INVESTMENT CLIMATE STATEMENT, 2008 - SRI LANKA

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RUEHNE/AMEMBASSY NEW DELHI 1744
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UNCLAS SECTION 01 OF 22 COLOMBO 000061 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EEB/IFD/OIA, EEB/CBA, AND SCA/INS 
 
STATE PLEASE PASS USTR 
 
MCC FOR S GROFF, D NASSIRY AND E BURKE 
 
E.O. 12958: N/A 
TAGS: KTDB, OPIC, ECON, USTR, EINV, EFIN, ETRD, ELAB, PGOV, CE 
SUBJECT: INVESTMENT CLIMATE STATEMENT, 2008 - SRI LANKA 
 
REF: 2007 STATE 158802 
 

>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 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 24-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



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

and was formally abrogated by the government in early 2008.

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 four 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 2007

the service sector continued its strong expansion, fueled primarily

by strong growth in telecommunications, ports, trading and financial

services. Public administration and defense expenditures increased

sharply in 2007. There also is a growing information technology

sector, especially information technology training and software

development and exports. There are about 6,000 people employed in

export-oriented software development. Sri Lanka has seen some

investment in the business process outsourcing (BPO) sector, which

currently employs 5,500 to 6,000people and has potential to grow

further. Tourism remains well below potential due to resumed ethnic

conflict.

Manufacturing accounts for about 16% of GDP. The textile, apparel,

and leather products sector is the largest, accounting for 39% 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 posted strong growth rates in 2006-7, largely due to demand for

tsunami reconstruction projects. Mining and quarrying account for



SIPDIS

2% of GDP.

Agriculture has lost its relative importance to the Sri Lankan

economy in recent decades. It employs 32% 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; 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 2007, Sri Lanka's exports (mainly

apparel, tea, rubber, gems and jewelry) were $7.5 billion and

imports (mainly oil, textiles, food, and machinery) were $11.2

billion. Apparel is a vital industry accounting for about 45% of

exports. Although garment exports face increased competition

following the 2005 expiration of the worldwide Multifiber

Arrangement, exports increased by 6% in 2006 and 10% in the first 10

months of 2007. This growth was supported by duty free access to

the EU through the EU GSP+ scheme and by U.S. and EU safeguards on

exports from China. Apparel exporters expect tougher competition

once restrictions on Chinese apparel exports are lifted in 2008.

Sri Lanka's apparel industry is undertaking various efforts to meet

increasing global competition, including the establishment of fabric

mills and accessory manufacturing factories. The industry has also

embarked on a branding campaign under the slogan of "Garments

without Guilt" to highlight the industry's adherence to relatively

high labor standards, its prohibition of child labor, and its active

corporate social responsibility culture. Tea, Sri Lanka's second

largest export, attracted premium prices in 2007. Nevertheless, the

tea industry is challenged by a shortage of plantation labor, demand

for higher wages, and growing competition.



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

were $2.1 billion in 2006, or 31% of total exports. For many years,

the United States has been Sri Lanka's biggest market for garments,

taking about 56% of total garment exports. India is Sri Lanka's

largest supplier, with exports of $2.2 billion in 2006. The United

States exported approximately $200 million to Sri Lanka in 2006

consisting primarily of industrial machinery, as well as medical

instruments, paper, specialized fabrics and textiles for use in the

garment industry, and pharmaceuticals.

--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.



Although there are appearances that the BOI has been used for

political purposes upon occasion, 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 range of advantages.

However, 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 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. A new Companies Act came into effect in

2007 replacing the Companies Act of 1982. The new law aims to

improve trade and commerce as well as corporate governance in the

business sector. It features simplified regulations concerning

company formation; provisions specifying the duties of company

directors; provisions to prevent the abuse of powers by directors;

provisions to protect creditors; and a dispute board to settle

disputes among directors. Various labor laws and regulations also

affect investors. See sections below.



--Foreign Equity Shares by Sector





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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 and information technology

(software development and business process outsourcing),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



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. In

times of balance of payments difficulties the government tends to

impose controls on foreign exchange transactions. Most recently, in

October 2006, the Central Bank required importers to keep a 50%

deposit on letters of credit on non-essential imports. The

requirement was removed in March 2007.



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



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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 allows 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 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



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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, (approximately $500) 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.

However, loans below Rs 5 million ($460,000) are exempt 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 new Companies Act of 2007 introduced a "solvency test" to

determine the financial health of a company. There are provisions

relating to duty of a company's directors on serious loss of

capital. The solvency test is intended to prevent companies without

sufficient assets from obtaining loans and to protect rights of

creditors.



The Companies Act does not provide for the revival of struggling

companies. However, as in the past, it is expected that the courts

would take a liberal attitude towards any restructuring plans that

may be of benefit to a 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

(www.state.gov/documents/organization/43588.p df).



--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



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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 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.



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



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from a particular constituency or a given list, but have

successfully resisted such pressure with no apparent adverse

effects.



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. Please see the note at the end of this section on

proposed changes to the incentive programs listed:





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: Currently, the above industries qualify for a five-year

tax holiday. A preferential tax of 10% in the 6th and 7th years

follows the tax holiday for some industries. 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: Currently, IT services, IT training institutes, and BPO

firms qualify for tax holidays of 5-12 years provided they meet

minimum employment and student levels. Otherwise, a preferential

tax of 10% applies for 2 years. Regional operating headquarters

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



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preferential tax of 15% will apply. Capital goods for these

projects 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 a separate incentive program to promote regional

development, with the aim of establishing new factories or service

companies (such as hotels, hospitals, or training institutes) in the

regions outside the capital Colombo. The incentives include 10-20

year tax holidays for investments in northern and eastern provinces

and 2-10 year tax holidays for investments located in other

provinces. In addition, imports of machinery and equipment are

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

investment levels apply.



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 3 to 15 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.



Note: The Government has proposed to reduce all tax holidays listed

above to 3 years other than the tax holidays offered under regional

development program (to be revised to 5 years) and large

infrastructure projects of national importance. It is not known

when this revised incentive scheme will be implemented.



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 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 4,235

items; 50 to 100% reduction for tea and garments under quota; 25%

reduction for 553 textile items; and no reduction for 431 items on

India's "negative list." Discussions are underway to reduce the

negative lists of both countries. The two countries are also



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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 will 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



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



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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

are 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 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 Rs 500,000 ($4,600),but smaller penalties are the norm.

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.



Since the passage of the 2003 IPR law Sri Lanka has slowly begun

enforcing its provisions. The Police occasionally raid counterfeit

CD/VCD stores as well as counterfeit garment sellers. However, it

is rare for the police to act without a formal complaint and

assistance from an aggrieved party. Several offenders have been

charged or convicted by courts. But the minimal damages and

suspended sentences imposed suggest that the court system still fail

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



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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.



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 2005-2007, the Government awarded several key infrastructure

projects to Chinese companies outside the tender process. They

included a 300 megawatt coal power project, a fuel bunkering

project, and a large port construction project in the Southern

district of Hambantota. In addition, the Government has promised

oil exploration rights to India and China outside the tender

process.





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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 management and use of

long-term savings in the country. This inhibits the free flow of

financial resources to product and factor markets. For 2008, the

government's net borrowing from the local market is forecast to be

Rs 155 billion ($1.3 billion). Due to high inflation and increased

government borrowing, interest rates rose sharply towards the end of

2007.



--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 (S&P). 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. The

S&P rating outlook was revised to stable in September 2007. The

Government borrowed $500 million at an interest rate of 8.25% for

five years in October 2007. This was Sri Lanka's first sovereign

bond sale to international markets.



--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.



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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.



--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 3

days. 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 235 companies listed on the stock exchange with the top

ten positions by market capitalization held by telecommunication

companies, banks, conglomerates and food and beverage companies.

The CSE, after being one of the best performing markets in the

region in 2005-6, suffered due to increased conflict-related

violence in 2007, declining by about 7%. While the market is

sensitive to the security situation, strong corporate performance

and sometimes negative real interest rates have encouraged 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





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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. ICICI Bank of India is the newest

foreign bank in Sri Lanka; it 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. In January 2008, the Central Bank issued corporate

governance rules for banks. The new rules are aimed at promoting

the safety and soundness of the banking system. 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 1,771 billion ($17

billion) as of December 31, 2006. The two state-owned commercial

banks, Bank of Ceylon and People's Bank, with assets of Rs 378

billion ($3.6 billion) and Rs 339 billion ($3.2 billion)

respectively, still dominate banking, accounting for about 40% 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 5-7% in 2006, while provisioning and profitability have

improved. Capital adequacy ratios have also improved. However,

fast credit growth (especially to the government and state-owned

Ceylon Electricity Board and Ceylon Petroleum Corporation) and

directed lending to some sectors have once again raised 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 and

consumer sectors. The banking system could also become vulnerable

to credit and liquidity risk due to a sharp rise in the ratio of

credit to deposits.



Capital Adequacy



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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 in the banking sector was 11.9% in 2006.

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 government has commenced a

recapitalization program at the People's Bank 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 2007,

fighting escalated further, including the first-ever LTTE air

attacks -- one against a military base that adjoins the

international airport north of Colombo, another on oil storage

facilities outside Colombo. In July 2007, following heavy fighting,

the government regained control of the East from the LTTE. Targeted

attacks by LTTE against politicians -- and on one occasion against

civilians in a crowded shopping area -- continued in Colombo.



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). In 2007, the United States froze the

assets of and blocked transactions with the Tamils Rehabilitation

Organisation (TRO),a U.S.-registered non-profit group, on the

grounds that it provided support for the LTTE. 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 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 -0.30 in 2005, with a

minimal improvement to -0.29 in 2006. Transparency International's

Corruption Perception Index shows a decline from 67th place in 2004



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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 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.



In January 2007, a parliamentary commission found evidence of

serious and widespread waste, fraud, and abuse in the management of

Sri Lanka's numerous government enterprises. Privatization of a

handful of government enterprises between 2001 and 2004 also appears

to have been done in a corrupt manner. The mismanagement and

corruption reviewed by the Commission have cost Sri Lanka an

estimated USD 1.3 billion. However, the government has taken little

concrete action to date to address the commission's findings.

Following the commission's report, several other large scale

corruption incidents and frauds materialized, including at the

government's tax office.



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

6. France

7. Germany

8. Indonesia

9. India

10. Iran

11. Italy

12. Japan

13. Korea

14. Luxembourg

15. Malaysia

16. Netherlands



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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

$15 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 6.5%.

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 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 report a shortage 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 1.5 million Sri Lankan workers abroad.



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Remittances from migrant workers, at around $2.7 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 (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 to facilitate termination. 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. 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



About 20% of the 6.8 million-strong work force is unionized, but



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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.



All workers, other than police, armed forces, prison service, and

those in essential services, have the right to strike. By law,

workers may lodge complaints to protect their rights with the

commissioner of labor, a labor tribunal, or the Supreme Court. The

president retains the power to designate any industry as an

essential service.



Unions represented workers in many large private firms, but workers

in small-scale agriculture and small businesses usually did not

belong to unions. Public sector employees were unionized at very

high rates. Labor in export processing 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 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



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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.

However, in response to a challenge lodged by several unions, the

ILO Freedom of Association Committee noted that the port "go-slow"

action did not disrupt an essential service, i.e. one whose

disruption would endanger life, personal safety or health of the

whole or part of the population.



--Collective Bargaining



Collective bargaining is not yet popular. While about half of the

500 members of the Employers' Federation of Ceylon is unionized,

currently only about 44 of these companies (including a number of

foreign-owned firms) have collective agreements and use them to

conduct negotiations on their behalf.



--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 31 international labor conventions. The labor laws

of Sri Lanka are laid out in almost 50 different statutes. The

Ministry of Labor has published a Labor Code, consolidating

important labor legislation. Sri Lanka has ratified all eight of

the core labor conventions included in the 1998 ILO Declaration on

Fundamental 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 and

the Employers' Federation of Ceylon 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 12 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 addition, a large private apparel company recently

opened Sri Lanka's first privately run fabric park. The company

invites local and foreign companies to set up fabric and apparel

factories in this eco-friendly park.



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 and the government now encourage

export-oriented factories to set up in industrial zones farther from

Colombo. However, Sri Lanka's poor roads make these outlying zones

less appealing.



FOREIGN DIRECT INVESTMENT STATISTICS



--Investment Trends



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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 Foreign Direct Investment (FDI) has averaged about $200

million. In 2006, FDI increased to about $450 million. FDI is

expected to total $550 million in 2007, centered on

telecommunications, business process outsourcing, and hotel and

restaurant services.



--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, 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). Several Sri

Lankan-Americans have started IT and BPO companies in Sri Lanka

serving the US market. In addition, IBM, Lanier, NCR, GTE,

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

Penney, Sun Microsystems, Microsoft, Bates Strategic Alliance,

McCann-Erickson, Pricewaterhouse Coopers, Ernst and Young, and KPMG

all have branches, affiliated offices or local

distributors/representatives. Kentucky Fried Chicken, Pizza Hut,

Federal Express, UPS, and McDonald's are represented in Sri Lanka

through franchises. Numerous other American brands and products are

represented by local agents.



--Non-U.S. Investments



Leading sources of foreign direct investment in Sri Lanka are

Malaysia, the United Kingdom, the United States, Singapore, India,

China, the UAE, and Korea. Major non-U.S. investors include:

Unilever, Nestle, British American Tobacco Company, Mitsui, Pacific

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

the Indian Oil Corporation. 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



International Monetary Fund (IMF) Sri Lanka country information:

www.imf.org/external/country/LKA/index.htm



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.pd f



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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