Cablegate: Investment Climate Statement 2003 for Sri

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

UNCLAS SECTION 01 OF 26 COLOMBO 001389

SIPDIS

DEPT FOR EB/IFD/OIA, SA/INS, EB CBA

DEPT PLEASE PASS TO USTR, EXIM, TDA

MANILA FOR USADB

E.O. 12958: N/A

TAGS: EINV EFIN ELAB ETRD KTDB PGOV CE OPIC ECONOMICS

SUBJECT: INVESTMENT CLIMATE STATEMENT 2003 FOR SRI

LANKA

REF: (A) STATE 128494

1. The following is the 2003 Investment Climate

Statement for Sri Lanka. This report will be

included in post's FY 2004 Country Commercial Guide

to be sent separately.

Begin text.

INVESTMENT CLIMATE STATEMENT

SRI LANKA, JULY 2003

Openness to Foreign Investment

------------------------------

2. Sri Lanka actively welcomes foreign investment,

which has become an important element of the

country's economic growth. Sri Lanka opened its

economy to foreign investment in 1978, long before

its South Asian neighbors, but results have been

mixed. Over the past twenty-five years, several

hundred foreign investors have invested in the

country but foreign investment flows have been weak

in the last decade due to an ethnic conflict, and

economic and political problems. This situation is

improving due to current peaceful conditions in the

country, economic reforms and an infrastructure

development plan backed by increased foreign aid.

Although many investors have done well, some have had

problems with government practices and regulations.

3. Sri Lanka's economic growth has been reasonable,

averaging 4.6 percent during the past decade. The

country boasts unique human development achievements

for a developing country. Sri Lanka's per capita

income of $872, a literacy rate of over 90 percent

and life expectancy of 72 years rank well above those

of India, Bangladesh and Pakistan.

4. The current United National Front (UNF)

Government, led by Prime Minister Ranil

Wickremasinghe of the United National Party (UNP),

came into office in December 2001 on a platform of

peace and economic revival. It is strongly pro-

business and investor friendly. The UNF government

has moved to increase foreign investment and private

sector activity in key sectors of the economy,

initially concentrating on infrastructure

development. The government has launched an

extensive deregulation and economic reform program to

facilitate private sector activity and improve

economic growth. These programs are outlined in

"Regaining Sri Lanka" (www.regainingsrilanka.org), a

policy document of the Government of Sri Lanka. In

support of these programs, the International Monetary

Fund (IMF) approved a Poverty Reduction and Growth

Facility (PRGF) (www.imf.org/external/country/LKA)

for Sri Lanka in April 2003. International donors,

including the IMF, have pledged a total of $4.7

billion in grants and concessional loans for Sri

Lanka for a four-year period from 2003. These funds

will be used to facilitate development in the south,

and reconstruction in the north and east heavily

damaged by the ethnic conflict.

5. The most notable achievement of the UNF government

has been the ceasefire agreement signed on February

21, 2002, between the Government and the Liberation

Tigers of Tamil Ealam (LTTE). Although ceasefire

violations continue, the agreement has led to Sri

Lanka's most stable and peaceful period of the last

20 years. Both parties have expressed their

commitment to a negotiated settlement, and have held

six rounds of talks with the Government of Norway

acting as facilitator. As of August 2003, the LTTE,

which pulled out of the peace talks in April 2003, is

reviewing a government paper on an interim

administration in the North and East. There is hope

that the next round of peace talks may be held in the

near future. The peace process has substantially

improved the political, economic and investment

climate and has resulted in attracting substantial

funding from multilateral and bilateral donors to

rebuild the country. This has boosted foreign

investor interest.

6. Numerous risks and challenges remain, however.

The peace process could falter. Domestic political

frictions could disrupt the peace process or hamper

economic reform. Cohabitation tensions exist between

the President and Prime Minister, representing

opposing political parties. The President has

delegated most of her executive powers to the Prime

Minister and his cabinet of ministers, but retains

constitutional power to dismiss the parliament and

call for elections. Such an action could disrupt

progress on peace and economic reforms. One major

business concern in the medium term is the cost and

supply of power. Sri Lanka has faced periodic power

shortages since 1994, with the most recent period

extending from mid 2001 to early 2002. Although new

power plants are being added, the Government is yet

to procure base load power needed to avert a power

crisis in the medium term. Most businesses have

installed on site generating capacity.

Board of Investment

7. The Board of Investment (BOI) (www.boi.lk), an

autonomous statutory agency, is the primary

government authority responsible for foreign

investment. The BOI acts as a facilitator for

investment. It is intended to provide "one-stop"

service for foreign investors, including approval of

projects, granting incentives and arranging services

such as water, power, waste treatment and

telecommunications. The BOI also assists in

obtaining resident visas for expatriate personnel and

facilitates import and export clearance.

8. The Bureau for Infrastructure Investment (BII)

(www.boi.lk), a division of BOI, coordinates all

private infrastructure projects. Projects are

usually structured on the basis of build, own,

operate (BOO), build, operate, and transfer (BOT) or

build, own, operate and transfer (BOOT).

Laws Affecting Investment

9. The principal law governing foreign investment is

Law No. 4 of 1978 (known as the BOI Act), including

amendments made in 1980, 1983 and 1992, and

implementing regulations established under the Act.

The BOI Act provides for two types of investment

approvals. Under section 17 of the Act, the BOI is

empowered to grant concessions (see details below) to

companies satisfying certain eligibility criteria.

Investment approval under section 16 of the act

permits entry for foreign investment to operate under

the "normal" laws of the country and is applicable to

investments that do not satisfy eligibility criteria

for BOI incentives. Other laws affecting foreign

investment are the Securities and Exchange Commission

Act of 1987, amendments made in 1991 and 2003 and the

Takeovers and Mergers Code of 1995. In addition,

various labor laws and regulations affect investors.

See sections below.

10. In early 2003, the Parliament passed a new BOI

law to bring BOI's power to grant tax holidays and

incentives with in the regular income tax law. BOI

will retain most of the other powers granted under

earlier laws; it will be responsible for investment

approvals and granting of other incentives. The new

law also provides for decentralization of some BOI

activities to five regional economic development

commissions formed under the BOI. These commissions

are to promote development in the regions, provide

facilities for investments, and develop and manage

export processing zones. As of July 2003, although

the new law had not come into force, some of the

commissions had been established. When the new law

comes into effect, the previous BOI Act of 1978 will

be automatically repealed.

Foreign Equity and Sectors

11. Foreign equity participation of up to 100

percent is allowed in many sectors of the economy and

the BOI gives automatic approval for most foreign

investments.

12. The Government relaxed investment rules in early

2002, allowing 100 percent foreign investment in the

following services: banking, finance, insurance,

stockbroking, construction of residential buildings

and roads, supply of water, mass transportation,

telecommunications, production and distribution of

energy, professional services and the establishment

of liaison offices or local branches of foreign

companies. These services are regulated and subject

to approval by various government agencies. The

screening mechanism is non-discriminatory and, for

the most part, routine.

13. Investment in some other sectors is restricted

and subject to screening and approval on a case-by-

case basis, where foreign equity exceeds 49 percent:

shipping and travel agencies; freight forwarding;

fishing; timber-based industries; growing and primary

processing of tea, rubber, coconut, rice, cocoa,

sugar and spices; and, finally, the production for

export of goods subject to international quota.

Foreign investment restrictions and government

regulations also apply to international air

transportation; coastal shipping; lotteries; large-

scale mechanized gem mining; and "sensitive"

industries such as military hardware, dangerous drugs

and currency.

14. Foreign investment is not permitted in the

following businesses: non-bank money lending; pawn-

broking; retail trade with a capital investment of

less than $1 million (with one notable exception: the

BOI permits retail and wholesale trading by reputed

international brand names and franchises with an

initial investment of not less than US$ 150,000);

personal services other than for the export or

tourism sectors; coastal fishing; education of Sri

Lankan citizens under 14 years; and award of local

university degrees.

15. In general, the treatment given to foreign

investors is non-discriminatory. In fact, some local

companies have complained that they are discriminated

against, while qualifying foreign investors can

benefit from a wide range of advantages. Even with

incentives and BOI facilitation, foreign investors

can face difficulties operating here. Problems range

from the mundane, but critical, matter of clearing

equipment and supplies through customs speedily, to

getting land for factories. The BOI encourages

investors to locate their factories in industrial

processing zones managed by the BOI to overcome land

allocation problems. Investors locating in

industrial zones also get access to relatively better

infrastructure facilities such as reliable power,

telecommunication and water supplies.

16. Government treatment of foreign investors in the

privatization process has been largely non-

discriminatory. Recently, however, the government

sold part of retail operations of state-owned Ceylon

Petroleum Corporation (CPC) to Indian Oil Corporation

(IOC) without a formal tender process. Caltex, which

had earlier acquired a government owned lubricant

plant and obtained exclusivity in the sale of

lubricants in CPC outlets till mid-2004, has also

complained that the Government had reneged on the

terms of the exclusivity agreement. Labor unions in

the state-owned enterprises are often opposed to

privatization and seem particularly averse to foreign

owners, which has made the purchase of certain

strategic entities problematic for new foreign

owners. In addition, some privatization sales,

particularly to foreign investors, have been

controversial. Sometimes liberal and unwieldy

concessions, not announced during the bidding process

were granted to investors, and other times

substantive changes were introduced once the process

had begun.

Investment Trends

17. Foreign direct investment flows to Sri Lanka

have averaged only about $140 million per year

(excluding privatization receipts) in the past

decade. Since the commencement of the peace process

and improved investor confidence, foreign investment

flows rose to over $245 million in 2002. FDI has

funded mainly infrastructure projects (power,

telecom, ports) and manufacturing industries.

Investment approvals by BOI also rose sharply in

2002. FDI is expected to rise further this year to

over $350 million. The stock market also recovered

markedly in 2002 to become the second best performing

market in Asia. The upward trend is continuing, with

the market recording an all time high in June 2003.

Both foreign direct investment and portfolio

investment are expected to rise further due to

increased investor confidence, private sector

participation in infrastructure and utilities,

increased donor funding and incentives provided by

the BOI. The UNF government's privatization and

economic reform programs offer new investment

opportunities for foreign investors. In addition,

the Indo-Lanka Free Trade Agreement, which offers

duty free entry into India for most products with 35

percent Sri Lankan value addition, offers a gateway

for foreign investors in Sri Lanka to access markets

in India. Currently, US companies avail themselves

of this agreement adding 35% value in Sri Lanka and

getting import duties into India reduced from as much

as 40 percent to as little as zero.

Conversion and Transfer Policies

--------------------------------

18. Sri Lanka has accepted Article VIII status of

the IMF and has liberalized exchange controls on

current account transactions. In early 2001, in

response to a fall in Sri Lanka's foreign exchange

reserves, the Central Bank brought in temporary

controls on foreign exchange transactions, which have

since been removed. There are no surrender

requirements on export receipts, but exporters need

to repatriate export proceeds within 120 days to

settle export credit facilities. Other export

proceeds can be retained abroad. Currently,

contracts for forward bookings of foreign exchange

are permitted for a maximum period of 360 days for

the purposes of payments in trade and 720 days for

the repayment of loans.

19. There are also no barriers, legal or otherwise,

to the expeditious remitting of corporate profits and

dividends for foreign enterprises doing business in

Sri Lanka. Remittance of business fees (management

fees, royalties and licensing fees) is also freely

permitted. Funds for debt service and capital gains

of BOI-approved companies exempted from exchange

control regulations are freely permitted. Other

foreign companies remitting funds for debt service

and capital gains require Central Bank approval. All

stock market investments can be remitted without

prior approval of the Central Bank. Investment

returns can be remitted in any convertible currency

at the legal market rate. Controls on capital

account (investment) transactions usually prohibit

foreigners from investing in debt and fixed income

securities. One exception has been the Central

Bank's dollar denominated bond issues in the local

market in 2001-2002, which were opened to foreign

investors. It has been proposed to allow foreigners

to invest in corporate debentures and government

bonds.

20. Local companies require Central Bank approval to

invest abroad. The process of granting approval for

such investments was streamlined in 2002, resulting

in a substantial increase in approvals.

Expropriation and Compensation

-------------------------------

21. Since economic liberalization policies began in

1978, the Sri Lankan Government has never been

legally found to have expropriated a foreign

investment. Under the terms of the US/Sri Lanka

Bilateral Investment Treaty (BIT), investors have the

right to arbitration under the International Center

for the Settlement of Investment Disputes (ICSID). A

longstanding dispute involving an alleged

expropriation of a US company's investment was

satisfactorily resolved during 1998 after lengthy

negotiations involving the company, the Sri Lankan

Foreign Ministry, the Sri Lankan Attorney General and

the US Embassy.

Dispute Settlement

------------------

Legal System

22. Sri Lankan commercial law is almost entirely

statutory. The law was codified before independence

in 1948 and reflects the letter and spirit of British

law of that era. It has, by and large, been amended

to keep pace with subsequent legal changes in the

U.K. The court system is largely free from

government interference. Procedures exist for

enforcing foreign judgments. Litigation can be very

time consuming. Several important legislative

enactments regulate commercial matters: the Board of

Investment Law, the Code of Intellectual Property,

the Companies Act, the Securities and Exchange

Commission Act, the Banking Act, and the Industrial

Promotion Act. Most of these laws are being revised

to meet current business practices. In addition, a

new Consumer Affairs Authority Act, with wide ranging

provisions for consumer protection was enacted in

2003.

Bankruptcy Laws

23. The Companies Act and the Insolvency Ordinance

e

provide for winding up insolvent companies, but

existing legislation hinders smooth re-organization.

Currently, there is no mechanism to facilitate the

re-organization of financially troubled companies.

The Termination Act, for example, prohibits employers

from laying off workers even on the grounds of

inefficiency. At the urging of the business

community and the donor agencies, the Government took

steps to reform labor laws in 2003. The Parliament

has passed an amendment to the Termination Act to

facilitate easier retrenchment, but its

implementation has been delayed until the development

of a compensation formula and an unemployment

insurance scheme for displaced workers. The new

termination law is expected to come into force in

December 2003, but could be delayed.

24. In the absence of proper Bankruptcy Laws, extra

judicial powers granted to financial institutions by

law protect rights of the creditors and have helped

to strengthen credit discipline. Lenders are able to

enforce financial contracts through powers that allow

them to foreclose on loan collateral without the

intervention of courts. Recently, though, financial

institutions have faced legal challenges, as

defaulters obtain restraining orders on frivolous

grounds due to technical defects in the recovery

laws. Also, for default cases that are filed in

courts, the judicial process is time consuming. The

private sector has urged the Government to introduce

US Chapter 11-style Bankruptcy laws. The financial

community has requested strengthening of debt

recovery laws.

Investment Protection

25. Foreign investments are, in principle,

guaranteed protection by the constitution of Sri

Lanka. The Government has entered into 24 investment

protection agreements with foreign governments

(including the United States) and is a founding

member of the Multilateral Investment Guarantee

Agency (MIGA) of the World Bank. Sri Lanka is also a

founding member of the World Trade Organization. The

Government has ratified the provisions of the

convention on Settlement of Investment Disputes,

which provides the mechanism and facilities for

international arbitration through the ICSID of the

World Bank.

26. The US-Sri Lanka BIT was ratified by both

governments in early 1993. A bilateral treaty on

avoidance of double taxation was signed in September

2002. The treaty shall enter into force upon

ratification by the respective governments and the

exchange of instruments of ratification.

27. Settlement of disputes through the Sri Lankan

court system is subject to protracted and

inexplicable delay. Aggrieved investors (especially

those dealing with the Government of Sri Lanka on

projects) have frequently pursued out-of-court

settlements, which offer the possibility -- not

frequently realized -- of speedier resolution of

disputes.

Arbitration

28. The Arbitration Act of 1995 gives recognition to

the New York Convention on recognition and

enforcement of foreign arbitral awards. Arbitral

awards made abroad are now enforceable in Sri Lanka.

Similarly, awards made in Sri Lanka are enforceable

abroad. A center for arbitration known as the

Institute for the Development of Commercial Law and

Practice (ICLP) has been established in Colombo, for

the expeditious, economical and private settlement of

commercial disputes. The ICLP appears unlikely to

become involved in disputes involving the Sri Lankan

Government, the source of most disputes involving US

companies in recent years. Sri Lanka's first

commercial mediation center was established in 2000,

and became operational in mid 2001. Commercial

mediation is conducted under the Commercial Mediation

Act. Interest in mediation is still low.

29. The Labor Department has a process involving

labor tribunals for settling industrial disputes with

labor, and compulsory arbitration is available when

attempts to reconcile industrial disputes fail. The

Parliament has passed an amendment to the Industrial

Disputes Act to expedite labor dispute resolution

through the Labor Tribunals of the Department of

Labor. The Labor Commissioner typically becomes

involved in labor-management mediation. The Labor

Minister, and even the President, has intervened in

particularly difficult cases.

Investment Disputes Involving U.S. Companies

30. There have been some troublesome investment and

investment-related commercial disputes involving US

companies in recent years. One such dispute,

involving an alleged expropriation, was resolved in

1998 after 17 years of on-and-off negotiations

between the company, the Government of Sri Lanka and

the US Embassy.

31. A partially US-owned Internet service provider

became involved in a major dispute in 1999 when its

new "enhanced voice" service competed successfully

with the national telecom service provider, Sri Lanka

Telecom (SLT). Though the company had a valid

license to provide enhanced voice service, SLT and

the Government of Sri Lanka effectively blocked its

implementation. Additional harassment and baseless

charges were brought against one company employee,

though intervention by the U.S. Embassy led to some

respite. Changes in the Telecommunications

Regulatory Commission under the new government have

resulted in the resolution of many, though not all,

of this company's difficulties. SLT still retains

much control over telecom operations. The Sri Lankan

government subsequently opened international

telephony in early 2003 to all telecom technologies,

though interconnection problems plague operators.

32. In another case, the Sri Lankan Supreme Court in

May 2000 effectively blocked an existing investment

agreement between the Government of Sri Lanka and a

US mining company. Although the investment agreement

was already signed and approved by the Sri Lankan

cabinet, work on the project had not yet begun. A

group of citizens filed a fundamental rights case,

which under Sri Lankan law goes directly to the

Supreme Court. The plaintiffs alleged in this case

that their rights would be violated by implementation

of the mining project, and the court upheld their

complaint. Without any technical argument, the Court

ruled that the project could not proceed before

completion of a new series of detailed and highly

comprehensive and expensive studies, some of which

appear to be technically impractical. Because this

is a Supreme Court decision, options for reversing

the decision appear limited.

33. Another US investor with a substantial

investment in an export manufacturing company has

faced lengthy delays in a court case over a large

insurance claim. The company instituted legal action

in June 1999 and court proceedings are still ongoing

with the company suffering financial losses as a

result. In many disputes, defendants resort to

obtaining injunctions, stay orders or postponements

to drag cases on for years.

Performance Requirements/Incentives

-----------------------------------

Performance Requirements

34. The Board of Investment specifies certain

minimum investment amounts for both local and foreign

investors to qualify for incentives. Firms enjoying

preferential incentives in the manufacturing sector

in most cases are required to export 80 percent of

production, while those in the service sector must

export at least 70 percent of production. Sri Lanka

complies with WTO Trade Related Investment Measures

(TRIMS) Obligations.

35. Foreign investment is encouraged in information

technology, electronic assembly, light engineering,

automobile parts and accessories manufacture,

industrial and IT parks, rubber based industries,

information and communication services, tourism and

leisure related activities, agriculture and agro

processing, port related services, regional operating

headquarters and infrastructure projects. Foreign

investors are generally not expected to reduce their

equity over time or to transfer technology within a

specified period of time, except for build-own-

transfer or other projects in which such terms are

clearly specified.

36. Maintaining a certain level of employment is a

condition in some BOI-approved enterprises. In

addition, privatization agreements as a rule prohibit

new owners from laying off workers, although the

owners are free to offer voluntary retirement

packages to reduce their workforce. Some foreign

investors have received political pressure to hire

workers from a particular constituency or a given

list, but have successfully resisted such pressure

with no apparent adverse effects.

37. Foreign investors who make an equity investment

of $50,000 can qualify for a resident visa.

Employment of foreign personnel is permitted when

there is a demonstrated shortage of qualified local

labor. Technical and managerial personnel are in

short supply, and this shortage is likely to continue

in the near future. Foreign employees attached to

BOI-approved companies usually receive preferential

tax treatment and do not experience significant

problems in obtaining work or residence permits.

Investment Incentives

38. The Board of Investment has announced the

following investment incentives:

39. Incentive Program I

Qualifying industries:

-- Non traditional manufacturing exports (excluding

tea, rubber and coconut), and companies supplying to

exporting companies. Minimum investment of $150,000;

-- Export oriented services. Minimum investment of

$150,000;

-- 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

$50,000;

-- Agriculture and agro processing industries.

Minimum investment of $10,000;

Incentives: Above industries will qualify for a

five-year tax holiday initially. A preferential tax

of 10 percent in the 6th and 7th years follows the

tax holiday. After the 7th year, a preferential tax

of 15-20 percent will apply. In addition, these

industries qualify for duty-free imports (generally,

during the life of the project for export-oriented

projects, and during the project implementation

period for others). Exporting companies and export-

oriented services will be exempted from exchange

control regulations. They will also qualify for free

repatriation of profits and dividends and free

transferability of shares.

40. Incentive Program II

Qualifying Industries:

-- Information technology services such as call

centers, data entry services, data centers, software

development, hosting centers of e-governance related

projects (a);

-- IT training institutes (b);

-- Regional operating headquarters providing

following services to related businesses outside Sri

Lanka: sourcing raw materials, R, technical

support, financial and treasury management, marketing

and sales promotion;

-- Any industrial, agriculture, service, or

construction activity approved by the BOI. Minimum

investment of $5 million.

(a)Minimum employment of 15 IT professionals is

required in IT companies

(b) Minimum 300 students required for IT training

institutes.

Incentives: Above industries will qualify for a 3-

year tax holiday period initially. A preferential

tax of 10 percent will apply in the 4th and 5th

years. From 6th year onwards a preferential tax of

15-20 percent will apply. In addition, capital goods

will be exempted from import duty.

Infrastructure development:

41. Companies acquiring existing companies in

petroleum, power generation, transmission,

development of highways, sea ports, airports,

railway, water services, public transport,

agriculture and agro processing and other

infrastructure projects approved by the Finance

Minister. Minimum investment of $12.5 million.

42. The above projects will qualify for tax holidays

ranging from 5 to 10 years depending on the magnitude

of investment. A preferential tax of 15 percent will

follow the tax holiday. They will also qualify for

duty free imports of capital goods.

43. Large-scale infrastructure projects in power

generation, transmission and distribution;

development of highways, seaports, airports, public

transport and water services; establishment of

industrial parks, and other infrastructure projects

approved by the BOI. Minimum investment of $10

million.

44. The above investments will qualify for tax

holidays ranging from 6 to 12 years depending on the

size of the investment. A preferential tax of 15

percent will follow the tax holiday. They will also

qualify for duty free imports of capital goods.

Indo-Lanka Free Trade Agreement

45. A preferential trade agreement, Indo Lanka Free

Trade Agreement (ILFTA) (www.indolankafta.org),

between Sri Lanka and India is in operation. Under

this agreement, most products manufactured in Sri

Lanka, with at least 35 percent domestic value

addition (if raw materials are imported from India,

domestic value addition required is only 25 percent),

qualify for duty free entry to the Indian market.

Tariff concessions for Sri Lankan products include

zero tariffs on 4,150 items; 50 to 75 percent

reduction for tea and garments under quota; 25

percent reduction for 528 items, and no reduction for

429 items (negative list). The two countries have

begun discussions on services sector liberalization,

although no specific goals have been set yet.

46. Sri Lanka also hopes to sign free trade

agreements with Pakistan soon. These are seen as

steps towards making Sri Lanka a regional hub and the

gateway to South Asia and Middle East for foreign

investors.

Prospects for U.S. Investment Under Indo Lanka Free

Trade Agreement (ILFTA)

47. Foreign investors in Sri Lanka can enjoy

preferential access to the Indian market, under the

ILFTA. Domestic value addition of 35 percent is

required to qualify for concessions granted under the

agreement. The BOI hopes to attract foreign joint

ventures to Sri Lanka under the ILFTA. Indian

imports amounted to over $49 billion in 2002. The

BOI's strategy is to identify products imported into

India and to target its investment promotion efforts

to countries and companies manufacturing them. The

US is one such country; the US accounts for about 7.5

percent of Indian imports valued at $3.7 billion in

2002. A majority of these products would qualify for

substantial duty concessions if exported from Sri

Lanka under the ILFTA. The BOI encourages US

manufacturing companies and regional operating

headquarters to relocate in Sri Lanka to benefit from

ILFTA. The BOI has identified the following sectors

for investment promotion in the US: electronics,

light engineering, pharmaceuticals/cosmetics,

information technology and financial services.

48. 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.boi.lk, or reached via e-mail at info@boi.lk

Right to Private Ownership and Establishment

--------------------------------------------

49. Private entities are free to establish, acquire

and dispose of interests in business enterprises.

Private enterprises enjoy benefits similar to those

granted to public enterprises, and there are no known

limitations on access to markets, credit or licenses.

Foreign ownership is allowed in most sectors.

Private land ownership is limited to fifty acres per

person. About 80 percent of the land in Sri Lanka is

owned by the Government, including most tea, rubber

and coconut plantations. In the past three and a

half years, the Government divested most of these

plantations to the private sector on 50-year lease

terms as part of ongoing privatization efforts.

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.

50. Foreign investors can purchase land from private

sellers. The Government removed a 100 percent tax on

land transfers to foreigners in March 2002.

Protection of Property Rights

-----------------------------

Property rights

51. Secured interests in property are recognized and

enforced. A fairly reliable registration system

exists for recording private property such as land,

buildings and mortgages. The legal system is

nondiscriminatory and protects and facilitates

acquisition and disposition of property rights by

foreigners.

52. Private farmers are working state-owned lands

under varying tenure agreements, ranging from

restrictive tenures to land grants. These lands have

ill-defined property rights. A World Bank-funded

project is underway to develop a legal framework for

implementing a titling system for land. This will

also remove restrictions related to the sale, leasing

and transfer and mortgaging of rural lands previously

distributed to farmers.

Intellectual Property Rights Protection

53. Sri Lanka is a party to major Intellectual

Property Agreements including the Berne 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's intellectual

property law is based on the WIPO model law for

developing countries. Sri Lanka and the US signed a

Bilateral Agreement for the Protection of

Intellectual Property Rights in 1991, and Sri Lanka

is also a party to the Trade Related Intellectual

Property Rights (TRIPS) Agreement in the World Trade

Organization.

54. In July 2003, the Sri Lankan Parliament passed a

new intellectual property law to replace the

Intellectual Property Act of 1979. The new law is

expected to come into force in August 2003 and will

meet both US-Sri Lanka bilateral IPR agreement and

TRIPS obligations (due on January 1, 2000), to a

great extent. The law will govern copyrights and

related rights, industrial designs, patents for

inventions, trademarks and service marks, trade

names, layout designs of integrated circuits,

geographical indications, unfair competition and

undisclosed information. All trademarks, designs,

industrial designs and patents must be registered

with the Director General of Intellectual Property.

55. Infringement of Intellectual Property Rights

(IPR) is a punishable offense under the new law.

Intellectual Property Rights come under both criminal

and civil jurisdiction. Relief available to owners

under the new law includes injunctive relief, seizure

and destruction of infringing goods and plates or

implements used for the making of infringing copies,

and prohibition of importation and exports.

Enforcement, however, is a serious problem, as is

public awareness of IPR. Domestic implementing

legislation, under the old law, has been very weak

and the Government does not act as an enforcer of IPR

laws. At present, aggrieved parties must, on their

own, seek redress of any IPR violation through the

courts, which can be a frustrating and time-consuming

process. Although the legal system is well-

established and non-discriminatory, it is fraught

with long delays.

56. It will take time before new procedures and

court precedents are established. In addition, Sri

Lanka needs to ratify and conform to the WIPO

Performances and Phonograms Treaty (WPPT) and the

WIPO Copyright Treaty (WCT). Ratification of these

two treaties will support electronic commerce,

protect the rights of performers and producers of

phonograms and the rights of authors in their

literary and artistic works, and offer an adequate

basis to fight international piracy in view of the

new technological developments. Meanwhile, local

agents of reputed US and other international

recording companies, software development companies

and motion picture companies continue to complain

that lack of IPR protection is damaging their

businesses. The Embassy, along with key industry

players including the IFPI, continues to lobby the

Government to improve Sri Lanka's IPR regime.

57. Patents are granted for inventions, with the

following exceptions: discoveries, scientific

theories and mathematical methods, plant or animal

varieties (other than micro biological processes) and

essentially biological processes for the production

of plants and animals (other than non biological and

microbiological processes), business rules and

methods, methods of treatment by surgery or therapy,

and diagnostic methods practiced on the human or

animal body. The new law will also permit compulsory

licensing and parallel imports of pharmaceutical

products. The compulsory licensing will allow

government to grant licenses to manufacture certain

drugs, overruling patent licenses, in a national

emergency. The parallel imports will allow the

import of a branded drug from an alternative source.

A patent is valid for 20 years from the date of

grant, but must be renewed annually.

58. 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. The enforcement

limitations described above apply to copyrights,

including software.

59. 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.

Transparency of the Regulatory System

-------------------------------------

60. The BOI strives to inform potential investors

about laws and regulations that may affect operations

in Sri Lanka. Laws pertaining to tax, labor and

labor standards, exchange controls, customs,

environmental norms, building and construction

standards are in place. Some of the laws and

regulations are not freely available and are

difficult to access. Foreign and domestic investors

often complain that the regulatory system allows far

too much leeway for bureaucratic discretion.

Outdated regulations and rigid administrative

procedures imposed by public sector institutions have

been identified as impediments to private sector

growth. Effective enforcement mechanisms are

sometimes lacking and coordination problems between

the BOI and relevant line agencies frequently emerge.

Lethargy and indifference on the part of mid- and

lower-level public servants compound transparency

problems. Non-availability of technical capacity

within the Government to review financial proposals

for private infrastructure projects also creates

problems during tendering. The Government has begun

to carry out extensive deregulation to facilitate

private sector activity.

61. Although many foreign investors, including US

firms, have had positive experiences in Sri Lanka,

some have encountered significant problems with

government practices and regulations. For example,

one foreign company that had obtained a waiver of a

particular requirement in order to obtain a license

was later told it must meet the requirement to

continue to be qualified for the license, with no

advance warning and little justification. Some

multinational firms have experienced extensive

unexplained delays in trying to reach agreement on

investment projects. Others have had contracts

inexplicably canceled without compensation, even

after those contracts had been approved by the Sri

Lankan Cabinet.

62. The partially US-owned Internet service provider

mentioned above encountered further difficulties in

1999 when its "enhanced voice" service competed

successfully with Sri Lanka Telecom (SLT) which is

partly owned by the Government. The company had a

valid license to offer enhanced voice service, but

SLT claimed otherwise. Although technical questions

regarding the interpretation of licenses should in

theory be resolved by the industry regulatory

authority, this option was less attractive to the

company because the Director General of the

Regulatory Authority at that time was in this case a

former CEO of SLT with a bias towards SLT. This

problem was partially resolved in 2002 with the

appointment of a new Telecom Regulator and in 2003,

when the government fully liberalized the external

gateway operations. Implementation and enforcement

of the new regulations is inconsistent.

Efficient Capital Markets and Portfolio Investment

--------------------------------------------- -----

Availability of financial resources

63. Retained profits finance about 70 percent of

private investment, with short term borrowing

financing a further 20 percent of investment. The

stock market and corporate securities market have not

been significantly used to raise capital. FDI

finances about 4 percent of investment.

64. The State consumes over 50 percent of the

country's domestic financial resources, and has a

virtual monopoly on the management and use of long

term savings in the country. This inhibits the free

flow of financial resources to product and factor

markets. In the past, high interest rate volatility

due to excessive use of short term borrowing by the

state increased intermediation cost leading to higher

costs to other borrowers. The current government has

initiated a low interest rate regime and has begun to

replace short-term government debt with long-term

debt. Together with lower inflation and improved

government fiscal discipline this contributed to

lower interest rates during the past 18 months. The

Central Bank has decreased its key monetary policy

rates significantly during this period. The prime

lending rate currently averages 10.36 percent

compared with about 21.5 percent in December 2000.

Foreign investors are allowed to access credit on the

local market. They are also free to raise foreign

currency loans.

65. In 2002, there was a revival in the Colombo

stock market. A total of Rs 4.0 billion (approx. $42

million) was raised in the primary market by way of

new equity and debt, reflecting the potential for

companies to raise funds through the market. Due to

economic and political problems and depressed stock

market conditions, capital raised in the primary

market was extremely low during 1999-2001.

66. The International Finance Corporation (IFC), the

arm of the World Bank group which invests in the

private sector, also provides equity and debt

financing for private sector ventures in Sri Lanka

such as infrastructure, financial markets, tourism,

IT, healthcare and education as well as general

manufacturing and services. The IFC's current

portfolio in Sri Lanka is about $75 million.

Credit Instruments

67. Commercial banks and two development finance

institutions, the National Development Bank (NDB) and

the Development Finance Corporation of Ceylon Bank

(DFCC), are the principal source of bank finance.

Bank loans are the most widely used credit instrument

for the private sector. Financial institutions such

as the DFCC and some commercial banks also raise

syndicated bank loans to fund large-scale investment

projects undertaken by the private sector.

68. The domestic debt market in Sri Lanka is still

at a very nascent stage. A few leading companies and

financial institutions have raised capital through

credit instruments such as debentures, corporate

bonds and commercial paper. In the past, high

interest rates on government bonds due to excessive

government borrowing have made it unprofitable for

private companies to raise capital through corporate

bonds. This situation is set to change with the

current relatively low interest rates on government

bonds. In 2002, Rs 2.7 billion ($27.8 million) was

raised through listed debentures. Corporate debt of

both publicly listed companies and companies not

listed on the stock exchange are traded through the

stock exchange. Fitch IBRC (formerly Duff and Phelps

Credit Rating Company) which opened an office in

Colombo in 1999, is the only credit rating agency in

Sri Lanka. The local branch company, Fitch Rating

Lanka Ltd, is a joint venture between Fitch IBRC,

IFC, the Central Bank of Sri Lanka and several local

financial institutions. Fitch Lanka rates debt

instruments of corporations, banks and other

financial institutions in accordance with

international rating standards. But a strong credit

rating culture has not yet developed in Sri Lanka.

This is set to change as the government has made

credit ratings mandatory for all deposit taking

institutions from January 2004. Credit ratings are

also mandatory for all varieties of debt instruments.

Accounting Standards

69. There is an active and relatively competent

accounting profession, based on the British model.

The source of accounting standards is the Institute

of Chartered Accountants of Sri Lanka (ICASL) and

standards are constantly updated to reflect current

international accounting and audit standards. Due to

the lack of an adequate enforcement mechanism,

however, problems with the quality and reliability of

financial statements exist. Sri Lanka carried out a

major revision of accounting and auditing standards

in September 1997. Since then, the standards have

been periodically updated to meet new international

standards adopted by the International Accounting

Standards Board (IASB). As of mid 2003, there were

five new international standards awaiting adoption in

Sri Lanka.

70. Sri Lanka accounting standards are applicable

for all banks and companies listed on the stock

exchange and all other large- and medium-sized

companies in Sri Lanka. Accounts of such business

enterprises are required to be audited by

professionally qualified auditors holding ICASL

membership. ICASL has recently published accounting

standards for small companies as well. Companies in

Sri Lanka now have the choice of adopting

International Financial Reporting Standards (IFRS) of

the IASB. An Accounting Standards and Monitoring

Board (ASMB) which started operations in April 2000,

is responsible for monitoring compliance with Sri

Lanka accounting and auditing standards. In 2001,

the ASMB has reviewed financial statements of 397

companies and found major deviations in 9 percent of

the financial statements.

Securities Exchange Commission

71. The Securities and Exchange Commission (SEC)

regulates the securities market in Sri Lanka. The

SEC law was revised in 2003, enhancing its coverage

and investigative powers. The SEC now covers stock

exchanges, unit trusts, stock brokers, listed public

companies, margin traders, underwriters, investment

managers, credit rating agencies and securities

depositories.

72. Foreign investors can freely purchase up to 100

percent of equity in Sri Lankan companies in numerous

permitted sectors. In order to facilitate portfolio

investments, country funds and regional funds are

also allowed to invest in Sri Lanka's stock market;

such funds must first receive Ministry of Finance

approval to operate in Sri Lanka. These funds make

transactions through share investment external rupee

accounts maintained in commercial banks.

73. Sri Lanka's SEC was rocked by a scandal in early

2003, tarnishing the image of the market watchdog.

The SEC Chairman and another leading businessman were

implicated for insider dealing at a blue chip local

conglomerate where they were both directors. Initial

attempts by the SEC secretariat to institute legal

actions against the two were blocked by the SEC Board

of Directors. Later, the Attorney General ruled that

the SEC Board had acted improperly, casting doubt on

the board members' credibility. Since then, the SEC

Chairman has resigned. He has pleaded innocent and

has filed legal action, opposing SEC decision to

prosecute. The SEC is awaiting a decision on this

case to proceed with legal action. The SEC Director

General, who was instrumental in pursuing the case,

also resigned, citing unwarranted interference by the

SEC board of directors to stop investigations.

74. The SEC scandal has caused many to call for

increased corporate governance and accountability in

the private sector. Some business consultants have

asked for laws such as the recent US Sarbanes-Oxley

Act to regulate financial services and professional

services organizations.

Colombo Stock Exchange

75. The Colombo Stock Exchange (CSE), while small by

"big emerging market" standards, is one of the most

efficient in the region. The CSE is fully automated,

with automated trading and clearing and settlement

systems. The CSE has a rolling settlement period of

five days for buyers and six days for sellers.

Fifteen local and foreign joint venture brokers

currently operate at the CSE. Foreign stock-brokers

are permitted to hold up to 100 percent equity in

stock broking firms operating at the CSE. SEC has a

settlement guarantee fund with an initial capital of

Rs 100 million ($1 million) which aims to guarantee

the settlement of trades between clearing members of

the exchange. The Chartered Financial Analysts (CFA)

program is conducted in Sri Lanka.

76. Acquisition of companies through mergers and

takeovers is governed by the Takeovers and Mergers

Code of 1995 made under the Securities and Exchange

Commission of Sri Lanka Act. This law applies only

to companies listed on the Colombo Stock Exchange.

Acquisition of more than a 30 percent stake of a

listed company requires the buyer to make an offer to

all other shareholders. There are 240 companies

listed on the stock exchange. The articles of

association of a few listed companies restrict

foreign equity to certain levels.

77. In mid-2003, CSE was one of the best performing

markets in the world. In June 2003, the stock market

hit an all time high. The cease-fire agreement

between the Government of Sri Lanka and the LTTE and

economic reforms has helped to boost investor

confidence. During 1998-2001, the Colombo Stock

Market experienced a sharp downturn due to a variety

of local and international factors. The CSE was

removed from the Morgan Stanley Capital International

(MSCI) Index in 2001 due to a drop in market

capitalization and liquidity. The CSE hopes to get

reclassified in the MSCI soon. The single overriding

factor inhibiting the sustainable development of the

stock market has been the conflict in the North and

East and its effect on investor confidence and the

economy as a whole. Other broader issues include

lack of liquidity and limited market size.

Improvements are also needed in corporate governance,

accountability and public disclosure in companies.

The Accounting and Auditing Standards Monitoring

Board, the Ceylon Chamber of Commerce, the Colombo

Stock Exchange and professional accounting bodies are

taking initiatives in these areas.

Banking System

78. Sri Lanka has a fairly well diversified banking

system. There are 23 commercial banks, consisting of

eleven local banks and twelve foreign banks. In

addition, there are thirteen local specialized banks.

The banking sector moved towards consolidation in

2001-2002 as four foreign commercial banks, ABN Amro,

Nova Scotia, Habib Bank AG Zurich and American

Express left Sri Lanka after selling their

operations. Citibank NA is the only US bank

operating in Sri Lanka and has expanded its

operations recently. In 2002, the American Express

Bank sold its banking operations in Colombo in

keeping with its global strategy. Sri Lanka

experienced its first bank failure in December 2002,

when the Central Bank took action to revoke the

license of a small licensed specialized bank as its

financial condition deteriorated to insolvency.

There has not been any fallout for other banks from

this incident as of June 2003. At the request of the

Central Bank, two other small troubled commercial

banks are being taken over by larger banks. Sri

Lanka's banking sector has various outdated

regulations that restrict banking sector

consolidation. The Government is proposing to amend

the Banking Act to further facilitate mergers and

acquisitions in the banking sector in a strategy to

help consolidation. Further, the Government has

launched an extensive financial sector reforms

program, which is set to overhaul the financial

sector to suit modern times.

79. The Central Bank is responsible for supervision

of all banking institutions. Wide-ranging

improvements have been made in banking regulation and

in public disclosure of banking sector performance.

In 1997, the Central Bank issued, for the first time,

directives on loan classification, suspension of

interest, provisioning, investments in equity, and

the acquisition of immovable property, and it

tightened its directives on capital adequacy and

single borrowers. Subsequently, the Central Bank has

expanded its reporting system to monitor compliance.

Standards for the public disclosure of banking sector

data were raised considerably in 1999. With the

exception of classification and provisioning, all

Central Bank requirements are up to international

standards. In 2002, the Monetary Law Act (MLA) was

amended to provide Central Bank broader supervisory

powers and greater independence. It also contained

improvements to the payment and settlement systems.

The bank also commenced additional training programs

for bank supervision staff and introduced more on-

site and off-site surveillance during the year. The

Central Bank also issued a code of corporate

governance for banks and financial institutions in

2002.

80. Despite recent progress, bank supervision

remains weak. Central Bank supervision as well as

auditing practices of private audit firms came under

criticism after the recent specialized bank failure

mentioned above. The Central Bank is planning to

obtain the services of an international expert to

strengthen bank supervision in 2003. In addition,

the Government is proposing to introduce amendments

to the Banking Act to enhance Central Bank's

supervision capacity (including fit and proper tests

of new entrants and penal violations for violation of

prudential laws). Further amendments to the MLA are

also expected in the next two years under ongoing

financial and legal reforms programs.

State Owned Banks

81. Total assets of the commercial banks stood at Rs

788 billion ($8.1 billion) as of December 31, 2002.

Despite a gradual loss in market share, the two

state-owned commercial banks, Bank of Ceylon and

People's Bank with assets of Rs 228 billion and Rs

180 billion, respectively, still dominate banking,

making up a little over half of all assets and

liabilities. The state banks are weak, with high

NPLs, inadequate loan loss provisioning, low

equity/assets ratio. Much of that is due to past

government interference. Since most of the bad debt

of the two banks is implicitly guaranteed by the

state, these problems do not affect the credibility

of the banking system in Sri Lanka.

82. The weaknesses in the state banks, however, make

it possible for other inefficient banks to operate

and for the more efficient banks to make higher

profits than they would otherwise. The World Bank

and IMF have identified the dominance of the

inefficient state banks as a main constraint for

development of the financial sector. In a bid to

overcome the problems at the state-owned banks, the

Government has been trying to reorganize the banks

since mid 1998. Both banks have launched

restructuring exercises to return to commercial

viability in the medium term. Top management at both

Bank of Ceylon and People's Bank now contains members

from the business community and experienced bankers

from the private sector. Corporate governance

practices in the state banks, however, remain

questionable.

83. Bank of Ceylon met most of the World Bank

established restructuring targets by end 2002,

including loan recovery and return on assets. The

situation at People's Bank, however, remains grave.

Although the People's Bank strengthened its financial

position, reflecting increased recoveries and higher

margins and posted a profit in 2002, the Bank is

insolvent. The Government has agreed on the urgent

need for the restructuring of the Peoples Bank under

the PRGF with the IMF. As a first option, the

Government has set a December 2003 target to sell the

Bank as a single unit, after transferring problem

loans to an asset management company. If this fails,

it is proposed to separate the bank into a savings

and commercial bank-the former remaining under the

government and the latter divested. In either case,

the Government aims to complete the restructuring by

March 2004.

Private Commercial Banks and foreign banks

84. 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. Banking sector profits increased

quite sharply in 2002 after suffering badly in 2001

due to the economic slowdown. Nonetheless, the

private banking sector also remains trapped with a

high level of non-performing loans, despite high

margins. In 2002, the average rate of non-performing

loans to total loans was 19 percent for the two state

commercial banks, 15.3 percent for private domestic

banks and 12.1 percent for foreign banks operating in

Sri Lanka. There are concerns regarding inadequate

loan loss provisioning and low operational efficiency

in some local private banks. Foreign banks tend to

make provisions in line with international best

practices as most foreign bank branches are subject

to home country supervision in addition to that of

the Central Bank of Sri Lanka. To help improve bank

performance, an Asset Management Company Law is being

prepared with World Bank and IMF assistance. The law

aims to provide troubled banks with a mechanism to

effectively deal with their non-performing loans.

85. Credit ratings will become mandatory for all

banks operating in Sri Lanka from January 2004.

Currently, six banks have been assigned ratings by

Fitch Ratings: State-owned National Savings Bank:SL

AAA; Citibank NA, Colombo:SL AAA; Commercial Bank of

Ceylon:SLAA+,.DFCC Bank:SL AA; Bank of Ceylon:SL AA-

and Hatton National Bank: SL A.

Capital Adequacy

86. Sri Lanka adopted capital adequacy standards set

by the Basel Committee on banking regulations and

supervisory practices in 1993. The Central Bank has

raised the minimum capital adequacy standards from

4.5 to 5 percent for core capital (Tier I) and from 9

to 10 percent for risk weighted assets (Tier I and

Tier II) from January 2003. Further enhancing

banking sector stability, Central Bank has also

imposed capital adequacy standards on foreign

currency banking units from June 30, 2003.

87. The two state owned banks' risk based capital

asset ratio (CA) at 0.3 percent was well below the

minimum in 2002. For private domestic banks, CA

averaged 9.3. The foreign banks comfortably met the

requirement at 36.6 percent.

Political Violence

------------------

88. Since early 2002, there has been a marked

improvement in the business climate due to the

peaceful atmosphere prevailing in the country. This

is in contrast to the period between 1983-2001, when

the country was plagued by ethnic conflict, a civil

war and related urban terrorism. The fighting

between the Liberation Tigers of Tamil Eelam (LTTE)

and the Sri Lankan military was primarily in northern

and eastern Sri Lanka, but other parts of the country

suffered sporadic terrorist attacks. Since 1997, the

LTTE has been on the State Department list of foreign

terrorist organizations. Terrorist activities of the

LTTE have declined significantly since late 2001 when

the LTTE declared a unilateral cease-fire and signed

a formal open-ended cease-fire agreement on February

22, 2002 with the hope of ending the war. The two

parties have held six rounds of peace talks with the

government of Norway acting as facilitator. The

LTTE, which temporarily suspended its participation

in the peace talks in April 2003 was giving signals

of returning to the talks as of July 2003. Although

several ceasefire violations have been recorded, the

enduring ceasefire in Sri Lanka has increased

investor confidence and has allowed the government

and private sector to embark on new investment and

business initiatives. There are no guarantees that

the process will succeed in ending the years of

conflict, but optimism is stronger than at any time

in the past decade.

89. During the almost 19 years of war, tourists and

foreign business representatives have not been

terrorist targets but have suffered collateral injury

during attacks on other targets. On July 24, 2001

the LTTE attacked the International Airport and

destroyed both commercial and military aircraft.

Several military personnel were killed in the attack,

military and airport employees were injured, and

civilians were caught in crossfire. Sri Lankan

Airlines, jointly owned by the Government of Sri

Lanka and Emirates Airlines of Dubai, lost several

commercial aircraft in the attack. The LTTE has

also attacked several commercial ships flying foreign

flags in the waters off the north and east of the

country. In response to these attacks, insurers

imposed war risk insurance surcharges on aircraft and

ships using Sri Lankan seaports and airports. These

surcharges have since been lifted. During the

conflict, the LTTE also detonated several large bombs

in Colombo's financial and business districts causing

extensive damage to life and property. Very few

foreigners were injured in these terrorist incidents

due to the LTTE's policy of targeting local

interests. There have been no major attacks since

the peace process began on December 24, 2001. In

recent months (April-July 2003), however, the LTTE is

implicated in the slayings of several anti-LTTE

politicians of Tamil heritage. There have also been

several violent incidents at sea.

90. In 1998, the US Peace Corps suspended operations

in Sri Lanka after LTTE bombings occurred outside the

Colombo area, including places such as Galle in the

south and Kandy in the central highlands -- locations

where volunteers had been posted, based on the low

probability of terrorist attacks. There are efforts

by the current government to bring the Peace Corps

back and a Peace Corps assessment team is expected in

September.

Corruption

----------

91. The country has fairly adequate laws and

regulations to combat corruption, but they are

unevenly enforced. US firms identify corruption as a

constraint on foreign investment, but, by and large,

it is not a major threat to operating in Sri Lanka.

Corruption is a persistent problem in customs

clearance and enables wide-scale smuggling of certain

consumer items, to the detriment of legitimate

manufacturers and importers. Corruption appears to

have the greatest effect on investors in large

projects as well as government procurement and

tendering, especially in previous defense purchases.

The law states that giving or accepting a bribe is a

criminal offense and carries a maximum sentence of

seven years imprisonment and a fine at the discretion

of the courts. The Bribery Commission is the main

body responsible for investigating allegations of

bribery and corruption. The function of the Bribery

Commission, under Act No 19 of 1994, is to

investigate allegations brought to its attention and

institute proceedings against responsible individuals

in the appropriate court. The commission was

appointed for a 5-year term in December 1999 but has

not been effective in dealing with bribery or

corruption. As of June 2003, this commission was not

functioning, due to the failure of the Constitutional

Council to fill a vacancy caused by the death of one

of the three commissioners.

92. Few have been found guilty of corruption in

recent years. Highly publicized efforts to

investigate bribery and corruption have failed,

damaging public confidence in such processes. During

the latter part of previous Government's term,

corruption charges were leveled against politicians

and top officials in charge of key government

corporations, but no politician has been prosecuted

for bribery or corruption. In 2002, the Criminal

Investigation Department raided bank vaults of a

former senior cabinet minister and discovered a large

cache of certificates of deposits for millions of

rupees. The Bribery Commission is investigating this

case. In April 2001, the Chairman of the Board of

Investment was forced to resign on allegations of

bribery and corruption. He is currently being

prosecuted for bribery. A handful of other key

government officials, including the former General

Manager of Railways, are being prosecuted for

corruption and bribery, but prosecutions are

proceeding slowly.

93. The current UNF government came into power

promising a corruption-free regime, but corruption

allegations continue to surface regularly. In

response to various reports of corruption and lack of

an effective mechanism to handle corruption

complaints, the ruling United National Party has

recently appointed an internal party committee to

investigate corruption allegations of its members.

The Government is also taking other steps to combat

corruption. All tenders presented for Cabinet

approval now need to be routed through a cabinet

subcommittee chaired by the Minister of Finance.

Tender board decisions presented to the subcommittee

are vetted thoroughly by Treasury officials. The

Government has taken additional measures to regulate

defense spending by appointing a Budget Monitoring

Committee and a Procurement Monitoring Committee in

the Defense Ministry.

94. Transparency International (TI), an

international "watchdog" organization promoting anti-

corruption strategies, opened a national chapter in

Sri Lanka in September 1999. In TI's Corruption

Perception Index for 2002, Sri Lanka was ranked 52

among 102 countries with a score of 3.7 out of a

clean score of 10, reflecting a relatively high

perceived level of corruption among politicians and

public officials. TI has asked the international

donor community to ensure transparency and clear

lines of accountability in the disbursement of donor

aid for post war reconstruction.

Bilateral Investment Agreements

-------------------------------

95. The Government of Sri Lanka has signed

Investment Protection Agreements with the United

States (which came into force in May 1993) and the

following 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

96. A bilateral treaty on avoidance of double

taxation between Sri Lanka and United States is

currently awaiting ratification by both sides.

97. Foreign investors not qualifying for BOI

incentives such as tax and exchange control

exemptions or concessions will be liable to pay taxes

on corporate profits, dividends, and remittance of

profits. They will also be liable to pay a Value

Added Tax on goods and services. The Government has

also imposed a tax of 0.1 percent on debits to any

current or savings account maintained at any bank in

Sri Lanka. Debits made to accounts of Government and

international organizations are excluded. Accounts

maintained at Foreign Currency Banking Units,

accounts maintained for stock exchange transactions

(SIERA) and resident and non-resident foreign

currency accounts are exempted from the tax. The

Embassy encourages prospective US investors to

contact an international auditing firm operating in

Sri Lanka to assess their tax liability.

OPIC and Other Investment Insurance Programs

--------------------------------------------

98. The US and Sri Lanka concluded in 1966 (and

renewed in 1993) an agreement that allows the

Overseas Private Investment Corporation (OPIC) to

provide investment insurance guarantees for US

investors. OPIC currently provides coverage to

banking and power sector investments in Sri Lanka.

Sri Lanka's membership in the Multilateral Investment

Guarantee Agency (MIGA) offers the opportunity for

insurance against non-commercial risks.

99. Over $12 million is spent annually by the US

Embassy and other US Government institutions in Sri

Lanka. This amount can potentially be utilized by

OPIC to honor an inconvertibility claim; however, no

such claims have been made to date in Sri Lanka. The

Embassy purchases local currency at the financial

rate. The Sri Lankan Rupee has been quite stable

during past 12 months. The currency is not expected

to fluctuate by more than 10 percent relative to the

US dollar over the next year.

Labor

-----

Labor Force

100. Sri Lanka's labor force is literate and

trainable, although weak in certain technical skills.

More computer skills training programs are becoming

available, but the demand still outpaces supply and

many qualified workers seek employment overseas. The

average worker has eight years of schooling. Two-

thirds of the labor force is male. The unemployment

rate (employment is defined as one who worked for

pay, profit or unpaid family gain for one or more

hours during the survey week) in the third quarter of

2002 was 9.1 percent, with an estimated 641,000 of a

total labor force of 7.1 million out of work. (Labor

force data excludes the North and East; armed forces

personnel deployed away from home and Sri Lankan

migrant workers abroad.) Including unpaid family

workers, the unemployment rate is 10.0 percent.

Youth unemployment remains a critical problem.

Nearly 80 percent of unemployed persons are in the

15-29 year age range. Over 50 percent of unemployed

youth are educated at the O-Level (10th grade) or

higher.

101. A significant proportion of unemployed seek

"white collar" jobs, and most sectors facing labor

shortages offer manual or semi-skilled jobs or

require technical or professional skills such as

management, marketing, information technology,

accountancy and finance, and English language. The

Government has recognized the challenge of

reformulating the educational system to meet the

needs of the private sector better, but it will take

time before the mismatch of skills to requirements is

addressed. Asian Development Bank and the World Bank

have recently approved projects to improve distance

learning and tertiary education. The Government has

also embarked on a "Youth Corps" program to provide

job related training to the unemployed.

Migrant Workers Abroad

102. There are an estimated 970,000 Sri Lankan

workers abroad. The majority of Sri Lankan workers

abroad is unskilled (housemaids and laborers) and is

located primarily in the Middle East. Sri Lanka is

also losing many of its technically and

professionally qualified workers to more lucrative

jobs abroad.

Labor Regulations, Cost of Labor

103. Labor is available at a relatively low cost,

though it is priced higher than in other South Asian

countries. Child labor is prohibited and is

virtually nonexistent in the organized sector though

child labor occurs in informal sectors. The minimum

legal age for employment is set at 14. Most

permanent full-time workers are covered by laws

pertaining to maximum hours of work, minimum wage,

leave, the right of association, and safety and

health standards. The Termination of Employment Act

(TEA) makes it difficult to fire or lay off workers

who have been employed more than six months for any

reason other than serious, well-documented

disciplinary problems. Disputes over dismissals can

be brought to a labor tribunal administered by the

Ministry of Justice. The labor tribunals have large

backlogs of unresolved cases. Certain labor disputes

founded upon fundamental rights (allegations of

termination/transfers based upon discrimination,

etc.) can be brought directly to the Supreme Court.

TEA prevented many companies from laying off

permanent staff in 2001 despite economic contraction

and export slowdown. Consequently, affected

companies had to bear the cost of maintaining excess

labor.

104. There is widespread belief that the labor laws

and a plethora of holidays are dampening

productivity. The full moon day of each month, if it

falls on a weekday, is a paid holiday. There are

also eight other public holidays. The public sector

and banks enjoy additional holidays. The statutory

holidays are in addition to 21 days annual/casual

leave and approximately 21 days sick leave (number of

days for sick leave is at the discretion of the

management). In addition, female employees are

entitled to 84 days fully paid maternity leave for

the first two confinements.

Labor reforms

105. The current Government has embarked on a

program to carry out needed labor reforms covering

legal reforms, training and employment and increasing

productivity of the labor force. In January 2003,

the Parliament passed amendments to the TEA and the

Industrial Disputes Act (IDA) to improve labor

mobility. The amendments to TEA seek to facilitate

easier termination, and provided for a standard

compensation formula and an unemployment benefit

scheme. Amendments to the IDA included time-bound

labor dispute resolution rules to expedite labor

dispute resolution. These laws will come into effect

only after a new compensation formula and a new

unemployment insurance scheme are established. The

current social safety net for the unemployed is

inadequate and compensation is subject to

discretionary rulings by the Labor Commissioner. In

the interim, the Labor Department uses the following

non-binding minimum compensation formula as a

guideline: 2 to 3 months salary for each year of

service or full salary for remaining period of

service up to retirement, whichever is less, subject

to a maximum of 50 months salary. Some trade unions

have shown reluctance to accept this formula and some

companies have offered better packages. The

Government also relaxed restrictions on overtime work

by women, permitting them to 60 hours of overtime

work per month instead of 100 hours per year. Other

planned reforms include amendments to the Shop and

Office Act to allow shop and office employees to work

on shift basis and an amendment to the wages board

ordinance, to encourage outsourcing and

subcontracting. These amendments are expected to

especially facilitate call center-type operations. A

more systematic overhaul of the TEA and IDA would

help to bring labor laws in line with international

norms.

106. In addition to labor reforms, the Government

has also prepared policy documents on labor. A joint

public and private sector committee has prepared a

draft national employment policy. The policy

contains seven initiatives to facilitate employment

creation through economic growth and improve

employability of the current work force. Among other

measures, it recommends labor law reforms to

facilitate private investment and improvements to

tripartite dialogue between the state, private sector

and employees to deal with industrial relations

issues. The Government has also developed a national

productivity policy with the assistance of USAID. It

is aimed at developing long-term strategies to

enhance productivity in all sectors of the economy.

Trade Unions

107. About 15 percent of labor in the industry and

service sector is unionized. Labor in free trade

zone enterprises tends to be represented by non-union

worker councils.

108. In 1999, the Government introduced regulations

that prohibit unfair labor practices by employers.

The law now requires employers to recognize trade

unions and the right to collective bargaining, in

line with ILO Convention 87 on freedom of association

and 98 on the right to organize and bargain

collectively. The law compels employers to enter

into negotiations with a trade union where the

membership is at least 40 percent of the total

workforce. Some employers have been reluctant to

accept this legislation as they claim it is one-sided

and does not contain reciprocal guarantees from trade

unions for responsible conduct.

109. Unions have complained that the government 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 Janatha Vimukthi Peramuna (JVP), a Marxist

political party that is against private ownership, is

provoking labor to strike in the guise of trade union

activity. Due to its violent past, employers are

generally not in favor of the JVP and its trade union

arm, the Inter-Company Trade Union. Prior to the

December 2001 parliamentary elections, Inter-Company

Trade Union became popular among workers. It also

staged strikes and protests in a few companies during

2002. Although the JVP continues to agitate against

economic reforms and the peace process, its trade

union activities are limited to normal union actions.

110. In 2002, the American Federation of Labor and

Congress of Industrial Organizations (AFL-CIO)

submitted a petition to the United States Trade

Representative seeking suspension of GSP benefits for

Sri Lanka due to labor right violations in some

factories in the export processing zones. This

petition was not acted upon. A similar submission

was made to the EU by a local trade union when Sri

Lanka applied for benefits under the special

incentive arrangements of the GSP. After an audit,

the EU is positively considering granting

preferential access to Sri Lanka based on protection

of core labor standards. The audit did not find

serious problems with regard to core labor standards.

The BOI has issued a new "labor standards and

employee relations manual", instructing BOI companies

to recognize trade unions and the right to collective

bargaining. According to the manual, 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.

111. In the plantation sector, union participation

rates are as high as 75 percent, though unionization

levels are reportedly on the decline. Key public

sector entities such as the Ceylon Electricity Board

and Sri Lanka Ports Authority also have large unions,

which stage protests, often to obtain pay hikes and

sometimes to protest anticipated moves towards

privatization or restructuring. Most of the major

trade unions are affiliated with political parties,

creating a highly politicized labor environment. In

what is seen as a positive development, several trade

unions with affiliations to main political parties

have formed themselves into an organized group, the

National Association for Trade Union Research and

Education (NATURE), to promote education and training

among trade unionists.

Collective Bargaining

112. Collective bargaining is not yet popular.

Currently, about 50 companies (including a number of

foreign-owned firms) belonging to the Employers'

Federation of Ceylon (EFC) have collective agreements

and use them to conduct negotiations on their behalf.

Labor-Management Relations

113. Labor-management relations in the past have

e

been by and large confrontational. This is due to a

failure to recognize the need for a social

partnership for mutual benefit. The attitude of

employers towards workers has changed considerably in

the last few years. Employers are becoming more

conscious of the need to look after their human

resources, and more effort is taken to ensure that

workers feel motivated and cared for. Labor-

management relations vary from organization to

organization; managers who emphasize communication

with workers and offer training opportunities

generally experience fewer difficulties. US

investors in Sri Lanka (including US garment buyers)

generally promote good labor management relations and

labor conditions that exceed local standards. A few

large Sri Lankan firms have started Employee Share

Option Schemes. Work stoppages and strikes in the

private sector have been on a decline in the past six

months. Civil servants other than officers in the

police, armed forces, and prison service, also have a

right to strike.

ILO conventions

114. Sri Lanka is a member of the International

Labor Organization (ILO) and has ratified 39

international labor conventions. The labor laws of

Sri Lanka are laid out in almost 50 different

statutes. Sri Lanka has ratified all eight

conventions included in 1998 ILO Declaration on

Fundamental Principals and Rights at Work (ILO Core

Labor Standards). ILO Convention 138 on minimum age

for admission to employment and Convention 182 on

worst forms of child labor were ratified during 2000-

2001. Sri Lanka ratified ILO convention 105 on

Forced Labor in 2003. The ILO, EFC and the AFL-CIO-

sponsored American Center for Labor Solidarity are

working to improve awareness about core labor

standards. The ILO also promotes a Decent Work

Agenda in Sri Lanka.

Foreign Trade Zones

-------------------

115. Sri Lanka has 10 free trade zones, also called

export-processing zones, administered by the BOI.

The oldest, the Katunayake and Biyagama Zones,

located north of Colombo near the Bandaranaike

International Airport, are fully occupied. The third

zone is located at Koggala on the southern coast.

Several new mini export-processing zones were opened

in the provinces during the last few years. There

are nearly 200 foreign export processing enterprises

operating in these zones. There are also two

industrial parks that have both export-oriented and

non-export oriented factories. They are located in

Pallekelle, near Kandy in central Sri Lanka and in

Seethawaka in Avissawela about 60 kilometers from

Colombo.

116. In the past, industrialists preferred to locate

their factories in close proximity to Colombo harbor

or airport to reduce transport cost and save time.

The excessive concentration of industries around

Colombo has created problems such as scarcity of

labor, inadequate infrastructure, environmental

pollution, escalation of real estate prices and

congestion in the city. Now, the BOI actively

encourages the establishment of export-oriented

factories in the newly developed industrial zones.

The BOI also finds it easier to provide

infrastructure facilities and security, as well as to

monitor enterprises, when they are located in the

zones.

Foreign Direct Investment

-------------------------

US Investments

117. Major US companies with investments in Sri

Lanka include: Energizer Battery, Mast Industries,

Smart Shirts (a subsidiary of Kellwood Industries),

Caltex, Sportif, Citibank, Caterpillar, 3M, Cargill,

Coca Cola, Celetron, Inc (formerly Tandon), Paxar

Corp, Pepsi Co, Warburg Pincus, Worldquest, Fitch

IBCR, AES Corporation, American International Group

(AIG) and American Premium Water. In addition, IBM,

Lanier, NCR, GTE, Motorola, Procter & Gamble, Liz

Claiborne, May Department Stores, Federated

Department Stores, Tommy Hilfiger, J.C. Penney, the

Gap, Sun Microsystems, Microsoft, Bates Strategic

Alliance, McCann-Erickson, Pricewaterhouse Coopers,

Ernst and Young and KPMG all have branches,

affiliated offices or local

distributors/representatives. Kentucky Fried

Chicken, Pizza Hut, Federal Express, UPS, Domino's

Pizza and McDonald's are represented in Sri Lanka

through franchises. Numerous other American brands

and products are represented by local agents.

118. US investment in Sri Lanka is estimated to be

in the range of $200 million. Among the recent

investors in the power sector are AES Corporation and

Caterpillar. AIG insurance entered Sri Lanka in

1999. Others are expanding, such as Celetron Inc

(memory boards), Citibank, and Mast Inc (apparel and

related products). During the past few years,

several US companies have formed joint ventures or

other partnerships with Sri Lankan companies in the

IT sector, mainly in software development.

Non-US Investments

119. Major non-US investors include: Unilever,

Nestle's, British American Tobacco Company, Mitsui,

Pacific Dunlop/Ansell, Prima, FDK and S.P. Tao.

Indian Oil Corporation came to Sri Lanka in 2003,

investing in an abandoned oil tank farm and the

petroleum retailing business of the Ceylon Petroleum

Corporation. Leading US and foreign investors which

have acquired significant stakes in privatized

companies include Caltex; Norsk Hydro of Norway;

Kabool Spinning and Textile, Tongyang Nylon, and

Hanjung Steel, all of Korea; Nippon Telephone and

Telegraph, Mitsubishi Corporation and C. Itoh (A.K.A.

Itochu) of Japan; Emirates Airlines of United Arab

Emirates; Shell Oil of the UK; and P Netherlands.

120. Reliable statistics on foreign investment by

country are not available. Leading sources of

foreign investments are South Korea, Japan, US,

Australia, Hong Kong, Singapore, and the U.K. FDI in

2002 was $246 million.

Investment Statistics

121. Estimated total foreign investment by sector

(in $ millions)

SectorCumulative Total

End 2002

Food & beverage91

Textile/apparel, leather265

Chemical, rubber, plastic115

stic 115

Non-met. Mineral products37

Fabricated metal, machinery58

Other manufactured products101

Services1,056

Total1,723

Source: Board of Investment of Sri Lanka

Note: Investment figures reported here consist of

direct investment plus loan financing. The data

provided by the BOI are incomplete. They do not

include foreign investment that came through non-BOI

sources prior to 1994. Foreign investment in the

banking and insurance sectors are also not included.

Figures reported by the BOI have been converted at

average exchange rates prevailing in 2001 and 2002.

End text.

ENTWISTLE

ISTLE