ECONOMIC PROBLEMS AND COMMUNAL CONFLICT IN SRI LANKA

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP06T00412R000505150001-4
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 19
• Document Creation Date: December 22, 2016
• Document Release Date: April 30, 2012
• Sequence Number: 1
• Publication Date: February 1, 1986
• Content Type: REPORT

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Intelligence 25X1
Economic Problems and
Communal Conflict in
Sri Lanka
Seeret
NESA 86-10010
February 1986
Copy 2 4 9
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Directorate of Secret
Intelligence
Sri Lanka
Economic Problems and
Communal Conflict in
Office of Near Eastern and South
Asia Division, NESA,
Asian Analysis. Comments and queries are
welcome and may be addressed to the Chief, South
Secret
NESA 86-10010
February 1986
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Economic Problems and
Communal Conflict in
Sri Lanka
Key Judgments Two and a half years of mounting communal violence have created
Information available economic problems for Sri Lanka:
as of 28 January 1986 ? Increased defense costs have led to spending cuts in rural development
was used in this report.
programs, public-sector industrial investment, and social welfare
programs.
? The threat of violence has reduced earnings from the tourist industry by
nearly 40 percent from a peak in 1982 and contributed to large current
account deficits.
? Concern over political stability and the protection of property has made
foreign and domestic businessmen reluctant to launch new ventures.
? Preoccupation with the communal violence has contributed to the
government's backsliding on economic liberalization and failure to
correct the currency's overvalued exchange rate.
The most important contributors to the Sri Lankan economy-the industri-
al heartland in the south, the central tea plantations, and the massive
Mahaweli Development Program aimed at irrigating Sri Lanka's extensive
dry zone-have not been severely damaged.
The communal violence is fueled in part by Tamil perceptions of economic
discrimination by the dominant Sinhalese. Tamils believe the government
has denied them a fair share of development funds and restricted their
access to government jobs. The settlement of newly irrigated lands-
particularly in the Eastern Province, considered a traditional homeland by
Tamils-is the most divisive economic issue. Prospects for agreement on
economic issues are dimming as overall national economic performance
declines.
If there is no peace settlement within the next six months, we believe the
insurgents will take the war to key economic facilities in Sinhalese areas.
The threat early this year to contaminate Sri Lanka's tea exports is
probably the beginning of militant attempts to hurt Sri Lanka's credibility
as a tea supplier.
Even if a peace settlement is reached, overall economic performance will
not improve significantly any time soon. The economy will remain heavily
dependent on world prices of agricultural commodities, which show no sign
of a dramatic increase. Government protection and structural inefficiencies
Secret
NESA 86-10010
February 1986
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will continue to plague public-sector industries. Foreign investors will
probably return only slowly. Repaying the large debt incurred to finance
development programs will continue to be a burden for the remainder of
the decade, and we expect Colombo to seek additional financial assistance
from the United States and other aid donors.
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Key Judgments
The Cost of Insurgency
Disruption
Growing Spending Strains
Foreign Investment and Aid
Tourism Hard Hit
Economic Issues in the Communal Conflict
Land Settlement
More Problems Down the Road
Implications for the United States
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Economic Problems and
Communal Conflict in
Sri Lanka
The communal conflict between Sri Lanka's Tamil
minority and Sinhalese majority is rooted in deeply
contested political and ethnic issues such as power
sharing, the preservation of distinct and separate
cultures, and the definition of minority rights in a
pluralist society. Any lasting settlement to the conflict
will require political concessions from both sides. As
the conflict continues, economic costs to both commu-
nities are mounting, and competition for land, em-
ployment, and development assistance is intensifying.
Economic issues, thus, are becoming increasingly
central to the conflict.
The Cost of Insurgency
The two-and-a-half-year-old insurgency has taken a
toll on the country's economic well-being. Rising
government expenditures for defense are forcing a
cutback in a wide range of social and economic
development projects. Civil strife has stunted the once
rapidly growing tourist industry and, we believe, has
contributed to the declining confidence of foreign
businessmen and aid donors in the government's
economic policies. The local economies of the North-
ern and Eastern Provinces have been imperiled by
insurgent attacks on critical rail links and mining of
the limited road network.
Disruption. The insurgency has had its greatest eco-
nomic impact in the economically backward Northern
and Eastern Provinces, where most of the fighting has
taken place and where most Tamils live. Embassy
reports indicate insurgent attacks on infrastructure
targets, such as roadways, railroads, and port facili-
ties; repeated robberies of banks and businesses by
Tamil militants; and the general collapse of civil order
have crippled economic life in Jaffna, the major city
in the north. Products supplied from Jaffna to the rest
of the country-fish, salt, and cement-are in short
supply throughout Sri Lanka due to the decline in
economic activity in the north.
Sri Lanka's insurgency is based primarily in rural
areas, except on the Jaffna Peninsula, where the
militants have control of or access to most of the city,
the country's second largest. In the Northern Prov-
ince, the insurgents have established training camps
and stockpiled weapons within striking distance of
main rail and road links. In the Eastern Province,
they control the outskirts of key towns and coastal
areas. They also control jungle areas bordering on
sectors of the Mahaweli Development Program. Jun-
gle hideouts have proved so effective that the govern-
ment is clearing foliage in the Eastern Province as a
counterinsurgency measure.
Insurgent strategy has relied heavily on attacks
against central government authority in the Tamil-
dominated areas of the north and east. Army camps,
police stations, central banks, libraries, railroads and
stations, roads, and residences of local government
agents reporting to Colombo have been targeted for
landmine and grenade attacks by the guerrillas. By
avoiding large-scale clashes with government forces,
the insurgents have kept their casualties low. Their
strategy has provoked frustrated and undisciplined
security forces into reprisals against Tamil civilians
that frequently include the destruction of homes,
villages, farm implements, and vehicles.
The insurgents' successes, however, have cost them
some Tamil civilian support. According to Embassy
reports, economic disruption in Tamil areas is help-
ing to shape Tamil opinion in favor of a negotiated
settlement and against continued logistic support to
the guerrillas. some
Tamil groups recognize the need to avoid antagoniz-
ing Tamil civilians
Other militants, how-
ever, remain committed to antigovernment attacks in
Fishing, a major part of the economy in the north, has
been hit hard. The fish catch dropped by 23 percent in
1984, and the government estimates another 10-
percent decline for 1985. Press and Embassy reports
spite of Tamil civilian opinion.
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note that the decline in coastal fish catches in the
northern and eastern regions results from increased
Sri Lankan naval surveillance, Army attacks on fish-
ing villages, and Tamil flight to India-mostly of
The most ambitious of Sri Lanka's major investment
projects is the Mahaweli Development Program.
Originally conceived as a 30-year undertaking by the
previous government, the project was accelerated
when Jayewardene came to power, and we expect that
the bulk of construction will be completed by the late
1980s at a cost of well over $2 billion.
The project involves the construction of four major
dams along the Mahaweli Ganga (River) and its
tributaries and a network of downstream irrigation
canals stretching from the mountainous center of the
island in a wide diagonal swath northeast to the
Trincomalee region. The dams will provide badly
needed hydroelectric power, while irrigation will open
up and areas to intensive agriculture and the resettle-
ment of landless farmers.
fishermen.
Blocked transport links to Colombo and periodic
militant attacks on rice farmers have disrupted pro-
duction, milling, and marketing in the north and east,
resulting in near famine conditions in parts of the
Eastern Province. Rice farmers in the Sinhalese
south-where food production is concentrated-have
been unable to compensate for the disruptions, and
the government imported 200,000 metric tons of rice
in 1985 to bolster national stocks.
In at least one case, Tamil militants may already have
engaged in economic warfare against the government.
One group in January 1986 claimed to have contami-
nated an undetermined quantity of Sri Lanka's tea
export with potassium cyanide. Although no poisoned
tea has been found, the threat prompted one Austra-
lian firm to cancel imports of Sri Lankan tea; other
buyers are assessing their purchases. Any long-term
disruption in Sri Lanka's tea trade, which accounted
for approximately 30 percent of Sri Lanka's 1985
export earnings, would have a severe impact on the
country's balance of payments and government
revenues.
Growing Spending Strains. The government's
counterinsurgency effort has begun to cut into eco-
nomic development. Supplementary appropriations by
Parliament in 1985 boosted allocations for defense to
about $230 million-85 percent greater than the
original budget and almost 170 percent more than
1984. Defense expenditures-more than half of which
are earmarked for Army and police pay-are now the
second-largest item in the budget and account for 10
percent of government spending, compared to 3 per-
cent in 1982. Spending on rural development projects,
public-sector industries, social welfare programs, and
the Mahaweli Development Program has been re-
duced; and the budget for 1986 indicates additional
cuts will be made in these areas.
last year increased to an estimated 23 percent from a
1984 level of about 17 percent
The government's financial aid to industries damaged
by the fighting has put additional, if small, strains on
the budget. In 1985, about $8 million was advanced to
the public cement corporation, whose plant on the
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Table 1
Confirmed Sri Lankan
Arms Purchases, 1980-85
1981
1982
1984
985 a
1985-
Table 2
Table
Sri Lanka:
Foreign Participation in
Approved Industrial Investments, 1979-84
Greater Colombo
52
163
51
56
8
Economic Commission
Outside Greater
NA
55
32
16
11
Colombo Economic
Commission
17
20
Jaffna Peninsula had virtually halted operations be-
cause of the fighting, so it could meet interest and
amortization payments. The government recently an-
nounced a plan to bail out hotel owners to help the
tourist industry survive the next year or so. The relief
package includes a soft loan of $3.3 million for
seriously affected hotels, rescheduling of old debts,
and a reduction of the business tax.
Backed by hardliners in the Cabinet and supported by
his Sinhalese constituents, Jayewardene, in our view,
will not significantly cut defense spending until he
and the Sinhalese public believe the insurgents no
longer pose a major security threat. The government
will have to increase nonbank borrowing and domestic
commercial bank loans to cover its budgetary short-
fall. Domestic commercial bank liquidity is ample
because interest rates and poor investment prospects
have dampened private demand for funds.
Foreign Investment and Aid. Although the militants
have not launched attacks against foreign companies
operating in Sri Lanka, the general instability has
taken a toll on foreign investment. The government
maintains that foreign investors continue to express
interest in Sri Lanka, although it admits their num-
bers have been reduced.
Embassy in Colombo reported that a West German
and Swiss partnership withdrew a $10 million com-
mitment to a construction project in Trincomalee in
mid-1985 in the wake of growing guerrilla operations
in the Eastern Province.
New government incentives for foreign investors sug-
gest the government is trying to offset some of the
insurgency's negative impact on investor confidence.
In October 1985, Colombo authorized foreign firms to
lease readymade factories, exempted their earnings
from income tax during certain periods, and allowed
each firm to employ an unlimited number of foreign
personnel.
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Finance Minister Ronnie de Mel echoed concern that
new foreign investment might not be forthcoming in
his budget speech to Parliament in November 1985.
He cited two prerequisites for new foreign investment
in economic development programs: peace and the
political will and determination to carry through the 25X1
economic reforms initiated in 1977.
The communal conflict has also caused some cuts in
foreign aid. Diplomatic reporting indicates Canada-
a major donor to the Mahaweli Development Pro-
gram-decided in early 1985 to withhold funds ear-
marked for the next stage of the irrigation network to
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Figure 2. Communal violence frightens investors
and tourists.)
protest alleged violations of human rights by govern-
ment security forces against Tamils. In our view,
Ottawa will resume its aid, which is targeted for
Tamil areas within the program's purview and tied to
Saudi and World Bank funding, only if Colombo gives
assurances that Tamils will get a fair share of lands to
be irrigated. To some degree, the cutback reflects
lobbying by Canada's large and well-organized Sri
Lankan Tamil community.
Another aspect of the communal conflict-Colombo's
search for foreign military expertise-has, in at least
one instance, adversely affected foreign aid. In 1984,
Saudi Arabia, a major donor to the Mahaweli Pro-
gram, withheld a $50 million installment on the
program's next irrigation project to protest Colombo's
willingness to accept Israeli security assistance. Rela-
tions with Israel may also jeopardize trade relations
with Arab states that import large quantities of Sri
Lankan tea.
Lobbying efforts by vocal Tamil support organiza-
tions in Europe threaten to harm Colombo's relations
with its principal European donors.
Figure 3
Sri Lanka: Tourism, 1978-85
Receipts
I I I I I I 1 1
1978 79 80 81 82 83 84 85a 0
a Based on January through November arrivals.
groups recognize that nonmilitary development assis-
tance eases Colombo's budgetary constraints, giving
the government a freer hand to boost defense
spending.
250,000 in 1985.
Tourism Hard Hit. The tourist industry, cited not
long ago as the success story of Asian tourism, has
been a major casualty of the insurgency. Earnings
from the tourist industry have declined from a peak of
almost $150 million in 1982-before the conflict
worsened-to about $90 million in 1985. The number
of tourists declined from 407,000 in 1982 to about
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Figure 4
Principal Ethnic Groups in Sri Lanka
Sinhalese-inhabited area
Tamil-inhabited area
Province boundary
the cutback in arrivals since the fighting has been among
large charter agencies, particularly in Western Eu- Asians, predominantly Indians. Tourism is likely to
rope, are canceling Sri Lankan tours because of the remain a depressed sector until a lasting communal
continuing communal conflict. Western Europe has settlement is reached and Sri Lanka repairs its repu-
accounted for over half of tourist arrivals for the last tation as an island paradise.
decade, and West European tourists were the only
group to show an increase in 1984. The biggest
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Economic Issues in the Communal Conflict
The insurgency is fueled in part by Tamil perceptions
of Sinhalese economic discrimination. Tamils claim
that, since the early 1970s, successive Sinhalese gov-
ernments have denied Tamil areas a fair share of
central government development outlays, restricted
access to government jobs, and denied Tamils the
benefits of newly irrigated lands. In our view, the
failure of the Jayewardene government over the last
four years to address these economic grievances and
to fulfill promises of limited autonomy to Tamil areas
has heightened Tamil frustrations and strengthened
Tamil civilian support for the insurgency.
Prospects for reconciliation on these economic issues
are dimming as overall national economic perfor-
mance declines. Weak demand in the labor-intensive
construction and tourism industries in the last two
years has reduced job opportunities in the Sinhalese
south, and his will lead to
increased unemployment. We believe Jayewardene
will be reluctant to make concessions to Tamils on
employment in state-run industries or in the govern-
ment as long as rising unemployment threatens his
Sinhalese constituency.
Tamil demands for central government outlays will
face even tougher opposition from the government in
the face of foreign aid cuts. A study by a prominent
US academician using interviews with Tamil political
leaders indicates that most Tamils have considered
Colombo's investment policy biased in favor of Sinha-
lese areas since the late 1970s. In cases where the
government has decided to invest in Tamil areas or to
permit foreign investment, such as in Jaffna's cement
factory and in fish-processing plants in the Eastern
Province, Sinhalese and foreign personnel have often
been employed at the expense of local Tamils. Faced
with diminished resources, the government is even
more likely to continue its preferential development
strategy and will probably be reluctant to allot new
funds to Tamils.
Land Settlement. The settlement of newly irrigated
lands is the most divisive economic issue between the
government and Tamils. Jayewardene's decision in
1977 to accelerate the Mahaweli Program under-
scores the government's desire to find new land for
Sinhalese farmers and to resettle them in sparsely
populated areas of Sri Lanka's extensive dry zone,
which is to be irrigated by the program. It is intended
to promote both domestic food production and pro-
duction of crops for export-both important political
demands of the government's Sinhalese constituency.
With the core of its electoral support anticipating
benefits from the Mahaweli Program, Colombo is
determined to keep control of the settlement issue. As
lands have become arable under the program,
Jayewardene has financed and armed Sinhalese set-
tlements in areas regarded by Tamils as their tradi-
tional homeland. The Tamil militants want jurisdic-
tion over land settlement to establish control over the
Eastern Province. Tamils consider the area a tradi-
tional homeland, but they constitute only 42 percent
of the population there. A US Embassy source sug-
gests no Colombo government responsive to Sinhalese
interests could cede authority over settlement of these
areas to local administrative units-a key Tamil
demand.
Tamils have argued publicly that Colombo's land
settlement perpetuates economic discrimination
against them. As long as Colombo retains a monopoly
on both the best lands in the south and on newly
irrigated lands in the north and east, Tamil farmers
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Figure 6
Economic Activity in Sri Lanka
Cement
Railroad equipment
? `(
Ceramics
and repair
Saltern
Kankesanturai
Chemicals
Sawmill
0.Chunnakam
tt.Elephant Pass
0(
Ift
0
Fish processing
Mineral sands
processing
Petroleum refining
Plywood
jk
0
Ship repair
Steel mill
Textiles
Tires
Parantan
Tea growing area
Jaffna
Mullaittivu??
MINING
ELECTRIC POWER
Pulmad dai
Gembearing area
Graphite
Iron nre
Mineral sands
Hydro
Thermal
Diesel
Mannar
Kalpitiya'~ - ,~i
-- _ ! Eppawala
Negomba
?0; 0 0 ~Pugoda ,.
Colombo
B 111ougaltakanda
?d' $'Oruwala
B emuwala
DRY ZONE
(under 65 inches ps/year)
Galle
will be forced to cultivate the economically less
productive land. Embassy reports indicate that, while
new Sinhalese settlements have drawn frequent insur-
gent attacks, the militants have not attacked the
Mahaweli Program's network of canals and dams,
suggesting they are reluctant to sabotage an economic
asset that could be vital to Tamils.
~yPadtupana
1 ` Bundala Wellaga ngoda
Hambantota
50 Kul omr?rirs
50 Miles
More Problems Down the Road
We see two likely scenarios for the Sri Lankan
economy in 1986. In the first and less likely case,
Indian mediation efforts could lead to a partial settle-
ment between the government and moderate Tamil
11 Jo.
Trincomalee
?,~B a tt is ada
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groups that would grant some autonomy to Tamils
but not enough to defuse insurgent demands for a
separate state. A partial settlement would have only a
limited positive impact on the Sri Lankan economy.
In our view, Colombo would be forced to maintain
high defense expenditures to protect against militants
who reject the settlement, as well as to rebuild the
central government presence in the Northern and
Eastern Provinces. Even if the government makes
significant concessions on autonomy, we doubt all
major militant groups can reconcile their internal
rivalries and accept an agreement. With some Tamil
militants still likely to launch antigovernment opera-
tions, we doubt that investors and tourists would
return quickly to Sri Lanka.
The second and more likely scenario entails a collapse
of negotiations between the government and Tamil
leaders and a resumption of full-scale fighting. Under
these conditions, the economic costs of the insurgency
to the government would probably grow. The govern-
ment would probably continue a military buildup,
forcing higher budget deficits and further cuts in
economic development programs. Damage to Sri
Lanka's agricultural output, fish production, econom-
ic infrastructure, tourist industry, and foreign investor
and donor confidence would become more pro-
nounced.
In either scenario, the most hardline Tamil groups are
likely to attack economic centers in the Sinhalese
south to force further concessions from Colombo.
Even in the unlikely event that a political settlement is
reached and communal violence subsides quickly, the
Sri Lankan economy faces longer term structural
problems. Domestic economic growth will continue to
be plagued by insufficient public funds for domestic
investment. The government has not shown the will to
broaden the tax base and is likely to continue the
inefficient structure that relies heavily on export and
import taxes. Colombo is also faced with the burden
of paying for past borrowing from foreign commercial
banks and domestic banking and nonbanking sources
to cover budget deficits. Debt service is now the
largest item in the budget, accounting for 20 percent
of expenditures.
The long-term imbalance in Sri Lanka's foreign pay-
ments, obscured in 1984 by an improvement in ex-
ports, reappeared in 1985. The country's ability to pay
its foreign trade debts is highly dependent on volatile
world commodity prices, and the government is doing
little to stimulate new items for export. Sri Lanka's
"managed floating" exchange rate has not reflected
the high rate of domestic inflation, and most financial
observers consider the currency overvalued. The open
market value of the rupee has appreciated almost
continuously since 1977, adversely affecting the com-
petitiveness of nontraditional exports and import-
substituting industries.
ments.
Implications for the United States
Continuing violence, whether the result of an untidy
settlement or widespread new fighting, is likely to
make Sri Lanka even more dependent on US and
other foreign aid to offset mounting defense expendi-
tures and a worsening foreign payments position.
Even if the insurgency subsides, Colombo will almost
certainly request additional development assistance
from the United States and others to help fund
recovery costs and to meet international debt commit-
attract investment.
Prospects for renewed foreign investment will depend
not only on the status of the insurgency, but also on
the development of new investment opportunities.
Even if domestic peace can be restored, Colombo will
have to resume its economic liberalization program to
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Table 3
Sri Lanka: Balance of Payments, 1980-85
-798
-610
-732
-644
-220
-570
Trade account
-987
-818
-983
-856
-436
-750
Exports, f.o.b.
1,065
1,065
1,013
1,062
1,475
1,260
Tea
374
335
305
353
620
370
Garments and textiles
109
156
168
201
296
375
Imports, c.i.f.
2,051
1,883
1,996
1,918
1,911
2,010
Services, net
52
6
-14
-61
-62
- 100
Tourist receipts
111
132
147
127
115
90
Interest payments
-59
-121
-128
-173
-180
-190
Private transfers, net
137
203
265
274
277
280
-216
-31
- 20
0
304
-- 20
11 Based on CIA estimates and preliminary data from the Govern-
ment of Sri Lanka.
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Appendix
Economic Conditions
Under Jayewardene
Following his election in 1977, President J. R.
Jayewardene undertook a free market approach to
economic development. He eliminated foreign trade
and currency controls, devalued the rupee, liberalized
imports, introduced investment tax incentives, and
reduced consumer subsidies on essential commodities.
His policies encouraged an increased flow of foreign
aid to help finance development projects. Official
foreign aid grew from about $130 million in 1976 to
$530 million in 1984. In particular, the government
accelerated public investment in the Mahaweli Devel-
opment Program to enable Sri Lanka to reach food-
grain self-sufficiency and to increase electrical power
supplies by the end of the decade.
Jayewardene's program stimulated rapid economic
growth in sectors providing quick returns on invest-
ment and yielding high profits. During 1978-81,
annual real growth rates averaged about 6.5 percent,
compared to less than 3 percent under the left-of-
center government led by Sirimavo Bandaranaike
from 1970 to 1977. The most dramatic growth oc-
curred in the private sector in construction, real
estate, trade, and tourism. Nontraditional exports,
particularly textiles and garments, also registered
impressive increases. New jobs created by higher
investment reduced the unemployment rate from a
peak of 24 percent during the Bandaranaike period to
about 14 percent in 1983. One of the most successful
ventures was the free trade zone established near
Colombo, which accounts for more than 90 percent of
Sri Lanka's foreign investment. The government re-
ports 30 countries have so far invested $350 million in
over 200 projects in the zone
Economic liberalization produced only mixed results
in the agricultural sector. By paying higher prices for
rice, promoting new seed varieties, increasing fertiliz-
er subsidies, and removing a myriad of controls, the
government successfully encouraged farmers to in-
crease rice production dramatically. Output in recent
years has averaged 60 percent above the 1970s, and
Sri Lanka is now nearly self-sufficient in rice.
Figure 7
Sri Lanka: GDP Growth, 1978-85
Production of traditional cash crops, however, re-
mained sluggish. Output of tea, coconut, and rubber,
which accounts for about half of export earnings, 25X1
continued the trend of stagnation that followed the
nationalization of plantations in the early 1970s. The
Jayewardene government maintained state ownership
and control and did little to improve management or
spur new investment. Instead, high export taxes were
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 Declassified in Part - Sanitized Copy Approved for Release 2012/06/18: CIA-RDP06T00412R000505150001-4
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Figure 8
Sri Lanka: Agricultural
Production, 1978-85
I I
1.2 1978 79 80 81 82 83 84 85a
imposed as the most expedient method of buttressing
government revenues, and public expenditures were
directed toward other crops.
Growth Stalls
After a short initial burst, economic growth began to
slow and probably fell below 4.5 percent in 1985-the
lowest level since 1977. The ambitious public invest-
ment program was not accompanied by adequate
incentives for private domestic savings or exports. The
budget regularly included large deficits, inflation hit
almost 40 percent compared to less than 10 percent in
the early 1970s, and the current account deficit
widened to more than six times the level of the 1970s.
Fiscal and monetary restraints, started in 1982 under
Million kilograms
pressure from the IMF, were the primary causes for
I I I I I I 1 1
120 1978 79 80 81 82 83 84 85a
I I I I I I I I
1.8 1978 79 80 81 82 83 84 85a
the economic slowdown. The flagging international
trade environment, drought, and the expanding com-
munal conflict have also been major contributing
factors in the faltering growth rates.
With the exception of the textile and garment indus-
tries, which the government has actively promoted,
growth in the industrial sector has slowed. Colombo
has been unwilling to make the personnel and other
changes needed to improve the poor performance of
the politically entrenched state-run enterprises. In-
stead, it has continued to provide subsidies for ineffi-
cient industries that are having difficulty competing
in a more open domestic economy. The government
also has been unable to reverse a five-year decline in
the development of new private-sector industries.
Some of the problems can be attributed to a lack of
lucrative investment opportunities and to infrastruc-
ture weaknesses such as poor communications. They
can also be traced to the government's failure to build
upon earlier reforms and to maintain the momentum
of the liberalization program. The Jayewardene gov-
ernment has not pursued policies to encourage invest-
ment in new areas and has done little to correct the
rupee's overvalued exchange rate.
Sri Lanka's foreign payments position, which has
been in deficit throughout most of Jayewardene's
tenure because of the high level of imports, improved
in 1984. Colombo's trade deficit was nearly half that
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 Declassified in Part - Sanitized Copy Approved for Release 2012/06/18: CIA-RDP06T00412R000505150001-4
Figure 9
World Tea Prices, 1976-85
I I I I I I I I I I
0 1976 77 78 79 80 81 82 83 84 85a
of 1983, and, by the first quarter of 1985, foreign
financial reserves had increased by almost 85 percent
over the previous year-to $540 million-and were
equivalent to about three months' imports. Record
world tea prices enabled Sri Lanka to almost double
the value of foreign tea sales, which amounted to
more than 40 percent of total exports in 1984. Tex-
tiles, which contributed only 7 percent of export
earnings in 1979, had by 1984 nearly tripled their
share to 20 percent-largely because of exports to the
United States.
We expect the foreign payments position will deterio-
rate again in 1986. Tea earnings are likely to drop by
more than 40 percent because of lower world prices;
the volume of exports will probably grow slowly.
Exports of textiles and garments, while still growing
donors and the IMF for additional loans.
and even rivaling tea as the top money earner, face
stiff competition from other exporters and growing
protectionist sentiment from importing countries.
Slow export growth, a growing debt burden, and
falling tourist receipts might compel the government
to impose controls on imports and will make it
difficult for Colombo to meet foreign debt repay-
ments. The government probably will turn to aid
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 Declassified in Part - Sanitized Copy Approved for Release 2012/06/18: CIA-RDP06T00412R000505150001-4
Secret
Secret
Declassified in Part - Sanitized Copy Approved for Release 2012/06/18: CIA-RDP06T00412R000505150001-4