BOARD

OF
DIRECTORS

ASIAN

DEVELOPMENT

BANK

INAST1R COPYI
IN.1-98 2 January 1998

SPECIAL STUDY

The following Special Study prepared by the Post-Evaluation attached for information:

Office is

Macroeconomic

Environment and Project Performance in Sri Lanka

(SPECIAL STUDY SERIES NUMBER 28)

SPECIAL STUDY

OFTHE

MACROECONOMIC

ENVIRONMENT

AND PROJECT PERFORMANCE

IN SRI LANKA

December 1997

CURRENCY EQUIVALENTS Currency Unit - Sri Lanka Rupee/s (SLRe/SLRs) (as of September 1997) SLRe1.00 $0.017 $1.00 = SLRs58.63

=

ABBREVIATIONS GOP REER Gross Domestic Product Real Effective Exchange Rate

NOTES (i) (ii) The fiscal year (FY) of the Government ends on 31 December. In this Report, U$" refers to US dollars.

SS - 28

CONTENTS Page EXECUTIVE SUMMARY I. INTRODUCTION

A.
B. C. II.

Background Performance of Bank Projects in Sri Lanka . Study Objectives and Methodology

1 1
1 2

MAIN FINDINGS

A.
B. III. IV.

The Pervasive Effect of the Economic Environment and of Economic Policies on Bank Projects The Impact of Bank Projects on Policies and on the Economy

2

8
9 9 9 10 10

KEY ISSUES AND IMPLICATIONS FOR THE BANK'S CURRENT PROGRAM CONCLUSIONS AND RECOMMENDATIONS

A.
B.

C.
APPENDIXES

Overall Assessment Lessons Learned Recommendations

11

EXECUTIVE SUMMARY The Bank's past assistance to Sri Lanka has shown varying degrees of success. Out of 26 projects postevaluated, only 46 percent were successful. A number of projects have met implementation difficulties rooted in macroeconomic policy changes. This Study arose from the need to assess the linkage between project performance and the specific conditions associated with the macroeconomic environment. The objectives of the Study are to assess the Sri Lankan macroeconomic conditions and policies at the time of project implementation, evaluate the impact of such conditions and policies on the projects, and establish lessons learned associated with policy changes. The study was conducted over a three-week period in Sri Lanka and is based on a review of selected projects that have been postevaluated. The success of the postevaluated Bank projects in Sri Lanka was substantially affected by changes in economic policy and the economic environment. The sectors exhibited no systematic differences in the vulnerability of projects to changes in policy. Because Sri Lanka is a relatively open and small economy, projects were most seriously affected by changes in world prices and in foreign trade policies, especially in the real effective exchange rate. The civil conflict also had a profound effect on the success or failure of Bank-assisted projects. Despite the substantial dismantling of Government controls over the economy since 1977, changes in the control regime still had a substantial impact. Fiscal policy was next in importance, with monetary policy of least significance to the projects reviewed. While Sri Lankan economic policies had a strong impact on Bank projects, Bank projects had only a limited effect on economic policies and on the economy. One reason is that most of the projects reviewed were developed before policy conditionalities became an important element in Bank projects. The lessons are clear: it is important to take account of the impact of policies and policy changes on Bank projects and, even more important, for the Bank to help shape these changes. The key issues involved the need to pay greater attention to the macroeconomic environment during project formulation and implementation, the sustainability of policy reforms, and the challenge of pursuing policy reforms in an integrative, coherent, and focused manner to effect the desired policy changes. The most important conclusion of the study is to emphasize the importance of economic policies for the success or failure of Bank programs and therefore the importance of policy conditions in shaping a program strategy. Recommendations include the giving of adequate consideration to the macroeconomic environment during project formulation and the continuance of all projects and programs to have policy content designed to contribute towards improvement in the policy environment of Sri Lanka.

I.
A. Background

INTRODUCTION

1. The Bank's past assistance to Sri Lanka (programs, projects, and technical assistance) has shown varying degrees of success. A number of projects have met implementation difficulties. They include the reversal of policy measures that were introduced during past programs (such as the abolition of agricultural fertilizer subsidies), inability to comply with conditions agreed upon under Bank assistance, or the budgetary constraints that lead to lack of funds for maintenance of Bank-financed project facilities. Fundamental to these difficulties is the macroeconomic environment including policy and other changes in the country. At the macroeconomic management level, in part due to the ongoing Government efforts to restore law and order, there is the constraint of the fiscal budget and the consequent adjustment in public expenditure reviews from time to time. The need to assess the extent of the linkage between project performance and specific conditions especially those associated with macroeconomic management is obvious. B. Performance of Bank Projects in Sri Lanka

2. Bank assistance to Sri Lanka as of October 1997 comprises 80 loan projects and 157 technical assistance projects in various sectors. Of that number, 26 loans and 1 technical assistance have been postevaluated (including 26 Project Performance Audit Reports, 1 Reevaluation Study, and 3 Impact Studies). The 26 Project Performance Audit Reports completed rated only 12 projects (46 percent) as successful, 11 (42 percent) partly successful, and 3 (12 percent) unsuccessful (Appendix 1). The specific reasons for the poor performance of the projects are varied, ranging from changes in their economic viability to lack of sustainability because of an inadequate maintenance budget. These reasons spring from changes in the macroeconomic and other conditions in the course of project implementation. C. Study Objectives and Methodology

3. The objectives of the Study are to (i) assess the Sri Lankan macroeconomic, sector, institutional, social, and other policies; policy constraints; and conditions prevailing at the time of formulation and implementation of the loan projects funded by the Bank; (ii) evaluate the impact of such policies, policy constraints, and conditions on the performance of the loan projects; and (iii) establish lessons associating policy changes and the performance of projects. 4. The Study was based on a review of policy impact on 14 selected programs and projects implemented from 1980 and which have been postevaluated, interviews with a wide spectrum of respondents from both the public and private sector as well as funding agencies in Sri Lanka, and consultations with Bank staff. The cutoff date of 1980 was adopted to limit the case studies to a more manageable proportion as a result of time and budget constraints, and as a result of interdepartmental consultation to limit the Study to more recent projects that would have more relevance to the Bank's current portfolio management for Sri Lanka.

2

II.
A.

MAINFINDINGS

The Pervasive Effect of the Macroeconomic Environment and Economic Policies on Bank Projects

5. It is striking that the success of every one of the postevaluated Bank projects in Sri Lanka was substantially affected by changes in economic policy and the macroeconomic environment. The impact of economic factors on project performance may have been greater in Sri Lanka than in some other countries because of the importance of trade in the Sri Lankan economy. Five of the projects studied involved the production of goods for exports and all projects were affected by the price of imported inputs. Even health and power projects, which might be thought to be little affected by changes in economic policy, were substantially influenced by the price of imported medical equipment and medicines in one case, and the cost of imported petroleum products on the other. 6. Because of the heavy trade dependence, degree by changes in (i) every project was affected to some

world market prices of products exported or inputs imported, or of imports that competed with project products; the nominal exchange rate, which determined the rupee price of exports, imported inputs, imports competing with domestic goods, and the cost of Sri Lankan labor in competing in the world market; and the real effective exchange rate (REER), which measured the real rupee benefit or cost of traded goods and services, after taking account of inflation; export duties and import tariffs; import and export controls; and costs of shipping, ports, and insurance.

(ii)

(iii) (iv) (v)

7. Virtually all projects in Sri Lanka were also affected by civil conflicts-some of whose impact came through their economic effects-and by fiscal (tax, subsidy, and other Government expenditure) policies. Other policies had less universal but still very powerful effects on the success or failure of projects. Especially far-reaching were the effects of various Government controls. Monetary policy was less important. A detailed discussion is given in the following paragraphs, a tabulated summary is given in Appendix 2, and details of the selected projects are in Appendix 3. 1. Systematic Differences in Economic Effects Among Groups of Projects

8. It may be assumed that some sectors or categories of projects are more insulated or protected from changes in economic policies or in the economic environment than others. But the study found that there were no systematic differences among sectors in the vulnerability of projects to changes in policy. 9. Instead there seem to be three overlapping factors that influenced the impact of economic policies on a project:

3

(i)

the importance to the project of the prices of imported inputs, of competing imports, and of exports; the extent to which there are taxes, controls, or other forms of Government intervention with respect to goods and services important to the project; and the ambitiousness or modesty of the project's objectives.

(ii)

(iii)

10. The first of these factors has already been discussed (paras. 5 and 6). The second is largely self-evident: for instance, if the Government controls the price of milk and sets it low to benefit consumers, then a project to increase milk production may fail because policies have made it unprofitable. 11. If the aims of the project are modest, for instance, to improve the technical efficiency of already established units, then economic policy may have little impact. An increase in technical efficiency, which lowers cost, can be sought by both private and public enterprises. The prices of inputs and outputs, which are strongly affected by policies, would have minimal impact. The Secondary Town Power Distribution Project' is a case in point. It was to increase the efficiency in the distribution of electricity and in collecting energy charges. Macroeconomic policies had little impact on this project with its narrow technical goals. 12. But if the purpose of a power project is more ambitious, then economic policies would be crucial. If the aim, for example, is to increase power availability efficiently without raising the cost to productive sectors and to poor consumers, while reducing the cost to the Government, then the following issues become crucial: (i) (ii) (iii) (iv) how world petroleum, coal, and gas prices are changing; what the Sri Lankan exchange rate is and whether it reflects the true scarcity of foreign exchange: whether there are tariffs/ taxes/ subsidies on imported oil; and above all: what prices are set for electricity; are cross-subsidies involved and, if so, who benefits and who loses; and do prices reflect costs.

13. Even within a single project, one component can be more affected by economic policies than another. In the Livestock Project, 2 the pig production component was minimally affected by economic factors. Pork products are not exported and most are not imported, so world prices and trade policies had little effect. Nor did the Government control, tax, or subsidize the activity. The aim was to upgrade the stock of pigs and thus to increase output, a modest goal little affected by prices of inputs and outputs. The milk production component of the same project, however, was substantially affected by policies. Most milk products were imported, producer prices were controlled by the Government, and consumer prices were determined by trade and payments policies. The aim was to increase domestic production and farmers' income without raising consumers' prices. When world prices for milk powder were low and tariffs were reduced to benefit consumers, farmers' incentives were negatively

2

Loan No. 732-SRI(SF):Secondary Towns Power Distribution Project, for $12.4 million, approved January 1985. Loan No. 606(SF):Uvestock Development, for $15.2 million, approved on 7 December 1982.

on 22

4
affected (or the Government had to subsidize the processors). Changed tariff and price policies meant that the project resulted in only modest increases in output.

2.

Effect of Exogenous Economic Changes

14. World prices are the most important exogenous economic variable affecting Bank projects. Not under Sri Lankan control are the international prices of imported inputs, or of goods exported by Sri Lanka, or of imports that compete with domestic products. For example, the major elements of tree crops sector projects, such as those involving replanting and upgrading, were difficult to implement when world prices of products were low. They are now easier for tea producers to execute because world prices have risen. On the other hand, in 1994 there were strong and successful pressures to reintroduce the fertilizer subsidy because the world prices of tea were low at the time. This involved reversal of a policy condition in the Plantation Sector Project.' 15. The Coconut Development Projece fell far short of its production target because of the combined effect of increased land and fertilizer prices and declining world prices of coconut products. With declining demand for coconut oil in developed countries and increased production fostered in other countries by various aid agencies, there was a downward trend in world prices, which decreased the profitability of coconut production. Combined with higher costs, the result was that the project's planned output and returns could not be achieved. 16. The effect on other projects was more subtle than the effect on export crops. The centerpiece of the Livestock Development Project was increased production of milk. Domestically produced milk had to compete with imported milk powder, which accounted for about half of all dairy products consumed in the country. World prices of milk powder were low when the project started. Domestic production therefore was not sufficiently profitable to stimulate a substantial increase in output. Moreover, world prices fluctuated by over 20 percent from year to year, increasing the risk of domestic producers. However, there is an upward trend in world milk powder prices (at least partly because Europe is phasing out its subsidies). A project started in the future will therefore have a better chance of success. 17. The Second Fisheries Development Project'' was affected by the world price of imported canned fish. Firewood produced by the Community Forestry Project" competed with imported kerosene. The Rural Credit Project5 might be considered largely isolated from economic, and especially exogenous, factors, but an important element was the provision of tractors and other machinery. Farmers' demand for them was affected by the world price of diesel fuel. Moreover, the profitability of dryland crops to be fostered by the project depended in part on the price of competing vegetables imported from India. 18. A much less important exogenous economic variable than world prices was the price of land. It rose quite rapidly near cities as industry and service activities expanded, especially in the area around Colombo. That is also the prime coconut growing area. Farmers

2 3 4 5

Loan Loan Loan Loan Loan

No. No. No. No. No.

712(SF):Plantation Sector, for $45 million, approved on 4 December 1984. 526(SF):Coconut Development, for $12 million, approved on 24 September 1981. 520(SF):Second Fisheries Development, for $13.5 million, approved on 20 August 1981. 568(SF):Community Forestry, for $10 million, approved on 25 March 1982. 432(SF):Rural Credit, for $10.9 million, approved on 6 December 1979.

5
near urban centers found it far more profitable to sell land for development coconuts there, with negative effects on the coconut project. than to grow

19. There is little evidence that the potential impact of exogenous economic changes was taken into account in project design, implementation, or postevaluation. But such variables had some effect on results for about 80 percent of the projects analyzed and had substantial effects on perhaps half that number. 3. Civil Conflict

20. The two civil conflicts that have affected Sri Lanka involving the Tamil Tigers in the north and northeast since 1983 and the Janatha Vimukthi Peramuna (People's liberation Front) in the South in 1986-1988 are, of course, not economic factors. But they have had substantial economic consequences and clearly have affected a number of projects. 21. Some projects have not been implemented or have been poorly implemented in some areas as the result of the conflict. livestock, fisheries, and tourism projects have been particularly damaged. The northern areas have been important for both livestock and fisheries. As a result the livestock Project, which started in 1983, was delayed and was only partly successful since it could not be implemented in one of its two principal target areas. The Second Fisheries Project, started in 1981, was also badly affected. 22. Less obvious is the effect on the Second Development Finance Corporation 1 and the First National Development Bank2 projects. Both institutions were suostantial lenders to the tourism sector. Many of these loans are in arrears as tourism income has dramatically declined after each incident of terrorism or civil disturbance. Industry loans were also affected after some factories were burned in 1983. 23. The conflicts have also inflicted serious damage on the budget, on economic stability, and on both public and private investment. Some 6 percent of the gross domestic product (GOP) is now spent on defense and another 6 percent on debt servicing, much of it for loans incurred to finance past defense expenditure. 24. As a result, funds for Government investment have been sharply cut, from around 16 percent of GOP in 1978-1983 to about 7 percent in the last few years. The impact of the First Agricultural Program Loan" and other projects in that sector was reduced by the decline in public investment for agriculture from 5 percent to 1 percent of GOP. Other projects have been slowed by inadequate counterpart funds or been less effective for lack of maintenance funding (e.g., Health and Population Project). 4 25. Private investors, and especially foreign investors, have been deterred by the additional perceived risk. Existing foreign investors have not withdrawn and, indeed, have often reinvested profits and expanded. But many potential new investors have stayed away

2 3 4

Loan No. 451-SRI(SF):Second Development Finance Corporation, for $10 million, approved on 14 February 1980. Loan No. 519-SRI{SF):First National Development Bank, for $10 million, approved on 29 June 1981. Loan No. 994-SRI(SF):First Agricultural Program Loan, for $80 million, approved on 28 November 1989. Loan No. 576-SRI{SF):Health and Population Project, for $9.3 million, approved on 22 July 1982.

6
because of perceived risks. Domestic investors have also been less inclined to commit their funds for projects after any escalation of the violence. 26. Moreover, Government borrowing needed to fund defense has "crowded out" private borrowing and has resulted in high interest rates and greater difficulty of borrowing for the private sector. The civil conflict was by no means the only factor explaining the budget deficit and inflation, but it was a major factor. Inflation and high interest rates deterred investment in tourism and industry and affected the Development Finance and National Development Bank Projects as well as all projects that required private investment. 4. Trade and Payments Policies

27. In a trade-dependent economy like Sri Lanka, changes in the REER have a widespread impact. During reform periods, as in 1977-1979, the REER is often depreciated: the exchange rate is devalued substantially while domestic prices change much less. Imports become more expensive and exports more profitable, providing strong incentives to increase domestic production and exports and to reduce imports. On the other hand, if the rate of inflation exceeds the rate of devaluation then the REER appreciates. A more than 20 percent appreciation of the REER, as in 1979-1984 and again in 1988-1996, hampered all exportbased projects and all efforts to increase domestic production and to reduce imports (Appendix 4). 28. The Sri Lankan import policy regime is more complicated than would appear at first glance. For instance, the highest official rate of import tariffs is 35 percent with only three major bands (35 percent, 20 percent, 10 percent). But some commodities are outside the system. In addition to higher tariffs for these commodities, there is a defense levy, and another tariff based on the assumed trade margin that can result in an effective tariff estimated at 70 percent, or double the official top rate. 29. There are no longer export duties. But a number of tree crop products bear cesses. These are not, as the name would imply, universally levied, but levied only on exports. The result is that producers for domestic markets have a small advantage over producers for exports. 30. The exemptions from all import duties under the Board of Investment concessions are so widespread that some commodities effectively do not bear any import duty, while the nominal tariff may be high. This is especially true of textiles and other imported inputs into the garment industry. With an Export Processing Zone status for over 100 garment factories set up all over the country, virtually all textiles sold in Sri Lanka come in duty-free for these Board of Investment export enterprises and then leak into the domestic market. As a result, the domestic textile industry is operating without protection and many firms are in serious trouble. This reality is forcing further policy changes on the Government and needs to be taken into account in designing Bank projects in the future. 5. Fiscal Policy

31. Despite major fiscal policy reforms and a substantial reduction in some taxes, the tax and expenditure regime still has a substantial impact on Bank projects. Further reforms are needed. The budget deficit has been rising, and Government investment and maintenance

7
expenditures have been falling as a result of heavy defense, debt, subsidy, and social welfare expenditures. Some projects have been affected by the drastic cut in the Government's investment program from nearly 13 percent in the mid-1980s to 5.4 percent estimated for 1996 (World Bank estimate). The impact on agriculture projects of a decline in Government investment in that sector from nearly 5 percent in 1985 to just above 1 percent in 1994 has already been mentioned (para. 24). Health and transport projects suffered from inadequate funds for maintenance. Several postevaluation reports indicated that projects were slowed by shortages of counterpart funds to cover the contribution of the Government. 32. More broadly, the budget deficit and its financing were the principal reasons for high and increasing rates of inflation recently (para. 26). These in turn increased the risk of investment as perceived by the private sector. The resulting high interest rates are cited as a major problem by Sri Lankan enterprises in industry, tourism, and other service activities and plantations. That has directly affected the two loans to development finance institutions and, indirectly, the rate of investment and growth of the economy. 6. Monetary Policy

33. The fiscal deficit and its financing have contributed to a high rate of interest which has been an obstacle to investment. It might be assumed that both savers and investors would be concerned only with the real rate of interest, the rate after adjusting for inflation; that what matters for borrowers is not the nominal rate of 20 percent, about average in 1996, but a real rate of about 9 percent, if inflation is about 11 percent. Borrowers pay back in rupees that are worth 11 percent less at the end of the year, so their real cost is 9 percent. 34. Private borrowers in Sri Lanka, as elsewhere, also build in an inflation risk premium into their calculations. They are concerned not only about high real rates, but also about high nominal rates. If inflation slows from 11 percent to 6 percent, and they have borrowed at a fixed nominal rate of 20 percent, then they are suddenly faced with real rates of 14 percent. Such a rate would bankrupt many firms. 35. Also, if investor/borrowers are exporting some of their production, they face an exchange risk. In 1996, the devaluation of the rupee was only 6.5 percent, so an exporter who received only 6.5 percent more rupees for every dollar exported had a high real interest cost of 13.5 percent if he borrowed at 20 percent. To put it another way, high rates of inflation, if not fully compensated by exchange rate devaluation, resulted in an appreciation of the REER. That had profound effects on the profitability of a wide range of products. 36. In short, fiscal and monetary policy during the period under review resulted in a high real cost of borrowing and increased the risk of borrowing and investing for the long term. The impact was most direct on the two credit projects. But it affected to a lesser degree many other projects involving credit financing. But since most of the effects of monetary policy on Bank projects were indirect and limited, they had little clear impact on project success. 7. Controls

37. It seemed likely that Government controls would have little impact on Bank projects. After all, Sri Lanka had been carrying out a reform program for 20 years and most of the reforms involved the reduction or elimination of controls, of direct Government intervention

8
in the economy. By now, it might be assumed that controls would largely be gone. But this assumption proved ill-founded, especially for projects completed between 1980 and 1992. Virtually all the projects examined were affected by controls. 38. Some examples follow: The Government set the price of milk; fish and wood had to be sold to a Government agency; tea had to be sold at the Colombo auction or its price had to be approved by a Government-established Board; the Government determined electricity and water rates and instituted a massive system of cross-subsidization from industrial/commercial to residential consumers; a Government agency was the principal importer of fertilizer; through its ownership of the two largest commercial banks, the Government substantially influenced interest rates and lending patterns; the Paddy Marketing Board intervened in the rice market; and so on. 39. Perhaps the most important was Government control and management of the plantations until 1992. In that year, private firms were given five-year contracts to manage the plantations. The contract period was clearly too short to allow for any private investment. In 1996, private managers were allowed to buy 53-year leases of the plantations, fundamentally changing the incentive system for investment and management of this important sector. 40. In short, by 1997 the importance of controls had diminished, with the most dramatic change coming in the plantation sector. Some controls had disappeared. But a very large array continued. One of the unfinished tasks of reform is to further reduce or eliminate the controls that cause the biggest distortions (para. 38). B. The Impact of Bank Projects 1. on Policies and the Economy

The Limited Effect of Bank Assistance

41. A rough impression of the impact of 14 postevaluated projects on policies and the economy is given in Appendix 2 and summarized by tabulated individual projects in Appendix 3. There is no rigorous, scientific method for evaluating the impact of aided projects or programs on the economy or policy because there is no sure way of knowing what would have happened in their absence. Compounded by the time constraint in the field, such an assessment is largely judgmental. However, it is based on information from Bank documents, and extensive discussions with Sri Lankan and foreign economists. 42. All the 14 projects examined seemed to have either a small effect on the economy or an uncertain, but probably small effect. However, they had a greater effect on policies. For two projects, the policy impact seemed to be unambiguously large and positive; for two others, it was probably large. For the remaining ten projects, the impact on policy was either small, or negative or uncertain. 2. Reasons for Limited Effect of Bank Assistance

43. One reason for the seemingly limited impact of the Bank's projects on the economy and policies was that most of the projects examined were started in the early 1980s before the Bank's evaluation of projects and decisions on priority consciously included the impact of the project on policy, and before policy condition was part of project design. Any impact on policy would therefore be largely accidental for most projects. The impact on the

9 economy was also likely to be limited if the project did not lead to a change in policy, because the Bank's whole program was too small for the investment by itself to have much of an effect. 44. Even when the Bank did impose policy conditions these were not always appropriate or effective and, especially in the early years, largely supported the conditions imposed by the World Bank and the International Monetary Fund. Among conditions that had some negative consequences were the requirements that timber be sold to a Government agency and that milk prices had to be fixed by the Government. The abolition of the fertilizer subsidy, a major condition, was reversed after a brief period. The most important and effective policy conditions imposed by the Bank included a greater scope for private banks and privatization of the management of the plantations. But in both cases Government officials felt that the impetus for reform came primarily from within the Government and as a result of pressure from the World Bank and the International Monetary Fund. The Bank was seen as playing a definitely secondary role. 45. A contributory explanation could be that the Study included those projects not likely to have an important catalytic effect on the economy. Assistance in support of telecommunications and power generation, for instance, could have a greater impact on the economy.

III.

KEY ISSUES AND RECOMMENDATIONS

46. The importance of economic policies and the economic environment in determining the fundamental success or failure of virtually all Bank projects in Sri Lanka is unquestioned. When policies provided the wrong incentives, even substantial investments produced only limited results. The clearest example is in the plantation sector: as long as the plantations were managed by the Government, the overriding objective was not their long-term profitability, but rather a variety of short-term and political goals. Similarly, with falling world prices for commodities or an appreciating REER, any project to increase crop production from the plantations could not perform well. As a result, the substantial investment funded by external agencies had only a limited effect in increasing output and efficiency. 47. The implication is that greater attention to the macroeconomic environment and policies in Sri Lanka at the project design stage would enhance the likelihood of successful project performance. Moreover, considerinq the volatile policy context in Sri Lanka, careful monitoring would be needed during project implementation to track possible adverse impacts and to provide remedial actions. 48. Certainly, there are policies that would be difficult to implement, important as they may be. But policy reforms should be pursued according to their practicality in implementation and their sustainability once implemented. Reforms that are likely to meet with difficulties even though important could perhaps be deferred to a more opportune time. Nevertheless, in some cases, the objectives for reforming such policies can be attained through other reforms that are more workable. There are a number of potential areas where external support would generate more productive results. 49. Past Bank projects did not have much impact on the policies of Sri Lanka. A major reason for this was that policy conditions were not part of the project desiqn for Bank projects implemented in the 1980s. Recent projects and programs have more policy content

10 and their impact on Sri Lanka's economic policies should be reviewed in the future. The challenge in framing policy reforms comes from pursuing them in an integrated, coherent, and focused manner so as to catalyze a reform process.

11

APPENDIXES

Number

Title

Page Number

Cited on (page, para no.)

1

Postevaluation Reports on Programs, Projects and Technical Assistance in Sri Lanka as of November 1997 Summary of Table of Impacts on Bank Projects Details of Selected Projects under the Study Movement of Real Effective Exchange Rate

12

1,2

2

15

2, 7

3
4

16

2, 7

29

6, 27

PROGRAMS,

POSTEVALUATION REPORTS ON PROJECTS AND TECHNICAL ASSISTANCE AS OF NOVEMBER 1997

IN SRI LANKA

Report Number, Circulation Date PE0001 Sep 73

LoanlTA 0002-SRI

Number

Table 1: Proaram/Project Performance Perfonnance Report Title Rating" Generally successful Generally successful Generally successful Partly successful Unsuccessful First Tea Factory Modernization

Audit Re~orts SectorlSubsector Project Industrial Crops and Agro-industry

PE0026 Sep 79

0078-SRI 0202-SRI 0071-SRI(SF) 0203-SRI(SF) 0064 TA 0123-SRI(SF) 0115-SRI(SF)

Mineral Sands Project

Nonfuel Minerals

PE0032 Jun 80

Communications

Satellite Earth Station

Telecommunications

PE0054 Oct 81

Gal Oya Sugar Industry Project

Industrial Crops and Agro-industry

PE0059 Mar 82

Fisheries Development

Project

Fisheries

PE0070 Aug 82

0016-SRI(SF) 0017-SRI 0118-SRI(SF)

Partly successful Generally successful Partly successful Generally successful Unsuccessful

Walawe Development

Project

Irrigation and Rural Development

......
Bowatenna Power Project Electric Power

PE0114 Jun 84

I\)

PE0126 Dec 84

0288-SRI(SF)

First Development of Ceylon Project

Finance Corporation

Development

Finance Institution

PE0165 Dec 85

0299-SRI(SF)

Canyon Hydropower Project

Electric Power

PE0207 Jun 87

0060 TA 0231 -SRI(SF) 0403-SRI(SF) 0451-SRI(SF)

Urea Fertilizer Project

Fertilizer Production

PE0210 Aug 87

Generally successful Generally successful Partly successful Generally successful

Second Development of Ceylon National Development

Finance Corporation

Development

Finance Institution

"'0 "'0
CD

»
:.::J 0-

PE0254 Sep 88

0519-SRI(SF)

Bank of Sri Lanka

Development

Finance Institution


......
Q)

PE0293 Dec 89

0241 TA 0432-SRI(SF) 0219 TA 0436-SRI(SFl

Rural Credit Project

Agricultural

Support Services

"'0

PE0298 Dec 89

Rural Electrification

Project

Electric Power

co CD ......

a

Performance rating as of report circulation.

Report Number, Circulation Date PE0330 May91

loanlTA

Number

Performance Ratins Partly successful Partly successful Generally successful Generally successful Partly successful Generally successful Partly successful Generally successful Partly successful Unsuccessful

Report Title

SectorlSubsector

0338 TA 0526-SRI(SF) 0410 TA 0520-SRI(SF) 0732-SRI(SF)

Coconut Development Project

Industrial Crops and Agro-industry

PE0357 Mar 92

Second Fisheries Development

Project

Fisheries

PE0361 Jun 92

Secondary Towns Power Distribution

Project

Electric Power

PE0366 Oct 92

0359 TA 0568-SRI(SF) 0276 TA 0472-SRI(SF) 0576-SRI(SF)

Community

Forestry Project

Forestry

PE0365 Oct 92

Third Tea Development

Project

Industrial Crops and Agro-industry

PE0399 Aug 93

Health and Population Project

Health and Population

PE0406 Dec 93

0765 TA OB20-SRI(SF) 0712-SRI(SF)

Agricultural

Inputs Program

Irrigation and Rural Development

w

~

PE0438 Feb 95

Plantation Sector Project

Industrial Crops and Agro-industry

PE0443 Aug 95

OB48-SRI(SF)

Aquaculture

Development

Project

Fisheries

PE0446 Aug 95

0191 TA 0369-SRI(SF) 0371 TA OB06-SRI(SF) 0994-SRI(SF)

Sevanagala Sugar Development

Project

Industrial Crops and Agro-industry

PE0452 Nov 95

Partly successful Partly successful

Livestock Development Project

Livestock

PE0477 Dec 96

Agriculture

Program Loan

Agricultural

Support Services

-0 -0
(1)

»
:J
Q.

-0 I»

-

~


(1)

co

N

Table 2: Technical
Report Number, Circulation Date
TE 0010 Dec 94
a

Assistance

Performance

Audit Reports
SectorlSu bsector

LoanlTA Number

Performance Ratinga
Partly successful

Report Title

1735-TA

SSTA for Study on Policy Impact of Agricultural Loans

Program

Agricultural

Support Services

Performance rating as of report circulation.

Table 3: Impact Evaluation
Report Number, Circulation Date
IE0001 Jun 84

Reports
SectorlS ubsector

LoanlTA Number

Report Title

0115-SRI{SF) 0410 TA 0520-SRI{SF) 0576-SRI{SF) 1291 TA 0002-SRI 0039-SRI 0064 TA 0123-SRI( SF) 0191 TA 0369-SRI(SF) 0276 TA 0472-SRI{SF) 0338 TA 0526-SRI(SF) 0712-SRI{SF) 0897 TA

Bank Assistance

in the Fisheries Sector in Sri Lanka

Fisheries

IE0033

Dec 95

An Impact Evaluation Study of Bank's Assistance in the Health and Population Sector in Sri Lanka An Impact Evaluation Study of Bank Assistance to the Industrial Crops and Agro-Industry Sector in Sri Lanka

Health and Population

IE0038

Jul 96

Industrial Crops and Agro-industry

SUMMARY TABLE OF IMPACTS ON BANK PROJECTS Project Economic Exogenous n,s p,s n,1 p,s n,?,s n,l p,s ?,s n,1 n,p,l n,l n,s n,l n,l Civil Conflict n,s n,1 n,s n,1 n,1 n,s Trade & Pal!ments n,p,s n,p,l,s n,p,1 n,p,l,s n,p,s n,p,1 n,p,1 n,p,s n,p,1 n,p,s n,p,l n,p,s n,p,l n,p,l Fiscal POlicl! n,s n,s n,1 n,s p,1 n,1 Monetary Policl! n,s n,s Controls Effect on Economl! p,s p,? p,s p,? p,s p,s Effect on Policl! Bank's Rating PS GS PS GS PS PS GS GS PS PS GS GS PS GS

1. Rural Credit 2. Second Development Finance Corp. Project 3. Third Tea Development 4. First National Development Bank Project 5. Second Fisheries Development 6. Coconut Development 7. Community Forestry 8. Health and Population 9. Livestock (Dairy) 10. Aquaculture Development 11. Plantation Sector 12. Secondary Towns Power Distribution 13. Agricultural Inputs Program 14. First Agriculture Program Loan n

n,1 n,p,s n,s p,s n,1 ? n,l x n,l n,s n,l n,s n,p,s n,l

x
? p,I,? ? n,s

x
n,s n,s

x x x x x x x x
n,s

x
p,s p,l n,l

x
n,s n,1 n,l n,s

x x
p,s

x
p,s p,s p,s p,s p,s p,s p,s

~

<.n

x
n,s n,s p,1 p,l

x
p,I,? p,s p,s p,l

x
n,s n,s

= negative, p = positive, I = large, s = small, x = no effect, ? = uncertain/unknown, PS = partially successful, GS = generally successful.

16

Appendix 3, page 1

DETAILS OF SELECTED PROJECTS UNDER THE STUDY A. Loan No. 432-SRI(SF): Rural Credit Project 1. Objective: To improve the incomes of small farmers in Sri Lanka's Dry Zone, and to strengthen the rural credit system in the country through the two stateowned commercial banks-including credit for tractors and other equipment. Time Period: 1980-1986 Economic Factors That Affected the Project (i) Economic Exogenous: Due to the more attractive World Bank Small and Medium Industries Project, rice milling facilities were scaled down. The high world prices of fuel hurt the project. Civil Conflict: Ethnic disturbances in 1983, and especially the People's Liberation Front (JVP) in the south in the late 1980s affected the ability of banks to operate. Trade and Exchange Rate Policy: Undervaluation of the yen at the time of importation of tractors was helpful for the project. Fiscal Policy: Farmers in default continued to receive bank credit, largely on noncommercial considerations, thus disrupting loan discipline and weakening the financial bases of credit institutions. Monetary Policy: Rural lending from the informal sector is estimated at around 75-80 percent of total rural credit needs. Out of this, around 31 percent is interest free, obtained from friends and relatives. The average loan size is small, with informal interest rates averaging around an estimated 60 percent per annum. Medium- and long-term loans are relatively few. The consumer price index rose on average by 16.4 percent during 1980-1984, while it rose on average by only 6.8 percent in the next four years. Controls: The Paddy Marketing Board (PMB) did not protect paddy farmers' interests effectively. There was no guaranteed quota system through PMB; the paddy millers had to rely on their own resources to finance relatively large stocks of paddy during harvest seasons, or to accept low sale prices.

2. 3.

(ii)

(iii)

(iv)

(v)

(vi)

4.

Effect on Economy/Policy The impact was very small where the key issue, which was marketing, was not addressed.

17 B.

Appendix 3, page 2

Loan No. 4S1-SRI{SF): Second Development Finance Corporation 1. Objective: To extend the Development Finance Corporation of Ceylon's (DFCC) foreign currency resources for on-lending to the country's manufacturing and tourism sectors either through loans or equity investments. Time Period: 1980-1986 Economic Factors That Affected the Project (i) Economic Exogenous: Increasing industrial labor costs and exhaustion of quotas in East Asia resulted in investment moving to Southeast and South Asia. Reform Cycles: Reforms of 1977-1979 were crucial to the industry sector. Civil Conflict: Due to the ethnic conflict in 1983 when factories were burned down, the tourist industry suffered with a fall in tourist arrivals. Trade and Exchange Rate Policies: Real effective exchange rate (REER) appreciated during the project period, hurting exports. Subprojects that were in difficulty sector-wise (as they had arrears in loans) were chemicals, packaging and printing, building materials, construction and engineering, and tourism. The chemicals sector, which was mostly state controlled in the previous decade, operated with very low nominal rates of effective protection. Both chemicals, and packaging and printing sectors faced competition with imports due to the opening up of the economy in 1977-1979 and had difficulties in adjusting to the new environment. The tourist industry faced a different situation where with liberalization, new hotels came up with the increased arrival of tourists. When ethnic conflict erupted in 1983, the tourist arrivals dropped and even construction of tourist facilities suffered due to uncertainty in the security situation in the country. Fiscal Policy: High income taxes were not helpful in achieving positive results from the project. Monetary Policy: High nominal interest rates due to massive budget deficits mainly because of the ambitious public expenditure programs combined with high inflation made Sri Lanka's export products less competitive in the world market. Loans were rescheduled for projects that were in difficulty. Controls: Abolition of licensing and controls helped exports and efficiency, but import substitution industries, especially those operating under a controlled economy, faced difficulty.

2. 3.

(ii) (iii) (iv)

(v) (vi)

(vii)

18 4.

Appendix 3, page 3

Effect on Economy/Policy: Effect on the economy was positive mainly due to extending of loans, but it was small. End effect on policy is not clear. Project

c.

Loan No. 472-SRI(SF): Third Tea Development 1.

Objective: To increase the productivity of tea lands, enhance the quality of processed tea, and improve the living conditions of plantation workers in a specified area. The Bank's first two projects focused on modernizing tea factories. Time Period: Economic (i) 1981-1990

2. 3.

Factors That Affected the Project

Economic Exogenous: Downward trend in tea prices due to new entrants in the world market. Reform Cycles: Slowing down of reforms and some reversals in 1980s; no plans on privatizing plantations. Return of some smaller estates to previous owners. Civil Conflict: Some project areas were affected by deteriorating situation during the JVP insurrection in 1987-1988. security

(ii)

(iii)

(iv)

Trade and Exchange Rate Policies: The tea sector was taxed directly through a combination of taxes and export duty from the 1970's throuqh 1992. Due to taxes combined with appreciating REER from 1981-1984 and 1988-1991, the producers were in much difficulty. Fiscal Policy: Ad valorem taxes and cesses were part of taxes that were borne by the tea industry where cess was returned to industry amidst high transaction costs. Only cess on tea is still applicable. Direct subsidies for replanting and machinery and indirect subsidies for research and extension services were estimated to amount to 3 percent of the production costs. Controls: (a) The cost of labor has been rising since the mid-1970s due to (1) political interference that was not related to inflation or productivity growth; (2) union pressure; (3) guaranteed work period; and (4) need for monitoring labor performance. Estates were government-owned: (1) small estates were returned to owners; (2) management was privatized in 1992, but with only 5-year contracts; (3) in 1996, management contract with private firms was extended to 53-year leases.

(v)

(vi)

(b)

19 4.

Appendix 3, page 4

Effect on Economy/Policy: Effect on the economy was small, but that on policy was large because of the move toward privatization. The role of the Bank in this is unclear. Bank of Sri Lanka

D.

Loan No. 519-SRI{SF): First National Development 1.

Objective: To provide the National Development Bank with foreign currency to spur the development of the country's private and public industry sectors. Time Period: 1981-1986 Economic (i) Factors That Affected the Project

2. 3.

Economic Exogenous: With the availability of quotas for garments and East Asian countries experiencing increasing wages, the tendency of investors was to move toward this part of the world. Reform Cycles: Rapid liberalization that took place from 1977 through 1979 drifted until 1983, slowing down until 1986 when the JVP insurrection created some uncertainty in the industry sector. Reforms accelerated again from 1989. Civil Conflict: Factories were burned and foreign direct investment and domestic investment curtailed. Due to the conflict, some cancellations occurred for entire subprojects; in other instances, there were reductions in the scope of projects. Tourism sector projects suffered due to reduction in tourist arrivals because of the riots in 1983. Trade and Exchange Rate Policies: As far as import duties were concerned, liberalization took place in 1977-1978 and continued at a slower pace. REER appreciated in certain periods, making Sri Lanka's import substitution industries less competitive. Fiscal Policy: High income taxes were not helpful in achieving positive results from the project. Monetary Policy: High nominal interest rates due to massive budget deficits mainly because of the ambitious public expenditure programs combined with high inflation made Sri Lanka's export products less competitive in the world market. Loans for projects that were in difficulty were rescheduled. Controls: Abolition of licensing and controls helped exports and efficiency, but import substitution industries, especially those operating under a controlled economy, faced difficulty.

(ii)

(iii)

(iv)

(v)

(vi)

(vii)

4.

Effect on Economy/Policy: Effect on the economy was positive mainly due to extending of loans, but it was small. End effect on policy is not clear.

20
E. Loan No. 520-SRI(SF}: Second Fisheries Development Project 1.

Appendix 3, page 5

Objective: To expand fishing operations in the private sector involved extending credit from the two state banks to fishermen for the purchase of new vessels, and replacement of engines and sails; and to investors for chill storage facilities and insulated trucks. Construction of a fish landing jetty and institutional support were also provided. Time Period: 1981-1990 Economi.c Factors That Affected the Project (i) Economic Exogenous: World price of canned fish had some effect (though undetermined) on the price of fish during this period. (That depends on how close a substitute canned fish is for fresh fish.) Civil Conflict: The northeast coastal area is a major fishing area for Sri Lanka but there is very little fishing due to the ethnic conflict. Prices of fish have escalated because of this conflict. Trade and Exchange Rate Policies: Import duty on fish was at 10 percent, while that for canned fish was at 5 percent. Consumers bought canned and dried fish as a substitute for the relatively expensive fresh fish. The exchange rate also affected the demand for fresh fish via the price of canned fish. Fiscal Policy: Investment targets mentioned in the Fisheries Master Plan (1979-1983) were met largely due to a 35 percent subsidy for hulls, engines, and gear, and concessionary financing from Governmentowned banks. Monetary Policy: People were not willing to borrow at high interest rates. Controls: There were controls on the marketing side where the shippers were required to turn their catch over to Fishermen's Cooperative Societies (CSs); mainly because if the CSs were to assist effectively in loan recovery, they must collect fish directly from shippers upon landing. Two new marketing cooperatives were created. But after two years of operation, one cooperative was liquidated and the other was operating with losses. Private traders took over the bulk of fish marketing.

2. 3.

(ii)

(iv)

(v)

(vi) (vii)

4.

Effect on Economy/Policy: Net effect small, possibility of reduced catch for smaller boats. Subsidy gave rise to distortions.

F.

Loan No. 526-SRI(SF}: Coconut Development Project 1. Objective: To increase coconut production and farm incomes of coconut smallholders and improve the standards for quality and output of the coconut

21
processing industry. The first Bank project production and processing in Sri Lanka. 2. 3. Time Period: Economic (i) aimed

Appendix 3, page 6 at increasing coconut

1982-1987

Factors That Affected the Project

Economic Exogenous: World market prices of coconut and coconutrelated products were declining, affecting Sri Lanka's exports of coconut and coconut-related products. Reform Cycles: The reform cycles influenced coconut production mainly through the fertilizer subsidy. This project was dependent on one single input, Le., fertilizer. The fertilizer subsidy was eliminated in 1990 and reintroduced in 1994. Civil Conflict Civil disturbances (JVP activities in the south) had a negative effect. Not the ethnic conflict because the project area was away from the area of ethnic conflict. Trade and Exchange Rate Policies: Export taxes on the coconut sector were higher relative to the other coconut-producing countries during the late 19705 and early 19805. It has been estimated that since all the taxes were passed on to the producers, the 12-35 percent tax rate on free-on-board price of coconut oil resulted in a price reduction paid to the producers of 13-43 percent. REER which depreciated by around 25 percent during 1984 to 1988, significantly benefited the industry. Fiscal Policy: Transfers from the coconut sector to other sectors of the economy were substantial and far outweighed the value of all the subsidies combined. Only about 12 percent of the total tax income from the producers was returned to them mostly as fertilizer subsidy. Of the 60 loan covenants, one was to ensure a "reasonable price ratio between fertilizer and coconut prices." But in 1990, the removal of the 50 percent subsidy on the price of fertilizer had a negative impact on coconut, which outweighed the benefits of the project.

(ii)

(iii)

(iv)

(v)

4.

Effect on Economy/Policy: Coconut production did not increase as expected mainly due to the reduction in fertilizer usage. For example, fertilizer application resulted in a 40 percent yield increment by 1988 over a three- to five-year period after application.

G.

Loan 1.

No,

,

568-SRI(SF): Community

Forestry Project

Objective: To support conventional reforestation in the block plantations program of the Forest Department and to pursue tree cultivation in rural communities by individual and collective efforts. The Bank's first project in this sector.

22
2. 3. Time Period: 1982-1990 Economic Factors That Affected the Project (i)

Appendix 3, page 7

Economic Exogenous: Kerosene is a substitute for fuelwood in Sri Lanka. Not only is kerosene subsidized, but there also exists a Kerosene Stamps Scheme for the poor. Therefore, the extent of the subsidy and the international price of kerosene had an effect on the project. Trade and Exchange Rate Policy: Import duty on wood and wood products (other than fuelwood) was reduced in 1995 from 10 percent to zero. According to the REER fluctuations, the price of import-competing commodities would fluctuate. Controls: State Timber Corporation, a Government monopoly, harvests, sets prices, and markets forestry products.

(ii)

(iii)

4.

Effect on Economy/Policy: The Project has become viable mainly because of the shift in the trees' end use from fuelwood to higher valued sawlogs.

H.

Loan No. 576-SRI(SF): Health and Population Project 1. Objective: To improve the health status of the rural population in eight selected districts and assist the Government to curb the population growth rate. The Bank's first project in this sector. Time Period: 1982-1990 Economic factors (i) That Affected the Project

2. 3.

Economic Exogenous: The world prices of health care equipment and products. (It is not clear whether the price went up or down.) Civil Conflict: In Northern and Eastern Provinces, the project could not be implemented due to the security situation and also the JVP insurrection in 1987-1988. Trade and Exchange Rate Policy: Fluctuations of the REER had effects on imported medical equipment, vehicles, and other accessories. Fiscal Policy: Although no data are available, the maintenance costs of several health establishments would add to the burden of the budget. Controls: The Government bears the full cost of public health services, with some limited cost recovery in the larger hospitals. (The country provides free health care services to its people.)

(ii)

(iii)

(iv)

(v)

4.

Effect on Economy/Policy: The establishment of 400 Gramodaya Health Centers was very positive as health care services were subsequently channeled

23

Appendix 3, page 8

through them. There was a large positive effect on policy, but the effect on the economy was small, and also positive.

I.

Loan No. 606-SRI(SF): 1.

Livestock

Development

Project

Objective: To improve smallholder dairy, pig, and poultry production so as to increase food supply and improve rural incomes and employment. The major focus was dairy production from cattle. Time Period: Economic (i) 1983-1992

2. 3.

Factors That Affected the Project

Economic Exogenous: Sri Lanka remains heavily dependent on commercial imports of milk products, and domestic prices are significantly influenced by international prices. Imported milk powder accounted for half of the dairy products. The world price of full cream milk powder demonstrated a secular upward trend where in certain years it fluctuated by over 20 percent, affecting the domestic price by the same proportion. Civil Conflict: Due to ethnic conflict, the project was not implemented in the northern area, which is an important area for the livestock industry. The completion date of the project was also delayed by around two and a half years mostly due to civil unrest, and $1.63 milliion of the loan amount was allocated for the rehabilitation of agrarian centers damaged during the conflict. Trade and Exchange Rate Policies: The Government resorted to ad hoc changes in the import duty of milk powder mainly for cost of living considerations. The import duty was 5 percent in 1983, increased to 15 percent by 1987, brought down to zero in 1988, and increased to 20 percent in 1990. Presently, the import duty of full cream powder is 10 percent. The REER appreciated by about 5 percent from 1983 to 1985, cheapening imports; depreciated by 25 percent from 1986 to 1988 raising the price of competing imports; and appreciated by 20 percent during the subsequent period up to 1991. Therefore, the domestic price fluctuated with the exchange rate and import duty. Fiscal Policy: During different periods, various subsidies were given for pasture, fresh milk producers, and milk processors. Controls: The Government has been "setting" the producer price for raw milk by establishing the chilling center price through the Governmentowned milk processor (MILCO) where other milk processors (Nestle) have to purchase fresh milk at the "set" price. The loan requires the Government to maintain an adequately attractive buying price for milk procured under the project. Local milk processors had difficulty in

(ii)

(iii)

(iv)

(v)

24
producing milk powder due to the reduction powder and increase in farmgate price of milk. 4.

Appendix 3, page 9 in import duties of milk

Effect on Economy/Policy The Project has a small and positive effect on the economy but had a large and negative effect on policy as the loan requires the Government to maintain price support for milk procured at an adequately attractive level. Development Project

J.

Loan No. 648-SRI(SF): Aquaculture 1.

Objective: To exploit the abundant inland freshwater resources and promote shrimp culture in brackish water through credit and support schemes. Time Period: Economic (i) 1984-1993 the Project

2. 3.

Factors That Affected

Economic Exogenous: effect on the project.

World price of shrimp (mainly increase) had an

(ii)

Reform Cycles: In mid-1990, the Government made a sudden policy change to end provision of Government services to all inland fisheries and to privatize such activity as fingerling production. This resulted in the termination of most project activities and reduction in production scope. With the election of the new Government in 1994, the policy change of 1990 was reversed. Civil Conflict: Civil conflict had a direct effect on the project. Fingerling production went down due to the conflict's effect on inland freshwater fisheries stations. The commissioning of the shrimp hatchery complex was also delayed because of the disturbance. Trade and Exchange Rate Policies: Inputs such as shrimp feed were exempted from import duty during the later part of the project and a duty of 10 percent was reintroduced in 1995, which was again removed to relieve the industry because of the spread of a disease. REER depreciated from 1984 until 1988 when it started appreciating, hurting exports until 1991, after which depreciation occurred again. Controls: Inland fisheries, freshwater stations, and shrimp hatchery complexes were state-controlled, but privatized in 1994. There is no control over the number of small-scale operators and no enforcement of regulatory measures on the use of common canals for water supply. This unregulated growth of the industry led to disastrous consequences as an outbreak of shrimp disease wiped out some of the farms.

(iii)

(iv)

(v)

4.

Effect on Economy/Policy: The impact of the project was overwhelmed by a policy change, i.e., to privatize activities such as fingerling production. Overall effect was positive but small.

25

Appendix 3, page 10

K.

Loan No. 712-SRI(SF): Plantation 1.

Sector Project

Objective: To increase productivity of the two public sector plantation corporations-Janatha Estates Development Board (JEDB) and the State Plantations Corporation (SPC). Time Period: Economic (i) 1985-1992

2. 3.

Factors That Affected the Project

Economic Exogenous: Since the 1980s, there has been a downward trend in world prices for tree crops because of decreasing demand and increasing production. New competitive market entrants like Kenya has taken away the market share of tea from traditional exporters like Sri Lanka. Reform Cycles: Due to the nationalization of the estates in the early 1970s, new investments did not take place. Because of inefficient management, the plantation sector suffered from monopolistic inefficiencies. Privatization of management took place in 1992. Civil Conflict: Insurgency in the south affected most of the project area and loan utilization during 1986-1990. Trade and Exchange Rate Policies: Export taxes were operational until 1992. From the start of the project, the REER depreciated until 1988, helping exports, and then appreciated to 1991, hurting competitiveness during the later part of the project. Fiscal Policy: Subsidies on fertilizer until 1990 substantially lowered the price of inputs. The fertilizer subsidy was removed in 1990 and reintroduced in 1994. Cesses on exports were reduced over time. Controls: Project investment was restricted to the two state-controlled corporations, which were operating under a non market orientation. The two corporations frequently faced political pressures and interferences mainly in the area of wages where wage increases were not linked to productivity, market price of the product, or the industry's profitability. Also, the Government's requirement that the estates provide workers six days work per week, 25 days work per month, 300 days work per year had an adverse effect on profitability. Overstaffing was also another problem. The remedies to the problems that were diagnosed sector-wise were limited to the two state-controlled corporations. (The private smallholders who escaped controls comprise 47 percent for tea, 72 percent for rubber, and 93 percent for coconut by area). Fixing of minimum prices for green tea leaves, ceilings on individual landholdings, regulation against termination of services of workers were some of the other controls that hurt the industry.

(ii)

(iii)

(iv)

(v)

(vi)

26

Appendix 3, page 11

4.

Effect on Economy/Policy: The impact was limited because the key issue of inefficiency of the public sector enterprise was not addressed. Privatization of management under donor pressure in 1992 subsequently improved the situation. Role of the Bank in this is unclear. Project

L.

Loan No. 732-SRI(SF): Secondary Towns Power Distribution 1.

Objective: To assist the Government-controlled private sector company Lanka Electricity Company (Pvt.) Ltd. (LECO) take over, rehabilitate, and expand the electric power distribution of local authorities and to improve the quality of supply and reduce system losses. Time Period: 1985-1990 Economic Factors That Affected the Project (i) Economic Exogenous: Depreciation of the dollar affected the project through imports. Trade and Exchange Rate Policy: Appreciating REER in 1981-1984 and 1988-1991 decreased domestic fuel prices. Appreciation of the REER in other periods increased domestic fuel prices. Fiscal Policy: From 1978 through 1992, Sri Lanka's electricity tariffs were adjusted five times. There were long intervals before tariff adjustments, followed by large increases. Controls: Consumer prices are controlled with the same consumer electricity tariff schedule for LECO and Ceylon Electricity Board.

2. 3.

(ii)

(iii)

(iv)

4.

Effect on Economy/Policy: Effect is not clear, but moving the energy sector toward a less controlled regime was positive. Inputs Program

M.

Loan No. 820-SRI(SF): Agriculture 1.

Objective: Loan for fertilizer imports with policy conditions on (i) elimination of price subsidies for fertilizer by 1990, (ii) reduction in the number of mixed fertilizer products, (iii) enactment of new fertilizer legislation, and (iv) more effective cost recovery from irrigation water provided to farmers. Time Period: 1987-1989 Economic Factors That Affected the Project (i) Economic Exogenous: Deteriorating foreign exchange situation in 19861987 (official reserve level dropped to two months of imports) provided impetus for the project. The world price of fertilizer also had an effect on the project. The landed cost of imported fertilizer was higher under the

2. 3.

27

Appendix 3, page 12

Bank program because imports were restricted to Bank member countries and the cost of fertilizer exceeded the open market price. Consequently, the National Fertilizer Secretariat was authorized to apply for a rebate of $5 million per metric ton in payment to counterpart funds with effect from 12 October 1987. (ii) Reform Cycle: The fertilizer subsidy was eliminated with the support of the program in 1990, but was reintroduced in 1994. Civil Conflict: The project was implemented at the height of disturbances in the south. Such disturbances had an impact on the project. Trade and Exchange Rate Policy: Fertilizer was imported free of duty throughout the period. Since 95 percent of the fertilizer used in Sri Lanka are imported, appreciation of the REER from 1988 through 1991 made fertilizer imports less expensive. But during the periods when the REER depreciated, local prices (and subsidy) were high. Importation of fertilizer was liberalized with more private sector participation. Fiscal Policy: In 1981, the fertilizer subsidy was 8.2 percent of total budget expenditure. The percentage dropped to 3.2 in 1983, increased to 5.3 in 1984, and dropped until its withdrawal in 1990. Controls: Sri Lanka's leading fertilizer importer and wholesaler was Ceylon Fertilizer Corporation, which accounted for 73 percent of program imports. The Government also encouraged private sector participation in fertilizer sales.

(iii)

(iv)

(v)

(vi)

\
4.

Effect on Economy/Policy: The overall effect was small as the pressure for the removal of the fertilizer subsidy came mainly from other aid agencies, Program Loan

N.

Loan No. 994-SRI(SF): First Agriculture 1.

Objective: To revitalize the agriculture sector by improving overall productivity and growth in agriculture, achieving a high degree of self-reliance in rice, enhancing export earnings from tree and minor export crops, and promoting agro-industries. Funding was provided to move to a more market-oriented approach, removing taxes on tree crops, recovering irrigation costs, and improving extension services. Increase in output was based on greater reliance on the market. Time Period: 1990-1992 Economic (i) Factors That Affected the Project

2. 3.

Economic Exogenous: External conditions for agriculture were relatively favorable when the agricultural program loan was implemented, but Sri Lanka later experienced a sharp price increase in agricultural inputs (mainly fertilizer).

28

Appendix 3, page 13

(ii)

Reform Cycle: Three periods since 1985 are clearly identifiable: 19851987, 1988-1993, and 1994 to present. During 1988-1993, real agricultural wages rose by 19.4 percent mainly due to a 20 percent administrative increase in plantation sector wages, Janasaviya Program in 1989 followed by a new program called Samurdhi in 1995. The increased growth in the garment sector and the overseas migration of unskilled laborers, which had escalated since 1989, also put pressure on the agricultural labor market. Policy reversal took place in 1994 with the reintroduction of the fertilizer subsidy and also the reactivation of support-price purchases of paddy by PMB. Civil Conflict: Not only the ethnic conflict, but also the disturbances in the south had an impact on the project. Due to mounting fiscal pressures (mainly due to the conflict), public investment in agriculture was sharply reduced. Trade and Exchange Rate Policy: Reduction of export duties and subsequent elimination of export duties in 1992 were helpful and had an impact on the project. The high and irrational tariff system especially in the agriculture sector where most of the commodities carried specific duties did not contribute to the goals of the project. Appreciation of the REER from 1988 through 1991 made exports less profitable than import substitution. Imports and distribution of fertilizer were liberalized with more private sector participation. Fiscal Policy: The fertilizer subsidy was removed during the project implementation period, but was reintroduced in 1994 with the arrival of the new Government. Due to mounting fiscal pressure, public investment in agriculture was sharply reduced, from 4.9 percent of GOP in 1985 to 1.1 percent of GOP in 1994, also in part due to debt servicing. Monetary Policy: Interest rates remained high throughout the period. The policy of increasing rural interest rates remained ineffective due to the persistence of subsidized term lending. Controls: Distribution of fertilizer was liberalized, but import licensing in agricultural products was in place. This had a negative effect on the project because, to import agricultural seed, one had to obtain a license. Private sector participation in the rice market increased, but support price purchase of paddy by PMB was reactivated.

(iii)

(iv)

(v)

(vi)

(vii)

4.

Effect on Economy/Policy: The overall effect on the economy was positive where more private sector participation and enhanced incentives for export agriculture reduced the fiscal burden.

29

Appendix 4

MOVEMENT OF REAL EFFECTIVE EXCHANGE RATE

Time Period

Effect

Percentage Change

1977-1979 1979-1984 1984-1988 1988-1986

Depreciation Appreciation Depreciation Appreciation

40 21 26 23

Source: Consultant's Report.

Sign up to vote on this title
UsefulNot useful