SRI LANKA: UNAFFORDABLE SOCIALISM

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP79T01098A000600070001-3
• Release Decision: RIPPUB
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• Document Creation Date: November 16, 2016
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• Sequence Number: 1
• Publication Date: September 1, 1975
• Content Type: REPORT

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RN QAr3
Sri Lanka: Una f fordable Socialism
Confidential
ER RP 75-28
September 1975
Copy N2
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NATIONAL SECURITY INFORMATION
Unauthorized Disclosure Subject to Criminal Sanctions
Classified by 015319
Exempt from General Declassification Schedule
of E.O. 11652, exemption category:
? 5B(1), (2), and (3)
Automatically declassified on:
date impossible to determine
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SRI LANKA: UNAFFORDABLE SOCIALISM
SUMMARY AND CONCLUSIONS
1. Sri Lanka is a no-growth welfare state, which until recently
could get by with minimal foreign assistance. This situation is changing, in
part because of Colombo's chronic neglect of its key agricultural sector,
in part because of the higher costs of imported oil and grain.
2. Output from tree crops -- tea, rubber, and coconuts -- which
provide 75% of export earnings, is declining under the pressure of
government takeovers, a discriminatory exchange rate system, and heavy
taxation. Rice production, which increased steadily during 1965-70, has
failed to increase further since 1970. The country's heavy dependence on
imported grain and petroleum and its inability to expand exports have
forced stringent controls on nonfood imports and an increased reliance on
short-term foreign loans.
3. Prospects for sustained economic growth are poor. Foreign
investors are effectively locked out by government policy, and domestic
investors are discouraged by constraints on private economic activity. The
governent shows no signs of shifting toward growth-oriented policies.
Failure to generate growth has worsened widespread unemployment and
has eroded welfare programs. The attention of the Sri Lankan government
remains focused on its hosting of the 1976 nonaligned countries confer-
ence and on the national elections slated to be held before mid-1977.
Because of these factors, Colombo is likely to depend upon increasing
amounts of foreign assistance simply to maintain welfare programs.
Failure to maintain these programs will increase the likelihood of political
instability.
Note: Comments and queries re ardin this publication are welcomed.
They may be directed to of the Office of Economic
Research, Code 143, Extension 6202.
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DISCUSSION
Policy Orientation
4. Sri Lanka has maintained a strong polio;: orientation toward
development of a socialist-welfare state inherited from the British.. All
major political parties share this basic orientation, and debate centers on
how fast and how far change should go. Twenty-five years of welfare
policies have increased the transfer payments share in the government
budget. For example, they grew from 23% to 38% of total government
spending between 1958 and 1973 (see Figure 1). These transfers include
SRI LANKA: Distribution of Government Spending,
1958 and 1973 (In percent)
Social
Services
20.6%
Atlmin
13.3.,
Transfer Total
Capital
Payments Expenditures
c 22.96A 26.0%
1958
(fiscal year)
1,510.9 Million Rupees
Social Services
17.3%
Economic
Services
9.2% ,
Adminisrt`i ation
1%
-Others
0.3%
Total Capital
Expenditures
23.4%
1973
(calendar year)
4,951.4 Million Rupees
financing free rice, other consumer subsidies, and government pensions.
Although domestically obtained revenues financed 70% to 80% of the
welfare-style budget in recent years, foreign aid is now increasing sharply.
It is projected to meet half of Sri Lanka's 1975 budget deficit of $200
million.
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Economic
Services
17.2% ,
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5. The government has successfully redistributed income. Between
196:3 and 1973 the share of income earned by the top 20% of income
earners fell from 55% to 46% and the share of the bottom 50% rose from
17% to 22%. The main impetus for redistribution came from wage
adjustments for the lowest paid workers, heavy taxes on high income and
wealth, and land reforms.
6. These programs have contributed to slower growth, encouraged
emigration of businessmen and professionals, and increased unemployment
and underemployment. At the same time, welfare programs have provided
extensive educational and health services and minimum food supplies.
Priority for transfer payments and social welfare programs, however, has
restrained government outlays for capital investment in development
projects such as irrigation while socialist policies restricted private
enterprise. As a result, per capita income growth has stagnated and about
one-third of the labor force is unemployed or underemployed. Unemploy-
ment hits well-educated young people the hardest; about two-thirds of
the unemployed are educated beyond the ninth grade. While welfare
programs ease the burden of the unemployed, failure to stimulate new
growth and generate new jobs remains a continuing threat to political
stability. This will be particularly true if welfare services have to be
reduced. Widespread youth-centered unemployment was a contributing
cause of the 1971 insurrection, which nearly toppled the government.
Agricultural Stagnation
7. Sri Lanka's economic structure has not changed significantly in
the past 50 years. The country remains an exporter of tree crops -- tea,
rubber, and coconuts -- and an importer of grains and manufactures. The
output of tree crops, which accounts for about three-fourths of export
earnings, has generally failed to grow for a decade (see Figure 2). Rice
production has consistently fallen far short of domestic needs, and Sri
Lanka relies on rice and flour imports for about half of its consumption
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(see Figure 3). Food imports, mainly
rice, wheat flour, wheat, and sugar,
accounted for 48% of imports in 1974.
8. Government policies have
hampered production in the tree crop
sector.
? Heavy export taxes left over
from the 1950s remain in ef-
fect, although depressed world
prices have limited earnings
since 1955. Moreover, since
1968, tea, rubber, and coconut
exports have been denied the
export bonus over the official
exchange rate -- currently
65% -- provided to encourage
nontraditional exports.
& Implementation of a 1964
agreement with New Delhi to
repatriate stateless Tamil
workers to India has disrupted
the experienced labor force on
tea and rubber plantations.
The exchange rate system
adopted in 1968 in part to help
control trade deficits also re-
quires payment of a 65% pre-
mium for imports of machin-
ery and parts.
4
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"`pproved
Figure 2
SRI LANKA: Production
of Major Export Crops
Tea
Million Pounds
600 r-
400 LI I I I I I I I
Rubber
Million Pounds
200 "- I I I I I I 1_J
1965 70 74
Million Nuts
3,000 r-
1,500 I J __ I I I I I I 1
1965 70 74
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O The Business Acquisition Act
of 1971 removed judicial re-
course to challenge nationali-
zations. Redistribution of land
under the 1972 Land Reform
Law has transferred ownership
of 20% of tea, 15% of rubber,
and 10% of coconut acreage.
Further nationalizations are
currently under discussion.
9. The cumulative impact of
these policies on producers has been to
reduce investment in agriculture, par-
ticularly outlays to maintain and im-
prove land and crops. Fertilizer con-
surription is falling (see Table 1). Invest-
ment in the replacement of old trees is
declining (see Table 2). Current plant-
ing rates are far below levels needed to
maintain tree crop production over the
long term. In addition, the poor business
climate is causing experienced man-
agers to emigrate to plantations in
Indonesia, Malaysia, and East Africa.
Figure 3
SRI LANKA: Rice and Flour
Thousand Metric Tons
1,500 r-
1965
686971 8-75
Sri Lanka: Fertilizer Consumption
of Major Export Crops
75
est.
Thousand Nutrient Metric Tons
1970
34.9
6.0
19.8
1971
33.4
4.2
18.4
1972
30.5
3.4
15.7
1973
24.3
3.9
11.6
10. The steady growth in rice output achieved during the 1960s ended
with the record harvest in 1970. Average annual growth in rice production
of 6.1% between 1960 and 1970 consisted of a 3.6% growth in yields and a
2.4% growth in acreage. Improved varieties and increased fertilizer use,
supported by enlarged credit facilities and active government research
and extension services, raised yields. Acreage expanded because of double
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Sri Lanka: Replanting of Export Crops and Total Acreage
Thousand Acres
Tea
Rubber
Coconuts
Replanted
'Total
Cultivated
Replanted
Total
Cultivated
Replanted
Total
Cultivated'
1970
6.9
597
10.2
569
24
1,150
1971
6.6
597
8.5
568
23
1,150
1972
6.4
598
8.7
567
19
1,150
1973
6.0
599
7.2
565
14
1,150
1974
4.3
598
7.1
563
13'
1,150
cropping and the planting of new acreage.The rice production effort lost
momentum after 1970. The 1971 insurrection a.n i poor weather the
following two years helped reduce output. Goverr vent credit for rice
farmers steadily declined during these years as more farmers became
ineligible for credit because of defaults on prey. ious loans. Acreage
planted contracted owing to both poor growing conditions and the
increasing cost of bringing new acreage under cultivation.
11. Rapidly rising world food prices forced the overnment to return
to its food production problem in late 1973. In ieptember, Colombo
launched a "Food War." The government raised its guaranteed procure--
ment price 40% to try to keep up with increasing free market prices.
Government loans for rice production in the major rowing seasons were
increased threefold through upward revisions in credit lines, and credit
was reinstated to many in default. Offices responsible to the prime
minister were opened in all 22 administrative districts to oversee local
expenditures, identify production bottlenecks, and -id land reclamation.
The prime minister and other top officials traveled the island exhorting
farmers and local officials to increase production. P ese efforts paid off.
Despite the late arrival of the monsoon rains, the winter 1974 harvest set
6
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a record, and a good summer harvest enabled 1974 rice production to
nearly match the 1970 record.
12. While the "Food War" remains a top government priority, support
to sustain the effort is flagging. Drought in late 1974 and early 1975 has
reduced 1975 rice production to the lowest level since 1966. As a result of
reinstated credit lines in 1973, many farmers felt no compunction to repay
government loans, and 56% of rice loans for the record 1974 winter
harvest were never repaid. Sri Lanka's complete reliance on imported
chemical fertilizers makes it vulnerable to world market shortages.
Construction of a urea plant to reduce this dependence, currently under
consideration, will take several years. Government price policies, which
have caused wasteful use of irrigation water, also have not been
corrected.
Grain Distribution Problems
13. The government provides free weekly rice rations to everyone in
the country except the 5% of the population who pay income taxes. This
program has constituted both a serious drain on the economy's resources
and a source of political instability since its inception in 1942.
Widespread political discontent following attempts to reduce the subsidy
in 1953 and 1962 caused the resignation of a prime minister and a finance
minister. Following elections in 1970, Prime Minister Bandaranaike
augmented the free weekly rice ration of 2 pounds per person with an
additional 2 pounds at a subsidized price. Flour and sugar were also
available through the government system.
14. The cost of government food distribution amounted to 14% of
total government expenditures in 1973. The distribution system is supplied
through government procurement of domestic rice and government
imports of rice, wheat, and flour.
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15. Rapidly rising world food prices in 197 and stagnant rice
production forced the government to cut back i?s food distribution
program. In February 1973 the subsidized price for the extra 2 pounds of
rice was raised 60%, only to be cut by 12% in March. In June, flour prices
were raised 26%. In October, as part of the Food War, the free rice ration
was halved to 1 pound, the subsidized rice ration was eliminated, and flour
was put on rationing at 1 pound per week at a 469ihigher price. Most
Ceylonese reacted calmly, realizing that domesti: drought and high
import prices necessitated these moves. Since 1973 the free rice ration
has remained untouched, but the extra rice ration and the flour ration
have been periodically cut and re-instated as the government attempted
to adjust to fluctuations in supply. Cutbacks in subsidized food distribution
have contributed to unprecedented malnutrition among the poorest 4096 of
the population.
Foreign Investment
16. Despite shortages of investment funds, infl _ential leftists in the
government have prevented nascent attempts to encourage private foreign
investment. Investments in export-oriented light manufacturing, oil
exploration, banking, and tourism are being held up t. ntil the government
enacts legislation proposed in its 1972 White Paper on Private Foreign
Investment. Action has been stalled by leftists who denounce foreign
"exploitation" and advocate further nationalization. Their control over
labor unions, which has been instrumental in preventing strikes in the face
of austerity measures, gives them the clout to block n 2w legislation.
17. The discouragement of foreign private it vestment has been
particularly damaging in the search for domestic sources of petroleum. Sri
Lanka relies totally on oil imports to supply the government-owned 39,000
barrel per day refinery near Colombo. Enquiries about oil exploration from
Western oil firms have been consistently turned down. Private foreign oil
has an odious reputation with leftist politicians. in the early 1960s,
8
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inadequate compensation to US oil companies for nationalized properties
led to a brief cutoff of US aid under the Hickenlooper Amendment.
18. Sri Lanka turned to the USSR for help in oil exploration in 1972.
The Soviets surveyed both onshore and offshore areas, but were willing to
drill only onshore. The first exploratory well was inaugurated in February
1974, but only traces of oil and gas were found. Further test wells are
being pursued. When it became apparent that offshore drilling would be
necessary, Sri Lanka reluctantly turned to Western firms. Still wary of
foreign investment, the government is hiring drilling services on a
contract basis.
Foreign Trade and Payments
19. Despite continuing deficits in its international accounts, the
government has staved off severe financial crises through rigorous import
and foreign exchange controls. Food imports have been given priority,
forcing curtailment of imports of other raw materials and capital goods.
20. A $135 million deterioration in Sri Lanka's current account deficit
in 1974 mainly reflects higher world commodity prices. Export growth of
28% was surpassed by the 66% growth in imports (see Table 3). Food
imports rose $126 million despite little increase in grain import volume
and a 78% decline in sugar import volume. Although petroleum imports
increased $92 million on 13% lower volume, higher earnings from product
exports, largely bunkers, offset 35% of the increased cost. The value of
tea and rubber exports went up while their volumes declined by 15% and
20%, respectively. The value of coconut product exports more than
doubled on higher volume.
21. Sri Lanka relied heavily on foreign aid and short-term capital
inflows to finance the 1974 current account deficit of $173 million (see
Table 4). Net aid inflows jumped from $37 million in 1973 to $109 million
in 1'974. The largest inflows were from the IMF through the Oil Facility
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Table 3
Sri Lanka: Foreign Trade'
Million US $
Imports
431
717
Food
215
341
Petroleum
46
138
Fertilizer
17
33
Other
153
205
Exports
411
527
Tea
197
205
Rubber
92
111
Coconut products
35
81
Petroleum products
21
53
Gems
24
20
Other
42
57
1. Data are on an arrivals and departure basis.
and from China -- $41 million and $22
million, respectively. The government
increased its dependence on foreign
short-term credits in 1974 rather than
cut the volume of imports back even
Sri Lanka:
talance of Payments'
Million US $
1973
1974
Trade ba a rice
-47
-185
Services and private
transfers ! net)
9
12
Current account balance
-38
-173
Economic assistance (net)
37
109
Inflows 4 aid
87
160
Repayment of debt
-50
-51
Long-term private capital
(net)
Short-tern. private capital
(net)
27
42
Inflows
159
193
Repayments
-132
-151
Other capital, errors
and omissions
-9
12
Capital account flows
55
164
Changes in official
reserves
Official reserve level
(end of year)
1. Data ar on a payment basis.
and the relatively hard
terms of the IMF Oil Facility (repayment in seven years at 7% interest)
have heightened the potential for serious repayment problems in the
coming years.
Prospects
22. This year, Colombo will have to obtain foreign funds to finance a
current account deficit in the neighborhood of $200 million. Lower
domestic rice harvests in 1-975 will sharply raise grain import volume, but
the value should grow less because of lower prices. Continuing strength in
tea prices in 1975 should offset volume declines. Coconut and rubber
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exports will decline because of lower world prices and production
problems. The government will limit the trade deficit to keep it in line
with available financing by controlling nonfood imports. Aid inflows in
1975 will increase sharply because of an expanded IMF Oil Facility; $140
million in aid from oil producers in 1974, which was largely unused; and a
$32.5 million aid commitment from the United States. The government is
also likely to seek some short-term loans to meet the situation.
23. Sri Lanka's longer term growth prospects are bleak. Output from
the major tree crops is not likely to reach previous record levels in the
next few years, because the government gives no indication that it is
going to alter its detrimental production policies. Rice production,
however, could increase somewhat if recent government efforts to grow
more food are pursued.
24. During the next two years, attention will be diverted from
measures to generate economic growth, as Sri Lanka hosts the 1976
nonaligned conference and holds national elections, required before mid-
1977. Further reductions in consumption will be studiously avoided,
particularly while the opposition is making wild electioneering promises of
more consumer goods at lower prices.. As a result, every effort will be
made to create the appearance of economic success and to increase
consumption prior to the elections. As part of this effort, Colombo will
increasingly turn to short-term borrowing abroad. These developments will
contribute little toward solving Sri Lanka's production and unemployment
problems. They raise the potential. for sharp consumption cutbacks after
election day, which, when combined with continuing widespread unemploy-
ment, could easily lead to political instability.
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ya-
Sri Lanka Paper Distribution
Albert Thibault NEA/INS
Room 5251
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