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UNCLAS SECTION 01 OF 34 COLOMBO 000321 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EB/IFD/OIA AND SA/INSSTATE PASS USTR 
STATE PASS OPIC, TDA, EXIM 
 
TREASURY FOR DO/GCHRISTOPOLUS 
 
USDOC FOR ITA/ATAYLOR 
 
E.O 12958:N/A 
TAGS: EINV EFIN ETRD ELAB KTDB PGOV ECON OPIC
USTR, CE 
SUBJECT: IMI - INVESTMENT CLIMATE STATEMENT, 2006 ? SRI 
LANKA 
REF: (A) 
 
COLOMBO 00000321  001.2 OF 034 
 
 
¶1.  THE FOLLOWING IS THE INVESTMENT CLIMATE STATEMENT 
FOR SRI LANKA FOR 2006. 
 
INVESTMENT CLIMATE STATEMENT SRI LANKA 
 
February 2006 
 
 
CLAIMED OPENNESS TO FOREIGN INVESTMENT; REALITY DIFFERS 
--------------------------------------------- ------- 
 
¶2.  Over the past two years, Sri Lanka has begun to 
change course economically and is heading in a more 
statist direction.  It has shown significantly less 
interest in economic reform and the privatization of 
loss-making state-owned enterprises than previous 
governments and has apparently decided not to pursue a 
program with the International Monetary Fund (IMF), 
which, along with the World Bank, has provided budget 
support in the past.  On the trade front, Sri Lanka had 
played an active and productive role in the WTO Doha 
Round, up to the Cancun Ministerial in June 2003.  More 
recently, however, Sri Lanka has taken a much more 
defensive posture in the WTO and has instituted a 
number of import and export fees and para-tariffs that 
have increased the cost of trade.  While the economy 
continues to grow, inflation and a depreciating 
currency are deteriorating purchasing power.  The 
recently elected Government of President Mahinda 
Rajapakse has not taken significantly different stances 
economically from the previous Government headed by 
President Chandrika Kumaratunga, but both have been 
more statist in their approach to the economy than the 
government that ruled from 2002-2004.  Since the 
implementation of the cease-fire in early 2002, Sri 
Lanka has seen increased interest on the part of 
potential foreign investors, but the on-again, off- 
again nature of the peace process has tended to depress 
the overall flow of funds into the country. 
 
--Historic Progress; Conflictive History 
 
¶3.  Sri Lanka?s economic growth over the past decade 
averages 4.6 percent annually.  The country has 
traditionally boasted unique human development 
achievements for a developing country although it has 
seen some of its neighbors surpass its earlier 
achievements.  Sri Lanka's per capita income of USD 
1,100, a literacy rate of over 90 percent in the local 
language, and life expectancy of 72 years rank well 
above those of India, Bangladesh and Pakistan, yet fall 
behind other neighbors such as Singapore and Thailand. 
It is generally acknowledged that English ability has 
declined significantly since the 1970s.  While Sri 
Lanka?s progress in achieving UN Millennium Development 
Goals (MDGs) compared to its South Asian neighbors is 
commendable, Sri Lanka needs to address several issues 
in meeting the MDGs by 2015.  These include disparities 
in achievement at sub-national levels and reducing 
poverty (23 percent according to the official poverty 
line for Sri Lanka). 
 
¶4.  The 20-year ethnic conflict between the U.S. 
designated terrorist organization Liberation Tigers of 
Tamil Ealam (LTTE) and the Government of Sri Lanka 
(GSL) has been widely recognized as a key impediment to 
development and as an obstacle to foreign investment. 
A Norwegian-brokered cease-fire between the LTTE and 
the government, in effect since February 23, 2002, 
continues to hold despite the LTTE withdrawal from 
peace talks in April 2003 and continuous tit-for-tat 
killings between LTTE members and anti-LTTE 
 
COLOMBO 00000321  002 OF 034 
 
 
paramilitaries, hartals by Muslims and Tamil 
communities in the east and the August 12 assassination 
of Sri Lanka?s Foreign Minister, among other factors. 
After a rapid escalation in violence immediately 
following the election of Mahinda Rajapaksa as 
President on November 17, 2005, the GSL and LTTE agreed 
to meet in Switzerland on February 22 and 23 for talks 
to strengthen the ceasefire.  There does not seem to be 
an appetite on either side for an immediate return to 
full-scale hostilities, but increasing violence, 
particularly on the part of the LTTE, is a worrying 
trend.  Despite cease-fire violations, however, the 
peace process had substantially improved the political, 
economic and investment climate and initially resulted 
in attracting substantial funding from multilateral and 
bilateral donors to rebuild the country.  The lack of 
recent progress on the peace front as well as 
difficulty in facilitating rapid reconstruction, 
however, has led to concerns that donor money for 
reconstruction may be diverted to other countries. 
Investment interest has also waned in the last year. 
 
--December 26, 2004 Tsunami 
 
¶5.  The December 2004 tsunami caused extensive damage 
to life and property, affecting Sri Lanka?s economic 
performance.  Approximately 32,000 people were killed, 
another 6,300 are missing, and 443,000 people were 
displaced.  A joint damage and needs assessment by the 
key donor agencies estimated the overall damage to Sri 
Lanka at around USD 1 billion, with a large portion of 
losses concentrated in the housing, tourism, fisheries 
and transportation sectors.  Major export sectors were 
not affected.  Some of the worst destruction was in 
areas under LTTE control.  An agreement on coordinating 
tsunami aid signed between LTTE and Government 
 
SIPDIS 
representatives in June 2005 (known as Post-Tsunami 
Operational Management Structure (P-TOMS)) was 
challenged in court and has never been implemented. 
According to post-tsunami assessments, Sri Lanka needs 
approximately USD 1.5 billion to implement a 
reconstruction program.  After one year, Sri Lanka has 
completed the construction of 53,000 transitional 
shelters and is well into its permanent housing program 
with approximately 20,000 units completed.  The entire 
rebuilding program will likely last three to five 
years. 
 
--Leadership Changes 
 
¶6.  Since independence, the rule of government has 
alternated between the two major political parties, the 
United National Party (UNP) and the Sri Lanka Freedom 
Party (SLFP), or coalitions led by them.  Both the UNP 
and the SLFP generally support open and outward looking 
economic policies.  However, some coalition partners 
have thwarted such policies, leading to a failure to 
embrace consistent economic reform policies.  This 
political complexity has sent confusing and 
inconsistent messages to investors and donors. 
 
¶7.  A Presidential election was held in Sri Lanka on 
November 17, 2005.  Former Prime Minister Mahinda 
Rajapaksa of the SLFP, backed by the Marxist- 
Nationalist Janatha Vimukthi Permuna (JVP), the 
Buddhist monk-based Jathika Hela Urumaya (JHU) and some 
other minor parties was elected President, narrowly 
defeating Opposition Leader Ranil Wickremesinghe of the 
UNP.  Rajapaksa had been Prime Minister in former- 
President Kumaratunga?s government, which took over 
following general elections in April 2004.  In those 
elections, Kumaratunga aligned her party with the JVP 
 
COLOMBO 00000321  003 OF 034 
 
 
to form the United People?s Freedom Alliance (UPFA). 
Later, the JVP quit the Government to protest the 
coordination agreement (P-TOMS) between the Government 
and the LTTE. 
 
--New Economic Policies 
 
¶8.  While Rajapaksa?s tenure is quite young, his broad 
economic strategy was outlined in his election 
manifesto ?Mahinda Chintana? (Mahinda?s Thoughts) and 
used for development of the 2006 Government budget. 
Mahinda Chintana loosely follows the previous 
government?s Economic Policy Framework ?Creating Our 
Future, Building Our Nation? 
(http://www.treasury.gov.lk) which focused on 
developing the small and medium enterprise sector 
(SME), agriculture and infrastructure, with a heavy 
reliance on government intervention in markets. 
Rajapaksa?s policies also have a heavy focus on poverty 
alleviation and redistribution of economic gains to 
disadvantaged areas.  The Government rejects the 
privatization of state enterprises, including 
?strategic? enterprises such as state-owned banks, 
airports, and electrical utilities.  Instead, it plans 
to retain ownership and management of these enterprises 
and make them profitable.  At the same time, it is 
taking steps to further expand the already enormous 
civil service.  The previous government created three 
new agencies intended to improve state-owned 
enterprises: The Strategic Enterprises Management 
Agency (SEMA), the National Council for Economic 
Development (NCED) and the Procurement Management 
Agency.  It appears the current Government will retain 
these institutions. 
 
¶9.  The 2006 budget, presented to Parliament in 
December 2005, increased corporate and personal taxes 
and other indirect taxes.  These taxes are in addition 
to prohibitive new taxes on the acquisition of land by 
foreigners (except foreign investors meeting certain 
criteria) and a new import fee on a range of consumer 
goods and non-essential items introduced in 2004. 
These additional taxes on imports go against the 
liberal trade regime once followed by Sri Lanka.  An 
?Economic Service Charge? (ESC) tax, ranging from 0.25 
percent to 1 percent of turnover depending on the type 
of business, applies to all companies with turnover 
exceeding Rs 50 million (USD 500,000), including those 
currently benefiting from tax holidays.  Companies 
already paying income tax will be able to offset the 
new tax against their income taxes.  Nevertheless, for 
some companies, especially foreign investors which have 
tax holidays, it will be an extra financial burden. 
The private sector is also concerned about a government 
initiative to mandate specific wage increases for 
private sector workers. 
 
¶10.  On a positive note, the government has 
acknowledged the vital role that both foreign and local 
private investors play in the economy.  Tax holidays 
have been offered to industries that set up outside the 
Colombo and Gampaha Districts in the Western Province 
in addition to tax holidays and other incentives 
already offered to investors by the Board of Investment 
of Sri Lanka.  In addition, the budget also identified 
a list of infrastructure projects to be developed in 
the next few years. 
 
--Economic Statistics 
 
¶11.  The economic situation in Sri Lanka in 2005 was 
remarkably stable, considering the huge potential 
 
COLOMBO 00000321  004 OF 034 
 
 
impact of the 2004 tsunami.  The Tsunami?s overall 
economic impact appears to have been less severe than 
originally feared.  Growth is expected to remain above 
5.5 percent in 2005 and 6 percent in 2006.  Part of the 
adverse impact on growth was offset by the 
reconstruction effort.  Also, tourism and fishing, the 
two industries most heavily affected by tsunami, 
comprise a relatively small share of overall GDP. 
While inflation rose significantly in the months 
following the tsunami, it has begun to moderate, and 
fell to around 11 percent (from a high of 16 percent) 
in December 2005.  Monetary policy has continued to be 
looser than forecast by the Central Bank and interest 
rates have been held artificially low in comparison to 
inflation. 
 
¶12.  Foreign investment remained stagnant, below USD 
150 million in 2005.  External trade was quite robust: 
exports rose by 10 percent and imports by 14 percent 
during the first ten months of 2005.  Due to higher 
imports, the trade deficit has increased 25 percent to 
USD 2.1 billion during this period.  The Government is 
trying to minimize the fiscal impact of the 
reconstruction program by seeking foreign assistance. 
Meanwhile, the GSL accepted a Paris Club offer by 
industrialized countries, including the US, to freeze 
its debt payments until the end of 2005.  This released 
approximately USD 300 million from the regular budget 
(currently allocated for debt repayment) for 
reconstruction.  In addition, the IMF has provided an 
emergency loan of about USD 159 million to Sri Lanka. 
The World Bank and the ADB have also pledged both grant 
and loan assistance.  Due to the debt moratorium 
granted by several donors, a USD 100 million syndicated 
loan raised by the Government in December, and 
increased remittances by Sri Lankan workers abroad, the 
overall Balance of Payment (BOP) is projected to record 
a surplus of around USD 500 million in 2005.  This is a 
strong contrast to Sri Lanka?s USD 200 million deficit 
in 2004.  Total reserves increased to USD 4.1 billion 
as of October 2005 from USD 3.4 billion in December 
2004 and were sufficient for 5.5 months of imports. 
The rupee strengthened in early 2005 because of 
speculation on aid flows for post-tsunami 
reconstruction.  However as aid flows began to moderate 
and the underlying inflation concerns continued, the 
rupee began to depreciate in late 2005.  According to 
the Central Bank, due to the higher nominal growth in 
the GDP, the outstanding debt stock is estimated to 
decline to 98 percent of GDP by end 2005 from 105.5 
percent at end 2004. 
 
--Public Finance 
 
¶13.  Weakness in public finance is a key worry. 
Government fiscal control deteriorated in 2004-2005. 
Both the new government and the previous government 
focused on a larger government and increased welfare 
spending.  Although, the government attempted to rein 
in the fiscal deficit by revising petroleum prices 
upwards, and removing a costly subsidy on wheat flour, 
these moves were insufficient to offset rising import 
prices.  Numerous subsidies continue, including those 
for petroleum, electricity and fertilizer.  Several 
private and public sector players in these sectors have 
suffered financial losses due to government?s failure 
to pay the required subsidy costs or to allow price 
increases in a timely manner. 
 
¶14.  The 2006 budget envisages a deficit of 9.1 percent 
of GDP.  Tsunami expenditure will account for about 1.8 
percent of the deficit and will be financed largely by 
 
COLOMBO 00000321  005 OF 034 
 
 
foreign grants and loans.  The budget focuses on 
reducing poverty through assistance to farmers and 
development of the agriculture sector, increasing 
welfare benefits to poorer sections and on higher 
spending for public infrastructure.  It also includes 
significant increases in government employment and 
public sector wages.  The Government will hire 10,000 
new graduates in 2006, in addition to about 42,000 
hired in 2005, in an effort to stem unemployment, 
thereby expanding public sector employment by about 5 
percent.  As previously explained, the Government is 
trying to boost tax revenues through increased direct 
and indirect taxation.  The Rajapaksa Government has 
expressed a desire to maintain macroeconomic stability 
(albeit at a delayed pace), and put fiscal reforms in 
line with the policy outlines of the Fiscal Management 
?Responsibility? Act, which has a deficit and debt 
reduction plan over the medium term. 
 
--Sri Lanka Obtains Sovereign Ratings 
 
¶15.  Sri Lanka received its first sovereign ratings on 
December 8, 2005.  Fitch Ratings assigned Sri Lanka a 
?BB-minus? rating (sub-investment grade) noting that 
all the long-term rating outlooks were stable. 
Standard and Poor?s rating was slightly lower at ?B- 
plus?.  The sub-investment grade ratings were related 
to continuing uncertainty surrounding Sri Lanka?s 
political situation, the peace process and the 
relatively high budget deficit.  The rating agencies 
commended Sri Lanka?s resilience to adverse shocks, 
strong institutions and an unblemished debt service 
record.  Analysts widely expect Sri Lanka to use the 
rating to seek capital on the international market at 
better rates than the prevailing 11 percent domestic 
rate. The GSL would possibly use the ratings to pursue 
a foreign bond issue. 
 
--IMF Programs No Longer Being Pursued 
 
¶16.  In 2003, the IMF approved a three year Poverty 
Reduction Growth Facility (PRGF) and an Extended Fund 
Facility (EFF) arrangement for SDR 413 million (USD4.31 
million).  The programs were put on hold after the first 
disbursements in 2003 due to lack of progress with key 
structural reforms.  The current Government is not 
pursuing an IMF program as they do not intend to 
implement the kinds of economic reforms that would be 
required. 
 
--ADB/WB Investment Climate Assessment 
 
¶17.  According to a joint Asian Development Bank 
(ADB)/World Bank (WB) investment climate assessment 
released in June 2005, Sri Lankan firms have identified 
sharply deteriorated infrastructure (electricity and 
transport) and cost of finance as major constraints for 
doing business.  The study surveyed 450 urban and 1,300 
rural firms during 2003/2004.  Over 40 percent of urban 
firms cited electricity as the biggest constraint for 
investment followed by policy uncertainty, macro 
instability, cost of finance and labor regulations. 
Rural firms cited transport problems as the key 
constraint followed by cost and access to finance and 
marketing. Rural firms identified lack of electricity 
as the fifth biggest constraint.  The survey also 
generally lists labor regulations and infrastructure 
deficiencies as the most severe constraints affecting 
FDI.  Other perceived constraints to FDI were concerns 
about the peace process, and economic and regulatory 
policy uncertainty. 
 
 
COLOMBO 00000321  006 OF 034 
 
 
--Possible Post-Tsunami Commercial Opportunities 
 
¶18.  There may continue to be commercial opportunities 
for US companies in the post-tsunami reconstruction 
program.  The bulk of reconstruction expenditure will 
be spent on housing, transportation infrastructure 
(roads, railway and ports), fisheries infrastructure 
(harbors, anchorage and related facilities), water 
supply and sanitation projects, and school and hospital 
buildings.  There may also be opportunities in public 
infrastructure programs.  The government plans to 
undertake several development programs in the next few 
years.  The 2006 budget estimates a 51 percent increase 
in the public investment program. 
 
--Risks to the Economy 
 
¶19.  Numerous risks and challenges to the economy 
remain.  Continuing cease-fire talks might not lead to 
tangible progress on peace.  Despite his recent 
electoral victory, President Rajapaksa must depend on 
an inherently unstable Parliamentary coalition.  There 
are concerns regarding the speed of reconstruction and 
resettlement of the tsunami affected population.  Other 
down-side risks will stem from uncertainties over oil 
prices, government fiscal largesse and the continued 
impact of the end of the Multi-Fiber Agreement, which 
set quotas on developing country textile exports to 
developed countries, although large factories 
accounting for the bulk of the exports are expected to 
continue to perform well.  Another major business 
concern in the medium term is the cost and availability 
of power.  Sri Lanka has faced episodic power 
shortages, with the most recent period extending from 
mid 2001 to early 2002.  Although new power plants have 
been added, the government has yet to procure 
sufficient low-cost base load power to avert a power 
crisis in the medium term.  There has been some recent 
activity toward a 300 megawatt coal plant from China, 
though the government is still to prove that it can 
deal with entrenched opposition in the community around 
the proposed site.  Despite the dire need for power, 
the JVP resists Government moves to restructure the 
state owned electrical utility board, thus reducing the 
possibility of solving power problems in the 
foreseeable future.  High oil prices are also causing 
an already inefficient and money losing state-owned 
electrical company to face serious cash flow 
difficulties and to backtrack on power purchase 
agreements and contractual obligations.  Uncertainty 
over the future of the energy sector has led most 
businesses to install onsite generating capacity. 
 
--Board of Investment 
 
¶20.  The Board of Investment (BOI) (www.boi.lk), an 
autonomous statutory agency, is the primary government 
authority responsible for investment, with a particular 
emphasis on foreign investment.  The BOI acts as a 
facilitator for investment.  It is intended to provide 
"one-stop" service for foreign investors, with duties 
including approving projects, granting incentives, and 
arranging services such as water, power, waste 
treatment and telecommunications.  But the BOI is best 
at assisting investors who want to establish operations 
within its industrial processing zones.  It also 
assists people in obtaining resident visas for 
expatriate personnel and facilitates import and export 
clearances.  The BOI has undertaken a major review of 
its activities in order to improve its services.  The 
Bureau for Infrastructure Investment (BII) 
(www.bii.lk), a division of BOI, has responsibility for 
 
COLOMBO 00000321  007 OF 034 
 
 
coordinating 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 
 
¶21.  The principal law governing foreign investment is 
Law No. 4, created in 1978 (known as the BOI Act), as 
amended in 1980, 1983 and 1992, along with 
implementation 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 on 
minimum investment, exports and in some cases 
employment.  Investment approval under section 16 of 
the act permits entry for foreign investment to operate 
under the "normal" laws of the country and applies 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 as amended in 1991 and 2003, and the 
Takeovers and Mergers Code of 1995 revised in 2003. 
Various labor laws and regulations affect investors 
also.  See sections below. 
 
--Foreign Equity and Sectors 
 
¶22.  The government relaxed investment rules in early 
2002, allowing 100 percent foreign investment in the 
following services:  banking, finance, insurance, 
stock-brokering, construction of residential buildings 
and roads, supply of water, mass transportation, 
telecommunications, energy production and distribution, 
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. 
 
¶23.  Investment in other sectors is restricted and 
subject to screening and approval on a case-by-case 
basis when foreign equity exceeds 49 percent.  The 
affected sectors are:  shipping and travel agencies; 
freight forwarding; fishing; timber-based industries; 
growing and primary processing of tea, rubber, coconut, 
rice, cocoa, sugar and spices; and the production for 
export of goods subject to international quota. 
Foreign investment restrictions and government 
regulations also apply to international air transport; 
coastal shipping; lotteries; large-scale mechanized gem 
mining; and sensitive industries such as military 
hardware, dangerous drugs and currency. 
 
¶24.  Foreign investment is not permitted in the 
following businesses:  non-bank money lending; pawn- 
brokering; retail trade with a capital investment of 
less than USD 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 USD 150,000); 
coastal fishing; and the awarding of local university 
degrees.  Foreign degree courses can be offered in Sri 
Lanka by affiliating with foreign universities. 
However, there is no scheme to monitor the quality 
assurance or accreditation of the foreign courses 
offered in Sri Lanka. 
 
¶25.  Generally, the treatment given to foreign 
investors is non-discriminatory.  In fact, some local 
companies have complained that they are discriminated 
 
COLOMBO 00000321  008 OF 034 
 
 
against, as qualifying foreign investors can benefit 
from a wide range of advantages.  However, entry into 
sectors such as liquefied petroleum gas, flour milling 
and fixed line telephony are controlled, in order to 
ensure that currently existing monopolies or 
oligopolies supplying products or services in Sri Lanka 
are protected.  Sri Lanka also does not have anti- 
competition laws.  Even with incentives and BOI 
facilitation, foreign investors face difficulties 
operating here.  Problems range from the mundane but 
critical matter of clearing equipment and supplies 
through customs speedily, to obtaining a factory site. 
Legal challenges to environmentally sensitive projects 
have been particularly challenging, even when 
objections are unfounded.  Perhaps the most difficult 
barriers to investment are the enormous set of 
bureaucratic requirements and poor decision practices 
of GSL entities.  Several high profile and needed 
infrastructural projects have dried up in the past two 
years, as investors simply tired of waiting for 
approval and action.  In part to avoid part of these 
tangles, in addition to overcoming land allocation 
problems, the BOI encourages investors to locate their 
factories in industrial processing zones managed by the 
BOI.  Investors locating in industrial zones also get 
access to relatively better infrastructure facilities 
such as reliable power, telecommunication and water 
supplies. 
 
--Privatization Frozen 
 
¶26.  Previous governments, including ones headed by the 
SLFP, actively pursued privatization.  When the UPFA 
Government came to power in 2004, however, it pledged 
to halt the privatization process of strategic 
enterprises and to institute more effective government 
oversight while privatizing smaller entities.  The 
current Government has said that it will not privatize 
any government entity. 
 
¶27.  Government treatment of foreign investors in past 
privatization processes had been largely non- 
discriminatory.  In 2003, however, the then UNP 
government sold part of the retail operations of state- 
owned Ceylon Petroleum Corporation (CPC) to Indian Oil 
Corporation (IOC) without a formal tender process.  One 
US firm, which had earlier acquired a government-owned 
lubricant plant and obtained exclusivity in the sale of 
lubricants in CPC outlets until mid-2004, has also 
complained that the government had reneged on the terms 
of the exclusivity agreement. 
 
--Labor Unions Block Privatization 
 
¶28.  Labor unions in state-owned enterprises are often 
opposed to privatization and restructuring and seem 
particularly averse to foreign ownership.  In the past, 
this made the purchase of certain strategic entities 
problematic for new foreign owners. 
 
--Investment Trends 
 
¶29.  From 1998-2001, foreign direct investment (FDI) 
flows to Sri Lanka averaged only about USD 150 million 
per year (excluding privatization receipts).  Following 
the commencement of the peace process and improved 
investor confidence, annual FDI flows have averaged 
about USD 200 million.  Although initially FDI was 
expected to rise faster following the cease-fire, it 
has stagnated due to the stalemate in the peace 
process.  In 2004, FDI was about USD 178 million.  The 
Sri Lankan government reported with its budget an 
 
COLOMBO 00000321  009 OF 034 
 
 
anticipated USD 250 million of FDI for 2005, but this 
amount appears to be overstated since FDI had been 
about USD 110 million by October 2005.  FDI could 
eventually be reported at less than USD 150 million for 
¶2005.  No single big investment occurred in 2005.  Most 
2005 FDI occurred in housing projects, existing 
business expansion, and spillover effects of 
investments that came in 2004 when FDI mainly funded 
telecommunications and manufacturing industries (cement 
and textiles). 
 
--The Colombo Stock Exchange 
 
¶30.  The Colombo Stock Exchange (CSE) has been growing 
markedly since 2002, due to local investor activity. 
The CSE is taking steps to broaden the investor base 
both in Sri Lanka and abroad.  The CSE has been one of 
the best performing stock markets globally since 2001 
and has recorded a consistent annual growth of over 30 
percent in market indices for the last 4 years. 
However, the November 2005 election of President 
Mahinda Rajapaksa backed by Marxist JVP and a string of 
serious cease-fire violations dampened the market in 
December 2005.  Foreign investors have largely stayed 
out of the market, and were net sellers in 2003-2004. 
Uncertainty about the peace process, weak macro 
economic fundamentals, and reversals in economic 
reforms, are major concerns to foreign investors. 
 
 
CONVERSION AND TRANSFER POLICIES 
-------------------------------- 
 
¶31.  Sri Lanka has accepted Article VIII status of the 
IMF and has liberalized exchange controls on current 
account transactions.  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. 
 
¶32.  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 
for companies with majority foreign investment approved 
under Section 17 of the BOI Act.  Other companies 
require Central Bank approval.  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 through a 
special bank account.  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 that were opened to foreign 
investors.  It has been proposed to allow foreigners to 
invest in corporate debentures and government bonds. 
 
¶33.  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. 
 
COLOMBO 00000321  010 OF 034 
 
 
 
 
EXPROPRIATION AND COMPENSATION 
------------------------------ 
 
¶34.  Since economic liberalization policies began in 
1978, the Sri Lankan Government has not 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) of 
the World Bank.  The last expropriation dispute was 
resolved in 1998. 
 
 
DISPUTE SETTLEMENT 
------------------ 
 
--Legal System 
 
¶35.  Sri Lanka's legal system reflects diverse cultural 
influences. Criminal law is fundamentally British. 
Basic civil law is Roman-Dutch.  Laws pertaining to 
marriage, divorce, and inheritance are communal.  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.  Its amendments have, by and large, kept pace with 
subsequent legal changes in the U.K.  Until recently, 
the court system was largely free from government 
interference.  There are allegations that the judiciary 
is sometimes subject to political influence, but this 
has not been evident in commercial litigation so far. 
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 Intellectual 
Property Act, the Companies Act, the Securities and 
Exchange Commission Act, the Banking Act, the 
Industrial Promotion Act and Consumer Affairs Authority 
Act.  Most of these laws were revised recently. 
 
--Bankruptcy Laws 
 
¶36.  The Companies Act and the Insolvency Ordinance 
provide for dissolution of insolvent companies.  But 
currently, there is no mechanism to facilitate the re- 
organization of financially-troubled companies.  Other 
laws make it very difficult to keep a troubled company 
afloat.  The Termination of Employment of Workmen Act 
(TEA), for example, prohibits employers from dismissing 
workers even on the grounds of inefficiency.  The 
Termination Act was recently revised to facilitate 
retrenchment.  Under the revised act, a compensation 
formula for retrenched workers has been published.  But 
employers have protested that it is excessive compared 
to similar formulae in the Asian region, with terms in 
Sri Lanka about twice as generous as the East Asian 
average.  [Please see section on ?LABOR? for details]. 
Obviously, this compensation plan could adversely 
affect companies? restructuring plans and discourage 
future employment growth. 
 
¶37.  In the absence of proper bankruptcy laws, extra- 
judicial powers granted by law to financial 
institutions protect the rights of creditors and have 
helped 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.  A recent judgment, however, 
ruled that these powers would not apply with respect to 
collateral provided by guarantors to a loan.  Financial 
 
COLOMBO 00000321  011 OF 034 
 
 
institutions also face other legal challenges as 
defaulters obtain restraining orders on frivolous 
grounds due to technical defects in the recovery laws. 
Also, for default cases filed in courts, the judicial 
process is time consuming.  The private sector has 
urged the government to introduce US Chapter 11-style 
bankruptcy laws, although the enactment of a similar 
procedure is unlikely as government officials currently 
take a dim view of this approach.  Additionally, the 
financial community has requested the strengthening of 
debt recovery laws. 
 
--Investment Protection 
 
¶38.  In principle, foreign investments are 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 Convention on Settlement of Investment Disputes, 
which provides the mechanism and facilities for 
international arbitration through the World Bank?s 
ICSID. 
 
¶39.  The U.S.-Sri Lanka Bilateral Investment Treaty 
(BIT) was ratified by both governments in early 1993. 
A bilateral treaty to prevent double taxation went into 
effect on June 12, 2004. 
 
¶40.  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 a possibility of speedier dispute resolution. 
 
--Arbitration 
 
¶41.  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 with U.S. companies in recent 
years. 
 
¶42.  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. 
 
¶43.  The Labor Department has a process involving labor 
tribunals for settling industrial disputes with 
laborers or unions, and arbitration is required when 
attempts to reconcile industrial disputes fail.  The 
Labor Commissioner typically becomes involved in labor- 
management mediation.  Other senior officials, 
including the Labor Minister, and the President, have 
intervened in particularly difficult cases. 
 
--Investment Disputes Involving U.S. Companies 
 
¶44.  There continue to be trade and investment 
 
COLOMBO 00000321  012 OF 034 
 
 
disputes, particularly surrounding government 
procurement.  The government procurement process in Sri 
Lanka is slow and opaque.  US companies continue to 
face problems with payment of valid contracts, 
finalization of agreement language, implementation of 
agreements with the Government, and inexplicable 
failure to secure contracts, despite demonstrated 
superior performance, high value, and low bids.  Some 
US companies have found it difficult to secure payment 
for power generation due to CEB?s tight cash flow 
situation, with at least one major payment currently 
disputed by the Government under the ironic theory that 
the Government was forced to enter into a contract 
?under duress? because a fire forced an energy plant to 
produce energy in a more costly manner than prior to 
the fire.  The Government had asked the plant?s 
management to continue operations, and the company 
despite management?s strong preference to shut down for 
repairs. 
 
¶45.  In May 2000, the Sri Lankan Supreme Court 
effectively blocked an existing investment agreement 
between the Government of Sri Lanka and a US mining 
company.  Although the investment agreement was already 
initialed and approved by the Sri Lankan cabinet, work 
on the project had not yet begun.  A group of citizens 
filed a fundamental rights case under a Sri Lankan law 
that allows any person to seek protection from the 
Supreme Court if a government or administrative act 
impedes his/her rights.  In this case, the plaintiffs 
alleged that their rights would be violated if the 
project was implemented, and the court upheld their 
complaint.  Without any technical argument, a partial 
bench of three judges ruled that the project could not 
proceed before completion of a new series of detailed 
and highly comprehensive and expensive studies, some of 
which appeared to be technically impractical.  Because 
this is a Supreme Court decision, options for reversing 
the decision appear limited. 
 
¶46.  In another case, a 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.  The 
Company withdrew its operations from Sri Lanka in 2004. 
In many disputes, defendants resort to obtaining 
injunctions, stay orders, or postponements to drag 
cases on for years. 
 
 
PERFORMANCE REQUIREMENTS/INCENTIVES 
----------------------------------- 
 
--Performance Requirements 
 
¶47.  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. 
 
¶48.  Foreign investment is encouraged in information 
technology, electronic assembly, light engineering, 
automobile parts and accessories manufacturing, 
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 
 
COLOMBO 00000321  013 OF 034 
 
 
headquarters, and infrastructure projects.  Foreign 
investors are generally not expected to reduce their 
equity over time, nor are they expected to transfer 
technology within a specified period of time, except 
for build-own-transfer or other such projects in which 
the terms are specified within pertinent contracts. 
 
¶49.  In some BOI-approved enterprises, businesses are 
required to maintain certain levels of employment.  In 
addition, privatization agreements prohibit new owners 
from dismissing workers as a rule, 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. 
 
¶50.  Foreign investors who remit at least USD 50,000 
can qualify for a one-year resident visa, which can be 
renewed.  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 for an initial period and do not experience 
significant problems in obtaining work or residence 
permits. 
 
--Investment Incentives 
 
¶51.  The Board of Investment has announced the 
following investment incentives, with such investments 
typically requiring prior approval of various 
ministries: 
 
Incentive Program I 
 
Qualifying industries: 
--Non-traditional manufacturing exports and companies 
supplying to exporting companies.  Minimum investment 
of USD 150,000; 
--Export oriented services.  Minimum investment of USD 
150,000; 
--Manufacture of industrial tools and/or machinery. 
Minimum investment of USD 150,000; 
--Small-scale infrastructure.  Minimum investment of 
USD 500,000; 
--Research and development.  Minimum investment of USD 
50,000; 
--Agriculture and agro processing industries.  Minimum 
investment of USD 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.  A 
recently introduced Economic Service Charge at 0.25 
percent of income will be applicable to BOI approved 
companies with tax holidays, from the fourth year of 
operation.  The tax applies even to existing companies. 
There is no grandfather clause. 
 
 
COLOMBO 00000321  014 OF 034 
 
 
Incentive Program II 
 
Qualifying Industries: 
--Information technology services such as call centers, 
data entry services, data centers, software development 
services, host centers for e-governance and related 
projects; 
--IT training institutes; 
--Regional operating headquarters providing the 
following services to related businesses outside Sri 
Lanka:  sourcing raw materials, R&D, technical support, 
financial and treasury management, marketing and sales 
promotion; 
--Any industrial, agricultural, service, or 
construction activity approved by the BOI.  Minimum 
investment of USD 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 the 
6th year onwards, a preferential tax of 15-20 percent 
will apply.  In addition, capital goods will be 
exempted from import duty.  A recently introduced 
Economic Service Charge at 0.25 percent of income will 
be applicable to BOI approved companies enjoying tax 
holidays, from the fourth year of operation.  The new 
tax applies even to those companies already operating 
in Sri Lanka. 
 
--Incentives for Regional Development 
 
¶52. The BOI has launched a new incentive program to 
promote regional development with the aim of 
establishing 300 new factories or service companies 
(such as hotels, hospitals, training institutes) in the 
regions outside the capital Colombo.  The incentives 
include 5-10 year tax holidays depending on the 
location, with firms going to most difficult areas 
eligible for a 10-year tax holiday.  In addition, 
imports of machinery and equipment would be exempted 
from both customs duty and the value-added tax. 
 
--Infrastructure development 
 
¶53.  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 BOI 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 after the 
tax holiday period.  These companies will also qualify 
for duty free imports of capital goods.  A minimum 
investment of USD 12.5 million is required. 
 
¶54.  Large-scale new 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 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. A minimum investment of USD 10 
million is required. 
 
COLOMBO 00000321  015 OF 034 
 
 
 
--Trade Agreements to Make Sri Lanka a Gateway to South 
Asia; ?GSP-Plus?. 
 
¶55.  A preferential trade agreement, the Indo Lanka 
Free Trade Agreement (ILFTA) between Sri Lanka and 
India, is now 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).  Discussions are underway to 
reduce the negative lists of both countries.  The two 
countries are discussing services sector 
liberalization, under a proposed Comprehensive Economic 
Partnership Agreement (CEPA).  Other areas covered by 
the CEPA are investment and economic cooperation. 
Because production constitutes a portion of the value, 
ILFTA and the proposed CEPA may be well utilized as a 
mode of entry into the Indian market by U.S. companies. 
 
¶56.  Sri Lanka also signed a free trade agreement with 
Pakistan that came into operation on June 12, 2005. 
Under the Sri Lanka-Pakistan FTA (SLPKFTA) 
(www.doc.gov.lk), Pakistan has offered duty free entry 
to 206 items.  Pakistan?s negative list contains 541 
items with no duty concessions.  Pakistan will phase 
out tariffs on the balance of approximately 4,000 items 
over a 3 year period.  Under the agreement, Pakistan 
would offer duty free entry to all Sri Lankan exports 
by June 2008. 
 
¶57.  Sri Lanka and six other south Asian nations 
belonging to the South Asia Association for Regional 
Cooperation (SAARC) signed a South Asia Free Trade 
Agreement (SAFTA) in January 2004.  SAFTA was launched 
on January 1, 2006 and will become operational on July 
1, 2006.  SAFTA will offer regionalized tariff 
reductions for imports from member countries.  Stated 
goals of SAARC members under SAFTA are to reduce duties 
for imports from member countries to between zero and 5 
percent over a period of 7-10 years.  These agreements 
are seen as steps towards making Sri Lanka a regional 
hub and a gateway to South Asia and the Middle East for 
foreign investors 
¶58.  Sri Lankan exports to EU are also duty free under 
the ?GSP-Plus? incentive scheme which came into force 
on July 1, 2005.  Under this program, 7,200 Sri Lankan 
products meeting rules-of-origin criteria can enter the 
EU duty free. 
--Prospects for U.S. Investment under Indo Lanka Free 
Trade Agreement (ILFTA) and Pakistan Sri Lanka Free 
Trade Agreement (SLPKFTA). 
 
¶59.  Foreign investors in Sri Lanka can enjoy 
preferential access to the Indian and Pakistan markets 
under the ILFTA and SLPKFTA.  The BOI hopes to attract 
foreign joint ventures to Sri Lanka under these 
agreements.  The BOI has picked several product sectors 
for promotion under the agreements, and targets its 
investment promotion efforts to countries and companies 
manufacturing them.  The selected products, if 
manufactured in Sri Lanka and meet rules of origin 
criteria, are eligible for duty free entry into India. 
The products targeted for Pakistan will qualify for a 
34 percent duty reduction immediately and will see 
duties coming down to zero over three years.  The BOI 
has identified the following sectors for investment 
 
COLOMBO 00000321  016 OF 034 
 
 
promotion under the ILFTA and SLPKFTA: 
 
--ILFTA: confectionary and cocoa products, rubber 
products, plastic, footwear, ceramic, jewelry, 
machinery and mechanical appliances, electronics and 
electrical products, automobiles and spares parts, 
medical instruments and furniture and doors. 
 
--SLPKFTA: rubber products, ceramic, machinery and 
mechanical appliances, electronics and electrical 
appliances, medical instruments and automobiles and 
spare parts. 
 
¶60.  Some US companies currently avail themselves of 
the ILFTA by adding at least 35 percent value in Sri 
Lanka and getting import duties into India reduced from 
as much as 40 percent to as little as zero. 
 
¶61.  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.  The 
BOI is planning to create an investor matchmaking 
service via the BOI website.  Information regarding 
this service could be found on www.boi.lk/partnership. 
 
RIGHT TO PRIVATE OWNERSHIP AND ESTABLISHMENT 
-------------------------------------------- 
 
¶62.  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 to access to markets, credit, or licenses. 
Foreign ownership is allowed in most sectors.  Private 
land ownership is limited to fifty acres per person. 
The government owns about 80 percent of the land in Sri 
Lanka, including the land housing most tea, rubber, and 
coconut plantations.  The government has leased most of 
these plantations to the private sector on 50-year 
terms.  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. 
 
¶63.  While foreign investors can purchase land from 
private sellers, the government recently imposed a 100 
percent tax on land transfers to foreigners.  It also 
imposed a definition of foreign investment to include 
corporations with as little as 25 percent foreign 
ownership ? a definition that can be particularly 
difficult for companies listed on the Colombo Stock 
Exchange since on any particular day, their ownership 
characteristics may vary.  Apartments above the third 
floor of condominium buildings, land for the 
development of large housing schemes, hospitals and 
hotels with a minimum investment of USD 10 million, 
exporting companies with a minimum investment of USD 1 
million, and large infrastructure projects with a 
minimum investment of USD 50 million are to be exempted 
from the tax.  Foreigners maintaining USD 150,000 in a 
bank account in Sri Lanka will be given concessionary 
treatment.  Regulations regarding these exceptions have 
been published in Gazette No 1386/18 dated March 30, 
¶2005. 
 
 
PROTECTION OF PROPERTY RIGHTS 
----------------------------- 
 
--Property rights:  problematic but may be improving 
 
COLOMBO 00000321  017 OF 034 
 
 
 
¶64.  Secured interests in property are recognized and 
enforced.  A fairly reliable registration system exists 
for recording private property including land, 
buildings and mortgages.  However, there have been 
problems due to fraud and forged documents.  The 
Government has begun to address these issues under a 
World Bank-sponsored judicial reforms project.  The 
legal system is nondiscriminatory and protects and 
facilitates acquisition and disposition of property 
rights by foreigners, although it has recently become 
subject to political influence. 
 
¶65.  Private farmers generally work state-owned lands 
under varying tenure agreements, ranging from 
restrictive tenures to land grants, although the 
property rights to these lands are frequently ill- 
defined.  Changes to the legal framework covering land 
titling have been proposed under a World Bank-funded 
project.  These changes aim to establish land tenure, 
remove restrictions related to the sale, leasing and 
transfer and mortgaging of rural lands previously 
distributed to farmers by the Government.  The project 
has also implemented a model computerized land titling 
system in a few villages.  The Government has sought 
World Bank assistance to extend the system to cover the 
entire country.  Such a project, yet to be designed and 
approved, would take about 6 years to implement. 
 
--Intellectual Property Rights Protection 
 
¶66.  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). 
 
¶67.  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.  Enforcement of these 
agreements, however, is in its infancy. 
 
¶68.  A new intellectual property law came into force in 
November 2003.  It meets both US-Sri Lanka bilateral 
IPR agreement and TRIPS obligations to a great extent. 
The IPR law governs copyrights and related rights, 
reproduction rights, public distribution rights, 
industrial designs, patents for inventions, trademarks 
and service marks, trade names, layout designs of 
integrated circuits, geographical indications, unfair 
competition, databases, computer programs, and 
undisclosed information.  The law also covers the 
rights of performers, producers of sound recordings, 
and broadcasting organizations.  All trademarks, 
designs, industrial designs and patents must be 
registered with the Director General of Intellectual 
Property. 
 
¶69.  Infringement of Intellectual Property Rights (IPR) 
is a punishable offense under the 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 
 
COLOMBO 00000321  018 OF 034 
 
 
imports and exports.  Police can take ex-officio action 
to enforce the law.  Aggrieved parties can also, on 
their own, seek redress for any IPR violations through 
the courts, though this can be a frustrating and time- 
consuming process. 
 
¶70.  Although the legal system is well-established and 
non-discriminatory, it is fraught with long delays. 
IPR enforcement was a serious problem under the old 
law, and public awareness of IPR continues to be 
limited.  Under the old law, domestic implementation 
legislation was very weak and the government did not 
act as an enforcer of IPR laws. 
 
¶71.  With the passage of the new law, Sri Lanka has 
begun to enforce IPR laws.  However, it will take time 
before new procedures and court precedents are 
established.  In October 2004, Sri Lankan Police raided 
an illegal CD manufacturing plant owned by Malaysian 
nationals.  In December 2005, the courts fined a 
Malaysian employee of the company (the only person 
arrested for the crime), Rs 40,000 (USD 400) for 
illegal possession of CDs and DVDs and handed down a 
suspended prison sentence of 24 months.  The Police 
carried out additional raids of counterfeit CD/VCD 
stores as well as counterfeit garment sellers in 2005. 
Customs has also seized counterfeit consumer goods, 
mainly cigarettes.  Vendors of pirated CDs, DVDs and 
garments were fined and received suspended jail 
sentences in Sri Lanka?s courts, suggesting minor 
progress in the enforcement of the new law.  Meanwhile, 
local agents of reputed US and other international 
recording companies, software development companies, 
motion picture companies, clothing companies and 
consumer product companies continue to complain that 
lack of IPR protection is damaging their businesses. 
Further, CD/VCD stores that were raided in early 2005 
again sell pirated goods and a ?trade association? to 
look after the interest of pirates and distributors was 
established.  The association claims that IPR 
enforcement violates its members? right to generate 
business.  The Embassy, along with key industry players 
including the IFPI, continues to lobby the government 
to improve Sri Lanka's IPR regime. 
 
¶72.  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 new technological 
developments.  Sri Lanka lacks provisions to deal with 
electronic transactions, electronic signatures, and 
computer crimes and evidence, although draft laws to 
deal with these matters have been finalized.  The IPR 
law does not cover protection of new plant varieties. 
 
--Patents, Copyrights and Trademarks 
 
¶73.  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 a human or animal body.  The law also 
permits compulsory licensing and parallel imports of 
pharmaceutical products.  Compulsory licensing will 
 
COLOMBO 00000321  019 OF 034 
 
 
allow the government to grant licenses to manufacture 
certain patented drugs, overruling patent licenses in a 
national emergency.  The parallel imports will allow 
the import of a branded drug from an alternative 
source. 
 
¶74.  A patent is valid for 20 years from the date of 
application but must be renewed annually. 
 
¶75.  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.  There are enforcement limitations applying to 
copyrights, including software. 
 
¶76.  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.  For instance, 
the Supreme Court of Sri Lanka recently held that a 
local company did not have a right to use the MTV 
trademark owned by Viacom International of the U.S. 
Registered trademarks are valid for ten years and 
renewable.  The law also recognizes both certification 
marks and collective marks. 
 
 
TRANSPARENCY IN THE REGULATORY SYSTEM 
------------------------------------- 
 
¶77.  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, and building and construction standards are in 
place.  However, 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.   Lack of sufficient technical 
capacity within the government to review financial 
proposals for private infrastructure projects also 
creates problems during tendering.  In late 2005, the 
Government awarded several key infrastructure projects 
to Chinese companies, outside the tender process.  They 
include a 300 megawatt coal power project and a 
bunkering project. 
 
¶78.  Although many foreign investors, including US 
firms, have had positive experiences in Sri Lanka, some 
have encountered significant problems with government 
practices and regulations.  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 though the Sri Lankan Cabinet had 
approved those contracts. 
 
 
EFFICIENT CAPITAL MARKETS AND PORTFOLIO INVESTMENT 
--------------------------------------------- ----- 
 
 
COLOMBO 00000321  020 OF 034 
 
 
--Availability of financial resources 
 
¶79.  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. 
 
¶80.  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 intermediate costs, which led to higher costs 
to other borrowers.  Since 2002, government policy has 
supported a low interest rate regime and has given 
impetus to increased credit, which has contributed to 
increased domestic investment as well as inflation. 
The investment/GDP ratio rose to 26 percent in 2005, 
compared with 22 percent in 2001.  The prime lending 
rate currently averages 12 percent.  Foreign investors 
are allowed to access credit on the local market.  They 
are also free to raise foreign currency loans. 
 
¶81.  A total of Rs 12.3 billion (approx. USD 123 
million) was raised in the primary market by way of new 
equity and debt in 2004, reflecting the potential for 
companies to raise funds through the market. 
 
--Credit Instruments 
 
¶82.  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 Bank and some commercial banks also raise 
syndicated bank loans to fund large-scale investment 
projects undertaken by the private sector. 
 
¶83.  The domestic debt market in Sri Lanka is still at 
a very nascent stage.  The first credit rating agency, 
Fitch IBRC (www.fitchratings.lk) opened an office in 
Colombo in 1999, which has helped companies to raise 
funds through debt markets.  Fitch Ratings Lanka Ltd, 
is a joint venture between Fitch IBRC, IFC, the Central 
Bank of Sri Lanka, and several local financial 
institutions.  Credit ratings are now mandatory for all 
deposit-taking institutions and for all varieties of 
debt instruments. 
 
--Accounting Standards 
 
¶84.  There is an active and fairly 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.  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).  Due to the lack of an adequate 
enforcement mechanism, however, problems with the 
quality and reliability of financial statements still 
exist. 
 
 
COLOMBO 00000321  021 OF 034 
 
 
¶85.  Sri Lanka accounting standards are applicable for 
all banks and stock exchange listed companies 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.  The 
Accounting Standards and Monitoring Board (ASMB) is 
responsible for monitoring compliance with Sri Lankan 
accounting and auditing standards.  There is an active 
presence of British professional accounting bodies in 
Sri Lanka.  The Chartered Institute of Management 
Accountants (CIMA), a leading professional accounting 
body based in the UK and spread over the Commonwealth 
has its largest overseas presence in Sri Lanka. 
 
--Securities and Exchange Commission 
 
¶86.  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. 
 
¶87.  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. 
 
¶88.  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.  The SEC Chairman 
resigned and later pleaded innocence.   The two parties 
subsequently came to an out-of-court settlement. 
 
¶89.  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 US Sarbanes-Oxley Act to 
regulate financial services and professional services 
organizations. 
 
--Colombo Stock Exchange 
 
¶90.  The Colombo Stock Exchange (CSE), while small by 
"big emerging market" standards, is one of the most 
technologically sophisticated in the region.  The CSE 
has fully automated trading, 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 stockbrokers are permitted 
to hold up to 100 percent equity in stock brokerage 
firms operating at the CSE.  SEC has a settlement 
guarantee fund with an initial capital of Rs 100 
million (USD 1 million) which aims to guarantee the 
settlement of trades between clearing members of the 
 
COLOMBO 00000321  022 OF 034 
 
 
exchange.  The Chartered Financial Analysts (CFA) 
program is conducted in Sri Lanka. 
 
¶91.  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.  It is 
modeled on the lines of the London City Code on 
Takeovers and Mergers.  Acquisition of more than a 30 
percent stake of a listed company requires the buyer to 
make an offer to all other shareholders.  The articles 
of association of a few listed companies restrict 
foreign equity to certain levels. 
 
¶92.  There are 242 companies listed on the stock 
exchange with the top ten positions by market 
capitalization held by banks and food and beverage 
companies.  In 2003-2005, CSE was one of the best 
performing markets in the world.  The Cease-Fire 
Agreement between the Government of Sri Lanka and the 
LTTE has helped to boost investor confidence. 
Following the November 17, 2005 election of President 
Mahinda Rajapaksa, the CSE has fluctuated in part 
depending on the level of violence in the northern and 
eastern provinces and hopes for improvement due to the 
cease-fire talks.  During 1998-2001, the Colombo Stock 
Market experienced a sharp downturn due to a variety of 
local and international factors.  As a result, the CSE 
was removed from the Morgan Stanley Capital 
International (MSCI) Index in 2001.  It has not been 
reclassified in the MSCI yet, despite recent surge 
driven mainly by locals.  Meanwhile, the California 
Public Employees? Retirement System (CalPERS), a large 
public pension fund for the state of California, which 
designated Sri Lanka a permissible country for 
investments in 2005, lowered its overall score for Sri 
Lanka in its latest review in 2006 to 1.8 from 2.00 in 
¶2005.  The threshold for inclusion in CalPERS is 2.00 
and Sri Lanka?s position is to be reviewed after one 
year.  The index is based on political stability, 
transparency, labor productivity, market liquidity, 
capital market openness, investor protection, and 
transaction cost. 
 
¶93.  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 
 
¶94.  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. 
Citibank NA is the only US bank operating in Sri Lanka 
and has expanded its operations recently.  ICIC Bank of 
India is the newest foreign bank in Sri Lanka and 
commenced operations in January 2006.  In 2001-2003, 
Mashreq Bank, American Express Bank, Nova Scotia Bank 
and ABN Amro Bank all sold their banking operations in 
Colombo to existing banks.  Sri Lanka experienced its 
first bank failure in December 2002 when the Central 
Bank took action to revoke the license of a small 
 
COLOMBO 00000321  023 OF 034 
 
 
licensed specialized bank as its financial condition 
deteriorated to insolvency.  There has not been any 
fallout for other banks from this incident.  Two other 
small troubled banks were restructured under Central 
Bank guidance.  In April 2005, the Central Bank 
introduced higher capital requirements for commercial 
banks in an effort to enhance the banking system 
stability, promote consolidation and facilitate entry 
of larger banks. 
 
¶95.  The Central Bank is responsible for supervision of 
all banking institutions.  Wide-ranging improvements 
have been made in banking regulations and in public 
disclosure of banking sector performance.  In 2002 the 
Monetary Law Act (MLA) was amended to provide the 
Central Bank broader supervisory powers and greater 
independence.  The Bank also issued a code of corporate 
governance for banks and financial institutions in 
¶2002.  In addition, rules on classification and 
provisioning were improved significantly from January 
¶2004.  Further, the Banking Act was amended in 2005 to 
give additional supervisory powers to the Central Bank 
and to introduce guidelines to check the suitability of 
bank directors.  The amended Banking Act outlaws 
pyramid-type programs.  Further amendments to the laws 
are also expected in the next two years under ongoing 
financial and legal reforms programs.  The Central Bank 
however still suffers from lack of autonomy, especially 
with regard to the large state owned banks. 
 
¶96.  In 2004, the Central Bank introduced technical 
improvements to facilitate banking sector efficiency by 
establishing a Real Time Gross Settlement (RTGS) system 
and a Scriptless Securities Settlement (SSS) system. 
They have improved the efficiency and the safety of the 
country?s payment and settlement systems and will 
facilitate trade in government securities. 
 
¶97.  Central Bank supervision as well as auditing 
practices of private audit firms came under criticism 
after the 2002 specialized bank failure mentioned 
above.  The Central Bank obtained the services of an 
international expert to strengthen bank supervision in 
¶2004. 
 
--State Owned Banks 
 
¶98.  Total assets of commercial banks stood at Rs 1,028 
billion (USD 10 billion) as of December 31, 2004.  The 
two state-owned commercial banks, Bank of Ceylon and 
People?s Bank with assets of Rs 266 billion (USD 2.7 
billion) and Rs 224 billion (USD 2.2 billion) 
respectively in 2004, still dominate banking, 
accounting for about 45 percent of all assets. 
 
¶99.  The financial profiles of both state banks have 
deteriorated over the years, mainly as a result of 
direct lending and operating inefficiencies.  Since 
most of the bad debts of the two banks were implicitly 
guaranteed by the state, these problems did not affect 
the credibility of the banking system in Sri Lanka. 
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 to developing the financial 
sector.  The government re-capitalized the state banks 
during the 1990?s without success.  The government has 
been trying to reorganize the banks.  Top management at 
both Bank of Ceylon and People's Bank now contains 
private sector personnel, and the banks were granted 
 
COLOMBO 00000321  024 OF 034 
 
 
greater autonomy.  Further, asset classification and 
provisioning norms have been progressively 
strengthened.  While Bank of Ceylon has met most of the 
restructuring targets and shows substantial 
improvements in its financial profile, the situation at 
People?s Bank remains weak.  In particular, the 
provisioning has left the bank with a large negative 
equity affecting its operations.  In addition, the 
failure to restructure large state owned utilities such 
as the Ceylon Electricity Board and the Ceylon 
Petroleum Corporation, and the failure to adjust prices 
in a timely manner, have recently forced these agencies 
to borrow from state banks, leading to a possible 
deterioration of asset quality in state banks. 
 
¶100.  In early 2005, the Cabinet approved new business 
development plans for the two state banks to make them 
more viable.  The plans were developed under the 
guidance of the Strategic Enterprise Management Agency 
(SEMA), the high-powered restructuring agency of the 
Government.  The plan for Bank of Ceylon aims to 
increase its profitability and efficiency.  In the case 
of People?s Bank, the state is to re-capitalize the 
bank, for the third time, to meet a capital shortfall 
of Rs 10 billion.  The latest capitalization is to be 
supported by an ADB program, which will include equity 
funding of about Rs 6 billion (USD 60 million) over 3 
years.  ADB funding will be required to meet 
performance targets on non-performing loans and 
demonstrate profitability, cost, and capital adequacy. 
The new plan signifies a departure from the earlier IMF 
agreed plan to sell the bank under a restructuring 
program. 
 
--Private Commercial Banks and Foreign Banks 
 
¶101.  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.  Nonetheless, the private banking 
sector also remains trapped with a high level of non- 
performing loans, despite high margins.  In 2004, the 
average rate of non-performing loans to total loans was 
10 percent for domestic private banks and 14.2 percent 
for state banks.  Foreign banks reported a much better 
ratio of 3.3 percent.  There are concerns regarding 
inadequate loan loss provisioning and low operational 
efficiency in some local private banks.  The banks are 
expected to improve provisioning with the introduction 
of new rules by the Central Bank in 2004.  Foreign 
banks tend to make provisions in line with 
international best practices, as most foreign bank 
branches are subject to host 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 to provide troubled banks with a mechanism 
to effectively deal with their non-performing loans. 
 
¶102.  Credit ratings are mandatory for all banks 
operating in Sri Lanka from January 2004. 
 
--Capital Adequacy 
 
¶103.  Sri Lanka adopted capital adequacy standards set 
by the Basel Committee on banking regulations and 
supervisory practices in 1993.  In 2003, the Central 
Bank 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).  Further enhancing banking sector stability, the 
Central Bank has also imposed capital adequacy 
 
COLOMBO 00000321  025 OF 034 
 
 
standards on foreign currency banking units.  In line 
with Basel Core Principles on effective banking 
supervision, compliance with Capital Adequacy on a 
consolidated basis was introduced in 2003. 
 
¶104.  People?s Bank currently does not meet Capital 
Adequacy Requirements (CAR), but it has a Ministry of 
Finance guarantee for funds required to meet its 
obligations.  The ADB funded capital infusion is 
expected to help the bank meet its minimum capital 
requirements.  Bank of Ceylon Tier I CAR was about 12.1 
percent in 2003.  Risk based capital adequacy at 
domestic commercial banks was 11.1 in 2004.  CAR at 
foreign commercial Banks was 12.4 in 2004. 
 
 
POLITICAL VIOLENCE 
------------------ 
 
¶105.  Since early 2002, there has been a marked 
improvement in the business climate due to the 
relatively peaceful atmosphere prevailing in the 
country.  This is in contrast to the period between 
1983-2001, when the country was plagued by ethnic 
conflict 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 a US-designated Foreign Terrorist 
Organization (FTO).  Terrorist activities of the LTTE 
declined since the LTTE and the Government signed a 
formal open-ended Cease-Fire Agreement in February 
¶2002.  Following six rounds of peace talks with the 
government of Norway acting as facilitator, the LTTE 
suspended its participation in the negotiations in 
April 2003. 
 
¶106.  Since April 2003,  there have been numerous 
cease-fire violations, particularly in the eastern part 
of the country, primarily related to fighting between 
the LTTE and anti-LTTE Tamil groups, including a 
faction that split from the LTTE in 2004.  Government 
of Sri Lanka intelligence officials, military and 
informants have also been targeted.  In July 2004, a 
suicide bomb exploded in a Colombo police station 
following an assassination attempt against an anti-LTTE 
Tamil minister.  Five people (including the bomber) 
were killed.  In August 2005 suspected LTTE snipers 
shot and killed Foreign Minister Lakshman Kadirgamar at 
his Colombo residence.  In December 2005 a Sri Lanka 
Navy bus was struck by an LTTE-command detonated mine, 
killing 13 soldiers?the highest number of casualties in 
a single incident since the beginning of the cease-fire 
in 2002.   In January 2006, there were several 
additional troubling cease-fire violations, including 
the sinking of a Navy patrol boat, killing 13.  The GSL 
and the LTTE have agreed to meet in Geneva in February 
2006 to discuss ways to strengthen cease-fire 
implementation. 
 
¶107.  During almost 19 years of war, tourists and 
foreign business representatives have not been 
terrorist targets, but they have suffered collateral 
injuries 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 Sri 
Lankan civilians were caught in the crossfire.  Sri 
Lankan Airlines, jointly owned by the Government of Sri 
Lanka and Emirates Airlines of Dubai, lost several 
 
COLOMBO 00000321  026 OF 034 
 
 
commercial aircraft in the attack.  The LTTE has also 
attacked several commercial ships prior to 2001 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 been lifted since the cease-fire went 
into effect.  During the conflict, the LTTE also 
detonated several large bombs in Colombo?s financial 
and business districts, causing numerous casualties and 
extensive damage to property.  Very few foreigners were 
injured in these terrorist incidents due to the LTTE?s 
policy of targeting local interests. 
 
CORRUPTION 
---------- 
 
¶108.  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 ? at least once 
a contract has been won.  Corruption appears to have 
the greatest effect on investors in large projects as 
well as government procurement and tendering. 
According to Transparency International (TI), 
corruption is perceived as most pervasive in terms of 
political appointments to government institutions and 
in government procurement awards, as well as in high 
frequency/low value transactions.  The police force and 
the judiciary are perceived to be the most corrupt 
public institutions.  Corruption is also a persistent 
problem in customs clearance and enables wide-scale 
smuggling of certain consumer items, to the detriment 
of legitimate manufacturers and importers. 
 
--The Bribery Commission is not very effective. 
 
¶109.  The Bribery Commission is the main body 
responsible for investigating allegations of bribery 
and corruption.  The Commission?s most recent term 
expired in December 2004, and a new Commission was 
appointed after a 3-month delay in March 2005.  The 
previous Commissions were not effective in dealing with 
bribery or corruption.  The function of the Commission, 
under Act No 19 of 1994, is to investigate allegations 
brought to its attention and to institute proceedings 
against responsible individuals in the appropriate 
court.  The law states that a public official?s offer 
or acceptance of a bribe constitutes a criminal offense 
and carries a maximum sentence of seven years 
imprisonment and a fine at the discretion of the 
courts.  A bribe by a local company to a foreign 
official is not covered by the Bribery Act. 
 
¶110.  Few have been found guilty of corruption in 
recent years.  Although highly publicized, efforts to 
investigate bribery and corruption have failed, 
damaging public confidence in such processes.  While 
corruption charges have been leveled against 
politicians and top officials in charge of key 
government corporations, none of the accused has been 
convicted of bribery yet. 
 
¶111.  Sri Lanka ratified the UN Anti-corruption 
Convention in March 2004.  Sri Lanka has signed but not 
ratified the UN Convention against Transnational 
Organized Crime.  Sri Lanka is not a signatory to the 
OECD-ADB Anti-Corruption Regional Plan. 
 
¶112.  Transparency International (TI), an international 
"watchdog" organization promoting anti-corruption 
 
COLOMBO 00000321  027 OF 034 
 
 
strategies, runs a national chapter in Sri Lanka.  In 
TI?s Corruption Perception Index for 2005, Sri Lanka 
was 78th among 158 countries with a score of 3.2 out of 
a clean score of 10, reflecting a relatively high 
perceived level of corruption among politicians and 
public officials.  Sri Lanka?s corruption ranking and 
score deteriorated in 2005 from 67th and 3.5 
respectively in 2004.  TI?s 2003 National Integrity 
Systems Country Report recommends creating an 
independent anti-corruption authority with sufficient 
powers as a top priority to combat corruption.  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 
and post tsunami reconstruction.  In response, the 
Government?s tsunami reconstruction agency (now known 
as Reconstruction and Development Agency (RADA) with 
the assistance of the United Nations (UN) has created a 
web based Development Assistance Database (DAD) 
(www.dad.tafren.gov.lk) for tracking information 
regarding tsunami aid disbursement and project 
implementation. 
 
¶113.  In terms of Economic Freedom, Sri Lanka is ranked 
92 out of 157 countries in the Heritage Foundation?s 
2006 Index of Economic Freedom.  Countries receive a 1- 
5 rating - with one being the best - on 10 broad 
measures of economic freedom: trade policy, government 
fiscal burden, government intervention in the economy, 
monetary policy, foreign investment, banking and 
finance, wages and prices, property rights, regulation 
and informal market activity.  Sri Lanka?s overall 
rating score worsened in 2006 to 3.19 from 3.03 in 
¶2005. 
 
 
BILATERAL INVESTMENT AGREEMENTS 
------------------------------- 
 
¶114.  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 
 
 
--Taxation 
 
 
 
COLOMBO 00000321  028 OF 034 
 
 
¶115.  A bilateral treaty between Sri Lanka and the 
United States to avoid double taxation was ratified and 
entered into force on June 12, 2004. 
 
¶116.  Foreign investors not qualifying for Board of 
Investment incentives such as tax and exchange control 
exemptions or concessions are liable to pay taxes on 
corporate profits, dividends, and remittances of 
profits.  They are also 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 
-------------------------------------------- 
 
¶117.  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. 
 
¶118.   The US Embassy and other US Government 
institutions spend over USD 21 million annually 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 fluctuated against major 
foreign currencies 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 
 
¶119.  Sri Lanka's labor force is literate (particularly 
in the local language) and trainable, although weak in 
certain technical skills and the English language. 
More computer and business skills training programs and 
English language programs are becoming available.  But 
the demand for these skills still outpaces supply, and 
many qualified workers seek employment overseas.  The 
average worker has eight years of schooling. 
 
¶120.  Two-thirds of the labor force is male.  In the 
third quarter of 2004, 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) was 8.5 percent, or an 
estimated 678,600 of a total labor force of 8 million 
out of work. (Labor force data excludes some areas in 
the Northern Province, armed forces personnel deployed 
away from home, and Sri Lankan migrant workers abroad.) 
If one does not count unpaid family workers as 
employed, the unemployment rate is higher. 
 
COLOMBO 00000321  029 OF 034 
 
 
Underemployment is also a major problem, with thousands 
of university graduates seeking places in the already 
bloated public sector, yet lacking skills needed in the 
private sector.  Youth and entry-level unemployment 
remains a critical problem.  Nearly 80 percent of 
unemployed persons are in the 15-29 year age range. 
Over 50 percent of unemployed young people are educated 
at the Ordinary-Level (British System equivalent of US 
10th grade) or higher. 
 
¶121.  A significant proportion of unemployed people 
seek "white collar" jobs, and most sectors seeking 
employees offer manual or semi-skilled jobs or require 
technical or professional skills such as management, 
marketing, information technology, accountancy and 
finance, and the English language.  Following pledges 
during April 2004 parliamentary elections and recently 
concluded Presidential elections, the government has 
initiated several programs to expand state sector 
employment.  For instance, a graduate employment 
program provided about 42,000 new jobs in the 
government sector in 2005.  A further 10,000 new jobs 
are to be created in 2006 and the Government has 
promised to hire into its bulging bureaucracy an 
additional 10,000 each year thereafter. 
 
¶122.  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.  USAID, the Asian Development Bank and the 
World Bank have recently approved projects to improve 
distance learning and tertiary education.  The private 
sector is offering various professional study courses 
accredited to local and foreign professional institutes 
and foreign universities.  However, access to these 
courses is limited due to the high fees involved. 
Additionally, a fair number of Sri Lankans study 
abroad. 
 
--Migrant Workers Abroad 
 
¶123.  There are an estimated 970,000 Sri Lankan workers 
abroad.  Remittances from migrant workers, at around 
$1.5 billion, is one of Sri Lanka?s largest sources of 
foreign exchange.  The majority of this labor force is 
unskilled (housemaids and factory laborers) and located 
primarily in the Middle East.  But Sri Lanka is also 
losing many of its technically and professionally 
qualified workers to more lucrative jobs abroad.  The 
Government has pledged to promote programs aimed at 
increasing overseas employment opportunities for Sri 
Lankans. 
 
--Low Cost of Labor; Fair to Growth-Limiting Labor 
Regulations 
 
¶124.  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, although 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 of Workmen 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 
 
COLOMBO 00000321  030 OF 034 
 
 
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. Productivity lags behind other countries 
in Asia. 
 
¶125.  There is widespread belief that Sri Lanka?s labor 
laws and its plethora of holidays dampen productivity. 
The full moon day of each month (sacred in the Buddhist 
faith), 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.  These 
statutory holidays are in addition to 21 days of 
annual/casual leave and approximately 21 days of sick 
leave (the number of days for sick leave is at the 
discretion of the management).  Further, female 
employees are entitled to 84 days fully paid maternity 
leave for the first two pregnancies.  The 2005 budget 
proposed additional maternity leave benefits, but they 
are yet to be implemented.  Female workers are 
permitted 60 hours of overtime work per month. 
 
¶126. The Government continues to interfere with private 
sector wage setting.  In October 2005, the Government 
through an act of Parliament took steps to mandate a 
wage increase (of approximately Rs 1,000) to private 
sector workers.  The private sector is concerned about 
such interference in wage setting, which could damage 
competitiveness in certain sectors. 
 
--Termination laws 
 
¶127.  While the Termination of Employment of Workmen 
Act (TEA) described above makes it difficult to fire or 
lay off workers, Parliament, through the UNF 
government?s labor reform agenda, passed amendments in 
January 2003 to the TEA and the Industrial Disputes Act 
(IDA) to improve labor mobility.  The amendments to TEA 
seek to facilitate termination and provide for a 
standard compensation formula and an unemployment 
benefit scheme.  Amendments to the IDA include labor 
dispute resolution rules to expedite the dispute 
process.  The new termination rules became operational 
with the establishment of a new compensation formula in 
March 2005.  The compensation formula takes into 
account the number of years of service and offers 2.5 
months salary as compensation for 1 year of service, 
12.5 months salary for 5 years of service; 38 months 
for 20 years and up to a maximum of 48 months salary 
for 34 years service.  This of course assumes that the 
government will approve such a termination, which 
frequently is not the case.  The proposed unemployment 
benefit insurance scheme to provide an additional 
payment has not yet come into effect.  According to a 
recent IMF report, Sri Lanka?s firing cost for 20 years 
of service, at 38 months, is among the highest in Asia 
compared with Pakistan and Nepal?s 22.5 months, India?s 
19.6 months, Malaysia?s 18.5 months, China?s 13.2 
months and Bangladesh?s 11.7 months.  Under the new 
arrangements, the Labor Commissioner?s approval or the 
affected employee?s consent is required to fire 
workers.  Employers complain that the package is 
excessive, especially compared to international norms. 
They have also pointed out that higher compensation 
could adversely affect companies requiring 
restructuring, and discourage investment. 
 
¶128.  Other planned reforms include amendments to the 
Shop and Office Act to allow female employees in the IT 
sector to work at night.  A more systematic overhaul of 
the TEA and IDA would help to bring labor laws in line 
 
COLOMBO 00000321  031 OF 034 
 
 
with international norms. 
 
--Trade Unions 
 
¶129.  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. 
 
¶130.  Unions have complained that the BOI and some 
employers, especially in the BOI-run export processing 
zones (EPZ), prohibit union access and do not register 
unions on a timely basis.  Employers allege that the 
JVP, a Marxist political party against private 
ownership, could provoke labor to strike in the guise 
of trade union activity.  Due to the JVP?s violent 
past, employers are generally not in favor of it or its 
trade union arm, the Inter-Company Trade Union. 
 
¶131.  The Government continues to take steps to improve 
enforcement of labor regulations inside EPZs.  In BOI 
enterprises, including those in the EPZs, worker 
councils composed of employees generally engage in 
labor and management negotiations.  These worker 
councils have functioned well in some companies in 
providing for worker welfare.  The BOI has requested 
that companies recognize trade unions and accept the 
right to collective bargaining.  According to the BOI, 
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. 
 
¶132.  The ILO Freedom of Association Committee has 
observed that Sri Lankan trade unions and employee 
councils can co-exist, but advises that there should 
not be any discrimination against those employees 
choosing to join a union.  The right of employee 
councils to engage in collective bargaining has been 
held as valid by the ILO.  The ILO has, however, noted 
weaknesses in rules governing operation of employee 
councils and low prevalence of collective bargaining 
agreements and requested that the Government carry out 
improvements. 
 
¶133.  In response to these observations, the BOI 
revised its labor manual in March 2004, requesting that 
companies located in EPZs allow union access to zones 
and provide official time off to union members to 
attend meetings.  Along with this revision, the BOI 
also issued new guidelines for the formation and 
operation of employee councils, giving powers to 
employee councils to negotiate binding collective 
agreements. 
 
¶134.  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 Generalized System 
of Preferences (GSP) benefits for Sri Lanka due to 
labor rights violations in some factories in the EPZs. 
This petition was not acted upon.  A similar submission 
was made to the European Union (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, in January 2004, granted significant 
benefits to Sri Lanka under EU GSP in recognition of 
the country?s efforts to implement core labor standards 
because the audit did not find serious problems with 
regard to those standards.  The EU, however, observed 
the need for further improvements in freedom of 
association. 
 
COLOMBO 00000321  032 OF 034 
 
 
 
¶135.  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. 
Several trade unions with affiliations to major 
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. 
 
¶136.  The growing strength of Marxist parties in active 
politics and in parliament has increased politicized 
union activity, especially in government institutions. 
State agencies with large unionized workforces have 
become vulnerable to politically motivated strikes in 
response to restructuring and privatization. 
 
--Collective Bargaining 
 
¶137.  Collective bargaining is not yet popular.  While 
more than half of the Employers? Federation of Ceylon?s 
(EFC?s) 435-strong membership is unionized, currently 
only about 50 of these companies (including a number of 
foreign-owned firms) have collective agreements and use 
them to conduct negotiations on their behalf.  Civil 
servants other than officers in the police, armed 
forces, and prison service, also have a right to 
strike. 
 
--Labor-Management Relations 
 
¶138.  Labor-management relations in the past have 
typically been confrontational.  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.  While 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.  Work stoppages and 
strikes in the private sector are on the decline. 
 
--ILO conventions 
 
¶139.  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.  The Ministry 
of Labor has published a Labor Code, consolidating 
important labor legislation.  Sri Lanka has ratified 
all eight of the core labor conventions included in the 
1998 ILO Declaration on Fundamental Principles and 
Rights at Work.  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 its Decent Work Agenda program in Sri 
 
COLOMBO 00000321  033 OF 034 
 
 
Lanka. 
 
 
FOREIGN TRADE ZONES 
------------------- 
 
¶140.  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. 
 
¶141.  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.  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.  However, the limitations of transportation 
infrastructure may make some distant zones somewhat 
less appealing. 
 
 
FOREIGN DIRECT INVESTMENT 
------------------------- 
 
--US Investments 
 
¶142.  Major US companies with investments in Sri Lanka 
include:  Energizer Battery, Mast Industries, Smart 
Shirts (a subsidiary of Kellwood Industries), Chevron, 
Citibank, Caterpillar, 3M, Cargill, Coca Cola, 
Celetronix, Inc, Paxar Corporation, Pepsi Co, Sportif, 
Worldquest, Fitch IBCR, AES Corporation, American 
International Group (AIG), American Premium Water, 
Virtusa, Avery Denison, North Sails, and Amsafe 
Bridport.  In addition, IBM, Lanier, NCR, GTE, 
Motorola, Procter & Gamble, Liz Claiborne, 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, and McDonald?s are 
represented in Sri Lanka through franchises.  Numerous 
other American brands and products are represented by 
local agents. 
 
¶143.  US investment in Sri Lanka is estimated to be in 
the range of USD 200 million.  A recent investor in the 
power sector is AES Corporation.  AIG insurance entered 
Sri Lanka in 1999.  Other foreign companies in Sri 
Lanka are expanding, such as Celetronix Inc (memory 
boards), Virtusa and Citibank.  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. 
 
COLOMBO 00000321  034 OF 034 
 
 
 
--Non-US Investments 
 
¶144.  Major non-US investors include: Unilever, Nestle, 
British American Tobacco Company, Mitsui, Pacific 
Dunlop/Ansell, Prima, FDK, Telekom Malaysia Bhd, S.P. 
Tao and HSBC.  Leading US and foreign investors that 
have acquired significant stakes in privatized 
companies include Chevron, Norsk Hydro of Norway, 
Hanjung Steel 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, P&O Netherlands, and the Indian Oil 
Corporation (IOC) 
 
¶145.  Reliable statistics on foreign investment by 
country are not available.  Leading sources of foreign 
investments are Singapore, United Kingdom, Japan, South 
Korea, Hong Kong, and Australia.  FDI in 2005 was about 
USD 150 million. 
 
¶146.  Note: 2005 data are estimates. 
 
Entwistle