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Cablegate: Imi - Investment Climate Statement, 2005 - Sri

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






E.O 12958:N/A

REF: (A) 04 STATE 269486 (B) 04 STATE 250356



March 2005

Openness to Foreign Investment

2. Sri Lanka 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, a result of
half-hearted commitment to economic reforms and policy
inconsistency through changes in successive
governments. Over the past twenty-six 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 the inconsistent
and erratic economic policies mentioned above. While
the current ceasefire led to improved investment flows
in the recent past, the reversal of economic policies
following the change of Government in 2004 has put a
damper on flows once more. Although some investors
have done well, particularly in the manufacturing and
services sectors, others have had problems with
government practices and regulations, particularly in
large-scale infrastructure projects.

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3. Sri Lanka's economic growth has been reasonable,
averaging 4.6 percent over the past decade. The
country boasts unique human development achievements
for a developing country. Sri Lanka's per capita
income of $1,000, a literacy rate of over 90 percent in
the local language and life expectancy of 72 years rank
well above those of India, Bangladesh and Pakistan.

4. The 20-year ethnic conflict between the US-
designated Liberation Tigers of Tamil Eelam (LTTE) and
the Government of Sri Lanka has been widely recognized
as a key drag on development and an obstacle to foreign
investment. A Norwegian-brokered ceasefire, between
the LTTE) and the government, in effect since February
23, 2002, continues to hold despite the LTTE withdrawal
from peace talks in April 2003. The LTTE presented its
proposals for an Interim Self Governing Authority
(ISGA) in October 2003. While both parties have
expressed their commitment to a negotiated settlement,
efforts to restart peace talks have floundered so far.
It is important though to differentiate between the
peace talks, which are suspended and the overall peace
process, which continues. Although many ceasefire
violations have been recorded, the peace process has
substantially improved the political, economic and
investment climate and initially resulted in attracting
substantial funding from multilateral and bilateral
donors to rebuild the country.

5. The December 2004 tsunami caused extensive damage
to life and property, fundamentally altering Sri
Lanka's economic outlook and increasing economic
vulnerability. Approximately 31,000 people were
killed, another 6,300 are missing and 443,000 people
have been displaced. A joint damage and needs
assessment by the key donor agencies has estimated the
overall damage to Sri Lanka at $1.5 billion, with a
large portion of losses concentrated in housing,
tourism, fisheries and transportation. Major export
sectors were not affected. Some of the destruction is
in areas under the control of LTTE, which requires the
Government to work with them to start reconstruction.
The reconstruction program will take at least three
years to implement.

6. Since independence, the rule of government has
alternated between the two major political parties,
United National Party (UNP) and the Sri Lanka Freedom
Party (SLFP) or coalitions led by them. Both the UNP
and the SLFP generally support open and outward looking
economic policies, though a failure to embrace
consistent economic reform policies has sent confusing
and inconsistent messages to investors and donors.

7. In February 2004, President Chandrika Kumaratunga
dissolved the Parliament, just two years into the rule
of the reform-minded United National Front Government.
Subsequent elections resulted in a resounding defeat of
the UNP, largely at hands of rural voters who had not
yet tasted the benefits of economic reforms. As no
single party was expected to garner sufficient seats to
form a government, the President's SLFP joined with the
left leaning, Marxist-nationalist Janatha Vimukthi
Peramuna (JVP) to form the United People's Freedom
Alliance (UPFA) ticket to run for the election. The
UPFA contested the election on a platform of pro-poor
growth policies. The UPFA government's Economic Policy
Framework "Creating Our Future, Building Our Nation"
http://www. treasury. focuses on development of
the small and medium enterprise sector (SME),
agriculture and infrastructure, with a much heavier
reliance on government intervention in markets. The
Government has also abandoned plans to privatize
strategic state enterprises. Instead, the government
will retain ownership and management of these
enterprises ranging from large state-owned banks to
electrical utilities. The government hopes to insulate
them from political interference and make them
profitable. Recent efforts to restructure large public
utilities, however, have faced serious problems, due to
stiff JVP and union opposition. Smaller non-strategic
state enterprises are to be privatized. The government
has created three new agencies to improve state-owned
enterprises, economic development, and procurement the
Strategic Enterprises Management Agency (SEMA),
National Council for Economic Development (NCED) and
Procurement Management Agency.

8. On a positive note, the government has acknowledged
the vital role played by both foreign and local private
investors in the economy. The government has promised
to encourage private investment through the removal of
impediments and an introduction of an investor friendly
administration. However, they have introduced
prohibitive new taxes on the acquisition of land by
foreigners and other bureaucratically inspired
impediments to foreign investments. Further, import
duties have been increased. A new tax "Economic
Service Charge (ESC)", ranging from 0.25 percent to 1
percent, depending on the type of company, applies to
all companies with a turnover exceeding Rs 50 million
(USD 500,000), including companies enjoying tax
holidays. Companies already paying income tax will be
able to set it off against income tax but for those
companies, especially foreign investments, with tax
holidays it will be an additional tax.

9. The government has rejected the former government's
poverty reduction strategy paper (PRSP) titled
"Regaining Sri Lanka," citing its failure to benefit
the poor and rural areas and is in the process of
revising the PRSP. Pending clarity on economic and
fiscal policies, and the presentation of a revised
PRSP, the IMF has withheld disbursements under a
Poverty Reduction Growth Facility (PRGF) and Enhanced
Fund Facility (EFF) extended to Sri Lanka in April
2003. The government conducted Article IV discussions
with the IMF and resumed discussions on PRGF/EEF
supported programs in May 2005.

10. Over the past year, prior to the tsunami, macro
economic conditions deteriorated. In the face of a
drought and increasing oil prices, the government
resorted to expansionary fiscal and monetary policies
which helped to maintain GDP growth at around 5
percent. Inflation rose sharply and the fiscal and
external positions deteriorated. There was a slowdown
in aid and investment inflows. The trade deficit
expanded in 2004, despite strong export growth, due to
a heavy oil import bill. Gross official receipts fell
by 13 percent to $1.8 billion. As a result, the Sri
Lankan Rupee depreciated throughout 2004, falling by 8
percent against the US Dollar. The rupee strengthened
in early 2005, on the expectation of aid flows for
reconstruction of tsunami damaged areas, but this
strengthening is likely to be temporary. Total
reserves in January 2005 were approximately $3.3
billion, sufficient to cover 4.9 months of imports.
Sri Lanka's total government debt rose to 108 percent
of GDP in 2004, of which about half was foreign (mostly
concessional) debt.

11. The government took steps towards the end of 2004
to strengthen the macro economic policy stance.
Petroleum prices were revised upwards, and a costly
subsidy on wheat flour was removed. But numerous
subsidies including petroleum (still significant,
despite price increases) and electricity continue. The
2005 budget, presented in November 2004, envisaged a
reduction in the fiscal deficit to 7.5 percent of GDP.
The budget focuses on reducing poverty through rural
development and higher spending for health, education
and public infrastructure. The budget also includes
significant increases in government employment and
wages (the Government has hired about 40,000 previously
unemployed university graduates in an effort to stem
unemployment). It also contains new revenue measures.
In the count down to the budget, the government took
action to increase import taxes on selected imports.
Despite tsunami losses, the Government has expressed a
desire to take required action to maintain macro
economic stability, pursue the reform agenda of the
2005 budget, and fiscal reforms in line with the policy
outlines of the Fiscal Management (Responsibility) Act,
which has a deficit and debt reduction plan over the
medium term.

12. Estimates vary about the tsunami's overall
economic impact but reliable projections predict GDP
growth to slow by .5 - 1 percent. The bulk of the
impact on growth is expected to be offset by the
reconstruction effort. The Government is trying to
minimize the fiscal impact of the reconstruction
program, by seeking foreign assistance. The impact on
balance of payments could also be significant due to
reconstruction related imports. Meanwhile, for the
first time, Sri Lanka has accepted a Paris Club offer
to freeze its debt payments by industrialized countries
until the end of 2005, which will release approximately
$300 million from the regular budget (allocated for
dept repayment) for reconstruction. In addition, the
IMF has also approved an emergency loan of about $159
million to Sri Lanka. The World Bank and the ADB have
also pledged both grant and loan assistance. On
balance, the level of fiscal and balance of payment
impact of reconstruction will depend on the ability of
the government to mobilize external resources and the
absorptive capacity of the country. The inflationary
momentum from 2004 is expected to continue in 2005 with
inflation projected to remain at double digit level for
most of the year. The Central Bank has so far left key
interest rates unchanged despite rising inflation, in
order to facilitate spending on reconstruction and
provide liquidity for restarting economic activity.

13. There may be commercial opportunities for US
companies in the post-tsunami reconstruction program.
The bulk of the reconstruction expenditure will be
spent on housing, townships, transportation
infrastructure (roads, railway and ports), fisheries
infrastructure (harbors, anchorage and related
facilities), water supply and sanitation projects, and
school and hospital buildings.

14. Numerous risks and challenges to the economy
remain. The peace process could falter. Domestic
political frictions between the President and her
coalition partner JVP could disrupt the peace process
or further hamper economic reform. A weak coalition of
political parties, and the inability of the main
parties to cooperate on key issues have compounded the
political difficulties facing Sri Lanka at this
juncture. There are concerns regarding the speed of
reconstruction and resettlement of tsunami affected
population. The Government is trying to reach
consensus with the LTTE on a framework for tsunami
related reconstruction in the north and east. The pace
of reconstruction could also be hampered by
administration bottlenecks as the state is not equipped
to carry out large scale projects in a timely manner.
Other down side risks will stem from uncertainties over
oil prices and the impact of the end of the Multi Fiber
Agreement, although large factories accounting for bulk
of the exports are expected to continue to perform well
in the quota free era. Another major business concern
in the medium term is the cost and supply of power.
Sri Lanka has faced periodic power shortages, 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 sufficient base-load power
to avert a power crisis in the medium term. The JVP is
resisting Government moves to restructure the state
owned electrical utility, which reduces the possibility
of solving the power problem in the foreseeable future.
Increasing oil prices are also causing an already
inefficient and money losing state-owned electrical
company to face serious cash flow difficulties and
renege on power purchase agreement commitments and
contractual obligations. Uncertainty over the future
of the energy sector has led most businesses to install
onsite generating capacity.

--Board of Investment

15. The Board of Investment (BOI) (, 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. The BOI
has undertaken a major review of its activities with
the intention of improving its services.

16. The Bureau for Infrastructure Investment (BII)
(, a division of BOI, is assigned the
responsibility to coordinate 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

--Laws Affecting Investment

17. 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.

--Foreign Equity and Sectors

18. 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.

19. 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.

20. 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.

21. 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);
coastal fishing; and award of local university degrees.

22. In general, the treatment given to foreign
investors is non-discriminatory. In fact, some local
companies have complained that they are discriminated
against, as qualifying foreign investors can benefit
from a wide range of advantages. Even with incentives
and BOI facilitation, foreign investors can face
difficulties operating in Sri Lanka. Problems range
from the mundane, but critical, matter of clearing
equipment and supplies through customs, 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.


23. Previous governments, including one headed by the
SLFP, actively pursued privatization. When the UPFA
(led by the SLFA) Government came to power in 2004,
however, it pledged to halt the privatization process
of strategic enterprises and institute more effective
government oversight. This was a concession to get JVP
participation in its coalition. Smaller government
corporations are to be privatized.
24. Government treatment of foreign investors in the
privatization process has been largely non-
discriminatory. In 2003, 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. One US firm,
which had earlier acquired a government owned lubricant
plant and obtained exclusivity in the sale of
lubricants in CPC outlets until 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 restructuring and seem particularly
averse to foreign ownership. In the past this has made
the purchase of certain strategic entities problematic
for new foreign owners. 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

25. Foreign direct investment flows to Sri Lanka have
averaged only about $150 million per year (excluding
privatization receipts) during 1998-2001. Following
the commencement of the peace process and improved
investor confidence, annual foreign investment flows
have averaged about $200 million. Although initially
FDI was expected to rise faster following the
ceasefire, due to the stalemate in the peace process it
has stagnated. In 2004, FDI was about $233 million,
according to the Central Bank. FDI mainly funded
telecommunications and manufacturing industries (cement
and textiles). Other major deals struck in 2004
included a $30 million BPO center by the Hong Kong and
Shanghai Banking Corporation Ltd (HSBC).

26. The Colombo Stock Exchange(CSE) has been growing
markedly since 2002, due to local investor activity.
In July 2004, Colombo was named the best performing
market in Asia and the fifth best performing equity
market in the world by Bloomberg. The upsurge in
stocks could be directly attributed to the ceasefire
agreement and a rise in tourism stocks. The market has
also become attractive to local investors due to
negative real interest rates. A large IPO from a new
Indian oil retail business in Sri Lanka also boosted
the market heavily in December. Despite the boom,
foreign investors have largely stayed out of the
market, and were net sellers in 2003-2004. Uncertainty
about the peace process, weak macro economic
fundamentals and reversals in economic reforms are
major concerns to foreign investors. CSE is taking
steps to broaden the investor base both in Sri Lanka
and abroad.

Conversion and Transfer Policies

27. 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 introduced 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.

28. 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 and 2004 which were opened
to foreign investors. It has been proposed to allow
foreigners to invest in corporate debentures and
government bonds.

29. 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

30. 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

31. 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.
Until recently, the court system was largely free from
government interference. The judiciary is sometimes
subjected to political influence. 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 Intellectual Property Act, the
Companies Act, the Securities and Exchange Commission
Act, the Banking Act, the Industrial Promotion Act and
Consumer Affairs Authority Act. Most of these laws
were revised recently to meet current business

--Bankruptcy Laws

32. The Companies Act and the Insolvency Ordinance
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.
The Parliament has passed an amendment to the
Termination Act to facilitate retrenchment, but its
implementation was delayed until the development of a
compensation formula and an unemployment insurance
scheme for displaced workers. After revisions and
delays, the compensation formula was finally published
in March 2005, but employers have protested as it is
excessive compared to similar formulae in the Asian
region. The compensation plan could adversely affect
restructuring plans of companies.

33. In the absence of proper Bankruptcy Laws, extra
judicial powers granted to financial institutions by
law protect the rights of 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. A recent judgment, however,
ruled that these powers would not apply in respect of
collateral provided by guarantors to a loan. Financial
institutions also face other 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

34. 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.

35. The US-Sri Lanka BIT was ratified by both
governments in early 1993. A bilateral treaty on
avoidance of double taxation went into effect on June
12, 2004.

36. 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.


37. 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.

38. 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. Other senior officials,
including the Labor Minister, and the President, have
intervened in particularly difficult cases.
--Investment Disputes Involving U.S. Companies

39. There continue to be trade and investment
disputes, particularly surrounding government
procurement. The government procurement process in Sri
Lanka is slow and non-transparent. US Companies
continue to face problems with payment on valid
contracts, implementation on agreements with the
Government and inexplicable failure to secure
contracts, despite superior performance, high value and
low bids. Some US companies have found it difficult to
secure payment for power generation due to CEB's tight
cash flow situation.

40. In May 2000, the Sri Lankan Supreme Court
effectively blocked an existing investment agreement
between the Government of Sri Lanka and a US mining
company. Although the investment agreement was already
initialed 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 allows any person to seek protection from the
Supreme Court in respect of infringement of a
fundamental right by the government or by
administrative action. 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, a partial bench of 3 judges 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.

41. In another case, a 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. The
Company has wound up its operations in Sri Lanka
recently. In many disputes, defendants resort to
obtaining injunctions, stay orders or postponements to
drag cases on for years.

Performance Requirements/Incentives

--Performance Requirements

42. 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.

43. 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

44. 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.

45. 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

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

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
--Manufacture of industrial tools and/or machinery.
Minimum investment of $150,000;
--Small scale infrastructure. Minimum investment of
--Research and development. Minimum investment of
--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. A
recently introduced Economic Service Charge at 0.25
percent of income will be applicable to BOI approved
companies with tax holidays, from the fourth year of

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
--Any industrial, agriculture, service, or construction
activity approved by the BOI. Minimum investment of $5
(a) Minimum employment of 15 IT professionals is
required in IT companies
(b) Minimum 300 students required for IT training
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. A recently introduced Economic
Service Charge at 0.25 percent of income will be
applicable to BOI approved companies enjoying tax
holidays, from the fourth year of operation.

Infrastructure development:

47. 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 BOI 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. Minimum investment of $12.5 million.

48. 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 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. Minimum investment of $10 million.

--Indo-Lanka Free Trade Agreement

49. A preferential trade agreement, the Indo Lanka
Free Trade Agreement (ILFTA) (,
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.

50. Sri Lanka recently signed a free trade agreement
with Pakistan. These are seen as steps towards making
Sri Lanka a regional hub and the gateway to South Asia
and the Middle East for foreign investors.

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

51. 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 percent
of Indian imports valued at $5.5 billion in 2003-4. 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.

52. Currently, US companies avail themselves of this
agreement adding 35 percent value in Sri Lanka and
getting import duties into India reduced from as much
as 40 percent to as little as zero.

53. 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, or reached via e-mail at

Right to Private Ownership and Establishment

54. 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. The government has divested most of these
plantations to the private sector on 50-year lease
terms. 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.

55. Foreign investors can purchase land from private
sellers. The government has re-imposed a 100 percent
tax on land transfers to foreigners.

Protection of Property Rights

--Property rights

56. Secured interests in property are recognized and
enforced. A fairly reliable registration system exists
for recording private property such as land, buildings
and mortgages. However, there have been problems due
to fraud and forged documents. The Government has
begun to address these issues under a World Bank
sponsored judicial reforms project. The legal system
is nondiscriminatory and protects and facilitates
acquisition and disposition of property rights by

57. 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.

58. In 2004, the Government changed land ownership
regulations, by re-imposing a 100 percent tax on land
sales to foreigners, which was removed in 2002. Under
the previous version of this tax, foreign companies
registered in Sri Lanka were considered local companies
and were not subject to tax. In its current form
however, any company with 25 percent foreign ownership
would be considered "foreign" for the purposes of the
tax. Apartments above the third floor of condominium
buildings, land for the development of large housing
schemes, hospitals, hotels, exporting companies with a
minimum investment of USD 1 million and large
infrastructure projects are to be exempted from the
tax. Foreigners maintaining $ 150,000 in a bank
account in Sri Lanka will be given concessionary
treatment. Regulations regarding these exceptions are
yet to be published. In addition to the tax, the
government has plans to prohibit certain geographical
areas for purchase by non-citizens.

--Intellectual Property Rights Protection

59. Sri Lanka is a party to major Intellectual
Property Agreements including the Bern 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 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.

60. A new intellectual property law came into force in
November 2003. It meets both US-Sri Lanka bilateral
IPR agreement and TRIPS obligations to a great extent.
The IPR law governs copyrights and related rights,
reproduction rights, public distribution rights,
industrial designs, patents for inventions, trademarks
and service marks, trade names, layout designs of
integrated circuits, geographical indications, unfair
competition, data bases, computer programs and
undisclosed information. The law also covers the
rights of performers, producers of sound recordings and
broadcasting organizations. All trademarks, designs,
industrial designs and patents must be registered with
the Director General of Intellectual Property.

61. Infringement of Intellectual Property Rights (IPR)
is a punishable offense under the 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. Police can take ex-officio
action to enforce the law. Aggrieved parties can also,
on their own, seek relief redress of any IPR violation
through the courts, which can be a frustrating and time-
consuming process.

62. Although the legal system is well-established and
non-discriminatory, it is fraught with long delays.
Enforcement was a serious problem under the old law, as
is public awareness of IPR. Domestic implementing
legislation, under the old law, was very weak and the
government did not act as an enforcer of IPR laws.

63. With the passage of new law, Sri Lanka has begun
to enforce IPR laws. However, it will take time before
new procedures and court precedents are established.
In October 2004, Sri Lankan Police raided a previously
unknown illegal CD manufacturing plant owned by
Malaysian nationals. The Police carried out additional
raids of counterfeit CD/VCD stores in the first quarter
of 2005. The Customs has also seized counterfeit
consumer goods, mainly cigarettes. Meanwhile, local
agents of reputed US and other international recording
companies, software development companies, motion
picture companies, clothing companies and consumer
product 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.

64. 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. Sri Lanka also does not have provisions
dealing with electronic transactions, electronic
signatures, computer crimes and evidence. The IPR law
does not cover protection of new plant varieties.

--Patents, Copy Rights and Trade Marks

65. 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 law also
permits 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

66. A patent is valid for 20 years from the date of
application but must be renewed annually.

67. 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. There are enforcement limitations applying to
copyrights, including software.

68. 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 and renewable. The
law also recognizes both certification marks and
collective marks.

Transparency of the Regulatory System

69. 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, and 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.

70. 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.

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

--Availability of financial resources

71. 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.

72. 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. Since 2002, the government policy
has supported a low interest rate regime. As a result,
interest rates have fallen significantly and have given
impetus to increased credit which has contributed to
increased domestic investment. The investment/GDP
ratio rose to 25.3 percent in 2004 compared with 22
percent in 2001. The prime lending rate currently
averages 9.8 percent compared with about 12.8 percent
in December 2001. Foreign investors are allowed to
access credit on the local market. They are also free
to raise foreign currency loans.

73. A total of Rs 12.3 billion (approx. $123 million)
was raised in the primary market by way of new equity
and debt in 2004, reflecting the potential for
companies to raise funds through the market.

--Credit Instruments

74. 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.

75. The domestic debt market in Sri Lanka is still at
a very nascent stage. The first credit rating agency,
Fitch IBRC opened an office in Colombo in 1999, which
has helped companies to raise funds through debt
markets. Fitch Rating Lanka Ltd, is a joint venture
between Fitch IBRC, IFC, the Central Bank of Sri Lanka
and several local financial institutions. Credit
ratings are now mandatory for all deposit taking
institutions and for all varieties of debt instruments.

--Accounting Standards
76. 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).

77. 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. The Accounting Standards and
Monitoring Board (ASMB) is responsible for monitoring
compliance with Sri Lanka accounting and auditing

--Securities and Exchange Commission

78. 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

79. 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.

80. 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. The SEC Chairman
resigned and pleaded innocence, subsequently. Later
the two parties came to an out of court settlement.

81. 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 US Sarbanes-Oxley Act to
regulate financial services and professional services
--Colombo Stock Exchange
82. 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.

83. 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. It is
modeled on the lines of the London City Code on
Takeovers and Mergers. Acquisition of more than a 30
percent stake of a listed company requires the buyer to
make an offer to all other shareholders. The articles
of association of a few listed companies restrict
foreign equity to certain levels.

84. There are 242 companies listed on the stock
exchange and the top ten positions by market
capitalization are held by banks and food and beverage
companies. In 2003-2004, CSE was one of the best
performing markets in the world. The cease-fire
agreement between the Government of Sri Lanka and the
LTTE 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. As a result, the CSE was removed from the
Morgan Stanley Capital International (MSCI) Index in
2001. It has not been reclassified in the MSCI yet,
despite recent surge driven mainly by locals. In April
2005, however, the California Public Pension Fund
(CALPERS) rated Sri Lanka as investment grade for
CALPERS Investment. As of early May 2005, however, no
CALPERS funds had been invested.

85. 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

86. Sri Lanka has a fairly well diversified banking
system. There are 22 commercial banks, consisting of
eleven local banks and eleven foreign banks. In
addition, there are thirteen local specialized banks.
Citibank NA is the only US bank operating in Sri Lanka
and has expanded its operations recently. In 2001-
2003, Mashreq Bank, American Express Bank, Nova Scotia
Bank and ABN Amro Bank sold their banking operations in
Colombo to existing banks. 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. Two other
small troubled banks were restructured under Central
Bank guidance. In April 2005, the Central Bank
introduced higher capital requirements for commercial
banks in a bid to enhance the banking system stability,
promote consolidation and facilitate entry of larger

87. 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 2002 the
Monetary Law Act (MLA) was amended to provide Central
Bank broader supervisory powers and greater
independence. The Bank also issued a code of corporate
governance for banks and financial institutions in
2002. In addition, rules on classification and
provisioning were improved significantly from January
2004. Further, the Banking Act was amended in 2005 to
give additional supervisory powers to the Central Bank
and introduce guidelines to check the suitability of
bank directors. The amended Banking Act outlaws
pyramid type programs. Further amendments to the laws
are also expected in the next two years under ongoing
financial and legal reforms programs.

88. In 2004, the Central Bank introduced technical
improvements to facilitate banking sector efficiency by
establishing a Real Time Gross Settlement (RTGS) system
and a Scriptless Securities Settlement (SSS) system.
They have improved the efficiency and the safety of the
country's payment and settlement systems and will
facilitate trading of government securities.

89. Central Bank supervision as well as auditing
practices of private audit firms came under criticism
after the 2002 specialized bank failure mentioned
above. The Central Bank obtained the services of an
international expert to strengthen bank supervision in

--State Owned Banks

90. Total assets of the commercial banks stood at Rs
885 billion ($8.8 billion) as of December 31, 2003.
Bank of Ceylon and People's Bank with assets of Rs 266
billion ($2.7 bn) and Rs 224 billion ($2.2 billion),
respectively in 2004, still dominate banking, making up
about half of all assets.

91. The financial profile of both state banks
deteriorated over the years, mainly as a result of
directed lending and operating inefficiencies. Since
most of the bad debt of the two banks was implicitly
guaranteed by the state, these problems did not affect
the credibility of the banking system in Sri Lanka.
The government re-capitalized these banks during the
1990's. 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. Consequently, the government has been trying
to reorganize the banks. Both banks 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 private
sector personnel and the banks were granted greater
autonomy. Further, asset classification and
provisioning norms have been progressively
strengthened. While Bank of Ceylon has met most of the
restructuring targets and shows substantial
improvements in its financial profile, the situation at
People's Bank remains weak. In particular, the
provisioning has left the bank with a large negative
equity affecting its operations. In addition, loans to
Government corporations could again badly affect the
bank's liquidity.

92. The Cabinet has recently approved new business
development plans for the two state banks to make them
more viable. The plans were developed under the
guidance of SEMA, the high powered restructuring agency
of the Government. The plan for Bank of Ceylon aims to
increase its profitability and efficiency. In case of
People's Bank, the state is to re-capitalize the bank,
for the third time, to meet a capital shortfall of Rs
10 billion. The latest capitalization is to be
supported by an ADB program, which will see equity
funding over 3 years. ADB funding will be subject to
meeting performance targets on non performing loans,
profitability, cost, and capital adequacy. The new
plan signifies a departure from the earlier IMF agreed
plan to sell the bank under a restructuring program.

--Private Commercial Banks and Foreign Banks

93. 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. 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.
The banks are expected to improve provisioning with the
introduction of new provisioning rules by the Central
Bank in 2004. 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.

94. Credit ratings are mandatory for all banks
operating in Sri Lanka from January 2004.

--Capital Adequacy

95. 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.
In addition, in keeping with Basel Core Principles on
effective banking supervision, compliance with Capital
Adequacy on a consolidated basis was introduced in

96. People's Bank does not meet Capital Adequacy
Requirements (CAR) of Sri Lanka but it has Ministry of
Finance guarantee for funds required to meet
requirements. Bank of Ceylon Tier I CAR was about 12.1
percent in 2003. Current data on average Capital
adequacy of private commercial banks is not available,
but most of them maintain CA at required levels. CA at
foreign commercial Banks usually exceeds required

Political Violence

97. 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 US 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. Following, six
rounds of peace talks with the government of Norway
acting as facilitator, the LTTE suspended its
participation in the peace talks in April 2003.

98. There have been many ceasefire violations, and an
uptick in violence, mostly in the eastern part of the
country, related to fighting between the LTTE and a
faction that split from the LTTE in 2004. In July
2004, there was a suicide bombing in a Colombo police
station following a failed assassination attempt
against an anti-LTTE Tamil minister. Five people
(including the bomber) were killed. Despite these
incidents, the ceasefire largely holds and both sides
have publicly committed to its maintenance. Optimism
remains as neither side sees an advantage in returning
to war.

99. 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 numerous casualties and
extensive damage to 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. The LTTE has been implicated in the
slayings of several anti-LTTE politicians and police
informants of Tamil heritage since the signing of the
ceasefire. There have also been several violent
incidents at sea.


100. 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 impediment to operating in Sri Lanka. According
to Transparency International (TI), corruption is most
pervasive in terms of political appointments to
government institutions, in government procurement, and
in high frequency low value transactions. Police and
the judiciary are perceived to be the most corrupt
public institutions. 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.

101. The law states that giving or accepting a bribe
(by a public official) is a criminal offense and
carries a maximum sentence of seven years imprisonment
and a fine at the discretion of the courts. A bribe by
a local company to a foreign official is not covered by
the bribery act. 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's most recent term
expired in December 2004, and a new Commission was
appointed after a 3-month delay in March 2005. The
previous Commissions were not effective in dealing with
bribery or corruption.

102. 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. While corruption charges
have been leveled against politicians and top officials
in charge of key government corporations, no politician
or senior government official has been convicted of
bribery yet. The Commission began investigating
corruption charges against the former deputy minister
of defense in 2002, but he is yet to be prosecuted. In
December 2004, the commission filed corruption charges
in courts against another former key minister (who ran
the Ministry in charge of public welfare).
Prosecutions and investigations against some former
senior public officials are moving slowly or have come
to an abrupt end.

103. Sri Lanka ratified the UN Anticorruption
Convention in March 2004. Sri Lanka has signed but not
ratified the UN Convention against Transnational
Organized Crime. Sri Lanka is not a signatory to OECD-
ADB Anti Corruption Regional Plan.

104. Transparency International (TI), an international
"watchdog" organization promoting anti-corruption
strategies runs a national chapter in Sri Lanka. In
TI's Corruption Perception Index for 2004, Sri Lanka
was ranked 67 among 146 countries with a score of 3.5
out of a clean score of 10, reflecting a relatively
high-perceived level of corruption among politicians
and public officials. TI's 2003 National Integrity
Systems Country Report recommends the establishment of
an independent anti-corruption authority with
sufficient powers as a top priority to combat
corruption. 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 and post-tsunami

105. In terms of Economic Freedom, Sri Lanka is ranked
78 out of 123 countries in Canada's Fraser Institute's
Economic Freedom of the World ranking released in
August 2004. Sri Lanka earned a score of 6 out of 10
in the Economic Freedom Index. This ranking is derived
on the basis of 21 components categorized under 5 major

Bilateral Investment Agreements

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

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

107. A bilateral treaty on avoidance of double
taxation between Sri Lanka and the United States was
ratified and entered into force on June 12, 2004.

108. 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 15 percent 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

109. 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.

110. Over $21 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 fluctuated against major
foreign currencies 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 Force

111. Sri Lanka's labor force is literate and
trainable, although weak in certain technical skills
and English language. More computer and business
skills training programs, and English language programs
are becoming available, but the demand still outpaces
supply and many qualified workers seek employment
overseas. The average worker has eight years of
112. 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 first quarter
of 2004 was 8.1 percent, with an estimated 650,000 of a
total labor force of 7.9 million out of work. (Labor
force data excludes some areas in the Northern
province; armed forces personnel deployed away from
home and Sri Lankan migrant workers abroad.) Including
unpaid family workers, the unemployment rate is higher.
Youth and entry level unemployment remains a critical
problem. Nearly 80 percent of unemployed persons are
in the 15-29 year age range. Over 50 percent of
unemployed young people are educated at the Ordinary-
Level (British System equivalent of US 10th grade) or
higher. Underemployment is also a major problem, with
thousands of university graduates seeking places in the
already bloated public sector, and lacking skills
needed in the private sector.

113. 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. Following election
pledges during April 2004 parliamentary elections, the
government has initiated several programs to expand
state sector employment. For instance, a graduate
employment program is expected to provide about 40,000
new jobs in the government sector.

114. 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. The Asian Development Bank and the World
Bank have recently approved projects to improve
distance learning and tertiary education. The private
sector is offering various well-recognized professional
study courses accredited to local and foreign
professional institutes and foreign universities.
However, access to these courses is limited due to high
fees involved. A fair number of Sri Lankan students
also proceed abroad for studies.

--Migrant Workers Abroad

115. There are an estimated 970,000 Sri Lankan workers
abroad. The majority of Sri Lankan workers abroad are
unskilled (housemaids and laborers) and are 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

116. 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.
117. There is widespread belief that the labor laws
and a plethora of holidays are dampening productivity.
The full moon day of each month (sacred to Buddhists),
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
pregnancies. The 2005 budget proposed additional
maternity leave benefits, but they are yet to be
implemented. Female workers are permitted 60 hours of
overtime work per month.

--Termination laws

118. The Termination of Employment Act (TEA) makes it
difficult to fire or lay off workers. In January 2003,
under the previous government's labor reform agenda,
the Parliament passed amendments to the TEA and the
Industrial Disputes Act (IDA) to improve labor
mobility. The amendments to TEA seek to facilitate
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. The
implementation of these new laws was delayed until the
establishment of a new compensation formula and a new
unemployment insurance scheme, which were finally
announced in March 2005. The compensation formula
takes into account the number of years of service and
offers 2.5 months salary as compensation for 5 years;
22.5 months for 10 years; and up to a maximum of 48
months salary for 34 years service. In addition, an
unemployment benefit insurance scheme would provide 12
months salary. Employers have shown reluctance to
accept this formula and complain that the package is
excessive, especially compared to international norms.
They have also pointed out that higher compensation
could adversely affect companies requiring
restructuring and discourage investment.

119. Other planned reforms include amendments to the
Shop and Office Act to allow female employees in the IT
sector to work in the night. A more systematic
overhaul of the TEA and IDA would help to bring labor
laws in line with international norms.

--Trade Unions

120. 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

121. Unions have complained that the BOI and some
employers, especially in the BOI-run export processing
zones (EPZ), prohibit union access and do not register
unions on a timely basis. Employers allege that the
Janatha Vimukthi Peramuna (JVP), a Marxist political
party now in government, could provoke 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.

122. The Government continues to take steps to improve
enforcement of labor regulations inside export
processing zones (EPZs). In BOI enterprises, including
those in the EPZs, worker councils composed of
employees generally provide for labor and management
negotiations. These worker councils have worked well
in some companies to provide for worker welfare. The
BOI has requested companies to recognize trade unions
and the right to collective bargaining. According to
the BOI, 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.

123. The ILO Freedom of Association Committee, has
observed that trade unions and employee councils can co-
exist, but there should not be any discrimination
against those employees choosing to join a union. The
right of employee councils to engage in collective
bargaining has been held as valid by the ILO. The ILO
has, however, noted weaknesses in rules governing
operation of employee councils and low prevalence of
collective bargaining agreements and requested the
Government to carry out improvements.

124. In response to these observations, the BOI
revised its labor manual in March 2004, requesting
companies located in EPZs to allow union access to
zones, and provide official time off to union members
to attend meetings. Along with this revision, the BOI
also issued new guidelines for the formation and
operation of employee councils giving powers to
employee councils to negotiate binding collective

125. 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 in
January 2004, granted significant benefits to Sri Lanka
under EU GSP in recognition of country's efforts to
implement core labor standards as the audit did not
find serious problems with regard to core labor
standards. The EU, however, observed the need for
further improvements in freedom of association.

126. 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

127. The growing strength of Marxist parties in active
politics and in parliament has increased politicized
union activity. State agencies with large unionized
workforces; have become vulnerable to politically
motivated strikes in response to restructuring and
--Collective Bargaining

128. 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.
More than half of EFC's 435 strong membership is
--Labor-Management Relations

129. Labor-management relations in the past have been
by and large confrontational. This is due to a failure
on the part of both unions and employees 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 plans. 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

130. 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. The Ministry
of Labor has published a Labor Code, consolidating
important labor legislation. Sri Lanka has ratified
all eight core labor conventions included in 1998 ILO
Declaration on Fundamental Principals and Rights at
Work. 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

131. 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.

132. 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

133. Major US companies with investments in Sri Lanka
include: Energizer Battery, Mast Industries, Smart
Shirts (a subsidiary of Kellwood Industries), Caltex,
Sportif, Citibank, Gtech, Caterpillar, 3M, Cargill,
Coca Cola, Celetronix, Inc, 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, and McDonald's are
represented in Sri Lanka through franchises. Numerous
other American brands and products are represented by
local agents.

134. 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 Celetronix 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

135. Major non-US investors include: Unilever,
Nestle's, British American Tobacco Company, Mitsui,
Pacific Dunlop/Ansell, Prima, FDK, Telekom Malaysia Bhd
and S.P. Tao. Leading US and foreign investors which
have acquired significant stakes in privatized
companies include Caltex; Norsk Hydro of Norway; and
Hanjung Steel 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; P&O Netherlands and the Indian Oil
Corporation (IOC)

136. 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 2004 was about
$33 million.

Investment Statistics

Estimated total foreign investment by sector
(in $ millions)

Sector Cumulative
Total End 2003
Food and beverage 98
Textile/apparel, leather 268
Chemical, rubber, plastic 151
Non-met. Mineral Products 52
Fabricated metal machinery 64
Other manufactured products 104
Services 1,126
Total 1,867
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.


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