Sri Lanka: Improving the Rural and Urban Investment Climate

115 Pages·2005·1.82 MB·English

SRI LANKA:
IMPROVING THE RURAL AND URBAN
INVESTMENT CLIMATE
An Investment Climate Assessment
Based on an Urban and Rural Enterprise Survey
Carried Out by the Asian Development Bank and
The World Bank with Support from Sri Lanka’s
Department of Census and Statistics and
ACNielsen Lanka (Pvt.) Ltd.
January, 2005
2004 The International Bank for Reconstruction and Development/The World Bank
1818 H Street
Washington DC 20433
Telephone: [phone]
Internet: www.worldbank.org
E-Mail:
TABLE OF CONTENTS
Acronyms and Abbreviations iv
Acknowledgments v
Executive Summary - English E I
- Sinhala S I
- Tamil T I
I. Investment Climate Matters 1
1.1 What is the Investment Climate and Why Does it Matter? 1
1.2 Overview of the Economy: Achievements and Challenges 2
II. The Different Profiles of Urban and Rural Enterprises 8
2.1 Great Diversity in the Enterprise Landscape 8
2.2 Greater Stability and Longevity among Urban Enterprises 10
2.3 More Assets and Higher Productivity in Urban Enterprises 11
2.4 Registration among Rural Firms Surprisingly High 11
2.5 Weak Links between Rural and Urban Firms 13
2.6 Strong Links with Agriculture 13
III. The Investment Climate and Its Impact on Enterprise Performance 15
3.1 Sri Lanka’s Investment Climate: Strong on Governance,
Weak on Infrastructure and Finance 15
3.2 Good Governance: Sri Lanka’s Success Story 16
3.3 Infrastructure: The Weakest Part of the Investment Climate 19
3.4 Access to Finance Costly and Limited 23
3.5 Growing Regional Differences across the Country 27
3.6 How the Investment Climate Affects Firms' Performance 29
IV. International Competitiveness: Challenges and Opportunities 32
4.1 Unlocking the Potential of Foreign Direct Investment 32
4.2 Restoring Stability 34
4.3 Easing Difficult Labor Market Conditions 35
4.4 Increasing the Efficiency of Ports and Customs to Facilitate Trade 38
4.5 Performance and Challenges of Key Export Sectors 40
V. Conclusions and Policy Recommendations 48
5.1 A Policy Strategy Recognizing the Sharp Rural-Urban Differences 48
5.2 Policy Recommendations 49
Appendixes
Appendix 1: Urban Manufacturing Survey: Sampling Methodology 55
Appendix 2: Urban Services Survey (Tourism and Information Technology):
Sampling Methodology 59
Appendix 3: Rural Survey: Instrument and Sampling Methodology 61
Appendix 4: Urban Manufacturing Survey: Technical Appendix on
Investment Climate and Firm Performance 69
Appendix 5: Rural Survey: Technical Appendix on Investment Climate,
Firm Performance and Start Up 80
Appendix 6: Rural Summary Tables 92
References 99
iii
ACRONYMS AND
ABBREVIATIONS
ASYCUDA - Automated System for Customs Data
BOI - Board of Investment
CEB - Ceylon Electricity Board
EPZ - Export Processing Zone
ERA - Electricity Reform Act
EU - European Union
FDI - Foreign Direct Investment
FMRA - Fiscal Management (Responsibility) Act
FTA - Free Trade Agreement
GDP - Gross Domestic Product
GN - Grama Niladhari
GNI - Gross National Income
GoSL - Government of Sri Lanka
IC - Investment Climate
ICA - Investment Climate Assessment
ICT - Information and Communication Technology
IT - Information Technology
ITU - International Telecommunications Union
LECO - Lanka Electricity Company
LG - Local Government
MFA - Multi- Fibre Arrangement
MFI - Microfinance Institutions
NGO - Non Government Organization
NWSDB - National Water Supply Development Board
OECD - Organization for Economic Cooperation and
Development
PS - Pradeshiya Sabha
PUCSL - Public Utilities Commission of Sri Lanka
RDA - Road Development Authority
R&D - Research and Development
SAGT - South Asia Gateway Terminals Ltd.
SLPA - Sri Lanka Port Authority
SLR - Sri Lankan Rupee
TEWA - Termination of Employment of Workers Act
TFP - Total Factor Productivity
UBS - Unemployment Benefit System
UI - Unemployment Insurance
USA - United States of America
UK - United KIngdom
WB - World Bank
WDI - World Development Indicators
iv
ACKNOWLEDGEMENTS
THE AUTHORS GRATEFULLY ACKNOWLEDGE the support received and the collaboration
with Sri Lanka's Department of Census and Statistics and ACNielsen Lanka (Pvt.) Ltd. This report
was prepared by a joint Asian Development Bank (ADB) - World Bank team led by Abuzar Asra,
Rana Hasan and Ernesto Pernia from the ADB and Esperanza Lasagabaster, Mona Sur and Ismail
Radwan from the World Bank. Other staff contributing to the report include Gemma Estrada,
Dalisay Maligalig and Georgina Nepomuceno from the ADB, and Terrence Abeysekera, Kareem
Aziz, Uwe Deichmann, Klaus Deininger, Naresha Duraiswamy, Marjorie Espiritu, Sriyani Hulugalle,
Giuseppe Iarossi, Songqin Jin, Radha Singla, Giovanni Tanzillo and Dina Umali-Deininger from the
World Bank.
Financial support from the Bank Netherlands Partnership Program for the Rural Investment Climate
Survey is gratefully acknowledged. The team thanks Mr. Selvin Ireneuss and staff from the Secretary
for Immediate Humanitarian and Rehabilitation Need (SIHRN) for their support and assistance in
facilitating the rural survey in the North and East. Thanks are also extended to the various Divisional
Secretary and Grama Niladhari officers for their support.
v
vi
EXECUTIVE SUMMARY
Over the past 25 years Sri Lanka has seen steady economic growth accompanied by a profound transformation of its
trade and industrial structure. Led by the garment sector, manufacturing exports took off in the late
1970s, growing by 32 percent a year between 1978-95. Spurring this remarkable transformation were
the opening of trade and liberalization of some sectors in the late 1970s. Also contributing, thanks
to an early commitment to human development, was the country’s skilled and literate labor force, a
feature distinguishing Sri Lanka from other lower-middle-income countries.
While this progress is heartening, Sri Lanka has failed to keep pace with East Asian countries in economic growth
and poverty reduction. In the 1960s Sri Lanka had a per capita income comparable to those of the
Republic of Korea, Malaysia, and Thailand. Today its per capita income is less than half of Thailand’s
and an even smaller share of Malaysia’s and Korea’s. Not surprisingly, Sri Lanka has made limited
gains in poverty reduction. The share of the population in poverty remains comparatively high, at
about 22.7 percent. Of most concern is the skewed distribution of growth. Economic activity has
been strongly concentrated in Western Province while growth in rural areas has lagged far behind.
As a result, poverty in Sri Lanka today is primarily a rural phenomenon.
Sri Lanka’s slower growth and poverty reduction can be attributed, in part, to its civil conflict of 1983-2001, but a
host of other institutional, macroeconomic, and microeconomic factors have also held the country back. This
investment climate assessment is aimed at understanding which factors have made it difficult for
firms to do business in Sri Lanka and how these obstacles have affected their productivity.
What are the most severe obstacles in Sri Lanka’s investment climate? To help answer that question,
the assessment uses micro-level data from a survey of the urban and rural investment climates
conducted in 2004. The urban survey covered 449 formal establishments in manufacturing (textiles,
garments, food and beverages, rubber products, and industrial equipment) and 94 firms in the
tourism and information technology sectors. The rural survey covered 1,327 nonfarm enterprises and
555 households not participating in rural nonfarm activities.1 Sri Lanka’s rural enterprises are largely
based outside the home. Most are engaged in manufacturing or trading, with a far smaller share
involved in services. These enterprises are small, employing an average of 2.4 workers, including
family members.
This investment climate assessment is the first to include an analysis of entrepreneurship in rural
areas, allowing a more comprehensive look at the business environment. Fostering the growth of the
rural nonfarm sector is critical to reducing poverty in Sri Lanka, still largely a rural society. Some 85
percent of the population lives in rural areas and rural nonfarm enterprises contribute significantly
to GDP. The survey findings suggest that the total value added by all rural nonfarm enterprises in
2003 was SL Rs 185 billion-equivalent to 12 percent of GDP or 78 percent of agricultural GDP in
2003.
Strong on Governance, Weak on Infrastructure and Finance
Sri Lanka stands out among developing countries for its good governance, and firms benefit from
the low levels of red tape and corruption. But despite differences between the urban and rural
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SRI LANKA: IMPROVING THE RURAL AND URBAN INVESTMENT CLIMATE
investment climates, urban manufacturing and rural enterprises alike suffer from poor-quality
infrastructure (especially energy and transport) and costly and limited access to finance (see figures 1
and 2).
Success in Governance
FIGURE 1
Top Five Urban Constraints and Their Rural Ratings
In sharp contrast with neighboring
countries, Sri Lanka has made big
strides in reducing red tape, and it
has improved the governance 50 Urban
framework to the point where it no 40 Rural
longer poses a significant obstacle to 30
doing business. Procedures for 20
registering a new firm are 10
simple-and, unusually, more 0
Electricity Policy Macro Finance Labor
than half of rural enterprises
uncertainty instability (cost) regulations
are registered. The one
exception to the success story st nd rd th th
Urban rank 1 2 3 4 5
in governance is the continuing th th nd th
Rural rank 5 10 N/A 2 15
need to achieve peace and
political stability. Source: Asian Development Bank and World Bank, Sri Lanka Investment Climate Survey, 2004.
Weaknesses in
Infrastructure
Electricity, cited as a top constraint
by Sri Lankan enterprises,
represents an entry barrier and a
significant operational cost for both
rural and urban firms. Access to
electricity is heavily
concentrated in urban areas
such as Western Province,
leaving rural areas such as Uva
Province grossly underserved.
Less than 70 percent of rural
enterprises use electricity from
the national grid.
Where electricity is available, the cost
is high and supply unreliable,
exposing firms to frequent outages
and raising their production costs.
Unreliable supply, leads nearly 75 percent of urban manufacturing firms in Sri Lanka to own a
generator, a significantly higher proportion than competitor countries such as China (27 percent). For
these Sri Lankan firms, generators cost the equivalent of 12 percent of their fixed assets on average-
absorbing resources that could otherwise be invested productively in their core business. Not only is
owning a generator costly, operating it is also expensive. It can cost 3 to 4 times as much to generate
electricity with a generator. Lack of reliable electricity reduces the productivity of urban
E II
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Pcoenrcsetrnatiangt ea so mf fairjmors ocri tsinegvere
Percentage of firms citing
constraint as major or severe
EXECUTIVE SUMMARY
manufacturing firms by almost half, while among rural firms the productivity of those without
connections to the grid is 25 percent lower than those with connections. Moreover, lack of
electrification lessens the probability that rural households will set up a new enterprise.
Transport is the biggest constraint for rural firms. It also poses an important obstacle to urban
manufacturing firms and the expansion of tourism. Nearly a third of rural enterprises cited transport
as a major or severe obstacle to starting or operating a business. While Sri Lanka has a dense road
network by regional standards, it performs poorly in road quality relative to its Asian competitors. As
much as 90 percent of the country’s paved road network is in poor condition because of lack of
maintenance.
As with electricity, transport conditions vary markedly across regions, with the inhabitants of
Western Province enjoying the greatest mobility. For rural firms the poor quality of roads and lack
of transport compound marketing problems and raise transport costs, reducing productivity. About
a quarter of urban firms also suffer transport problems, resulting in losses equivalent to 7 percent of
sales.
The telecommunications sector, an early reformer, performs much better than electricity and
transport. Even so, waiting times for new lines remain substantially longer than those in China and
Malaysia.
Costly and Limited Access to Finance
The cost of finance hampers urban and rural firms alike, with almost a third of urban firms and rural
businesses citing it as a major constraint. Rural entrepreneurs are also constrained by limited access
to finance.
Small urban manufacturing firms pay significantly higher average interest rates (18 percent) than large
ones (12 percent). They also pay higher rates than rural enterprises (14.5 percent), which benefit from
subsidies from some state financial institutions, especially Samurdhi banks and microfinance
institutions. (These subsidies, however, threaten the viability of these institutions.) With support
from international donors, commercial banks have also started to enter the market for small and
medium-size enterprise finance, though their lending remains concentrated in Colombo. Because of
these distortions, interest rates in rural areas vary widely. Moreover, high and persistent budget
deficits add to the cost of finance as government crowds out the private sector to meet its borrowing
requirements.
Rural enterprises avail themselves of external finance but have extremely limited access to formal finance. They
obtain most of their financing for new investments from internal sources (43 percent) and family and
friends (35 percent). Public financial institutions, despite a widespread presence in rural areas,
account for a far smaller share of rural investment finance, while private commercial banks provide
a minimal share (2 percent), mostly to larger enterprises. In the urban manufacturing sector, small
firms have less access to bank finance than large ones, forcing them to rely more on internal
financing, leasing, and informal and family sources. For firms with inadequate external finance, the
consequence is limited opportunities for growth.
Collateral plays a vital role in the availability of finance. Results from the urban manufacturing survey show
that greater productivity does not translate into easier access to bank loans. Apparently unable to
discriminate on the basis of performance, banks instead rely heavily on the value of collateral when
considering a loan application. Collateral in the form of land is especially important for rural
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