INVESTMENT CLIMATE STATEMENT, 2007 - SRI LANKA

UNCLAS SECTION 01 OF 25 COLOMBO 000082



SIPDIS



SIPDIS



STATE FOR EB/IFD/OIA AND SCA/INS



STATE PLEASE PASS USTR



MCC FOR S GROFF, D NASSIRY AND E BURKE



E.O 12958: N/A

TAGS: EINV, EFIN, ETRD, ELAB, KTDB, OPIC, PGOV, USTR, CE

SUBJECT: INVESTMENT CLIMATE STATEMENT, 2007 - SRI LANKA



REF: 2006 State 178303



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1. Per reftel, below is the investment climate

statement for Sri Lanka for 2007.



[Begin text:]

INVESTMENT CLIMATE STATEMENT-SRI LANKA

JANUARY 2007



OPENNESS TO FOREIGN INVESTMENT



--Unpredictability Impedes Investment



Sri Lanka's intractable civil war, erratic policy

environment, and cumbersome bureaucracy make it an

unpredictable investment destination. However, compared

to other South Asian countries, Sri Lanka is relatively

open to foreign investment. It offers a relatively open

financial system, moderately good infrastructure, and

generally capable workers. Some U.S. and other foreign

investors have realized worthwhile returns on investment

in Sri Lanka; others have tried and come away

frustrated.



Sri Lanka is a lower-middle income developing nation

with a gross domestic product of about $27.4 billion in

2006. This translates into a per capita income of

$1,375. Sri Lanka's gross domestic product (GDP) grew

by an estimated 7% in 2006. Growth was led by

telecommunications, ports, construction and agriculture.

This rapid growth rate came at the cost of double digit

inflation and the depreciation of the Sri Lankan Rupee,

which together eroded domestic purchasing power.

Despite the resumption of civil war in 2006, the

government predicts GDP growth of 7.5% and single-digit

inflation in 2007.



The Sri Lankan economy is remarkable for its resilience.

Although suffering a brutal civil war that began in

1983, Sri Lanka has seen GDP growth average around 4.5%

in the last ten years. Following a ceasefire in 2002

and subsequent economic reforms, the economy grew by

about 5.7% in 2003-2004. Even the December 2004 Indian

Ocean tsunami -- which killed 32,000 people, displaced

443,000, and caused an estimated $1 billion in damage --

failed to dent GDP growth, which was 6% in 2005; this

was due in part to the damage having been offset by

reconstruction.

Sri Lanka is a stable parliamentary democracy. In 1978,

it shifted away from a socialist orientation and opened

to foreign investment. However, changes in government

have often been accompanied by reversals in economic

policy. Of the two major parties, the more pro-business

United National Party has been in opposition in recent

years. When it last held power, from 2002 to 2004, it

pursued privatization and regulatory reform welcomed by

domestic and foreign investors. Currently, the ruling

Sri Lanka Freedom Party has a more statist economic

approach, guided by President Rajapaksa?s 2005 election

manifesto Mahinda Chintana ("Mahinda?s Thoughts").

Mahinda Chintana seeks to reduce poverty by steering

investment to disadvantaged areas; developing small and

medium enterprises; promoting agriculture; and expanding

the already enormous civil service. The Rajapaksa

government has halted most privatization and advocates

permanent state control of what it deems ?strategic?

enterprises such as state-owned banks, airports, and

electrical utilities. The government has increased

direct and indirect taxation to fund increased

government expenditure.

Sri Lanka?s Board of Investment (BOI) is authorized to

manage a number of export processing zones which feature

business-friendly regulations and improved

infrastructure for foreign investors. BOI incentives

are attractive and real, but the BOI is not the "one



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stop shop" it aspires to be. Sri Lanka's large,

inefficient, and dated bureaucracy often works at cross-

purposes with BOI authorities and commitments.

Additionally, major investments in Sri Lanka, such as

infrastructure projects, require approval from the full

cabinet, a process which is not transparent and which

can politicize even the most needed investments.

Registration of foreign company branch offices in Sri

Lanka can be cumbersome as well.



The 23-year ethnic conflict between the U.S.-designated

terrorist organization Liberation Tigers of Tamil Eelam

(LTTE) and the Government of Sri Lanka has been a

serious impediment to foreign investment. A Norwegian-

brokered ceasefire between the LTTE and the government,

in effect since February 23, 2002, broke down in 2006.

Resolution of the conflict appears unlikely in the near

future.



Other impediments to investment in Sri Lanka are

workers' declining English language skills, inflexible

labor laws, overburdened infrastructure, and its

unreliable court system. Sri Lanka boasts a 90%

literacy rate in the local Sinhala and Tamil languages,

but English, which was once widely spoken, is now far

less prevalent. Sri Lanka's labor laws include many

model protections, but can make it nearly impossible for

companies to lay off workers even when market conditions

fully warrant doing so. Sri Lanka has not invested in

infrastructure to keep pace with its growth. Its roads

are narrow and congested. Its electricity supply is

generally reliable but can fail to meet peak demand in

years of low rainfall. Delays in commissioning new

power plants could make installed power inadequate to

meet demand within five years. Sri Lanka's courts

cannot be relied upon to uphold the sanctity of

contracts. The courts are not practical for resolving

disputes or obtaining remediation, because their

procedures make it possible for one side in a dispute to

prolong cases indefinitely. Aggrieved investors

(especially those dealing with the government of Sri

Lanka on projects) have frequently pursued out-of-court

settlements, in hopes of speedier resolution.

--Major Sectors

The service sector is the largest component of GDP at

56%. In 2005-6, the service sector continued its strong

expansion, fueled primarily by strong growth in

telecommunications, ports, trading and financial

services. Public administration and defense expenditures

have increased in 2006 and are set to grow further in

2007. There also is a growing information technology

sector, especially information technology training and

software development and exports. Sri Lanka has seen

some investment in the business process outsourcing

(BPO) sector, which currently employs about 4,000 people

and has potential to grow further. While beach resorts

have rebuilt after the tsunami, tourism remains well

below potential due to worldwide media coverage of

resumed ethnic conflict.

Manufacturing accounts for about 16% of GDP. The

textile, apparel, and leather products sector is the

largest, accounting for 40% of total industrial output.

The second-largest industrial sector, at 22% of total

manufacturing output, is food, beverages, and tobacco.

The third-largest industrial sector is chemical,

petroleum, rubber, and plastic products. The

construction sector accounts for 7% of GDP and has

posted strong growth rates in 2005-6, largely due to

demand for tsunami reconstruction projects. Mining and

quarrying account for 2% of GDP.

Agriculture has lost its relative importance to the Sri

Lankan economy in recent decades. It employs 33% of the

working population, but accounts for only 17% of GDP.

Rice, the staple cereal, is cultivated extensively. The

plantation sector consists of tea, rubber, and coconut;



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in recent years, the tea crop has made significant

contributions to export earnings, and increasing global

demand for natural rubber augers well for that sector.

--Trade

According to preliminary data for 2006, Sri Lanka?s

exports (mainly apparel, tea, rubber, gems and jewelry)

were $7 billion and imports (mainly oil, textiles, food,

and machinery) were $10.5 billion. Garment exports face

increased competition following the 2005 expiration of

the worldwide Multifiber Arrangement. The tea industry

is challenged by a shortage of plantation labor and by

growing competition.

Exports to the United States, Sri Lanka's most important

market, were $2.1 billion in 2005, or 32.8% of total

exports. For many years, the United States has been Sri

Lanka's biggest market for garments, taking almost 60%

of total garment exports. India is Sri Lanka's largest

supplier, with exports of $1.8 billion in 2005. The

United States exported approximately $160 million to Sri

Lanka in 2005 (plus about $20 million of tsunami related

exports),consisting primarily of industrial machinery,

as well as medical instruments, pharmaceuticals and

specialized fabrics and textiles for the garment

industry.

--Board of Investment



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

autonomous statutory agency, is the primary government

authority responsible for investment, with a focus on

foreign investment. The BOI acts as a facilitator for

investment. It is intended to provide "one-stop"

service for foreign investors, with duties including

approving projects, granting incentives, and arranging

services such as water, power, waste treatment and

telecommunications. The BOI is relatively effective in

assisting investors who want to establish operations

within its industrial processing zones; it is less

effective in facilitating and service large investments

outside these zones. It also assists people in

obtaining resident visas for expatriate personnel and

facilitates import and export clearances. The Public-

Private Partnership Unit, a new division of BOI, has

responsibility for coordinating all public-private

infrastructure projects.



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, foreign investors face difficulties

operating in Sri Lanka. Problems range from difficulty

clearing equipment and supplies through customs speedily

to difficulty obtaining a factory site. Legal

challenges to environmentally sensitive projects have

been burdensome, even when objections are unfounded.

Slow and indecisive application of bureaucratic

requirements has also obstructed investment. Several

high profile and needed infrastructure projects have

dried up in the past two years, as investors tired of

waiting for approval and action. In part to avoid these

delays, and to overcome land allocation problems, the

BOI encourages investors to locate their operations in

BOI-established industrial processing zones. Investors

locating in industrial zones also get access to

relatively better infrastructure facilities such as

reliable power, telecommunication and water supplies.



--Laws Affecting Investment



The principal law governing foreign investment is Law

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

amended in 1980, 1983 and 1992, along with

implementation regulations established under the Act.

The BOI Act provides for two types of investment



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approvals. Under section 17 of the Act, the BOI is

empowered to grant concessions (see details below) to

companies satisfying certain eligibility criteria on

minimum investment, exports and in some cases

employment. Investment approval under Section 16 of the

act permits entry for foreign investment to operate

under the "normal" laws of the country and applies to

investments that do not satisfy eligibility criteria for

BOI incentives. Other laws affecting foreign investment

are the Securities and Exchange Commission Act of 1987

as amended in 1991 and 2003, and the Takeovers and

Mergers Code of 1995 revised in 2003. The Companies Act

of 1982 will soon be replaced by a new Companies Act,

which has been passed by Parliament and awaits

certification by the Speaker. Various labor laws and

regulations affect investors also. See sections below.



--Foreign Equity Shares by Sector



The government allows 100% foreign investment in the

following services: banking, finance, insurance, stock-

brokering, construction of residential buildings and

roads, supply of water, mass transportation,

telecommunications, energy production and distribution,

professional services, and the establishment of liaison

offices or local branches of foreign companies. These

services are regulated and subject to approval by

various government agencies. The screening mechanism is

non-discriminatory and, for the most part, routine.



Investment in other sectors is restricted and subject to

screening and approval on a case-by-case basis when

foreign equity exceeds 49%. The affected sectors are:

shipping and travel agencies; freight forwarding;

fishing; timber-based industries; growing and primary

processing of tea, rubber, coconut, rice, cocoa, sugar

and spices; and the production for export of goods

subject to international quota. Foreign investment

restrictions and government regulations also apply to

international air transport; coastal shipping;

lotteries; large-scale mechanized gem mining; and

sensitive industries such as military hardware,

dangerous drugs and currency.



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 $150,000); coastal fishing; and the

awarding of local university degrees. Foreign degree

courses can be offered in Sri Lanka by affiliating with

foreign universities. However, there is no scheme to

monitor the quality assurance or accreditation of the

foreign courses offered in Sri Lanka.



--Privatization Halted



The current Government has halted most privatization.

Government treatment of foreign investors in past

privatization processes has been largely non-

discriminatory. In 2003, however, the government sold

part of the retail operations of state-owned Ceylon

Petroleum Corporation to Indian Oil Corporation without

a formal tender process.



Labor unions in state-owned enterprises are often

opposed to privatization and restructuring and seem

particularly averse to foreign ownership. In the past,

this made the privatization of government entities

problematic for new foreign owners.



CONVERSION AND TRANSFER POLICIES





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In accordance with its Article VIII obligations as a

member of the International Monetary Fund

(http://www.imf.org/external/pubs/ft/aa/aa08. htm),Sri

Lanka has liberalized exchange controls on current

account transactions. However, in October 2006, the

Central Bank imposed controls on foreign exchange

transactions by requiring importers to keep a 50%

deposit on letters of credit on non-essential imports.

The requirement affected over 40 categories of consumer

items including confectionary, liquor, personal care

products, footwear and tableware and seemed designed to

mitigate downward pressure on the Sri Lankan Rupee.



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.

There are no barriers, legal or otherwise, to the

expeditious remitting of corporate profits and dividends

for foreign enterprises doing business in Sri Lanka.

Remittance of business fees (management fees, royalties

and licensing fees) is also freely permitted for

companies with majority foreign investment approved

under Section 17 of the BOI Act. Other companies

require Central Bank approval. Repatriation of funds

for debt service and capital gains of companies exempted

by the BOI from exchange control regulations is

permitted. Other foreign companies remitting funds for

debt service and capital gains require Central Bank

approval.

The average delay period for remitting investment

returns such as dividends, return of capital, interest

and principal on private foreign debt, lease payments,

royalties and management fees through normal, legal

channels is in the range of 1 to 4 weeks. All stock

market investments can be remitted without prior

approval of the Central Bank through a special bank

account. Investment returns can be remitted in any

convertible currency at the legal market rate.

While controls on capital account (investment)

transactions usually prohibit foreigners from investing

in Sri Lankan debt and fixed income securities, the

government has recently allowed limited access to

foreigners to invest in government rupee bonds. The

Central Bank?s dollar denominated bond issues in the

local market are also open to foreign investors. 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



Since economic liberalization policies began in 1978,

the Sri Lankan Government has not expropriated a foreign

investment. The last expropriation dispute was resolved

in 1998.



DISPUTE SETTLEMENT



--Legal System



Sri Lanka's legal system reflects diverse cultural

influences. Criminal law is fundamentally British.

Basic civil law is Roman-Dutch. Laws pertaining to

marriage, divorce, and inheritance are communal. Sri

Lankan commercial law is almost entirely statutory. The

law was codified before independence in 1948 and

reflects the letter and spirit of British law of that

era. Its amendments have, by and large, kept pace with

subsequent legal changes in the U.K. Several important



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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.



Sri Lanka?s court system consists of the Supreme Court,

the Court of Appeal, Provincial High Courts and the

Courts of First Instance viz. district courts (with

general civil jurisdiction) and magistrate courts (with

criminal jurisdiction). The provincial high courts have

original, appellate and reversionary criminal

jurisdiction. The Court of Appeal sits as the

intermediate appellate court with a limited right of

appeal to the Supreme Court. The Supreme Court

exercises final appellate jurisdiction for all criminal

and civil cases.



All commercial matters exceeding the value of Rs 3

million (approximately $28,000) fall within the

jurisdiction of the Commercial High Court of Colombo.

There are also a number of tribunals which exercise

judicial functions, such as the Labor Tribunals to hear

cases brought by workers against their employers. Until

recently, the court system was largely free from

government interference. There are allegations that the

judiciary is sometimes subject to political influence,

but this has not been evident in commercial litigation

so far. Litigation can be slow and unproductive,

though. Monetary judgments are usually made in local

currency. Procedures exist for enforcing foreign

judgments.



--Bankruptcy Laws



The Companies Act and the Insolvency Ordinance provide

for dissolution of insolvent companies, but there is no

mechanism to facilitate the re-organization of

financially-troubled companies. Other laws make it

difficult to keep a struggling company solvent. The

Termination of Employment of Workmen Act, for example,

prohibits employers from dismissing workers even on the

grounds of inefficiency. The Termination Act was

recently revised to facilitate downsizing. Under the

revised act, a compensation formula for laid-off workers

has been published. But employers have protested that

it is excessive compared to similar formulae in the

Asian region, with terms in Sri Lanka about twice as

generous as the East Asian average. (Please see section

on ?Labor? for details.)



In the absence of proper bankruptcy laws, extra-judicial

powers granted by law to financial institutions protect

the rights of creditors. When a company cannot meet the

demands of a creditor for a sum exceeding Rs 50,000, the

creditor may petition for company to be dissolved by the

court. Lenders are also able to enforce financial

contracts through powers that allow them to foreclose on

loan collateral without the intervention of courts.

Recently, however, the government brought in legislation

to exclude loans below Rs 5 million ($467,000) from the

application of the law. Additionally, a recent judgment

ruled that these powers would not apply with respect to

collateral provided by guarantors to a loan. These two

moves have weakened creditors? rights. 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 extremely slow.



The Companies Act and the new Companies Bill do not

provide for the revival of struggling companies.

However, the courts take a fairly liberal attitude



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towards any restructuring plans that may be of benefit

to the company.



--Investment Protection



In principle, foreign investments are guaranteed

protection by the Constitution of Sri Lanka. The

government has entered into 24 investment protection

agreements with foreign governments (including the

United States) and is a founding member of the

Multilateral Investment Guarantee Agency (MIGA) of the

World Bank. Under Article 157 of the Constitution of

Sri Lanka, investment protection agreements enjoy the

force of law and no legislative, executive or

administrative action can be taken to contravene them.

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 International Center for the Settlement of

Investment Disputes (ICSID).



The U.S.-Sri Lanka Bilateral Investment Treaty (BIT) was

ratified by both governments in 1993

(http://www.state.gov/

Documents/organization/43588.pdf).



--Arbitration



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)

(www.iclparbitrationcentre.com) has been established in

Colombo for the expeditious, economical, and private

settlement of commercial disputes. However, the ICLP

appears unlikely to become involved in disputes

involving the Sri Lankan Government, which is often a

party to disputes involving foreign investors.



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.



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.



The government record in handling investment disputes is

problematic. Disputes often become politicized, causing

the government to put political interests ahead of its

respect for the sanctity of contracts. For example, in

2006, Indian Oil Corporation's petroleum retailing

subsidiary in Sri Lanka temporarily closed its

operations when the government failed to honor its

commitment to reimburse the company for fuel sold at the

government-controlled price.



--Investment Disputes Involving U.S. Companies



U.S. companies have experienced 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 competitive bids.



A U.S. power company producing electricity in Colombo



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has been unable to obtain payment since 2004 for power

that it produced under a temporary, more costly,

operating mode following a fire in its plant. The

company had intended to suspend operations to conduct

repairs following the fire, but agreed to the

government's request that it keep producing power even

at a higher cost. However, the government has withheld

payment on the basis of a questionable Attorney General

finding that the higher than usual electricity price was

imposed on the government "under duress."



In 2000, the Sri Lankan Supreme Court effectively

blocked an investment agreement between the Government

of Sri Lanka and a U.S. mining company. Although the

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

Supreme Court protection if a government or

administrative act impedes their rights. In this case,

the plaintiffs alleged that their rights would be

violated if the project was implemented, and the court

upheld their complaint. Without any technical argument,

a partial bench of three judges ruled that the project

could not proceed before completion of a new series of

comprehensive and expensive studies, some of which

appeared to be technically impractical. The Supreme

Court decision has never been reversed.



In another case, a U.S. firm 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 ongoing. The company withdrew

its operations from Sri Lanka in 2004.



PERFORMANCE REQUIREMENTS AND INCENTIVES



--Performance Requirements



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% of production, while those in the

service sector must export at least 70% of production.

Sri Lanka complies with WTO Trade Related Investment

Measures (TRIMS) obligations.



Sri Lanka encourages foreign investment in information

technology, electronics assembly, light engineering,

automobile parts and accessories manufacturing,

industrial and information technology 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.



In some BOI-approved enterprises, businesses are

required to maintain certain levels of employment to

enjoy incentives. In addition, privatization agreements

generally prohibit new owners from dismissing workers,

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.





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Foreign investors who remit at least $250,000 can

qualify for a one-year resident visa, which can be

renewed. Employment of foreign personnel is permitted

when there is a demonstrated shortage of qualified local

labor. Technical and managerial personnel are in short

supply, and this shortage is likely to continue in the

near future. Foreign employees attached to BOI-approved

companies usually receive preferential tax treatment for

an initial period and do not experience significant

problems in obtaining work or residence permits.



--Investment Incentives



The Board of Investment (www.boi.lk) has various

incentives, with such investments typically requiring

prior approval by various ministries:



Incentive Program I:



Qualifying industries:

-Non-traditional manufacturing exports and companies

supplying to exporting companies. Minimum investment of

$500,000(a);

-Export oriented services. Minimum investment of

$500,000;

-Manufacture of industrial tools and/or machinery.

Minimum investment of $500,000;

-Small-scale infrastructure. Minimum investment of

$500,000;

-Research and development. Minimum investment of

$100,000;

-Agriculture and agro processing industries. Minimum

investment of $150,000;

-Export trading houses of rural sector. Minimum

investment of $150,000



Incentives: The above industries qualify for a five-

year tax holiday initially. A preferential tax of 10%

in the 6th and 7th years follows the tax holiday for

some industries. In addition, some of 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 two-

year tax holiday is available for investments with an

investment less than $500,000. A recently introduced

Economic Service Charge (ESC) at 0.25% of income applies

to BOI-approved companies with tax holidays. The tax

applies even to existing companies -- there is no

grandfather clause. ESC will apply to BOI approved

manufacturing companies from the fourth year of

operation.



Incentive Program II:



Qualifying Industries:

-Information technology (IT) or information technology

enabled services. Minimum investment of $150,000.

Minimum employment levels apply;

-Information technology training institutes. Minimum

number of students applies;

-Business Process Outsourcing (BPO). Minimum investment

of $150,000. Minimum employment levels apply;

-Regional operating headquarters providing the following

services to related businesses outside Sri Lanka:

administration, business planning, sourcing raw

materials, research and Development, technical support,

financial and treasury management, marketing and sales

promotion. Minimum investment of $250,000.



Incentives: IT services, IT training institutes, and

BPO firms will qualify for tax holidays of 5-12 years



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provided they meet minimum employment and student

levels. Otherwise, a preferential tax of 10% will apply

for 2 years. Regional operating headquarters will

qualify for a tax holiday of 3 years. A preferential

tax of 10% will apply in the 4th and 5th years. From

the 6th year onwards, a preferential tax of 15% will

apply. In addition, capital goods will be exempted from

import duty for above investments. A recently

introduced Economic Service Charge at 0.25% of income

applies to BOI- approved companies enjoying tax

holidays, from the fourth year of operation. The new

tax applies even to those companies already operating in

Sri Lanka.



Incentives for Regional Development:



The BOI has launched a new incentive program to promote

regional development with the aim of establishing 300

new factories or service companies (such as hotels,

hospitals, or training institutes) in the regions

outside the capital Colombo. The incentives include 2-

10 year tax holidays depending on the location and

number of employees, with investments located in the

most difficult areas eligible for a 10-year tax holiday.

In addition, imports of machinery and equipment would be

exempted from both customs duty and the value-added tax.

A minimum investment of approximately $280,000 is

required.



Incentives for Infrastructure Development:



Companies acquiring existing companies in petroleum,

power generation, transmission, development of highways,

seaports, airports, railways, 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 8 years depending on

the magnitude of investment. A preferential tax of 15%

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.



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% will follow the tax holiday. They will also

qualify for duty free imports of capital goods. A

minimum investment of $12.5 million is required.



Incentives for Other Investments:



-Industrial estates. Minimum investment of $500,000 to

$10 million; tax holidays ranging from 3 to 15 years;

-Textile fabric manufacturing, processing. Minimum

investment of $500,000 to $10 million; tax holidays

ranging from 5 to 15 years.



For further information on investment incentives and

other investment-related issues, potential investors are

encouraged to contact the Board of Investment directly.

The BOI can be found at www.boi.lk, or reached via e-

mail at info@boi.lk. The BOI has introduced an investor

matchmaking service via the BOI website. Information

regarding this service can be found at

www.boi.lk/partnership.



--Trade Agreements Enhance Market Access to South Asia

and Europe



A preferential trade agreement, the Indo-Lanka Free



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Trade Agreement (ILFTA) (www.doc.gov.lk) between Sri

Lanka and India, is now in effect. Under this

agreement, most products manufactured in Sri Lanka with

at least 35% domestic value addition (if raw materials

are imported from India, domestic value addition

required is only 25%),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%

reduction for tea and garments under quota; 25%

reduction for 528 textile items; and no reduction for

429 items on India's "negative list." Discussions are

underway to reduce the negative lists of both countries.

The two countries are also discussing services sector

liberalization, under a proposed Comprehensive Economic

Partnership Agreement (CEPA). Other areas potentially

covered by the CEPA are investment and economic

cooperation. Because production constitutes a portion

of value addition, ILFTA and the proposed CEPA enables

foreign firms operating in Sri Lanka to gain

preferential entry into the Indian market.



Some U.S. companies currently avail themselves of the

ILFTA by adding at least 35% value in Sri Lanka and

getting import duties into India reduced from as much as

15% to as little as zero. The American Chamber of

Commerce in Sri Lanka, in a study on the ILFTA,

identified agro processing, food preparation, tea,

rubber products, coconut products, spices, furniture,

ceramic and confectionary as having growth potential in

India. The study also found vehicles and vehicle parts,

aircraft parts and motorcycles to be possible attractive

sectors for U.S. manufacturers under the Indo-Lanka

Agreement.



Sri Lanka's Board of Investment promotes the following

product sectors under ILFTA: confectionary and cocoa

products, rubber products, plastics, footwear, ceramics,

jewelry, machinery and mechanical appliances,

electronics and electrical products, automobiles and

spare parts, medical instruments, furniture, and doors.





The 2005 Sri Lanka-Pakistan Free Trade Agreement

(SLPKFTA) (www.doc.gov.lk) provides Sri Lanka with duty-

free entry into Pakistan for 206 items. Pakistan?s

negative list contains 541 items with no duty

concessions. Pakistan will phase out tariffs on the

balance of approximately 4,000 items over a 3 year

period, meaning Pakistan would offer duty free entry to

almost all Sri Lankan exports by June 2008. Sri Lanka's

Board of Investment promotes the following product

sectors under SLPKFTA: rubber products, ceramics,

machinery and mechanical appliances, electronics and

electrical appliances, medical instruments, and

automobiles and spare parts.



Sri Lanka and six other South Asian nations belonging to

the South Asian Association for Regional Cooperation

(SAARC) agreed in 2004 to establish a South Asian Free

Trade Area (SAFTA) (http://www.saarc-sec.org/main.php),

which began operation on July 1, 2006. SAFTA offers

regionalized tariff reductions for imports from member

countries. Stated goals of SAARC members under SAFTA

are to reduce duties for imports from member countries

to between zero and 5% over a period of 7-10 years.

These agreements help make Sri Lanka a gateway to South

Asia for foreign investors.



Sri Lankan exports to the European Union (EU) are also

duty free under the ?GSP-Plus? incentive agreement,

which came into force on July 1, 2005. Under this

program, 7,200 Sri Lankan products meeting rules-of-

origin criteria can enter the EU duty free.



RIGHT TO PRIVATE OWNERSHIP AND ESTABLISHMENT



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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% 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.



While foreign investors can purchase land from private

sellers, the government has imposed a 100% tax on land

transfers to foreigners. For this purpose, Sri Lanka

has defined foreign investment to involve as little as

25% foreign ownership ? a definition that can be

particularly difficult for companies listed on the

Colombo Stock Exchange since on any particular day,

their ownership characteristics may vary. Apartments

above the third floor of condominium buildings, land for

the development of large housing schemes, hospitals and

hotels with a minimum investment of $10 million,

exporting companies with a minimum investment of $1

million, and large infrastructure projects with a

minimum investment of $50 million are exempted from the

tax. Regulations regarding these exceptions have been

published in Gazette No 1386/18 dated March 30, 2005.



PROTECTION OF PROPERTY RIGHTS



--Property Rights



Secured interests in property are recognized and

enforced. 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. 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.



--Intellectual Property Rights Protection



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 United States in 1991 signed a

Bilateral Agreement for the Protection of Intellectual

Property Rights. Sri Lanka is also a party to the Trade

Related Intellectual Property Rights (TRIPS) agreement

in the World Trade Organization. Sri Lanka has not

acceded to the WIPO Performances and Phonograms Treaty

(WPPT); the WIPO Copyright Treaty (WCT); or the WTO

Information Technology Agreement.



In November 2003, a new intellectual property law came

into force that was intended to meet both U.S.-Sri Lanka

bilateral IPR agreement and TRIPS obligations to a great

extent. The law governs copyrights and related rights,

industrial designs, patents, trademarks and service



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marks, trade names, layout designs of integrated

circuits, geographical indications, unfair competition,

databases, computer programs, and undisclosed

information. All trademarks, designs, industrial

designs and patents must be registered with the Director

General of Intellectual Property. Sri Lanka recently

introduced regulations to regulate the commercial use of

local creations.



Infringement of intellectual property rights (IPR) is a

punishable offense under the law. Intellectual property

rights come under both criminal and civil jurisdiction.

Recourse available to owners 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. Penalties for

the first offence include a prison sentence of 6 months

or a fine of up to $5,000. Penalties can be doubled for

a second offense. Aggrieved parties can seek redress

for any IPR violations through the courts, though this

can be a frustrating and time-consuming process.



Sri Lanka enforced its IPR laws sporadically between

2004 and 2006. The Police occasionally raided

counterfeit CD/VCD stores as well as counterfeit garment

sellers in 2005 and 2006. Several offenders have been

charged or convicted by courts. But the minimal damages

and suspended sentences imposed suggest that the court

system still fails to recognize the significance of

intellectual property rights.



Counterfeit goods continue to be widely available in Sri

Lanka. Local agents of well-known U.S. and other

international companies representing recording,

software, movie, clothing and consumer product

industries continue to complain that lack of IPR

protection is damaging their businesses. Piracy of

sound recordings and software is widespread, making it

difficult for the legitimate industries to protect their

market and realize their potential in Sri Lanka.

Software companies complain of the lack of IPR

enforcement within government institutions and even some

larger corporations, including several banks. An IPR

working group of adversely affected industries, led by

the American Chamber of Commerce of Sri Lanka, is

working to pursue more aggressive enforcement and

enhance public awareness.



--Patents, Copyrights and Trademarks



Patents are valid for 20 years from the date of

application but must be renewed annually.

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 essential

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.



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.





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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. Registered

trademarks are valid for ten years and renewable. The

law also recognizes both certification marks and

collective marks.



TRANSPARENCY OF REGULATORY SYSTEM



The Board of Investment strives to inform potential

investors about laws and regulations that may affect

operations in Sri Lanka. Laws are in place pertaining

to tax, labor and labor standards, exchange controls,

customs, environmental norms, and building and

construction standards. However, some of the laws and

regulations are difficult to access.



Foreign and domestic investors often complain that the

regulatory system is unpredictable due to outdated

regulations, rigid administrative procedures, and

excessive leeway for bureaucratic discretion. Effective

enforcement mechanisms are sometimes lacking, and

coordination problems between the BOI and relevant line

agencies frequently emerge. Lethargy and indifference

on the part of mid- and lower-level public servants

compound transparency problems. Lack of sufficient

technical capacity within the government to review

financial proposals for private infrastructure projects

also creates problems during tendering. An example of

weakness in regulations occurred in mid-2006, when

police and government agencies closed two satellite

television broadcasting stations for not possessing

required licenses. The two stations remained closed for

over five months, before various government agencies

reauthorized their operations.



In late 2005, the Government awarded several key

infrastructure projects to Chinese companies, outside

the tender process. They include a 300 megawatt coal

power project and a fuel bunkering project. In

addition, the Government has promised oil exploration

rights to India and China outside the tender process.



Although many foreign investors, including U.S. firms,

have had positive experiences in Sri Lanka, some have

encountered significant problems with government

practices and regulations. Some multinational firms

have experienced extensive unexplained delays in trying

to reach agreement on investment projects. Others have

had contracts arbitrarily canceled without compensation,

even though the Sri Lankan Cabinet had approved those

contracts.



Proposed laws and regulations are generally made

available for public comment. However, occasionally

they are published without public discussion.



EFFICIENT CAPITAL MARKETS AND PORTFOLIO INVESTMENT



--Availability of Financial Resources



Retained profits finance about 70% of private

investment, with short term borrowing financing a

further 20% of investment. The stock market and

corporate securities market have not been significantly

used to raise capital. Foreign direct investment (FDI)

finances about 4% of overall investment. Foreign

investors are allowed to access credit on the local

market. They are also free to raise foreign currency

loans.



The state consumes over 50% of the country's domestic

financial resources and has a virtual monopoly on the



COLOMBO 00000082 015.3 OF 025





management and use of long-term savings in the country.

This inhibits the free flow of financial resources to

product and factor markets. For 2007, the government?s

net borrowing from the local market is forecast to be Rs

156 billion ($1.4 billion). The Central Bank is

currently maintaining negative real interest rates,

which have contributed to increased lending and domestic

investment as well as inflation. Towards the end of

2006, the government attempted several measures to curb

credit expansion including margin requirements for

import of non-essential goods.



--Credit Instruments



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 also raise

syndicated bank loans to fund large-scale investment

projects undertaken by the private sector.



The domestic debt market in Sri Lanka is still at a

nascent stage. The first credit rating agency in Sri

Lanka was Fitch Rating Lanka (www.fitchratings.lk),

which opened an office in Colombo in 1999. Fitch

Ratings Lanka is joint venture between Fitch Ratings

Inc, International Finance Corporation, (IFC),Central

Bank of Sri Lanka, and several leading local financial

institutions. Credit ratings are now mandatory for all

deposit-taking institutions and for all varieties of

debt instruments and have helped numerous Sri Lankan

companies raise funds through debt markets.



Sri Lanka received its first sovereign credit ratings in

December 2005, with a ?BB-minus? from Fitch Ratings and

a ?B-Plus? from Standard and Poor?s. These sub-

investment grade ratings reflect the high level of

government indebtedness and weak revenue mobilization,

together with political and security concerns. The two

agencies changed their rating outlook, but not the

ratings, from stable to negative in April 2006 following

escalating violence. Consequently, the Government has

delayed plans to borrow from the international markets

and instead continued to borrow domestically.



--Accounting Standards



There is an active and fairly competent accounting

profession, based on the British model. The source of

accounting standards is the Institute of Chartered

Accountants of Sri Lanka (ICASL),and standards are

constantly updated to reflect current international

accounting and audit standards 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.



Sri Lankan accounting standards are applicable for all

banks, 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 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. British professional accounting

bodies are quite active in Sri Lanka. The Chartered

Institute of Management Accountants (CIMA),a leading

professional accounting body based in the UK and spread

over the Commonwealth, has its largest overseas presence

in Sri Lanka.



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--Securities and Exchange Commission



The Securities and Exchange Commission (SEC) regulates

the securities market in Sri Lanka. The SEC law was

revised in 2003, enhancing the SEC's 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.



Foreign investors can purchase up to 100% of equity in

Sri Lankan companies in numerous permitted sectors. In

order to facilitate portfolio investments, country funds

and regional funds may obtain Ministry of Finance

approval to invest in Sri Lanka's stock market. These

funds make transactions through share investment

external Rupee accounts maintained in commercial banks.



--Colombo Stock Exchange



The Colombo Stock Exchange (CSE),while small by "big

emerging market" standards, is one of the most

technologically sophisticated in the region. The CSE

has fully automated trading, clearing and settlement

systems. The CSE has a rolling settlement period of

five days for buyers and six days for sellers. Fifteen

local and foreign joint venture brokers currently

operate at the CSE. Foreign stockbrokers are permitted

to hold up to 100% equity in stock brokerage firms

operating at the CSE. The SEC has a settlement

guarantee fund with an initial capital of Rs 100 million

($93,000),which aims to guarantee the settlement of

trades between clearing members of the exchange.



There are 242 companies listed on the stock exchange

with the top ten positions by market capitalization held

by banks and food and beverage companies. The CSE has

become one of the best performing markets in the region.

The market gained 28% in 2005 and 42% in 2006. While

the market is sensitive to the security situation,

strong corporate performance and negative real interest

rates encourage stock purchases in an environment with

few other attractive opportunities.



Stock market development, though progressing, has been

slowed by the long term impact of the civil war on

investor confidence. Other issues include lack of

liquidity and limited market size. Improvements are

also needed in corporate governance, accountability, and

public disclosure. 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.



Acquisition of companies through mergers and

acquisitions 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%

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.



--Banking System



Sri Lanka has a fairly well diversified banking system.

There are 23 commercial banks ? eleven local and twelve

foreign. In addition, there are thirteen local

specialized banks. Citibank NA is the only U.S. bank

operating in Sri Lanka and has expanded its operations



COLOMBO 00000082 017.2 OF 025





recently. ICICI Bank of India is the newest foreign

bank in Sri Lanka and commenced operations in January

2006. In 2001-2003, Mashreq Bank, American Express

Bank, Nova Scotia Bank and ABN Amro Bank all sold their

banking operations in Colombo to existing banks. Sri

Lanka experienced its first bank failure in December

2002 when the Central Bank took action to revoke the

license of a small licensed specialized bank as it

approached insolvency. There was no fallout for other

banks from this incident. Two other small troubled

banks were restructured under Central Bank guidance.



The Central Bank is responsible for supervision of all

banking institutions. It has driven improvements in

banking regulations, provisioning, and public disclosure

of banking sector performance. Since 2004, credit

ratings have been mandatory for all banks operating in

Sri Lanka. In 2006, the Central Bank introduced higher

capital requirements for commercial banks to further

stabilize the banking system, promote consolidation, and

facilitate entry of larger banks. Nevertheless, the

Central Bank still suffers from lack of autonomous

authority, especially with regard to the large state

owned banks.



Sri Lanka has enacted laws to deal with money laundering

and terrorist financing. The Bank Supervision

Department of the Central Bank supervises and examines

financial institutions for compliance with anti-money

laundering and terrorist financing regulations. A

Financial Intelligence Unit (FIU) was created in 2006

and has authority to establish requirements and issue

instructions to banks regarding these anti-money

laundering and terrorist financing regulations.



State Owned Banks



Total assets of commercial banks stood at Rs 1,412

billion ($13.1 billion) as of December 31, 2005. The

two state-owned commercial banks, Bank of Ceylon and

People?s Bank, with assets of Rs 266 billion ($2.5

billion) and Rs 224 billion ($2.1 billion) respectively

in 2004, still dominate banking, accounting for about

45% of all assets.



The two state banks are inefficient and have accumulated

extensive bad debt. However, as these banks are

implicitly guaranteed by the state, their problems have

not harmed the credibility of the rest of the banking

system. Progress has been made in restructuring the two

banks ? their nonperforming loan ratios have declined

from 18% in 2003 to 8% in June 2006, while provisioning

and profitability have improved. Capital adequacy

ratios have also improved. However, fast credit growth

(especially to the state owned Ceylon Electricity Board

and the Ceylon Petroleum Corporation) is once again

raising concerns about credit quality.



Private Commercial Banks and Foreign Banks



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. The

average rate of non performing loans to total loans in

domestic private banks was 8.5% and in foreign banks was

2.0% in 2005. According to the World Bank, the banks

continue to make high provisions for the nonperforming

loans and risk management of the banks has significantly

improved. 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.

There are concerns regarding credit acceleration in the

housing sector and high spreads which are almost double

those in other countries in the region.



COLOMBO 00000082 018.2 OF 025





Capital Adequacy



Sri Lanka adopted capital adequacy standards set by the

Basel Committee on banking regulations and supervisory

practices in 1993. The minimum capital adequacy ratio

required by the Central Bank is 5% for core capital

(Tier I) and 10% for risk weighted assets (Tier I and

Tier II). The Central Bank has decided to adopt Basel

II standards for all banks in 2008.



Risk based capital adequacy at domestic private banks

was 10.9% and foreign banks was 20.4% in 2005. The Bank

of Ceylon?s capital adequacy ratio has increased to 12

percent. People?s Bank currently does not meet capital

adequacy requirements, but it has a Ministry of Finance

guarantee for funds required to meet its obligations.

The Asian Development Bank plans to provide a capital

infusion to enable the bank to meet its minimum capital

requirements.



POLITICAL VIOLENCE



In 2006, fighting between the ethnic separatist

Liberation Tigers of Tamil Eelam (LTTE) and the Sri

Lankan military intensified in northern and eastern Sri

Lanka; other parts of the country, including Colombo,

suffered sporadic terrorist attacks. In August 2006

suspected LTTE snipers shot and killed the deputy chief

of the government Peace Secretariat, a Tamil, at his

Colombo residence. In November 2006 a Sri Lanka Navy

bus was struck by an LTTE truck bomb, killing 100

soldiers ? the highest number of casualties in a single

incident since the beginning of the cease-fire in 2002.

Direct military engagement in Jaffna and in the east has

also been troubling. The government and the LTTE met in

Geneva in February and October 2006 to discuss ways to

strengthen cease-fire implementation, but neither round

of talks bore fruit.



Prior to 2006, LTTE terrorist activities had declined

after the LTTE and the government signed a formal open-

ended Cease-Fire Agreement in February 2002. Between

2002 and 2005, there was a marked improvement in the

business climate due to the relatively peaceful

atmosphere prevailing in the country.



In 1997, the United States designated the LTTE as a

Foreign Terrorist Organization (FTO). During two

decades of war, tourists and foreign business

representatives have not been terrorist targets, but

they have been injured in attacks on other targets. In

2001, the LTTE attacked Colombo's international airport

and destroyed commercial and military aircraft. Several

military personnel were killed in the attack, airport

employees were injured, and Sri Lankan civilians were

caught in the crossfire. Sri Lankan Airlines, jointly

owned by the Government of Sri Lanka and Emirates

Airlines of Dubai, lost several commercial aircraft in

the attack. The LTTE prior to 2001 attacked several

foreign-flagged commercial ships in the waters off the

north and east of the country. In response to these

attacks, insurers imposed war risk insurance surcharges

on aircraft and ships using Sri Lankan seaports and

airports. These surcharges have been lifted since the

cease-fire went into effect. The LTTE has also in the

past bombed Colombo?s financial and business districts,

causing numerous casualties and extensive damage to

property.



CORRUPTION



Sri Lanka has generally adequate laws and regulations to

combat corruption, but they are unevenly enforced. U.S.

firms identify corruption as a constraint on foreign

investment, but, by and large, it is not a major threat



COLOMBO 00000082 019.2 OF 025





to operating in Sri Lanka ? at least once a contract has

been won. Corruption appears to have the greatest

effect on investors in large projects and on those

pursuing government procurement contracts.



There is a consensus that corruption is increasing in

Sri Lanka. Both the Transparency International

Corruption Perception and the World Bank's Control of

Corruption indices for Sri Lanka show a decline in

recent years. The World Bank Control of Corruption Index

has shown a decline from -0.17 in 2004 to -0.31 in 2005.

Transparency International's Corruption Perception Index

shows a decline from 67th place in 2004 to 84th in the

2006 ranking. During the 2006 USAID Democracy and

Governance assessment, anecdotal evidence from the

private sector indicated that the percentage of a public

sector contract paid in bribes has nearly tripled.

According to Transparency International, corruption is

perceived as most pervasive in political appointments to

government institutions and in government procurement

awards, as well as in high frequency/low value

transactions. The police force and the judiciary are

perceived to be the most corrupt public institutions.

Corruption is also a persistent problem in customs

clearance and enables wide smuggling of certain consumer

items, to the detriment of legitimate manufacturers and

importers.



Sri Lanka ratified the UN Anti-corruption Convention in

2004. Sri Lanka has signed but not ratified the UN

Convention against Transnational Organized Crime. Sri

Lanka became a signatory to the OECD-ADB Anti-Corruption

Regional Plan in May 2006.



--Bribery Commission is Not Effective.



The Bribery Commission is the main body responsible for

investigating allegations of bribery and 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.



Several other government entities try to address

corruption, the most important being the Auditor

General's Department and the National Procurement

Agency. However, there is a confusion of mandates and

these institutions frequently interpret their mandates

narrowly, inhibiting their effectiveness.



Few Sri Lankans have been found guilty of corruption in

recent years. Although highly publicized, efforts to

investigate bribery and corruption have failed, damaging

public confidence in such processes. While corruption

charges have been leveled against politicians and top

officials in charge of key government corporations, none

of the accused has been convicted.



BILATERAL INVESTMENT AGREEMENTS



The Government of Sri Lanka has signed investment

protection agreements with the United States (which came

into force in May 1993) and with the following

countries:



1. Belgium

2. People?s Republic of China

3. Denmark

4. Egypt

5. Finland



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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



A bilateral treaty between Sri Lanka and the United

States to avoid double taxation was ratified and entered

into force on June 12, 2004.



Foreign investors not qualifying for Board of Investment

incentives such as tax and exchange control exemptions

or concessions are liable to pay taxes on corporate

profits, dividends, and remittances of profits. They

are also liable to pay a Value Added Tax on goods and

services. The government has also imposed a tax of 0.1%

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 U.S. investors to contact an

international auditing firm operating in Sri Lanka to

assess their tax liability.



OPIC AND OTHER INVESTMENT INSURANCE PROGRAMS



The United States 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 U.S. 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.



The U.S. Embassy and other U.S. Government institutions

spend over $25 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.



LABOR



--Labor Force

Sri Lanka's labor force is literate (particularly in

local languages) and trainable, although weak in certain

technical skills and the English language. The average

worker has eight years of schooling. Two thirds of the

labor force is male.

The unemployment rate has declined in recent years to

around 6.7%. The rate of unemployment among women and

high school and college graduates, however, has been

proportionally higher than the rate for less-educated

workers. Youth and entry-level unemployment and

underemployment remain a problem. A significant



COLOMBO 00000082 021.2 OF 025





proportion of unemployed people seek "white collar"

jobs. However, 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

English language proficiency. The construction,

plantation and apparel industries have reported

shortages of workers. Some investors have faced

problems in finding sufficient employees with the

requisite skills.



The government has initiated educational reforms it

hopes will lead to better preparation of students and

better matches between graduates and jobs. More

computer, accounting and business skills training

programs and English language programs are becoming

available. But the demand for these skills still

outpaces supply.



--Migrant Workers Abroad



There are an estimated 970,000 Sri Lankan workers

abroad. Remittances from migrant workers, at around $2

billion, are one of Sri Lanka?s largest sources of

foreign exchange. The majority of this labor force is

unskilled (housemaids and factory laborers) and located

primarily in the Middle East, but Sri Lanka is also

losing many of its technically and professionally

qualified workers to more lucrative jobs abroad.



--Wages and Holidays



Labor is available at relatively low cost, though it is

priced higher than in some other South Asian countries.

Productivity lags behind other countries in Asia.

Child labor is prohibited and is virtually nonexistent

in the organized sector, although child labor occurs in

informal sectors. The minimum legal age for employment

is set at 14. Most permanent full-time workers are

covered by laws pertaining to maximum hours of work,

minimum wage, leave, the right of association, and

safety and health standards.



There is widespread belief that Sri Lanka?s labor laws

and its numerous official holidays dampen productivity.

The full moon day of each month (sacred in the Buddhist

faith),if it falls on a weekday, is a paid holiday.

There are also eight other public holidays. The public

sector and banks enjoy additional holidays. These

statutory holidays are in addition to 21 days of

annual/casual leave and approximately 21 days of sick

leave (the number of days for sick leave is at the

discretion of the management). Further, female

employees are entitled to 84 days fully paid maternity

leave for the first two pregnancies. Female workers

are permitted 60 hours of overtime work per month.



The Government continues to interfere with private

sector wage setting. In October 2005, the Government

through an act of Parliament took steps to mandate a

wage increase (of approximately Rs 1,000 per month) to

private sector workers. The private sector is concerned

about such interference in wage setting, which could

damage competitiveness in certain sectors.



--Termination Laws



The Termination of Employment of Workmen Act (TEA) makes

it difficult to fire or lay off workers who have been

employed more than six months for any reason other than

serious, well-documented disciplinary problems.

Disputes over dismissals can be brought to a labor

tribunal administered by the Ministry of Justice. The

labor tribunals have large backlogs of unresolved cases.

Certain labor disputes founded upon fundamental rights



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(allegations of termination/transfers based upon

discrimination, etc.) can be brought directly to the

Supreme Court.



The government has introduced a standard compensation

formula under the TEA which is expected to facilitate

termination. An unemployment benefit scheme is yet to

be formulated. Recent amendments to the Industrial

Disputes Act (IDA) include labor dispute resolution

rules to expedite the dispute process.



The compensation formula takes into account the number

of years of service and offers 2.5 months salary as

compensation for 1 year of service, 12.5 months salary

for 5 years of service; 38 months for 20 years and up to

a maximum of 48 months salary for 34 years service.

This assumes that the government will approve such a

termination, which frequently is not the case. The

proposed unemployment benefit insurance scheme to

provide an additional payment has not yet come into

effect. According to a recent IMF report, Sri Lanka?s

firing cost for 20 years of service, at 38 months, is

among the highest in Asia compared with Pakistan and

Nepal?s 22.5 months, India?s 19.6 months, Malaysia?s

18.5 months, China?s 13.2 months and Bangladesh?s 11.7

months. Under the new arrangements, the Labor

Commissioner?s approval or the affected employee?s

consent is required to fire workers. Employers complain

that the package is excessive, especially compared to

international norms. They have also pointed out that

higher compensation could adversely affect companies

requiring restructuring, and discourage investment.



--Trade Unions



More than 20% of the 7.5 million-strong work force is

unionized, but union membership is declining. There are

more than 1,650 registered trade unions (many of which

have 50 or fewer members),and 19 federations. About

15% of labor in the industry and service sector is

unionized. Most of the major trade unions are

affiliated with political parties, creating a highly

politicized labor environment. Several trade unions

with affiliations to major political parties have formed

themselves into an organized group, the National

Association for Trade Union Research and Education

(NATURE),to promote education and training among trade

unionists. Labor in free trade zone enterprises tends

to be represented by non-union worker councils.



Unions have complained that the Board of Investment and

some employers, especially in the BOI-run export

processing zones, prohibit union access and do not

register unions on a timely basis. Employers allege

that the JVP, a Marxist political party opposed to

private enterprise, could provoke labor to strike under

the pretense 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.



In BOI enterprises, including those in the export

processing zones, worker councils composed of employees

generally engage in labor and management negotiations.

These worker councils have functioned well in some

companies in providing for worker welfare. The BOI has

requested that companies recognize trade unions and

accept the right to collective bargaining. According to

the BOI, where both a recognized trade union with

bargaining power and a non-union worker council exist in

an enterprise, the trade union will represent the

employees in collective bargaining.



The International Labor Organization's (ILO) Freedom of

Association Committee has observed that Sri Lankan trade

unions and employee councils can co-exist, but advises



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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

address these issues.



In response to these observations, the BOI revised its

labor manual in March 2004, requesting that companies

located in export processing zones 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.



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. USTR did not act on this petition. A Sri Lanka

trade union made a similar case with the European Union

(EU) 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.

The EU, however, urged improvements in freedom of

association.



Key public sector entities such as the Ceylon

Electricity Board and the Sri Lanka Ports Authority also

have large unions which have protested anticipated moves

towards privatization or restructuring. In July 2006,

the Supreme Court broke a port slowdown which had

disrupted shipping through the Colombo Port for over a

week. The Brussels based International Textile and

Garment Workers Federation (ITGWF) lodged a complaint

with the ILO on this ruling.



--Collective Bargaining



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



Formerly confrontational labor-management relations have

improved in the last few years as employers have worked

harder to motivate and care for workers. Work stoppages

and strikes in the private sector are on the decline.

While labor-management relations vary from organization

to organization, managers who emphasize communication

with workers and offer training opportunities generally

experience fewer difficulties. U.S. investors in Sri

Lanka (including U.S. garment buyers) generally promote

good labor management relations and labor conditions

that exceed local standards.



--ILO conventions



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



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Labor has published a Labor Code, consolidating

important labor legislation. Sri Lanka has ratified all

eight of the core labor conventions included in the 1998

ILO Declaration on Fundamental Principles and Rights at

Work. ILO Convention 138 on minimum age for admission

to employment and Convention 182 on worst forms of child

labor were ratified during 2000-2001. Sri Lanka

ratified ILO convention 105 on Forced Labor in 2003.

The ILO, EFC and the AFL-CIO-sponsored American Center

for International Labor Solidarity are working to

improve awareness of core labor standards. The ILO also

promotes its Decent Work Agenda program in Sri Lanka.



FOREIGN TRADE ZONES/FREE PORTS



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.



In the past, firms preferred to locate their factories

near Colombo harbor or airport to reduce transport time

and cost. However, excessive concentration of

industries around Colombo has caused heavy traffic,

higher real estate prices, environmental pollution, and

scarcity of labor. The BOI now encourages export-

oriented factories to set up in newly developed

industrial zones farther from Colombo. However, Sri

Lanka's poor roads make these outlying zones less

appealing.



FOREIGN DIRECT INVESTMENT STATISTICS



--Investment Trends



From 1998-2001, foreign direct investment (FDI) flows to

Sri Lanka averaged only about $150 million per year

(excluding privatization receipts). Since the 2002

ceasefire improved investor confidence, annual FDI flows

have averaged about $200 million. 2006 FDI is expected

to total about $400 million, centered on

telecommunications and construction.



--U.S. Investments



Total cumulative U.S. investment in Sri Lanka is

estimated to be in the range of $200 million. Major

U.S. investors include: Energizer Battery, Mast

Industries, Smart Shirts (a subsidiary of Kellwood

Industries),Chevron, Citibank, Caterpillar, 3M,

Cargill, Coca Cola, Tandon Corporation, Paxar

Corporation, Pepsi Co, Sportif, Worldquest, Fitch IBCR,

AES Corporation, American International Group (AIG),

American Premium Water, Virtusa, Avery Denison, North

Sails, Amsafe Bridport, and RR Donnelly (through Office

Tiger). In addition, IBM, Lanier, NCR, GTE, Motorola,

Procter & Gamble, Liz Claiborne, Tommy Hilfiger, J.C.

Penney, the Gap, Sun Microsystems, Microsoft, Bates

Strategic Alliance, McCann-Erickson, Pricewaterhouse

Coopers, Ernst and Young, and KPMG all have branches,

affiliated offices or local

distributors/representatives. Kentucky Fried Chicken,

Pizza Hut, Federal Express, UPS, and McDonald?s are

represented in Sri Lanka through franchises. Numerous

other American brands and products are represented by



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local agents.



--Non-U.S. Investments



Leading sources of foreign direct investment in Sri

Lanka are Singapore, the United Kingdom, Japan, South

Korea, Hong Kong, Australia and Malaysia. Major non-

U.S. investors include: Unilever, Nestle, British

American Tobacco Company, Mitsui, Pacific Dunlop/Ansell,

Prima, FDK, Telekom Malaysia Bhd, S.P. Tao and HSBC.

Leading U.S. and foreign investors that have acquired

significant stakes in privatized companies include

Chevron, Norsk Hydro of Norway, Hanjung Steel of Korea,

Nippon Telephone and Telegraph, Mitsubishi Corporation

and C. Itoh (A.K.A. Itochu) of Japan, Emirates Airlines

of United Arab Emirates, Shell Oil of the UK, P&O

Netherlands, and the Indian Oil Corporation.



Web Resources:



Board of Investment of Sri Lanka: www.boi.lk



Article VIII obligations of the International Monetary

Fund: www.imf.org/external/pubs/ft/aa/aa08.htm



U.S.-Sri Lanka Bilateral Investment Treaty:

www.state.gov/documents/ organization/43588.pdf



Institute for the Development of Commercial Law and

Practice: www.iclparbitrationcentre.com



Indo-Lanka Free Trade Agreement: www.doc.gov.lk



South Asian Free Trade Area: www.saarc-sec.org/main.php



Fitch Ratings Lanka: www.fitchratings.lk



Development Assistance Database: www.dad.tafren.gov.lk



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