US embassy cable - 04COLOMBO1171

C O N F I D E N T I A L SECTION 01 OF 05 COLOMBO 001171 
 
SIPDIS 
 
DEPT FOR SA/PAB 
DEPT PLEASE PASS TO USTR FOR J. ROSENBAUM AND A. WILLS 
COMMERCE FOR A. BENAISSA 
 
E.O. 12958:  DECL:  07/13/2014 
TAGS: ECON, ETRD, EAGR, EAID, CE, ECONOMICS 
SUBJECT:  GSL ECONOMIC PLAN HEAVY ON PROMISES, SHORT ON 
DETAILS 
 
Classified By:  ECONCHIEF DEAN THOMPSON, REASONS 1.5 D AND E. 
 
1.  (C) Summary:  Following the Central Bank's first quarter 
review of the Sri Lankan economy, which indicated strong GDP 
growth and posited a generally sound economic situation, the 
UPFA Government released its "Economic Policy Framework." 
The plan clearly notes the GSL,s focus on the agricultural 
and Small and Medium Enterprise sectors, but, as one observer 
put it, "does not answer how they intend to get where they 
want to go."  It also appears to strongly favor government 
intervention, and promises of heretofore illusory public 
sector efficiency, rather than market forces and export-led 
growth to lift the nation's economy.  In the run-up to the 
policy framework's release, there have also been conflicting 
statements from GSL officials on issues such as 
privatization.  It is possible that much of this stemmed from 
internal debate and that the release of the framework may 
help keep elements of the GSL "on message."  The stated link 
of the policy framework to the UPFA's election manifesto, its 
continual criticism of the former Government's economic plan 
and the avoidance of straightforward policy recommendations 
lend credence to the notion that this policy framework is 
largely a political beast, leaving most of the heavy lifting 
to the implementation phase.  End Summary. 
 
Central Bank Lauds Continued Economic Growth 
-------------------------------------------- 
 
2.  (U) The Central Bank,s first quarter (a period under the 
economic stewardship of the previous UNP Government) report 
on the Sri Lankan economy, issued on June 29, indicated that 
GDP grew at an annualized rate of 6.2 percent, marking the 
seventh consecutive quarter that Sri Lanka recorded economic 
growth in excess of 5.5 percent.  The Central Bank credited 
this performance to a generally sound macroeconomic 
environment and a continuation of the ceasefire between the 
GSL and the Liberation Tigers of Tamil Eelam (LTTE) terrorist 
organization. 
 
3.  (U) Not all economic sectors shared in the expansion, 
however.  While the services sector continued its strong 
growth rate at 9.5 percent (providing 80 percent of the GDP 
growth) and the industrial sector grew by 5.5 percent, the 
agricultural sector contracted by 1.4 percent (a result of 
dry weather conditions affecting domestic agriculture and tea 
output) widely felt to have been the harbinger of bad 
electoral tidings for the previous government. 
 
4.  (U) While the Bank was generally positive about the 
direction of the economy, it warned that continued success 
relied on increased investment, which would only continue as 
a result of increased political stability, a long-term 
solution to the civil conflict with the LTTE, further 
improvements in macroeconomic management, implementing much 
needed structural reforms and more effective aid utilization, 
particularly in support of infrastructure (power and roads). 
 
UPFA Plan:  Protecting our Sectors, Buying Your Votes 
--------------------------------------------- -------- 
 
5.  (SBU) On the heels of this largely positive economic news, 
the GSL issued its "Economic Policy Framework" (EPF) 
"Creating our Future, Building our Nation."  The EPF is 
general and heavily focused on Small and Medium Enterprises 
(SME) and agriculture, the two sectors from which the UPFA 
Government believes it draws its electoral strength. 
 
6.  (C) While more specific aspects of the EPF are outlined 
below, a principle criticism has been that it is short on 
specifics.  IMF ResRep Jeremy Carter ((please protect)) told 
Econchief that the plan is more akin to an election speech, 
noting that it adhers closely to the UPFA's election 
manifesto.  His primary concern was the lack of financial 
figures associated with the plan's goals.  Carter suggested 
that the GSL,s mid-year fiscal review painted a bleak 
picture on the deficit front, driven by the GSL's abysmal 
revenue collection performance.  In that regard, the EPF's 
deficit pledge (8% of GDP) was unrealistic.  The deficit will 
be the IMF's main concern and IMF approval will be needed 
for World Bank budget assistance as well.  During a separate 
meeting between Econchief and Japanese Economic Counselor 
Mitsuo Kawaguchi, Kawaguchi indicated that the GOJ believes 
that Sri Lanka's economic fundamentals are basically sound, 
but the UPFA's plan "tells a nice story, but doesn't answer 
how they intend to get where they want to go".  These 
sentiments have been echoed in the press by several leading 
business figures and organizations. 
 
Macro-Economic Goals 
-------------------- 
7.  (U) In its EPF, the GSL sets macroeconomic targets of 6-8 
percent GDP growth, enhanced revenue collection (20 percent 
of GDP), and deficit reduction (8 percent of GDP in 2004, 
narrowing to five percent "over the medium term").  The GSL 
would maintain a liberal foreign exchange policy, with 
Central Bank interventions to smooth fluctuations.  Regarding 
inflation, the EPF calls for a regular price surveillance 
mechanism to ensure competitive prices for essential food 
items.  The mechanism would include "profit percentage 
caps," set by an internal rate of return (IRR) index.  This 
IRR index would be extended to public transport and other 
services as well.  The GSL claims priority will be given to 
an "island-wide infrastructure development program and 
social safety net." 
 
It's the UNP's Fault 
-------------------- 
8.  (SBU) The EPF is heavy on criticism of the previous 
Government, which changed in April 2004.  The current UPFA 
Government blames the former UNP Government for increasing 
the deficit by increasing debt relative to GDP.  The plan 
blames revenue shortfalls on the prior Government,s tax 
amnesty program and corruption.  It accuses the former 
regime,s poverty reduction program "Regaining Sri Lanka" of 
gutting popular rural development programs, education 
initiatives and needed government support for industrial 
development. 
 
New Layers to the Bureaucracy, or Old Wine in New Wineskins 
--------------------------------------------- -------------- 
9.  (U) The EPF calls for the creation of a National Council 
for Economic Development (NCED) a permanent secretariat 
charged with improving policy formulation and implementation 
in a well-coordinated fashion.  Line Ministries would retain 
their day-to-day implementation responsibilities.  There will 
also be a Strategic Enterprise Management Agency (SEMA) 
charged with overseeing public enterprises, returning them to 
profitability and channeling those profits into Government 
coffers.  SEMA CEO Mano Tittawella, also a Senior Policy 
Advisor to the President, told Econchief that SEMA's focus 
will be on reforming poor performers and looking for market 
oriented solutions to their problems, but not through 
privatization.  The EPF also calls for a National Procurement 
Agency (NPA), charged with streamlining the unwieldy, 
non-transparent government procurement process.  Treasury 
Secretary P.B. Jayasundera told the Ambassador on July 12 
 
SIPDIS 
that the NCED and SEMA would be working closely with the 
private sector to "add structure" to the EPF and identify 
those policies the GSL will need to pursue to help the EPF 
take root. 
 
10.  (SBU) The development of the North-East, a key issue for 
progress on the peace front, gets relatively short shrift in 
the plan.  The GSL acknowledges that relief and 
rehabilitation efforts in the North East are important to all 
stakeholders in the peace process.  The Government intends to 
implement relief activities primarily through the North-East 
Provincial Council and the District Secretariats.  The 
Ministry of Relief, Rehabilitation and Reconciliation would 
be the apex coordinating body, coming directly under the 
President. 
 
11.  (U) The following are some highlights of the UPFA,s main 
goals outlined in the plan: 
 
Agriculture: 
 
The GSL,s key economic objective is to assist the 
agricultural sector to become self-sufficient in food 
production and food security.  The EPF claims Sri Lanka can 
achieve self-sufficiency in milk, sugar, vegetables and rice, 
but that these segments cannot compete with imports due to 
misaligned trade and tariff regimes.  Assistance will be 
provided through new technology, subsidized inputs, storage 
and credit facilities, as well as continued high tariffs on 
key agricultural commodities.  Cultivation zones will be 
established for strategic food crops (potato, onion, other 
vegetables).  Expert assistance will be provided to farmers 
in remote and war-affected areas of the country.  Existing 
irrigation facilities will be rehabilitated and drought 
resistance technologies popularized.  Livestock and fisheries 
sectors will be targeted for improvements, including 
infrastructure development.  Duty on agricultural commodities 
will be maintained at the "high duty range" of 25-35 
percent or "such other appropriate rates to insulate pressure 
on domestic agriculture." 
 
Small and Medium Scale Industries: 
 
SMEs are referred to as the &nerve center of economic 
development" and the EPF suggests that a primary focus should 
be protecting this sector from undue import competition, 
while at the same time "balancing the needs of consumers." 
The GSL will promote SME entrepreneurs through the 
establishment of a "multi-prong support mechanism" 
consisting of streamlining bureaucratic procedures related to 
taxation, customs, and export procedures; increased training 
to SMEs; technical support in the areas of quality 
management, productivity improvement, IT access; access to 
venture capital equity funds and SME development finance; 
programs to foster the emergence and deepening of selected 
industrial clusters with comparative advantage; efficient and 
cost-competitive infrastructure development.  Donor countries 
will also be asked to assist in SME development by providing 
access to best practice knowledge, upgrading the capacity of 
SME associations and committing resources to SME 
competitiveness programs. 
 
The Public Service: 
 
Public servants are going to become more responsible and 
efficient, with time-based targets and financial incentives 
for meeting efficiency goals.  The departments of Inland 
Revenue, Customs and Excise will be the first agencies to 
undergo modernization and improvement.  The 27,000 unemployed 
graduates the GSL pledged to hire are going to become 
"Change Agents" in the public sector, following a 
comprehensive management-training program. 
 
Export Sector: 
 
The GSL will promote maximum value-addition to domestic raw 
materials for export.  The GSL will ban the export of local 
minerals in raw form and encourage the establishment of 
processing and conversion plants to upgrade the industry 
toward value-added finished goods.  The GSL will encourage 
agricultural producers to move from bulk to packaged exports. 
 
Textile and Apparel Industry: 
 
In its opening chapter, the EPF taunts the garment sector 
(indirectly) for not making "distinctive claims about the 
local identity based on environment attributes, and socially 
responsible corporate and individual citizen behavior 
standards."  The EPF indicates the GSL will provide 
assistance to consolidate the lead role of textile and 
apparel manufacturing and export in the economy, enabling it 
to perform efficiently in the post-2005, quota-free era.  The 
GSL will promote global market access, particularly bilateral 
arrangements with the EU markets.  The GSL will also offer 
special assistance to enhance Sri Lanka,s competitiveness, 
through the development of design skills, the opening of 
promotion offices, trade lobbying and business development in 
global markets.  The GSL will assist the garment industry to 
leverage Sri Lanka as an apparel producer that is the "only 
socially responsible business practitioner in Asia..." 
 
Tourism: 
 
The GSL would like to refocus the tourism sector away from 
high-volume European charter groups for resort holidays, 
toward smaller, "higher-spending" eco-conscious tourists. 
The GSL refers to this as a shift from "quantity to 
quality."  Tourism will be developed in a matter that 
safeguards Sri Lanka,s environment, while providing unique, 
Asia-oriented holiday experiences.  (Note:  The plan does not 
talk about the need to improve infrastructure to meet the 
needs of these up-market tourists.  End note.) 
 
Transportation: 
 
Regional bus and rail companies will be redeveloped to become 
"efficient transport agencies."  The GSL will increase the 
operational bus fleet of the regional bus companies and 
improve route diversity.  Additional law enforcement and 
streamlined administration will enhance efficient operation 
of the transportation industry.  Rail service will be 
modernized and passenger usage will be increased through 
improved service reliability.  A fare structure based on an 
agreed IRR will be implemented. 
 
Infrastructure: 
 
The GSL believes the country cannot rely on the private 
sector to build infrastructure.  The road-network will be 
expanded and the country,s power generation plan will be 
implemented as the highest national priority.  Development of 
the Colombo South Port, the Galle Port, the airport terminal 
facility and an Air Cargo Village will be immediate 
development priorities.  The GSL,s infrastructure 
development strategy will also include rural water supply 
schemes, economic centers, storage facilities and recreation 
and leisure facilities. 
 
Other areas of note: 
 
The GSL will introduce legislation to provide an 
institutional mechanism to facilitate restructuring of 
financially troubled enterprises. 
 
The GSL will take steps to revive the construction industry, 
including the development of a Construction Industry 
Guarantee Fund and the exploration of opportunities for local 
contractors in foreign-funded projects.  The GSL will also 
encourage the sourcing and manufacture of construction 
industry materials based on local raw materials. 
 
The GSL has targeted the building of 300,000 housing units 
island-wide. 
 
Corporate best practices will be encouraged and regulatory 
frameworks will be further developed. 
 
Regulatory surveillance of the financial sector will be 
strengthened. 
 
One Government, Several Voices 
------------------------------ 
 
12.  (C) The lead up to the release of the Government's EPF 
was marked by several conflicting public pronouncements, 
ranging from Trade Minister Fernandopulle's recent assurances 
in Washington that the GSL will follow the former regime's 
economic reform policies, including privatization, to 
Treasury Secretary Jayasundera's hard-core adherence to the 
UPFA election manifesto insistence that no privatization will 
take place.  In the middle is Finance Minister Amunugama, who 
has flip-flopped on the issue, but lately has been indicating 
that if loss making state-owned enterprises are not 
privatized, neither should they expect to be subsidized by 
the Government.  These kinds of conflicting statements 
present a lack of discipline within the ranks at best, the 
notion that the audience is what determines the message at 
worst.  It is possible that much of the internal bickering 
was being hashed out in the press and, with the release of 
the EPF, there may now be a clearer script from which GSL 
officials can read. 
 
Comment 
------- 
 
13.  (C) Politics is the order of the day with the EPF 
(underscored in the minds of the UPFA by the similar recent 
electoral change in India), in deference to the rural voters 
who carried them to power.  The EPF reads like a testimony of 
faith in the power of government, rather than markets, to 
lift the country out of its economic malaise.  This possibly 
signals the influence the Marxist/Nationalist Janatha 
Vimukthi Peramuna (JVP) party on the UPFA coalition.  Much of 
the plan, while highlighting a desire for competition or 
private-sector led growth, goes on to describe how the 
Government wants to engineer that competition or growth. 
While the agriculture and SME sectors are clearly in need of 
improvement, and were clearly at the root of the UPFA's 
electoral victory, the plan says little about key obstacles 
to development in these areas, such as land reform, a 
relatively shallow financial sector and inappropriate 
government interference in business and farming decisions 
(e.g. requirements for farmers to petition for permission to 
grow crops rather than rice in "designated paddy lands"). 
 
 
14.  (C) Comment cont'd:  Perhaps the EPF's biggest 
question-mark is its failure to address in a systematic way 
how the UPFA Government intends to finance new programs while 
trying to raise sufficient revenue to cut an already growing 
deficit.  Based on Secretary Jayasundera's comments to the 
Ambassador about the work of the NCED and SEMA, it seems that 
the Finance Ministry is still focused on putting structure 
underneath the framework cover.  In that regard, it will be 
necessary to watch the continued development of GSL 
discussions with the IFIs and the actions taken by the NCED 
and SEMA.  (Note:  The entire plan is available on the GSL 
Finance Ministry's website 
http://www.treasury.gov.lk/epsg/ecopolstgov.p df.)  End Comment. 
 
LUNSTEAD