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Cablegate: Investment Climate Statement 2003 for Sri

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 26 COLOMBO 001389

SIPDIS

DEPT FOR EB/IFD/OIA, SA/INS, EB CBA
DEPT PLEASE PASS TO USTR, EXIM, TDA
MANILA FOR USADB

E.O. 12958: N/A
TAGS: EINV EFIN ELAB ETRD KTDB PGOV CE OPIC ECONOMICS
SUBJECT: INVESTMENT CLIMATE STATEMENT 2003 FOR SRI
LANKA

REF: (A) STATE 128494

1. The following is the 2003 Investment Climate
Statement for Sri Lanka. This report will be
included in post's FY 2004 Country Commercial Guide
to be sent separately.

Begin text.

INVESTMENT CLIMATE STATEMENT
SRI LANKA, JULY 2003

Openness to Foreign Investment
------------------------------

2. Sri Lanka actively welcomes foreign investment,
which has become an important element of the
country's economic growth. Sri Lanka opened its
economy to foreign investment in 1978, long before
its South Asian neighbors, but results have been
mixed. Over the past twenty-five years, several
hundred foreign investors have invested in the
country but foreign investment flows have been weak
in the last decade due to an ethnic conflict, and
economic and political problems. This situation is
improving due to current peaceful conditions in the
country, economic reforms and an infrastructure
development plan backed by increased foreign aid.
Although many investors have done well, some have had
problems with government practices and regulations.

3. Sri Lanka's economic growth has been reasonable,
averaging 4.6 percent during the past decade. The
country boasts unique human development achievements
for a developing country. Sri Lanka's per capita
income of $872, a literacy rate of over 90 percent
and life expectancy of 72 years rank well above those
of India, Bangladesh and Pakistan.

4. The current United National Front (UNF)
Government, led by Prime Minister Ranil
Wickremasinghe of the United National Party (UNP),
came into office in December 2001 on a platform of
peace and economic revival. It is strongly pro-
business and investor friendly. The UNF government
has moved to increase foreign investment and private
sector activity in key sectors of the economy,
initially concentrating on infrastructure
development. The government has launched an
extensive deregulation and economic reform program to
facilitate private sector activity and improve
economic growth. These programs are outlined in
"Regaining Sri Lanka" (www.regainingsrilanka.org), a
policy document of the Government of Sri Lanka. In
support of these programs, the International Monetary
Fund (IMF) approved a Poverty Reduction and Growth
Facility (PRGF) (www.imf.org/external/country/LKA)
for Sri Lanka in April 2003. International donors,
including the IMF, have pledged a total of $4.7
billion in grants and concessional loans for Sri
Lanka for a four-year period from 2003. These funds
will be used to facilitate development in the south,
and reconstruction in the north and east heavily
damaged by the ethnic conflict.

5. The most notable achievement of the UNF government
has been the ceasefire agreement signed on February
21, 2002, between the Government and the Liberation
Tigers of Tamil Ealam (LTTE). Although ceasefire
violations continue, the agreement has led to Sri
Lanka's most stable and peaceful period of the last
20 years. Both parties have expressed their
commitment to a negotiated settlement, and have held
six rounds of talks with the Government of Norway
acting as facilitator. As of August 2003, the LTTE,
which pulled out of the peace talks in April 2003, is
reviewing a government paper on an interim
administration in the North and East. There is hope
that the next round of peace talks may be held in the
near future. The peace process has substantially
improved the political, economic and investment
climate and has resulted in attracting substantial
funding from multilateral and bilateral donors to
rebuild the country. This has boosted foreign
investor interest.

6. Numerous risks and challenges remain, however.
The peace process could falter. Domestic political
frictions could disrupt the peace process or hamper
economic reform. Cohabitation tensions exist between
the President and Prime Minister, representing
opposing political parties. The President has
delegated most of her executive powers to the Prime
Minister and his cabinet of ministers, but retains
constitutional power to dismiss the parliament and
call for elections. Such an action could disrupt
progress on peace and economic reforms. One major
business concern in the medium term is the cost and
supply of power. Sri Lanka has faced periodic power
shortages since 1994, with the most recent period
extending from mid 2001 to early 2002. Although new
power plants are being added, the Government is yet
to procure base load power needed to avert a power
crisis in the medium term. Most businesses have
installed on site generating capacity.

Board of Investment

7. The Board of Investment (BOI) (www.boi.lk), an
autonomous statutory agency, is the primary
government authority responsible for foreign
investment. The BOI acts as a facilitator for
investment. It is intended to provide "one-stop"
service for foreign investors, including approval of
projects, granting incentives and arranging services
such as water, power, waste treatment and
telecommunications. The BOI also assists in
obtaining resident visas for expatriate personnel and
facilitates import and export clearance.

8. The Bureau for Infrastructure Investment (BII)
(www.boi.lk), a division of BOI, coordinates all
private infrastructure projects. Projects are
usually structured on the basis of build, own,
operate (BOO), build, operate, and transfer (BOT) or
build, own, operate and transfer (BOOT).

Laws Affecting Investment

9. The principal law governing foreign investment is
Law No. 4 of 1978 (known as the BOI Act), including
amendments made in 1980, 1983 and 1992, and
implementing regulations established under the Act.
The BOI Act provides for two types of investment
approvals. Under section 17 of the Act, the BOI is
empowered to grant concessions (see details below) to
companies satisfying certain eligibility criteria.
Investment approval under section 16 of the act
permits entry for foreign investment to operate under
the "normal" laws of the country and is applicable to
investments that do not satisfy eligibility criteria
for BOI incentives. Other laws affecting foreign
investment are the Securities and Exchange Commission
Act of 1987, amendments made in 1991 and 2003 and the
Takeovers and Mergers Code of 1995. In addition,
various labor laws and regulations affect investors.
See sections below.


10. In early 2003, the Parliament passed a new BOI
law to bring BOI's power to grant tax holidays and
incentives with in the regular income tax law. BOI
will retain most of the other powers granted under
earlier laws; it will be responsible for investment
approvals and granting of other incentives. The new
law also provides for decentralization of some BOI
activities to five regional economic development
commissions formed under the BOI. These commissions
are to promote development in the regions, provide
facilities for investments, and develop and manage
export processing zones. As of July 2003, although
the new law had not come into force, some of the
commissions had been established. When the new law
comes into effect, the previous BOI Act of 1978 will
be automatically repealed.

Foreign Equity and Sectors

11. Foreign equity participation of up to 100
percent is allowed in many sectors of the economy and
the BOI gives automatic approval for most foreign
investments.


12. The Government relaxed investment rules in early
2002, allowing 100 percent foreign investment in the
following services: banking, finance, insurance,
stockbroking, construction of residential buildings
and roads, supply of water, mass transportation,
telecommunications, production and distribution of
energy, professional services and the establishment
of liaison offices or local branches of foreign
companies. These services are regulated and subject
to approval by various government agencies. The
screening mechanism is non-discriminatory and, for
the most part, routine.

13. Investment in some other sectors is restricted
and subject to screening and approval on a case-by-
case basis, where foreign equity exceeds 49 percent:
shipping and travel agencies; freight forwarding;
fishing; timber-based industries; growing and primary
processing of tea, rubber, coconut, rice, cocoa,
sugar and spices; and, finally, the production for
export of goods subject to international quota.
Foreign investment restrictions and government
regulations also apply to international air
transportation; coastal shipping; lotteries; large-
scale mechanized gem mining; and "sensitive"
industries such as military hardware, dangerous drugs
and currency.

14. Foreign investment is not permitted in the
following businesses: non-bank money lending; pawn-
broking; retail trade with a capital investment of
less than $1 million (with one notable exception: the
BOI permits retail and wholesale trading by reputed
international brand names and franchises with an
initial investment of not less than US$ 150,000);
personal services other than for the export or
tourism sectors; coastal fishing; education of Sri
Lankan citizens under 14 years; and award of local
university degrees.

15. In general, the treatment given to foreign
investors is non-discriminatory. In fact, some local
companies have complained that they are discriminated
against, while qualifying foreign investors can
benefit from a wide range of advantages. Even with
incentives and BOI facilitation, foreign investors
can face difficulties operating here. Problems range
from the mundane, but critical, matter of clearing
equipment and supplies through customs speedily, to
getting land for factories. The BOI encourages
investors to locate their factories in industrial
processing zones managed by the BOI to overcome land
allocation problems. Investors locating in
industrial zones also get access to relatively better
infrastructure facilities such as reliable power,
telecommunication and water supplies.

16. Government treatment of foreign investors in the
privatization process has been largely non-
discriminatory. Recently, however, the government
sold part of retail operations of state-owned Ceylon
Petroleum Corporation (CPC) to Indian Oil Corporation
(IOC) without a formal tender process. Caltex, which
had earlier acquired a government owned lubricant
plant and obtained exclusivity in the sale of
lubricants in CPC outlets till mid-2004, has also
complained that the Government had reneged on the
terms of the exclusivity agreement. Labor unions in
the state-owned enterprises are often opposed to
privatization and seem particularly averse to foreign
owners, which has made the purchase of certain
strategic entities problematic for new foreign
owners. In addition, some privatization sales,
particularly to foreign investors, have been
controversial. Sometimes liberal and unwieldy
concessions, not announced during the bidding process
were granted to investors, and other times
substantive changes were introduced once the process
had begun.

Investment Trends

17. Foreign direct investment flows to Sri Lanka
have averaged only about $140 million per year
(excluding privatization receipts) in the past
decade. Since the commencement of the peace process
and improved investor confidence, foreign investment
flows rose to over $245 million in 2002. FDI has
funded mainly infrastructure projects (power,
telecom, ports) and manufacturing industries.
Investment approvals by BOI also rose sharply in
2002. FDI is expected to rise further this year to
over $350 million. The stock market also recovered
markedly in 2002 to become the second best performing
market in Asia. The upward trend is continuing, with
the market recording an all time high in June 2003.
Both foreign direct investment and portfolio
investment are expected to rise further due to
increased investor confidence, private sector
participation in infrastructure and utilities,
increased donor funding and incentives provided by
the BOI. The UNF government's privatization and
economic reform programs offer new investment
opportunities for foreign investors. In addition,
the Indo-Lanka Free Trade Agreement, which offers
duty free entry into India for most products with 35
percent Sri Lankan value addition, offers a gateway
for foreign investors in Sri Lanka to access markets
in India. Currently, US companies avail themselves
of this agreement adding 35% value in Sri Lanka and
getting import duties into India reduced from as much
as 40 percent to as little as zero.

Conversion and Transfer Policies
--------------------------------

18. Sri Lanka has accepted Article VIII status of
the IMF and has liberalized exchange controls on
current account transactions. In early 2001, in
response to a fall in Sri Lanka's foreign exchange
reserves, the Central Bank brought in temporary
controls on foreign exchange transactions, which have
since been removed. There are no surrender
requirements on export receipts, but exporters need
to repatriate export proceeds within 120 days to
settle export credit facilities. Other export
proceeds can be retained abroad. Currently,
contracts for forward bookings of foreign exchange
are permitted for a maximum period of 360 days for
the purposes of payments in trade and 720 days for
the repayment of loans.

19. There are also no barriers, legal or otherwise,
to the expeditious remitting of corporate profits and
dividends for foreign enterprises doing business in
Sri Lanka. Remittance of business fees (management
fees, royalties and licensing fees) is also freely
permitted. Funds for debt service and capital gains
of BOI-approved companies exempted from exchange
control regulations are freely permitted. Other
foreign companies remitting funds for debt service
and capital gains require Central Bank approval. All
stock market investments can be remitted without
prior approval of the Central Bank. Investment
returns can be remitted in any convertible currency
at the legal market rate. Controls on capital
account (investment) transactions usually prohibit
foreigners from investing in debt and fixed income
securities. One exception has been the Central
Bank's dollar denominated bond issues in the local
market in 2001-2002, which were opened to foreign
investors. It has been proposed to allow foreigners
to invest in corporate debentures and government
bonds.
20. Local companies require Central Bank approval to
invest abroad. The process of granting approval for
such investments was streamlined in 2002, resulting
in a substantial increase in approvals.

Expropriation and Compensation
-------------------------------

21. Since economic liberalization policies began in
1978, the Sri Lankan Government has never been
legally found to have expropriated a foreign
investment. Under the terms of the US/Sri Lanka
Bilateral Investment Treaty (BIT), investors have the
right to arbitration under the International Center
for the Settlement of Investment Disputes (ICSID). A
longstanding dispute involving an alleged
expropriation of a US company's investment was
satisfactorily resolved during 1998 after lengthy
negotiations involving the company, the Sri Lankan
Foreign Ministry, the Sri Lankan Attorney General and
the US Embassy.

Dispute Settlement
------------------

Legal System

22. Sri Lankan commercial law is almost entirely
statutory. The law was codified before independence
in 1948 and reflects the letter and spirit of British
law of that era. It has, by and large, been amended
to keep pace with subsequent legal changes in the
U.K. The court system is largely free from
government interference. Procedures exist for
enforcing foreign judgments. Litigation can be very
time consuming. Several important legislative
enactments regulate commercial matters: the Board of
Investment Law, the Code of Intellectual Property,
the Companies Act, the Securities and Exchange
Commission Act, the Banking Act, and the Industrial
Promotion Act. Most of these laws are being revised
to meet current business practices. In addition, a
new Consumer Affairs Authority Act, with wide ranging
provisions for consumer protection was enacted in
2003.

Bankruptcy Laws

23. The Companies Act and the Insolvency Ordinance
e
provide for winding up insolvent companies, but
existing legislation hinders smooth re-organization.
Currently, there is no mechanism to facilitate the
re-organization of financially troubled companies.
The Termination Act, for example, prohibits employers
from laying off workers even on the grounds of
inefficiency. At the urging of the business
community and the donor agencies, the Government took
steps to reform labor laws in 2003. The Parliament
has passed an amendment to the Termination Act to
facilitate easier retrenchment, but its
implementation has been delayed until the development
of a compensation formula and an unemployment
insurance scheme for displaced workers. The new
termination law is expected to come into force in
December 2003, but could be delayed.

24. In the absence of proper Bankruptcy Laws, extra
judicial powers granted to financial institutions by
law protect rights of the creditors and have helped
to strengthen credit discipline. Lenders are able to
enforce financial contracts through powers that allow
them to foreclose on loan collateral without the
intervention of courts. Recently, though, financial
institutions have faced legal challenges, as
defaulters obtain restraining orders on frivolous
grounds due to technical defects in the recovery
laws. Also, for default cases that are filed in
courts, the judicial process is time consuming. The
private sector has urged the Government to introduce
US Chapter 11-style Bankruptcy laws. The financial
community has requested strengthening of debt
recovery laws.

Investment Protection
25. Foreign investments are, in principle,
guaranteed protection by the constitution of Sri
Lanka. The Government has entered into 24 investment
protection agreements with foreign governments
(including the United States) and is a founding
member of the Multilateral Investment Guarantee
Agency (MIGA) of the World Bank. Sri Lanka is also a
founding member of the World Trade Organization. The
Government has ratified the provisions of the
convention on Settlement of Investment Disputes,
which provides the mechanism and facilities for
international arbitration through the ICSID of the
World Bank.

26. The US-Sri Lanka BIT was ratified by both
governments in early 1993. A bilateral treaty on
avoidance of double taxation was signed in September
2002. The treaty shall enter into force upon
ratification by the respective governments and the
exchange of instruments of ratification.

27. Settlement of disputes through the Sri Lankan
court system is subject to protracted and
inexplicable delay. Aggrieved investors (especially
those dealing with the Government of Sri Lanka on
projects) have frequently pursued out-of-court
settlements, which offer the possibility -- not
frequently realized -- of speedier resolution of
disputes.

Arbitration

28. The Arbitration Act of 1995 gives recognition to
the New York Convention on recognition and
enforcement of foreign arbitral awards. Arbitral
awards made abroad are now enforceable in Sri Lanka.
Similarly, awards made in Sri Lanka are enforceable
abroad. A center for arbitration known as the
Institute for the Development of Commercial Law and
Practice (ICLP) has been established in Colombo, for
the expeditious, economical and private settlement of
commercial disputes. The ICLP appears unlikely to
become involved in disputes involving the Sri Lankan
Government, the source of most disputes involving US
companies in recent years. Sri Lanka's first
commercial mediation center was established in 2000,
and became operational in mid 2001. Commercial
mediation is conducted under the Commercial Mediation
Act. Interest in mediation is still low.

29. The Labor Department has a process involving
labor tribunals for settling industrial disputes with
labor, and compulsory arbitration is available when
attempts to reconcile industrial disputes fail. The
Parliament has passed an amendment to the Industrial
Disputes Act to expedite labor dispute resolution
through the Labor Tribunals of the Department of
Labor. The Labor Commissioner typically becomes
involved in labor-management mediation. The Labor
Minister, and even the President, has intervened in
particularly difficult cases.

Investment Disputes Involving U.S. Companies

30. There have been some troublesome investment and
investment-related commercial disputes involving US
companies in recent years. One such dispute,
involving an alleged expropriation, was resolved in
1998 after 17 years of on-and-off negotiations
between the company, the Government of Sri Lanka and
the US Embassy.
31. A partially US-owned Internet service provider
became involved in a major dispute in 1999 when its
new "enhanced voice" service competed successfully
with the national telecom service provider, Sri Lanka
Telecom (SLT). Though the company had a valid
license to provide enhanced voice service, SLT and
the Government of Sri Lanka effectively blocked its
implementation. Additional harassment and baseless
charges were brought against one company employee,
though intervention by the U.S. Embassy led to some
respite. Changes in the Telecommunications
Regulatory Commission under the new government have
resulted in the resolution of many, though not all,
of this company's difficulties. SLT still retains
much control over telecom operations. The Sri Lankan
government subsequently opened international
telephony in early 2003 to all telecom technologies,
though interconnection problems plague operators.

32. In another case, the Sri Lankan Supreme Court in
May 2000 effectively blocked an existing investment
agreement between the Government of Sri Lanka and a
US mining company. Although the investment agreement
was already signed and approved by the Sri Lankan
cabinet, work on the project had not yet begun. A
group of citizens filed a fundamental rights case,
which under Sri Lankan law goes directly to the
Supreme Court. The plaintiffs alleged in this case
that their rights would be violated by implementation
of the mining project, and the court upheld their
complaint. Without any technical argument, the Court
ruled that the project could not proceed before
completion of a new series of detailed and highly
comprehensive and expensive studies, some of which
appear to be technically impractical. Because this
is a Supreme Court decision, options for reversing
the decision appear limited.

33. Another US investor with a substantial
investment in an export manufacturing company has
faced lengthy delays in a court case over a large
insurance claim. The company instituted legal action
in June 1999 and court proceedings are still ongoing
with the company suffering financial losses as a
result. In many disputes, defendants resort to
obtaining injunctions, stay orders or postponements
to drag cases on for years.

Performance Requirements/Incentives
-----------------------------------

Performance Requirements

34. The Board of Investment specifies certain
minimum investment amounts for both local and foreign
investors to qualify for incentives. Firms enjoying
preferential incentives in the manufacturing sector
in most cases are required to export 80 percent of
production, while those in the service sector must
export at least 70 percent of production. Sri Lanka
complies with WTO Trade Related Investment Measures
(TRIMS) Obligations.

35. Foreign investment is encouraged in information
technology, electronic assembly, light engineering,
automobile parts and accessories manufacture,
industrial and IT parks, rubber based industries,
information and communication services, tourism and
leisure related activities, agriculture and agro
processing, port related services, regional operating
headquarters and infrastructure projects. Foreign
investors are generally not expected to reduce their
equity over time or to transfer technology within a
specified period of time, except for build-own-
transfer or other projects in which such terms are
clearly specified.

36. Maintaining a certain level of employment is a
condition in some BOI-approved enterprises. In
addition, privatization agreements as a rule prohibit
new owners from laying off workers, although the
owners are free to offer voluntary retirement
packages to reduce their workforce. Some foreign
investors have received political pressure to hire
workers from a particular constituency or a given
list, but have successfully resisted such pressure
with no apparent adverse effects.
37. Foreign investors who make an equity investment
of $50,000 can qualify for a resident visa.
Employment of foreign personnel is permitted when
there is a demonstrated shortage of qualified local
labor. Technical and managerial personnel are in
short supply, and this shortage is likely to continue
in the near future. Foreign employees attached to
BOI-approved companies usually receive preferential
tax treatment and do not experience significant
problems in obtaining work or residence permits.

Investment Incentives

38. The Board of Investment has announced the
following investment incentives:

39. Incentive Program I

Qualifying industries:
-- Non traditional manufacturing exports (excluding
tea, rubber and coconut), and companies supplying to
exporting companies. Minimum investment of $150,000;
-- Export oriented services. Minimum investment of
$150,000;
-- Manufacture of industrial tools and/or machinery.
Minimum investment of $150,000;
-- Small scale infrastructure. Minimum investment of
$500,000;
-- Research and development. Minimum investment of
$50,000;
-- Agriculture and agro processing industries.
Minimum investment of $10,000;

Incentives: Above industries will qualify for a
five-year tax holiday initially. A preferential tax
of 10 percent in the 6th and 7th years follows the
tax holiday. After the 7th year, a preferential tax
of 15-20 percent will apply. In addition, these
industries qualify for duty-free imports (generally,
during the life of the project for export-oriented
projects, and during the project implementation
period for others). Exporting companies and export-
oriented services will be exempted from exchange
control regulations. They will also qualify for free
repatriation of profits and dividends and free
transferability of shares.

40. Incentive Program II

Qualifying Industries:
-- Information technology services such as call
centers, data entry services, data centers, software
development, hosting centers of e-governance related
projects (a);
-- IT training institutes (b);
-- Regional operating headquarters providing
following services to related businesses outside Sri
Lanka: sourcing raw materials, R&D, technical
support, financial and treasury management, marketing
and sales promotion;
-- Any industrial, agriculture, service, or
construction activity approved by the BOI. Minimum
investment of $5 million.

(a)Minimum employment of 15 IT professionals is
required in IT companies
(b) Minimum 300 students required for IT training
institutes.

Incentives: Above industries will qualify for a 3-
year tax holiday period initially. A preferential
tax of 10 percent will apply in the 4th and 5th
years. From 6th year onwards a preferential tax of
15-20 percent will apply. In addition, capital goods
will be exempted from import duty.

Infrastructure development:

41. Companies acquiring existing companies in
petroleum, power generation, transmission,
development of highways, sea ports, airports,
railway, water services, public transport,
agriculture and agro processing and other
infrastructure projects approved by the Finance
Minister. Minimum investment of $12.5 million.

42. The above projects will qualify for tax holidays
ranging from 5 to 10 years depending on the magnitude
of investment. A preferential tax of 15 percent will
follow the tax holiday. They will also qualify for
duty free imports of capital goods.

43. Large-scale infrastructure projects in power
generation, transmission and distribution;
development of highways, seaports, airports, public
transport and water services; establishment of
industrial parks, and other infrastructure projects
approved by the BOI. Minimum investment of $10
million.

44. The above investments will qualify for tax
holidays ranging from 6 to 12 years depending on the
size of the investment. A preferential tax of 15
percent will follow the tax holiday. They will also
qualify for duty free imports of capital goods.

Indo-Lanka Free Trade Agreement

45. A preferential trade agreement, Indo Lanka Free
Trade Agreement (ILFTA) (www.indolankafta.org),
between Sri Lanka and India is in operation. Under
this agreement, most products manufactured in Sri
Lanka, with at least 35 percent domestic value
addition (if raw materials are imported from India,
domestic value addition required is only 25 percent),
qualify for duty free entry to the Indian market.
Tariff concessions for Sri Lankan products include
zero tariffs on 4,150 items; 50 to 75 percent
reduction for tea and garments under quota; 25
percent reduction for 528 items, and no reduction for
429 items (negative list). The two countries have
begun discussions on services sector liberalization,
although no specific goals have been set yet.

46. Sri Lanka also hopes to sign free trade
agreements with Pakistan soon. These are seen as
steps towards making Sri Lanka a regional hub and the
gateway to South Asia and Middle East for foreign
investors.

Prospects for U.S. Investment Under Indo Lanka Free
Trade Agreement (ILFTA)

47. Foreign investors in Sri Lanka can enjoy
preferential access to the Indian market, under the
ILFTA. Domestic value addition of 35 percent is
required to qualify for concessions granted under the
agreement. The BOI hopes to attract foreign joint
ventures to Sri Lanka under the ILFTA. Indian
imports amounted to over $49 billion in 2002. The
BOI's strategy is to identify products imported into
India and to target its investment promotion efforts
to countries and companies manufacturing them. The
US is one such country; the US accounts for about 7.5
percent of Indian imports valued at $3.7 billion in
2002. A majority of these products would qualify for
substantial duty concessions if exported from Sri
Lanka under the ILFTA. The BOI encourages US
manufacturing companies and regional operating
headquarters to relocate in Sri Lanka to benefit from
ILFTA. The BOI has identified the following sectors
for investment promotion in the US: electronics,
light engineering, pharmaceuticals/cosmetics,
information technology and financial services.

48. For further information on investment incentives
and other investment-related issues, potential
investors are encouraged to contact the Board of
Investment directly. The BOI can be found at
www.boi.lk, or reached via e-mail at info@boi.lk

Right to Private Ownership and Establishment
--------------------------------------------

49. Private entities are free to establish, acquire
and dispose of interests in business enterprises.
Private enterprises enjoy benefits similar to those
granted to public enterprises, and there are no known
limitations on access to markets, credit or licenses.
Foreign ownership is allowed in most sectors.
Private land ownership is limited to fifty acres per
person. About 80 percent of the land in Sri Lanka is
owned by the Government, including most tea, rubber
and coconut plantations. In the past three and a
half years, the Government divested most of these
plantations to the private sector on 50-year lease
terms as part of ongoing privatization efforts.
Although state land for industrial use is usually
allotted on a 50-year lease, 99-year leases may also
be approved on a case-by-case basis, depending on the
nature of the project.

50. Foreign investors can purchase land from private
sellers. The Government removed a 100 percent tax on
land transfers to foreigners in March 2002.

Protection of Property Rights
-----------------------------

Property rights

51. Secured interests in property are recognized and
enforced. A fairly reliable registration system
exists for recording private property such as land,
buildings and mortgages. The legal system is
nondiscriminatory and protects and facilitates
acquisition and disposition of property rights by
foreigners.

52. Private farmers are working state-owned lands
under varying tenure agreements, ranging from
restrictive tenures to land grants. These lands have
ill-defined property rights. A World Bank-funded
project is underway to develop a legal framework for
implementing a titling system for land. This will
also remove restrictions related to the sale, leasing
and transfer and mortgaging of rural lands previously
distributed to farmers.


Intellectual Property Rights Protection

53. Sri Lanka is a party to major Intellectual
Property Agreements including the Berne Convention
for the protection of literary and artistic works,
the Paris Convention for the protection of industrial
property, the Madrid Agreement for the repression of
false or deceptive indication of source on goods, the
Nairobi Treaty, the Patent Co-operation Treaty, the
Universal Copyright Convention and the Convention
establishing the World Intellectual Property
Organization (WIPO). Sri Lanka's intellectual
property law is based on the WIPO model law for
developing countries. Sri Lanka and the US signed a
Bilateral Agreement for the Protection of
Intellectual Property Rights in 1991, and Sri Lanka
is also a party to the Trade Related Intellectual
Property Rights (TRIPS) Agreement in the World Trade
Organization.

54. In July 2003, the Sri Lankan Parliament passed a
new intellectual property law to replace the
Intellectual Property Act of 1979. The new law is
expected to come into force in August 2003 and will
meet both US-Sri Lanka bilateral IPR agreement and
TRIPS obligations (due on January 1, 2000), to a
great extent. The law will govern copyrights and
related rights, industrial designs, patents for
inventions, trademarks and service marks, trade
names, layout designs of integrated circuits,
geographical indications, unfair competition and
undisclosed information. All trademarks, designs,
industrial designs and patents must be registered
with the Director General of Intellectual Property.

55. Infringement of Intellectual Property Rights
(IPR) is a punishable offense under the new law.
Intellectual Property Rights come under both criminal
and civil jurisdiction. Relief available to owners
under the new law includes injunctive relief, seizure
and destruction of infringing goods and plates or
implements used for the making of infringing copies,
and prohibition of importation and exports.
Enforcement, however, is a serious problem, as is
public awareness of IPR. Domestic implementing
legislation, under the old law, has been very weak
and the Government does not act as an enforcer of IPR
laws. At present, aggrieved parties must, on their
own, seek redress of any IPR violation through the
courts, which can be a frustrating and time-consuming
process. Although the legal system is well-
established and non-discriminatory, it is fraught
with long delays.

56. It will take time before new procedures and
court precedents are established. In addition, Sri
Lanka needs to ratify and conform to the WIPO
Performances and Phonograms Treaty (WPPT) and the
WIPO Copyright Treaty (WCT). Ratification of these
two treaties will support electronic commerce,
protect the rights of performers and producers of
phonograms and the rights of authors in their
literary and artistic works, and offer an adequate
basis to fight international piracy in view of the
new technological developments. Meanwhile, local
agents of reputed US and other international
recording companies, software development companies
and motion picture companies continue to complain
that lack of IPR protection is damaging their
businesses. The Embassy, along with key industry
players including the IFPI, continues to lobby the
Government to improve Sri Lanka's IPR regime.

57. Patents are granted for inventions, with the
following exceptions: discoveries, scientific
theories and mathematical methods, plant or animal
varieties (other than micro biological processes) and
essentially biological processes for the production
of plants and animals (other than non biological and
microbiological processes), business rules and
methods, methods of treatment by surgery or therapy,
and diagnostic methods practiced on the human or
animal body. The new law will also permit compulsory
licensing and parallel imports of pharmaceutical
products. The compulsory licensing will allow
government to grant licenses to manufacture certain
drugs, overruling patent licenses, in a national
emergency. The parallel imports will allow the
import of a branded drug from an alternative source.
A patent is valid for 20 years from the date of
grant, but must be renewed annually.

58. Copyrights are not registered. A work is
protected automatically by operation of law.
Original literary, artistic, and scientific works
including computer programs and databases are
protected under the new law. The enforcement
limitations described above apply to copyrights,
including software.

59. Sri Lanka recognizes both trademarks and service
marks. The exclusive right to a mark is acquired by
registration. A mark may consist of words, slogans,
designs, etc. Protection also is available to well
known marks not registered in Sri Lanka. Registered
trademarks are valid for ten years.
Transparency of the Regulatory System
-------------------------------------
60. The BOI strives to inform potential investors
about laws and regulations that may affect operations
in Sri Lanka. Laws pertaining to tax, labor and
labor standards, exchange controls, customs,
environmental norms, building and construction
standards are in place. Some of the laws and
regulations are not freely available and are
difficult to access. Foreign and domestic investors
often complain that the regulatory system allows far
too much leeway for bureaucratic discretion.
Outdated regulations and rigid administrative
procedures imposed by public sector institutions have
been identified as impediments to private sector
growth. Effective enforcement mechanisms are
sometimes lacking and coordination problems between
the BOI and relevant line agencies frequently emerge.
Lethargy and indifference on the part of mid- and
lower-level public servants compound transparency
problems. Non-availability of technical capacity
within the Government to review financial proposals
for private infrastructure projects also creates
problems during tendering. The Government has begun
to carry out extensive deregulation to facilitate
private sector activity.

61. Although many foreign investors, including US
firms, have had positive experiences in Sri Lanka,
some have encountered significant problems with
government practices and regulations. For example,
one foreign company that had obtained a waiver of a
particular requirement in order to obtain a license
was later told it must meet the requirement to
continue to be qualified for the license, with no
advance warning and little justification. Some
multinational firms have experienced extensive
unexplained delays in trying to reach agreement on
investment projects. Others have had contracts
inexplicably canceled without compensation, even
after those contracts had been approved by the Sri
Lankan Cabinet.

62. The partially US-owned Internet service provider
mentioned above encountered further difficulties in
1999 when its "enhanced voice" service competed
successfully with Sri Lanka Telecom (SLT) which is
partly owned by the Government. The company had a
valid license to offer enhanced voice service, but
SLT claimed otherwise. Although technical questions
regarding the interpretation of licenses should in
theory be resolved by the industry regulatory
authority, this option was less attractive to the
company because the Director General of the
Regulatory Authority at that time was in this case a
former CEO of SLT with a bias towards SLT. This
problem was partially resolved in 2002 with the
appointment of a new Telecom Regulator and in 2003,
when the government fully liberalized the external
gateway operations. Implementation and enforcement
of the new regulations is inconsistent.

Efficient Capital Markets and Portfolio Investment
--------------------------------------------- -----

Availability of financial resources

63. Retained profits finance about 70 percent of
private investment, with short term borrowing
financing a further 20 percent of investment. The
stock market and corporate securities market have not
been significantly used to raise capital. FDI
finances about 4 percent of investment.
64. The State consumes over 50 percent of the
country's domestic financial resources, and has a
virtual monopoly on the management and use of long
term savings in the country. This inhibits the free
flow of financial resources to product and factor
markets. In the past, high interest rate volatility
due to excessive use of short term borrowing by the
state increased intermediation cost leading to higher
costs to other borrowers. The current government has
initiated a low interest rate regime and has begun to
replace short-term government debt with long-term
debt. Together with lower inflation and improved
government fiscal discipline this contributed to
lower interest rates during the past 18 months. The
Central Bank has decreased its key monetary policy
rates significantly during this period. The prime
lending rate currently averages 10.36 percent
compared with about 21.5 percent in December 2000.
Foreign investors are allowed to access credit on the
local market. They are also free to raise foreign
currency loans.

65. In 2002, there was a revival in the Colombo
stock market. A total of Rs 4.0 billion (approx. $42
million) was raised in the primary market by way of
new equity and debt, reflecting the potential for
companies to raise funds through the market. Due to
economic and political problems and depressed stock
market conditions, capital raised in the primary
market was extremely low during 1999-2001.

66. The International Finance Corporation (IFC), the
arm of the World Bank group which invests in the
private sector, also provides equity and debt
financing for private sector ventures in Sri Lanka
such as infrastructure, financial markets, tourism,
IT, healthcare and education as well as general
manufacturing and services. The IFC's current
portfolio in Sri Lanka is about $75 million.

Credit Instruments

67. Commercial banks and two development finance
institutions, the National Development Bank (NDB) and
the Development Finance Corporation of Ceylon Bank
(DFCC), are the principal source of bank finance.
Bank loans are the most widely used credit instrument
for the private sector. Financial institutions such
as the DFCC and some commercial banks also raise
syndicated bank loans to fund large-scale investment
projects undertaken by the private sector.

68. The domestic debt market in Sri Lanka is still
at a very nascent stage. A few leading companies and
financial institutions have raised capital through
credit instruments such as debentures, corporate
bonds and commercial paper. In the past, high
interest rates on government bonds due to excessive
government borrowing have made it unprofitable for
private companies to raise capital through corporate
bonds. This situation is set to change with the
current relatively low interest rates on government
bonds. In 2002, Rs 2.7 billion ($27.8 million) was
raised through listed debentures. Corporate debt of
both publicly listed companies and companies not
listed on the stock exchange are traded through the
stock exchange. Fitch IBRC (formerly Duff and Phelps
Credit Rating Company) which opened an office in
Colombo in 1999, is the only credit rating agency in
Sri Lanka. The local branch company, Fitch Rating
Lanka Ltd, is a joint venture between Fitch IBRC,
IFC, the Central Bank of Sri Lanka and several local
financial institutions. Fitch Lanka rates debt
instruments of corporations, banks and other
financial institutions in accordance with
international rating standards. But a strong credit
rating culture has not yet developed in Sri Lanka.
This is set to change as the government has made
credit ratings mandatory for all deposit taking
institutions from January 2004. Credit ratings are
also mandatory for all varieties of debt instruments.
Accounting Standards

69. There is an active and relatively competent
accounting profession, based on the British model.
The source of accounting standards is the Institute
of Chartered Accountants of Sri Lanka (ICASL) and
standards are constantly updated to reflect current
international accounting and audit standards. Due to
the lack of an adequate enforcement mechanism,
however, problems with the quality and reliability of
financial statements exist. Sri Lanka carried out a
major revision of accounting and auditing standards
in September 1997. Since then, the standards have
been periodically updated to meet new international
standards adopted by the International Accounting
Standards Board (IASB). As of mid 2003, there were
five new international standards awaiting adoption in
Sri Lanka.

70. Sri Lanka accounting standards are applicable
for all banks and companies listed on the stock
exchange and all other large- and medium-sized
companies in Sri Lanka. Accounts of such business
enterprises are required to be audited by
professionally qualified auditors holding ICASL
membership. ICASL has recently published accounting
standards for small companies as well. Companies in
Sri Lanka now have the choice of adopting
International Financial Reporting Standards (IFRS) of
the IASB. An Accounting Standards and Monitoring
Board (ASMB) which started operations in April 2000,
is responsible for monitoring compliance with Sri
Lanka accounting and auditing standards. In 2001,
the ASMB has reviewed financial statements of 397
companies and found major deviations in 9 percent of
the financial statements.

Securities Exchange Commission

71. The Securities and Exchange Commission (SEC)
regulates the securities market in Sri Lanka. The
SEC law was revised in 2003, enhancing its coverage
and investigative powers. The SEC now covers stock
exchanges, unit trusts, stock brokers, listed public
companies, margin traders, underwriters, investment
managers, credit rating agencies and securities
depositories.

72. Foreign investors can freely purchase up to 100
percent of equity in Sri Lankan companies in numerous
permitted sectors. In order to facilitate portfolio
investments, country funds and regional funds are
also allowed to invest in Sri Lanka's stock market;
such funds must first receive Ministry of Finance
approval to operate in Sri Lanka. These funds make
transactions through share investment external rupee
accounts maintained in commercial banks.

73. Sri Lanka's SEC was rocked by a scandal in early
2003, tarnishing the image of the market watchdog.
The SEC Chairman and another leading businessman were
implicated for insider dealing at a blue chip local
conglomerate where they were both directors. Initial
attempts by the SEC secretariat to institute legal
actions against the two were blocked by the SEC Board
of Directors. Later, the Attorney General ruled that
the SEC Board had acted improperly, casting doubt on
the board members' credibility. Since then, the SEC
Chairman has resigned. He has pleaded innocent and
has filed legal action, opposing SEC decision to
prosecute. The SEC is awaiting a decision on this
case to proceed with legal action. The SEC Director
General, who was instrumental in pursuing the case,
also resigned, citing unwarranted interference by the
SEC board of directors to stop investigations.

74. The SEC scandal has caused many to call for
increased corporate governance and accountability in
the private sector. Some business consultants have
asked for laws such as the recent US Sarbanes-Oxley
Act to regulate financial services and professional
services organizations.
Colombo Stock Exchange

75. The Colombo Stock Exchange (CSE), while small by
"big emerging market" standards, is one of the most
efficient in the region. The CSE is fully automated,
with automated trading and clearing and settlement
systems. The CSE has a rolling settlement period of
five days for buyers and six days for sellers.
Fifteen local and foreign joint venture brokers
currently operate at the CSE. Foreign stock-brokers
are permitted to hold up to 100 percent equity in
stock broking firms operating at the CSE. SEC has a
settlement guarantee fund with an initial capital of
Rs 100 million ($1 million) which aims to guarantee
the settlement of trades between clearing members of
the exchange. The Chartered Financial Analysts (CFA)
program is conducted in Sri Lanka.

76. Acquisition of companies through mergers and
takeovers is governed by the Takeovers and Mergers
Code of 1995 made under the Securities and Exchange
Commission of Sri Lanka Act. This law applies only
to companies listed on the Colombo Stock Exchange.
Acquisition of more than a 30 percent stake of a
listed company requires the buyer to make an offer to
all other shareholders. There are 240 companies
listed on the stock exchange. The articles of
association of a few listed companies restrict
foreign equity to certain levels.

77. In mid-2003, CSE was one of the best performing
markets in the world. In June 2003, the stock market
hit an all time high. The cease-fire agreement
between the Government of Sri Lanka and the LTTE and
economic reforms has helped to boost investor
confidence. During 1998-2001, the Colombo Stock
Market experienced a sharp downturn due to a variety
of local and international factors. The CSE was
removed from the Morgan Stanley Capital International
(MSCI) Index in 2001 due to a drop in market
capitalization and liquidity. The CSE hopes to get
reclassified in the MSCI soon. The single overriding
factor inhibiting the sustainable development of the
stock market has been the conflict in the North and
East and its effect on investor confidence and the
economy as a whole. Other broader issues include
lack of liquidity and limited market size.
Improvements are also needed in corporate governance,
accountability and public disclosure in companies.
The Accounting and Auditing Standards Monitoring
Board, the Ceylon Chamber of Commerce, the Colombo
Stock Exchange and professional accounting bodies are
taking initiatives in these areas.

Banking System

78. Sri Lanka has a fairly well diversified banking
system. There are 23 commercial banks, consisting of
eleven local banks and twelve foreign banks. In
addition, there are thirteen local specialized banks.
The banking sector moved towards consolidation in
2001-2002 as four foreign commercial banks, ABN Amro,
Nova Scotia, Habib Bank AG Zurich and American
Express left Sri Lanka after selling their
operations. Citibank NA is the only US bank
operating in Sri Lanka and has expanded its
operations recently. In 2002, the American Express
Bank sold its banking operations in Colombo in
keeping with its global strategy. Sri Lanka
experienced its first bank failure in December 2002,
when the Central Bank took action to revoke the
license of a small licensed specialized bank as its
financial condition deteriorated to insolvency.
There has not been any fallout for other banks from
this incident as of June 2003. At the request of the
Central Bank, two other small troubled commercial
banks are being taken over by larger banks. Sri
Lanka's banking sector has various outdated
regulations that restrict banking sector
consolidation. The Government is proposing to amend
the Banking Act to further facilitate mergers and
acquisitions in the banking sector in a strategy to
help consolidation. Further, the Government has
launched an extensive financial sector reforms
program, which is set to overhaul the financial
sector to suit modern times.

79. The Central Bank is responsible for supervision
of all banking institutions. Wide-ranging
improvements have been made in banking regulation and
in public disclosure of banking sector performance.
In 1997, the Central Bank issued, for the first time,
directives on loan classification, suspension of
interest, provisioning, investments in equity, and
the acquisition of immovable property, and it
tightened its directives on capital adequacy and
single borrowers. Subsequently, the Central Bank has
expanded its reporting system to monitor compliance.
Standards for the public disclosure of banking sector
data were raised considerably in 1999. With the
exception of classification and provisioning, all
Central Bank requirements are up to international
standards. In 2002, the Monetary Law Act (MLA) was
amended to provide Central Bank broader supervisory
powers and greater independence. It also contained
improvements to the payment and settlement systems.
The bank also commenced additional training programs
for bank supervision staff and introduced more on-
site and off-site surveillance during the year. The
Central Bank also issued a code of corporate
governance for banks and financial institutions in
2002.

80. Despite recent progress, bank supervision
remains weak. Central Bank supervision as well as
auditing practices of private audit firms came under
criticism after the recent specialized bank failure
mentioned above. The Central Bank is planning to
obtain the services of an international expert to
strengthen bank supervision in 2003. In addition,
the Government is proposing to introduce amendments
to the Banking Act to enhance Central Bank's
supervision capacity (including fit and proper tests
of new entrants and penal violations for violation of
prudential laws). Further amendments to the MLA are
also expected in the next two years under ongoing
financial and legal reforms programs.

State Owned Banks

81. Total assets of the commercial banks stood at Rs
788 billion ($8.1 billion) as of December 31, 2002.
Despite a gradual loss in market share, the two
state-owned commercial banks, Bank of Ceylon and
People's Bank with assets of Rs 228 billion and Rs
180 billion, respectively, still dominate banking,
making up a little over half of all assets and
liabilities. The state banks are weak, with high
NPLs, inadequate loan loss provisioning, low
equity/assets ratio. Much of that is due to past
government interference. Since most of the bad debt
of the two banks is implicitly guaranteed by the
state, these problems do not affect the credibility
of the banking system in Sri Lanka.

82. The weaknesses in the state banks, however, make
it possible for other inefficient banks to operate
and for the more efficient banks to make higher
profits than they would otherwise. The World Bank
and IMF have identified the dominance of the
inefficient state banks as a main constraint for
development of the financial sector. In a bid to
overcome the problems at the state-owned banks, the
Government has been trying to reorganize the banks
since mid 1998. Both banks have launched
restructuring exercises to return to commercial
viability in the medium term. Top management at both
Bank of Ceylon and People's Bank now contains members
from the business community and experienced bankers
from the private sector. Corporate governance
practices in the state banks, however, remain
questionable.
83. Bank of Ceylon met most of the World Bank
established restructuring targets by end 2002,
including loan recovery and return on assets. The
situation at People's Bank, however, remains grave.
Although the People's Bank strengthened its financial
position, reflecting increased recoveries and higher
margins and posted a profit in 2002, the Bank is
insolvent. The Government has agreed on the urgent
need for the restructuring of the Peoples Bank under
the PRGF with the IMF. As a first option, the
Government has set a December 2003 target to sell the
Bank as a single unit, after transferring problem
loans to an asset management company. If this fails,
it is proposed to separate the bank into a savings
and commercial bank-the former remaining under the
government and the latter divested. In either case,
the Government aims to complete the restructuring by
March 2004.

Private Commercial Banks and foreign banks

84. Private commercial banks and foreign banks
operating in Sri Lanka generally follow more prudent
credit policies and as a group are in better
financial shape. Banking sector profits increased
quite sharply in 2002 after suffering badly in 2001
due to the economic slowdown. Nonetheless, the
private banking sector also remains trapped with a
high level of non-performing loans, despite high
margins. In 2002, the average rate of non-performing
loans to total loans was 19 percent for the two state
commercial banks, 15.3 percent for private domestic
banks and 12.1 percent for foreign banks operating in
Sri Lanka. There are concerns regarding inadequate
loan loss provisioning and low operational efficiency
in some local private banks. Foreign banks tend to
make provisions in line with international best
practices as most foreign bank branches are subject
to home country supervision in addition to that of
the Central Bank of Sri Lanka. To help improve bank
performance, an Asset Management Company Law is being
prepared with World Bank and IMF assistance. The law
aims to provide troubled banks with a mechanism to
effectively deal with their non-performing loans.

85. Credit ratings will become mandatory for all
banks operating in Sri Lanka from January 2004.
Currently, six banks have been assigned ratings by
Fitch Ratings: State-owned National Savings Bank:SL
AAA; Citibank NA, Colombo:SL AAA; Commercial Bank of
Ceylon:SLAA+,.DFCC Bank:SL AA; Bank of Ceylon:SL AA-
and Hatton National Bank: SL A.

Capital Adequacy

86. Sri Lanka adopted capital adequacy standards set
by the Basel Committee on banking regulations and
supervisory practices in 1993. The Central Bank has
raised the minimum capital adequacy standards from
4.5 to 5 percent for core capital (Tier I) and from 9
to 10 percent for risk weighted assets (Tier I and
Tier II) from January 2003. Further enhancing
banking sector stability, Central Bank has also
imposed capital adequacy standards on foreign
currency banking units from June 30, 2003.

87. The two state owned banks' risk based capital
asset ratio (CA) at 0.3 percent was well below the
minimum in 2002. For private domestic banks, CA
averaged 9.3. The foreign banks comfortably met the
requirement at 36.6 percent.
Political Violence
------------------

88. Since early 2002, there has been a marked
improvement in the business climate due to the
peaceful atmosphere prevailing in the country. This
is in contrast to the period between 1983-2001, when
the country was plagued by ethnic conflict, a civil
war and related urban terrorism. The fighting
between the Liberation Tigers of Tamil Eelam (LTTE)
and the Sri Lankan military was primarily in northern
and eastern Sri Lanka, but other parts of the country
suffered sporadic terrorist attacks. Since 1997, the
LTTE has been on the State Department list of foreign
terrorist organizations. Terrorist activities of the
LTTE have declined significantly since late 2001 when
the LTTE declared a unilateral cease-fire and signed
a formal open-ended cease-fire agreement on February
22, 2002 with the hope of ending the war. The two
parties have held six rounds of peace talks with the
government of Norway acting as facilitator. The
LTTE, which temporarily suspended its participation
in the peace talks in April 2003 was giving signals
of returning to the talks as of July 2003. Although
several ceasefire violations have been recorded, the
enduring ceasefire in Sri Lanka has increased
investor confidence and has allowed the government
and private sector to embark on new investment and
business initiatives. There are no guarantees that
the process will succeed in ending the years of
conflict, but optimism is stronger than at any time
in the past decade.

89. During the almost 19 years of war, tourists and
foreign business representatives have not been
terrorist targets but have suffered collateral injury
during attacks on other targets. On July 24, 2001
the LTTE attacked the International Airport and
destroyed both commercial and military aircraft.
Several military personnel were killed in the attack,
military and airport employees were injured, and
civilians were caught in crossfire. Sri Lankan
Airlines, jointly owned by the Government of Sri
Lanka and Emirates Airlines of Dubai, lost several
commercial aircraft in the attack. The LTTE has
also attacked several commercial ships flying foreign
flags in the waters off the north and east of the
country. In response to these attacks, insurers
imposed war risk insurance surcharges on aircraft and
ships using Sri Lankan seaports and airports. These
surcharges have since been lifted. During the
conflict, the LTTE also detonated several large bombs
in Colombo's financial and business districts causing
extensive damage to life and property. Very few
foreigners were injured in these terrorist incidents
due to the LTTE's policy of targeting local
interests. There have been no major attacks since
the peace process began on December 24, 2001. In
recent months (April-July 2003), however, the LTTE is
implicated in the slayings of several anti-LTTE
politicians of Tamil heritage. There have also been
several violent incidents at sea.

90. In 1998, the US Peace Corps suspended operations
in Sri Lanka after LTTE bombings occurred outside the
Colombo area, including places such as Galle in the
south and Kandy in the central highlands -- locations
where volunteers had been posted, based on the low
probability of terrorist attacks. There are efforts
by the current government to bring the Peace Corps
back and a Peace Corps assessment team is expected in
September.

Corruption
----------

91. The country has fairly adequate laws and
regulations to combat corruption, but they are
unevenly enforced. US firms identify corruption as a
constraint on foreign investment, but, by and large,
it is not a major threat to operating in Sri Lanka.
Corruption is a persistent problem in customs
clearance and enables wide-scale smuggling of certain
consumer items, to the detriment of legitimate
manufacturers and importers. Corruption appears to
have the greatest effect on investors in large
projects as well as government procurement and
tendering, especially in previous defense purchases.
The law states that giving or accepting a bribe is a
criminal offense and carries a maximum sentence of
seven years imprisonment and a fine at the discretion
of the courts. The Bribery Commission is the main
body responsible for investigating allegations of
bribery and corruption. The function of the Bribery
Commission, under Act No 19 of 1994, is to
investigate allegations brought to its attention and
institute proceedings against responsible individuals
in the appropriate court. The commission was
appointed for a 5-year term in December 1999 but has
not been effective in dealing with bribery or
corruption. As of June 2003, this commission was not
functioning, due to the failure of the Constitutional
Council to fill a vacancy caused by the death of one
of the three commissioners.

92. Few have been found guilty of corruption in
recent years. Highly publicized efforts to
investigate bribery and corruption have failed,
damaging public confidence in such processes. During
the latter part of previous Government's term,
corruption charges were leveled against politicians
and top officials in charge of key government
corporations, but no politician has been prosecuted
for bribery or corruption. In 2002, the Criminal
Investigation Department raided bank vaults of a
former senior cabinet minister and discovered a large
cache of certificates of deposits for millions of
rupees. The Bribery Commission is investigating this
case. In April 2001, the Chairman of the Board of
Investment was forced to resign on allegations of
bribery and corruption. He is currently being
prosecuted for bribery. A handful of other key
government officials, including the former General
Manager of Railways, are being prosecuted for
corruption and bribery, but prosecutions are
proceeding slowly.

93. The current UNF government came into power
promising a corruption-free regime, but corruption
allegations continue to surface regularly. In
response to various reports of corruption and lack of
an effective mechanism to handle corruption
complaints, the ruling United National Party has
recently appointed an internal party committee to
investigate corruption allegations of its members.
The Government is also taking other steps to combat
corruption. All tenders presented for Cabinet
approval now need to be routed through a cabinet
subcommittee chaired by the Minister of Finance.
Tender board decisions presented to the subcommittee
are vetted thoroughly by Treasury officials. The
Government has taken additional measures to regulate
defense spending by appointing a Budget Monitoring
Committee and a Procurement Monitoring Committee in
the Defense Ministry.

94. Transparency International (TI), an
international "watchdog" organization promoting anti-
corruption strategies, opened a national chapter in
Sri Lanka in September 1999. In TI's Corruption
Perception Index for 2002, Sri Lanka was ranked 52
among 102 countries with a score of 3.7 out of a
clean score of 10, reflecting a relatively high
perceived level of corruption among politicians and
public officials. TI has asked the international
donor community to ensure transparency and clear
lines of accountability in the disbursement of donor
aid for post war reconstruction.

Bilateral Investment Agreements
-------------------------------
95. The Government of Sri Lanka has signed
Investment Protection Agreements with the United
States (which came into force in May 1993) and the
following countries:

1. Belgium
2. People's Republic of China
3. Denmark
4. Egypt
5. Finland
6. France
7. Germany
8. Indonesia
9. India
10. Iran
11. Italy
12. Japan
13. Korea
14. Luxembourg
15. Malaysia
16. Netherlands
17. Norway
18. Romania
19. Singapore
20. Sweden
21. Switzerland
22. Thailand
23. United Kingdom

96. A bilateral treaty on avoidance of double
taxation between Sri Lanka and United States is
currently awaiting ratification by both sides.

97. Foreign investors not qualifying for BOI
incentives such as tax and exchange control
exemptions or concessions will be liable to pay taxes
on corporate profits, dividends, and remittance of
profits. They will also be liable to pay a Value
Added Tax on goods and services. The Government has
also imposed a tax of 0.1 percent on debits to any
current or savings account maintained at any bank in
Sri Lanka. Debits made to accounts of Government and
international organizations are excluded. Accounts
maintained at Foreign Currency Banking Units,
accounts maintained for stock exchange transactions
(SIERA) and resident and non-resident foreign
currency accounts are exempted from the tax. The
Embassy encourages prospective US investors to
contact an international auditing firm operating in
Sri Lanka to assess their tax liability.

OPIC and Other Investment Insurance Programs
--------------------------------------------

98. The US and Sri Lanka concluded in 1966 (and
renewed in 1993) an agreement that allows the
Overseas Private Investment Corporation (OPIC) to
provide investment insurance guarantees for US
investors. OPIC currently provides coverage to
banking and power sector investments in Sri Lanka.
Sri Lanka's membership in the Multilateral Investment
Guarantee Agency (MIGA) offers the opportunity for
insurance against non-commercial risks.

99. Over $12 million is spent annually by the US
Embassy and other US Government institutions in Sri
Lanka. This amount can potentially be utilized by
OPIC to honor an inconvertibility claim; however, no
such claims have been made to date in Sri Lanka. The
Embassy purchases local currency at the financial
rate. The Sri Lankan Rupee has been quite stable
during past 12 months. The currency is not expected
to fluctuate by more than 10 percent relative to the
US dollar over the next year.

Labor
-----
Labor Force
100. Sri Lanka's labor force is literate and
trainable, although weak in certain technical skills.
More computer skills training programs are becoming
available, but the demand still outpaces supply and
many qualified workers seek employment overseas. The
average worker has eight years of schooling. Two-
thirds of the labor force is male. The unemployment
rate (employment is defined as one who worked for
pay, profit or unpaid family gain for one or more
hours during the survey week) in the third quarter of
2002 was 9.1 percent, with an estimated 641,000 of a
total labor force of 7.1 million out of work. (Labor
force data excludes the North and East; armed forces
personnel deployed away from home and Sri Lankan
migrant workers abroad.) Including unpaid family
workers, the unemployment rate is 10.0 percent.
Youth unemployment remains a critical problem.
Nearly 80 percent of unemployed persons are in the
15-29 year age range. Over 50 percent of unemployed
youth are educated at the O-Level (10th grade) or
higher.

101. A significant proportion of unemployed seek
"white collar" jobs, and most sectors facing labor
shortages offer manual or semi-skilled jobs or
require technical or professional skills such as
management, marketing, information technology,
accountancy and finance, and English language. The
Government has recognized the challenge of
reformulating the educational system to meet the
needs of the private sector better, but it will take
time before the mismatch of skills to requirements is
addressed. Asian Development Bank and the World Bank
have recently approved projects to improve distance
learning and tertiary education. The Government has
also embarked on a "Youth Corps" program to provide
job related training to the unemployed.

Migrant Workers Abroad

102. There are an estimated 970,000 Sri Lankan
workers abroad. The majority of Sri Lankan workers
abroad is unskilled (housemaids and laborers) and is
located primarily in the Middle East. Sri Lanka is
also losing many of its technically and
professionally qualified workers to more lucrative
jobs abroad.

Labor Regulations, Cost of Labor

103. Labor is available at a relatively low cost,
though it is priced higher than in other South Asian
countries. Child labor is prohibited and is
virtually nonexistent in the organized sector though
child labor occurs in informal sectors. The minimum
legal age for employment is set at 14. Most
permanent full-time workers are covered by laws
pertaining to maximum hours of work, minimum wage,
leave, the right of association, and safety and
health standards. The Termination of Employment Act
(TEA) makes it difficult to fire or lay off workers
who have been employed more than six months for any
reason other than serious, well-documented
disciplinary problems. Disputes over dismissals can
be brought to a labor tribunal administered by the
Ministry of Justice. The labor tribunals have large
backlogs of unresolved cases. Certain labor disputes
founded upon fundamental rights (allegations of
termination/transfers based upon discrimination,
etc.) can be brought directly to the Supreme Court.
TEA prevented many companies from laying off
permanent staff in 2001 despite economic contraction
and export slowdown. Consequently, affected
companies had to bear the cost of maintaining excess
labor.

104. There is widespread belief that the labor laws
and a plethora of holidays are dampening
productivity. The full moon day of each month, if it
falls on a weekday, is a paid holiday. There are
also eight other public holidays. The public sector
and banks enjoy additional holidays. The statutory
holidays are in addition to 21 days annual/casual
leave and approximately 21 days sick leave (number of
days for sick leave is at the discretion of the
management). In addition, female employees are
entitled to 84 days fully paid maternity leave for
the first two confinements.

Labor reforms

105. The current Government has embarked on a
program to carry out needed labor reforms covering
legal reforms, training and employment and increasing
productivity of the labor force. In January 2003,
the Parliament passed amendments to the TEA and the
Industrial Disputes Act (IDA) to improve labor
mobility. The amendments to TEA seek to facilitate
easier termination, and provided for a standard
compensation formula and an unemployment benefit
scheme. Amendments to the IDA included time-bound
labor dispute resolution rules to expedite labor
dispute resolution. These laws will come into effect
only after a new compensation formula and a new
unemployment insurance scheme are established. The
current social safety net for the unemployed is
inadequate and compensation is subject to
discretionary rulings by the Labor Commissioner. In
the interim, the Labor Department uses the following
non-binding minimum compensation formula as a
guideline: 2 to 3 months salary for each year of
service or full salary for remaining period of
service up to retirement, whichever is less, subject
to a maximum of 50 months salary. Some trade unions
have shown reluctance to accept this formula and some
companies have offered better packages. The
Government also relaxed restrictions on overtime work
by women, permitting them to 60 hours of overtime
work per month instead of 100 hours per year. Other
planned reforms include amendments to the Shop and
Office Act to allow shop and office employees to work
on shift basis and an amendment to the wages board
ordinance, to encourage outsourcing and
subcontracting. These amendments are expected to
especially facilitate call center-type operations. A
more systematic overhaul of the TEA and IDA would
help to bring labor laws in line with international
norms.

106. In addition to labor reforms, the Government
has also prepared policy documents on labor. A joint
public and private sector committee has prepared a
draft national employment policy. The policy
contains seven initiatives to facilitate employment
creation through economic growth and improve
employability of the current work force. Among other
measures, it recommends labor law reforms to
facilitate private investment and improvements to
tripartite dialogue between the state, private sector
and employees to deal with industrial relations
issues. The Government has also developed a national
productivity policy with the assistance of USAID. It
is aimed at developing long-term strategies to
enhance productivity in all sectors of the economy.

Trade Unions

107. About 15 percent of labor in the industry and
service sector is unionized. Labor in free trade
zone enterprises tends to be represented by non-union
worker councils.

108. In 1999, the Government introduced regulations
that prohibit unfair labor practices by employers.
The law now requires employers to recognize trade
unions and the right to collective bargaining, in
line with ILO Convention 87 on freedom of association
and 98 on the right to organize and bargain
collectively. The law compels employers to enter
into negotiations with a trade union where the
membership is at least 40 percent of the total
workforce. Some employers have been reluctant to
accept this legislation as they claim it is one-sided
and does not contain reciprocal guarantees from trade
unions for responsible conduct.
109. Unions have complained that the government and
some employers, especially in the BOI-run export
processing zones, prohibit union access and do not
register unions on a timely basis. Employers allege
that the Janatha Vimukthi Peramuna (JVP), a Marxist
political party that is against private ownership, is
provoking labor to strike in the guise of trade union
activity. Due to its violent past, employers are
generally not in favor of the JVP and its trade union
arm, the Inter-Company Trade Union. Prior to the
December 2001 parliamentary elections, Inter-Company
Trade Union became popular among workers. It also
staged strikes and protests in a few companies during
2002. Although the JVP continues to agitate against
economic reforms and the peace process, its trade
union activities are limited to normal union actions.

110. In 2002, the American Federation of Labor and
Congress of Industrial Organizations (AFL-CIO)
submitted a petition to the United States Trade
Representative seeking suspension of GSP benefits for
Sri Lanka due to labor right violations in some
factories in the export processing zones. This
petition was not acted upon. A similar submission
was made to the EU by a local trade union when Sri
Lanka applied for benefits under the special
incentive arrangements of the GSP. After an audit,
the EU is positively considering granting
preferential access to Sri Lanka based on protection
of core labor standards. The audit did not find
serious problems with regard to core labor standards.
The BOI has issued a new "labor standards and
employee relations manual", instructing BOI companies
to recognize trade unions and the right to collective
bargaining. According to the manual, where both a
recognized trade union with bargaining power and a
non-union worker council exist in an enterprise, the
trade union will represent the employees in
collective bargaining.

111. In the plantation sector, union participation
rates are as high as 75 percent, though unionization
levels are reportedly on the decline. Key public
sector entities such as the Ceylon Electricity Board
and Sri Lanka Ports Authority also have large unions,
which stage protests, often to obtain pay hikes and
sometimes to protest anticipated moves towards
privatization or restructuring. Most of the major
trade unions are affiliated with political parties,
creating a highly politicized labor environment. In
what is seen as a positive development, several trade
unions with affiliations to main political parties
have formed themselves into an organized group, the
National Association for Trade Union Research and
Education (NATURE), to promote education and training
among trade unionists.

Collective Bargaining

112. Collective bargaining is not yet popular.
Currently, about 50 companies (including a number of
foreign-owned firms) belonging to the Employers'
Federation of Ceylon (EFC) have collective agreements
and use them to conduct negotiations on their behalf.

Labor-Management Relations
113. Labor-management relations in the past have
e
been by and large confrontational. This is due to a
failure to recognize the need for a social
partnership for mutual benefit. The attitude of
employers towards workers has changed considerably in
the last few years. Employers are becoming more
conscious of the need to look after their human
resources, and more effort is taken to ensure that
workers feel motivated and cared for. Labor-
management relations vary from organization to
organization; managers who emphasize communication
with workers and offer training opportunities
generally experience fewer difficulties. US
investors in Sri Lanka (including US garment buyers)
generally promote good labor management relations and
labor conditions that exceed local standards. A few
large Sri Lankan firms have started Employee Share
Option Schemes. Work stoppages and strikes in the
private sector have been on a decline in the past six
months. Civil servants other than officers in the
police, armed forces, and prison service, also have a
right to strike.

ILO conventions

114. Sri Lanka is a member of the International
Labor Organization (ILO) and has ratified 39
international labor conventions. The labor laws of
Sri Lanka are laid out in almost 50 different
statutes. Sri Lanka has ratified all eight
conventions included in 1998 ILO Declaration on
Fundamental Principals and Rights at Work (ILO Core
Labor Standards). ILO Convention 138 on minimum age
for admission to employment and Convention 182 on
worst forms of child labor were ratified during 2000-
2001. Sri Lanka ratified ILO convention 105 on
Forced Labor in 2003. The ILO, EFC and the AFL-CIO-
sponsored American Center for Labor Solidarity are
working to improve awareness about core labor
standards. The ILO also promotes a Decent Work
Agenda in Sri Lanka.

Foreign Trade Zones
-------------------

115. Sri Lanka has 10 free trade zones, also called
export-processing zones, administered by the BOI.
The oldest, the Katunayake and Biyagama Zones,
located north of Colombo near the Bandaranaike
International Airport, are fully occupied. The third
zone is located at Koggala on the southern coast.
Several new mini export-processing zones were opened
in the provinces during the last few years. There
are nearly 200 foreign export processing enterprises
operating in these zones. There are also two
industrial parks that have both export-oriented and
non-export oriented factories. They are located in
Pallekelle, near Kandy in central Sri Lanka and in
Seethawaka in Avissawela about 60 kilometers from
Colombo.

116. In the past, industrialists preferred to locate
their factories in close proximity to Colombo harbor
or airport to reduce transport cost and save time.
The excessive concentration of industries around
Colombo has created problems such as scarcity of
labor, inadequate infrastructure, environmental
pollution, escalation of real estate prices and
congestion in the city. Now, the BOI actively
encourages the establishment of export-oriented
factories in the newly developed industrial zones.
The BOI also finds it easier to provide
infrastructure facilities and security, as well as to
monitor enterprises, when they are located in the
zones.

Foreign Direct Investment
-------------------------
US Investments

117. Major US companies with investments in Sri
Lanka include: Energizer Battery, Mast Industries,
Smart Shirts (a subsidiary of Kellwood Industries),
Caltex, Sportif, Citibank, Caterpillar, 3M, Cargill,
Coca Cola, Celetron, Inc (formerly Tandon), Paxar
Corp, Pepsi Co, Warburg Pincus, Worldquest, Fitch
IBCR, AES Corporation, American International Group
(AIG) and American Premium Water. In addition, IBM,
Lanier, NCR, GTE, Motorola, Procter & Gamble, Liz
Claiborne, May Department Stores, Federated
Department Stores, Tommy Hilfiger, J.C. Penney, the
Gap, Sun Microsystems, Microsoft, Bates Strategic
Alliance, McCann-Erickson, Pricewaterhouse Coopers,
Ernst and Young and KPMG all have branches,
affiliated offices or local
distributors/representatives. Kentucky Fried
Chicken, Pizza Hut, Federal Express, UPS, Domino's
Pizza and McDonald's are represented in Sri Lanka
through franchises. Numerous other American brands
and products are represented by local agents.

118. US investment in Sri Lanka is estimated to be
in the range of $200 million. Among the recent
investors in the power sector are AES Corporation and
Caterpillar. AIG insurance entered Sri Lanka in
1999. Others are expanding, such as Celetron Inc
(memory boards), Citibank, and Mast Inc (apparel and
related products). During the past few years,
several US companies have formed joint ventures or
other partnerships with Sri Lankan companies in the
IT sector, mainly in software development.

Non-US Investments

119. Major non-US investors include: Unilever,
Nestle's, British American Tobacco Company, Mitsui,
Pacific Dunlop/Ansell, Prima, FDK and S.P. Tao.
Indian Oil Corporation came to Sri Lanka in 2003,
investing in an abandoned oil tank farm and the
petroleum retailing business of the Ceylon Petroleum
Corporation. Leading US and foreign investors which
have acquired significant stakes in privatized
companies include Caltex; Norsk Hydro of Norway;
Kabool Spinning and Textile, Tongyang Nylon, and
Hanjung Steel, all of Korea; Nippon Telephone and
Telegraph, Mitsubishi Corporation and C. Itoh (A.K.A.
Itochu) of Japan; Emirates Airlines of United Arab
Emirates; Shell Oil of the UK; and P&O Netherlands.

120. Reliable statistics on foreign investment by
country are not available. Leading sources of
foreign investments are South Korea, Japan, US,
Australia, Hong Kong, Singapore, and the U.K. FDI in
2002 was $246 million.

Investment Statistics

121. Estimated total foreign investment by sector
(in $ millions)


SectorCumulative Total
End 2002
Food & beverage91
Textile/apparel, leather265
Chemical, rubber, plastic115
stic 115
Non-met. Mineral products37
Fabricated metal, machinery58
Other manufactured products101
Services1,056

Total1,723

Source: Board of Investment of Sri Lanka
Note: Investment figures reported here consist of
direct investment plus loan financing. The data
provided by the BOI are incomplete. They do not
include foreign investment that came through non-BOI
sources prior to 1994. Foreign investment in the
banking and insurance sectors are also not included.
Figures reported by the BOI have been converted at
average exchange rates prevailing in 2001 and 2002.

End text.

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