Cablegate: Economic Leaders Must Focus On Defense; Imf

VZCZCXYZ0000
RR RUEHWEB

DE RUEHLM #2096/01 3521247
ZNR UUUUU ZZH
R 181247Z DEC 06
FM AMEMBASSY COLOMBO
TO RUEHC/SECSTATE WASHDC 4976
INFO RUEHKA/AMEMBASSY DHAKA 9711
RUEHIL/AMEMBASSY ISLAMABAD 6647
RUEHKT/AMEMBASSY KATHMANDU 4707
RUEHNE/AMEMBASSY NEW DELHI 0388
RUEHKP/AMCONSUL KARACHI 2077
RUEHCG/AMCONSUL CHENNAI 7210
RUEHGV/USMISSION GENEVA 1619

UNCLAS COLOMBO 002096

SIPDIS

SENSITIVE
SIPDIS

DRL/IL FOR LAUREN HOLT
STATE FOR SCA/INS
MCC FOR S GROFF, D NASSIRY AND E BURKE
GENEVA PASS USTR

E.O. 12958: N/A
TAGS: ECON EFIN ETRD EAID CE
SUBJECT: ECONOMIC LEADERS MUST FOCUS ON DEFENSE; IMF
LEAVING SRI LANKA

REF: COLOMBO 2063

1. (SBU) Summary: Corruption within the Government of Sri
Lanka (GSL), shifting of budgetary allocations for defense
expenditures, Sri Lanka,s true potential for economic
growth, and the planned closure of the International Monetary
Fund,s (IMF,s) Resident Office in Sri Lanka, were topics on
December 15 when the Ambassador met with IMF Resident
Representative Luis Valdivieso. While Valdivieso described
the GSL as being focused on the conflict with little time to
focus on economic development, he assessed the
currently-embattled Treasury Secretary as a visionary who
could move Sri Lanka toward greater economic prosperity, if
not required to use his skills and creativity to finance a
conflict. End Summary.

MILITARY FINANCING VIA LINE ITEM SHIFTS

2. (SBU) Valdivieso in a December 15 meeting with Ambassador
Blake said that that GSL,s defense allocation for 2007 is
expected to be about 4.3 percent of GDP, an increase of about
0.7 percent over 2006. (See reftel for more coverage of the
2007 budget.) Valdivieso said that large portions of funding
targeted for other purposes were used for 2006 military
expenditures. He cited as an example that as much as 75
percent of the 2006 budget allocation to provide housing for
citizens displaced by the conflict was shifted to cover
military and related security obligations. He added that
most of the defense budget goes to recurrent military
expenditures, such as salaries, special allowances and
pensions, with virtually all military hardware procurements
for 2007 to be obtained off-budget via
government-to-government programs, resulting in loans for
such acquisitions being deferred, to appear only in future
budgets.

SRI LANKA,S POTENTIAL FOR ECONOMIC GROWTH

3. (SBU) Although stating that the Sri Lankan economy has
shown "great resilience" over the past few years, Valdivieso
qualified the term "resilience," showing that he was using it
in a different manner than is so commonly used by Sri Lankan
optimists. Where the optimists point to continued 6-8
percent growth throughout many years of conflict,
extrapolating that Sri Lanka is an unstoppable engine of
moderate growth, Valdivieso identified the GSL,s skill in
using donor funds following the tragic tsunami of December
2004 to rescue Sri Lanka from was about to become an
"economic disaster." The post-tsunami donor aid enabled
Jayasundera to use the debt relief, debt deferral and tsunami
assistance provided by many countries to enhance the GSL
budget. Valdivieso projected that this type of donor
assistance, and Treasury,s ability to use this tool to mask
the GSL,s economic situation, could continue through 2007,
but would then diminish significantly as deferred loans
become due and as other aid decreases.

4. (SBU) Valdivieso, who has experience in several countries
that have seen conflict, including East Timor, Tajikistan and
El Salvador, said that countries with conflict often see as
much as a 20 percent spike in economic growth following
conflict. However, war-affected countries frequently revert
to conflict after a period of relative peace. Despite
President Rajapaksa,s stated economic goals of higher
economic growth described in Mahinda Chintana, the IMF
estimates that Sri Lanka can maintain only 6 percent
sustained growth utilizing its current resources. If the GSL
wishes to obtain a higher sustained growth rate, it will need
to create an environment that is more friendly to foreign
direct investment, as well as improve its health system and
provide a better tertiary education system ) one that
ensures that its graduates are ready to work in today,s
business climate, and one that increases access for its
qualified young people. (Note: Currently the state
university system, which has a monopoly on Sri Lanka degree
conferral, can only accommodate about 15 percent of those who
qualify for tertiary education. End Note.)

5. (SBU) Commenting that the GSL is currently so focused on
the conflict that its leadership cannot focus on economic
development, Valdivieso identified Treasury Secretary P.B.
Jayasundera and the Ministry of Planning and Implementation
as the "visionaries" who could help move the country toward a
more stable economic environment. He added that Central Bank
Governor Nivard Cabraal, while performing well, is more of an
"implementer" than a visionary, and must focus right now on
the current needs of the GSL while trying to keep the economy
afloat.

CORRUPTION CHALLENGES

6. (SBU) The Ambassador asked about Valdivieso,s views on
the prevalence of corruption in the GSL. Valdivieso
responded that corruption is endemic, although some steps
have been taken to reduce the leakage. For the last 10
years, the IMF has advised the GSL to simplify its revenue
collection systems, to no avail. Instead of simplifying, the
GSL has complicated its revenue collection mechanisms. While
simplification is needed, Valdivieso conceded that it is
quite difficult in any country to break up the "kingdoms"
that exist in revenue collection. He identified a universal
VAT as potential solution for revenue generation. However,
since the provincial governments rely on sales tax to support
their functions, he said the addition of a universal VAT
would be extremely problematic politically.

7. (SBU) The GSL,s procurement and other disbursement
systems are also rife with corruption. Funds are frequently
allocated and disbursed for projects that, if ever begun,
typically are not completed. The Ambassador cited an example
of how one GSL official (who received an award on December 9
for battling corruption) who decided to verify whether funds
allocated for the building of culverts and other water
channels were being used for their stated purpose. The
official investigated and discovered that some funding was
being used to build luxurious homes rather than channels, and
other projects funded to build large channels resulted in
only small ditches. That official received many complaints
from Members of Parliament, but received backing from the
President,s office.

8. (SBU) According to Valdivieso, Treasury Secretary P.B.
Jayasundera has been pushing the GSL toward greater
accountability and more effective measurement of outcomes by
moving the implementation of projects into a "sectoral"
approach. The IMF has been encouraging this methodology, as
well as the formation of an &expanded budget8 that would
include NGO projects. Using this approach would enable the
GSL to project its future financial obligations to maintain
NGO-funded projects, such as schools, after initial NGO
funding ceases. (Comment: An article in early December in
the government newspaper announced that P.B. Jayasundera will
resign from office. Despite his later statement that he does
not plan to resign, the article suggests pressure by
influential GSL officials to remove him from office. End
Comment.)

IMF CLOSING ITS SRI LANKA OFFICE

9. (SBU) Valdivieso informed the Ambassador that the IMF
will close its resident office in Sri Lanka. He cited a
strategic restructuring of the IMF, which will locate
resident offices in countries that have already accepted an
IMF program, or are near entry into a program, and other
countries of systemic importance or with major financial
markets. He said that the GSL has already been officially
informed of this move, and that a press release would be made
public on December 18. He said that Sri Lanka is not even
interested in entering into a program with the IMF. Factors
contributing to this lack of interest include the numerous
donors currently working with Sri Lanka (citing India, China,
Iran, and the "traditional donors") that provide aid without
the IMF,s conditions, requirements that the current GSL,s
has no desire to fulfill.

10. (SBU) The GSL has encouraged the IMF to delay its
withdrawal from Sri Lanka. But the closure continues to be
scheduled for February 1. Valdivieso noted that the IMF,s
five-member office in Washington will continue working with
Sri Lanka, perhaps making more frequent visits.

11. (SBU) COMMENT: Valdivieso has served as IMF Resident
Representative for almost two years in Sri Lanka. Working
behind-the-scenes in providing advice to the GSL, he
strategically reversed the style of his predecessor who was
more visible and more outspoken as to how Sri Lanka could
improve economically. While the current GSL does not heed
criticism by locals or foreign officials who cast the GSL,s
economic policy in a negative light, it also tends to ignore
quiet and astute counsel, such as Valdivieso,s. His
assessment of the GSL,s lack of economic discipline confirms
Embassy,s view that the GSL is focusing on the conflict to
the virtual exclusion of all else, and is dependent on
temporary foreign assistance to sustain its economic
viability.
BLAKE

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