely, Bank of America Merrill Lynch (BAML), the Royal Bank of Scotland PLC (RBS), and the HSBC were appointed to co-ordinate with country authorities and rating agencies to upgrade the country’s rating level.

6 August 2010

- A decision was taken to obtain a sovereign rating from Moody’s Investment Services.

4 October 2010

- International sovereign bonds worth US dollars 1,000 million were issued.

Forthcoming

- Allowing commercial banks to participate at the primary auctions without having a dedicated capital for the purpose, if eligibility criteria are fulfilled.

- Reviewing and updating directions issued to Primary Dealers (PDs) in line with the accepted best practices in the financial sector. Financial Sector

01 January 2010

- The lending rates of the three agricultural credit schemes namely, New Comprehensive Rural Credit Scheme, Agro Livestock Development Loan Scheme and “Krushi Navodaya” Special Loan Scheme were reduced from 12 per cent to 8 per cent.

199

Major Economic Policy Changes and Measures: 2010

Government Expenditure

Central Bank of Sri Lanka Annual Report - 2010

Major Economic Economic Policy Changes and Social andInfrastructure Measures: 2010

- Direction was issued to Registered Finance Companies (RFCs) to amend the upper limit on the rate of interest on deposits and the discount rate of bonds or other instruments.

- Direction was issued to RFCs allowing payment of additional interest of one percentage point above the rates of interest on time or savings deposits maintained by senior citizens.

05 January 2010

- The Government decided to pay a 20 per cent bonus interest to senior citizens on rupee deposits maintained in licensed banks with effect from 01 January 2010.

19 January 2010

- Operating instructions were issued to all RFCs and specialised leasing companies (SLCs) on the Central Bank Credit Guarantee Scheme for bank loan facilities to RFCs and SLCs that are facing liquidity problems in specific circumstances.

22 January 2010

- Interest rates of the Awakening North Special Loan Scheme and the Eastern Province Development Scheme, operated by the CBSL were reduced from 12 per cent per annum to 9 per cent per annum.

25 February 2010

- Banks that are non-compliant with the mandatory requirement imposed since end 2009 of 10 per cent of total lending to the agriculture sector were required to contribute any shortfall to a refinance fund operated by the Regional Development Department of CBSL for lending to the agriculture sector through other banks.

01 March 2010

- An operational guideline was circulated to streamline the operations of credit card issuers.

11 March 2010

- Withdrawal of operating instruction on payment of import bills, issued under Reference No. 02/17/800/0006/01 dated 31 October 2008.

22 March 2010

- A new loan scheme titled Prosperity (‘Saubagya’) was launched for the purpose of providing credit facilities to agriculture, livestock, micro, small and medium scale enterprises (MSMEs) and MSMEs affected by any disaster in the island.

07 May 2010

- Approval was granted to open six new bank branches in the Northern Province.

14 May 2010

- The Financial Intelligence Unit (FIU) of CBSL signed a Memorandum of Understanding (MoU) with Sri Lanka Customs to share information to facilitate the investigation and prosecution of persons suspected of money laundering and terrorist financing.

26 May 2010

- All licensed banks were allowed to grant credit facilities for repayment of non-performing loans (NPLs) in the name of the same borrower or any other party without requiring the new facility to be classified as an NPL, until 30 June 2011.

01 July 2010

- CBSL opened its fourth provincial office in Jaffna whose primary function is to implement the development oriented loan schemes introduced by CBSL in the Northern Province.

09 July 2010

- The CBSL’s Repurchase and Reverse Repurchase rates were reduced by 25 basis points to 7.25 per cent and 9.50 per cent, respectively.

26 July 2010

- All eligible security deposit holders of the Golden Key Credit Card Company Ltd. were paid on the basis of either 75 per cent of the security deposit balances as at 31 December 2008 or Rs. 100,000, whichever is lower, after verification by the auditors.

29 July 2010

- The minimum capital requirement of banks was increased to the following levels:

Minimum capital requirement of new banks (Rs. billion)

Type of Bank Licensed Commercial Banks Licensed Specialised Banks

200

From 2010 3.0 2.0

From 2012 4.0 2.5

From 2014 5.0 3.0

Central Bank of Sri Lanka Annual Report - 2010 Minimum capital requirement of existing banks (Rs. billion)

Type of Bank Licensed Commercial Banks Licensed Specialised Banks

End 2011 3.0 2.0

End 2013 4.0 2.5

End 2015 5.0 3.0

08 August 2010

- The CBSL’s Reverse Repurchase rate was reduced by 50 basis points to 9.00 per cent.

19 August 2010

- All unlisted licensed banks are required to list on the Colombo Stock Exchange (CSE) by 31 December 2011.

09 September 2010

- Licensed banks were requested to reduce their lending rates to at least the following levels by end October 2010: • housing loans to 14 per cent per annum • credit card advances to 24 per cent per annum • other loans and advances by 1-2 per cent per annum

27 September 2010

- All licensed banks were required to maintain 0.5 per cent general provisions on total outstanding of on-balance sheet performing loans accounts (PLAs) and special mentioned on-balance sheet credit facilities net of interest in suspense, commencing from 01 January 2012, by reducing the existing 1 per cent general provisions to 0.5 per cent at a rate of 0.1 per cent per quarter during the five quarters commencing 01 October 2010.

01 October 2010

- The Sri Lanka Deposit Insurance Scheme (SLDIS) was implemented under the provisions of the Monetary Law Act where all licensed banks and RFCs will participate on a mandatory basis.

06 October 2010

- The license fee payable in the year of first registration by an RFC was increased from Rs. 50,000 to Rs. 500,000.

- The annual license fee of RFCs fixed at Rs. 50,000 was increased to a range of Rs. 150,000 to Rs. 500,000 to be levied on the basis of the total assets of the RFC as at the end of the preceding financial year.

- Auctions under open market operations (OMO) were suspended.

28 October 2010

- The Financial Intelligent Unit (FIU) of the Central Bank of Sri Lanka signed a Memorandum of Understanding (MoU) with the Anti–Money Laundering Department of the Central Bank of Bangladesh to share financial information to facilitate investigation and prosecution of persons suspected of money laundering and terrorist financing.

02 November 2010

- All licensed banks were advised to regulate and manage the risks that could arise from outsourcing of their business operations.

08 November 2010

- The annual license fee of licensed banks for 2011 was increased to a range between Rs. 2 million and Rs. 10 million based on the total assets of the banks as at the end of the previous year.

23 November 2010

- Introduction of a scheme to guarantee cultivation loans secured on lands in conflict affected areas in the Northern Province.

24 November 2010

- Extended the assessment of fitness and propriety to officers performing executive functions in all licensed banks.

09 December 2010

- SLCs are required to increase their minimum core capital to Rs. 100 million by 01 January 2012 and further raise it to Rs. 150 million, Rs. 200 million, Rs. 250 million and Rs. 300 million as at the beginning of 2013, 2014, 2015 and 2016 respectively, with a view to promoting their soundness and resilience to shocks.

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Major Economic Policy Changes and Measures: 2010

Central Bank of Sri Lanka Annual Report - 2010

Major Economic Economic Policy Changes and Social andInfrastructure Measures: 2010

- A web based data transmission system was introduced for the mandatory periodic returns submitted by SLCs to CBSL.

- The opening, change of location, closure of any branch/business place of an SLC was formalised requiring SLCs to obtain prior approval in writing from the Director, Supervision of Non-Bank Financial Institutions for any such activity.

27 December 2010

- The minimum issued and paid-up capital of a public company applying for license under the Finance Leasing Act was increased to Rs. 100 million by 01 January 2011, and will be increased progressively by Rs. 50 million each year thereafter to reach Rs. 300 million by 01 January 2015.

- The fee payable at application, first registration and annual renewal with respect to Registered Finance and Leasing Establishments (RFLEs) was increased. Of these, the annual fee on renewal ranging from Rs. 150,000 to Rs. 500,000 would be based on the audited total assets of the respective RFLE as at the preceding year end.

11 January 2011

- All licensed banks were required to adopt appropriate risk management standards and introduced limits on banks’ exposure to margin trading business on shares to mitigate the risk that could arise from the volatility of prices and emergence of asset price bubbles from margin trading business on shares.

- The CBSL’s Repurchase rate was reduced by 25 basis points to 7.00 per cent and the Reverse Repurchase rate was reduced by 50 basis points to 8.50 per cent.

04 February 2011

- CBSL issued a new series of currency notes for circulation on the theme “Development, Prosperity and Sri Lanka Dancers”. This is the 11th series of currency notes of the Bank and consists of denominations of Rs. 20, Rs. 50, Rs. 100, Rs. 500, Rs. 1,000 and Rs. 5,000.

09 March 2011

- Mobile Payment Guidelines were issued with the objective of regularising and monitoring mobile payment systems.

Forthcoming

- Issuing guidelines to implement Pillar II of Basel II to further strengthen the risk management and capital planning process.

- Issuing customers’ charter and directions to banks to adopt the same.

- Facilitating the adoption of Sri Lanka Accounting Standards (SLAS) 44 and 45 to improve disclosure.

- Finalising the proposed amendments to the Banking Act.

- Formulating a framework on consolidated supervision.

- Further fine-tuning the internal rating system of banks.

- Implementing Basel III proposals.

- Issuing Internet Payment Guideline with the objective of regularising internet payment systems.

- Introducing the new Finance Business Act.

- Initiating the necessary amendments to the Finance Leasing Act.

- Issuing prudential directions covering Islamic banks.

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