US embassy cable - 02COLOMBO1448

UNCLAS SECTION 01 OF 02 COLOMBO 001448 
 
SIPDIS 
 
SENSITIVE 
 
TREASURY FOR AKIFYAT 
DOC FOR JFERNANDEZ, ASTERN 
 
E.O. 12958: 08/06/12 
TAGS: ECON, PREL, ETRD, CE, ECONOMICS 
SUBJECT:  ECONOMIC REFORMS 
 
Ref: Colombo 561 
 
1. (U) Summary: In its eight months in power, Sri Lanka's 
UNF government has made measurable progress on one of its 
main goals, economic reform, with efforts starting to show 
real results over a broad range of promised actions.  The 
true tests will be action on pending economic legislation 
and implementation of difficult measures.  End summary. 
 
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THE MEANS 
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2. (U) To spark growth and rein in the deficit, the UNF's 
March 2002 budget incorporated tax reforms, realignment of 
investment incentives, privatization, removal of subsidies, 
deregulation, and pension and labor reforms (reftel).  New 
laws are required for many proposed measures, and economic- 
related drafts comprise the majority of the thirty-six new 
bills on the docket for an extended August/September 
parliamentary session.  Parliament will consider laws or 
amendments on fiscal responsibility, revenue authority, bank 
rescue, IPR, financial sector revamping, the monetary law, 
the electricity act, and pension supervision, among others. 
 
3.  (U) To carry out economic reform measures, the 
government is using a variety of tactics.  Leading the 
effort is the Policy Development and Implementation 
Ministry, a small group headed by the Prime Minister, that 
operates largely behind the scenes with personnel brought in 
from UNF's previous administrations and foreign (including 
US) advisors.  Also, experienced Sri Lankans have been lured 
back from abroad to take key governmental positions.  After 
conferences on two major issues, deregulation and financial 
sector reform, public/private sector working groups were 
established to advise on implementation.  In some cases, 
consultations are held with involved parties, e.g., the 
Minister of Employment and Labor met regularly with 
employers, unions and government officials before drafting 
wide reaching reform legislation.  The government has also 
contracted world class marketing firms for a public 
information campaign to sell its most controversial (e.g., 
privatization and tax) measures. 
 
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TO THESE ENDS 
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4.  (U) The GSL has already implemented promised changes in 
many areas.  It has made upward adjustments of utility, 
transport, wheat flour and fuel prices, eliminating 
subsidies.  One hundred percent foreign ownership is now 
allowed in sectors formerly restricted, including banking, 
insurance, finance, and supply of water, mass transport, 
telecom and professional services.  Long term debt 
instruments have been added, increasing the maximum term 
treasury bonds from 6 years to 12 years.  Incentives offered 
to investors under the Board of Investment were restructured 
and reduced.  Civil service recruitment is frozen. 
Licensing controls on rice, potatoes and onions were 
removed, leaving these food items with only a duty. 
 
5. (U) Privatization: Real progress has been made in 
privatization of state-owned enterprises.  The government is 
moving to reach its goal of Rps. 21 billion (approx. $219 
million) in privatization proceeds by year's end.  The 
largest privatization this year was the sale of Lanka Marine 
Services, the bunkering arm of Ceylon Petroleum Corporation, 
for Rs. 1.2 billion (approx. $12.5 million).  The government 
has sold the residual stakes of two regional plantation 
companies through the Colombo Stock Exchange.  Two sugar 
mills were sold to local investors, and a Cabinet decision 
is pending on a third.  The results of a tender to privatize 
50 percent of the bus transport system are expected in early 
September.  The GSL has announced the sale of two insurance 
companies, including Sri Lanka Insurance Company, the 
largest player in the market.  There are plans to sell an 
additional 15 percent of Sri Lanka Telecom (out of the 65 
percent still government-held) in October.  The GSL's 49 
percent equity in Shell Gas Lanka will also be sold later 
this year. 
 
6.  (U) Tax reforms: Major tax reform was implemented with 
the introduction of a Value Added Tax (VAT) on August 1. 
The VAT replaces the GST of 12.5 percent and the National 
Security Levy of 6.5 percent, and is expected to simplify 
the tax system and improve tax administration.  Local 
wholesale and retail activities, and exports are exempt from 
VAT.  The VAT has reduced the number of exemptions under the 
former system, expanding its regime, but a significant 
portion of private consumption is still protected.  In 
addition to VAT, the GSL introduced a 0.1 percent tax on 
bank debits, and a 10 percent tax on interest.  The import 
duty surcharge was reduced from 40 to 20 percent, a 25 
percent customs fee was lifted, and the one percent stamp 
duty was eliminated.  The cost to the government of VAT 
exemptions was recently estimated at Rps. 800 million ($8.33 
million).  The revenue from the tax on interest payments, 
however is expected to net Rs. 5.7 billion ($59.4 million) 
more than forecast. 
 
7. (U) International Financing Institutions' support for the 
government's reforms efforts is strong.  The ADB and World 
Bank have programs in Central Bank restructuring, legal and 
judicial reforms, economic reforms technical assistance, and 
public sector resources management.  USAID-funded 
consultants are providing assistance in the public 
information campaign, and in economic and productivity 
policy development.  Support is also seen from local firms, 
who are beginning to upgrade and expand, after a period of 
subdued activity preceding and following the December 
elections. 
 
8.  (SBU) Comment: The way forward for the GSL is clear, but 
will not be smooth.  The government has already felt 
compelled to respond to public complaints about the rising 
cost of living associated with the removal of subsidies, by 
lifting a cost-recovery charge on fuel.  The hinted-at 
restructuring of a state-owned bank has provoked protests 
from unions, as have some privatization plans.  If the GSL 
does follow through on these plans, and the proposed labor 
reforms, a stronger social safety net to help those 
displaced by these measures must be in place. 
 
9. (SBU) Comment continued: Political will to carry through 
reforms seems firm at the top, and is the key reason for 
results achieved so far.  US support for continued strong 
leadership on economic reforms could strengthen the GSL's 
resolve.  Lack of technical expertise, a bloated and 
inefficient public sector and the entrenched culture of 
delays, opacity and personal agendas hinder the efforts in 
implementation.  More importantly, a derailment of the peace 
process or political disruption caused by infighting in the 
government could stop the momentum.  End comment. 
 
Wills