US embassy cable - 03COLOMBO1686

C O N F I D E N T I A L SECTION 01 OF 03 COLOMBO 001686 
 
SIPDIS 
 
DEPT PLEASE PASS TO E, EB, SA/INS, SA/RA, DRL 
DEPT ALSO PASS TO USAID FOR BERNADETTE BUNDY - ANE/SA 
DEPT ALSO PASS TO USTR FOR AUSTR WILLS 
TREASURY FOR JERRY ADKINS 
DOL FOR SUDHA HALEY 
NSC FOR ELIZABETH MILLARD 
COMMERCE FOR ARIADNE BENAISSA 
TOPEC 
 
E.O. 12958:  DECL:  ONE YEAR AFTER CONCLUSION OF US-SL FTA 
TAGS: ETRD, EAID, ECON, EFIN, KIPR, ELAB, PREL, CE, ECONOMICS 
SUBJECT:  FTA IMPLICATIONS OF SRI LANKAN INVESTMENT CLIMATE 
 
Ref:  a) Colombo 1673, b) Colombo 1386, c) Colombo 772 
 
1.  (U) Classified by Ambassador Jeffrey J. Lunstead for 
reasons 1.5 B and D. 
 
2.  (C) Summary: The investment climate in Sri Lanka is 
improving and the GSL is committed to economic reforms and 
attracting more capital as the island continues its efforts 
to restore peace and prosperity.  The Indo-Lanka FTA, 
increasing interest of major U.S. companies, and efforts by 
the GSL and the private sector to diversify exports and 
improve competitiveness are indicators of a government we 
can work with in forging a closer bilateral trade 
relationship.  Challenges remain, however, and one avenue 
for our influence is through FTA negotiations.  USAID is 
already involved in several areas of capacity building and 
economic reform and has indicated it could do more in the 
lead up to FTA negotiations.  End Summary 
 
Investment Climate 
------------------ 
 
3.  (U) The investment climate in Sri Lanka is improving 
and well poised to take advantage of a potential US-SL FTA 
(Ref A).  GSL emphasis on free trade and bilateral FTAs has 
spurred interest in foreign investment.  U.S. and other 
foreign investment is steadily climbing upward (admittedly 
from a very low base).  Private sector interest is 
increasing in the power, IT, telecom, infrastructure and 
financial services sectors and the GSL is actively 
soliciting additional investment in these areas.  The Indo- 
Lanka Free Trade Agreement has led to some increased 
investment in SL as a production point for the Indian 
market (Ref C).  There is great potential for US firms to 
reach the huge Indian market through Sri Lanka at greatly 
reduced, even zero, tariff rates.  FTAs with Bangladesh and 
Pakistan are reportedly also in the offing. 
 
4.  (U) Increasing interest in Sri Lanka on the part of 
global investors and the GSL's sound fiscal policies, are 
having an overall positive effect on the economy. 
Inflation has shown a sharp decrease this year (latest 
estimates are approximately 6.5 percent, down from 9 
percent a year ago).  The central bank has further reduced 
interest rates and the currency has strengthened, with a 
three percent appreciation in the last two months. 
Projected GDP growth is estimated to be somewhere between 
5.5 and 6.5 percent for the year.  Finally, the budget 
deficit appears to be on track for hitting its target of 
7.5 percent of GDP. 
 
5.  (SBU) However, major problems have not yet been 
eliminated.  Regulatory barriers, corruption and a lack of 
transparency, as well as general bureaucratic hassles (due 
in part the proliferation of ministries - over 75 and 
counting), continue to plague the investment process. 
Further, the GSL currently keeps tremendous responsibility 
and decision-making authority in a tiny inner circle 
surrounding the PM.  This causes significant decision- 
making bottlenecks and creates a serious transparency 
issue.  Devolution of decision-making authority and 
responsibility, along with regulations and reforms to help 
insulate decision makers from political influence - while 
still protecting the integrity of the process - are 
imperative.  The government procurement process is slow and 
opaque, lacks technical capacity and is subject to 
political and personal influences. 
 
6.  (C) As mentioned in previous reporting (Ref A), U.S. 
companies such as Microsoft, Dell, Honeywell, Program 
Development International, Bechtel, Lockheed Martin, GE and 
Caterpillar are seriously looking at Sri Lanka or are 
already present in the market.  The potential for 
investment in infrastructure and market development 
programs over the next five to ten years is over USD 5 
billion. 
 
7.  (C) On the other hand, the January 2005 expiration of 
the Multi-Fiber Agreement (MFA) looms large, and Sri Lanka 
believes that only a FTA with the US will help offset the 
negative effects on the garment industry.  The rationale is 
clear; 68 percent of Sri Lanka's garment exports are to the 
US.  Best estimates are that Sri Lanka's garment industry 
will consolidate significantly. Those companies that have 
focused on the high-end specialty garment markets will 
survive and, potentially, thrive while smaller, general 
merchandise factories will close or merge.  The GSL is also 
attempting to diversify its exports to end its reliance on 
the garment sector. 
 
8.  (C) Many of Sri Lanka's garment manufacturers have 
begun the transition to insulate themselves against the end 
of the MFA.  The Joint Apparel Association specifically is 
promoting a move to high-end, specialized garments, 
improved efficiency, introduction of new manufacturing 
techniques and is offering assistance to factories seeking 
ways to become more competitive in the post-MFA world.  We 
recognize that an FTA would not allow 100 percent duty-free 
entry of all garments, but the GSL will be sure to push 
hard on garments in any FTA negotiations. 
 
Economic Reforms 
---------------- 
 
9.  (C) The GSL is committed to the economic reform 
process and continues to make headway - particularly in the 
areas of debt management, monetary policy and macroeconomic 
stabilization.  In the past two years, the GSL has 
implemented promising changes in many areas.  It has made 
upward adjustments of utility, transport, wheat flour and 
fuel prices and eliminated subsidies.  One hundred percent 
foreign ownership is now allowed in formerly restricted 
sectors, including banking, insurance, finance, supply of 
water, mass transport, telecom and professional services. 
Long-term debt instruments have been added and incentives 
offered to investors under the Board of Investment were 
restructured and reduced.  Civil service recruitment was 
frozen.  Some licensing controls on agricultural products 
were removed.  The tax system was reformed with the 
introduction of a VAT in August 2001, a tax on bank debits 
and interest and a reduction in the import duty surcharge. 
 
10.  (C) While progress has been made on privatization, it 
proceeds at a slow and uneven pace.  Contract enforcement 
mechanisms are a weak spot and revenue collection needs 
more improvement.  Several areas of reform are under 
review, including land, labor laws, banking and regulatory 
issues. 
 
11.  (C) The GSL also will benefit from considerable 
outside expertise in the reform arena.  This is true 
particularly with regard to: 
 
--  the budget process and debt management (through U.S. 
Treasury Advisors), 
 
--  investment (via an UNCTAD consultant on investment), 
--  the financial services sector (through new laws and 
policies aimed at deepening the financial sector and the 
creation of a stronger secondary debt market) and 
 
--  competitiveness policy (via the USAID sponsored 
competitiveness initiative). 
 
12.  (C) The GSL is committed to making many of the tough 
decisions necessary to move forward with economic reform, 
setting the right tone as capital comes looking for a place 
to invest.  While there are still areas that need to be 
improved, our influence can have a powerful effect, and our 
interests would be well served by engaging on many of these 
topics through the mechanism of FTA negotiations as 
outlined in Ref A. 
 
LUNSTEAD