IMI - INVESTMENT CLIMATE STATEMENT, 2005 - SRI LANKA

UNCLAS SECTION 01 OF 28 COLOMBO 001366



SIPDIS



STATE FOR EB/IFD/OIA AND SA/INS

STATE 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, CE, OPIC, USTR, ECONOMICS

SUBJECT: IMI - INVESTMENT CLIMATE STATEMENT, 2005 - SRI LANKA



REF: (A) 04 STATE 269486 (B) 04 STATE 250356



1. THE FOLLOWING IS THE INVESTMENT CLIMATE STATEMENT

FOR SRI LANKA FOR 2005.



INVESTMENT CLIMATE STATEMENT SRI LANKA



July 2005



Openness to Foreign Investment

--------------



2. Sri Lanka welcomes foreign investment, which has

become an important element of the country's economic

growth. Sri Lanka opened its economy to foreign

investment in 1978, long before its South Asian

neighbors, but results have been mixed due to half-

hearted commitment to economic reforms and policy

inconsistency through changes in successive governments.

Over the past twenty-six years, several hundred foreign

investors have invested in the country, but foreign

investment flows have been weak in the last decade due

to an ethnic conflict and the inconsistent and erratic

economic policies mentioned above. While the current

ceasefire has led to improved investment flows in the

recent past, the reversal of economic policies following

the change of Government in 2004 has put a dampener on

flows once more. Although some investors have done

well, particularly in the manufacturing and services

sectors, others have had problems with government

practices and regulations, particularly in large-scale

infrastructure projects, and recently have experienced

governmental delays in payment and other forms of

governmental non-compliance with contracts.



3. Sri Lanka's economic growth over the past decade has

been reasonable, averaging 4.6 percent. The country

boasts unique human development achievements for a

developing country. Sri Lanka's per capita income of

$1,000, 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.



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 ceasefire 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 recent assassinations of a journalist and

a senior military intelligence officer, among others.

While both parties have expressed their commitment to a

negotiated settlement, efforts to restart peace talks

have floundered so far. However, it is important to

differentiate between the currently suspended peace

talks and the overall peace process, which continues.

Although many ceasefire violations have been recorded,

the peace process has 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 stalemate, however, had led to concerns

that donor money may be diverted to other countries.



5. The December 2004 tsunami caused extensive damage to

life and property, affecting Sri Lanka's economic

performance. Approximately 31,000 people were killed,

another 6,300 are missing, and 443,000 people have been

displaced. A joint damage and needs assessment by the

key donor agencies estimated the overall damage to Sri

Lanka at around $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 destruction is in areas under

LTTE control, which requires the Government to work with

them to start reconstruction. According to GSL

assessments, Sri Lanka needs approximately $2 billion to

implement a reconstruction program, estimated to take at

least three years. The donor assessment has estimated

the recovery cost at $1.5 billion.



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. In February 2004, President Chandrika Kumaratunga

dissolved Parliament, just two years into the rule of

the reform-minded United National Front Government.

Subsequent elections resulted in a resounding defeat for

the UNP, largely because rural voters felt they had not

tasted the benefits of the recently implemented economic

reforms. As no single party was expected to garner

sufficient seats to form a government, the President's

SLFP joined with the left leaning, nationalist Marxist

Janatha Vimukthi Peramuna (JVP) to form the United

People's Freedom Alliance (UPFA) ticket to run for the

election. The UPFA coalition remained intact until June

2005, when the JVP quit the Government in protest of the

Post-Tsunami Operational Mechanical Structure (P-TOMS),

an aid-sharing deal between the Government and the LTTE.

While the P-TOMS has opened the path for cooperation on

reconstruction in the North and East, it has also left

the government in a shaky minority. The SLFP and

opposition UNP back the new mechanism while the JVP and

Buddhist monk-based Janatha Hela Urumaya (JHU) oppose it

and have petitioned the constitutionality of P-TOMS to

the Supreme Court. On July 15, 2005, the Supreme Court

ordered the suspension of four crucial clauses in the P-

TOMS agreement until the conclusion of the case which

should take place in September 2005. The effects of the

mechanism's actual implementation remain to be seen.



8. The UPFA government's Economic Policy Framework

"Creating Our Future, Building Our Nation"

(http://www.treasury.gov.lk) focused on developing the

small and medium enterprise sector (SME),agriculture,

and infrastructure, with a heavy reliance on government

intervention in markets. The Government has also

abandoned plans to privatize "strategic" state

enterprises, such as state-owned banks, airports, and

electrical utilities. Instead, it will retain ownership

and management of these enterprises in an attempt to

insulate them from political interference and make them

profitable. The government has created three new

agencies to improve state owned enterprises: The

Strategic Enterprises Management Agency (SEMA),the

National Council for Economic Development (NCED) and the

Procurement Management Agency.



9. Recent efforts to restructure large, inefficient

public utilities have faced serious problems due to

stiff opposition from the JVP and labor unions.

Government shares in smaller non-strategic state

enterprises such as hotels and small manufacturing

companies, however, are due to be sold. The recent JVP

decision to leave the government may lead to a shift in

some economic policies.



10. On a positive note, the government has acknowledged

the vital role that both foreign and local private

investors play in the economy. The government has

promised to encourage private investment by removing

impediments and introducing investor-friendly practices.

Paradoxically, they have also introduced prohibitive new

taxes on the acquisition of land by foreigners (except

foreign investors meeting certain criteria) along with

other bureaucratic impediments to foreign investments.

Further, import duties on a range of consumer goods and

non-essential items have been increased. A new

"Economic Service Charge (ESC)" tax, ranging from 0.25

percent to 1 percent depending on the type of business ,

applies to all companies with a 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 those companies,

especially foreign investors which have tax holidays, it

will be an extra financial burden.



11. The UPFA government has rejected the former

government's poverty reduction strategy paper (PRSP)

entitled "Regaining Sri Lanka," citing the UNP's failure

to benefit poor and rural areas in its two years of

rule. The government is now in the process of revising

the PRSP. Pending clarifications on economic and fiscal

policies and the draft of a revised PRSP, the IMF is

withholding disbursements under a Poverty Reduction

Growth Facility (PRGF) and Enhanced Fund Facility (EFF)

extended to Sri Lanka in April 2003. The government

plans to resume discussions on PRGF/EEF supported

programs once the new PRSP is finalized.



12. Throughout 2004, macro economic conditions

deteriorated. In the face of a drought and increasing

oil prices, the government resorted to expansionary

fiscal and monetary policies that helped maintain GDP

growth at around 5 percent. Consequently, inflation

rose sharply and the fiscal situation deteriorated.

There was a slowdown in aid and investment in-flows as

well. Due to a heavy oil import bill, the trade deficit

expanded in 2004, despite strong export growth. Gross

official receipts fell by 13 percent to $1.8 billion.

As a result, the Sri Lankan Rupee depreciated throughout

2004, falling by 8 percent against the US Dollar. The

rupee strengthened in early 2005 because of speculation

on aid flows for post-tsunami reconstruction. Total

reserves in January 2005 were approximately $3.3

billion, sufficient to cover 4.9 months of imports. Sri

Lanka's total government debt rose to 108 percent of GDP

in 2004, of which about half was foreign (mostly

concessional) debt.



13. Towards the end of 2004, the government took steps

to strengthen its macro- economic policy. Petroleum

prices were revised upwards, and a costly subsidy on

wheat flour was removed. But numerous subsidies,

including those for petroleum and electricity, continue.

The 2005 budget, presented in November 2004, envisaged a

reduction in the fiscal deficit to 7.5 percent of GDP.

The budget focused on reducing poverty through rural

development and on higher spending for health, education

and public infrastructure. It also included

significant increases in government employment and

wages. The Government has hired about 42,000 recent

university graduates as trainees in an effort to stem

unemployment, expanding public sector employment by 4

percent. The budget also contains new revenue

measures. Before the budget was passed, the government

increased selected import taxes. Despite losses due to

the tsunami, the Government has expressed a desire to

maintain macroeconomic stability, pursue the reform

agenda of the 2005 budget, 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.



14. Estimates vary about the tsunami's overall economic

impact. According to some estimates, GDP growth is

predicted to fall from 6 percent to about 5 percent.

The bulk of adverse impact on growth is expected to be

offset by the reconstruction effort. The Government is

trying to minimize the fiscal impact of the

reconstruction program by seeking foreign assistance.

The impact on balance of payments could also be

significant due to reconstruction related imports.

Meanwhile, for the first time, the GSL has accepted a

Paris Club offer by industrialized countries to freeze

its debt payments until the end of 2005. This will

release approximately $300 million from the regular

budget (currently allocated for debt repayment) for

reconstruction. In addition, the IMF has approved an

emergency loan of about $159 million to Sri Lanka. The

World Bank and the ADB have also pledged both grant and

loan assistance. On balance, the level of fiscal and

balance of payment impact of reconstruction will depend

on the government's ability to mobilize external

resources as well as the Sri Lankan economy's absorptive

capacity. The inflationary momentum of 2004 is expected

to continue in 2005, with inflation projected to remain

between 10 to 12 percent for most of the year. The

Central Bank has raised interest rates only marginally,

despite rising inflation, in order to facilitate

spending on reconstruction and provide liquidity for

restarting economic activity.



15. There may be commercial opportunities for US

companies in the post-tsunami reconstruction program.

The bulk of the 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.



16. Numerous risks and challenges to the economy

remain. The peace process could falter. With the

withdrawal of the JVP from the governing coalition, the

government does not have a majority in Parliament and is

vulnerable to being dismissed. 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 and

the impact of the end of the Multi Fiber Agreement,

although large factories accounting for the bulk of the

exports are expected to continue to perform well in the

quota-free era. 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 are being added, the

government has yet to procure sufficient base load power

to avert a power crisis in the medium term. 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. Increasing 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



17. The Board of Investment (BOI) (www.boi.lk),an

autonomous statutory agency, is the primary government

authority responsible for 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. 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.boi.lk),a division

of BOI, has responsibility for 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

18. The principal law governing foreign investment is

Law No. 4 created in 1978 (known as the BOI Act),and

now encompassing amendments made 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. 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. Various labor

laws and regulations affect investors also. See

sections below.



--Foreign Equity and Sectors





19. 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, production and distribution of

energy, 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.



20. 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, finally, 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.



21. Foreign investment is not permitted in the

following businesses: non-bank money lending; pawn-

brokering; retail trade with a capital investment of

less than $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 US$150,000); coastal

fishing; and the awarding of local university degrees.



22. Generally, the treatment given to foreign investors

is non-discriminatory. In fact, some local companies

have complained that they are discriminated against, as

qualifying foreign investors can benefit from a wide

range of advantages. Even with incentives and BOI

facilitation, however, foreign investors can 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. The BOI encourages investors to locate

their factories in industrial processing zones managed

by the BOI to overcome land allocation problems.

Investors locating in industrial zones also get access

to relatively better infrastructure facilities such as

reliable power, telecommunication and water supplies.

--Privatization viewed with suspicion

23. Previous governments, including one 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.

Still, smaller government corporations are to be

privatized.



24. Government treatment of foreign investors in past

privatization processes had been largely non-

discriminatory. In 2003, however, the previous

government sold part of 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.



25. Labor unions in state-owned enterprises are often

opposed to privatization and restructuring and seem

particularly averse to foreign ownership. In the past

this has made the purchase of certain strategic entities

problematic for new foreign owners. In some previous

cases, liberal and unwieldy concessions, not announced

during the bidding process, were granted to investors.

At other times, substantive changes were introduced

after the process had begun.



--Investment Trends



26. From 1998-2001, foreign direct investment flows to

Sri Lanka averaged only about $150 million per year

(excluding privatization receipts). Following the

commencement of the peace process and improved investor

confidence, annual foreign investment flows have

averaged about $200 million. Although initially FDI was

expected to rise faster following the ceasefire, it has

stagnated due to the stalemate in the peace process. In

2004, FDI was about $178 million, according to recent

IMF estimates. FDI mainly funded telecommunications and

manufacturing industries (cement and textiles). Other

major deals struck in 2004 included a $30 million

Business Process Outsourcing (BPO) center by the Hong

Kong and Shanghai Banking Corporation Ltd (HSBC).



27. The Colombo Stock Exchange (CSE) has been growing

markedly since 2002, due to local investor activity. In

July 2004, Colombo was named the best performing market

in Asia and the fifth best performing equity market in

the World by Bloomberg. The upsurge in stocks could be

directly attributed to the ceasefire agreement and a

rise in tourism stocks. The market has also become

attractive to local investors due to negative real

interest rates. A large IPO from a new Indian oil

retail business in Sri Lanka also boosted the market

heavily in December. Despite the boom, 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. The CSE is taking steps to broaden

the investor base both in Sri Lanka and abroad.



Conversion and Transfer Policies

--------------



28. 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.

29. 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.

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.

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 in

2001, 2002 and 2004 that were opened to foreign

investors. It has been proposed to allow foreigners to

invest in corporate debentures and government bonds.



30. 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.



Expropriation and Compensation

--------------



31. Since economic liberalization policies began in

1978, the Sri Lankan Government has never been convicted

of expropriating 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. A long-standing

dispute involving an alleged expropriation of a US

company's investment was satisfactorily resolved during

1998 after lengthy negotiations involving the company,

the Sri Lankan Foreign Ministry, the Sri Lankan Attorney

General, and the US Embassy.



Dispute Settlement

--------------



--Legal System



32. 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 now sometimes subject to political

influence, but this has not negatively affected

commercial litigation. 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



33. 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 Act, for example, prohibits

employers from dismissing workers even on the grounds of

inefficiency. The Parliament has passed an amendment to

the Termination Act to facilitate retrenchment, but the

amendment's implementation was delayed until the

government could develop a compensation formula and an

unemployment insurance scheme for displaced workers.

After revisions and delays, the compensation formula was

finally published in March 2005, 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. The

compensation plan could adversely affect companies'

restructuring plans and discourage future employment

growth.



34. 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

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. The financial community has requested

the strengthening of debt recovery laws.



--Investment Protection



35. 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 that of

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.



36. 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.



37. 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



38. 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.

Unfortunately, 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.

39. 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.



40. 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



41. There continue to be trade and investment 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, 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.



42. 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 were implemented, and the court upheld their

complaint. Without any technical argument, a partial

bench of 3 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.



43. 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



44. 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.



45. 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

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.



46. 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.



47. Foreign investors who make an equity investment of

at least $50,000 can qualify for a resident visa.

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 and

do not experience significant problems in obtaining work

or residence permits.



--Investment Incentives



48. The Board of Investment has announced the following

investment incentives:



Incentive Program I



Qualifying industries:

--Non-traditional manufacturing exports and companies

supplying to exporting companies. Minimum investment of

$150,000;

--Export oriented services. Minimum investment of

$150,000;

--Manufacture of industrial tools and/or machinery.

Minimum investment of $150,000;

--Small-scale infrastructure. Minimum investment of

$500,000;

--Research and development. Minimum investment of

$50,000;

--Agriculture and agro processing industries. Minimum

investment of $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.



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 (a);

--IT training institutes (b);

--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 $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.



Infrastructure development:



49. 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 $12.5 million is required.



50. 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 $10 million is required.



--Indo-Lanka and Pakistan-Lanka Free Trade Agreements: A

Gateway to South Asia.



51. A preferential trade agreement, the Indo Lanka Free

Trade Agreement (ILFTA) (www.indolankafta.org) 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). The two

countries have begun discussions on services sector

liberalization, although no specific goals have been set

yet. Because production constitutes a portion of the

value, this agreement may be well utilized as a mode of

entry into the Indian market by U.S. companies.



52. Sri Lanka recently signed a free trade agreement

with Pakistan. The two 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.



--Prospects for U.S. Investment under Indo Lanka Free

Trade Agreement (ILFTA)

53. Foreign investors in Sri Lanka can enjoy

preferential access to the Indian market under the

ILFTA. The BOI hopes to attract foreign joint ventures

to Sri Lanka under the ILFTA. Indian imports amounted

to over $49 billion in 2002. The BOI's strategy is to

identify products imported into India and to target its

investment promotion efforts to countries and companies

manufacturing them. The US is one such country; the US

accounts for about 7 percent of Indian imports, valued

at $5.5 billion in 2003-4. A majority of these products

would qualify for substantial duty concessions if

exported from Sri Lanka under the ILFTA. The BOI

encourages US manufacturing companies and regional

operating headquarters to relocate in Sri Lanka to

benefit from ILFTA. The BOI has identified the

following sectors for investment promotion in the US:

electronics, light engineering,

pharmaceuticals/cosmetics, information technology and

financial services.



54. Some US companies currently avail themselves of

this agreement, adding 35 percent value in Sri Lanka and

getting import duties into India reduced from as much as

40 percent to as little as zero.



55. 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



Right to Private Ownership and Establishment

--------------



56. 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.



57. Foreign investors can purchase land from private

sellers. The government recently imposed a 100 percent

tax on land transfers to foreigners and imposed a

definition of foreign investment to include corporations

with as little as 25 percent foreign ownership.



Protection of Property Rights

--------------



--Property rights



58. 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.

59. 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. A World Bank-funded project is underway to

develop a legal framework for implementing a titling

system for land. The project aims to remove, or at

least clarify, restrictions related to the sale, leasing

and transfer and mortgaging of rural lands previously

distributed to farmers.



60. In 2004, the Government changed land ownership

regulations by re-imposing a 100 percent tax on land

sales to foreigners, which had been removed in 2002.

Under the previous version of this tax, foreign

companies registered in Sri Lanka were considered local

companies and were not subject to tax. In its current

form however, any company with 25 percent foreign

ownership is considered "foreign" for the purposes of

the tax. Apartments above the third floor of

condominium buildings, land for the development of large

housing schemes, hospitals, hotels, exporting companies

with a minimum investment of USD 1 million, and large

infrastructure projects are to be exempted from the

tax. Foreigners maintaining US$150,000 in a bank

account in Sri Lanka will be given concessionary

treatment. Regulations regarding these exceptions are

yet to be published. In addition to the tax, the

government has plans to prohibit certain geographical

areas from purchase by non-citizens.



--Intellectual Property Rights Protection



61. 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).

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.



62. 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.



63. 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

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.

64. Although the legal system is well-established and

non-discriminatory, it is fraught with long delays.

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.



65. 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

a previously unknown illegal CD manufacturing plant

owned by Malaysian nationals. The Police carried out

additional raids of counterfeit CD/VCD stores in the

first quarter of 2005. Customs has also seized

counterfeit consumer goods, mainly cigarettes.

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 of

pirates and distributors was recently established. The

association claims that IPR enforcement violates its

members' right to generate business. Nevertheless, in

June 2005, vendors of pirated CDs and DVDs were fined

and received suspended jail sentences in Sri Lanka's

courts, suggesting minor progress in the enforcement of

the new law. The Embassy, along with key industry

players including the IFPI, continues to lobby the

government to improve Sri Lanka's IPR regime.



66. 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 also lacks provisions to deal with electronic

transactions, electronic signatures, and computer crimes

and evidence. The IPR law does not cover protection of

new plant varieties.



--Patents, Copyrights and Trademarks



67. 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

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.



68. A patent is valid for 20 years from the date of

application but must be renewed annually.



69. 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.



70. 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.



Lack of Transparency in the Regulatory System and

Tendering Process

-------------- --------------

--------------



71. 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.

Non-availability of technical capacity within the

government to review financial proposals for private

infrastructure projects also creates problems during

tendering.



72. Although many foreign investors, including US

firms, have had positive experiences in Sri Lanka, some

have encountered significant problems with government

practices and regulations. For example, one foreign

company that had obtained a waiver of a particular

requirement in order to obtain a license was later told

it must meet the requirement to continue to be qualified

for the license, with no advance warning and little

justification. 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 earlier approved

those contracts.



Efficient Capital Markets and Portfolio Investment

-------------- --------------



--Availability of financial resources



73. 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.



74. 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. As a result, interest rates

have fallen significantly and have given impetus to

increased credit, which has contributed to increased

domestic investment as well as inflation. The

investment/GDP ratio rose to 25.3 percent in 2004,

compared with 22 percent in 2001. The prime lending

rate currently averages 10 percent, which is well below

the current inflation rate. Foreign investors are

allowed to access credit on the local market. They are

also free to raise foreign currency loans.

75. A total of Rs 12.3 billion (approx. $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



76. 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.



77. The domestic debt market in Sri Lanka is still at a

very nascent stage. The first credit rating agency,

Fitch IBRC, opened an office in Colombo in 1999, which

has helped companies to raise funds through debt

markets. Fitch Rating 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



78. There is an active and relatively 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.



79. 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.



--Securities and Exchange Commission



80. 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.



81. 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.



82. 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.



83. 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



84. The Colombo Stock Exchange (CSE),while small by

"big emerging market" standards, is one of the most

efficient in the region. The CSE is fully automated,

with automated trading and 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

(US$1 million) which aims to guarantee the settlement of

trades between clearing members of the exchange. The

Chartered Financial Analysts (CFA) program is conducted

in Sri Lanka.



85. 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.



86. There are 242 companies listed on the stock

exchange and the top ten positions by market

capitalization are held by banks and food and beverage

companies. In 2003-2004, 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. 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. 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



87. Sri Lanka has a fairly well diversified banking

system. There are 22 commercial banks, consisting of

eleven local banks and eleven 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. 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

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 a bid to enhance the banking system stability,

promote consolidation and facilitate entry of larger

banks.



88. 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 Central 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.



89. 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.



90. 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



91. Total assets of commercial banks stood at Rs 1,028

billion ($10 billion) as of December 31, 2003. Bank of

Ceylon and People's Bank with assets of Rs 266 billion

($2.7 billion) and Rs 224 billion ($2.2 billion)

respectively in 2004, still dominate banking, accounting

for about 45 percent of all assets.



92. The financial profile of both state banks

deteriorated over the years, mainly as a result of

direct lending and operating inefficiencies. Since most

of the bad debt of the two banks was implicitly

guaranteed by the state, these problems did not affect

the credibility of the banking system in Sri Lanka. The

government re-capitalized these banks during the 1990's

without success. 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. Consequently, the government has been

trying to reorganize the banks. Both banks launched

restructuring exercises to return to commercial

viability in the medium term. Top management at both

Bank of Ceylon and People's Bank now contains private

sector personnel, and the banks were granted 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. These loans to Government corporations could

again badly affect the People's Bank's liquidity.



93. 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 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 see equity

funding 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



94. 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 all commercial banks. 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 provisioning 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. The law aims to provide troubled banks with

a mechanism to effectively deal with their non-

performing loans.



95. Credit ratings are mandatory for all banks

operating in Sri Lanka from January 2004.



--Capital Adequacy



96. 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 standards

on foreign currency banking units. In addition, in

keeping with Basel Core Principles on effective banking

supervision, compliance with Capital Adequacy on a

consolidated basis was introduced in 2003.



97. People's Bank does not meet Capital Adequacy

Requirements (CAR),but it has a Ministry of Finance

guarantee for funds required to meet its obligations.

Bank of Ceylon Tier I CAR was about 12.1 percent in

2003. Current data on average Capital adequacy of

private commercial banks is not available, but most of

them maintain CAR at required levels. CAR at foreign

commercial Banks usually exceeds required levels.



Political Violence

--------------



98. Since early 2002, there has been a marked

improvement in the business climate due to the peaceful

atmosphere prevailing in the country. This is in

contrast to the period between 1983-2001, when the

country was plagued by ethnic conflict, a civil war, 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 on the US State Department list of foreign

terrorist organizations. Terrorist activities of the

LTTE have declined since late 2001 when the LTTE and the

Government signed a formal open-ended cease-fire

agreement on February 22, 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.



99. Since then, there have been numerous ceasefire

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 and informants have also been

targeted. In July 2004, there was a suicide bombing in

a Colombo police station following a failed

assassination attempt against an anti-LTTE Tamil

minister. Five people (including the bomber) were

killed. Despite these incidents, the ceasefire largely

holds, and both sides have publicly committed to its

maintenance.



100. During the 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 civilians were

caught in the crossfire. Sri Lankan Airlines, jointly

owned by the Government of Sri Lanka and Emirates

Airlines of Dubai, lost several commercial aircraft in

the attack. The LTTE has also attacked several

commercial ships 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 since been lifted.

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. There have been no major

attacks since the peace process began on December 24,

2001. The LTTE has been implicated in the slayings of

several anti-LTTE politicians and police informants of

Tamil heritage since the signing of the ceasefire.

There have also been several violent incidents at sea.



101. In 1998, the US Peace Corps suspended operations

in Sri Lanka after LTTE bombings occurred outside the

Colombo area in places such as Galle in the south and

Kandy in the central highlands -- locations where

volunteers had previously been posted based on the low

risk of terrorist attacks.



102. The business climate could be threatened by

increased political uncertainty. Recently there have

been protest campaigns against the tsunami

reconstruction agreement between the Government and the

LTTE. Political opinion is strongly divided on the

agreement. While the government members laud the

agreement, the government's former coalition partner,

the Marxist Janatha Vimukthi Peramuna (JVP),which is

opposing the agreement, has organized general strikes

(hartals) and mass rallies and has taken legal action

against the agreement, supported by a nationalist

Buddhist monk group. The JVP's resignation has left a

minority government in power. In addition, government

moves to restructure state-owned Ceylon Electricity

Board and the Ceylon Petroleum Corporation have also met

with heavy resistance. JVP-affiliated trade unions have

protested against restructuring state owned companies

and have threatened to strike if the Government moves

ahead with the substantial restructuring required to

make them viable. There is also controversy about the

term of the Presidency. The opposition United National

Party (UNP) has begun campaigns urging the Government to

call for Presidential elections in 2005.



Corruption

--------------



103. 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. 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 most pervasive in terms of political

appointments to government institutions, in government

procurement, and 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



104. 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.

105. Few have been found guilty of corruption in recent

years. 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. The Commission began

investigating corruption charges against the former

Deputy Minister of Defense in 2002, but he is yet to be

prosecuted. In December 2004, the commission filed

corruption charges in courts against another former key

minister (who ran the Ministry in charge of public

welfare). Prosecutions and investigations against some

former senior public officials are moving slowly or have

come to an abrupt halt.



106. Sri Lanka ratified the UN Anticorruption

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.



107. Transparency International (TI),an international

"watchdog" organization promoting anti-corruption

strategies, runs a national chapter in Sri Lanka. In

TI's Corruption Perception Index for 2004, Sri Lanka was

ranked 67 among 146 countries with a score of 3.5 out of

a clean score of 10, reflecting a relatively high

perceived level of corruption among politicians and

public officials. 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.



108. In terms of Economic Freedom, Sri Lanka is ranked

78 out of 123 countries in Canada's Fraser Institute's

Economic Freedom of the World ranking released in August

2004. Sri Lanka earned a score of 6 out of 10 in the

Economic Freedom Index. This ranking is derived on the

basis of 21 components categorized under the following 5

major indicators: (1) size of government; (2) legal

structure and security of property rights; (3) access to

sound money; (4) freedom to trade internationally; and

(5) regulation of credit, labor and business.



Bilateral Investment Agreements

--------------



109. The Government of Sri Lanka has signed an

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

--------------



110. A bilateral treaty between Sri Lanka and the

United States to avoid double taxation was ratified and

entered into force on June 12, 2004.



111. Foreign investors not qualifying for Board of

Investment incentives such as tax and exchange control

exemptions or concessions will be liable to pay taxes on

corporate profits, dividends, and remittances of

profits. They will also be liable to pay a 15 percent

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

--------------



112. 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.



113. The US Embassy and other US Government

institutions spend over $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



114. Sri Lanka's labor force is literate 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 still outpaces

supply, and many qualified workers seek employment

overseas. The average worker has eight years of

schooling.



115. Two-thirds of the labor force is male. 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) in the third quarter

of 2004 was 8.5 percent, with 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. 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. 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.



116. 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, the government has initiated

several programs to expand state sector employment. For

instance, a graduate employment program is expected to

provide about 42,000 new jobs in the government sector.



117. 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. 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. However, a fair

number of Sri Lankans do study abroad as well.



--Migrant Workers Abroad



118. There are an estimated 970,000 Sri Lankan workers

abroad. The majority of the labor is unskilled

(housemaids and factory laborers) and located primarily

in the Middle East. Sri Lanka is also losing many of

its technically and professionally qualified workers to

more lucrative jobs abroad.



--Labor Regulations, Cost of Labor



119. 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, though 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 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 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.



120. There is widespread belief that the labor laws and

a plethora of holidays are dampening productivity. The

full moon day of each month, 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. The statutory holidays are in addition to 21

days annual/casual leave and approximately 21 days sick

leave (number of days for sick leave is at the

discretion of the management). In addition, 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.

--Termination laws



121. The Termination of Employment Act (TEA) makes it

difficult to fire or lay off workers. In January 2003,

under the previous government's labor reform agenda, the

Parliament passed amendments to the TEA and the

Industrial Disputes Act (IDA) to improve labor mobility.

The amendments to TEA seek to facilitate termination and

provided for a standard compensation formula and an

unemployment benefit scheme. Amendments to the IDA

included labor dispute resolution rules to expedite the

dispute process. Implementation of these new laws was

delayed until the establishment of a new compensation

formula and a new unemployment insurance scheme, which

were finally announced in March 2005. The compensation

formula takes into account the number of years of

service and offers 2.5 months salary as compensation for

5 years; 22.5 months for 10 years; and up to a maximum

of 48 months salary for 34 years service. In addition,

an unemployment benefit insurance scheme would provide

12 months salary. The Labor Commissioner's approval is

required to fire workers. Employers have shown

reluctance to accept this formula and 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.



122. 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

with international norms.



--Trade Unions



123. 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.



124. 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.



125. 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 provide for

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.



126. The ILO Freedom of Association Committee has

observed that 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.



127. In response to these observations, the BOI revised

its labor manual in March 2004, requesting companies

located in EPZs to 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.



128. 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 export processing

zones. This petition was not acted upon. A similar

submission was made to the 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.



129. 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. In what is seen as a

positive development, 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.



130. The growing strength of Marxist parties in active

politics and in parliament has increased politicized

union activity. State agencies with large unionized

workforces have become vulnerable to politically

motivated strikes in response to restructuring and

privatization.



--Collective Bargaining



131. 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



132. Labor-management relations in the past have been

by and large confrontational. This is due to a failure

to recognize the need for a social partnership for

mutual benefit. 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. 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. A few large Sri Lankan

firms have started Employee Share Option plans. Work

stoppages and strikes in the private sector have been on

a decline in the past six months.



--ILO conventions



133. 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 Principals 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 Lanka.



Foreign Trade Zones

--------------



134. 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.



135. 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. Now,

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



136. Major US companies with investments in Sri Lanka

include: Energizer Battery, Mast Industries, Smart

Shirts (a subsidiary of Kellwood Industries),Chevron

(Caltex),Citibank, Caterpillar, 3M, Cargill, Coca Cola,

Celetronix, Inc, Paxar Corporation, Pepsi Co, Sportif,

Worldquest, Fitch IBCR, AES Corporation, American

International Group (AIG),and American Premium Water.

In addition, IBM, Lanier, NCR, GTE, Motorola, Procter &

Gamble, Liz Claiborne, May Department Stores, Federated

Department Stores, 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.



137. US investment in Sri Lanka is estimated to be in

the range of $200 million. Among the recent investors

in the power sector are AES Corporation and Caterpillar.

AIG insurance entered Sri Lanka in 1999. Other foreign

companies in Sri Lanka are expanding, such as Celetronix

Inc (memory boards),Citibank, and Mast Inc (apparel and

related products). 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.



--Non-US Investments



138. Major non-US investors include: Unilever, Nestle,

British American Tobacco Company, Mitsui, Pacific

Dunlop/Ansell, Prima, FDK, Telekom Malaysia Bhd, and

S.P. Tao. Leading US and foreign investors that have

acquired significant stakes in privatized companies

include Caltex, 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)



139. 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 2004 was about $200 million.

Lunstead