Promoting growth in Sri Lanka : lessons from East Asia

Sri Lanka's weak economic performance, although compounded by the civil war and budgetary imbalance, largely reflects the following: 1) a stop-and-go pattern of policy reform, because of political constraints - even though the results of reform were generally positive; 2) weak economic management, resulting in high inflation and a high fiscal and balance of payments deficit; 3) poor management of public spending; 4) mixed performance in exchange-rate management, with periods of substantial overvaluation; 5) financial policies that (despite recent improvements) hamper efficient financial intermediation; 6) prolonged trade protection, followed by selective trade liberalization; 7) continued distortion in agricultural policies; 8) inflexible labor markets and, despite Sri Lanka's outstanding track record on human development, problems with the quality of the labor force. To address a substantially unfinished policy agenda, Sri Lanka needs to intensify efforts to peacefully resolve civil conflict. There is also a need to squarely address its macroeconomic imbalances, involving a sharp reduction in the fiscal deficit, a cutback on public spending and redefinition of spending priorities, improvement of cost recovery for public services, and continuing to improve the management of the exchange rate. In trade policy, eliminate most quanitative restrictions, further reduce tariff protection, simplify the tariff structure, and, possibly, reform customs (to reduce leakage and abuse). Rationalize employment, exit, and bankruptcy regulations and procedures. The authors recommend improvement in communications between government and the private sector. It is necessary for the financial sector to become more competitive by legislating banking reform, giving state-owned banks more autonomy and putting private commercial banks on an equal footing with the two state banks, with the ultimate goal of privatizing the state banks, and also strengthen the supervision of banking. Also in the financial sector the authors have identified a need for privatization in insurance and pension funds to strengthen the capital market. Several aspects of the agricultural sector need to be revamped. Primarily, privatization of the estate plantations, perhaps through long-term management contracts and the gradual sale of share in assets; reduced trade protection; implementation of land reform; strengthen agricultural support; and possibly support rural financing institutions. Lastly, the authors suggest an end to government controls on hiring, firing, and wage setting as well as rationalization in civil service employment decisions.