VZCZCXYZ0000
RR RUEHWEB

DE RUEHLM #2096/01 3521247
ZNR UUUUU ZZH
R 181247Z DEC 06
FM AMEMBASSY COLOMBO
TO RUEHC/SECSTATE WASHDC 4976
INFO RUEHKA/AMEMBASSY DHAKA 9711
RUEHIL/AMEMBASSY ISLAMABAD 6647
RUEHKT/AMEMBASSY KATHMANDU 4707
RUEHNE/AMEMBASSY NEW DELHI 0388
RUEHKP/AMCONSUL KARACHI 2077
RUEHCG/AMCONSUL CHENNAI 7210
RUEHGV/USMISSION GENEVA 1619

UNCLAS COLOMBO 002096 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DRL/IL FOR LAUREN HOLT 
STATE FOR SCA/INS 
MCC FOR S GROFF, D NASSIRY AND E BURKE 
GENEVA PASS USTR 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EAID CE
SUBJECT: ECONOMIC LEADERS MUST FOCUS ON DEFENSE; IMF 
LEAVING SRI LANKA 
 
REF: COLOMBO 2063 
 
¶1.  (SBU) Summary:  Corruption within the Government of Sri 
Lanka (GSL), shifting of budgetary allocations for defense 
expenditures, Sri Lanka,s true potential for economic 
growth, and the planned closure of the International Monetary 
Fund,s (IMF,s) Resident Office in Sri Lanka, were topics on 
December 15 when the Ambassador met with IMF Resident 
Representative Luis Valdivieso.  While Valdivieso described 
the GSL as being focused on the conflict with little time to 
focus on economic development, he assessed the 
currently-embattled Treasury Secretary as a visionary who 
could move Sri Lanka toward greater economic prosperity, if 
not required to use his skills and creativity to finance a 
conflict.  End Summary. 
 
 
MILITARY FINANCING VIA LINE ITEM SHIFTS 
 
¶2.  (SBU) Valdivieso in a December 15 meeting with Ambassador 
Blake said that that GSL,s defense allocation for 2007 is 
expected to be about 4.3 percent of GDP, an increase of about 
0.7 percent over 2006.  (See reftel for more coverage of the 
2007 budget.)  Valdivieso said that large portions of funding 
targeted for other purposes were used for 2006 military 
expenditures.  He cited as an example that as much as 75 
percent of the 2006 budget allocation to provide housing for 
citizens displaced by the conflict was shifted to cover 
military and related security obligations.  He added that 
most of the defense budget goes to recurrent military 
expenditures, such as salaries, special allowances and 
pensions, with virtually all military hardware procurements 
for 2007 to be obtained off-budget via 
government-to-government programs, resulting in loans for 
such acquisitions being deferred, to appear only in future 
budgets. 
 
 
SRI LANKA,S POTENTIAL FOR ECONOMIC GROWTH 
 
¶3.  (SBU) Although stating that the Sri Lankan economy has 
shown "great resilience" over the past few years, Valdivieso 
qualified the term "resilience," showing that he was using it 
in a different manner than is so commonly used by Sri Lankan 
optimists.  Where the optimists point to continued 6-8 
percent growth throughout many years of conflict, 
extrapolating that Sri Lanka is an unstoppable engine of 
moderate growth, Valdivieso identified the GSL,s skill in 
using donor funds following the tragic tsunami of December 
2004 to rescue Sri Lanka from was about to become an 
"economic disaster."  The post-tsunami donor aid enabled 
Jayasundera to use the debt relief, debt deferral and tsunami 
assistance provided by many countries to enhance the GSL 
budget.  Valdivieso projected that this type of donor 
assistance, and Treasury,s ability to use this tool to mask 
the GSL,s economic situation, could continue through 2007, 
but would then diminish significantly as deferred loans 
become due and as other aid decreases. 
 
¶4.  (SBU) Valdivieso, who has experience in several countries 
that have seen conflict, including East Timor, Tajikistan and 
El Salvador, said that countries with conflict often see as 
much as a 20 percent spike in economic growth following 
conflict.  However, war-affected countries frequently revert 
to conflict after a period of relative peace.  Despite 
President Rajapaksa,s stated economic goals of higher 
economic growth described in Mahinda Chintana, the IMF 
estimates that Sri Lanka can maintain only 6 percent 
sustained growth utilizing its current resources.  If the GSL 
wishes to obtain a higher sustained growth rate, it will need 
to create an environment that is more friendly to foreign 
direct investment, as well as improve its health system and 
provide a better tertiary education system ) one that 
ensures that its graduates are ready to work in today,s 
business climate, and one that increases access for its 
qualified young people.  (Note: Currently the state 
university system, which has a monopoly on Sri Lanka degree 
conferral, can only accommodate about 15 percent of those who 
qualify for tertiary education.  End Note.) 
 
 
¶5.  (SBU) Commenting that the GSL is currently so focused on 
the conflict that its leadership cannot focus on economic 
development, Valdivieso identified Treasury Secretary P.B. 
Jayasundera and the Ministry of Planning and Implementation 
as the "visionaries" who could help move the country toward a 
more stable economic environment.  He added that Central Bank 
Governor Nivard Cabraal, while performing well, is more of an 
"implementer" than a visionary, and must focus right now on 
the current needs of the GSL while trying to keep the economy 
afloat. 
 
 
CORRUPTION CHALLENGES 
 
¶6.  (SBU) The Ambassador asked about Valdivieso,s views on 
the prevalence of corruption in the GSL.  Valdivieso 
responded that corruption is endemic, although some steps 
have been taken to reduce the leakage.  For the last 10 
years, the IMF has advised the GSL to simplify its revenue 
collection systems, to no avail.  Instead of simplifying, the 
GSL has complicated its revenue collection mechanisms.  While 
simplification is needed, Valdivieso conceded that it is 
quite difficult in any country to break up the "kingdoms" 
that exist in revenue collection.  He identified a universal 
VAT as potential solution for revenue generation.  However, 
since the provincial governments rely on sales tax to support 
their functions, he said the addition of a universal VAT 
would be extremely problematic politically. 
 
¶7.  (SBU) The GSL,s procurement and other disbursement 
systems are also rife with corruption.  Funds are frequently 
allocated and disbursed for projects that, if ever begun, 
typically are not completed.  The Ambassador cited an example 
of how one GSL official (who received an award on December 9 
for battling corruption) who decided to verify whether funds 
allocated for the building of culverts and other water 
channels were being used for their stated purpose.  The 
official investigated and discovered that some funding was 
being used to build luxurious homes rather than channels, and 
other projects funded to build large channels resulted in 
only small ditches.  That official received many complaints 
from Members of Parliament, but received backing from the 
President,s office. 
 
¶8.  (SBU) According to Valdivieso, Treasury Secretary P.B. 
Jayasundera has been pushing the GSL toward greater 
accountability and more effective measurement of outcomes by 
moving the implementation of projects into a "sectoral" 
approach.  The IMF has been encouraging this methodology, as 
well as the formation of an &expanded budget8 that would 
include NGO projects.  Using this approach would enable the 
GSL to project its future financial obligations to maintain 
NGO-funded projects, such as schools, after initial NGO 
funding ceases.  (Comment:  An article in early December in 
the government newspaper announced that P.B. Jayasundera will 
resign from office.  Despite his later statement that he does 
not plan to resign, the article suggests pressure by 
influential GSL officials to remove him from office.  End 
Comment.) 
 
 
IMF CLOSING ITS SRI LANKA OFFICE 
 
¶9.  (SBU) Valdivieso informed the Ambassador that the IMF 
will close its resident office in Sri Lanka.  He cited a 
strategic restructuring of the IMF, which will locate 
resident offices in countries that have already accepted an 
IMF program, or are near entry into a program, and other 
countries of systemic importance or with major financial 
markets.  He said that the GSL has already been officially 
informed of this move, and that a press release would be made 
public on December 18.  He said that Sri Lanka is not even 
interested in entering into a program with the IMF.  Factors 
contributing to this lack of interest include the numerous 
donors currently working with Sri Lanka (citing India, China, 
Iran, and the "traditional donors") that provide aid without 
the IMF,s conditions, requirements that the current GSL,s 
has no desire to fulfill. 
 
 
¶10.  (SBU) The GSL has encouraged the IMF to delay its 
withdrawal from Sri Lanka.  But the closure continues to be 
scheduled for February 1.  Valdivieso noted that the IMF,s 
five-member office in Washington will continue working with 
Sri Lanka, perhaps making more frequent visits. 
 
¶11.  (SBU) COMMENT:  Valdivieso has served as IMF Resident 
Representative for almost two years in Sri Lanka.  Working 
behind-the-scenes in providing advice to the GSL, he 
strategically reversed the style of his predecessor who was 
more visible and more outspoken as to how Sri Lanka could 
improve economically.  While the current GSL does not heed 
criticism by locals or foreign officials who cast the GSL,s 
economic policy in a negative light, it also tends to ignore 
quiet and astute counsel, such as Valdivieso,s.  His 
assessment of the GSL,s lack of economic discipline confirms 
Embassy,s view that the GSL is focusing on the conflict to 
the virtual exclusion of all else, and is dependent on 
temporary foreign assistance to sustain its economic 
viability. 
BLAKE