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

C O N F I D E N T I A L SECTION 01 OF 03 COLOMBO 000495 
 
SIPDIS 
 
STATE PASS USTR 
 
E.O. 12958:  DECL:  03/25/2013 
TAGS: ECON PTER EINV CE LTTE ECONOMICS
SUBJECT:  SRI LANKA: ECONOMIC GULF BETWEEN NORTH AND SOUTH 
POISED TO WIDEN 
 
REF:  A. COLOMBO 172 (NOTAL) 
 
      ¶B. 02 COLOMBO 893 (NOTAL) 
 
Classified By: Deputy Chief of Mission W. Lewis Amselem.  Reasons: 
1.5 (b, d) 
 
¶1.  (C) Summary:  The economic gulf between northern and 
southern Sri Lanka, formed over two decades of conflict, is 
poised to widen in the coming years.  Sri Lanka, though 
nominally a united nation, is in fact divided on multiple 
fronts - political, military, social and economic.  Since the 
formal cease-fire came into effect just over one year ago, 
the economic differences between north and south have 
persisted.  In the south, the economy has benefited from the 
cease-fire, and the government of Sri Lanka (GSL) has 
initiated ambitious economic reform plans that aim to improve 
the nation's productivity and per capita income.  In the 
north, meanwhile, the Liberation Tigers of Tamil Eelam (LTTE) 
has kept the areas it controls isolated, endangering 
prospects for a peace dividend.  Continued divergence of 
these two economies will increase the substantial north/south 
wealth gap and lengthen the odds for peace in a united Sri 
Lanka.  End Summary. 
 
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One country, two systems 
------------------------ 
 
¶2.  (U) When the formal cease-fire began in February 2002, Sri 
Lanka's economic landscape was characterized by two distinct 
economic systems - one run by the LTTE in the north, and one 
run by GSL in the rest of the country.  The two systems were 
underpinned by radically different economic philosophies and 
world-views.  As would be expected, the two systems produced 
radically different results. 
 
¶3.  (U) During two decades of civil war, GSL succeeded in 
strengthening its trading links with the global economy by 
developing a range of export-oriented industries.  Thriving 
tea and apparel exports centered in the south helped propel 
the overall Sri Lankan economy to an average annual growth 
rate of 5% in the 1990s.  Repeated LTTE terrorist attacks, 
including in the heart of Colombo, did not halt the south's 
steady rise in average living standards. In the north, by 
contrast, frequent and heavy fighting ravaged the local 
economy:  LTTE held areas saw very little formal economic 
activity over a period of twenty years.  In 1995, GSL imposed 
an economic embargo on the LTTE that further isolated and 
weakened the region's economy.  The end result was a dramatic 
difference in wealth between north and south.  A local think 
tank estimated in 2001 that GDP per capita in the Western 
Province (which includes greater Colombo as well as poorer 
outlying areas) stood at $1400, while per capita income in 
the North and North Eastern Provinces stood below $400. 
 
¶4.  (U) One of GSL's early objectives after the cease-fire 
began was to re-integrate the economies of north and south. 
It lifted the economic embargo on LTTE areas and re-opened 
the A9 road linking Jaffna with the south.  GSL encouraged 
traders to do business island-wide, in the hopes of 
stimulating domestic commerce.  One year later, however, we 
find that economic integration of north and south has not 
materialized and the two economic systems are set to move 
further apart. 
 
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The South:  GSL prioritizes growth 
---------------------------------- 
 
¶5.  (U) The February 2002 cease-fire had immediate and 
positive benefits for the economy of the south.  In 2002 
overall economic growth will come in at around 3%, a big 
improvement over the 1.3% contraction the economy experienced 
in 2001.  (Note: Overall Sri Lanka growth rates are a 
reasonable proxy for growth in GSL-held areas.  The Central 
Bank includes estimates of economic activity in LTTE held 
areas in its overall GDP figures, but the numbers from the 
north are not large enough to sway significantly the 
magnitude of growth measured in the rest of the island. End 
Note.)  Much of the improved economic performance was due to 
better crop yields, particularly in tea and paddy production. 
But a cease-fire conducive to tourism and foreign investment 
also played a role.  Tourist arrivals in 2002 increased by 
8%, and foreign direct investment was up 35% to $230 million. 
 
¶6.  (U) GSL is wisely not content with 3% growth. It has 
launched an ambitious plan - summarized in a policy document 
called "The Future: Regaining Sri Lanka" - for achieving long 
term growth rates of 8-10%.  The document begins by 
acknowledging that some sectors of Sri Lanka's economy have 
remained inefficient and uncompetitive, subsidized by more 
productive sectors. It then lays out a strategy for achieving 
growth targets by "removing the barriers to productivity and 
putting in place review mechanisms to ensure that new 
barriers do not arise." 
 
¶7.  (U) Thus far, after 16 months in office, the United 
National Front government of Prime Minister Ranil 
Wickremesinghe has made solid progress toward productivity 
improvements.  A new wave of privatization of state-run 
enterprises has begun, with GSL having sold off full or 
partial stakes in oil, telecom, mass transit and insurance. 
To improve the efficiency of labor markets, GSL has enacted 
legislation that gives employers more flexibility to entrench 
staff when necessary. GSL has also begun to contain the 
budget deficit by limiting government spending and putting in 
place measures to improve revenue collection.  While 
implementation of "Regaining Sri Lanka" is only in the early 
stages, GSL's performance to date indicates it has a credible 
chance of achieving the dramatic growth rates it desires. 
 
------------------------------------ 
The North:  LTTE prioritizes control 
------------------------------------ 
 
¶8.  (C) The sophisticated policy prescriptions of "Regaining 
Sri Lanka" are a world away from the on-the-ground situation 
in Sri Lanka's war-torn north.  The LTTE's plan for economic 
growth - to the extent there is one - appears to be focused 
on aid, not trade.  The LTTE rightly reasons that it is 
easier to control aid flows than it is to control capital 
flows.  It will gladly accept donor funds targeted at 
reconstructing the north, because it can control how and 
where the money is spent.  Opening up the north to commerce, 
by contrast, would require the LTTE to sacrifice some degree 
of control over the lives of the local people - one sacrifice 
the LTTE is not willing to make. 
 
¶9.  (C) In a press conference last April, LTTE leader 
Velupillai Prabhakaran voiced the LTTE's commitment to 
pursuing an open economy.  But the actions of the group 
indicate just the opposite: it is building a 
centrally-planned economy based on a quasi-socialist model. 
The LTTE is developing a sophisticated financial system (ref 
A), but that system rests entirely in its hands, without any 
apparent role for the private sector.  The LTTE does permit 
trade, but its prohibitive taxation system - especially its 
"import duties" into the areas it controls - serve to dampen 
economic activity.  The LTTE has done nothing to attract 
investment from Colombo's blue chip corporates, much less 
from foreign firms.  The Tigers have made a few patriotic 
appeals to the Tamil diapsora to invest in the "Tamil 
homeland," but it has shown no interest in working with GSL's 
Board of Investment to lure capital to the north. 
 
¶10.  (C) To be fair, the LTTE does not have many economic 
resources to work with in the north.  Even before the ethnic 
conflict broke out, infrastructure in the north was much less 
developed than in the south.  And mother nature has not been 
as kind to the north as to the south: the land is less 
fertile and incapable of producing high value crops like the 
tea grown in south-central Sri Lanka.  The Wanni region where 
the LTTE is based, for instance, is exactly the kind of harsh 
jungle terrain you would expect to be home to an insurgency 
movement.  Still, the economic policies of the LTTE since the 
cease-fire have made a bad economic situation worse.  If the 
LTTE continues to prioritize maintaining its own control 
higher than fostering trade, it will share the poor 
performance of the world's other centrally-planned economies. 
 Aid flows may provide a temporary boost to the region, but 
long-term growth in living standards will not materialize. 
And the gap between north and south will widen instead of 
shrinking. 
 
-------------------------------- 
Comment:  Implications for peace 
-------------------------------- 
 
¶11.  (C) The economic divisions that formed between north and 
south over two decades of war have crystallized during the 
past year.  Both the LTTE and GSL have settled into their 
preferred economic models: in the south, a free market 
economy based on trade; in the north, a centrally planned 
economy based on future aid.  Unfortunately, these divergent 
systems cast doubt on the future of the peace process.  If 
current trends continue, the south will continue to outgrow 
the north, widening the prosperity gap between the regions. 
The underlying economic tensions, therefore, that helped 
spawn the war will not disappear, nor will the risk of 
further conflict. 
 
¶12.  (C) Furthermore, the LTTE's unwillingness to open the 
economy of the north to trade belies its commitment to a 
federal system.  If the LTTE were truly committed to 
remaining part of a united Sri Lanka, it would welcome rather 
than eschew trade links with the south and the rest of the 
world.  Instead, the LTTE's economic strategy is more 
indicative of an organization intent on walling itself off in 
a de facto separate state. 
 
WILLS