TradePromotion

Invest in Sri Lanka

2017-2-6 13:06:51

  Positive Trends for Investment

With the 2009 end to Sri Lanka's long-running civil war, the country has an historic opportunity to take advantage of its peacetime stability, geography, educated workforce, and scenic beauty. The Government of Sri Lanka (GSL) has set ambitious goals for economic development – aspiring to GDP growth rates over 8% and developing economic hubs in ports, aviation, commerce, knowledge, and energy. With a relatively open investment climate and financial system, moderately stable monetary policy, improving infrastructure, and world-class local companies, Sri Lanka has many of the ingredients to progress economically. For some U.S. and foreign investors, Sri Lanka’s frontier market has been fertile ground for both direct and capital investments.

Most of the current economic potential is in the tourism sector, with Sri Lanka designated as Lonely Planet’s top destination in 2013, and major international hotel chains opening in Colombo and around the country over the next few years. Tourist arrivals reached 1,000,000 in 2012. Investors are capitalizing on Sri Lanka’s environment, culture, religious history, and wildlife to attempt to attract high-end tourists, especially from the growing markets in India and China. Chinese tourist arrivals in Sri Lanka increased 58% in 2012 alone. The ports are another important driver of growth, with the Colombo Port being one of the most active and efficient in the region, and the country situated at the crossroads of global shipping lines.

Ample scope exists as well for an expansion in the information technology/business processing operations (IT/BPO) sector. With a growing and aspirational middle class, investors see opportunities in franchising, retail, and services, as well as light manufacturing. Investments with an export dimension have the most potential. Reconstruction in the North and East, and infrastructure development throughout the country, including new ports and roads, are also fuelling growth. Sri Lanka’s free trade agreements with India and Pakistan offer preferential access to those markets, and Sri Lanka maintains friendly relations with all its neighbors in the region. The capital city of Colombo offers expatriate managers a good quality of life, with excellent international schools, good housing, and decent urban conditions relative to the region. Political stability and the cessation of the war have allowed the government and population to focus on rebuilding their economy and society.

Areas of Concern

But Sri Lanka can still be a challenging place to do business, with high transactions costs related to an unpredictable economic policy environment. While many government departments and ministries boast competent, highly motivated staff, the government’s overall provision of services is impeded by inefficiency, and economic growth is stymied by opaque government procurement practices. While some U.S. companies have done and continue to do well here, others have departed frustrated.

While growth has been moderate, inflation is high and exports are declining. Many observers believe Sri Lanka will have trouble paying back loans taken to improve infrastructure, although government officials are confident that growth will bring in the necessary revenue. In a March 2013 report, Moody’s Investor Services noted that Sri Lanka’s short-term debt maturing within a year remained elevated, even above the total foreign reserves. Moody’s considers this a significant risk to Sri Lanka if there was a sudden halt in external credit expansion.

Certain recent policies have also sent mixed signals to investors. The 2013 budget prohibited all land sales to foreigners and imposed a tax on lease transfers to foreigners, but the government then issued draft temporary regulations providing certain limited exceptions. These exceptions include diplomatic missions, condominiums over the fourth floor, and foreign majority-owned companies in business for ten consecutive years. The Cabinet can also approve a land purchase for an investment “in the national interest,” provided there is a substantial foreign remittance for the purchase of the land. The land transfer tax would still apply.

Other recent policies include the November 2011 “Underutilized Assets” Act, which resulted in the seizure of 37 companies and assets. Although most of these companies were defunct enterprises, several were viable businesses. The government stated that these companies had violated the terms of their land leases with the government. The government has promised that this was a “one-time” measure, but subsequently announced plans to seize 10,000 hectares of allegedly unused tea plantation land. The expropriation law – and its passage after one day of debate in Parliament – created an atmosphere of uncertainty and unpredictability in the business environment.

In the past 15 months, four senior Securities and Exchange Commission (SEC) officials have resigned over regulatory issues, citing pressures from high net-worth local investors. In December 2012, a special parliamentary committee impeached the Chief Justice over corruption charges in what many called a politically-motivated process. Local investors cite the risks of contract repudiation, cronyism, damage to reputation, and de facto or de jure expropriation as concerns.

Economic Growth

Sri Lanka has the potential for strong economic growth. Despite the 1983-2009 civil war, GDP growth averaged around 5% from 2000-2008. GDP growth slowed to 3.5% in 2009, and foreign reserves fell sharply as global demand for Sri Lankan exports dropped due to the financial crisis. Economic activity rebounded at the end of the war and the negotiation of a US$2.6 billion International Monetary Fund (IMF) Stand-By Agreement, resulting in two straight years of 8% growth in 2010 and 2011. Growth slowed again to about 6.5% in 2012 due to a decline in agriculture, exports, and trade, as well as the end of the “peace dividend,” i.e., the economic re-integration of the former northern and eastern conflict zones, which had boosted agriculture and fisheries. Now that those areas are more fully exploited, their impact on the growth rate has diminished. Significant regional disparities remain between the Western Province, which contributes about 44% of GDP, and the northern and eastern provinces, which contribute 3.7% and 5.7% respectively. But growth in the North and East is promising.

The Central Bank predicts the economy will grow by 7.5% in 2013 and to over 8% annually during 2014-2016. The January 2013 Central Bank Economic Roadmap claims the GDP will almost double in four years, from US$59 billion in 2012 to US$100 billion in 2016, and the government hopes to increase Sri Lanka’s per capita income from US$2,900 in 2012 to US$4,000 by 2016. Most observers believe that this is overly optimistic, but could happen if the investment rate rises from 27% of GDP to 35% of GDP, and growth rates stay above 7-8%. While the Central Bank estimates 2013 growth at 7-7.5%, the IMF predicted 6.5% growth, with concerns regarding inflation, losses from state-owned enterprises, and slow structural and tax reforms. The majority of investment is expected from private investment, as public investment is expected to remain around 6.5%.

But growth could be hampered by the lack of diversification of the export base, economic problems in the United States and EU, which are Sri Lanka’s main export markets, and the absence of private investment. Government fiscal control has improved, but the losses of state-owned enterprises (SOE) are a major concern. Sri Lanka requires high levels of FDI to meet the desired growth levels, and the government claimed FDI in 2012 reached US$1 billion, which was only half of the US$2 billion target. UNCTAD reported 2011 FDI in Sri Lanka as only US$300 million. (See http://unctad.org/sections/dite_dir/docs/wir12_fs_lk_en.pdf)

Inflation

The Central Bank applauded the fact that, by January 2013, Sri Lanka had maintained single-digit inflation for the prior 47 months, but current inflation at 8% is a major worry for economic analysts and businesses. An Urban Price Index, created by Capital Alliance Research and based on a different basket of goods, put inflation for urban middle-class households at 20%. This is consistent with a Nielsen Lanka poll that shows the Fast Moving Consumer Goods sector experienced only 1% growth in 2012, compared to 15% in 2011, likely due to a sharp rise in prices. This impacts consumer purchasing power, and has a ripple effect throughout the economy, including for education and services.

Monetary Policy

The government conducted a more stable monetary policy in the latter half of 2012 after defending the rupee in the beginning of the year and then allowing it to float, causing a significant depreciation. Had the exchange rate been adjusted on a more incremental basis over a longer time period, the shock to consumers and businesses would have been lessened. While many investors now believe the Central Bank is adequately managing the macroeconomic environment, economists criticized the Central Bank’s loosening of monetary policy in late 2012, which many feared would lead to double digit inflation. As of early 2013, this fear has not been realized.

Budget Deficit

The budget deficit (excluding state-owned enterprises (SOEs)) reached 7% in 2011, and is forecast to fall to around 6.2% in 2012 and 5.8% in 2013. However, massive losses of SOEs are a major concern and could increase the government deficit sharply, as well as diminish the service the SOEs provide and increase their internal costs. The public debt has at times reached close to 100% of GDP, but due to declining budget deficits and strong economic growth, has decreased to about 81% of GDP in 2012. While this is a positive trend, the cost of debt servicing is rising as the government takes on more commercial rather than concessionary debt.

Trade Deficit; Current Account Deficit

Sri Lanka’s large current account deficit is a concern. According to preliminary data for 2012, Sri Lanka exported US$10 billion, mainly in apparel, tea, rubber, gems and jewelry. The country imported almost double that amount (US$19 billion) in oil, textiles, food, and machinery. The country’s exports for January 2013 decreased by 18% from January 2012, following a 6.7% drop in (the full year of) 2012. Manufactured exports fell by 21% in January 2013, mostly due to sharp declines in garments and food and beverage exports. Garments alone – Sri Lanka’s leading export – dropped 9%. Garment exports to the EU have fallen due to decreased demand but also due to the loss of the Generalized System of Preferences-Plus (“GSP-Plus”) trade benefits, which are EU trade concessions provided to nations that implement international human rights conventions.

Sri Lanka’s 2012 imports were about US$19 billion, including a US$5 billion oil bill. Imports for January 2013 declined by 21% year-on-year, which the Central Bank ascribes to 2012 policy measures taken to discourage non-essential imports (depreciation of the rupee, limits on bank credit, and import duty hikes on motor vehicles). The government also introduced credit controls on banks in 2012 due to pressures on the current account. The credit ceiling was removed in 2013, however, and banks are now free to lend. The 2013 oil bill should also be lower due to increased hydropower generation. The narrowing of the trade deficit (from US$1.2 billion in January 2012 to US$780 million in January 2013) is positive, but the decline in exports is troubling. Sri Lanka has a limited range of exports that depend on a few key markets, which makes the country especially vulnerable to external shocks.

To realize higher export growth, Sri Lanka needs to focus on manufactured exports. Apart from garments, the country still exports primarily the same goods as during the colonial and post-colonial era, i.e., tea, rubber, coconut and spices. While the rubber industry has made progress in moving up the value chain, the other industries are still focusing on raw product. In addition, the services sector needs to grow, along with the IT/BPO industry, and medical and leisure tourism.

Remittances from migrant workers, at around US$6 billion per year, are Sri Lanka’s largest source of foreign exchange and helped to partially offset the trade deficit. Sri Lanka also receives multilateral and bilateral financial support. While China has emerged as the largest recent lender, traditional donors such as the International Monetary Fund, World Bank, Asian Development Bank (ADB), and Japan as well as neighboring India continue to provide significant funds. Australia is also the new leading bilateral donor, providing US$40 million a year in assistance. Increased foreign commercial borrowings, including US$1 billion sovereign bond issues in 2010, 2011, and 2012, have also helped external reserves, which reached US$6.4 billion (4 months of imports) in 2012. In 2012, Sri Lanka successfully completed the IMF Stand-By Agreement, but in February 2013, the Government and IMF failed to agree on a follow-on facility.

Large Trade Surplus with the United States

Sri Lanka has a US$9 billion trade deficit with the world (primarily India, Singapore, and China), but maintains a large trade surplus with the United States. Exports to the United States, Sri Lanka's largest single-country market, are projected to be US$2.2 billion in 2012, or 20% of total exports (the EU and UK are 33% and 10%, respectively). The United States is also Sri Lanka’s largest single-country market for garments, taking in almost 40% of total garment exports (the EU and UK are 50% and 23%, respectively). The United States' exports to Sri Lanka are projected at US$230 million for 2012, comprised primarily of industrial machinery, medical instruments, aircraft parts, lentils, paper, specialized fabrics and textiles for use in the garment industry, fruits, and pharmaceuticals.

Political Situation

Sri Lanka is a constitutional, multiparty republic. In 1978, it shifted away from a socialist orientation and opened to foreign investment, although changes in government have often been accompanied by reversals in economic policy. The current president, Mahinda Rajapaksa, was reelected to a second six-year term in January 2010. Both the President and the Parliament, elected in April 2010, share constitutional power. In 2010, the Parliament amended the constitution to end presidential term-limits and broaden presidential powers.

Statist Economic Policy

The government follows a statist economic policy, with key goals including the development of Sri Lanka as a regional hub for air and sea transportation, trading, energy, and knowledge-based services. The government also aims to reduce poverty by steering investment to disadvantaged areas; developing small and medium enterprises (SMEs); promoting agriculture; and expanding the civil service. The government has halted privatization – reversing several previous privatizations – and advocates state control of what it deems "strategic" enterprises such as state-owned banks, airports, and electrical utilities. The government has increased its control of the banking sector and utilized government-controlled pension funds and companies to take majority control of leading private banks listed on the Colombo Stock Exchange. The Sri Lankan military is also expanding into activities traditionally reserved for the private sector, including air services, agriculture, and tourism.

The 2013 budget continues import substitution policies, and import duties remain high on vehicles and retail items. The government has removed taxes on certain intermediate imports, however, to make the country a trading hub.

Non-Concessional Foreign Debt

In its drive to improve infrastructure, Sri Lanka’s non-concessional foreign debt has gone from only 2% of total debt in 2004 to 43% in 2011. This is partly due to Sri Lanka’s graduation to a middle income country and failure to qualify for concessional loans, but also due to the increase in foreign debt overall, rising from US$10.7 billion in 2003 to US$24.4 billion in 2011.

Private Sector Involvement

While the state is a major player in many economic sectors, the private sector plays a key role across the economy, including in finance, exports, tea, apparel, IT, and tourism. However, both local and multinational companies complain that an increasing government role in business is harming the investment climate. Though many multinational companies and local small and medium enterprises often perform better than large local companies, some feel that government procurement and project approval decisions favor large local operators.

Infrastructure

Until recently, Sri Lanka had not invested in infrastructure to keep pace with its growth. Roads are narrow and congested, with many drivers poorly trained and vehicles badly maintained. With the conclusion of the war, Sri Lanka is renovating and constructing roads in the North and East, and has built the country’s first expressway, linking Colombo to the southern city of Galle. The government has also undertaken a significant urban renewal program – cleaning up and beautifying cities, and revamping the capital city of Colombo with new roads, brick sidewalks, fountains, and leisure venues.

Multi-year projects to expand the ports in Colombo and Hambantota are underway, and the new Hambantota port, airport, and conference center are to be the centerpiece of southern development. The port, however, has been slow to take off in commercial terms, and businesspeople express skepticism that these projects will be viable without market-distorting policies designed to steer businesses to them. The eastern port in Trincomalee, on the other hand, is considered one of the best natural deepwater ports in the world, but remains underdeveloped.

Energy

Sri Lanka has an over 90% electrification rate, and the electricity supply is generally reliable. However, given the country’s dependence on hydropower, power failures during peak demand periods can occur in years of low rainfall. Breakdowns at the new Chinese-built coal power plant also add unpredictability. Sri Lanka has stood firmly with the international community in implementing the U.S. and EU sanctions against Iran, which has led Sri Lanka to halt all importations of Iranian crude oil. However, the country’s sole refinery, Sapugaskanda, has experienced efficiency losses and shutdowns as it adapts to different crudes. Renewable energy use is rising, and the government expects to meet its target of 10% renewables by 2015. So far, solar and wind power hold the most promise. Sri Lanka is also pursuing exploration of its domestic offshore oil and gas potential. One block has yielded two possible gas and condensate wells, but commercial viability, if any, is years away.

From an investor viewpoint, the power sector is particularly challenging, as decision-making authority is highly fragmented, and the capital investments required are substantial. Trade union opposition at both the Ceylon Petroleum Corporation and the Ceylon Electricity Board (CEB) make reform of these loss-generating SOEs very difficult. A projected 30% increase in electricity cost will be passed on to consumers in early 2013.

Interest Rates

Businesses in Sri Lanka also face high interest rates, and access to credit is a problem, particularly for small and medium enterprises. In December 2012, lending rates for SMEs were between 12.5% and 22%, compared to 14% for blue-chip companies. The latter rate has risen steeply, however, with blue-chips borrowing at 10% in December 2011. The rate for personal consumption loans range between 15%-17.5%, housing loan interest rates are 15%, and credit card interest rates are 28%.

Contracts

Sri Lanka's courts have a mixed record with regard to upholding the sanctity of contracts. The courts are not practical for resolving disputes or obtaining remediation, because their procedures allow one party to prolong cases indefinitely. Aggrieved investors (especially those dealing with the government on projects) have frequently pursued out-of-court settlements in hopes of speedier resolution. In late 2008, the Supreme Court, in an interim order, halted payments to five international and local banks involved in oil hedge contracts with the government. One of the involved banks was American. The banks filed for international arbitration. The record on international arbitration is mixed, as two banks won their cases and the government won the third case against the American bank.

English-language Skills and Education

Sri Lanka claims a 90% literacy rate in the local Sinhala and Tamil languages, but English, which was once widely spoken, is now less prevalent. The government has launched a drive to increase English proficiency. Many IT/BPO businesses report needing six to nine months to train English-speaking college graduates to an acceptable level. Lack of educational opportunities remains an enormous problem in Sri Lanka. The government has not increased the education budget significantly since the end of the war, and there is a severe shortage of university slots. Those students who go abroad for education often do not return to the country. Investors often speak of a “mismatch” between the skills graduates currently possess and those that businesses actually need.

Board of Investment

The Board of Investment (BOI) (www.investsrilanka.com), an autonomous statutory agency, is the primary government authority responsible for investment, with a focus on foreign investment. BOI promotes the following sectors as priority sectors for FDI: tourism and leisure; infrastructure; knowledge services; utilities; apparel; export manufacturing; export services; agriculture; and education. Specialized divisions representing these sectors are tasked with providing services to foreign investors through the entire investment process.

The BOI manages a number of export processing zones that feature business-friendly regulations and improved infrastructure for foreign investors. The BOI 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. It also assists in obtaining resident visas for expatriate personnel, and facilitates import and export clearances.

BOI incentives are attractive and real, but the BOI is not yet a "one-stop shop." Although the BOI is relatively effective in assisting investors who want to establish operations within its industrial processing zones, especially for export, it is less effective in facilitating and servicing large investments outside these zones. Sri Lanka's bureaucracy often works at cross-purposes with BOI authorities. For example, registration of foreign company branch offices in Sri Lanka can be expensive.

The Treasury and a special Cabinet Review Committee outside of the BOI handle large investment projects, both local and foreign, identified as strategic development projects. These projects require approval from the full Cabinet, as well as Parliamentary approval.

Start-up Costs, Scalability, Retention, and the Need for a Local Partner

Investors report that starting a business in Sri Lanka is relatively simple and rapid – especially when compared to other frontier markets – and 20% cheaper than in neighboring countries. But scalability is a problem. Lack of skilled labor and a smaller talent pool means that companies can take years to double in size. Investors claim retention is good in Sri Lanka, but numerous public holidays, worker reluctance to work at night (which is especially problematic in the IT/BPO sector), lack of labor mobility, and a difficulty in recruiting women can reduce efficiency and increase start-up times. The garment industry has had more difficulty with employee retention, especially in the North and East.

Many service sector companies rely on Sri Lankan engineers, researchers, technicians, and analysts to deliver high-quality, high-precision products. Foreign and local companies report a strong worker commitment to excellence in Sri Lanka, with rapid adaptation to quality standards.

Foreign investments, particularly if not keyed toward export, are often more successful when guided by a local partner who can navigate the cultural and political landscape. Some sectors, however, such as IT/BPO, report relatively little need to rely on local agents or the government to start operations. Most investors agree that any export-based investment faces fewer problems, especially if the company is registered with the BOI. The greatest challenges lie in infrastructure contracts or competing for any government tender offer, where foreign investors find it difficult to navigate the opaque procurement process.

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 implementing 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 recommend concessions to companies satisfying certain eligibility criteria on minimum investment. Such companies are eligible for generous investment concessions. Investment approval under Section 16 of the BOI Act permits companies to operate under the "normal" laws of the country and applies to investments that do not satisfy eligibility criteria for BOI incentives. The Strategic Development Project Act of 2008 (SDPA) provides generous tax incentives for large projects that the Cabinet identifies as Strategic Development Projects. Projects approved under the Strategic Development Act of 2012-2013 include Welcom Hotel, a mixed development project in Colombo, an industrial zone development project in Trincomalee, and a British university branch campus (University of Central Lancashire). In 2011, the government granted incentives to Shangri-La Hotels for hotel projects and to Cairn Lanka Ltd for oil exploration. Other laws affecting foreign investment are the Securities and Exchange Commission Act of 1987 as amended in 1991 and 2003, the Takeovers and Mergers Code of 1995 (revised in 2003), and the Companies Act of 2007. Various labor laws and regulations also affect investors. (See “Investment Incentives for Strategic Development Projects,”below.)

Foreign Equity Shares by Sector

The government allows 100% foreign investment in any commercial, trading, or industrial activity other than a few specified sectors, which are regulated and subject to approval by various government agencies or the BOI: air transportation; coastal shipping; large scale mechanized mining of gems; lotteries; and manufacture of military hardware, military vehicles, and aircraft; dangerous drugs; alcohol; toxic, hazardous, or carcinogenic materials; currency; and security documents.

Foreign investments in the areas listed below are limited to 40% of foreign equity. Foreign ownership in excess of 40% must be approved on a case-by-case basis by the BOI: the production for export of goods subject to international quotas; growing and primary processing of tea, rubber, coconut; timber-based industries using local timber; deep-sea fishing; mass communications; education; freight forwarding; travel agency; and shipping agency business. The government is considering opening higher education to foreign investment. Foreign investment is not permitted in the following businesses: non-bank money lending; pawn-brokering; retail trade with a capital investment of less than US$1 million; and coastal fishing.

Privatization

The government has halted privatizations, preferring to maintain state-owned enterprises, and has even reversed several privatizations. The government recommitted to this policy in the 2013 budget. Labor unions in state-owned enterprises often oppose 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. In 2008, the Supreme Court cancelled the 2002 privatization of a government-owned bunkering company, and in 2009, the Supreme Court cancelled the 2003 sale of a large government-owned insurance company. In 2010, the government bought back shares of two privatized companies (Sri Lankan Airlines and Shell Gas Lanka) when their owners sought to exit the companies.

International Business Rankings

Sri Lanka ranks 81st out of 185 countries in the World Bank's Doing Business 2013 Index, ahead of all of its South Asian neighbors. However, critics say that Sri Lanka’s ranking increased mainly due to computerization of some activities, with only minimal increases in actual efficiency of business support services. Within the index, Sri Lanka ranked 33 in terms of starting a business, 51 in resolving insolvency, and 49 in protecting investors. The country ranked lower, at 169, in paying taxes, 143 in registering property, 133 in enforcing contracts, 112 in dealing with construction permits, 103 in receiving electricity, and 70 in obtaining credit.

Conversion and Transfer Policies

Sri Lanka generally has investor-friendly policies in terms of conversion and transfer policies. Companies note they can repatriate funds relatively easily. In accordance with its Article VIII obligations as a member of the IMF (http://www.imf.org/external/pubs/ft/aa/aa08.htm), Sri Lanka liberalized exchange controls on current account transactions in 1994, and in 2010-2012, the government relaxed exchange controls on several categories of capital account transactions. When the government experiences balance of payments difficulties (such as in 2009), the government tends to impose controls on foreign exchange transactions but has showed restraint in recent years.

Local business contacts claim there is also a legal parallel mechanism for conversion, i.e., small traders carrying up to US$10,000 on travel in personal luggage. Exporters must repatriate export proceeds within 120 days to settle export credit facilities. Other export proceeds can be retained abroad in a local bank's correspondent bank. No barriers exist, legal or otherwise, to the expeditious remittance of corporate profits and dividends for foreign enterprises doing business in Sri Lanka. The average delay period for remitting investment returns, interest, and principal on private foreign debt, lease payments, royalties, and management fees through normal legal channels is one to four 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. Policies are becoming more restrictive for real estate investment, however; no gains can leave the country, and investors can only take out what they brought in. Gains from real estate cannot be transferred unless the investment is in a BOI-approved project. The informal money transfer/exchange system (hawala) is active, although with higher rates.

Foreigners are now permitted to invest in Sri Lankan debt instruments, both government and corporate debt. The Central Bank’s rupee-denominated T-bill and T-bond issues in the local market are also open to foreign investors. Both foreign and local companies are permitted to borrow from foreign sources.

Expropriation and Compensation

Until recently and since economic liberalization policies began in 1978, the government had not expropriated a foreign investment. The last expropriation dispute was resolved in 1998. The government is currently involved in several major disputes with foreign companies, as detailed in the section on disputes involving U.S. companies. However, on November 9, 2011, the Government of Sri Lanka approved a new law entitled the Revival of Underperforming Enterprises and Underutilized Assets Act that allowed expropriation of assets belonging to 37 companies the government considered as underperforming. These companies had leased land from the government, but the government claimed the companies were not meeting the lease conditions. Although many of the 37 companies were defunct, several were viable businesses. The Central Bank stated that the Act was a “one-off” measure, but the government subsequently announced plans in the 2012 and 2013 budgets to retake 10,000 hectares of tea plantation land leased to private companies that the government said was not being fully utilized. The law increases investor uncertainty regarding property rights in Sri Lanka and is often cited as having a chilling effect on foreign direct investment.

Apart from the Underutilized Assets Act, the land acquisition law empowers the government to take over private land for public purposes. Compensation is paid per government valuation, which some local investors consider relatively fair. There are cases, however, of the military taking over businesses in the North and East on claims they are on government land, with little to no compensation. Many land records were lost or destroyed during the war, which complicates land tenure issues and delays resolution.

Dispute Settlement Rules

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 ethnic. Sri Lankan commercial law is almost entirely statutory. The law reflects colonial British law, but amendments have largely kept pace with subsequent legal changes in the United Kingdom. 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 the Consumer Affairs Authority Act.

Sri Lanka's court system consists of the Supreme Court, the Court of Appeal, Provincial High Courts and the Courts of First Instance, i.e., 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 is 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. Citizens may apply directly to the Supreme Court for protection if they believe any government or administrative action has violated their fundamental human rights.

All commercial matters exceeding the value of Rs 3 million (approximately US$23,000) fall within the jurisdiction of the Commercial High Court of Colombo. A number of tribunals also exercise judicial functions, such as the Labor Tribunals that hear cases brought by workers against their employers. Litigation can be slow and unproductive. Monetary judgments are usually made in local currency, but procedures exist for enforcing foreign judgments. Overall, Sri Lanka’s record in handling investment disputes is problematic. Disputes have become politicized, and the stability of contracts in general could be improved, as well as the process for debt collection.

Arbitration

Most investors prefer to choose arbitration over litigation due to court delays. Investors are advised to go to a neutral country for arbitration purposes. 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.

An independent 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.

The Labor Department has a process involving labor tribunals for settling industrial disputes with workers or unions, and arbitration is required when attempts to reconcile industrial disputes fail. The Labor Commissioner typically becomes involved in labor-management mediation. Other senior officials, including the Labor Minister and the President, have intervened in particularly difficult cases.

Bankruptcy Laws

The Companies Act and the Insolvency Ordinance provide for dissolution of insolvent companies, but there is no mechanism to facilitate the reorganization of financially-troubled companies. Other laws make it difficult to keep a struggling company solvent. The Termination of Employment of Workmen Act (TEA), for example, makes it difficult to fire or lay off workers who have been employed for more than six months for any reason other than serious, well-documented disciplinary problems. (See "Labor," below.)

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 creditor demands for a sum exceeding Rs 50,000 (approximately US$380), the creditor may petition the court to dissolve the company. Lenders are also empowered to foreclose on loan collateral without court intervention. However, loans below Rs 5 million (US$40,000) are exempt, and lenders cannot foreclose on collateral provided by guarantors to a loan. Financial institutions also face other legal challenges as defaulters obtain restraining orders on frivolous grounds due to technical defects in the recovery laws.

The Companies Act of 2007 introduced a "solvency test" to determine the financial health of a company. The solvency test is intended to prevent companies without sufficient assets from obtaining loans and to protect rights of creditors. The law sets forth the responsibilities of a company's directors in cases of serious loss of capital. While the Companies Act does not provide for the revival of struggling companies, the courts generally take a liberal attitude towards any restructuring plans that would benefit a company.

Investment Protection

The government has entered into 27 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 Sri Lankan Constitution, investment protection agreements enjoy the force of law, and no legislative, executive, or administrative action can 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.

Performance Requirements and Incentives

To qualify for investments, the Board of Investment specifies certain minimum investment amounts for both local and foreign investors. In most cases, firms enjoying preferential incentives in the manufacturing sector must export 80% of production, while those in the service sector must earn at least 70% of their income in foreign exchange. 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. A member of the World Trade Organization (WTO), Sri Lanka complies with the WTO Trade Related Investment Measures obligations.

Foreign investors who remit at least US$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 in the commercial sector do not experience significant problems in obtaining work or residence permits. Sri Lanka has ceased issuing dual citizenship status to Sri Lankans who have obtained foreign citizenship, and the dual citizenship provisions have recently been tightened. Tourist and business visas are granted for one month, with possible extensions.

Investment Incentives for Strategic Development Projects

The Strategic Development Project Act of 2008 provides tax incentives for large projects that the Cabinet identifies as Strategic Development Projects (SDP). SDPs are defined as investments that are in the national interest, likely to bring economic and social benefits to the country and change the landscape of the country through the provision of goods and services, substantial inflow of foreign currency, generation of employment and income, and transfer of technology. Information regarding projects selected as SDPs and incentives is published in the official gazette and needs to be approved by the Cabinet and Parliament. The incentives become operational upon parliamentary approval. Projects are exempted from taxes for up to 25 years. The exempted taxes include corporate income tax, Value Added Tax, Economic Service Charge, Debit Tax, Customs Import and Export taxes, Port and Airport Tax, and the Nation Building Tax.

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, although the new land ownership law prohibits foreigners from owning land according, with some exceptions. (See “Areas of Concern,” above) Most investors say acquiring land is often the biggest challenge for any new business in Sri Lanka. Private land ownership is limited to fifty acres per person. The government owns approximately 80% of the land in Sri Lanka, including the land housing most tea, rubber, and coconut plantations, leased to the private sector on 50-year terms. Although state land for industrial use is usually allotted on a 50-year lease, the government may approve 99-year leases on a case-by-case basis, depending on the nature of the project. As noted above, many land title records were lost during the war, and significant disputes remain over property ownership in the North and East.

Protection of Property Rights

Secured interests in property in Sri Lanka are generally recognized and enforced, but many investors claim protection can be flimsy. A fairly reliable registration system exists for recording private property including land, buildings, and mortgages, although problems exist due to fraud and forged documents.

Intellectual Property Rights Protection (IPR)

IPR enforcement has improved in Sri Lanka, although counterfeit goods continue to be widely available. Local agents of well-known U.S. and other international companies representing recording, software, movie, clothing, and consumer product industries continue to complain that lack of IPR protection is damaging their businesses. Piracy of sound recordings and software is widespread, making it difficult for the legitimate industries to protect their market and realize their potential in Sri Lanka. There has been an improvement in the use of legal software in the corporate and public sectors. Both proprietary software and open source software are permitted in government departments.

Sri Lanka is a party to major intellectual property agreements, including the Bern 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 Cooperation Treaty, the Universal Copyright Convention, and the Convention establishing the World Intellectual Property Organization (WIPO). In 1991, Sri Lanka and the United States signed a Bilateral Agreement for the Protection of Intellectual Property Rights. Sri Lanka is also a party to the WTO Trade Related Intellectual Property Rights (TRIPS) Agreement. Sri Lanka has not acceded to the WIPO Performances and Phonograms Treaty, the WIPO Copyright Treaty, or the WTO Information Technology Agreement.

Sri Lanka adopted an intellectual property law in 2003 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 introduced regulations to regulate the commercial use of local creations in 2008.

Infringement of intellectual property rights is a punishable offense under the IP law with criminal and civil penalties. 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 offense include a prison sentence of six months or a fine of up to Rs 500,000 (US$4,425), but smaller penalties are the norm. 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. In 2010, a separate Anti-Piracy Unit was created in the Criminal Investigations Division of the Sri Lanka Police. Sri Lanka Customs also created a trademark database and a separate Intellectual Property Unit within the Social Protection Division, although neither the database nor the Unit is fully functional yet. The police have conducted some raids to seize counterfeit goods, but 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. However, the minimal damages and suspended sentences imposed suggest that the court system still fails to recognize the significance of intellectual property rights.

The U.S. Embassy, the United States Patent and Trademarks Office (USPTO), and the American Chamber of Commerce of Sri Lanka are working to pursue more aggressive enforcement and enhance public awareness, including sponsoring IPR workshops for police, judges, and senior government officials.

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 microbiological processes) and essential biological processes for the production of plants and animals (other than nonbiological 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 law. Enforcement limitations apply 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 the Regulatory System

The Board of Investment strives to inform potential investors about laws and regulations that may affect operations in Sri Lanka, but some of the measures are difficult to find. Proposed laws and regulations are generally made available for public comment, but are occasionally published without public discussion. 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. The Sri Lankan cabinet must approve strategic projects by private investors to receive incentives.

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 claim that the level of corruption makes it difficult to compete with bidders not subject to the U.S. Foreign Corrupt Practices Act. 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 Cabinet had already approved the contracts.

Capital Markets and Portfolio Investment

With the end of the war and rebounding economic activities, opportunities to raise capital through the capital market have expanded, although the market is still underdeveloped, especially in relation to corporate debt. Contrary to market expectations, the stock market was not used extensively to raise new capital. The government permitted foreign investments in corporate debentures in December 2011. Retained profits finance about 70% of private investment in Sri Lanka, with short-term borrowing financing a further 20%. Local companies are allowed to borrow from foreign sources. Foreign direct investment finances about 6% of overall investment. Foreign investors are allowed to access credit on the local market and are free to raise foreign currency loans.

U.S. investors have shown a strong appetite for Sri Lanka’s capital market, holding a little over 40% (US$1.4 billion) of Sri Lanka’s sovereign bonds, as well as 75% (US$2.4 billion) of the 12.5% of rupee-denominated debt set aside for foreign investors.

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 2013, the government's net borrowing from the local market is forecast to be Rs 360 billion (US$2.7 billion). High budget deficits have caused interest rates to rise. (See “Interest Rates,” above.) Inflation is running at approximately 8%.

Credit Instruments

Commercial banks 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 Ratings Lanka (www.fitchratings.lk), a joint venture between Fitch Ratings Inc, International Finance Corporation (IFC), the 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). Current ratings stand at "BB-Minus" with a stable outlook (Fitch), "B-Plus" with a stable outlook (S&P) and “B1” with a positive outlook (Moody’s). The Central Bank points out that Sri Lanka’s sovereign credit rating was maintained in 2012 whereas many other countries saw their ratings downgraded.

Accounting Standards

There is an active and 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). Sri Lanka adopted IASB’s Financial Reporting Standards (IFRS) for financial reporting purposes from January 1, 2012. The ICASL has revised Sri Lanka’s Accounting Standards in line with IFRS. However, problems with the quality and reliability of financial statements still exist due to the lack of an adequate enforcement mechanism.

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 must 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 is responsible for monitoring compliance with Sri Lankan accounting and auditing standards. British professional accounting bodies are quite active in Sri Lanka, and the Chartered Institute of Management Accountants – a leading professional accounting body based in the UK – 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 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 SEC approval to invest in Sri Lanka's stock market. These funds make transactions through share investment external rupee accounts maintained in commercial banks.

In 2011, in a bid to control speculative trade in the Colombo Stock Exchange, the SEC introduced new rules that limited broker credit as well as price bands to limit stock volatility. The SEC also started to investigate insider trading, market manipulation, and fraud, but has come under pressure from powerful market players who argued that these regulations were depressing stock values.

Colombo Stock Exchange

The Colombo Stock Exchange (CSE) was the world’s second best performing stock market in 2009-2010, based on post-war economic optimism. The CSE declined by about 8% in 2012, however, following a 9% decline in 2011. Market capitalization has also fallen sharply. Analysts point to several factors driving the market downturn, including excessive speculative investment, market manipulation, insider trading, regulatory issues, interest rate hikes, rupee depreciation, and gloomy global economic prospects. Media reports continue to highlight purported market manipulation. Corporate profits of Sri Lankan companies are still strong, however, and do not seem to be a factor in driving away determined investors.

Notwithstanding the weak regulatory environment, investors still find good value in Sri Lanka, due, in the opinion of one large global and U.S. investment house, to the country’s strong economic growth, post-civil war economic revival, and sound corporate-level fundamentals. Compared to other frontier markets, the quality of Sri Lanka’s workforce, the broad regulatory framework, and government policies remain quite favorable. But market participation needs to be deepened – both in terms of investor base and number of businesses listed on the Colombo Stock exchange – a concern local investors echo.

The CSE has fully automated trading, clearing, and settlement systems, and maintains a rolling settlement period of three days. Twenty-nine 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 (US$770,000), which aims to guarantee the settlement of trades between clearing members of the exchange. There are 287 companies listed on the stock exchange, with the top ten positions by market capitalization held by conglomerates, telecommunication companies, banks, and food and beverage companies. Unlike the bond market, there is no restriction on foreign ownership.

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 and 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.

For long-term growth, Sri Lanka’s stock market needs to expand, improve regulation and monitoring, and increase liquidity. 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.

Banking System

Sri Lanka has a fairly well-diversified banking system. There are 24 commercial banks – 12 local and 12 foreign. In addition, there are nine local specialized banks. Citibank NA is the only U.S. bank operating in Sri Lanka. Several domestic private commercial banks now have substantial government equity acquired through investment agencies controlled by the government. The banking sector has been particularly active in the North and East after the war, expanding branches and offering a number of leasing and microfinance options. However, access to credit remains a significant problem for the SME sector nationwide.

The Central Bank is responsible for supervision of all banking institutions and has driven improvements in banking regulations, provisioning, and public disclosure of banking sector performance. Credit ratings are mandatory for all banks operating in Sri Lanka. The Central Bank has accepted the Basel II standardized approach framework, and has introduced new accounting standards corresponding to International Financial Reporting Standards for banks from January 1, 2012.

Sri Lanka has enacted amendments to its anti-money laundering and counter terrorist financing laws in 2011 and 2012. The amendments sought to address shortcomings identified by international and regional bodies. The Financial Action Task Force (FATF) publically identified Sri Lanka in 2010 for strategic anti-money laundering and terrorist financing deficiencies, and Sri Lanka made a high-level political commitment to address them. According to the Central Bank, the amendments to its anti-money laundering and terrorist financing regime now comply with international standards. The FATF has determined that Sri Lanka has made adequate progress to improving its legal regime and will make a final determination to remove Sri Lanka from FATF review in June 2013.

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 operates under the Central Bank. The Financial Intelligence Unit has issued instructions to banks, finance and insurance companies, money changers, and the securities industry regarding anti-money laundering and terrorist financing regulations. The FIU has also issued rules on "know your customer" and "customer due diligence" to these entities.

In late 2008, the Central Bank dissolved the board of directors of a private local bank, Seylan Bank, following a financial scandal at a non-regulated large finance company connected to the bank. Since then, the Seylan Bank has been restructured with equity from new shareholders. The bank has returned to normal business activity with a board of directors appointed by the new shareholders. The Central Bank also took control of several non-bank finance companies connected to the failed finance company. These companies are being restructured through mergers.

State-Owned Banks

Total assets of commercial banks stood at Rs 4,359 billion (US$34.5 billion) as of December 31, 2012. The two fully state-owned commercial banks – Bank of Ceylon and People’s Bank – with assets of Rs 1 trillion (US$7.9 billion) and Rs 873 billion (US$6.9 billion) respectively, are still important players, accounting for over 40% of all assets.

The two state banks have a large portfolio of non-performing loans. The non-performing loan ratio was 3.4% at both Bank of Ceylon and People’s Bank in 2011. Bank of Ceylon’s non- performing loans almost doubled in 2012. Both these banks have significant exposure to the state and state-owned companies, which are treated as performing loans. However, as these banks are implicitly guaranteed by the state, their problems have not harmed the credibility of the rest of the banking system.

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. Foreign banks tend to make provisions in line with international best practices, as most foreign bank branches are subject to supervision in their own country in addition to that of the Sri Lankan Central Bank. Non-performing loans of the banking sector, which increased in 2008-2009, declined to 4% in 2012.

Capital Adequacy

Sri Lanka adopted capital adequacy standards set by the Basel Committee on banking regulations and supervisory practices in 1993. The minimum capital adequacy ratio (CAR) 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 adopted Pillar 1 of Basel II capital adequacy standard for all banks in 2008. Capital adequacy in the banking sector was estimated at 16% in 2012. The Bank of Ceylon's and People’s Bank’s capital adequacy ratio is within Central Bank requirements.

Competition from State-Owned Enterprises (SOEs)

The government has halted SOE privatization, and SOEs are active in transport (bus and railways, ports and airport management, airline operations); utilities such as electricity; petroleum imports, and water supply; retail; banking and telecommunications; TV and radio broadcasting; newspaper publishing; banking; and insurance. Since the end of the war, Sri Lankan armed forces have begun operating air services, tourist resorts, and farms for civilian purposes, crowding out some private investment. Directors of SOEs are appointed by the Cabinet or a line Ministry. The government allocates board seats to both senior government officials and politically-affiliated individuals. There is concern that the public banks are required to take on increasing debt from inefficient SOEs, forcing them to carry a greater share of non-performing loans

Government Control of Private Sector Pension Funds

Sri Lanka does not have a sovereign wealth fund (SWF). Currently, the government manages and controls large pension funds of private sector employees, using these funds for budgetary purposes and stock market investments. The government and the Central Bank are accused of misusing the Employees Provident Fund (EPF), a large retirement fund of private sector workers managed by the Central Bank, for unwise stock market investments and to help governing party supporters. Contacts argue the fund must be segregated from politics and professionalized. SOEs and government-managed pension funds must meet Sri Lanka accounting standards.

Corporate Social Responsibility (CSR)

Leading companies in Sri Lanka are actively promoting CSR and some SME companies have also started to promote CSR. The Ceylon Chamber of Commerce, the largest business chamber in Sri Lanka, has a CSR section promoting CSR among its membership. The Ceylon Chamber also has an annual "Best Corporate Citizens" award to encourage CSR activities. In addition, a professional accounting body has a program to promote sustainability reporting. Internationally, some of Sri Lanka's leading companies have joined the UN Global Compact initiative. The apparel industry, Sri Lanka’s largest export industry, has a specially designated CSR program for the industry under the title "Garments without Guilt" (www.garmentswithoutguilt.com). The ethical sourcing and sustainable development practices under the program aim to empower women and their communities through poverty alleviation and opportunities for education and personal growth. In addition, the program endeavors to promote sustainable eco-friendly manufacturing practices in the apparel industry.

Political Violence

The Sri Lankan government's military campaign against the Liberation Tigers of Tamil Eelam (LTTE) ended in May 2009 with the defeat of the LTTE. During the war, the LTTE had a history of attacks against civilians, and the U.S. government designated the LTTE as a terrorist organization, although none of the attacks were directed against U.S. citizens. There have been no terrorist attacks since the end of the conflict, and the government has authority throughout the island. Demonstrations take place in Sri Lanka from time to time in response to world events or local developments. Demonstrations near Western embassies are not uncommon, but in many cases are frequently unrelated to embassy activity. Protests aimed at Western embassies have been well-contained, with support from the Sri Lankan police and military.

Business-related Violence

In May 2011, workers at the Katunayake Export Processing Zone (EPZ), the country’s largest EPZ, held a large protest demanding the withdrawal of a proposed new pension plan covering all private sector employees. The government had bypassed the labor consultations with workers and employers and submitted the proposal to the Parliament with little notice. The protest led to a violent clash between the workers and the police. The clashes resulted in the death of one EPZ worker, injuries to a number of protestors and police officers, and damage to several factories. The government closed the EPZ for two days as a precautionary measure. Following the clash, the government withdrew the pension bill, and the head of the police resigned.

Human Rights Concerns

The United States remains concerned over the human rights situation in Sri Lanka, which includes allegations of extrajudicial killings, disappearances, intimidation, discrimination, and harassment. Due to the lack of a credible reconciliation and accountability effort after the 2009 end of the conflict, the U.S. sponsored a resolution on the situation in Sri Lanka in the UN Human Rights Council in March 2012 and again in March 2013, calling on the government to implement the recommendations in its Lessons Learned and Reconciliation Commission (LLRC) and fulfill its international obligations. Both resolutions – which also requested reports from the Office of the High Commissioner of Human Rights – passed with a majority of the Council’s support.

Corruption

While the country has generally adequate laws and regulations to combat corruption, enforcement is considered weak and inconsistent. 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. The business community claims that corruption has the greatest effect on investors in large projects and on those pursuing government procurement contracts. Projects geared toward exports face fewer problems. Local investors say internal controls do exist, although they are weak.

According to Transparency International (TI), corruption is a systemic problem threatening democratic and economic development in Sri Lanka. In TI’s 2012 Corruption Perception Index, which ranks countries on perceived public sector corruption, Sri Lanka ranks 79th with a score of 40 out of a possible 100 points. TI’s Government Defence Anti Corruption Index for 2013 ranks Sri Lanka as a country with a high level of defense corruption (rated “E” out of a possible A-F), stating that the potential for financial corruption is exacerbated by centralized presidential control, limited opportunity for scrutiny, and lack of transparency. TI compared Sri Lanka to the Philippines and Indonesia for defense-sector corruption, citing weak controls of asset disposals and significant off-budget expenditures.

Sri Lanka’s ranking in the World Bank Control of Corruption Index, which ranges from -2.5 to +2.5, has deteriorated to -0.46 in 2011 from -0.45 in 2010 and -0.40 in 2009. In a 2006 USAID Democracy and Governance assessment, anecdotal evidence from the private sector indicated a tripling in the percentage of a public sector contract that must be paid in bribes. A senior economist claimed that, in 2012, Sri Lanka has lost as much as two percentage points of GDP growth due to corruption.

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. Attempts to introduce a Freedom of Information Act to increase transparency have been unsuccessful.

Bribery Commission

The Bribery Commission is the main body responsible for investigating allegations brought to its attention and instituting 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.

The Bribery Commission has recently investigated corruption charges involving junior and mid- level public officers. Several other government entities try to address corruption, the most important being the Auditor General's Department. However, there is confusion regarding mandates, with these institutions frequently interpreting their mandates narrowly and thus inhibiting their effectiveness.

(Source: https://www.state.gov/e/eb/rls/othr/ics/2013/204735.htm)