Sri Lanka

Author: | Published: 30 Sep 2004
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Economic growth

According to the Central Bank of Sri Lanka, gross domestic product (GDP) grew by 5.9% in real terms in 2003, continuing the recovery process that began from the second half of 2002. The growth was, of course, better than the growth of 5.5% forecasted for 2003 at the beginning of that year. Two factors that supported the growth achieved in 2003 were: the continuation of the ceasefire and the peace initiative, which expanded economic activity by enabling comparatively free mobility of goods services and labour throughout the country; and improved macroeconomic management. The growth in the banking sector in 2003 was 15.3%.

GDP growth forecast for 2004 is being maintained at 5% to 5.5%, which is low compared with 5.9% last year. The new governor of the Central Bank of Sri Lanka, Sunil Mendis, maintains that "the economy is growing, aided by growth in key sectors such as exports, imports, tourism and port services".

The political uncertainty and lack of clear economic policy direction on the part of the newly elected United People's Front Alliance (UPFA) government put paid to any hopes of a revival of the stock markets and Sri Lanka's rupee's gradual depreciation saw it pass the much anticipated US dollar mark in the second week of June.

As once stated by K N Choksy PC, who was the finance minister in the United National Front (UNF) government from December 2001 till the UNF was ousted from power by the UPFA in April 2004, there are four essential elements for Sri Lanka's economic prosperity. Firstly, its political stability; secondly, there has to be confidence in the continuity of government policies; thirdly, there has to be confidence in the government's transparency; and, lastly, there has to be no internal conflict in the country. Unfortunately the political crisis in which Sri Lanka has been placed since November 2003 has deprived the country of all these essential elements for economic prosperity.

Nevertheless, when disclosing the new economic policy of the UPFA Government on July 1 2004, Sarath Amunugama, the new minister of finance, claimed that his government was looking at a sustainable economic growth of 8% by the end of the year. According to him, the UPFA government's economic policy will focus on the promotion of agriculture, fisheries, livestock, exports and small- and medium-scale enterprises.


The UNF government aggressively followed a privatization policy. Sri Lanka Insurance Corporation was privatized on April 3 2003 and with that the government moved out almost entirely from the insurance business, leaving it in the hands of the private sector to be developed on market principles. The monopoly enjoyed by the Ceylon Petroleum Corporation (CPC) in import and distribution of petroleum came to an end with the second player, Lanka India Oil Corporation (LIOC), a company owned by Indian Oil Corporation that in March 2003was given 100 petrol sheds and is allowed to retail petroleum products in the local market. A new company, Ceylon Petroleum Storage Terminals Limited (CPSTL) was incorporated as the common user facility to manage petroleum infrastructure, such as oil terminals, storage facilities and pipelines, to be owned in equal shares by CPC, LIOC and a new third player. Bids were called to select the third player, but no final decision has yet been taken by the government of Sri Lanka. Forty percent of the retail outlets of the Cooperative Wholesale Establishment (CWE) were also privatized in 2003.

Foreign investment

Foreign investment into Sri Lanka, which increased in 2002, rose further in 2003. As stated by the central bank, the peace process, reforms in the labour markets, improvements of macroeconomic management, stable exchange rates, further liberalization of the capital account and relaxation of exchange controls helped to attract more foreign investment in 2003.

The attractive incentives and concessions granted by the government through the Board of Investment of Sri Lanka (BOI) and targeted investments for such incentives and concessions include:

  • manufacture of non-traditional goods for export, including deemed exports;
    export-oriented services;
  • manufacture of industrial tools and/or machinery;
  • small-scale infrastructure projects;
  • regional operating headquarters;
  • any industry, agriculture, construction or service, or any other business activity, approved by the Board;
  • research and development;
  • agriculture and/or agro-processing other than processing of black tea;
  • export trading houses;
  • large-scale infrastructure -
    - power generation, transmission and distribution;
    - development of highways, sea ports, airports, railways and water services;
    - establishment of industrial estates, or any other infrastructure; and
  • large-scale (new/existing) projects.

In addition to the above target sectors:

  • existing enterprises undertaking any expansion; and
  • non-performing or under-performing enterprises.

Incentives and concessions granted vary from full tax holidays of three to 10 years, with concessionary tax being levied for further periods, and also import duty exemption on capital goods and raw materials in certain categories and exemption from exchange control in most of the categories. However, foreign investment is not permitted in the following areas:

  • money lending;
  • pawnbroking;
  • retail trade investment with a capital of less than $1 million;
  • providing personal services other than for the export or tourism sectors;
  • coastal fishing;
  • the education of students who are citizens of Sri Lanka and not over 14 years of age; and
  • the award of local educational degrees.

Foreign investment in the following areas will be approved limited to 40%. Foreign ownership in excess of 40% will be approved on a case-by-case basis by the BOI.

  • production of goods where Sri Lanka's exports are subject to internationally determined quota restrictions;
  • growing and primary processing of tea, rubber, coconut, cocoa, rice, sugar and spices;
  • mining and primary processing of non-renewable national resources;
  • timber industries using local timber;
  • fishing (deep sea fishing);
  • mass communications;
  • education;
  • freight forwarding;
  • travel agencies; and
  • shipping agencies.

Foreign investment in certain regulated areas will be permitted only if approved by the respective government agency or BOI up to the percentage of foreign equity specified by the BOI. These regulated areas are:

  • air transportation;
  • coastal shipping;
  • industrial undertaking in the second schedule of the Industrial Promotion Act 46 of 1990, that is:
    - any industry making arms, ammunitions, explosives, military vehicles and equipment aircraft and other military hardware;
    - any industry making poisons, narcotics, alcohols, dangerous drugs, and toxic, hazardous or carcinogenic materials; and
    - any industry producing currency, coins or security documents;
  • large-scale mechanized mining of gems; and
  • lotteries.


The Central Bank of Sri Lanka introduced, on January 2 2004, a requirement to maintain a capital adequacy ratio of at least 10% in relation to risk-weighted assets, with core capital contributing not less than 5% both on a bank-only basis and on a consolidated basis (that is, including the bank and all subsidiaries) was imposed on all licensed commercial banks (LCBs) and licensed specialized banks (LSBs). All LCBs and LSBs were informed by the central bank that the proceeds of redeemable cumulative preference shares would constitute a part of capital funds for the purpose of the Banking Act and directions issued under it relating to the basis for the computation of the single borrower limit and investment in equity.

The total number of LCBs operating in Sri Lanka decreased to 22 (11 domestic banks and 11 branches of foreign banks) at the end of 2003 from 23 at the end of 2002 as a result of Standard Chartered Grindlays Bank's absorption of Standard Chartered Bank's operations. The total number of LSBs rose to 14 at the end of 2003 from 13 at the end of 2002 with the registration of Housing Development Finance Corporation (HDFC) as an LSB. One LSB, Pramuka Savings and Development Bank, was suspended by the central bank.

Interest rates

Interest rates charged by commercial banks on outstanding payments through credit cards, which were in the range of 21% to 33% at the end of 2002, remained unchanged at the end of 2003. A few banks, however, did reduce their rates on outstanding payments through credit cards. However, this should be viewed as an outlier from the rest of the interest rate structure; because it is only a penal rate on credit card holders that do not settle their balances, even after the one month's interest-free credit provided.

A decline was seen in the lending rates of long-term credit institutions, that is, DFCC Bank, National Development Bank (NDB), State Mortgage and Investment Bank (SMIB) and National Savings Bank (NSB). The lending rates of DFCC Bank were reduced from 11.5% - 19% in December 2002 to around 9.5% - 16% at the end of 2003, while the lending rates of NDB had come down from 10.81% - 18.35% to 8.23% - 16% during the same period. The lending rates of SMIB and NSB, which were in the range of 15% - 16% and 14% - 16.5%, respectively, at the end of 2002, were 12% - 13.25% and 10% - 12%, respectively, by the end of 2003.

After the declining trend in international market rates, commercial banks in Sri Lanka reduced their interest rates on foreign currency deposits and on foreign currency lending. At the end of 2003, interest rates on US dollar denominated savings accounts were in the range of 0.4% to 1.75%, while on sterling pound denominated savings accounts it was 1.5% to 4%. The interest rates applicable to lending in US dollars ranged between 2.20% and 8.00%, while on lending in sterling pounds, rates charged were between 3.5% and 6.80%.

Legal rate and the market rate

The central bank publishes the legal rate and the market rate applicable for the following year in the government gazette at the end of each year. The legal rate is defined under the Civil Procedure Code (Amendment) Act 6 of 1990 and applies to any action for the recovery of a sum of money. The market rate is defined under the Debt Recovery (Special Provisions) Act 2 of 1990. The market rate is applied only in relation to actions instituted by lending institutions for the recovery of debt exceeding Rs150,000 arising out of commercial transactions, where there is no agreed rate of interest. Both the legal rate and the market rate are computed based on the monthly average weighted deposit rates of commercial banks. Accordingly, for 2004, the legal rate and the market rate are 6.30% a year compared with 9.58% in 2003, and 11.11% in 2002.

Clearing systems

Interbank clearing, payment and settlement systems

The Central Bank of Sri Lanka is introducing a technologically advanced payment system in Sri Lanka. Under this project, payments and settlements, which were done manually, were converted to a computer-based real time gross settlement (RTGS) system; government securities, which were issued in scrip form, were made scripless in a scripless securities settlement (SSS) system; and the bank's own accounting system and treasury management were automated by the installation of an automated general ledger system (AGLS) and treasury dealing-room management system (TDRMS). The SSS system and central depository system (CDS), which maintained the records of government securities issued in electronic form, were brand-named LankaSecure. The RTGS System and LankaSecure were brand-named LankaSettle. The RTGS System went live in September 2003 and the other systems were inaugurated in early 2004.

With a view to outsourcing non-core functions, the central bank divested its cheque clearing and offline electronic payment system, titled Sri Lanka Interbank Payment System (SLIPS), to a newly formed company, LankaClear (Pvt) Ltd (LankaClear) jointly owned by the central bank and LCBs. LankaClear was expected to improve the efficiency of the clearing process of payment instruments by attracting new management and technology and adopting a cost-effective operating system. The central bank has announced that, as a way-forward strategy, the central bank and LankaClear are making arrangements to implement a cheque imaging/truncation project. To overcome legal constraints relating to retail payments and acceptance of electronic presentment of cheques, the central bank has initiated action to introduce a payment transactions law, yet to be presented to parliament.

Scripless securities

Legislation was enacted to enable the issue and trading of scripless securities and dematerialization of the existing scrip securities. The conversion of outstanding scrip securities into scripless securities commenced on January 30 2004 and the operation of the SSS system and the CDS for government securities commenced on February 3 2004.

Legal and regulatory structure

According to the UPFA government's economic policy statement: "the modernization of the country's legal and regulatory framework is essential for the promotion of the business environment and to reduce transaction cost of business operations. This government will place a significant emphasis on commercial law reforms, capacity building in the judicial and legal profession through specialized training, modernization of physical infrastructure and technology to improve efficiency and quality of judicial and legal services. Commercial and financial statutes will be reviewed and new legislation addressing institutional aspects and their transactions will be introduced. The company registry will be modernized and a new Companies Act will be introduced with a view to providing a business-friendly governance structure."

Exchange control

The central bank's annual report for 2003 published on April 30 2004 (a few days after the change of government) announced the Foreign Exchange Management Act (FEMA), to replace the current Exchange Control Act as decided earlier. It is expected that Sri Lankans will be permitted under the FEMA to hold foreign assets, including bank accounts, abroad, provided the foreign assets had not been derived from the conversion of Sri Lankan currency or the disposal or conversion of assets in Sri Lanka or the provision of a service within Sri Lanka. Capital transactions might also be further liberalized under the FEMA. The new UPFA government announced on July 1 2004 that it will maintain a liberal foreign exchange policy environment with regulatory safeguards to promote a stable foreign exchange market.


Among the new tax levies introduced from April 1 2004 are:

  • a new tax in the form of an economic service charge (ESC) of 1% is imposed on turnover or total assets value for entities carrying on trade business profession or vocation that have a turnover in excess of Rs20 million or total assets in value in excess of Rs10 million;
  • an upfront tax of 10% on the divisible profits and other income of all partnerships;
  • profits earned from sale of shares (including rights bonuses and warrants and shares in BOI companies) that are issued by any company are also made liable to tax at 15%.

From January 1 2004, value-added tax (VAT) rate was unified at 15%. The turnover threshold of Rs500,000 a quarter of payment of VAT is raised to Rs750,000 a quarter and annual threshold increased to Rs3 million.

Tax amnesty

The Inland Revenue (Special Provisions) Act 10 of 2003 was enacted to grant amnesty to tax payers from income tax and certain specified revenue laws. The amnesty was extended to exchange control, and also excise and customs duties if declarations were made in terms of the law. Constitutionality of this law was not challenged within the time prescribed in terms of the Constitution. Subsequently, on a reference made by Her Excellency the President, the Supreme Court opined that the law was not constitutional. However, the Supreme Court's opinion on such reference does not affect the validity of the amnesty law.

Author biographies

Velupillai Murugesu

Murugesu & Neelakandan

Velupillai Murugesu established the firm of Murugesu & Neelakandan in 1962. Murugesu completed his 50th year of practice in 1999. He is also a Solicitor of the Supreme Court of England.

Murugesu passed out as a proctor of the Supreme Court of Ceylon, as it was then known, and joined the firm of F J & G de Saram as a professional assistant in 1948. Murugesu was associated with that firm for 12 years and was a partner when he resigned from the partnership in 1962 to begin his own firm.

With the amalgamation of both branches of the legal profession (proctors and advocates) in 1974, all the proctors and the advocates who were in practice on that date are now attorneys-at-law.

Murugesu has wide experience and knowledge of trade marks, patents and other intellectual property matters and in company law, conveyancing and litigation. He now concentrates largely on conveyancing, company law, intellectual property law and testamentary matters and general legal advice on clients' specific problems. His expertise and experience is drawn upon for the overall guidance and supervision of the work of the firm. He was the secretary of the committee that drafted the Companies Act 17 of 1982. He was also a member of the Company Law Advisory Committee.

He is an overseas member of the Institute of Trade Mark Agents and a member of the Asian Patent Attorneys Association (APAA).

Kandiah Neelakandan

Murugesu & Neelakandan

Kandiah Neelakandan enrolled as a proctor of the Supreme Court of Ceylon in 1970. He joined the firm as a professional assistant in the same year and became a partner in 1973. Neelakandan specializes in international financial law, investments, banking and company matters, and has advised foreign clients on loans and commercial documentation. He has attended several law conferences and read papers on investment laws and securities for bankers' advances, including LAWASIA, APLA and IBA conferences and International Financial Law seminars.

He is a member of the IBA, the Asia-Pacific Lawyers Association (APLA), LAWASIA and the APAA. He is the council member for Sri Lanka in APLA and the country representative of the IBA in Sri Lanka. He is also an active member of the Bar Association of Sri Lanka (BASL), of which all the lawyers in the country are members, and was its assistant secretary for two years. Neelakandan has also been on the executive committee of the BASL for many years and held the office of Treasurer from 1997 to 1999. He has been editing the BASL law journal since 1989, and has contributed articles on various legal subjects. He has chaired a number of BASL standing committees and organized a number of law conferences and seminars.

Neelakandan was the chairman of the Legal Aid Commission of Sri Lanka (a national body in charge of legal aid work) until May 2001. He served on an advisory committee that was appointed by the Ministry of Justice to examine law delays and suggest amendments to civil laws. He is a member of the board of governors of the Sri Lanka Arbitration Centre. He was also a member of the Finance Commission of Sri Lanka, which advised the government on allocation of funds to provincial councils. He is a member of the Company Registry Advisory Committee of the Ministry of Trade. The Minister of Commerce and Consumer Affairs recently appointed him a member of the Company Law Advisory Commission.

Murugesu & Neelakandan
M&N Building (Level 5)
No. 2, Deal Place
Colombo 3
Sri Lanka
Tel: +94 11 237 1100
Fax: +94 11 2371111
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