Sri Lanka

Author: | Published: 9 Jul 2001
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(Note: Information contained herein is largely based on the Annual Report of the Central Bank of Sri Lanka for 2000).

Economic overview

Sri Lanka's economy recorded a real GDP growth rate of 6% in 2000, significantly above the rate of growth of 4.3% in 1999. The annual average growth rate during the decade was 5%.

In 2000, the Sri Lankan economy expanded strongly, in continuation of the revival of economic activity that commenced in mid-1999, with a significant increase in employment and a moderation of inflation. However, there was a slowdown towards the end of the year, with the fiscal and the balance of payments deficits widening considerably, largely owing to the sharp escalation in world petroleum prices, a shortfall in government revenue and the sudden expansion in security expenditure. This is the official view published by the Central Bank of Sri Lanka, which celebrated its Golden Jubilee, having been established on August 28 1950.

The Central Bank embarked on a programme to modernize itself with the objective of developing a more efficient, professional and compact organization. The challenges posed by rising globalization and new thinking on economic policy and the role of central banks in a changing world gave rise to the need for this change.

New exchange rate regime

The Central Bank introduced a new exchange rate regime on January 23 2001 by taking into account all the relevant factors and long-term economic prospects, as another step forward in the evolution towards a floating exchange rate system initiated in 1977, along with the introduction of an outward-oriented economic liberalization framework. Under the new system, the Central Bank refrained from announcing its buying and selling rates for the US dollar (ie the intervention currency) in advance. Instead, it decided to participate actively in the foreign exchange market, through buying and selling foreign exchange at or near market prices. This provided full freedom to the market to determine the exchange rate, while enabling the authorities to build up the official external reserves which, in the long run, would bring about stability on both price and exchange rate fronts and help achieve a sustainable high economic growth.

Banking system in Sri Lanka

The total number of commercial banks operating in the country at the end of 2000 was 26, consisting of two state banks, eight domestic private banks and 16 foreign banks. One of the domestic private banks is the national mercantile bank which commenced operations as a new private bank during the year 2000.

ANZ Grindlays Bank, a branch of a foreign bank has changed its name to Standard Chartered Grindlays Bank subsequent to the acquisition abroad of ANZ Grindlays Bank by Standard Chartered Bank Limited.

The Ceylinco Savings Bank Limited is a new private savings bank which has been licensed as a specialized bank and which commenced its operations in 2001.

Reforms in the banking sector

The banking sector, which had been rigidly controlled, has now been liberalized. Foreign banks are encouraged to enter the Sri Lankan market. Certain large financial institutions which undertake some banking functions have been given a special dispensation as licensed commercial banks and brought under the regulatory and supervision authority of the Central Bank.

The main objectives of an agreement signed by the Bank of Ceylon and People's Bank with the government of Sri Lanka on July 161998 were the improvement of banks' profitability, efficiency and financial soundness by commercializing and consolidating operations, increasing productivity, reducing costs, rationalizing staff levels and the branch network, conserving assets, increasing loan recoveries and improving risk management.

The two State Banks - Bank of Ceylon and Peoples Bank - have been re-capitalized and given greater autonomy in their commercial operations.

The activities of the leading savings bank, National Savings Bank, were also made more market-orientated and its capital base was restructured. The National Development Bank was privatized and the government's share ownership in the two development financial institutions, NDB and DFCC Bank, was sold to the public.

Foreign ownership of commercial banks has been permitted up to 60% of the issued share capital. The Central Bank has, with a view to reinforcing the stability of commercial banks, improved the regulatory system. The risk-weighted capital adequacy ratio has been raised from 8% to 9% and is expected to be increased to 10% in 2002.

Amendments have been proposed to the Banking Act to make it more effective by providing for the enforcement of the core principles formulated by the Bank for International Settlements in Basle.

The Finance Leasing Act has been passed recently to give powers to the Central Bank of Sri Lanka to regulate and supervise finance leasing institutions.

The Central Bank has announced that the Monetary Law will be amended to provide for price stability and financial system stability. The proposed amendment to the Monetary Law Act will give greater flexibility to the Monetary Board in monetary operations and management to adopt to changing conditions.

The Central Bank is also in the process of being reorganized to concentrate its operations on the core objectives and increase efficiency.

Banking facilities

Facilities by commercial banks expanded in an intensely competitive environment to cater to the growing needs of customers. Banking products such as automated teller machines (ATMs), credit cards, electronic funds transfer facilities, internet banking, phone banking, online services and extended banking hours are among the services provided by commercial banks, apart from traditional banking services. Commercial banks have introduced several new deposit and loan products, and some other services during the year, while applying technological advances in banking facilities.

Legal reforms

The following legal reforms have been made or are in the process of being prepared:

Regulation of Insurance Industry Act

This law was passed by Parliament in July 2000. The Act provides for the establishment of a regulatory authority for the insurance sector. The insurance regulatory body will be responsible for supervising the operating environment of insurance companies, insurance broking companies and agents. The minimum share capital and prudential requirements, such as solvency margins and reserves for insurance companies, are specified in the law.

The new Act also provides for greater diversification of the investment portfolio of insurance companies by reducing the minimum stipulated level of investment in government securities. The qualifications of the directors and key staff in the insurance and broking companies are specified in the law. There are also requirements relating to actuarial valuations and audited accounts. This Act replaced the Control of Insurance Act, No. 25 of 1962.

Finance Leasing Act

The new Finance Leasing Law was passed by parliament in August 2000. The Finance Leasing Law defines the rights and obligations of parties to a finance leasing transaction and provides a regulatory and supervisory framework for the finance leasing industry. The CBSL will license, regulate and supervise finance leasing companies.

Bill to amend the Banking Act

Amendments to the Banking Act were approved by the Monetary Board in February 2000, and cabinet approved the Bill in April 2000. This is yet to be presented to parliament.

These amendments would strengthen the supervisory and regulatory powers of the Central Bank relating to licensing procedures, revocation of licences, amalgamation, liquidation and closure of banks, qualifications, appointment and removal of bank directors and senior management. They also provide for the establishment of a regulatory framework for 'registered financial institutions' which is a category of institutions engaged in financial business, other than deposit taking.

Bill to amend the Monetary Law Act

The Monetary Law Act is proposed to be amended in relation to:

  • making price stability the main objective of the CBSL so as to avoid possible policy conflicts;
  • revising the definition of money supply to take in to account 'broad money';
  • removal of the maximum and the minimum limits on the statutory reserve ratios;
  • providing more flexibility to the Monetary Board to decide the basis of computation of the required reserves;
  • payment of interest on reserves; and
  • enabling the imposition of reserve requirements on financial liabilities other than deposit liabilities.
Foreign investment

Foreign investment inflows to Sri Lanka declined in 2000, despite intensive promotional campaigns undertaken by the Board of Investment of Sri Lanka. The main reason for the decline in investment may be deteriorating investor confidence owing to several war-related incidents in 2000. With the declaration of a 'war footing' condition in Sri Lanka in 2000, investors may have adopted a 'wait and see' approach by withholding investment projects. The uncertainty created by the general election also contributed to the lower investment flows in 2000.

Liberalization of the financial sector

The government continued its efforts to liberalize the financial sector in 2000. The prevailing restrictions on foreign equity holdings in the banking and insurance sectors were relaxed allowing foreign ownership up to 60% in banking institutions and 90% in insurance. The increase in foreign equity ownership is expected to improve the capital base and encourage foreign fund flows and help develop Colombo as a regional financial centre. Non-nationals are also now permitted to hold 100% stakes in stock broking firms if approved by the Securities and Exchange Commission. With a view to revitalizing unit trusts, the government permitted investments by non-residents in units of equity/growth unit trusts where relevant trust deeds do not permit more than 20% investment in government securities. Such investments are to be routed through the Share Investment External Rupee Accounts to ensure the monitoring of inflows and outflows of funds. In order to expand and diversify investments of venture capital companies, the government amended the law for venture capital companies to opt out of the tax holiday period, which was hitherto linked to investments in specified risk ventures. This move enabled venture capital companies to make investments of their own choice.

With a view to modernizing the insurance sector and revamping the insurance industry in Sri Lanka, the Regulation of the Insurance Industry Act No. 43 of 2000 was passed by parliament in August 2000. The Act provides for the establishment of an Insurance Board for the purpose of developing, supervising and regulating the insurance industry. By repealing the hitherto existing Control of Insurance Act No. 35 of 1962, the new act establishes a platform for the development of a modern regulatory environment for the insurance industry in Sri Lanka. The Board is empowered and responsible, among other things, to register persons carrying on insurance business as insurers, register insurance brokers, advise the government on the development of the insurance industry and implement policies of the government with regard to insurance.

A series of tax incentives had been granted during the past few years to develop the equity and debt markets and to increase the array of financial instruments available in Sri Lanka.

During 2000, the stamp duty for mortgages and asset-backed securities was removed with a view to promoting the diversification of financial instruments and creating an environment conducive to financial innovation.

International economic developments imposed constraints on the scheduled public enterprise reform programme for 2000.

The privatization process for the sale of 40% shares of Air Lanka was completed in January 2001. The privatization of Air Lanka entailed the divestiture of a 40% equity stake to a strategic partner, Emirates Airlines, with management control. A financial offer of $70 million was made by Emirates for 40% of the shares of the airline. The transaction was executed in two stages with the transfer of 26% of shares in 1998 for a total of $45 million and the balance 14% of shares being transferred in January 2001 for a sum of $25 million.

The PERC continued its preparatory work in the year under review for the reform of some selected public enterprises in the near future. The privatization of the National Insurance Corporation is due to be completed shortly.

Murugesu & Neelakandan

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