US embassy cable - 03COLOMBO2027

UNCLAS SECTION 01 OF 03 COLOMBO 002027 
 
SIPDIS 
 
DEPT PASS TO SA/INS, SA/RA, EB, USTR; COMMERCE FOR ARI 
BENAISSA; TREASURY FOR ROY ADKINS 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, PGOV, CE, ECONOMICS 
SUBJECT: Guns to Butter (and Pay Hikes, and Roads, and...): 
Optimistic Budget Reopens Sri Lankan Parliament 
 
REF: Colombo 2001 
 
1. (U) This telegram is Sensitive but Unclassified, please 
handle accordingly. 
 
2. (SBU) Summary: Finance Minister Choksy presented the 
2004 GSL budget to the Parliament on November 19.  The GSL 
sees the budget as the culmination of two years' work and a 
chance to relieve belt-tightening measures taken since 
coming to office.  The budget keeps within the tight 
macroeconomic framework established by the government, 
including deficit reduction, revenue enhancement and pro- 
growth initiatives.  Still, it included significant wage 
increases for the public sector, a generous voluntary 
retirement package and additional agricultural subsidies. 
Revenue collection is acknowledged as a major fiscal 
problem and the budget includes several measures to tackle 
this challenge.  Most observers consider the budget fair 
and even opposition politicians privately admit it is a 
move in the right direction.  The lack of any notable 
education initiatives is interesting, given stated GSL 
priorities.  Defense expenditures continued to decline as a 
share of budget and GDP.  End Summary 
 
3. (U) The Finance Minister presented a budget to a 
somewhat raucous Parliament on November 19.  Para 16 
contains relevant figures and projections discussed in this 
cable. 
 
Parliament Reconvenes to Hear the Budget 
---------------------------------------- 
4. (SBU) Parliament had reconvened the morning of November 
19, following a 15 day suspension by President Kumaratunga 
(Reftel).  Minister Choksy, a diminutive, professorial 
politician, read a two-hour speech to the entire 
parliament, including the Prime Minister.  The session was 
lively.  Clearly suffering from a cold, Choksy took 
frequent breaks to blow his nose, which prompted catcalls 
from the opposition about whatever item he had just 
discussed.  The GSL used the session to crow about its 
economic performance and complain about the President's 
recent political actions. 
 
GSL Economic Achievements Touted 
-------------------------------- 
5. (U) The Minister highlighted the GSL's economic 
achievements including significantly improved GDP growth, 
debt and deficit reduction, and increased exports.  FDI has 
also increased and the resulting foreign exchange inflows 
have led to a reversal of the rupee's three-year slide. 
Both interest rates and inflation have declined. 
 
Expenditures to Fall 
-------------------- 
6. (U) On the expenditure front, the government expects a 
contraction of about 1% of GDP.  Budget forecasts for 2004 
project a historically low budget deficit (the deficit has 
not been lower than 7.5% since the 1977 opening of the 
economy).  The overall deficit is to be financed by foreign 
grants, foreign borrowings, domestic financing and 
privatization receipts.  Recurrent expenditures are slated 
to fall, leading to a reduction in the current account 
deficit.  Capital expenditures are projected to increase. 
Total interest costs, which accounted for 30% of government 
spending in 2003, are expected to fall to about 27% in 
2004.  Spending on government corporations will also drop. 
Other administrative costs are expected to decline 
marginally.  Defense will represent just under 15% of total 
expenditure, continuing its decline as a share of 
expenditure since the 2002 ceasefire.  Though keeping a 
tight rein on spending, the GSL recognizes the need to 
boost the economy and upgrade infrastructure.  Therefore, a 
key component to the new budget is. 
 
Capital spending 
---------------- 
7. (U) The GSL plans to spend $1.1 billion in 2004 on 
infrastructure as part of a larger 3-year development 
program under the PM's "Regaining Sri Lanka" development 
plan.  Roads, power and water sectors, rehabilitation and 
resettlement, and lending to small and medium industry will 
receive the highest allocations from the government budget. 
The GSL expects to spend a total $4.1 billion on capital 
projects from 2004-2006. 
Public Sector Employee Benefits 
------------------------------- 
8. (U) The budget provides a salary increase to government 
employees and pensioners.   It also unveiled a costly plan 
to overhaul the bloated civil service.  The plan aims to 
reduce 100,000 state jobs in 2004, and a further 200,000 by 
2006 (cutting the total workforce by almost 30%).  The plan 
calls for a voluntary retirement package, for employees 
over 45 years old, including an initial payment of one 
year's salary, full monthly salary until age 55 and then a 
full pension.  In addition, the government has promised a 
debt forgiveness plan for public employees.  The savings 
from the package will result largely from the reduction in 
benefits including allowances, vehicles, and housing in 
some instances.  There could also be efficiencies gained 
from cutting the bloated bureaucracy (less overlap, fewer 
benefits and employees to monitor). 
 
Revenue to Rise 
--------------- 
9. (U) Choksy admitted a key problem in the budget is 
sluggish revenue.  The government has tried to boost 
revenues and broaden the tax base, but without much 
success.  In 2003, revenue did not meet expectations, but 
the GSL is projecting a nominal rise of 13 percent in 2004, 
a reasonable target given projected GDP growth and 
inflation.  Choksy outlined several glaring revenue 
realities, including the fact that a recent tax amnesty 
netted 51,000 tax evaders who will now be captured in the 
tax net.  Moreover, fewer than 3,000 of 32,000 registered 
companies pay taxes and only one percent of individual 
income earners are taxpayers.  Key to improving this 
revenue picture will be. 
 
 
Taxation 
-------- 
10. (U) Vowing to broaden the tax net, Choksy proposed a 
new economic service charge of 1% to be levied on all 
registered companies (including currently tax-free BOI 
companies).  This tax would be deductible from the 
corporate tax, but would increase revenues by bringing into 
the tax net thousands of tax evading companies. Other key 
tax reforms in the 2004 budget include a unified VAT rate, 
reduction of the import duty surcharge and an increased 
income tax exemption threshold.  Several other proposals 
aimed to increase collection from the business sector, 
including BOI companies.  They include a tax on previously 
exempt foreign currency banking units and a royalty tax on 
new foreign companies.  The GSL intends to address the 
weaknesses in tax administration through the establishment 
of a central revenue authority. 
 
Privatization and Private Sector Development 
-------------------------------------------- 
11. (U) The Government will continue its privatization 
program.  Companies listed for privatization in 2004 
include State Mortgage and Investment Bank, the petroleum 
sector, bus companies, hotels, remaining shares of 
plantations and Sri Lanka Telecom.  Total expected income 
is $154 million. 
 
12. (U) The private sector will benefit from increased 
government spending on infrastructure.  In addition, the 
government is to lend $361 million for small and medium 
industry development and to fund northeast development. 
Other programs will facilitate private sector activity in 
selected sectors.  To boost tourism, the government will 
facilitate the development of two lagoon areas and the 
southern province (airport, port, coal power plant, and an 
oil refinery); BOI will set up two new export processing 
zones and the government will make land available for 
development within Colombo. 
 
Comment 
------- 
13. (SBU) The budget was well-received and got fairly 
glowing commentary from the IMF (which had announced that 
Article IV consultations would be delayed until the budget 
was presented), World Bank and ADB reps in Colombo.  Local 
businesses have been enthusiastic as well.  Particularly 
interesting was the lack of many education initiatives, 
which get tremendous lip service from the GSL.  The decline 
in defense spending corresponds with optimism about the 
peace process. 
 
14. (SBU) The GSL had leaked portions of the budget plan, 
specifically public sector wage increases and increased 
agricultural subsidies, following the President's 
suspension of parliament.  This provided additional 
pressure to reconvene parliament and was used by the GSL in 
its litany of ways the President's actions had undermined 
the economy. 
 
15. (SBU) Members of the opposition used the budget hearing 
as a forum to voice their displeasure with the GSL and to 
advocate for more left-leaning social spending programs. 
In private though, most admit the budget is fair and well 
crafted, balancing the need to maintain fiscal restraint 
while showing the public some return after two years of 
austerity. End Comment. 
 
16. (U) Some numbers: 
20032004 (Proj) 
-------- 
GDP Growth5.6%6.0% 
Budget Deficit(% GDP)7.8%6.8% 
Debt (% GDP)100%95% 
Inflation7.2%6.9% 
Current Acct Deficit (% GDP)2.8%1.3% 
 
--Forex reserves - $3 Billion (5.2 mos import cover) 
--Inflation declined to 7.2% from 9.6% in 2002 
--Interest rates dropped to 9.4% from about 12% 
--Revenue fell in 2003 from a projected 17.1% of GDP to 
16.3%.  In 2004, revenue is to rise by 13.7% in nominal 
terms (to 16.4% of GDP). 
--For 2004, total spending is estimated at $4.8 billion, or 
23.2% of GDP, resulting in a budget deficit of $1.4 billion 
(6.8% of GDP). 
--Capital expenditure will increase from $927 million (5.0% 
rease from $927 million (5.0% 
of GDP) to $1.1 billion (5.3% of GDP). 
Deficit Finance: foreign grants ($103 million); foreign 
borrowings ($515 million); domestic financing ($670 
million); privatization receipts ($154 million). 
--Single VAT rate of 15% (replacing the current system of 
10% and 20%) 
--Cut in import duty surcharge to 10% from 20%. 
LUNSTEAD