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UNCLAS SECTION 01 OF 03 COLOMBO 000061 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR SCA/INS, F AMANDA LORMAN 
 
E.O 12958: N/A 
TAGS: EAID ECON EFIN CE
SUBJECT: SRI LANKA: ASSESSING IMPLICATIONS FOR U.S. BILATERAL 
ASSISTANCE 
 
REF: (A) STATE 134905 
(B) COLOMBO 22 
(C) 08 COLOMBO 1123 
(D) 08 COLOMBO 1133 
(E) 08 COLOMBO 1107 
 
¶1. (SBU) Summary:  Post does not anticipate significant negative 
implications for U.S. assistance due to the financial crisis, 
particularly as the majority of assistance is centered in the East, 
which, with low levels of development, remains predominantly 
insulated from the crisis.  However, post may experience some 
decline in available wholesale loan funds for on-lending (i.e., when 
the borrower agrees that loan proceeds will be made available to a 
third party) and a decline in available funds for public-private 
partnership program.  Sri Lanka's growth will continue in 2009, 
despite the global economic crisis and the country's ongoing 
conflict.  Analysts anticipate GDP growth of around 5%, while the 
government officially expects growth to reach a minimum of 6%. 
Although lower than in recent years, this growth level remains 
respectable for Sri Lanka's developing economy, which registered 6% 
growth in 2008 and 6.8% in 2007.  Sri Lanka's overall macro-economic 
outlook is, unfortunately, declining.  The government will face 
significant difficulty obtaining financing to meet its 2009 budget 
needs.  End Summary. 
 
Real Economy and 
Trade and Investment Impacts 
------------------------------ 
 
¶2. (U) Demand for key export commodities appears to be declining, as 
will earnings in key export sectors.  Some industry experts forecast 
a 10-15% decline in 2009 apparel exports, Sri Lanka's largest export 
earner.  On the other hand, Ajith Dias, the head of the Joint 
Apparel Association Forum (JAAF), is confident that industry 
earnings are more likely to remain at 2008 levels.  Other key export 
industries, including tea, rubber, cinnamon, and tourism, will face 
difficulties reaching growth targets in 2009, as demand and prices 
for these industries declined in the second half of 2008. 
Remittances, a key foreign exchange earner for the government, 
remained stable through late 2008; nevertheless, they are also 
likely to slow in 2009.  Some countries, such as South Korea, have 
frozen new migrant worker arrivals, and a decline in construction in 
countries such as the UAE will reduce demand for Sri Lankan 
expatriate workers. 
 
¶3. (U) The government has taken action to curb imports by making 
them more expensive, recently raising import taxes on a range of 
import items.  In October 2008, the Central Bank required importers 
to keep a 100% deposit on letters of credit on a range of imports. 
Forward bookings of foreign exchange are permitted for a maximum 
period of 180 days for trade payments.  In addition, from November 
1, 2008, banks are required to obtain a 100% deposit of the contract 
value foreign exchange contracts in rupees. 
 
¶4. (U) Sri Lanka's economy will, nevertheless, experience growth in 
¶2009.  Analysts anticipate growth of around 5% of GDP, while the 
government officially expects it to reach 6%.  To ensure the latter, 
the government announced a stimulus plan on December 30 (ref b) 
aimed at assisting key export earners and the energy sector; it will 
likely not be enough, however, to ensure growth at desired levels. 
 
 
Financial Sector Impacts 
------------------------- 
 
¶5. (SBU) Although Sri Lanka was largely insulated from the immediate 
effects of the global economic downturn, there are indications that 
firms are now finding it more difficult to borrow (ref d). 
Interlocutors report that some banks have closed their trade 
facilities.  This is not just a result of the global financial 
crisis; local factors are also limiting access to financing.  In 
early December, an interim Supreme Court order halted payments to 
several international and banks involved in hedge contracts with the 
government's Ceylon Petroleum Corporation (ref e).  The government's 
ability to obtain financing is now severely restricted. 
Additionally, in late December, the Central Bank of Sri Lanka 
dissolved the Board of Directors of the private Seylan Bank and 
vested administrative powers in the hands of state-owned Bank of 
Ceylon.  This was done to assure overall financial stability in the 
 
COLOMBO 00000061  002 OF 003 
 
 
market following mismanagement of an affiliated non-authorized 
financial institution, but the result is a more cautious outlook on 
bank operations by consumers. 
 
¶6.  (U) The government expects that interest rates will fall in 2009 
with inflation, which ended 2008 at 14.4%, year-on-year, following a 
high of 28% in July 2008.  Nevertheless, it is always expensive to 
borrow in the local market; interest rates for blue-chip companies 
average 18.5%, while rates for other companies are much higher. 
Although Sri Lanka's banking sector has remained quite resilient 
despite the global financial crisis, non-performing loan ratios 
increased from 5.2% in December 2007 to 6.5% in November 2008, 
suggesting growing credit risks. 
 
¶7. (U) The government's attempt to raise $300 million through a 
syndicated loan in international markets in October 2008 failed, and 
in December an Indian bank withdrew plans to provide a $25 million 
loan to the GSL.  Sri Lanka's credit rating declined recently, and 
S&P cut Sri Lanka's sovereign rating from B+ to B in December. 
Nevertheless, to date the GSL has never defaulted on loan payments. 
 
¶8. (U) To date there has been little evidence of firms closing their 
doors; however, some, particularly those in the export sector, are 
looking to scale back hiring until they have a clearer picture of 
orders through end-2009.  Others are working with staff to either 
amicably reduce wages or to encourage staff to voluntarily quit if 
provided a good severance package.  (Note:  Sri Lanka's labor laws 
make it extremely difficult to lay off or fire workers due to 
economic hardships; it is a long and costly process.) 
 
Impacts on Government Revenues and Expenditures 
--------------------------------------------- --- 
 
¶9. (SBU) The government's new economic stimulus plan (ref b) reduces 
fuel costs for consumers while providing benefits to key export 
industries, including apparel, tea, rubber and cinnamon producers. 
The government plans to finance this stimulus package through 
reduced state expenditures and imposing cess on various imported 
items, including milk, wheat, and flour.  However, realistically, 
the government will need significant additional expenditure cuts to 
adequately manage its 2009 budget and this new stimulus package. 
Contacts close to the President's chief economic advisor tell post 
that the government is discussing the possibility of a further Rs 
16-20 billion stimulus package, which would provide additional 
relief to export industries. 
 
¶10. (U) According to the official 2009 budget, government revenue is 
expected to increase by over 20% in 2009.  Approximately 40% of 
government tax revenue and 35% of total government revenue comes 
from taxes on imports.  Although the budget raised import taxes, due 
to falling import prices and a slowdown in imports, import tax 
yields may actually decline in 2009.  This will cause further budget 
financing difficulties for the government. 
 
Other Donor and Multilateral Institutions, Plans 
--------------------------------------------- ---- 
 
¶11. (U) Sri Lanka receives significant assistance from the World 
Bank, ADB, Japan, China, Iran and other donors.  To date post is 
unaware of any major alterations in 2009 donor financing due to the 
global economic downturn.  However, the government partially 
finances much of its infrastructure development through 
international organizations, and the lack of liquidity in the 
markets makes it very likely that the government will need to reduce 
its planned infrastructure development if unable to raise the 
necessary financing.  The IMF echoed these concerns in late October 
2008 when it cautioned that raising external financing will become 
increasingly challenging for Sri Lanka amid international risk 
aversion, further noting that Sri Lanka's external accounts are 
vulnerable to a reduction in international risk appetite. 
 
Effects on U.S. Assistance 
--------------------------- 
 
¶12. (SBU) Although not significant, post anticipates some negative 
effect on our bilateral assistance program.  Sri Lanka has been 
mostly insulated from the immediate impact of the global financial 
crisis; nevertheless, Sri Lanka's economy will have to cope with the 
effects of the economic downturn due to the global nature of the 
 
COLOMBO 00000061  003 OF 003 
 
 
crisis and to the restricted availability of credit markets in the 
coming year.  There will likely be two negative effects on USAID 
assistance programs.  The first will be a lack of available 
wholesale loan funds for on-lending through USG small business loan 
guarantees.   The second will be a decline in funds available from 
Sri Lankan partners for USAID public-private partnership projects 
that leverage funds from the private sector. 
 
BLAKE