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Cablegate: Guns to Butter (and Pay Hikes, and Roads, And...):

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

UNCLAS SECTION 01 OF 03 COLOMBO 002027

SIPDIS

DEPT PASS TO SA/INS, SA/RA, EB, USTR; COMMERCE FOR ARI
BENAISSA; TREASURY FOR ROY ADKINS

SENSITIVE

E.O. 12958: N/A
TAGS: ECON EFIN PGOV CE ECONOMICS
SUBJECT: Guns to Butter (and Pay Hikes, and Roads, and...):
Optimistic Budget Reopens Sri Lankan Parliament

REF: Colombo 2001

1. (U) This telegram is Sensitive but Unclassified, please
handle accordingly.

2. (SBU) Summary: Finance Minister Choksy presented the
2004 GSL budget to the Parliament on November 19. The GSL
sees the budget as the culmination of two years' work and a
chance to relieve belt-tightening measures taken since
coming to office. The budget keeps within the tight
macroeconomic framework established by the government,
including deficit reduction, revenue enhancement and pro-
growth initiatives. Still, it included significant wage
increases for the public sector, a generous voluntary
retirement package and additional agricultural subsidies.
Revenue collection is acknowledged as a major fiscal
problem and the budget includes several measures to tackle
this challenge. Most observers consider the budget fair
and even opposition politicians privately admit it is a
move in the right direction. The lack of any notable
education initiatives is interesting, given stated GSL
priorities. Defense expenditures continued to decline as a
share of budget and GDP. End Summary

3. (U) The Finance Minister presented a budget to a
somewhat raucous Parliament on November 19. Para 16
contains relevant figures and projections discussed in this
cable.

Parliament Reconvenes to Hear the Budget
----------------------------------------
4. (SBU) Parliament had reconvened the morning of November
19, following a 15 day suspension by President Kumaratunga
(Reftel). Minister Choksy, a diminutive, professorial
politician, read a two-hour speech to the entire
parliament, including the Prime Minister. The session was
lively. Clearly suffering from a cold, Choksy took
frequent breaks to blow his nose, which prompted catcalls
from the opposition about whatever item he had just
discussed. The GSL used the session to crow about its
economic performance and complain about the President's
recent political actions.

GSL Economic Achievements Touted
--------------------------------
5. (U) The Minister highlighted the GSL's economic
achievements including significantly improved GDP growth,
debt and deficit reduction, and increased exports. FDI has
also increased and the resulting foreign exchange inflows
have led to a reversal of the rupee's three-year slide.
Both interest rates and inflation have declined.

Expenditures to Fall
--------------------
6. (U) On the expenditure front, the government expects a
contraction of about 1% of GDP. Budget forecasts for 2004
project a historically low budget deficit (the deficit has
not been lower than 7.5% since the 1977 opening of the
economy). The overall deficit is to be financed by foreign
grants, foreign borrowings, domestic financing and
privatization receipts. Recurrent expenditures are slated
to fall, leading to a reduction in the current account
deficit. Capital expenditures are projected to increase.
Total interest costs, which accounted for 30% of government
spending in 2003, are expected to fall to about 27% in
2004. Spending on government corporations will also drop.
Other administrative costs are expected to decline
marginally. Defense will represent just under 15% of total
expenditure, continuing its decline as a share of
expenditure since the 2002 ceasefire. Though keeping a
tight rein on spending, the GSL recognizes the need to
boost the economy and upgrade infrastructure. Therefore, a
key component to the new budget is.

Capital spending
----------------
7. (U) The GSL plans to spend $1.1 billion in 2004 on
infrastructure as part of a larger 3-year development
program under the PM's "Regaining Sri Lanka" development
plan. Roads, power and water sectors, rehabilitation and
resettlement, and lending to small and medium industry will
receive the highest allocations from the government budget.
The GSL expects to spend a total $4.1 billion on capital
projects from 2004-2006.
Public Sector Employee Benefits
-------------------------------
8. (U) The budget provides a salary increase to government
employees and pensioners. It also unveiled a costly plan
to overhaul the bloated civil service. The plan aims to
reduce 100,000 state jobs in 2004, and a further 200,000 by
2006 (cutting the total workforce by almost 30%). The plan
calls for a voluntary retirement package, for employees
over 45 years old, including an initial payment of one
year's salary, full monthly salary until age 55 and then a
full pension. In addition, the government has promised a
debt forgiveness plan for public employees. The savings
from the package will result largely from the reduction in
benefits including allowances, vehicles, and housing in
some instances. There could also be efficiencies gained
from cutting the bloated bureaucracy (less overlap, fewer
benefits and employees to monitor).

Revenue to Rise
---------------
9. (U) Choksy admitted a key problem in the budget is
sluggish revenue. The government has tried to boost
revenues and broaden the tax base, but without much
success. In 2003, revenue did not meet expectations, but
the GSL is projecting a nominal rise of 13 percent in 2004,
a reasonable target given projected GDP growth and
inflation. Choksy outlined several glaring revenue
realities, including the fact that a recent tax amnesty
netted 51,000 tax evaders who will now be captured in the
tax net. Moreover, fewer than 3,000 of 32,000 registered
companies pay taxes and only one percent of individual
income earners are taxpayers. Key to improving this
revenue picture will be.


Taxation
--------
10. (U) Vowing to broaden the tax net, Choksy proposed a
new economic service charge of 1% to be levied on all
registered companies (including currently tax-free BOI
companies). This tax would be deductible from the
corporate tax, but would increase revenues by bringing into
the tax net thousands of tax evading companies. Other key
tax reforms in the 2004 budget include a unified VAT rate,
reduction of the import duty surcharge and an increased
income tax exemption threshold. Several other proposals
aimed to increase collection from the business sector,
including BOI companies. They include a tax on previously
exempt foreign currency banking units and a royalty tax on
new foreign companies. The GSL intends to address the
weaknesses in tax administration through the establishment
of a central revenue authority.

Privatization and Private Sector Development
--------------------------------------------
11. (U) The Government will continue its privatization
program. Companies listed for privatization in 2004
include State Mortgage and Investment Bank, the petroleum
sector, bus companies, hotels, remaining shares of
plantations and Sri Lanka Telecom. Total expected income
is $154 million.

12. (U) The private sector will benefit from increased
government spending on infrastructure. In addition, the
government is to lend $361 million for small and medium
industry development and to fund northeast development.
Other programs will facilitate private sector activity in
selected sectors. To boost tourism, the government will
facilitate the development of two lagoon areas and the
southern province (airport, port, coal power plant, and an
oil refinery); BOI will set up two new export processing
zones and the government will make land available for
development within Colombo.

Comment
-------
13. (SBU) The budget was well-received and got fairly
glowing commentary from the IMF (which had announced that
Article IV consultations would be delayed until the budget
was presented), World Bank and ADB reps in Colombo. Local
businesses have been enthusiastic as well. Particularly
interesting was the lack of many education initiatives,
which get tremendous lip service from the GSL. The decline
in defense spending corresponds with optimism about the
peace process.

14. (SBU) The GSL had leaked portions of the budget plan,
specifically public sector wage increases and increased
agricultural subsidies, following the President's
suspension of parliament. This provided additional
pressure to reconvene parliament and was used by the GSL in
its litany of ways the President's actions had undermined
the economy.

15. (SBU) Members of the opposition used the budget hearing
as a forum to voice their displeasure with the GSL and to
advocate for more left-leaning social spending programs.
In private though, most admit the budget is fair and well
crafted, balancing the need to maintain fiscal restraint
while showing the public some return after two years of
austerity. End Comment.

16. (U) Some numbers:
20032004 (Proj)
--------
GDP Growth5.6%6.0%
Budget Deficit(% GDP)7.8%6.8%
Debt (% GDP)100%95%
Inflation7.2%6.9%
Current Acct Deficit (% GDP)2.8%1.3%

--Forex reserves - $3 Billion (5.2 mos import cover)
--Inflation declined to 7.2% from 9.6% in 2002
--Interest rates dropped to 9.4% from about 12%
--Revenue fell in 2003 from a projected 17.1% of GDP to
16.3%. In 2004, revenue is to rise by 13.7% in nominal
terms (to 16.4% of GDP).
--For 2004, total spending is estimated at $4.8 billion, or
23.2% of GDP, resulting in a budget deficit of $1.4 billion
(6.8% of GDP).
--Capital expenditure will increase from $927 million (5.0%
rease from $927 million (5.0%
of GDP) to $1.1 billion (5.3% of GDP).
Deficit Finance: foreign grants ($103 million); foreign
borrowings ($515 million); domestic financing ($670
million); privatization receipts ($154 million).
--Single VAT rate of 15% (replacing the current system of
10% and 20%)
--Cut in import duty surcharge to 10% from 20%.
LUNSTEAD

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