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Cablegate: Investment Climate Statement, 2010 - Sri Lanka

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UNCLAS SECTION 01 OF 27 COLOMBO 000072

SIPDIS

STATE FOR EB/IFD/OIA AND SCA/INSB

STATE PLEASE PASS USTR

E.O 12958: N/A
TAGS: KTDB OPIC ECON USTR EINV EFIN ETRD ELAB PGOV CE
SUBJECT: INVESTMENT CLIMATE STATEMENT, 2010 - SRI LANKA

REF: 09 STATE 124006

1. Per reftel, below is the investment climate statement for Sri
Lanka for 2010. (NOTE: Hyperlinks were altered in the cable version
to permit transmission, but were sent as requested in the Word
version. END NOTE.)
INVESTMENT CLIMATE SURVEY: SRI LANKA
OPENNESS TO FOREIGN INVESTMENT
The end of Sri Lanka's long-running civil war in May 2009 should
usher in an era of sustained positive economic growth. Sri Lanka
can still be a difficult place to do business, however, with an
erratic policy environment and cumbersome bureaucracy. Nonetheless,
compared to other South Asian countries, Sri Lanka is relatively
open to foreign investment. It offers a relatively open financial
system, moderately good infrastructure, and generally capable
workers. Some U.S. and other foreign investors have realized
worthwhile returns on investment in Sri Lanka; others have tried and
departed frustrated.

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Sri Lanka is a lower-middle income developing nation with a gross
domestic product of about $42 billion in 2009. This translates into
a per capita income of just over $2,000, among the highest in the
region.

The Sri Lankan economy is remarkable for its resilience. Despite
the 1983-2009 civil war, GDP growth averaged around 5% in the last
ten years. Even the December 2004 Indian Ocean tsunami failed to
dent GDP growth, which was over 6% in 2005-2008, due in part to
tsunami reconstruction. While inflation soared in 207 and 2008, it
has dropped to 5% in 2009.

Despite directing resources to end the civil war, Sri Lanka saw its
gross domestic product (GDP) grow by an estimated 3.5% in 2009.
Main contributors to growth were government services, fisheries,
food and beverage, telecommunications, banking, and transport. Sri
Lanka's trade deficit narrowed sharply as both imports and exports
declined, but imports fell much faster than exports, mainly due to
lower oil prices. The trade deficit was fully offset by workers'
remittances estimated around $3 billion. The current account
recorded a small surplus after many years. Overall, the Balance of
Payments (BOP) is expected to record a surplus of about $2.7
billion, the highest ever, thanks partly to heavy government
borrowing. FDI was much lower than previous years with only about
$350 million in the first nine months.

While Sri Lanka's exposure to the global financial crisis is limited
due to controls on its capital account, Sri Lanka experienced
capital flight in early 2009 by foreign investors who had invested
in government debt instruments. Central Bank reserves declined
sharply in early 2009. However, business confidence rebounded with
the end of the war and an IMF agreement in July 2009, allowing gross
official reserves to increase to a historic high of $5.2 billion as
of November 2009, providing 6.3 months of imports cover. The rupee
has stabilized around Rs 114.50 to the dollar. Credit ratings were
revised upward to stable.

2010 will be an important year for the Sri Lankan economy. The
Central Bank expects the economy to grow by 7% in 2010, aided by
growth in agriculture, manufacturing, construction, tourism and
other services, and the Central Bank forecasts inflation to remain
at single digit levels. The government has postponed the
presentation of the 2010 budget until after the parliamentary
elections in March/April. The Government fiscal situation will be a
concern in 2010 especially due to spending on two national elections
as well as numerous promises to woo voters. However, defense
expenditures should decline. Furthermore, the potential loss of the
EU's GSP Plus trade benefit could further hinder Sri Lanka's
economic growth.

Sri Lanka is a stable parliamentary democracy. In 1978, it shifted
away from a socialist orientation and opened to foreign investment,
although changes in government have often been accompanied by
reversals in economic policy. Of the two major parties, the more
pro-business United National Party has been in opposition in recent
years. When it last held power, from 2002 to 2004, it pursued
privatization and regulatory reform welcomed by domestic and foreign
investors.

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Currently, the ruling Sri Lanka Freedom Party has a more statist
economic approach, guided by President Rajapaksa's 2005 election
manifesto Mahinda Chintana ("Mahinda's Thoughts"). Mahinda Chintana
seeks to reduce poverty by steering investment to disadvantaged
areas; developing small and medium enterprises; promoting
agriculture; and expanding the already enormous civil service. The
Rajapaksa government has halted privatization and advocates state
control of what it deems "strategic" enterprises such as state-owned
banks, airports, and electrical utilities. There are also private
banks which compete with the state owned banks. The government has
increased direct and indirect taxation to fund increased government
expenditure. The government has adopted import substitution
strategies and has increased taxes on imports to protect local
industries.

Multinational companies complain that increasing government bias in
favor of local businesses is harming the local investment climate.
Though many multinational companies perform better than the local
private sector, international MNCs and SMEs feel the government is
blatantly biased towards local companies. Some investors believe,
and are concerned, that Sri Lanka is becoming a highly nationalistic
environment where the government often blames foreigners for its
economic and social ills.

Other impediments to investment in Sri Lanka are workers' declining
English language skills, inflexible labor laws, overburdened
infrastructure, and its unreliable court system. Sri Lanka boasts a
90% literacy rate in the local Sinhala and Tamil languages, but
English, which was once widely spoken, is now far less prevalent.
Sri Lanka's labor laws include many model protections, but can make
it nearly impossible for companies to lay off workers even when
market conditions fully warrant doing so. The cost of dismissing an
employee in Sri Lanka is, percentage-wise, one of the highest in the
world. Sri Lanka has not invested in infrastructure to keep pace
with its growth. Its roads are narrow and congested. With the
conclusion of the war, Sri Lanka is renovating and constructing
roads in the North and East. Multi-year projects to expand the
ports in Colombo and Hambantota are underway.

Sri Lanka's electricity supply is generally reliable but can fail to
meet peak demand in years of low rainfall and is priced higher than
in other Asian countries. Businesses in Sri Lanka also face high
interest rates, although rates have come down in the past few
months. Sri Lanka's courts cannot be relied upon to uphold the
sanctity of contracts. The courts are not practical for resolving
disputes or obtaining remediation, because their procedures make it
possible for one side in a dispute to prolong cases indefinitely.
Aggrieved investors (especially those dealing with the government of
Sri Lanka on projects) have frequently pursued out-of-court
settlements, in hopes of speedier resolution. In late 2008, the
Supreme Court, in an interim order, halted payments to five
international and local banks involved in oil hedge contracts with
the government. One of the involved banks is American. The case is
now proceeding to international arbitration.

TRADE

According to preliminary data for 2009, Sri Lanka's exports (mainly
apparel, tea, rubber, gems and jewelry) were $6.9 billion and
imports (mainly oil, textiles, food, and machinery) were $9.6
billion. Exports to the United States, Sri Lanka's second largest
market, are projected around $1.6 billion in 2009, or 23% of total
exports. The United States is Sri Lanka's second biggest market for
garments, taking about 40% of total garment exports. India is Sri
Lanka's largest supplier, with exports of over $3.8 billion. The
United States' exports to Sri Lanka are projected at $180 million in
2009. U.S. exports consist primarily of wheat as well as industrial
machinery, medical instruments, aircraft parts, lentils, paper,
specialized fabrics and textiles for use in the garment industry,
fruits and pharmaceuticals.

BOARD OF INVESTMENT

The Board of Investment (BOI) (www.investsrilanka.com), an
autonomous statutory agency, is the primary government authority
responsible for investment, with a focus on foreign investment. The

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BOI is authorized to manage a number of export processing zones
which feature business-friendly regulations and improved
infrastructure for foreign investors. The BOI is intended to
provide "one-stop" service for foreign investors, with duties
including approving projects, granting incentives, and arranging
services such as water, power, waste treatment and
telecommunications. It also assists in obtaining resident visas for
expatriate personnel and facilitates import and export clearances.
The Public-Private Partnership Unit, a new division of BOI, has
responsibility for coordinating all public-private infrastructure
projects. The BOI has special investment incentives for investors
interested in the post conflict Northern and Eastern sections of Sri
Lanka.

BOI incentives are attractive and real, but the BOI is not the "one
stop shop" it aspires to be. Although it is relatively effective in
assisting investors who want to establish operations within its
industrial processing zones, it is less effective in facilitating
and servicing large investments outside these zones. Sri Lanka's
large, inefficient, and dated bureaucracy often works at
cross-purposes with BOI authorities and commitments. Additionally,
major investments in Sri Lanka, such as infrastructure projects,
require approval from the full cabinet, a process which is not
transparent and which can politicize even the most urgently needed
investments. Registration of foreign company branch offices in Sri
Lanka can be cumbersome as well.

Although there are cases in which it appears that the BOI has been
used for political purposes, generally the treatment given to
foreign investors is non-discriminatory. However, even with
incentives and BOI facilitation, foreign investors face difficulties
operating in Sri Lanka. Problems range from difficulty clearing
equipment and supplies through customs speedily to difficulty
obtaining a factory site. Legal challenges to environmentally
sensitive projects have been burdensome, even when objections are
unfounded. Slow and indecisive application of bureaucratic
requirements has also obstructed investment. In part to avoid these
delays, and to overcome land allocation problems, the BOI encourages
investors to locate their operations in BOI-established industrial
processing zones. Investors locating in industrial zones also get
access to relatively better infrastructure facilities such as
reliable power, telecommunication and water supplies.

LAWS AFFECTING INVESTMENT

The principal law governing foreign investment is Law No. 4, created
in 1978 (known as the BOI Act), as amended in 1980, 1983 and 1992,
along with implementation 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 on minimum investment, exports and in some cases
employment. Investment approval under Section 16 of the Act permits
entry for foreign investment to operate under the "normal" laws of
the country and applies 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 as amended in 1991 and 2003, and the Takeovers and Mergers Code
of 1995 revised in 2003. A new Companies Act came into effect in
2007 replacing the Companies Act of 1982. The new law aims to
improve trade and commerce as well as corporate governance in the
business sector. It features simplified regulations concerning
company formation; provisions specifying the duties of company
directors; provisions to prevent the abuse of powers by directors;
provisions to protect creditors; and a dispute board to settle
disputes among directors. Various labor laws and regulations also
affect investors. See sections below.

FOREIGN EQUITY SHARES BY SECTOR

The government allows 100% foreign investment in the following
services: banking, finance, insurance, stock-brokering,
construction of residential buildings and roads, supply of water,
mass transportation, telecommunications and information technology
(software development and business process outsourcing), energy
production and distribution, professional services, and the
establishment of liaison offices or local branches of foreign

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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.

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

Foreign investment is not permitted in the following businesses:
non-bank money lending; pawn-brokering; 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 $150,000); coastal fishing; and the awarding of local
university degrees. Foreign degree courses can be offered in Sri
Lanka by affiliating with foreign universities. However, there is
no system to monitor the quality assurance or accreditation of the
foreign courses offered in Sri Lanka.

PRIVATIZATION HALTED

The current Government has halted privatizations, preferring to
maintain state-owned enterprises. Government treatment of foreign
investors in past privatization processes has been largely
non-discriminatory. In 2003, however, the government sold part of
the retail operations of state-owned Ceylon Petroleum Corporation to
Indian Oil Corporation without a formal tender process. In 2008,
the Supreme Court cancelled a privatization of a government-owned
bunkering company, done in 2002, citing it was illegal. In 2009,
the Supreme Court cancelled a 2003 sale of a government-owned large
insurance company.

Labor unions in state-owned enterprises are often opposed to
privatization and restructuring and seem particularly averse to
foreign ownership. In the past, this made the privatization of
government entities problematic for new foreign owners.

Measure Year Index/Ranking

TI Corruption Index 2009 3.1/97
Heritage Economic Freedom 2009 56/111

World Bank Doing Business 2010 N.A/105
MCC Gov't Effectiveness 2008 0.50/92%

MCC Rule of Law 2008 0.88/98%
MCC Control of Corruption 2008 0.63/94%
MCC Fiscal Policy 2008 -7.1/8%
MCC Trade Policy 2009 62.2/27%

MCC Regulatory Quality 2008 0.35/87%
MCC Business Start Up 2009 0.96/85%
MCC Land Rights Access 2009 0.60/47%
MCC Natural Resource Mgmt 2009 89.79/100%

CONVERSION AND TRANSFER POLICIES

In accordance with its Article VIII obligations as a member of the
International Monetary Fund (http://www.imf.org/external/
pubs/ft/aa/aa08.htm), Sri Lanka has liberalized exchange controls on
current account transactions. In times of balance of payments
difficulties the government tends to impose controls on foreign
exchange transactions. Most recently, in October 2008, the Central
Bank required importers to keep a 100% deposit on letters of credit
on a range of imports. The deposit requirement on the import of
cars was 200% of the value of the import. These restrictions were
later lifted.

Exporters must repatriate export proceeds within 90 days to settle

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export credit facilities. Other export proceeds can be retained
abroad in a local bank's correspondent bank. Currently, contracts
for forward bookings of foreign exchange are permitted for a maximum
period of 180 days for the purposes of payments in trade.

There are no barriers, legal or otherwise, to the expeditious
remittance 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 for companies with majority foreign investment approved
under Section 17 of the BOI Act. Repatriation of funds for debt
service and capital gains of companies exempted by the BOI from
exchange control regulations is permitted. Other foreign companies
remitting funds for debt service, business fees and capital gains
require Central Bank approval.

The average delay period for remitting investment returns such as
dividends, return of capital, interest and principal on private
foreign debt, lease payments, royalties and management fees through
normal, legal channels is in the range of 1 to 4 weeks. All stock
market investments can be remitted without prior approval of the
Central Bank through a special bank account. Investment returns can
be remitted in any convertible currency at the legal market rate.

While controls on capital account (investment) transactions usually
prohibit foreigners from investing in Sri Lankan debt instruments,
the government allows limited access to foreigners to invest in
government rupee bonds and treasury bills. The Central Bank's
dollar-denominated bond issues in the local market are also open to
foreign investors. 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.

The government is planning to relax existing controls on capital
account transactions. The proposed plans include permission for Sri
Lankans to open foreign bank accounts and invest in shares and short
term debt of foreign companies; foreign nationals to invest in
debentures of local companies; insurance companies to invest funds
in foreign assets; Sri Lankan companies to list in foreign stock
exchanges; foreign tourists to open Sri Lanka Rupee accounts; and
relaxation of import payment mechanisms.

EXPROPRIATION AND COMPENSATION

Since economic liberalization policies began in 1978, the Sri Lankan
Government has not expropriated a foreign investment. The last
expropriation dispute was resolved in 1998.

DISPUTE SETTLEMENT

Sri Lanka's legal system reflects diverse cultural influences.
Criminal law is fundamentally British. Basic civil law is
Roman-Dutch. Laws pertaining to marriage, divorce, and inheritance
are communal. 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. Its
amendments have, by and large, kept pace with subsequent legal
changes in the U.K. 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.

Sri Lanka's court system consists of the Supreme Court, the Court of
Appeal, Provincial High Courts and the Courts of First Instance viz.
district courts (with general civil jurisdiction) and magistrate
courts (with criminal jurisdiction). The provincial high courts
have original, appellate and reversionary criminal jurisdiction.
The Court of Appeal sits as the intermediate appellate court with a
limited right of appeal to the Supreme Court. The Supreme Court
exercises final appellate jurisdiction for all criminal and civil
cases. Citizens may apply directly to the Supreme Court for
protection if they believe any government or administrative action
has violated their fundamental human rights.


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All commercial matters exceeding the value of Rs 3 million
(approximately $26,000) fall within the jurisdiction of the
Commercial High Court of Colombo. There are also a number of
tribunals which exercise judicial functions, such as the Labor
Tribunals to hear cases brought by workers against their employers.
Until recently, the court system was largely free from government
interference. There are allegations that the judiciary is sometimes
subject to political influence, but this has not been evident in
commercial litigation so far. Litigation can be slow and
unproductive, though. Monetary judgments are usually made in local
currency. Procedures exist for enforcing foreign judgments.

In late 2008, acting on a fundamental human rights petition, the
Supreme Court, in an interim order, halted payments to five
international and local banks involved in oil hedge contracts with
the government. One of the banks involved is American. The banks
are taking the case to international arbitration.

BANKRUPTCY LAWS

The Companies Act and the Insolvency Ordinance provide for
dissolution of insolvent companies, but there is no mechanism to
facilitate the re-organization of financially-troubled companies.
Other laws make it difficult to keep a struggling company solvent.
The Termination of Employment of Workmen Act (TEA), for example,
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. The Labor Commissioner's
approval or the affected employee's consent is required to fire
workers. The government has introduced a standard compensation
formula under the TEA to facilitate termination for other than
disciplinary reasons. Employers protest that compensation is
excessive compared to similar formulae in the Asian region, with
terms in Sri Lanka about twice as generous as the East Asian
average. (See section on "Labor" for further details.)

In the absence of proper bankruptcy laws, extra-judicial powers
granted by law to financial institutions protect the rights of
creditors. When a company cannot meet the demands of a creditor for
a sum exceeding Rs 50,000 (approximately $440) the creditor may
petition for the company to be dissolved by the court. Lenders are
also able to enforce financial contracts through powers that allow
them to foreclose on loan collateral without the intervention of
courts. However, loans below Rs 5 million ($435,000) are exempt
from the application of the law. Additionally, a judgment ruled
that these powers would not apply with respect to collateral
provided by guarantors to a loan. These two moves have weakened
creditors' rights. 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 filed in courts, the judicial process is extremely
slow.

The new Companies Act of 2007 introduced a "solvency test" to
determine the financial health of a company. There are provisions
relating to the responsibilities of a company's directors in cases
of serious loss of capital. The solvency test is intended to
prevent companies without sufficient assets from obtaining loans and
to protect rights of creditors.

The Companies Act does not provide for the revival of struggling
companies. However, as in the past, it is expected that the courts
would take a liberal attitude towards any restructuring plans that
may be of benefit to a company.

INVESTMENT PROTECTION

In principle, foreign investments are 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. Under Article
157 of the Constitution of Sri Lanka, investment protection
agreements enjoy the force of law and no legislative, executive or
administrative action can be taken to contravene them. The
government has ratified the Convention on Settlement of Investment
Disputes, which provides the mechanism and facilities for

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international arbitration through the World Bank's International
Center for the Settlement of Investment Disputes (ICSID).

The U.S.-Sri Lanka Bilateral Investment Treaty (BIT) was ratified by
both governments in 1993 (www.state.gov/documents/
organization/43588.pdf).

ARBITRATION

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)
(www.iclparbitrationcentre.com) has been established in Colombo for
the expeditious, economical, and private settlement of commercial
disputes. However, the ICLP appears unlikely to become involved in
disputes involving the Sri Lankan Government, which is often a party
to disputes involving foreign investors.

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.

The Labor Department has a process involving labor tribunals for
settling industrial disputes with workers or unions, and arbitration
is required when attempts to reconcile industrial disputes fail.
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.

The government record in handling investment disputes is
problematic. Disputes often become politicized, causing the
government to put political interests ahead of its respect for the
sanctity of contracts. For example, in 2006, the Indian Oil
Corporation's petroleum retailing subsidiary in Sri Lanka
temporarily closed its operations when the government failed to
honor its commitment to reimburse the company for fuel sold at the
government-controlled price.

INVESTMENT DISPUTES INVOLVING U.S. COMPANIES

U.S. companies have experienced problems with payment of valid
contracts; implementation of agreements with the government; and
inexplicable failure to secure contracts, despite demonstrated
superior performance, high value, and competitive bids.

A U.S. power company producing electricity in Colombo has been
unable to obtain payment since 2004 for power that it produced under
a temporary, more costly, operating mode following a fire in its
plant. The company had intended to suspend operations to conduct
repairs following the fire, but agreed to the government's request
that it keep producing power even at a higher cost. However, the
government withheld payment on the basis of a questionable Attorney
General finding that the higher than usual electricity price was
imposed on the government "under duress."

As mentioned previously, the Ceylon Petroleum Company (CPC) entered
into a contract with five banks on an oil hedging contract. Once
the international price of oil rose substantially, the CPC and
Government of Sri Lanka (GSL) refused to honor the oil hedging
contracts. One American bank is involved. The GSL has not resolved
the case, and the banks have filed for international arbitration.

PERFORMANCE REQUIREMENTS AND INCENTIVES

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% of production, while those
in the service sector must earn at least 70% of income in foreign
exchange. Sri Lanka complies with WTO Trade Related Investment
Measures (TRIMS) obligations.


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Sri Lanka encourages foreign investment in information technology,
electronics assembly, light engineering, automobile parts and
accessories manufacturing, industrial and information technology
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, nor are
they expected to transfer technology within a specified period of
time, except for build-own-transfer or other such projects in which
the terms are specified within pertinent contracts.

In some BOI-approved enterprises, businesses are required to
maintain certain levels of employment to enjoy incentives. In
addition, privatization agreements generally prohibit new owners
from dismissing 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.

Foreign investors who remit at least $250,000 can qualify for a
one-year resident visa, which can be renewed. 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. In the past, foreign employees attached to BOI-approved
companies received preferential tax treatment for an initial period.
This concession was withdrawn in April 2008. BOI is planning to
appeal to the Finance Ministry to reverse this decision. Foreign
employees in the commercial sector do not experience significant
problems in obtaining work or residence permits.

INVESTMENT INCENTIVES

The Board of Investment (www.investsrilanka.com) has various
incentives, with such investments typically requiring prior approval
by various ministries. Please see the note at the end of this
section on proposed changes to the incentive programs listed:

INCENTIVE PROGRAM I

Qualifying industries:
-Non-traditional manufacturing exports and companies supplying to
exporting companies. Minimum investment of $500,000(a);
-Export oriented services. Minimum investment of $500,000;
-Manufacture of industrial tools and/or machinery. Minimum
investment of $150,000;
-Small-scale infrastructure. Minimum investment of $500,000;
-Research and development. Minimum investment of $100,000;
-Agriculture and agro processing industries. Minimum investment of
$150,000;
-Export trading houses of rural sector. Annual turnover of
$5,000,000.

Incentives: Currently, the above industries qualify for a five-year
tax holiday. A preferential tax of 10% in the 6th and 7th years
follows the tax holiday for some industries. Some of 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. An
Economic Service Charge (ESC) at 0.25% of income applies to all
companies including BOI-approved companies with tax holidays. A
three year tax holiday is available for investments between $250,000
and $500,000.

INCENTIVE PROGRAM II

Qualifying Industries:
-Information technology (IT) or information technology enabled
services. Minimum investment of $150,000. Minimum employment
levels apply;
-Information technology training institutes. Minimum invest of

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$100,000. Minimum number of students applies;
-Business Process Outsourcing (BPO). Minimum investment of
$150,000. Minimum employment levels apply;
-Regional operating headquarters providing the following services to
related businesses outside Sri Lanka: administration, business
planning, sourcing raw materials, research and Development,
technical support, financial and treasury management, marketing and
sales promotion. Minimum investment of $250,000.

Incentives: Currently, IT services, IT training institutes, and BPO
firms qualify for tax holidays of 5-12 years provided they meet
minimum employment and student levels. Otherwise, a preferential
tax of 10% applies for 2 years. Regional operating headquarters
qualify for a tax holiday of 3 years. A preferential tax of 10%
will apply in the 4th and 5th years. From the 6th year onwards, a
preferential tax of 20% will apply for IT training institutes while
a tax of 15% will apply for others. Capital goods for these
projects will be exempted from import duty for above investments.
An Economic Service Charge at 0.25% of income applies to
BOI-approved companies enjoying tax holidays, from the fourth year
of operation.

INCENTIVES FOR REGIONAL DEVELOPMENT

The BOI has a separate incentive program to promote regional
development, with the aim of establishing new factories or service
companies (such as hotels, hospitals, or training institutes) in the
regions outside the capital Colombo. The incentives include 10-20
year tax holidays for investments in Northern and Eastern Provinces
and 2-10 year tax holidays for investments located in other
provinces. In addition, imports of machinery and equipment are
exempted from both customs duty and the value-added tax. Minimum
investment levels apply.

INCENTIVES FOR NORTH AND EAST DEVELOPMENT

Investments in the Northern and Eastern Provinces receive generous
tax incentives including 10-20 year tax holidays. Incentives are
targeted at producers of textile and apparel, food, wood, paper,
rubber and plastic products, fishing gear and fishing boats. In
addition, hotels, agriculture-based industries, and fisheries are
also entitled to these incentives. Exporting companies can import
raw material, capital goods and construction material free of import
duty under this program. Companies producing for the local market
can import capital goods and construction material without duty. In
addition, state lands will be made available at concessionary rates
for these projects.

INCENTIVES FOR INFRASTRUCTURE DEVELOPMENT

Companies acquiring existing companies in petroleum, power
generation, transmission, development of highways, seaports,
airports, railways, 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 8 years
depending on the magnitude of investment. A preferential tax of 15%
will follow after the tax holiday period. These companies will also
qualify for duty free imports of capital goods. A minimum
investment of $12.5 million is required.

Large-scale new 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 15 years
depending on the size of the investment. A preferential tax of 15%
will follow the tax holiday. They will also qualify for duty free
imports of capital goods. A minimum investment of $12.5 million is
required.

INCENTIVES FOR OTHER INVESTMENTS

-Industrial estates. Minimum investment of $500,000 to $75 million;
tax holidays ranging from 3 to 15 years;
-Textile fabric manufacturing, processing. Minimum investment of
$500,000 to $10 million; tax holidays ranging from 5 to 15 years.


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For further information on investment incentives and other
investment-related issues, potential investors are encouraged to
contact the Board of Investment directly. The BOI can be found at
www.investsrilanka.com and www.boi.lk, or reached via e-mail at
info@boi.lk. The BOI has introduced an investor matchmaking service
via the BOI website. Information regarding this service can be
found at www.boi.lk/partnership.

TRADE AGREEMENTS ENHANCE MARKET ACCESS TO SOUTH ASIA AND EUROPE

A preferential trade agreement, the Indo-Lanka Free Trade Agreement
(ILFTA) (www.doc.gov.lk) between Sri Lanka and India, is now in
effect. Under this agreement, most products manufactured in Sri
Lanka with at least 35% domestic value addition (if raw materials
are imported from India, domestic value addition required is only
25%), qualify for duty free entry to the Indian market. Tariff
concessions for Sri Lankan products include zero tariffs on 4,235
items; 50 to 100% reduction for tea and garments under quota; 25%
reduction for 553 textile items; and no reduction for 431 items on
India's "negative list." Discussions are underway to reduce the
negative lists of both countries. The two countries are also
discussing services sector liberalization, under a proposed
Comprehensive Economic Partnership Agreement (CEPA). Other areas
potentially covered by the CEPA are investment and economic
cooperation. Because production constitutes a portion of value
addition, ILFTA and the proposed CEPA enables foreign firms
operating in Sri Lanka to gain preferential entry into the Indian
market. The CEPA negotiations have stalled, however, and it is not
clear that Sri Lanka is interested in finalizing the deal.

Some U.S. companies currently avail themselves of the ILFTA by
adding at least 35% value in Sri Lanka and getting import duties
into India reduced from as much as 15% to as little as zero. The
American Chamber of Commerce in Sri Lanka, in a study on the ILFTA,
identified agro-processing, food preparation, tea, rubber products,
coconut products, spices, furniture, ceramic and confectionary as
having growth potential in India. The study also found vehicles and
vehicle parts, aircraft parts and motorcycles to be possible
attractive sectors for U.S. manufacturers under the Indo-Lanka
Agreement.

Sri Lanka's Board of Investment promotes the following product
sectors under ILFTA: beverages, confectionary, rubber products,
plastics, coconut products, footwear, paper, textiles and garments,
artificial plants, ceramics, glassware, jewelry, iron and steel
products, aluminum extrusions, machinery and mechanical appliances,
electronics and electrical products, automobiles and spare parts,
furniture, and doors.

The 2005 Sri Lanka-Pakistan Free Trade Agreement (SLPKFTA)
(www.doc.gov.lk) provides duty-free entry into Pakistan for almost
all Sri Lankan exports except those on the negative list.
Pakistan's negative list contains 541 items with no duty
concessions. Sri Lanka's Board of Investment promotes the following
product sectors under SLPKFTA: spices, coconut based products,
animal or vegetable oils, confectionary, processed food, rubber
products, ceramics, jewelry, iron and steel, copper and aluminum
articles machinery and mechanical appliances, electronics and
electrical appliances, medical instruments, and automobiles and
spare parts.

Sri Lanka and six other South Asian nations belonging to the South
Asian Association for Regional Cooperation (SAARC) agreed in 2004 to
establish a South Asian Free Trade Area (SAFTA)
(www.saarc-sec.org/main.php), which began operation on July 1, 2006.
SAFTA offers regionalized tariff reductions for imports from member
countries. Stated goals of SAARC members under SAFTA are to reduce
duties for imports from member countries to between zero and 5% over
a period of 7-10 years. The SAARC trade talks have had limited
effect to date on trade and investments.

These agreements could help make Sri Lanka a gateway to South Asia
for foreign investors.

Sri Lankan exports to the European Union (EU) are also duty free
under the "GSP-Plus" incentive agreement in effect since July 2005.
Under this program, 7,200 Sri Lankan products meeting

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rules-of-origin criteria can enter the EU duty free. The GSP Plus
scheme for Sri Lanka was renewed in January 2009 for a period of
three years, subject to the results of an on-going investigation of
the government's actions at the end of the civil war. Depending on
the findings of the investigation, benefits could be withdrawn by
July 2010.

RIGHT TO PRIVATE OWNERSHIP AND ESTABLISHMENT

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 to access to markets, credit, or licenses.
Foreign ownership is allowed in most sectors. Private land
ownership is limited to fifty acres per person. The government owns
about 80% of the land in Sri Lanka, including the land housing most
tea, rubber, and coconut plantations. The government has leased
most of these plantations to the private sector on 50-year 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. There are also
substantial land disputes arising from the end of the war, as the
Government regains control of areas after many years of war.

While foreign investors can purchase land from private sellers, the
government has imposed a 100% tax on land transfers to foreigners.
For this purpose, Sri Lanka has defined foreign investment to
involve as little as 25% foreign ownership - a definition that can
be particularly difficult for companies listed on the Colombo Stock
Exchange since on any particular day, their ownership
characteristics may vary. Apartments above the third floor of
condominium buildings, land for the development of large housing
schemes, hospitals and hotels with a minimum investment of $10
million, exporting companies with a minimum investment of $1
million, and large infrastructure projects with a minimum investment
of $50 million are exempted from the tax. Regulations regarding
these exceptions have been published in Gazette No 1386/18 dated
March 30, 2005.

PROTECTION OF PROPERTY RIGHTS

Secured interests in property are recognized and enforced. The
legal system is nondiscriminatory and protects and facilitates
acquisition and disposition of property rights by foreigners,
although it has recently become subject to political influence. A
fairly reliable registration system exists for recording private
property including land, buildings and mortgages. There are likely
to be difficult land disputes in the recently freed northern and
eastern regions of the country, following the end of the war.
However, there are problems due to fraud and forged documents.

INTELLECTUAL PROPERTY RIGHTS PROTECTION

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 United States in
1991 signed a Bilateral Agreement for the Protection of Intellectual
Property Rights. Sri Lanka, a WTO member, is also a party to the
Trade Related Intellectual Property Rights (TRIPS) agreement in the
World Trade Organization. Sri Lanka has not acceded to the WIPO
Performances and Phonograms Treaty (WPPT); the WIPO Copyright Treaty
(WCT); or the WTO Information Technology Agreement.

In November 2003, a new intellectual property law came into force
that was intended to meet both U.S.-Sri Lanka bilateral IPR
agreement and TRIPS obligations to a great extent. The law governs
copyrights and related rights, industrial designs, patents,
trademarks and service marks, trade names, layout designs of
integrated circuits, geographical indications, unfair competition,
databases, computer programs, and undisclosed information. All
trademarks, designs, industrial designs and patents must be
registered with the Director General of Intellectual Property. Sri

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Lanka introduced regulations to regulate the commercial use of local
creations in 2008.

Infringement of intellectual property rights (IPR) is a punishable
offense under the law. Intellectual property rights come under both
criminal and civil jurisdiction. Recourse available to owners
includes injunctive relief, seizure and destruction of infringing
goods and plates or implements used for the making of infringing
copies, and prohibition of imports and exports. Penalties for the
first offence include a prison sentence of 6 months or a fine of up
to Rs 500,000 ($4,425), but smaller penalties are the norm.
Penalties can be doubled for a second offense. Aggrieved parties
can seek redress for any IPR violations through the courts, though
this can be a frustrating and time-consuming process.

Since the passage of the 2003 IPR law Sri Lanka has slowly begun
enforcing its provisions. The Police occasionally raid counterfeit
CD/VCD stores as well as counterfeit garment sellers. However, it
is rare for the police to act without a formal complaint and
assistance from an aggrieved party. Several offenders have been
charged or convicted by courts. However, the minimal damages and
suspended sentences imposed suggest that the court system still
fails to recognize the significance of intellectual property
rights.

Counterfeit goods continue to be widely available in Sri Lanka.
Local agents of well-known U.S. and other international companies
representing recording, software, movie, clothing and consumer
product industries continue to complain that lack of IPR protection
is damaging their businesses. Piracy of sound recordings and
software is widespread, making it difficult for the legitimate
industries to protect their market and realize their potential in
Sri Lanka. Software companies complain of the lack of IPR
enforcement within government institutions and even some larger
corporations, including several banks. In December 2009, the
government of Sri Lanka approved a new Information Technology (IT)
policy for the government sector which includes rules on hardware
and software procurement. The implementation date of the new policy
is not known. The embassy and the American Chamber of Commerce of
Sri Lanka are working to pursue more aggressive enforcement and
enhance public awareness.

PATENTS, COPYRIGHTS AND TRADEMARKS

Patents are valid for 20 years from the date of application but must
be renewed annually. 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 essential 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
a human or animal body. The law also permits compulsory licensing
and parallel imports of pharmaceutical products. Compulsory
licensing will allow the government to grant licenses to manufacture
certain patented drugs, overruling patent licenses in a national
emergency. The parallel imports will allow the import of a branded
drug from an alternative source.

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.

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 REGULATORY SYSTEM

The Board of Investment strives to inform potential investors about
laws and regulations that may affect operations in Sri Lanka. Laws
are in place pertaining to tax, labor and labor standards, exchange

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controls, customs, environmental norms, and building and
construction standards. However, some of the laws and regulations
are difficult to access.

Foreign and domestic investors often complain that the regulatory
system is unpredictable due to outdated regulations, rigid
administrative procedures, and excessive leeway for bureaucratic
discretion. 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.
Lack of sufficient technical capacity within the government to
review financial proposals for private infrastructure projects also
creates problems during tendering. An example of weakness in
regulations occurred in mid-2006, when police and government
agencies closed two satellite television broadcasting stations for
not possessing required licenses. The two stations remained closed
for over five months, before various government agencies
reauthorized their operations.

In 2005-2009, the Government awarded several key infrastructure
projects to Chinese companies outside the tender process. They
included a 300 megawatt coal power project, a fuel bunkering
project, and a large port construction project and an airport
project in the southern district of Hambantota. In addition, the
Government has promised oil exploration rights to India and China
outside the tender process. Similarly, in 2008, the
government-owned Ceylon Petroleum Corporation signed an agreement
with the government of Iran to finance the expansion of the
country's oil refinery. The government had previously signed a
Memorandum of Understanding with an American company to negotiate an
agreement for the same project. Despite the purported agreement
with Iran, the refinery project is still on hold.

Although many foreign investors, including U.S. firms, have had
positive experiences in Sri Lanka, some have encountered significant
problems with government practices and regulations. Some
multinational firms have experienced extensive unexplained delays in
trying to reach agreement on investment projects. Others have had
contracts arbitrarily canceled without compensation, even though the
Sri Lankan Cabinet had approved those contracts.

Proposed laws and regulations are generally made available for
public comment. However, occasionally they are published without
public discussion.

EFFICIENT CAPITAL MARKETS AND PORTFOLIO INVESTMENT

Retained profits finance about 70% of private investment, with short
term borrowing financing a further 20% of investment. The stock
market and corporate securities market have not been significantly
used to raise capital. Foreign direct investment (FDI) finances
about 4% of overall investment. Foreign investors are allowed to
access credit on the local market. They are also free to raise
foreign currency loans.

The state consumes over 50% 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. For 2009, the
government's net borrowing from the local market is forecast to be
Rs 183 billion ($1.6 billion). Due to high inflation and increased
government borrowing, interest rates were high in 2007 and 2008.
Most companies cite high interest rates as a major impediment to
doing business and investment in Sri Lanka. With the decline in the
rate of inflation in 2009, the Central Banks reduced key interest
rates. Consequently, lending rates to blue chip companies declined
to 12% in January 2010 from about 20% in January 2009. Other
companies including SME's face higher rates.

CREDIT INSTRUMENTS

Commercial banks are the principal source of bank finance. Bank
loans are the most widely used credit instrument for the private
sector. Financial institutions also raise syndicated bank loans to
fund large-scale investment projects undertaken by the private
sector.

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The domestic debt market in Sri Lanka is still at a nascent stage.
The first credit rating agency in Sri Lanka was Fitch Rating Lanka
(www.fitchratings.lk), which opened an office in Colombo in 1999.
Fitch Ratings Lanka is a joint venture between Fitch Ratings Inc,
International Finance Corporation (IFC), the Central Bank of Sri
Lanka, and several leading local financial institutions. Credit
ratings are now mandatory for all deposit-taking institutions and
for all varieties of debt instruments and have helped numerous Sri
Lankan companies raise funds through debt markets.

Sri Lanka received its first sovereign credit ratings in December
2005, with a "BB-minus" from Fitch Ratings and a "B-Plus" from
Standard and Poor's (S&P). Current ratings are "B-Plus" (Fitch) and
"B" (S&P). Fitch has assigned a stable rating outlook for Sri
Lanka. S&P's rating outlook is positive.

ACCOUNTING STANDARDS

There is an active and fairly 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 adopted by the International
Accounting Standards Board (IASB). In addition, Sri Lanka is
following the worldwide move to adopt International Financial
Reporting Standards (IFRS) for financial reporting purposes set by
the IASB. The proposed full convergence is expected to be in 2011
for financial periods on or after January 1, 2012. A significant
change is expected with full convergence. Due to the lack of an
adequate enforcement mechanism, problems with the quality and
reliability of financial statements still exist.

Sri Lankan accounting standards are applicable for all banks, stock
exchange listed companies 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 published accounting standards for
small companies as well. The Accounting Standards and Monitoring
Board (ASMB) is responsible for monitoring compliance with Sri
Lankan accounting and auditing standards. British professional
accounting bodies are quite active in Sri Lanka. The Chartered
Institute of Management Accountants (CIMA), a leading professional
accounting body based in the UK and spread over the Commonwealth,
has its largest overseas presence in Sri Lanka. CIMA UK suspended
the Sri Lanka divisional council over a governance issue in December
2008 and a new council was appointed in January 2010. CIMA programs
and operations in Sri Lanka continued undisrupted during this
period.

SECURITIES AND EXCHANGE COMMISSION

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

Foreign investors can purchase up to 100% of equity in Sri Lankan
companies in numerous permitted sectors. In order to facilitate
portfolio investments, country funds and regional funds may obtain
Ministry of Finance approval to invest in Sri Lanka's stock market.
These funds make transactions through share investment external
Rupee accounts maintained in commercial banks.

COLOMBO STOCK EXCHANGE

The Colombo Stock Exchange (CSE) has fully automated trading,
clearing and settlement systems. The CSE maintains a rolling
settlement period of 3 days. Twenty one local and foreign joint
venture brokers currently operate at the CSE. Foreign stockbrokers
are permitted to hold up to 100% equity in stock brokerage firms
operating at the CSE. The SEC has a settlement guarantee fund with
an initial capital of Rs 100 million ($88,500), which aims to
guarantee the settlement of trades between clearing members of the
exchange.

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There are 232 companies listed on the stock exchange with the top
ten positions by market capitalization held by conglomerates,
telecommunication companies, banks, and food and beverage companies.
The CSE, which suffered in 2007-2008 due to increased
conflict-related violence and the global financial crisis, was the
second best performing market in the world after Russia in 2009.
The market gained 125% in 2009. The post-war optimism led to a
surge in investor interest.

The CSE suffered somewhat after insider trading charges were filed
in the U.S. against Raj Rajaratnam of Galleon fund, but quickly
recovered. The U.S. based Galleon fund was a major investor in the
CSE, and held shares in over 70 companies. Galleon has now exited
from most of the CSE companies. Investors have also been
discouraged by various Supreme Court decisions negatively impacting
businesses in 2008-2009. One ruling, citing bias by government
officials in favor of the eventual contract winner, reversed the
2002 privatization of a bunkering unit to a large conglomerate
listed in the stock exchange. A similar case reversed the sale of a
large government-owned insurance company to another listed
conglomerate. In yet another case, the Supreme Court temporarily
stopped payments due to local and foreign banks for oil hedging
contracts. Other issues include lack of liquidity and limited
market size.

Improvements are also needed in corporate governance,
accountability, and public disclosure. 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.

Acquisition of companies through mergers and acquisitions 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% 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.

BANKING SYSTEM

Sri Lanka has a fairly well diversified banking system. There are
23 commercial banks - eleven local and twelve foreign. In addition,
there are 14 local specialized banks. Citibank NA is the only U.S.
bank operating in Sri Lanka.

In late 2008, the Central Bank dissolved the board of directors of a
private local bank, Seylan Bank, and appointed the state-owned Bank
of Ceylon to carry on the business of the bank. This was done to
ensure stability in the overall financial sector following a
financial scandal at a non regulated large finance company connected
to the bank.

Since then, the Seylan Bank has been restructured with equity from
new shareholders. The bank has returned to normal business activity
with a board of directors appointed by the new shareholders.

The Central Bank also took control of several non-bank finance
companies connected to the failed finance company. These companies
are being restructured through mergers. The Central Bank also
launched a stimulus package for finance and leasing companies with
the aim of avoiding a crisis in them. However, weaknesses in
smaller finance and leasing companies exposed to real estate remains
a concern.

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 it approached insolvency. There was no
fallout for other banks from this incident. Two other small
troubled banks were restructured under Central Bank guidance.

The Central Bank is responsible for supervision of all banking
institutions. It has driven improvements in banking regulations,
provisioning, and public disclosure of banking sector performance.

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Since 2004, credit ratings have been mandatory for all banks
operating in Sri Lanka. In 2006, the Central Bank introduced higher
capital requirements for commercial banks to further stabilize the
banking system, promote consolidation, and facilitate entry of
larger banks. Notable progress in 2008 includes mandatory
provisioning on performing loans and acceptance of the Basel II
standardized approach framework. In addition, the Central Bank
issued corporate governance rules for banks. The new rules are
aimed at promoting the safety and soundness of the banking system.
In 2009, the Central Bank carried out capacity building programs on
Basel II. The Bank issued regulations for service providers of
payment cards regulations. The Central Bank will regulate all
payment card systems. The Central Bank has also developed a road
map for the full implementation of International Accounting
Standards on Financial Instruments for banks by January 1, 2011. In
addition, the Central Bank plans to introduce new Sri Lanka
accounting standards to the banking sector in 2011. Nevertheless,
the Central Bank still suffers from lack of autonomous authority,
especially with regard to the large state owned banks.

Sri Lanka has enacted laws to deal with money laundering and
terrorist financing. The Bank Supervision Department of the Central
Bank supervises and examines financial institutions for compliance
with anti-money laundering and terrorist financing regulations. A
Financial Intelligence Unit (FIU) was created in 2006, and operates
under the Central Bank. The Financial Intelligence Unit has issued
instructions to banks, finance and insurance companies, and the
securities industry regarding anti-money laundering and terrorist
financing regulations and, in 2008, extended it rules on "know your
customer" and "customer due diligence" to insurance companies and
the securities industry.

STATE-OWNED BANKS

Total assets of commercial banks stood at Rs 2,200 billion ($19
billion) as of December 31, 2008. The two state-owned commercial
banks, Bank of Ceylon and People's Bank, with assets of Rs 492
billion ($3.3 billion) and Rs 416 billion ($3.6 billion)
respectively, are still important players, accounting for about 40%
of all assets.

The two state banks are inefficient and have accumulated extensive
bad debt. However, as these banks are implicitly guaranteed by the
state, their problems have not harmed the credibility of the rest of
the banking system. Progress has been made in restructuring the two
banks -- their nonperforming loan ratios declined from 18% in 2003
to 5-7% in 2008, while provisioning and profitability have improved.
Nonetheless, both these banks have significant exposure to the
state and state-owned companies, which are treated as performing
loans.

PRIVATE COMMERCIAL BANKS AND FOREIGN BANKS

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. Foreign banks tend to make provisions in
line with international best practices, as most foreign bank
branches are subject to host country supervision in addition to that
of the Central Bank of Sri Lanka.

Non-performing loans to total loans ratio increased from 4.9% in
2007 to 6% in 2008. It is estimated to have increased sharply in
2009, with significant variations among individual banks. There are
concerns regarding credit exposure to housing and consumer sectors,
impact of high interest rates and the impact of prevailing economic
conditions on the banking system.

CAPITAL ADEQUACY

Sri Lanka adopted capital adequacy standards set by the Basel
Committee on banking regulations and supervisory practices in 1993.
The minimum capital adequacy ratio required by the Central Bank is
5% for core capital (Tier I) and 10% for risk weighted assets (Tier
I and Tier II). The Central Bank adopted Pillar 1 of Basel II
capital adequacy standard for all banks in 2008.

Risk-based capital adequacy in the banking sector was 13% in 2008.

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The Bank of Ceylon's capital adequacy ratio is well within Central
Bank requirements. Following a capital injection from the Ministry
of Finance, People's Bank reported core and total CAR ratios of
6.48% and 10.46%, under the Basel II framework in 2008.

COMPETITION FROM STATE-OWNED ENTERPRISES (SOE)

SOE's are active in transport (bus and railways, ports and airport
managements, air line operations), utilities such as electricity,
petroleum imports and retail, water supply, and telecommunications,
TV and Radio broadcasting, newspaper publishing, banking and
insurance.

Directors of SOE's are appointed by the cabinet or a line Ministry.
They report to line Ministries. The board seats are allocated to
both senior government officials and politically-affiliated
individuals. Senior management positions such as the post of CEO
are most often allocated to politically-affiliated individuals.

Sri Lanka does not currently have a sovereign wealth fund (SWF).

CORPORATE SOCIAL RESPONSIBILITY (CSR)

Leading companies in Sri Lanka are actively promoting CSR. Some SME
companies have also started to promote CSR. The Ceylon Chamber of
Commerce (CCC), the largest business chamber in Sri Lanka, has a CSR
section promoting CSR among its membership. CCC also has an annual
"Best Corporate Citizens" award to encourage CSR activities. In
addition, a professional accounting body has a program to promote
sustainability reporting. Internationally, some of Sri Lanka's
leading companies have joined the UN Global Compact initiative. In
fact, Sri Lanka won the Asia Award 2009 for the "best performing
global compact principles by a local network." The apparel
industry, Sri Lanka's largest export industry, has a specially
designated CSR program for the industry under the title "Garments
without Guilt" (www.garmentswithoutguilt.com). The ethical
sourcing and sustainable development practices under the program aim
to empower women and their communities through poverty alleviation
and opportunities for education and personal growth. In addition,
it also endeavors to promote sustainable eco-friendly manufacturing
practices in the apparel industry. Firms who pursue CSR are viewed
favorably by Sri Lanka's business sector resulting in positive media
attention.

POLITICAL VIOLENCE

The Sri Lankan government's military campaign against the Liberation
Tigers of Tamil Eelam (LTTE) ended in May 2009 with the defeat of
the LTTE. Prior to that, from January 2008 to June 2009 fighting
between the Sri Lankan military, paramilitary groups and the LTTE
increased. Bomb attacks in densely populated areas killed dozens of
civilians, including in some areas frequented by foreign tourists.
LTTE conducted several air attacks in Colombo during this period.
There were a series of other incidents throughout the country
targeting armed forces personnel, politicians and civilians in
2007-2009.

In 1997, the United States designated the LTTE as a Foreign
Terrorist Organization (FTO). In 2007, the United States froze the
assets of, and blocked transactions with, the Tamils Rehabilitation
Organization (TRO), a U.S.-registered non-profit group, on the
grounds that it provided support for the LTTE.

During the two and half decades of war, foreign tourists and foreign
business representatives were not LTTE targets, but they were
injured in attacks on other targets. In 2001, the LTTE attacked
Colombo's international airport and destroyed commercial and
military aircraft. Sri Lankan Airlines lost several commercial
aircraft in the attack. Prior to 2001 the LTTE attacked several
foreign-flagged commercial ships in the waters off the north and
east of the country. The LTTE also bombed Colombo's financial and
business districts, causing numerous casualties and extensive damage
to property.

Currently, Sri Lanka is included in the Lloyds Joint War Risk
Committee's war, strikes, terrorism and related perils areas list.
Insurers have the option of imposing war risk premiums on ships

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using Sri Lankan ports. Lines which call on Sri Lanka regularly are
not charged the war risk charge now, but could affect new
businesses.

CORRUPTION

Corruption, including bribery, raises the costs and risks of doing
business. Corruption has a corrosive impact on both market
opportunities overseas for U.S. companies and the broader business
climate. It also deters international investment, stifles economic
growth and development, distorts prices, and undermines the rule of
law.

It is important for U.S. companies, irrespective of their size, to
assess the business climate in the relevant market in which they
will be operating or investing, and to have an effective compliance
program or measures to prevent and detect corruption, including
foreign bribery. U.S. individuals and firms operating or investing
in foreign markets should take the time to become familiar with the
relevant anticorruption laws of both the foreign country and the
United States in order to properly comply with them, and where
appropriate, they should seek the advice of legal counsel.

The U.S. Government seeks to level the global playing field for U.S.
businesses by encouraging other countries to take steps to
criminalize their own companies' acts of corruption, including
bribery of foreign public officials, by requiring them to uphold
their obligations under relevant international conventions. A U. S.
firm that believes a competitor is seeking to use bribery of a
foreign public official to secure a contract should bring this to
the attention of appropriate U.S. agencies, as noted below.

U.S. FOREIGN CORRUPT PRACTICES ACT

In 1977, the United States enacted the Foreign Corrupt Practices Act
(FCPA), which makes it unlawful for a U.S. person, and certain
foreign issuers of securities, to make a corrupt payment to foreign
public officials for the purpose of obtaining or retaining business
for or with, or directing business to, any person. The FCPA also
applies to foreign firms and persons who take any act in furtherance
of such a corrupt payment while in the United States. For more
detailed information on the FCPA, see the FCPA Lay-Person's Guide
at: http://www.justice.gov/
criminal/fraud/docs/dojdocb.html.

OTHER INSTRUMENTS

It is U.S. Government policy to promote good governance, including
host country implementation and enforcement of anti-corruption laws
and policies pursuant to their obligations under international
agreements. Since enactment of the FCPA, the United States has been
instrumental in the expansion of the international framework to
fight corruption. Several significant components of this framework
are the OECD Convention on Combating Bribery of Foreign Public
Officials in International Business Transactions (OECD Antibribery
Convention), the United Nations Convention against Corruption (UN
Convention), the Inter-American Convention against Corruption (OAS
Convention), the Council of Europe Criminal and Civil Law
Conventions, and a growing list of U.S. free trade agreements. Sri
Lanka ratified the UN Anti-Corruption Convention in 2004. Sri Lanka
has signed but not ratified the UN Convention against Transnational
Organized Crime. Sri Lanka became a signatory to the OECD-ADB
Anti-Corruption Regional Plan in May 2006.

OECD ANTIBRIBERY CONVENTION

The OECD Antibribery Convention entered into force in February 1999.
As of December 2009, there are 38 parties to the Convention
including the United States (see http://www.oecd.org/
dataoecd/59/13/40272933.pdf). Major exporters China, India, and
Russia are not parties, although the U.S. Government strongly
endorses their eventual accession to the Convention. The Convention
obligates the Parties to criminalize bribery of foreign public
officials in the conduct of international business. The United
States meets its international obligations under the OECD
Antibribery Convention through the U.S. FCPA. Sri Lanka is not a
party to the OECD Convention.

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UN CONVENTION

The UN Anti-Corruption Convention entered into force on December 14,
2005, and there are 143 parties to it as of December 2009 (see
http://www.unodc.org/unodc/en/ treaties/CAC/signatories.html). The
UN Convention is the first global comprehensive international
anti-corruption agreement. The UN Convention requires countries to
establish criminal and other offences to cover a wide range of acts
of corruption. The UN Convention goes beyond previous
anti-corruption instruments, covering a broad range of issues
ranging from basic forms of corruption such as bribery and
solicitation, embezzlement, trading in influence to the concealment
and laundering of the proceeds of corruption. The Convention
contains transnational business bribery provisions that are
functionally similar to those in the OECD Antibribery Convention and
contains provisions on private sector auditing and books and records
requirements. Other provisions address matters such as prevention,
international cooperation, and asset recovery. Sri Lanka is a party
to the UN Convention.

OAS CONVENTION

In 1996, the Member States of the Organization of American States
(OAS) adopted the first international anti-corruption legal
instrument, the Inter-American Convention against Corruption (OAS
Convention), which entered into force in March 1997. The OAS
Convention, among other things, establishes a set of preventive
measures against corruption, provides for the criminalization of
certain acts of corruption, including transnational bribery and
illicit enrichment, and contains a series of provisions to
strengthen the cooperation between its States Parties in areas such
as mutual legal assistance and technical cooperation. As of
December 2009, the OAS Convention has 33 parties (see
www.oas.org/juridico/english/Sigs/b-58.html). Sri Lanka is not a
party to the OAS Convention.

COUNCIL OF EUROPE CRIMINAL LAW AND CIVIL LAW CONVENTIONS

Many European countries are parties to either the Council of Europe
(CoE) Criminal Law Convention on Corruption, the Civil Law
Convention, or both. The Criminal Law Convention requires
criminalization of a wide range of national and transnational
conduct, including bribery, money-laundering, and account offenses.
It also incorporates provisions on liability of legal persons and
witness protection. The Civil Law Convention includes provisions on
compensation for damage relating to corrupt acts, whistleblower
protection, and validity of contracts, inter alia. The Group of
States against Corruption (GRECO) was established in 1999 by the CoE
to monitor compliance with these and related anti-corruption
standards. Currently, GRECO comprises 46 member States (45 European
countries and the United States). As of December 2009, the Criminal
Law Convention has 42 parties and the Civil Law Convention has 34
(see www.coe.int/greco). Sri Lanka is not a party to the Council of
Europe Conventions.

LOCAL LAWS

U.S. firms should familiarize themselves with local anticorruption
laws, and, where appropriate, seek legal counsel. While the U.S.
Department of Commerce cannot provide legal advice on local laws,
the Department's U.S. and Foreign Commercial Service can provide
assistance with navigating the host country's legal system and
obtaining a list of local legal counsel.

ASSISTANCE FOR U.S. BUSINESSES:

The U.S. Department of Commerce offers several services to aid U.S.
businesses seeking to address business-related corruption issues.
For example, the U.S. and Foreign Commercial Service can provide
services that may assist U.S. companies in conducting their due
diligence as part of the company's overarching compliance program
when choosing business partners or agents overseas. The U.S.
Foreign and Commercial Service can be reached directly through its
offices in every major U.S. and foreign city, or through its Website
at www.trade.gov/cs. In Sri Lanka, this service is provided by the
Economic and Commercial Section at the U.S. Embassy

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(commercialcolombo
@state.gov).

The Departments of Commerce and State provide worldwide support for
qualified U.S. companies bidding on foreign government contracts
through the Commerce Department's Advocacy Center and State's Office
of Commercial and Business Affairs. Problems, including alleged
corruption by foreign governments or competitors, encountered by
U.S. companies in seeking such foreign business opportunities can be
brought to the attention of appropriate U.S. government officials,
including local embassy personnel and through the Department of
Commerce Trade Compliance Center "Report A Trade Barrier" Website at
tcc.export.
gov/Report_a_Barrier/index.asp.

GUIDANCE ON THE U.S. FCPA

The Department of Justice's (DOJ) FCPA Opinion Procedure enables
U.S. firms and individuals to request a statement of the Justice
Department's present enforcement intentions under the antibribery
provisions of the FCPA regarding any proposed business conduct. The
details of the opinion procedure are available on DOJ's Fraud
Section Website at www.justice.gov/
criminal/fraud/fcpa. Although the Department of Commerce has no
enforcement role with respect to the FCPA, it supplies general
guidance to U.S. exporters who have questions about the FCPA and
about international developments concerning the FCPA. For further
information, see the Office of the Chief Counsel for International
Counsel, U.S. Department of Commerce, Website, at
www.ogc.doc.gov/trans_anti_bribery.html. More general information
on the FCPA is available at the Websites listed below.

Exporters and investors should be aware that generally all countries
prohibit the bribery of their public officials, and prohibit their
officials from soliciting bribes under domestic laws. Most
countries are required to criminalize such bribery and other acts of
corruption by virtue of being parties to various international
conventions discussed above.

CORRUPTION IN SRI LANKA

Public sector corruption, including bribery of public officials,
remains a significant challenge for U.S. firms operating in Sri
Lanka. While the country has generally adequate laws and
regulations to combat corruption, enforcement is weak and
inconsistent. U.S. firms identify corruption as a constraint on
foreign investment, but, by and large, it is not a major threat to
operating in Sri Lanka - at least once a contract has been won.
Corruption appears to have the greatest effect on investors in large
projects and on those pursuing government procurement contracts.

There is a consensus that corruption is rampant in Sri Lanka. In
Transparency International's Corruption Perception Index for 2009
Sri Lanka ranks 97th with a score of 3.1 out of a possible 10
points. The World Bank Control of Corruption Index which ranges
from -2.5 to +2.5 has shown an improvement to -0.13 in 2006 and 2007
from -0.26 in 2005. In a 2006 USAID Democracy and Governance
assessment, anecdotal evidence from the private sector indicated
that the percentage of a public sector contract paid in bribes
nearly tripled. According to Transparency International, corruption
is perceived as most pervasive in political appointments to
government institutions and in government procurement awards, as
well as in high frequency/low value transactions. The police force
and the judiciary are perceived to be the most corrupt public
institutions. Corruption is also a persistent problem in customs
clearance and enables wide smuggling of certain consumer items, to
the detriment of legitimate manufacturers and importers.

In 2008-2009, the Supreme Court, examining public interest
litigations against the sale of three government properties, faulted
a former President and the Secretary to the Treasury for wrongdoing.
Both were fined. The Supreme Court also reversed the sales. Also
in 2008, the Supreme Court also removed the Secretary to the
Treasury from his position and ruled that he cannot hold any public
office in the future. However, in 2009 the Supreme Court chaired by
a new Chief Justice allowed the former the Treasury Secretary to
resume his duties, thereby reversing the 2008 decision.

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In January 2007, a parliamentary Commission found evidence of
serious and widespread waste, fraud, and abuse in the management of
Sri Lanka's numerous government enterprises. Privatization of a
handful of government enterprises between 2001 and 2004 also appears
to have been done in a corrupt manner. The mismanagement and
corruption reviewed by the Commission have cost Sri Lanka an
estimated USD 1.3 billion. However, the government has taken little
concrete action to date to address the Commission's findings, and it
later replaced the Commission's chairman and some of its members;
one new appointee is the President's brother. Following the
Commission's report, several other large scale corruption incidents
and frauds materialized, including at the government's tax office.

Sri Lanka ratified the UN Anti-Corruption Convention in 2004. Sri
Lanka has signed but not ratified the UN Convention against
Transnational Organized Crime. Sri Lanka became a signatory to the
OECD-ADB Anti-Corruption Regional Plan in May 2006.

BRIBERY COMMISSION NOT EFFECTIVE

The Bribery Commission is the main body responsible for
investigating allegations of bribery and corruption. The function
of the Commission, under Act No 19 of 1994, is to investigate
allegations brought to its attention and to institute proceedings
against responsible individuals in the appropriate court. The law
states that a public official's offer or acceptance of a bribe
constitutes 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.

Although highly publicized, efforts to investigate bribery and
corruption by the Bribery Commission and Presidential Commissions
have failed, damaging public confidence in such processes. In
February 2008, the President removed the Bribery Commission's
Director General, the sole individual able to serve indictments and
appointed a new Director General.

Several other government entities try to address corruption, the
most important being the Auditor General's Department. However,
there is a confusion of mandates and these institutions frequently
interpret their mandates narrowly, inhibiting their effectiveness.

ANTI-CORRUPTION RESOURCES

Some useful resources for individuals and companies regarding
combating corruption in global markets include the following:

Information about the U.S. Foreign Corrupt Practices Act (FCPA),
including a "Lay-Person's Guide to the FCPA" is available at the
U.S. Department of Justice's Website at: http://www.justice.gov/
criminal/fraud/fcpa.

Information about the OECD Antibribery Convention including links to
national implementing legislation and country monitoring reports is
available at: http://www.oecd.org/
department/0,3355,en_2649_34859_1_1_1_1_1,00. html. See also new
Antibribery Recommendation and Good Practice Guidance Annex for
companies: www.oecd.org/dataoecd/11/40/44176910.pdf

General information about anticorruption initiatives, such as the
OECD Convention and the FCPA, including translations of the statute
into several languages, is available at the Department of Commerce
Office of the Chief Counsel for International Commerce Website:
http://www.ogc.doc.gov/
trans_anti_bribery.html.

Transparency International (TI) publishes an annual Corruption
Perceptions Index (CPI). The CPI measures the perceived level of
public-sector corruption in 180 countries and territories around the
world. The CPI is available at: www.transparency.
org/policy_research/surveys_indices/cpi/2009. TI also publishes an
annual Global Corruption Report which provides a systematic
evaluation of the state of corruption around the world. It includes
an in-depth analysis of a focal theme, a series of country reports
that document major corruption related events and developments from

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all continents and an overview of the latest research findings on
anti-corruption diagnostics and tools. See
www.transparency.org/publications/gcr.

The World Bank Institute publishes Worldwide Governance Indicators
(WGI). These indicators assess six dimensions of governance in 212
countries, including Voice and Accountability, Political Stability
and Absence of Violence, Government Effectiveness, Regulatory
Quality, Rule of Law and Control of Corruption. See
http://info.worldbank.org/
governance/wgi/sc_country.asp. The World Bank Business Environment
and Enterprise Performance Surveys may also be of interest and are
available at: http://go.worldbank.org/
RQQXYJ6210.

The World Economic Forum publishes the Global Enabling Trade Report,
which presents the rankings of the Enabling Trade Index, and
includes an assessment of the transparency of border administration
(focused on bribe payments and corruption) and a separate segment on
corruption and the regulatory environment. See
http://www.weforum.org/en/initiatives/
gcp/GlobalEnablingTradeReport/index.htm.

Additional country information related to corruption can be found in
the U.S. State Department's annual Human Rights Report available at
www.state.gov/g/drl/rls/hrrpt/.

Global Integrity, a nonprofit organization, publishes its annual
Global Integrity Report, which provides indicators for 92 countries
with respect to governance and anti-corruption. The report
highlights the strengths and weaknesses of national level
anti-corruption systems. The report is available at:
http://report.globalintegrity.org/.

BILATERAL INVESTMENT AGREEMENTS

The Government of Sri Lanka has signed investment protection
agreements with the United States (which came into force in May
1993) and with the following other countries:

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

TAXATION

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

Foreign investors not qualifying for Board of Investment incentives
such as tax and exchange control exemptions or concessions are
liable to pay taxes on corporate profits, dividends, and remittances
of profits. They are also liable to pay a Value Added Tax on goods
and services. The government has also imposed a tax of 0.1% on
debits to any current or savings account maintained at any bank in
Sri Lanka. Debits made to accounts of government and international

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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.

An Economic Service Charge (ESC) at 0.25% of income applies to
BOI-approved companies enjoying tax holidays. The Embassy
encourages prospective U.S. investors to contact an international
auditing firm operating in Sri Lanka to assess their tax liability.

OPIC AND OTHER INVESTMENT INSURANCE PROGRAMS

The United States 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
U.S. 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.

The U.S. Embassy and other U.S. Government institutions spend over
$13 million annually 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.

LABOR FORCE

Sri Lanka's labor force is literate (particularly in local
languages) and trainable, although weak in certain technical skills
and the English language. The average worker has eight years of
schooling. Two-thirds of the labor force is male.

In 2009, 7.6 million Sri Lankans were employed, with 43% in
services, 25% in industry and 32% in agriculture jobs. Overall, 41%
of the workforce is in the private sector and 16% in the government.
Self employed workers constitute 30% of all employed while another
11% were unpaid family workers. About 61% of the employed are in
the informal sector.

The unemployment rate has declined in recent years to around 5%.
The rate of unemployment among women and high school and college
graduates, however, has been proportionally higher than the rate for
less-educated workers. Youth and entry-level unemployment and
underemployment remain a problem. A significant proportion of
unemployed people seek "white collar" jobs. However, most sectors
seeking employees offer manual or semi-skilled jobs or require
technical or professional skills such as management, marketing,
information technology, accountancy and finance, and English
language proficiency. The construction, plantation and apparel
industries report a shortage of workers. Some investors have faced
problems in finding sufficient employees with the requisite skills.


The government has initiated educational reforms it hopes will lead
to better preparation of students and better matches between
graduates and jobs. The government declared 2009 to be the year of
English and Information Technology. More computer, accounting and
business skills training programs and English language programs are
becoming available. But the demand for these skills still outpaces
supply.

MIGRANT WORKERS ABROAD

There are an estimated 1.5 million Sri Lankan workers abroad.
Remittances from migrant workers, at around $3 billion, are one of
Sri Lanka's largest sources of foreign exchange. The majority of
this labor force is unskilled (housemaids and factory laborers) and
located primarily in the Middle East, but Sri Lanka is also losing
many of its technically and professionally qualified workers to more
lucrative jobs abroad. Despite the global slowdown, remittances
from migrant workers abroad actually increased in 2009. At least
one labor importing country, South Korea, temporarily stopped
importing labor from Sri Lanka in 2009.

WAGES AND HOLIDAYS


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Labor is available at relatively low cost, though it is priced
higher than in some other South Asian countries. Productivity lags
behind other countries in Asia. Child labor is prohibited and is
virtually nonexistent in the organized sector, although 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.

Many believe that Sri Lanka's labor laws and its numerous official
holidays dampen productivity. The full moon day of each month
(sacred in the Buddhist faith), if it falls on a weekday, is a paid
holiday. There are eight other public holidays. The public sector
and banks enjoy additional holidays. These statutory holidays are
in addition to 21 days of annual/casual leave and approximately 21
days of sick leave (the number of days for sick leave is at the
discretion of the management). Further, female employees are
entitled to 84 days fully paid maternity leave for the first two
pregnancies. Female workers are permitted 60 hours of overtime
work per month.

The Government continues to interfere with private sector wage
setting. In October 2005 the Government, through an act of
Parliament, took steps to mandate a wage increase (of approximately
Rs 1,000 ($8.85) per month) to private sector workers. The private
sector is concerned about such interference in wage setting, which
could damage competitiveness in certain sectors.

TERMINATION LAWS

The Termination of Employment of Workmen 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. Recent amendments to the
Industrial Disputes Act (IDA) include labor dispute resolution rules
to expedite the dispute process.

The government has introduced a standard compensation formula under
the TEA to facilitate termination. The compensation formula takes
into account the number of years of service and offers 2.5 months'
salary as compensation for 1 year of service, 12.5 months' salary
for 5 years of service; 38 months for 20 years and up to a maximum
of 48 months' salary for 34 years service. According to the World
Bank's Doing Business 2009 report, Sri Lanka's firing cost is among
the highest in the world. For example, Sri Lanka's firing cost for
20 years of service, at 38 months, compares with Pakistan and
Nepal's 22.5 months, India's 19.6 months, Malaysia's 18.5 months,
China's 13.2 months and Bangladesh's 11.7 months. The Labor
Commissioner's approval or the affected employee's consent is
required to fire workers. The Labor Commissioner's approval is
often subject to delays of around 6-7 months. Employers 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.

TRADE UNIONS

About 20% of the 7 million-strong work force is unionized, but union
membership is declining. There are more than 1,900 registered trade
unions (many of which have 50 or fewer members), and 19 federations.
About 15% of labor in the industry and service sector is unionized.
Most of the major trade unions are affiliated with political
parties, creating a highly politicized labor environment. In many
cases several unions, affiliated with different political parties,
work together at state-owned enterprises. This is not the case for
private companies, which only have one union or perhaps a workers'
council to represent the employees. Several trade unions with
affiliations to major political parties have formed themselves into
an organized group, the National Association for Trade Union
Research and Education (NATURE), to promote education and training
among trade unionists.

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All workers, other than police, armed forces, prison service, and
those in essential services, have the right to strike. By law,
workers may lodge complaints to protect their rights with the
commissioner of labor, a labor tribunal, or the Supreme Court. The
president retains the power to designate any industry as an
essential service.

Unions represented workers in many large private firms, but workers
in small-scale agriculture and small businesses usually did not
belong to unions. Public sector employees were unionized at very
high rates. Labor in export processing zone enterprises tends to be
represented by non-union worker councils.

Unions have complained that the Board of Investment and some
employers, especially in the BOI-run export processing zones,
prohibit union access and do not register unions on a timely basis.
Employers allege that the JVP, a Marxist political party opposed to
private enterprise, could provoke labor to strike under the pretense
of trade union activity. Due to the JVP's violent past, employers
are generally not in favor of it or its trade union arm, the
Inter-Company Trade Union.

In BOI enterprises, including those in the export processing zones,
worker councils composed of employees generally engage in labor and
management negotiations. These worker councils have functioned well
in some companies in providing for worker welfare. The BOI has
requested that companies recognize trade unions and accept 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.

The International Labor Organization's (ILO) Freedom of Association
Committee has observed that Sri Lankan trade unions and employee
councils can co-exist, but advises that 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 that
the Government address these issues.

In response to these observations, the BOI revised its labor manual
in March 2004, requesting that companies located in export
processing zones 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 agreements.

In 2008, the American Federation of Labor and Congress of Industrial
Organizations (AFL-CIO) submitted a petition to the United States
Trade Representative seeking suspension of Generalized System of
Preferences (GSP) benefits for Sri Lanka due to alleged labor rights
violations in some factories in the export processing zones.
AFL-CIO submitted a similar petition in 2002, which was rejected.
USTR did not act on the 2008 petition and the AFL-CIO submitted a
revised petition in July 2009. The United States Government has not
yet made a decision whether to accept the GSP petition for review.
If accepted, the governments of the United States and Sri Lanka
would enter into consultations. A Sri Lanka trade union made a
similar case with the European Union (EU) 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 the country's efforts to
implement core labor standards. The EU, however, urged improvements
in freedom of association. The current review of GSP+ benefits
centers on alleged violations of human rights relating to the end of
the war and treatment of internally displaced persons, not labor
rights.

Key public sector entities such as the Ceylon Electricity Board,
Ceylon Petroleum Corporation and the Sri Lanka Ports Authority also
have large unions which have protested anticipated moves towards
privatization or restructuring. They staged a "work to rule"
campaign in 2009 demanding higher wages. They returned to work as

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the industries were made essential services by the President. The
government granted the striking workers salary increases, although
not as much as demanded. Trade unions in the plantations also
staged a "go-slow" campaign demanding higher wages, when a
plantation sector collective bargaining agreement came up for
renewal. They were granted a 40% increase.

In July 2006, the Supreme Court broke a port slowdown which had
disrupted shipping through the Colombo Port for over a week.
However, in response to a challenge lodged by several unions, the
ILO Freedom of Association Committee noted that the port "go-slow"
action did not disrupt an essential service, i.e. one whose
disruption would endanger life, personal safety or health of the
whole or part of the population.

COLLECTIVE BARGAINING

Collective bargaining is not yet popular. Employers' Federation of
Ceylon, the apex employers association in Sri Lanka, assists its
member companies to negotiate with unions and sign collective
bargaining agreements. While about half of the 520 members of the
Employers' Federation of Ceylon is unionized, currently 135 of these
companies (including a number of foreign-owned firms) are bound by
collective agreements. As of January 2010, there were only four
collective bargaining agreements signed in companies located in
export processing zones.

LABOR-MANAGEMENT RELATIONS

Formerly confrontational labor-management relations have improved in
the last few years as employers have worked harder to motivate and
care for workers. Work stoppages and strikes in the private sector
are on the decline, and there were few strikes in 2009. While
labor-management relations vary from organization to organization,
managers who emphasize communication with workers and offer training
opportunities generally experience fewer difficulties. U.S.
investors in Sri Lanka (including U.S. garment buyers) generally
promote good labor management relations and labor conditions that
exceed local standards.

ILO CONVENTIONS

Sri Lanka is a member of the International Labor Organization (ILO)
and has ratified 31 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 of
the core labor conventions included in the 1998 ILO Declaration on
Fundamental Principles 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 and
the Employers' Federation of Ceylon are working to improve awareness
of core labor standards. The ILO also promotes its Decent Work
Agenda program in Sri Lanka.

FREE TRADE ZONES

Sri Lanka has 12 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 mini
export-processing zones are located in provinces. 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. In addition, a large private
apparel company opened Sri Lanka's first privately run fabric park
in 2007. The company invites local and foreign companies to set up
fabric and apparel factories in this eco-friendly park.

In the past, firms preferred to locate their factories near Colombo
harbor or airport to reduce transport time and cost. However,
excessive concentration of industries around Colombo has caused
heavy traffic, higher real estate prices, environmental pollution,

COLOMBO 00000072 027 OF 027


and scarcity of labor. The BOI and the government now encourage
export-oriented factories to set up in industrial zones farther from
Colombo. However, Sri Lanka's poor roads make these outlying zones
less appealing. There have been two garment factories established
in Eastern Sri Lanka, for example. The Government has embarked on a
substantial plan to improve road infrastructure island-wide.

FOREIGN DIRECT INVESTMENT TRENDS

From 1998-2001, foreign direct investment (FDI) flows to Sri Lanka
averaged only about $150 million per year (excluding privatization
receipts). In 2007, FDI increased to about $600 million and in 2008
to about $750 million. There was $350 million as of September 2009.


U.S. INVESTMENTS

Total cumulative U.S. investment in Sri Lanka is estimated to be in
the range of $200 million. Major U.S. investors include: Energizer
Battery, Mast Industries, Smart Shirts (a subsidiary of Kellwood
Industries), Chevron, Citibank, Caterpillar, 3M, Coca-Cola, Tandon
Corporation, Pepsi Co, Sportif, Worldquest, Fitch IBCR, AES
Corporation, American International Group (AIG), American Premium
Water, Virtusa, Avery Denison, North Sails, Amsafe Bridport, RR
Donnelly (through Office Tiger and Revlon (through its Indian
subsidiary). Several Sri Lankan-Americans have started IT and BPO
companies in Sri Lanka serving the US market. In addition, IBM,
Lanier, NCR, GTE, Motorola, Procter & Gamble, Liz Claiborne, Tommy
Hilfiger, J.C. Penney, 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.

NON-U.S. INVESTMENTS

Leading sources of foreign direct investment in Sri Lanka are
Malaysia, the United Kingdom, the United States, Singapore, India,
China, the UAE, and Korea. Major non-U.S. investors include:
Unilever, Nestle, British American Tobacco Company, Mitsui, Pacific
Dunlop/Ansell, Prima, FDK, Telekom Malaysia Bhd, S.P. Tao, HSBC and
the Indian Oil Corporation. In 2008/9, India's Bharathi Airtel
invested in mobile cellular services. Leading U.S. and foreign
investors that have acquired significant stakes in privatized
companies include Chevron, Hanjung Steel of Korea, Mitsubishi
Corporation and C. Itoh (A.K.A. Itochu) of Japan, Emirates Airlines
of United Arab Emirates, Shell Oil of the UK, and the Indian Oil
Corporation.
Web Resources Return to top
Board of Investment of Sri Lanka: www.boi.lk or
www.investsrilanka.com

International Monetary Fund (IMF) Sri Lanka country information:
www.imf.org/external/country/LKA/index.htm

Article VIII obligations of the International Monetary Fund:
www.imf.org/external/pubs/ft/aa/aa08.htm

U.S.-Sri Lanka Bilateral Investment Treaty:
www.state.gov/documents/organization/43588.pd f

Institute for the Development of Commercial Law and Practice:
www.iclparbitrationcentre.com

Indo-Lanka Free Trade Agreement: www.doc.gov.lk

South Asian Free Trade Area: www.saarc-sec.org/main.php

Fitch Ratings Lanka: www.fitchratings.lk

Garments without Guilt program of the apparel industry:
www.garmentswithoutguilt.com

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