Sri Lanka WT/TPR/S/128 
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I. ECONOMIC ENVIRONMENT 
(1) INTRODUCTION  
1. Sri Lanka's real annual growth in GDP averaged 4% during the period under review 
(1996-03), despite domestic setbacks, includi ng civil hostilities and political uncertainty, and 
substantial economic difficulties.  Per capita GDP  rose to US$872 in 2002, 9% higher than in 1996 
(Table I.1).  Nonetheless, poverty remains widespre ad, especially in rural areas, and Sri Lanka’s UN 
development ranking has  declined.  The large public sector still has a dominant role in the economy  
and state-owned enterprises exist in many sectors.  Sustained high growth will require major macroeconomic and structural reforms to control inflation, reduce high fiscal deficits and mounting 
public debt, improve economic efficiency, and encourage private-sector-led growth.  A more 
diversified economy would help strengthen the economy’s resilience and performance. 
Table I.1 
Social indicators, 1996-02  
 1996 1997 1998 1999 2000 2001 2002a 
GDP per capita (US$) 799.7 853.2 879.0 863.0 899.0 845.0 872.0 
GDP US$ million        
Nominal (current prices) 13,949.7 15,104.2 15,761.0 15,755.1 16,548.0 15,622.2 16,412.3 
Real (1998 prices) .. .. 15,761.0 15,093.9 14,853.7 12,412.5 12,057.4 
Population (million) 17.5 17. 7 17.9 18.2 18. 5 18.7 19.0 
Growth of population (percentage change) 1.1 1.1 1.3 1.5 1.4 14 1.5 
Urban share  .. .. .. 23.3 22.8 23.1 .. 
Life expectancy at birth (years) .. .. .. 71.9 72.1 72.3 .. 
Infant mortality rate per ‘ 000 (2001)  .. .. .. 17.0 17.0 12.2 .. 
Adult literacy (per cent aged 15 and above) .. .. .. 91.4 91.6 91.9 .. 
Education enrolment ratio (per cent)b .. .. .. 70.0 63.0 63.0 .. 
Share in real GDP at factor cost (per cent)        
Agriculture, livestock and fishing 22.4 21.9 21.1 20.7 19.9 20.1 20.1 
Mining and quarrying 2.0 2.1 1.9 1.8 1.9 1.9 1.8 
Manufacturing 16.2 16.4 16.5 16.4 16.8 16.0 15.9 
Services 59.4 59.6 60.4 61.1 61.4 62.1 62.2 
Electricity, gas and water 1.3 1.4 1.5 1.5 1.2 1.3 1.4 
Construction 6.9 7.0 7.6 7.6 7.3 7.6 7.2 
Wholesale, retail trade, restaurants and 
hotels 22.3 22.0 21.5 21.2 22.6 21.1 20.5 
Transport and communication 10.6 10.7 11.1 11.4 11.7 12.1 12.4 
Banking, insurance and real estate, etc 7.1 7.4 7.6 8.1 7.6 8.5 9.2 
Ownership of premises 2.0 2.0 1.9 1.8 1.8 1.8 1.7 
Government services 5.1 5.1 5.3 5.3 5.2 5.6 5.8 
Services n.e.s. 4.0 4.0 4.0 4.1 4.0 4.1 4.0 
Share of employment (per cent of labour 
force)        
Agriculture, livestock and fishing .. .. .. 36.2 36.0 32.4 33.1 
Mining and quarrying .. .. .. 1.2 1.1 1.9 .. 
Manufacturing .. .. .. 14.8 16.6 17.5 17.0 
Services .. .. .. 47.8 46.3 48.2 .. 
Electricity, gas and water .. .. .. 0.5 0.5 .. .. 
Table I.1 (cont'd)WT/TPR/S/128 Trade Policy Review 
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 1996 1997 1998 1999 2000 2001 2002a 
Construction .. .. .. 5.3 5.5 5.6 4.1 
Trade and hotels .. .. .. 12.1 12.7 11.9 15.8 
Transport, storage and communication .. .. .. 5.1 4.9 6.5 4.6 
Finance, insurance and real estate .. .. .. 1.6 2.1 1.9 2.9 
Personal services .. .. .. 23.0 20.7 22.2 22.4 
Other .. .. .. 0.2 0.2 .. .. 
UN Development index .. .. .. 0.735 0.741 0.730 .. 
Ranking .. .. .. 81st 89th 99th .. 
Category  Mhdc Mhdc Mhdc Mhdc Mhdc Mhdc .. 
Ranking within category .. .. .. 33rd 36th 49th .. 
.. Not available. 
a Provisional. 
b Combined tertiary, secondary and primary enrolment, gross.  c Mhd is medium human development category. 
Note: Figures may not add due to rounding. 
Source:  Central Bank of Sri Lanka, Annual Report 2002 and 2000 ;  Department of Census and Statistics [Online].  
Available at:  http://www.statistics. gov.lk;  and United Nations Human De velopment Report, various issues.  
2. The civil war heavily burdened  the economy and impeded growth for almost two decades.  
Along with political uncertainty, it seriously curta iled production and investment, including in public 
infrastructure.1  However, economic mismanagement, refl ected in rising macroeconomic imbalances, 
especially fiscal deficits (accentuated by incr eased defence and security spending), and repeated 
delays in making other economic and structural refo rms needed to raise productivity, often for short-
term political reasons, also hampered growth.2 
3. The economy contracted in 2001 and remains fra il, despite renewed growth in 2002 following 
peace.  Public debt exceeds GDP (105.3% of GDP in  2002), the legacy of past expansionary fiscal 
policies;  the unsustainable fiscal situation is  compounded by escalating interest payments (7% of 
GDP in 2002).  The economy's robust turnaround hinges heavily on:  continued peace and avoidance 
of civil disturbances;  improved macroeconomic environment;  and accelerated progress in economic liberalization and other structural reforms.
3  Since the last Review of Sri Lanka, trade policy has 
focussed on the negotiation of preferential trade agreements to increase market access for Sri Lankan 
products (e.g. the Indo-Sri Lankan Free Trade Agreemen t).  However, the adoption of more coherent 
and transparent non-preferential trade reforms is likely to improve efficiency and provide other 
economic benefits to Sri Lanka, including improve d export competitiveness.  The new Government 
embarked on an economic reform programme in 2002 to address macroeconomic, especially fiscal, 
imbalances and structural weaknesses, assist ed by the IMF and World Bank.  Recent fiscal 
consolidation, based on increased tax revenues and privatization receipts, curtailed expenditure and 
improved budget and public debt management, has been combined with cautious monetary policy. 
4. In 2002, the economy's vulnerability was incr eased by its heavy reliance on consumer 
spending to generate growth.4  Investment demand, including foreign inflows, remained subdued 
                                                      
1 Parliament was dismissed in August 2001 until the general election in December 2001.  
2 Central Bank of Sri Lanka (2002a), p. 3. 
3 Central Bank of Sri Lanka (2002a), p. 3. 
4 Consumer demand accounted for over  two thirds of overall demand growth in 2002 (Central Bank of 
Sri Lanka, 2002a, p.14).  According to authorities this reliance on consumption was unusual and reflected the 
cease-fire and the consequent filling of pent-up consumer demand.   Sri Lanka WT/TPR/S/128 
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despite the relaxation of investment restrictions  in key services (e.g. insurance and banking) and 
investment incentives.  Poor export performance reflected mainly domestic supply and security 
problems as well as adverse developments affecti ng Sri Lanka's main exports.  Prices for tea and 
garments, its main exports, have declined, for ex ample, and garments increasingly face competition 
abroad from low-cost suppliers, as well as from su b-Saharan and Caribbean exporters, who receive 
special trade preferences from key markets.5  Sluggish growth in major markets, such as the United 
States and European Union, has also depressed expor ts.  With manufacturing and agriculture relying 
heavily on exports, recent economic growth has been largely attributed to services (80%), whose growth is driven mainly by domestic demand;  the services sector recovered strongly in 2002 to grow 
at 6%.  Further structural reforms to improve e fficiency offer the best prospects for boosting and 
diversifying exports.    
(2) R
ECENT ECONOMIC DEVELOPMENTS  
5. During the period under review, Sri Lanka's annua l real growth rate was generally between 
3.8% and 6.3% (Table I.2).  Although the economy c ontracted by 1.5% in 2001, growth rebounded to 
4% in 2002 following peace.  Unemployment fell from 11.3% in 1996 to 7.6% in 2000, but rose in 
2001 and 2002 to 7.9% and 9.1%, respectively.  Inflation jumped in 2001 from 1.5% to 12.1% (based 
on the new national index)6, but declined to 10.2% in 2002 (despite increased utility and other 
administered prices, especially for petroleum products and bus fares).  Eased inflationary pressures and greater fiscal discipline in 2002 to reduce the budget deficit to under 10% of GDP, assisted 
monetary policy;  monetary targets were met an d official central bank interest rates reduced 
cautiously.  Commercial bank rates fell in 2002 fr om 14.3% to 12.2% (lending rates), and private-
sector credit expanded by 12.0% (Table I.2). 
6. Sri Lanka's widening current account deficit re ached 6.4% of GDP in 2000.  It has since 
narrowed to 1.5% and 1.6% of GDP in 2001 and 2002, respectively (Table I.2).  The large merchandise trade deficit, which peaked at 10.8%  of GDP in 2000, rose again in 2002 to 8.5% from 
7.4% the previous year.  However, substantial private remittances from Sri Lankans living abroad 
have cushioned the impact of the trade deficit on  the balance of payments.  Current transfers, 
including remittances, have risen continuously sin ce 1996 from 5.5% of GDP to 6.8% in 2002, and 
are the second largest foreign exchange earner after garments.  The current account deficit reflects Sri 
Lanka’s excess of gross investment over savings, which must be met by remittances and net capital inflows.  Sri Lanka's domestic investment-savings gap declined from 1.7% to 1.6% of GDP in 2002 
(from 6.6% in 2000).  Its net external debt and de bt/service ratio as a share of GDP have remained 
relatively stable over the review period (62.1% and 13.2% in 2002, respectively).  Over 80% of Sri 
Lanka's external debt is public, mainly to official multilateral and bilateral creditors. 
7. The economy's structure has changed little since 1996.  Services (including electricity, gas, 
and water) remains the largest sector, accounti ng for 62.2% of GDP in 2002, up from 59.4% in 1996 
(Table I.1).  Agriculture, livestock and fishing (esp ecially tea, coconuts, rubber, and rice) is next 
(20.1% in 2002), followed by manufacturing (15.9%) (mainly textiles, garmen ts, and leather products, 
food, beverages and tobacco, and chemical, petroleu m, rubber, and plastic pr oducts), and mining and 
quarrying (1.8%).  Industrial capacity utilization w as slightly higher at 81% in 2002, but below the 
2000 level of 85%.  Formal employment is mainly in services (about half), especially trade and hotels 
and personal services, and in agriculture (one third). 
                                                     
 
5 Central Bank of Sri Lanka (2002a), p. 17. 
6 The new national consumer price index (the Sri Lank a Consumers’ Price Index) is intended to replace 
the Colombo Consumers' Price Index as the official measure of consumer inflation in 2004.  It is based on 1995 
to 1997 weights and has much broader geographical and income group coverage than the Colombo index, which covers a consumption basket of low-income households in the Municipality.  WT/TPR/S/128 Trade Policy Review 
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Table I.2 
Selected macroeconom ic indicators, 1996-02 
 1996 1997 1998 1999 2000 2001 2002a 
National accounts (Per cent) 
Real GDP (% change) 3.8 6.3 4.7 4.3 6.0 -1.5 4.0 
Unemployment rate  11.3 10.5 9.2 8.9 7.6 7.9 9.1 
Prices and interest rates (Per cent) 
Consumer price inflationb (% change) .. .. .. 4.0 1.5 12.1 10.2 
Colombo consumer price inflationc  
(%age change) 15.9 9.6 9.4 4.7 6.2 14.2 9.6 
Central Bank interest rates        
Repurchase (repo) rate (overnight) 12.75 11.00 11.25 9.25 17.00 12.00 9.75 
Rediscount (reverse repo) rate 
(overnight) 18.58 12.85 15.00 13.48 20.00 14.00 11.75 
Commercial bank interest rates        
Deposit rate 12.3 10.0 9.2 9.1 9.9 10.8 7.5 
Lending rate (prime) 20.2 15.2 14.9 15.9 21.5 14.3 12.2 
Monetary policy (end of period)  (Percentage change)  
M1 (narrow money)d 4.0 9.8 12.1 12.8 9.1 3.2 14.0 
M2b (consolidated broad money)e 11.3 15.6 13.2 13.4 12.9 13,6 13.4 
Reserve moneyf 8.8 -2.1 10.9 8.2 4.7 7.0 12.3 
Private sector credit growth 9.0 14.5 12.0 10.5 11.8 8.9 12.0 
 Exchange rate  
Rs/US$ (period average)  55.27 58.99 64.59 70.39 75.78 89.36 95.66 
Nominal effective (+ = appreciation)g 
(%age change) .. 13.3 -11.6 -1.2 -12.5 .. -10.0 
Real effective (CPI-based, + = 
appreciation)g  (% change) .. .. .. -1.2 1.3 1.1 -1.7 
Fiscal policy  (Per cent of GDP) 
Overall budget deficith 9.4 7.9 9.2 7.5 9.9 10.8 8.9 
Expenditure and net lending 28.5 26.4 26.3 25.2 26.7 27.5 25.4 
Revenue 19.0 18.5 17.2 17.7 16.8 16.7 16.5 
Tax revenue 17.0 16.0 14.5 15.0 14.5 14.6 14.0 
Public sector total debt 93.3 85.8 90.8 95.1 96.9 103.2 105.3 
Domestic debt 46.4 43.5 45.5 49.1 53.8 58.0 59.8 
Investment-saving (Per cent of GDP)  
Gross investment 24.1 24.4 25.1 27.2 28.1 22.2 21.5 
Gross national saving 18.9 21.5 23.4 23.5 21.5 20.5 19.9 
Investment-saving gap 5.3 2.9 1.8 3.7 6.6 1.7 1.6 
External sector  (Per cent of GDP, unless otherwise specified)  
Trade balance -9.7 -8.1 -6.9 -8.7 -10.8 -7.4 -8.5 
Exports 29.5 30.7 30.3 29.2 33.4 30.8 28.6 
Imports 39.2 38.8 37.4 37.9 44.2 38.2 37.2 
Services and income (net) -0.7 - -0.2 -0.7 -1.6 -0.6 0.1 
Current transfers (private and official, 
net)i 5.5 5.5 5.7 5.8 6.0 6.4 6.8 
Current account balance -4.9 -2.6 -1.4 -3.6 -6.4 -1.5 -1.6 
Capital and financial account balance 
(net) 3.3 4.0 2.6 2.4 2.7 3.6 3.1 
Private financial flows 0.8 1.8 0.8 1.5 2.1 0.7 1.7 
Foreign direct investment, netj 0.9 2.8 1.2 1.1 1.1 1.1 1.4 
  Table I.2 (cont'd)Sri Lanka WT/TPR/S/128 
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 1996 1997 1998 1999 2000 2001 2002a 
Overall balancek -0.5 1.1 0.2 -1.7 -3.1 1.4 2.1 
Merchandise trade        
Average of imports and exports  34.4 34.8 33.9 33.6 38.8 34.5 32.9 
Export growth (% change, end 
period) 7.6 13.3 3.4 -3.9 19.8 -12.8 -2.4 
Import growth (% change, end 
period) 2.4 7.8 0.4 1.5 22.4 -18.4 2.2 
Total external debt (end-period) 68.6 62.3 61.6 63.5 61.0 61.4 62.1 
Debt-service ratiol 15.3 13.3 13.3 15.2 14.7 13.2 13.2 
Gross reserves (US$ millions, end 
period) 1,937.0 2,029.0 1,984.0 1,639.0 1,049.0 1,338.0 1,700.0 
Reserve cover (months of GS 
imports)m 3.8 3.7 3.6 2.9 1.5 2.2 2.9 
.. Not available. 
- Negligible. 
a Provisional. 
b A new national index based on recen t weights and a broader geographi cal and income group coverage.  
c Based on a consumption basket of low-income  households in the Colombo Municipal area.  
d Currency and demand deposits held by the public. e M
1 plus public time and savings deposits, incl uding with Foreign Currency Banking Units (FCBUs). 
f Notes and coins issued by the central bank and commercial bank deposits with the central bank.  
g Against a 24 currency basket, which includes bot h trading partners and competitor countries. 
h Deficit before grants and ex cluding privatization proceeds. 
i Includes remittances. 
j Includes privatization proceeds. k Includes valuation adjustment s and errors and omissions. 
l Percent of exports of goods and services. 
m GS = goods and services. 
Source:  Central Bank of Sri Lanka, Annual Report 2002 and 2000 , and Sri Lankan authorities. 
(3) MACROECONOMIC POLICY DEVELOPMENTS  
(i) Monetary and exchange rate policy 
8. The multiple objectives of the Central Bank of Sr i Lanka were reduced to two in late 2002 
(Monetary Law (Amendment Act), No. 32, December).7  Its core monetary policy objective is 
economic and price stability (interpreted as stability in all areas of the economy, including prices).   
This has sharpened the Bank’s focus on reducing in flation.  Its governing Monetary Board was given 
more discretion in managing monetary policy, fo r example in defining money supply and setting 
statutory reserve requirements for  financial institutions. 8  The Bank’s controls on foreign currency 
transactions with commercial banks we re also relaxed to reflect the fl oating exchange rate.  The Bank 
generally sets monetary policy independently in clo se consultation with the Ministry of Finance, and 
has, according to authorities, a very large degree of autonomy.9  The Central Bank’s other core 
                                                      
7 Multiple objectives specified in the 1949 Monetary Law Act included stabilizing domestic monetary 
values;  preserving exchange rate stability; promoting production, employment and real income;  and developing 
the country’s productive resources. 
8 The Board's composition was also expanded to improve operational flexibility and make monetary 
and exchange rate policies more effective.  The Board in cludes the Central Bank Governor, the Secretary of the 
Ministry of Finance, and three members appointed by the President on the Finance Minister's recommendation.   
9 Consultation with the Finance Ministry is often through the Secretary.  Although the Monetary Law 
Act has an override provision whereby the Government (Minister of Finance) can direct the Bank’s Monetary 
Board to adopt government policy should disagreement occur (section 116), this is used only in extraordinary circumstances.  It was used once in 1959. WT/TPR/S/128 Trade Policy Review 
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objective is prudential regulation to achieve a stable financial system (Chapter IV).  These objectives 
are part of its statutory responsibility to “administ er, supervise and regulate the monetary, financial 
and payments system with a view to encouragi ng and promoting the development of the productive 
resources of Sri Lanka” (Section 2 of the Act). 
9. Monetary policy is based on a monetary targe ting framework;  the Bank sets intermediate 
targets in its monetary programme.10  They are set for reserve or b ase money, the nominal anchor and 
Bank’s operational variable, as well as for consolidated broad money (M 2b).11  The Bank's 2003 
Monetary Programme is to increase both reserve money and M 2b by 13.5%.  The monetary policy 
framework has placed greater reliance on market-b ased policy instruments, mainly open market 
operations, to achieve reserve money targets.  The Bank uses overnight repurchase (repo) and 
rediscount (reverse repo) rates with commercial banks  to determine interest rates and to signal its 
monetary policy stance.  It changed from passiv e to active open market operations in March 2003 by 
introducing a daily auction to control liquidity and better target reserve money levels.   The Bank's 
medium-term plan is to adopt inflation targeting.   However, it believes that this would only be 
feasible in a conducive fiscal environment of reduced budget deficits.  The Fiscal Management 
(Responsibility) Act of 2003 limits Government borrowings from the Central Bank to 10% of 
estimated revenues. 
10. Monetary policy in 2002 focussed on price st ability and supporting the economic recovery, 
i.e. providing adequate liquidity for recovery but avoiding demand-fuelled inflationary pressures.  The 
Bank "cautiously" relaxed its tight monetary polic y (adopted since mid 2000) in 2002 in line with 
fiscal consolidation.  Open market operations abso rbed sufficient excess liquidity to meet monetary 
growth targets, given foreign inflows at lower interest rates.  M 2b grew by 13.4% in 2002 and reserve 
money by 12.3%, well below the monetary target of 13.9% (Table I.2).  The downward trend in 
interest rates, which started in early 2001, con tinued; official rates fell on average from 12.0% to 
9.75% (repo) in 2002.12   
11. Monetary policy no longer controls external bala nce since the exchange rate was floated to 
replace the "crawling peg" system on 23 Janua ry 2001, following severe currency pressures.13  
However, the rupee exchange rate has remained rela tively stable, depreciating in real terms by 1.7% 
in 2002 (corresponding to nominal depreciati on of 10%) after a 1.1% appreciation in 2001 
(Table I.2).14  Temporary exchange controls applied on flotation to curb sp eculative activities were 
                                                      
10 The annual monetary programme is revised frequently by the Monetary Board, and published online 
at:  http://www.centralbanklanka.org.  It is prepared with input from the Monetary Policy Committee (MPC), 
which comprises senior Bank officials.   
11 Reserve money is currency and Central Bank depos its of commercial banks.  Consolidated broad 
money (M 2b) is M 2 plus public time and savings deposits with foreign currency banking units (FCBUs).  Money 
supply aggregates used for policy purposes have been progressively  broadened from narrow money (M 1:  
currency and demand deposits) to broad money (M 2:  M 1 plus time and savings deposits) in the 1980s, and to 
M2b now.  A broader concept, M 4, (M 2b plus time and savings deposits with licensed specialized banks and 
finance companies) is to be used more in future for policy purposes (Central Bank of Sri Lanka, 2002c). 
12 Official interest rates continued to ease during 2003; the Bank’s repo and reverse repo rates were 
reduced from 7.5% to 7% and from 9.5% to 8.5% in October 2003, respectively (Central Bank of Sri Lanka , 
Press Release , 16 October 2003). 
13 The exchange rate bands were initially widened to +/- 5% to allow the rupee to depreciate in early 
January 2003.  According to the IMF, Sri Lanka's adoption of flexible exchange rates has been generally 
favourable (IMF, 2002c). 
14 During 2003 the rupee has depreciated against the U.S. dollar (until June) and other major currencies 
(euro, pound sterling and the yen).  This, combined with  the faster decline in domestic inflation has improved 
Sri Lanka's international competitiveness;  the rupee has depreciated in real terms during 2003 (up to 15 October) by 4.2% (Central Bank of Sri Lanka, Press Release , 16 October 2003).   Sri Lanka WT/TPR/S/128 
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removed by end August 2001.15  The authorities indicated that while all payments on current account 
transactions have been liberalized, capital account  controls apply.  For example, non-residents 
purchasing shares in Sri Lankan companies must use share investment external rupee accounts 
(SIERA), and capital market securities as well as  money market instruments are controlled.16  
Exchange control liberalization was announced  in the 2003 Budget and new foreign exchange 
legislation is being prepared.  The Central Bank has no exchange rate ta rget.  It nevertheless 
intervenes in the foreign exchange market to maintain official reserves above an "unofficial" floor 
level as well as to minimize excessive fluctuations.17   
(ii) Fiscal policy   
12. High fiscal deficits continue to be a major cause of Sri Lanka's economic ills.  The overall 
budget deficit during the review period has averaged 9% of GDP;  it peaked at 10.8% in 2001 and fell 
to 8.9% in 2002 (Table I.2).  Large fiscal defic its and associated escalating public debt levels that 
exceed GDP are no longer sustainable18;  debt service payments (interest and amortized loan 
repayments) exceed total government revenue.  Prudent fiscal policy is urgently needed to turn around 
the rising debt/GDP ratio and to ensure me dium-term fiscal and debt sustainability.19  Large deficits 
have "crowded out" the private sector, raised intere st rates and reduced private credit availability and 
investment.  These have been increasingly funded by domestic borrowings (84.8% in 2002), mostly 
from non-bank sources, especially since 2001.  Contai nment of defence spending following the peace 
settlement should help fiscal consolidation, although  public reconstruction costs are also likely to be 
considerable.  
13. Reducing the fiscal deficit has been a major policy objective since the 2002 Budget.  The 
Fiscal Management (Responsibility) Act, passed in January 2003, mandates fiscal consolidation.  
Medium-term fiscal targets must be specified to reduce the budget deficit to 5% of GDP by 2006.  
Public debt must also be lowered to 85% of GDP by end 2006 and to 60% by end 2013.  Government 
guarantees have also been capped at 4.5% of GDP for consecutive three-year periods to contain 
contingent liabilities.  The Law has also improved accountability and transparency in the budgetary 
process by requiring obligatory reporting to Par liament to help meet budgetary targets.20  T h i s  
framework was first applied in the 2003 Budget, whic h projected the overall fiscal deficit to fall to 
5.6% in 2005 (7.5% of GDP in 2003) and the debt/GDP ratio to drop to 89.6% (101.5% in 2003).  The 2003 Budget was formulated to reduce the fiscal defi cit, contain the burgeoning public debt, introduce 
fiscal reforms and to achieve medium-term fiscal sust ainability.  To improve public debt management 
an independent Public Debt Management Office wi ll be created and a comprehensive Public Debt 
Management Law enacted.
21   
                                                      
15 The IMF subsequently re-classified Sri Lanka' s exchange arrangement from the category of 
“managed floating” to "independently floating", effective April 2002 (IMF, 2003a). 
16 Up to 100% equity is generally allowed without prior approval provided SIERAs are used.  Personal 
capital movements are controlled.  Outward direct investment by residents requires Finance Ministry permission 
based on evidence of reasonable rate s of return;  investments that prom ote exports receive priority (IMF, 
2003a). 
17 The U.S. dollar is the Bank's intervention currency.  Its targeted floor level of foreign reserves is not 
public.  It has purchased foreign reserves of US$333 million during 2003 (up to October).   
18 IMF (2002c), p.4. 
19 Central Bank of Sri Lanka (2002a), p. 175. 
20 For example, three-year medium-t erm fiscal projections, including key fiscal indicators such as 
government debt, have been incorporated in the budget, and mid-year fiscal position reports have been 
introduced. 
21 A steering committee was appointed in March 2003 and a project office established in August 2003 
to study and make recommendations on the formation of the Office. WT/TPR/S/128 Trade Policy Review 
Page 8 
 
 
14. Major fiscal consolidation will require substantial on-going tax, expenditure, and debt 
management reforms.  Total govern ment revenue as a share of GDP fell from 19.0% in 1996 to 16.5% 
in 2002;  tax concessions, poor  collection and sma ll number of taxpayers helped reduce tax revenue 
to 14.0% of GDP in 2002 (17.0% in 1996) (Table I. 2).  This ratio is low by international standards 
and may impair Sri Lanka’s ability to finance public services essential to its development needs, such 
as health and education.  Public expenditure shares also fell over the same period (28.5% to 25.4%).  
Tax reforms are a high government priority;  especia lly eliminating ad hoc tax concessions to broaden 
the tax base, and enhanced tax administration to improve collection.  The goods and services (GST) 
tax and the national security levy (NSL) were conso lidated into a single value-added tax in 2002.  A 
revenue authority is to be formed to improve tax administration and collection.22  Expenditure 
controls were also tightened and other reform s made to rationalize current and capital spending.23  
Government overdrafts with the two state banks were reduced from Rs 38 billion to Rs 5 billion 
during 2002, through the issue of market-oriented debt instruments.  Zero-based budgeting systems were introduced to improve public-sector efficiency.
24  GDP share for tax revenue is projected to rise 
to 16.6% in 2005, and for expenditure to fall to 24.2%.25    
15. Loss-making public corporations and institutions remain an increasing fiscal drain.26  
Privatizing inefficient state-owned enterprises is also  planned, to help ease the national debt crisis.  
While this has been slow, the Government remains committed to privatizing an d restructuring public 
enterprises.  This, along with further price reform s to enhance cost recovery, would improve their 
efficiency and financial viability.27  Privatization proceeds were budgeted to rise to Rs 13.5 billion in 
2003 from Rs 5.7 billion (mainly from the privatiza tion of Ceylon Petroleum Corporation’s filling 
stations and Sri Lanka Insurance Corporation Limited).28 
(4) STRUCTURAL MEASURES  
16. Extensive and accelerated structural reforms ar e needed to improve the economy's efficiency 
and performance.  Many of these, such as reform of  state-owned enterprises, and in key services also 
dominated by public entities (finance, energy and tran sport), have been delayed.  Low productivity, 
inefficient resource allocation, structural rigi dities, and resource under-utilization remain major 
concerns.29  Structural (as well as fiscal) reforms are integral to the Government’s Economic Reform 
                                                      
22 A steering committee was appointed in January 2003  and the draft Revenue Authority Bill is due to 
be submitted to Parliament by end-2003.  The Inland Revenue Department, the Customs Department, and the Excise Department will continue to operate as independent agencies. 
23 Several new committees, for example the Budget Monitoring Committee and the Cabinet Sub-
Committee on Budget and Tenders,  approve and  monitor budget implementation to minimize expenditure over-
runs. 
24 This requires government departments to explain proposed expenditure programmes to the Treasury 
and to evaluate them using cost-benefit analysis.  Public  service recruitment was also  cut, and a contributory 
pension scheme introduced from 2003.  The unfunded liability under the non-contri butory pension scheme is 
Rs 550 billion (Ministry of Finance, 2003, Part I, p. 9).  The Welfare Benefit Act  (No. 24 of 2002) also 
provided for more targeted welfare payments.   
25 Ministry of Finance (2003), Part I, Annex 9, Table 2.  
26 Budgetary transfers increased si gnificantly in 2002.  The Region al Transport Companies and Sri 
Lanka Railways, for example, incurred large losses of Rs  2.2 billion and Rs 2.8 billion, respectively (Central 
Bank of Sri Lanka, 2002a, p. 190).  Total debt of three state-owned enterprises (Ceylon Petroleum Corporation, 
Ceylon Electricity Board, and CWE) amounted to about 13.25% of GDP at end 2002 (IMF, 2003c). 
27 Central Bank of Sri Lanka (2002a), p. 190. 
28 According to the latest projecti ons, privatization proceeds will reach  Rs 17 billion in 2003 (Minister 
of Finance, 2003, p. 8). 
29 Central Bank of Sri Lanka (2002a), p. 3. Sri Lanka WT/TPR/S/128 
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Programme enunciated in its 2003 poli cy paper, "Regaining Sri Lanka".30  The Programme stressed 
the need for:  greater private-sector investme nt and development; better infrastructure (e.g. 
telecommunications);  improved productivity across all sectors;  and increased public-sector efficiency.  The large public service and number of ministries appear to have undermined efficiency 
and contributed to cumbersome and, at  times, poorly coordinated policymaking.
31  To ensure 
structural reform, an Economic Management Law will be enacted to require bi-annual reports to 
Parliament on progress by ministries in implementing economic reforms.  Budgets are to be directly linked to them achieving such reforms.
32  "Notable progress" was made in structural reforms during 
2002, especially in taxation, the financial sector, and labour markets.33 
17. Trade and investment reforms can improve pro ductivity by providing greater competition.  
While Sri Lanka is now much more open, trad e barriers still impose large and unnecessary economic 
costs and there have been some backward steps in the reform effort, as trade-related and other 
economic policies seem to be changed in an ad hoc manner (Chapter III and IV).34  For example, a 
temporary 40% tariff surcharge was introduced for revenue reasons in February 2001;  although 
reduced to 20% in November 2002, it is no longer to be eliminated in November 2003, but will be 
phased out gradually.35  Also, imposition of specific duties in early 2002, mainly on food and 
bicycles, and of 2%, 5%, and 10% tariffs on certain duty-free goods has undermined the goal of adopting a simplified two-band tariff regime (Chapter III).
36  Investment liberalization has focussed 
on relaxing foreign-equity restrictions in key services, such as banking, insurance, stock broking, 
mass transport, telecommunications, and professional services (Chapters II and IV). 
18. Deregulation of key utilities, like energy, trans port, ports, aviation, and water, is aimed at 
reducing state domination by allowing greater private-sector involvement.  Loss-making and inefficient public enterprises are a major cause of the economy’s economic problems.
37  However, 
privatization initiatives appear to have lost mome ntum as most profitable or potentially profitable 
companies have already been sold.  The state pow er monopolist, Ceylon Electricity Board (CEB), is 
still to be unbundled to permit competition in distri bution (Electricity Refo rm Act) as a means of 
boosting power supply (Chapter IV).  Regulatory refo rms also include the formation of the Public 
Utilities Commission to develop a national regulatory po licy in electricity, water, and other utilities.  
A new Consumer Affairs Authority has been created to administer competition policy (Chapter III(4)(iii)).    
19. Labour market reforms in 2002 have enhanced labour market flexibility.  They included 
amendments to several key labour laws, especially the Termination of Employment of Workmen Act 
of 1971, to allow employers (with over 15 employees) greater flexibility in retrenching staff subject to 
payment of a formula-determined compensation packag e.  Nevertheless, such rigidities still appear to 
be a major obstacle to industrial restructuring.   Government wages policy is to ensure that base 
adjustments awarded by wages boards reflect pr oductivity increases so as to minimize cost-push 
                                                     
 
30 Government of Sri Lanka (2003d). 
31 With almost one million government employees, Sri Lanka's public service is one of the largest in 
the world per capita.  There are some 57 ministries. 
32 Ministry of Finance (2003), Part I, p. 15. 
33 Central Bank of Sri Lanka (2002a), p. 1. 
34 UNESCAP (2003a), p. v.  
35 Daily News,  "20% surcharge on imports will not be eliminated by 2003, says Central Bank", 
13 October 2003, p. 1. 
36 Central Bank of Sri Lanka (2002a), p. 35.  The Government is committed to reducing trade 
protection and establishing a two-band (excluding zero) ta riff system (Government of Sri Lanka, 2003d, p. (ii)). 
37 Central Bank of Sri Lanka (2002a), p. 51. WT/TPR/S/128 Trade Policy Review 
Page 10 
 
 
inflation.  Real wages in the public sector seem to have risen much faster (almost double) than in the 
private sector from 1998-02.38    
(5) TRENDS AND DEVELOPMENTS IN TRADE AND FOREIGN DIRECT INVESTMENT  
(i) Composition of merchandise trade 
20. Merchandise exports and imports represented 28.6% and 37.2% of GDP in 2002 (Table I.2).  
Manufactured products accounted for 73.9% of e xports in 2002 (70.1% in 1996) (Chart I.1).39  
Clothing is increasingly the main export (50.2%  in 2002), followed by tea (although this has 
decreased since 1996), which is exported mainly (64%) in bulk form.  Manufactured goods accounted 
for 67.5% of imports in 2002 (72.4%  in 1996), consisting largely of te xtiles (21.8%), machinery, and 
transport equipment (18.4%), food (14.1%), and fuels (13.8%).  
(ii) Direction of merchandise trade 
21. The United States is Sri Lanka's main export ma rket, accounting for 37.6% of its exports in 
2002 (33.8% in 1996) (Chart I.2).  EU countries, especially the United Kingdom (12.5%), Belgium (5.5%), and Germany (4.2%), received 29.6% of  Sri Lanka's exports in 2002 (29.8% in 1996), 
followed by Middle Eastern countries (7.6%), the ma in tea markets.  Major import sources in 2002 
included the European Union (14.9%), Middle E ast (14.7%), and India (13.8%).  Developing 
countries are the main import sources (70%) and de veloped economies the main export destinations.  
SAARC members, especially India, accounted for 5% and 15% of Sri Lanka ’s exports and imports, 
respectively, in 2002. 
(iii) Composition of trade in services 
22. Trade in services is still dominated by trans portation, travel, insurance, and other business 
services.  These accounted for about 90% of both service exports and imports  in 2002 (97% and 95%, 
respectively, in 1996).  Peace initiatives substantiall y boosted tourism and net travel receipts in 2002.  
Tourism, an important source of foreign exchange  for Sri Lanka, is a government-declared "thrust" 
industry earmarked for development (Chapter IV(5)(v)). 
 
                                                     
 
38 Central Bank of Sri Lanka (2002a), p. 26.  Government salaries rose in 2002 due to implementation 
of wage rises of between 19% and 24% granted in October 2001. 
39 While relatively stable recently, export compositi on has changed significantly  over the longer term, 
as industrial products have displ aced agricultural exports (Central Bank of Sri Lanka, 2002a, p. 37). Sri Lanka WT/TPR/S/128 
 Page 11 
 
 
Chart I.1
Product composition of merchandise trade, 1996 and 2002
1996 2002
(a)    Exports
Other
1.9
Manufactures
70.1
Total:   Rs 227.8 billion = US$4,121.9 millio n Total:  Rs 448.4 billion = US$4,686.8 million
(b)    Imports
Iron & steel 
2.9
Machinery & 
transport 
equipment
21.1Other semi-manuf.
11.4Food
15.5
Fuels  
8.6Textiles
22.6
Manufactures
72.4
Chemicals
9.0Clothing  0.9Other 
consumer
  goods  
4.5Food
14.1Other
1.4
Fuels  
13.8
Other semi-
manufactures
10.2Clothing  1.7
Iron & steel
2.5Manufactures
67.5
Chemicals
8.7
Total:   Rs 277.9 billion = US$5,027.9 million Total:  Rs 578.3 billion = US$6,045.3 million Per cent
Manufactures
73.9Other 
1.3
Other food & bev.
7.2Black tea
13.8
Machinery & transport 
equipment
18.4Agricultural raw materials  
3.6
Clothing
50.2
 Textiles
21.8Other consumer goods
                   4.2Other 
0.3Other food & beverages
7.3
Machinery &  transport equip.
3.4Black tea
16.0
Clothing
43.8Other consumer goods
7.4
Machinery & transport 
equipment
4.6Other consumer goods
                    4.4
Other mining  
2.0Textiles
3.1Textiles
4.5Semi-manufactures
10.9
Source :  WTO calculations, based on data received from the authorities of Sri Lanka.Semi-manuf.
11.4
Other mining  1.2Mining  1.1Agriculture
26.9Agric.
22.6 Agric. raw mtrls.
  1.7
Mining  2.2
Agric.
15.3Agric.
17.4
Mining
15.8Mining
9.8Agric. raw materials 
2.0Agric. raw materials 
1.2
 WT/TPR/S/128 Trade Policy Review 
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Chart I.2
Direction of merchandise trade, 1996 and 2002
1996 2002
(a)    Exports
E. Asia
11.7
Middle East 
7.8
United Kingdom
9.4United States
33.8Other East Asia
5.5
Total:  Rs 227.8 billion = US$4,121.9 million Total:  Rs 448.4 billion = US$4,686.8 million
(b)    Imports
Other America
  2.0United 
States
3.9
EU15
17.8
East Asia
46.8Other  
1.7
India
13.8
Japan
5.9Other Europe
3.4EU15
14.9
S. Asia
15.5United States
  3.6
Total:  Rs 277.9 billion = US$5,027.9 million Total:  Rs 578.3 billion = US$6,045.3 million
Source :  WTO calculations, based on data received from the authorities of Sri Lanka.Per cent
South Asia   5.4
H.K., China  
8.1East Asia
  7.6
China  4.3Germany
4.2
Oceania  3.8Other America
 2.9
Belgium
5.5United States
37.6
Other E. Asia
8.5
Japan
9.9Other East Asia  
8.4
Hong Kong, China
7.0Other
3.7
Other South Asia  1.7Other EU15
9.3Middle East 
7.6
United Kingdom
12.5Other America
2.5Other
5.2
Other Europe
6.7
India
11.2
Middle East  
8.1Oceania  3.5
Middle East
14.7
Korea, Rep. of  
     5.0     Korea, Rep. of 
                  7.0Germany
5.8South Asia  2.6
Belgium
5.3Other EU15
7.4
Other Europe  
2.0
Malaysia  3.6
Singapore
5.1 Singapore
7.2Chinese Taipei   4.8Chinese Taipei  
5.7Africa 
  1.6
Other South Asia  1.7Japan   6.2
Other Europe
5.6
East Asia
43.7S. Asia
12.9EU15
29.8EU15
29.6
 Sri Lanka WT/TPR/S/128 
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(iv) Foreign direct investment (FDI) 
23. National saving falls well short of domestic investment, and so Sri Lanka has traditionally 
relied on private remittances and inward foreign direct  investment (FDI) to fill the gap.  However, 
since the last Trade Policy Review of Sri Lanka, inwa rd FDI has been adversely affected by the civil 
war.  FDI (net) shares of GDP rose substantially in 1997, from 0.9% to 2.8%, but fell to 1.1% in 1999 
and it remained at that level until rising to 1. 4% in 2002 after peace (Table I.2).  FDI fell 
continuously, from US$430 million in 1997 (US$120 million in 1996) to US$172 million in 2001, but 
increased to US$235 million in 2002.  Sri Lanka was cl assified as an "under-performer" in attracting 
FDI over the period 1998/00 (unchanged from 1988/90).40 
24. Sri Lanka’s total FDI stoc k was US$2.6 billion in 2001.41  The FDI stock by Board of 
Investment (BOI) approved enterprises was Rs  164.9 billion (US$1.7 billion) in 2002, up from 
Rs 141.3 billion (US$1.6 billion) in 2001 and Rs 61 b illion in 1996 (US$1.1 billion) (Table I.3).  In 
2002, their FDI stock was mainly in services (61. 3%);  textiles, wearing apparel, and leather 
products(15.4%);  chemicals, petroleum, rubber, a nd plastic products (6.7%);  and food, beverages, 
and tobacco (5.3%).  The services sh are has increased since 1996 (57%). 
Table I.3 
Realized investment stocks of Board of Inve stment (BOI) enterprises, 1996, 1998 and 2001-02 
(Rs million, number and per cent) 
Foreign investment Total investment applications Number of enterprises 
Category 
1996 1998 2001 2002a 1996 1998 2001 2002a 1996 1998 2001 2002a 
Amount  (Rs million) 
Food, beverages & tobacco 2,251 5, 199 5,058 8,732 4437 11,392 11,088 14,679 77 149 146 143 
Textiles, wearing apparel & 
leather products 12,312 16,819 22,006 25,437 14,997 25,021 32,823 39,976 268 386 458 480 
Wood & wood products 474 671 1,300 2,751 564 935 1,648 3,161 19 26 22 22 
Paper & paper products 326 461 517 567 550 649 744 1,577 12 22 21 23 
Chemical, petroleum, 
rubber & plastic products 5,778 7,121 10,178 11,040 6902 9,370 14,101 16,011 66 101 126 129 
Non-metallic mineral 
products 972 3,044 3,183 3,574 2783 4,842 6,642 6,763 42 66 57 64 
Basic metal products 0 0 000000 0  0  0  0  
Fabricated metal products, 
machinery & transport equipment 607 2,832 3,769 5,562 1180 3,616 5,116 7,230 20 35 41 67 
Manufactured products 
(n.e.s.) 3,509 5,646 5,924 6,212 4646 8,853 8,322 9,389 100 171 155 156 
Services 34,728 58,438 89,355 101,019 55,228 86,259 127,595 142,684 259 402 535 559 
Total 60,957 100,231 141,290 164,894 91,587 151,207 208,079 241,470 863 1,358 1,561 1,643 
Table I.3 (cont'd)
                                                      
40 UNCTAD (2002b), Chapter II, p. 31.  This classification is based on two constructed indexes, and 
indicates that it is ranked below the mid-point of all countries on both indexes.  These indexes are the inward 
FDI performance index (the ratio of a country’s share of global FDI flows to its share of global GDP) and the inward FDI potential index (an unweighted average of the scores of eight normalized economic and social 
variables).  Between 1988/90 and 1998/00, Sri Lanka’s country ranking on the FDI performance index slipped 
from 85
th to 103rd and improved from 113th to 111th on the FDI potential index.  
41 UNCTAD (2002b). WT/TPR/S/128 Trade Policy Review 
Page 14 
 
 
Foreign investment Total investment applications Number of enterprises 
Category 
1996 1998 2001 2002a 1996 1998 2001 2002a 1996 1998 2001 2002a 
Shares (per cent) 
Food, beverages & tobacco 3.7 5.2 3.6 5.3 4.9 7.5 5.3 6.1 8.9 11.0 9.3 8.7 
Textiles, wearing apparel & 
leather products 20.2 16.8 15.6 15.4 16.4 16.5 15.8 16.6 31.1 28.4 29.3 29.2 
Wood & wood products 0.8 0.7 0.9 1.7 0.6 6.2 0.8 1.3 2.2 1.9 1.4 1.3 
Paper & paper products 0.5 4.6 0.4 0.3 0.6 0.4 0.4 0.7 1.4 1.6 1.4 1.3 
Chemical, petroleum, 
rubber & plastic products 9.5 7.1 7.2 6.7 7.6 6.2 6.8 6.6 7.6 0.8 8.1 7.9 
Non-metallic mineral 
products 1.6 3.0 2.3 2.2 3.0 3.2 3.2 2.8 4.9 0.5 3.7 3.9 
Basic metal products 0 0 0 0 0 0 0 0 0 0 0 0 
Fabricated metal products, 
machinery & transport 
equipment 1.0 2.8 2.7 3.4 1.3 2.4 2.5 3.0 2.3 2.6 2.6 4.1 
Manufactured products 
(n.e.s.) 5.8 5.6 4.2 3.8 5.1 5.9 4.0 3.9 11.6 5.2 9.9 9.5 
Services 57.0 58.3 63.2 61.3 60.5 57.0 61.3 59.1 30.0 29.6 34.3 34.0 
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 
a Provisional. 
Source:  Central Bank of Sri Lanka, Annual Report 2002 , Statistical Appendix,  Table 20;  and Sri Lankan authorities. 
(6) OUTLOOK  
25. Sri Lanka's economic prospects depend heavily  on maintaining peace and political stability, 
and continuing to implement overdue  macroeconomic reforms, especially further fiscal consolidation 
and resolving the national debt crisis.  An importa nt milestone of the Gove rnment’s latest reform 
programme will be to meet the new statutory fi scal targets of a 5% budget deficit by 2006 and 
reducing national debt to 85% of GDP by end 2006.  This, a majo r challenge, will require on-going 
tax, expenditure, and debt manage ment reforms.  The projected 2 003 budget deficit is unchanged at 
7.5% of GDP, and inflation has continued to fall.42  Continuation of broad structural reforms, 
including in areas of trade, investment, production,  and institutions, should help raise the economy’s 
productivity and growth prospects.  A key aspect of these reforms will be to reduce the large role of 
the Government in the economy. 
26. Macroeconomic prospects appear favourable , provided civil and political stability is 
maintained and fiscal consolidation and compre hensive structural reforms continue to be 
implemented.  There remains, therefore, high do wnside risk to Sri Lanka's growth prospects.43  Latest 
official "baseline" forecasts see a more stable economy with real GDP growth rising from 5.5% in 
2003 to 6.8% in 2005 and 7.0% in 2006.44  Inflation is due to decline to 7.5% in 2003.  The current 
account deficit is expected to widen to 3.3% in 200 3, but to peak at 4.3% in 2005 and then fall to 
                                                      
42 Minister of Finance (2003). 
43 Central Bank of Sri Lanka (2002a), p. 46. 
44 Ministry of Finance (2003), Part II, Annex 9, Table 2;  Central Bank of Sri Lanka (2002a), p. 49;  
and Government of Sri Lanka (2003d), Table 3.2, p. 37.  The Government’s annual growth rate objective is to 
achieve 8-10% by 2010 and to raise per capita GDP to nearly US$2,000 (Government of Sri Lanka, 2003d, p. 36). Sri Lanka WT/TPR/S/128 
 Page 15 
 
 
3.7% in 2006.  The balance of payments, however, is expected to remain in surplus, rising to 4% of 
GDP in 2006 and raising official reserves to 4.4 months of import cover.   These forecasts are 
generally consistent with those of the IMF.  It s "baseline" medium-term projections are for real 
growth to rise steadily from 5.5% in 2003 to 6.5% in 2006, and for the external current account deficit 
to stay below 3% of GDP as global recovery and domestic structural reforms boost economic activity, 
competitiveness, and export growth.45 
27. Policy consistency is essential to attain the afor ementioned goals.  As stated by the Central 
Bank, inconsistency in economic policies, including in trade policies, reversing already implemented 
policies, postponing the implementation of policies or changing them in an ad hoc manner lead to loss 
of policy credibility and market confidence.  Given Sri Lanka's past experience, more attention should 
be paid to this issue.  For instance, there is a pro liferation of tariff exemptions and waivers used in an 
ad hoc manner to benefit different groups at di fferent points in time.  These policies not only 
discourage investment but lead to a wasteful use of  resources.  In this regard, the authorities could 
make further progress towards improving the trade a nd investment regimes through the simplification 
of the tariff structure, and the elimination of import and export licences, and tax incentives. 
                                                      
45 These assume significant structur al reforms and fiscal consolidation through revenue and expenditure 
rationalization to reduce the fiscal deficit to 4% of GDP and the debt/GDP ratio to 84% in 2006 (IMF, 2002d, p. 22). 