SRI LANKA: WAR, AIR ATTACKS HIT BUSINESS CONFIDENCE

UNCLAS SECTION 01 OF 03 COLOMBO 000843 SIPDIS SENSITIVE SIPDIS STATE FOR SCA/INS DOL/ILAB FOR TINA MCCARTER MCC FOR S. GROFF, D. TETER, D. NASSIRY AND E. BURKE TREASURY FOR LESLIE HULL E.O 12958: N/A TAGS: ECON EINV ETRD CE SUBJECT: SRI LANKA: WAR, AIR ATTACKS HIT BUSINESS CONFIDENCE REF: A) COLOMBO 536 B) COLOMBO 491 C) COLOMBO 637 ¶1. (SBU) Summary: The resumption of war in Sri Lanka is hurting the economy both in the short term and the long term, by driving up day-to-day business costs and by making firms nervous about new investments. Veteran Sri Lanka business people say the current investment environment is as bad as they have ever seen. The government continues to expect strong growth this year, pointing to good results in the first quarter and the fact that local blue chip companies continue to report strong revenues and profits as evidence. Even accounting for Sri Lanka's remarkable economic resilience, it appears likely that the economy will grow far less in 2007 than the seven percent growth it registered in 2006. End summary. ¶2. (U) Sri Lanka's $30 billion economy has grown at a steady average annual rate of four to five percent over the 24 years of conflict between the government and the ethnic separatist Liberation Tigers of Tamil Eelam (LTTE). The 2002-2005 ceasefire unlocked trade and investment that produced average growth during that period of five and a half percent. Growth peaked at over seven percent in 2006, despite the steady return to war, on the strength of investments made in the Western Province during the ceasefire, strong private sector services growth, and high government deficit spending (ref A). That momentum appeared to continue into 2007, with particularly strong export growth in the first quarter. LTTE AIR ATTACKS HURTING BUSINESS CONFIDENCE -------------- ¶3. (SBU) The healthy start in 2007 appears to have been undone by the LTTE air attacks on government and civilian targets in March and April (refs B and C). The government's decision to suspend night operations at Colombo's international airport was intended to insulate civilians and air traffic from the danger of future air attacks. However, the move sent an exceptionally strong signal to business decision-makers that they cannot continue to rely on the war having minimal impact on their operations in and around the capital. ¶4. (SBU) Since the airport attacks, day-to-day business costs have risen, and firms appear markedly more cautious about committing long term investments to Sri Lanka. The stock market is one indicator: after reaching an all-time high on February 13, it has fallen back about 15 percent, almost entirely since the first air attack in March. Real estate prices likewise have begun to fall after rising steadily for the preceding five years. A local business magazine's monthly business confidence survey hit a 32-month low in May, with 73 percent of respondents expecting their business to get worse in the next year, compared to 42 percent who felt that way in April. That decline in confidence appears to cut across sectors, as indicated by the following examples: GARMENTS -- Sri Lanka's largest garment manufacturer told Ambassador that it plans to move its design operations to India, to avoid disruption of foreign partners' visits to consult with the company's local designers. The company could not risk cancelled meetings and fouled up travel plans due to unpredictable airline schedules since the air attacks. Additionally, some of its clients' security officials were advising personnel against traveling to Sri Lanka at all. -- Sri Lanka's apparel producers' association is concerned that the airport attacks disrupted logistics for such functions as air freight delivery of production inputs and samples. Because such COLOMBO 00000843 002 OF 003 interruptions are incompatible with "just in time" production schedules, the association fears that apparel buyers may be forced to source purchases elsewhere. TOURISM -- Tourist arrivals in the first quarter of 2007 were down by 16 percent compared to 2006. Figures have gotten worse since the March and April air attacks, with some hotels reporting single digit occupancy. Most have resorted to drastic rate cuts to attract sufficient Sri Lankan visitors to simply cover costs. A major hotel operator said it has already decided not to hire temporary employees for this year's peak season, in order to control costs. -- Conferences that were to take place in Colombo have been cancelled. For example, the European Commission cancelled an EU-Sri Lanka Chamber of Commerce IPR seminar when the lead expert presenter deferred his travel, citing European embassy travel warnings. Similarly, Post was looking forward to the Near East and South Asia Council of Overseas Schools Leadership Conference that was scheduled to take place in Colombo this fall. However, NESA decided to move the conference to Bangkok -- again because many of its planned speakers from the United States and Europe were scared off by the airport attacks. -- A private domestic air carrier has ceased operations in response to the declining number of visitors and the government's request that it suspend services to certain destinations for security reasons. Government security concerns also drove the decision to order Colombo hotels to turn off generators during air raid warnings, despite the inconvenience to hotel guests. -- A number of hotel developers have deferred plans to invest in construction of new hotels or renovations of existing properties. A major Sri Lankan hotel operator told Ambassador that it will shift plans for new investment from Sri Lanka to India and Maldives. TRANSPORTATION -- The president's office stated that its decision to close the Colombo airport for night flights was made at the request of national carrier Sri Lankan Airlines, which believed that its insurance premiums would have been raised had it continued to fly at night. -- The Sri Lanka Ports Authority ordered the night-time closure of one of the Colombo port's two entry points to reduce the possibility of an LTTE attack on the port. According to the port authority chairman, this has resulted in the monthly loss of 222 hours of navigation time for ships calling at the port. The port will invest in video and underwater surveillance to in order to eventually restore operations to full capacity. -- A Singapore-owned flour milling operation in Trincomalee told Ambassador that it pays a risk premium of $250,000 for every shipment it brings into Trincomalee harbor. INFRASTRUCTURE -- A major Sri Lankan conglomerate told Ambassador that it will cut back on all capital spending planned for this year, to reduce costs in what it expects to be a slow economy. The company is looking especially cautiously at a planned major real estate development in Colombo's upcoming South Harbor expansion. It says the project is so large it could add two percent annually to GDP. Yet, as the project goes through planning and approvals processes, the company COLOMBO 00000843 003 OF 003 is evaluating whether to reduce its eventual investment, because the project would be less viable in a falling economy. -- The government also has cut back on infrastructure investment in order to finance its war effort. The state-owned oil refinery has been unable to fund routine maintenance, its labor union told local media. Periodic electricity outages attributed to power equipment failures also suggest insufficient investment in maintenance state-owned electricity board. HUMAN RESOURCES -- The CEO of a Colombo-based software company with offices in Chennai, Malaysia, Singapore, and the United States told Ambassador and a local newspaper that the company is experiencing a brain drain as a result of the conflict. The CEO noted that both Tamil and Sinhalese software engineers have left or were planning to leave. -- The Embassy Colombo consular section reports signs of increasing applications for visas by business people with portable sources of income, such as gem dealers. Many Sri Lankans with backgrounds in information technology, science, and mathematics are also applying for visas, despite the fact that work opportunities in those fields in Sri Lanka are generally good. COMMENT: GOVERNMENT REMAINS OPTIMISTIC DESPITE BUSINESSES' CONCERNS -------------- ¶5. (SBU) For Sri Lanka, one of the most alarming aspects of the current business climate is the fact that the government is not listening to business people's concerns. Virtually every business leader we talk to says that President Rajapaksa distrusts the Colombo business elite, in the belief that they support the opposition United National Party. Even those business people with access to the president say they are reluctant to speak frankly to him about their concerns for fear that he will shut them out or brand them as unpatriotic. The president may be ignoring their concerns in part because his own economic advisors remain optimistic. Thus, while business leaders are telling us the business environment is "about the worst it has ever been," the central bank governor, finance secretary, and minister of export promotion and enterprise development like to point out that many local and foreign firms have reported high revenues and profits in recent times. They cite the growth and export figures of the last few years as evidence that the economy remains strong despite the LTTE attacks and the government's increased war effort. They also state that sustained growth of eight to ten percent is necessary to achieve the poverty alleviation goals in the president's Mahinda Chintana election manifesto. Even in their optimism they are not predicting growth to reach those levels. If the current business climate is a good indicator, growth in 2007 is likely to fall well short of those levels.