SRI LANKA State of the Economy 2009 INSTITUTE OF POLICY STUDIES 99, St. Michael’s Road, Colombo 3, Sri Lanka Copyright C September 2010 Institute of Policy Studies of Sri Lanka ISBN 978-955-8708-55-2 National Library of Sri Lanka-Cataloguing-In-Publication Data Sri Lanka State of the Economy -- 2010 / Colombo : Institute of Policy Studies of Sri Lanka, 2010 . --- 225 ; 21cm ISBN 978-955-8708-59-0 Price Rs. i. 330.95493 DDC 21 ii. Title 1. Economics - Sri Lanka Please address orders to: Institute of Policy Studies of Sri Lanka 99 St Michael’s Road, Colombo 3, Sri Lanka Tel: +94 11 2431 368, 2431 378 Fax: +94 11 2431 395 Email: [email protected] Website: www.ips.lk This report was prepared by a team led by Dushni Weerakoon, with the guidance of Saman Kelegama, Executive Director, IPS. Contributing authors are Nisha Arunatilake, G.D. Dayaratne, Deshal de Mel, Ayodya Galappatige, Asha Gunawardena, Dilani Hirimuthugodage, Suwendrani Jayaratne, Ruwan Jayathilaka, Priyanka Jayawardena, Tilani Jayawardhana, Roshini Jayaweera, Haren Kodagoda, Malathy Knight-John, Sunimalee Madurawela, Wimal Nanayakkara, Nethmini Perera, Dharshani Premaratne, Parakrama Samarathunga, Athula Senaratne, Manoj Thibbotuwawa, Dushni Weerakoon, and Kanchana Wickremasinghe. Editorial support from Charmaine Wijesinghe and D.D.M Waidyasekera, and formatting support from Asuntha Paul is gratefully acknowledged. Contents Growth and Stability in Post-conflict Economic Recovery 1. Policy Perspectives 1 2. Growth and Stability in Post-conflict Economic Recovery 7 2.1 Introduction 7 2.2 Recovery and Growth 8 2.2.1 Employment 12 2.2.2 Savings and Investment 13 2.3 Fiscal Policy Management 14 2.3.1 Deficit Financing and Debt 16 2.3.2 Fiscal Policy and Macroeconomic Stability 19 2.4 Monetary Policy for Economic Recovery 20 2.4.1 The Impossible Trinity: Implications for Interest Rates and the Exchange Rate 22 2.5 External Sector: Current Account, Capital Flows and the Exchange Rate 24 2.5.1 'Dutch Disease' through a Post-conflict Lens 25 2.5.2 Capital Inflows and Official Reserves 27 2.6 Conclusion 28 3. Developments in the External Economy and its Role in Post-conflict Development 30 3.1 Overview 30 3.2 Global Economic Environment 31 3.2.1 Outlook for the US Economy 31 3.2.2 Outlook for the EU Region 34 3.2.3 Outlook for Emerging Economies 36 3.3 Sri Lanka's External Sector 37 3.3.1 Tea 38 3.3.2 Rubber and Rubber Products 40 3.3.3 Textile and Garments 42 3.3.4 Remittances 43 3.3.5 Tourism 44 3.3.6 Capital Flows 46 3.4 Prospects for Regional Integration 48 3.5 Conclusion 49 Post-conflict Economic Development Challenges 4. Poverty Reduction Challenges in Post-conflict Sri Lanka 55 4.1 Introduction 55 4.2 Conflict and Poverty: Channels of Effect 55 4.2.1 Conflict and Loss of Public Entitlements 57 4.2.2 Conflict and Loss of Livelihood Entitlements 57 4.2.3 Conflict and Loss of Civil/ Social Entitlements 59 4.2.4 Conflict and Reverse Entitlements/New Forms of Inequality 59 4.3 Gaps and Future Challenges 60 4.3.1 Addressing New Forms of Inequalities: Social Protection in the Aftermath of Conflict 60 4.3.2 Entitlement to Public Services 64 4.3.3 Restoring Livelihoods 65 4.3.4 Compensating the Loss of Social Entitlements 66 4.4 Conclusion 67 5. Post-conflict Employment and Skills Development 68 5.1 Introduction 68 5.2 Policy Context 69 5.3 Overview of Employment Outcomes in Sri Lanka 69 5.4 Employment in the N&E 72 5.5 Foreign Employment 73 5.6 Employment in the IT and ITES Sectors 74 5.7 Tertiary Education Reforms 76 5.8 Conclusions and Policy Direction 77 6. Challenges to Health Financing in a Post-conflict Environment 79 6.1 Introduction 79 6.2 Health Status and Challenges to the Health System in Sri Lanka 79 6.2.1 Health Status 79 6.2.2 Health Status in the N&E 81 6.3 Improving Health Care Facilities 82 6.3.1 Repairing and Rehabilitating Health Facilities in the North and East 82 6.4 Public Expenditure on Health 83 6.4.1 Overall Expenditure on Health 83 6.4.2 Expenditure on Preventive and Curative Care 84 6.4.3 Overall Expenditure on Health 84 6.5 Different Means of Meeting Financial Needs 85 6.5.1 Public Finance 85 6.5.2 Development Assistance 86 6.5.3 Increasing Private Participation 87 6.5.4 Out-of-Pocket (OOP) Expenditure 88 6.6 Conclusions 88 7. Challenges for the Food Crop Production Sector: A Post-conflict Perspective 90 7.1 Introduction 90 7.2 Agricultural Sector in Sri Lanka's Economy 90 7.2.1 The Demand Side 92 7.2.2 The Supply Side 94 7.3 Issues Relating to Agricultural Development 96 7.3.1 Reduction of Agrarian Poverty 97 7.3.2 Food Security 97 7.3.3 Public Investment in Technological and Institutional Innovations 98 7.3.4 Market and Regulation of Agricultural Land 98 7.3.5 Inefficiency in Irrigation Water Use 99 7.3.6 Adoption of Cutting-edge Technology 99 7.3.7 WTO, Regional and Bilateral Trade Agreements 100 7.3.8 Climate Change and Agriculture 101 7.3.9 Integrating Agriculture in Dynamic Markets 101 7.4 Conclusion and Policy Implications 102 7.6 Conclusions and Policy Implications 106 8. Environmental and Natural Resource Issues in Post-conflict Development 104 8.1 Introduction 104 8.2 Contextualizing the Global Financial Crisis 104 8.3 Profile of Resources and Livelihoods in the N&E 105 8.3.1 A Brief Profile of Resources 105 8.3.2 Major Livelihoods and Impacts of Conflict 109 8.3.3 Major Livelihoods and Impacts of Conflict 109 8.4 Impacts of Conflict on Natural Resources and the Environment 111 8.5 Conclusion 114 Policy Briefs 9. The Role of Foreign Aid in Post-conflict Recovery 115 9.1 Introduction 115 9.2 The Prima Facie Necessity for Foreign Aid in Post-conflict Sri Lanka 115 9.3 Priority Interventions 116 9.3.1 Key Sectors 117 9.4 Domestic Aid Management 118 9.4.1 Macroeconomic Management 120 9.5 Distributional Effects of Aid - Lessons from the Past 121 9.6 Institutional Factors 123 9.7 Conclusion 126 10. Infrastructure Challenges in Post-conflict Development 127 10.1 Introduction 127 10.2 Policy Context 127 10.3 Overall Infrastructure Plan 129 10.3.1 National Level Infrastructure Developmen 130 10.3.2 Rural Infrastructure 131 10.3.3 Infrastructure Development in N&E 133 10.4 Foreign Financing 135 10.5 Conclusion 135 11. Post-conflict Tourism Development in Sri Lanka 136 11.1 Background 136 11.2 Prospects for Tourism Development 136 11.2.1 Supply Side Factors 136 11.2.2 Demand Side Factors 137 11.3 Present Tourism Policies and Strategies 138 11.3.1 Post-conflict Tourism Policies 139 11.3.2 Post-conflict Tourism Projects and Initiatives 140 11.4 What Should be the Way Forward? 141 11.5 Conclusions and Policy Impli-cations 141 12. Fishery Sector and Post-Conflict Development Challenges 144 12.1 Introduction 144 12.2 Fishery Resource Base Sub-sectors 144 12.3 Impact of Conflict on the Fishery Sector 147 12.4 Post-conflict Development Opportunities, Potential and Challenges 149 12.5 Post-conflict Development Initiatives 151 12.5.1 Fisheries Sector Development Project in the Eastern Province 151 12.5.2 Fishery Sector Development Programme in the Northern Province 152 12.6 Conclusions and Recommen-dations 152 13. Policy Challenges for Industrial Development in Post-Conflict Sri Lanka 154 13.1 Introduction 154 13.2 Industrial Sector Performance 154 13.2.1 Contribution to the National Economy 154 13.2.2 Lacklustre Industrial Growth during the Conflict Era 156 13.3 Sri Lanka's Industrial Development Journey 156 13.3.1 Current Industrial Development Policy Framework and Ongoing Strategies 159 13.4 Opportunities and Constraints in Post-conflict Industrial Development 160 13.5 Policy Priorities: Key Areas Requiring Attention 161 13.5.1 Infrastructure 161 13.5.2 Labour Regulations 162 13.5.3 Investment Incentives Structure 162 13.5.4 Skilled Labour 163 13.5.5 Productivity, R&D and Technology 164 13.5.6 Access to Credit 165 13.6 Way Forward and Future Prospects 165 14. Adoption of ICT in Agriculture for Post-conflict Development 167 14.1 Introduction 167 14.2 Problems in Agriculture: Where Do We Stand? 167 14.3 ICT Coverage in Sri Lanka 169 14.4 Agricultural Productivity: How Can ICT Fit In? 170 14.5 Predicaments in ICT Application in Agriculture 171 14.6 Post-Conflict Challenges and Opportunities 173 14.7 Conclusion and Policy Recommendations 174 15. Protecting the Education Rights of Conflict-affected Children 176 15.1 Introduction 176 15.2 Difficulties of Restoring Education in Post-Conflict Situations 176 15.3 Post-Conflict Education in Sri Lanka 179 15.3.1 Measures for a Second Chance in Education 179 15.3.2 Some Issues and Challenges Ahead 182 15.4 Conclusion and Policy Implications 182 16. Post-conflict Sustainable Environmental Financing: Forestry Sector 184 16.1 Introduction 184 16.2 Current Financing Mechanism in the Forestry Sector 184 16.2.1 Forestry Financing: Sources and Expenditure Categorization 185 16.2.2 Revenue Generation in the Forestry Sector 187 16.3 N&E Forest Financing: Plans and Issues 188 16.3.1 Plans for Forestry Financing and Management 189 16.3.2 Issues and Challenges in Post-conflict Forest Financing 190 16.4 Conclusion and Policy Recommendations 191 Prospects 17.