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