Sri Lanka WT/TPR/S/237 
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I. ECONOMIC ENVIRONMENT 
(1) INTRODUCTION  
1. During the review period (2004-09), Sri Lanka's economy grew by a robust 6% per year in 
real terms, supported by strong domestic demand.  Th is fast growth allowed GDP per capita to double 
between 2004 and 2009 to reach US$2,053.  Such  performance was achieved despite the internal 
conflict, a major natural disaster, and the recent global  economic crisis.  Although the crisis has had a 
relatively limited impact on the country's economic gr owth, it did affect Sri Lanka's external trade, 
particularly owing to a drop in demand from its majo r trading partners, the EU and the United States.  
Foreign direct investment flows, on the other hand, do  not seem to have been severely affected by the 
internal conflict or the crisis.   
2. Sri Lanka responded to the global economic slowdown by adopting a number of fiscal 
measures targeted to support export-oriented i ndustries, and by increasing taxes falling mostly on 
imports.  Monetary policy was also used actively to ensure an adequate level of liquidity, while the 
exchange rate was allowed to float more freely.  Inflation, which had peaked in June 2008, fell to 
below 5% by end 2009, aided by tighter monetary policy and the easing of international commodity 
prices. 
3. The deficit in the current account of Sri Lanka's  balance of payments increased substantially 
during the review period, reaching 9.5% of GDP in 2008, and, together with a sharp outflow of capital 
resulting from the global financial crisis, led to a subs tantial loss in foreign exchange reserves.  This 
prompted the authorities to adopt measures to bolster  liquidity, increase foreign exchange inflows, and 
strengthen the balance-of-payments position, and to  seek IMF financing, resulting in a Stand-by 
Arrangement subscribed in mid 2009 for a total of US$2.6 billion.  Under the arrangement, Sri Lanka 
committed to trim the budget deficit and eliminate losses in two major state utilities, among other targets. 
4. The end of the internal armed conflict in  May 2009 offers new growth opportunities, 
particularly in the north and east of the country.  While economic expansion may be boosted by the 
reconstruction effort in the short- and medium-t erm, sustained growth will require macroeconomic 
stability and completion of the currently pending structural reforms, including tax reform, the 
restructuring of state-owned enterprises, and taking steps towards a more flexible labour market.  
5. The contribution to GDP of both merchandise exports and imports fell during the period 
under review:  from 27.9% in 2004 to  16.9% in 2009 in the case of exports, and from 38.7% to 24.3% 
in the case of imports.  Production and trade remain c oncentrated in a few products and markets, and 
agricultural products continue to be major ear ners of foreign exchange.  Exports to the 
European Union and the United States account for some 60% of Sri Lanka's total exports;  and the share of exports of tea and clothing, albeit lower th an in the last review, is still almost 60%.  The 
authorities consider that Sri Lanka has the potential  to expand its industrial base by focusing on 
industries with higher value added.  This will re quire investment in new technologies and in human 
capital. 
6. A more predictable and transparent trade and investment regime would help to enhance 
investor confidence.  Also, a rationalization of the incentive regime and lower reliance on taxes on 
imports could help improve resource allocation and overall economic efficiency, hence increasing 
Sri Lanka's international competitiveness.  The first steps in this direction were made in June 2010 
with the reduction of tariff rates and elimination of the import surcharge (see below). WT/TPR/S/237 Trade Policy Review 
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(2) RECENT ECONOMIC DEVELOPMENTS  
7. Large and persistent budget defic its, high inflation, a deterioration in the external current 
account balance, and over-reliance on short-term international financ ing, made Sri Lanka vulnerable 
to the world economic crisis that started in 2008.  The global financial crisis led to substantial capital 
outflows from the country, and efforts to keep th e Sri Lankan rupee from depreciating resulted in a 
drastic decline in foreign exchange reserves to US$1.7 billion by December 2008, equivalent to only 
1.5 months of imports.1  The crisis significantly curtailed trad e and capital flows, leading to a sharp 
drop in demand in Sri Lanka's major markets.  This  has caused exports (mainl y garments and tea) to 
contract since early 2009, exerting furthe r pressure on international reserves.   
8. To avert a balance-of-payment crisis, Sri Lanka requested support from the IMF and secured 
a Stand-by Arrangement in July 2009, for a total of SDR 1.65 billion (about  US$2.6 billion).  Under 
the Arrangement, the Government's economic re form programme (2009-11) aims primarily at 
restoring the country's public finances while ensuri ng the availability of resources for reconstruction 
spending, and maintaining an ade quate level of international reserves;  the programme is also 
expected to strengthen the domestic financial sector .  Several targets to attain these objectives have 
been set, most notably the reduction of the budget deficit to 5% of GDP by 2011.2  The Stand-by 
Arrangement has helped Sri Lanka avoid a balan ce-of-payments crisis, build foreign exchange 
reserves to a more comfortable level, and improved investor confidence.  Nevertheless, certain tax 
reform measures, envisaged under the Arrangement and necessary to pave the way for sustainable 
growth are still pending (see below). 
9. Sri Lanka's response to the global economic cris is has been mostly geared to supporting the 
export sector, which has been affected by demand s hortfalls and declining international commodity 
prices.  Some economic stimulus measures were in troduced in late 2008, including price-stabilization 
subsidies for tea, rubber, and cinnamon;  availability of subsidized fertilizer for tea smallholders;  and 
a subsidy for planting and replantin g offered to rubber growers (Chapter IV(2)).  Also, the prices of 
gasoline, diesel, and other petroleum products were reduced.   
10. In January 2009, the Government announ ced a Rs 16 billion (some US$140 million) 
economic stimulus package targeting export-oriented industries;  the authorities indicated that, as at 
June 2010, less than Rs 1 billion (US$89 million) had been disbursed.3  Approved by Parliament in 
2009, the package included an Export Development Reward Scheme, under which a 5% rebate is 
provided to industrial exporters th at maintain export earnings, employ ment, and value added at least 
at a level equivalent to that of 2008.4  The package also provided for the removal of a 15% surcharge 
on electricity for the apparel, rubber, and tourism i ndustries.  Moreover, a tax on manufactured rubber 
exports was lifted.  The package has been welcomed by the export sector, although its cost, estimated 
at 0.3% of GDP, could place an additional burde n on already constrained public finances.   
11. The end of the 30-year internal conflict h as led to a surge in business confidence and a 
rebound in capital inflows.  There has also been a revival of economic activities in the Northern and 
Eastern provinces, which were directly affected by the conflict, with substantial increases in 
agricultural production, as well as trade and transpor t.  The tourism and related sectors have also 
benefited from the return of peace, and offer cons iderable growth potential in the near future.  
However, the reconstruction effort, including hu manitarian assistance and the resettlement of 
                                                      
1 Institute of Policy St udies Sri Lanka (2009). 
2 For further details see International Monetary Fund (2009). 
3 The exchange rate (buying rate) at end-June 2010 was Rs 112.8 per US$1. 
4 Exporters may either apply for cash or set off the re bate against their taxes.  For further details see 
Institute of Policy Studies of Sri Lanka (2009). Sri Lanka WT/TPR/S/237 
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internally displaced persons, will require considerab le spending over the next several years, which the 
authorities estimate at about 1% of GDP per year.5  Reconstruction spending could weigh heavily on 
efforts to consolidate public finances, although th e Government expects that its costs will be met 
through revenue enhancements, savings in defence spending, and concessionary financing from 
development partners.6 
(3) OUTPUT AND EMPLOYMENT  
12. The Sri Lankan economy has demonstrated remark able resilience during the review period.  
Despite the internal conflict, the 2004 tsunami, a nd the recent global economic recession, it expanded 
at an annual average of 6% between 2004 and 2009.  Growth was driven mainly by strong domestic 
demand, in particular fixed capital formation, wh ich expanded rapidly during the first years covered 
by the review (Table I.1).  The contribution of net exports of goods and non-factor services to GDP 
was negative throughout the period.  Although its effect on Sri Lanka's economic growth was 
relatively limited, the global economic slowdown did ha ve some impact on Sri Lanka's external trade, 
with merchandise export earnings declining by 12.7 % in 2009.  In addition, a domestic downturn, the 
escalation of the internal conflict in early 2009, and a setback in agricultural production due to 
unfavourable weather conditions, caused real gr owth to decelerate to 3.5% in 2009.   
Table I.1  
Selected macroeconom ic indicators, 2004-09 
  2004 2005 2006 2007 2008 2009a 
National accounts (% change based on constant figures) 
Real GDP (2002 prices) 5.4  6.2  7.7  6.8  6.0  3.5  
   Domestic demand 6.1  4.7  8.6  5.4  6.9  3.4  
        Consumption 4.1  3.3  7.1  4.5  7.9  4.1  
        Gross fixed capital formation 17.8  9.8  12.9  9.1  5.3  1.3  
   Exports of goods and non-factor services 7.7  6.6  3.8  7.3  0.4  -12.3  
   Imports of goods and non-factor services 9.0  2.7  6.9  3.7  4.0  -9.1  
 (% of current GDP, unless otherwise indicated) 
   Domestic demand 108.8  108.9  111.0  110.4  113.7  106.5  
        Consumption 83.6  82.1  83.0  82.4  86.1  82.0  
             Private consumption 70.9 69.0 67.7  67.2  70.0  64.3  
             Government consumption 12.6 13.1 15.4  15.3  16.2  17.6  
        Gross fixed capital formation 22.6  23.4  24.9  24.7  25.3  23.8  
   Exports of goods and non-factor services 35.3  32.3  30.1  29.1  24.8  21.4  
   Imports of goods and non-factor services 44.2  41.3  41.1  39.5  38.5  27.9  
        Net exports of goods and non-factor se rvices -9.1  -8.9  -11.0  -10.4  -13.7  -6.5  
Labour force participation rate (%)b 48.6  48.3  51.2  49.8  49.5  48.7  
Unemployment rateb (%) 8.3  7.7  6.5  6.0  5.4  5.8  
Prices and interest rates (%, unless otherwise indicated) 
Inflation (CPI, % change) 7.6  11.6  10.0  15.8  22.6  3.4  
Central bank interest rates (end period)       
     Repurchase (repos) rate (overnight) 7.50  8.75  10.00  10.50  10.50  7.50  
     Rediscount (reverse repo) rate (ove rnight) 9.00  10.25  11.50  12.00  12.00  9.75  
Table I.1 (cont'd)  
                                                      
5 In the 2009 Budget, the Government allocated Rs 18 billion (US$160 million) to reconstruction 
spending in the north, mostly for the provision of hu manitarian assistance and resettlement of people.     
6 International Monetary Fund (2009). WT/TPR/S/237 Trade Policy Review 
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  2004 2005 2006 2007 2008 2009a 
Commercial bank interest rates (end period)       
    Deposit rate (average weighted) 5.31  6.24  7.60  10.31  11.63  8.01  
    Prime lending rate (average weight ed) 10.17  12.14  14.74  17.00  19.17  11.12  
Exchange rate       
Rs/US$ (annual average) 101.188  100.499  103.962  110.623  108.334  114.945  
Real effective exchange rate (% change) -3.0  7.7  2.6  0.3  18.1  2.1  
Nominal effective exchange rate (% change)  -8.3  -0.3  -3.9  -10.8  1.1  -0.8  
 (% of current GDP, unless otherwise indicated) 
Fiscal policy        
Central government balance (excluding grants) -7.9  -8.4  -8.0  -7.7  -7.7  -10.3  
Revenue 14.9  15.5  16.3  15.8  14.9  14.6  
    Tax revenue 13.5  13.7  14.6  14.2  13.3  12.8  
Expenditure and net lending 22.8  23.8  24.3  23.5  22.6  24.9  
Revenue including grants 15.3  16.8  17.3  16.6  15.6  15.1  
Central government balance (including grants) -7.5  -7.0  -7.0  -6.9  -7.0  -9.8  
Central government total debt 102.3  90.6  87.9  85.0  81.4  86.2  
      Domestic debt 54.7  51.6  50.3  47.9  48.5  49.8  
Saving and investment       
Gross national savings 22.0 23.8 22.3 23.3 17.8 23.9 
Gross domestic investment 25.3 26.8 28.0 28.0 27.6 24.5 
Savings-investment gap -3.3 -3.0 -5.6 -4.6 -9.8 -0.6 
External sector       
Current account balance  -3.1  -2.7  -5.3  -4.3  -9.5  -0.5  
Net merchandise trade  -10.9  -10.3  -11.9  -11.3  -14.7  -7.4  
   Merchandise exports 27.9  26.0  24.3  23.6  19.9  16.9  
   Merchandise imports 38.7  36.3  36.3  34.9  34.6  24.3  
Services balance 2.0  1.4  0.9  0.9  1.0  0.9  
Capital account 0.3  1.0  1.0  0.8  0.7  0.6  
Financial account 3.7  1.9  4.6  4.0  7.0  -0.9  
     Direct investment 1.1  1.0  1.6  1.7  1.7  0.9  
Balance of payments -1.0  2.1  0.7  1.6  -3.4  6.5  
Terms of trade (1997 = 100, % change) -5.2  -4.2  -3.5  -1.0  -10.6   24.0  
Merchandise exports (% change) 12.2  10.2  8.4  11.0  6.2  -12.7  
Merchandise imports (% change) 19.9  10.8  15.7  10.2  24.7  -27.6  
Service exports (% change) 8.2  0.9  5.5  9.3  12.9  -5.6  
Service imports (% change) 9.5  8.5  13.9  7.5  8.9  -6.4  
Foreign exchange reserves (US$ million, end-period): 
        Figures from IMF 2,058.0  2,581.0  2,762.0  3,433.0  2,487.0   4,521.0  
        Figures provided by author ities 2,196.0 2,735. 0 2,837.0 3,508.0 2,402.0 5,357.0 
Total external debt (US$ million;  end-period) 11,346.0  11,354.0  11,981.4  13,989.0  15,106.6  18,662.1  
Debt service ratioc 11.6  7.9  12.7  13.1  15.1  19.0  
a Estimates. 
b For 2004, figures exclude Mullaitivu and K illinochchi districts;  for 2006 and 2007,  figures exclude Northern and Eastern 
provinces;  for 2008 and 2009, figures exclude Northern province. 
c As a percentage of earnings from exports of goods and services. 
Source: Central Bank of Sri Lanka online in formation.  Viewed at:  http://www.cbsl.gov .lk [06/04/10];  IMF, Balance of 
Payments and International In vestment Positi on Statistics, CD-ROM database;  and data provided by the 
authorities. 
 Sri Lanka WT/TPR/S/237 
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13. Sri Lanka's per capita GDP almost doubl ed between 2004 and 2009, from US$1,062 to 
US$2,053, as a result of several years of robust gr owth.  The population below the official poverty 
line (or Poverty Head Count Index-PHCI) declined from 23% in 2002 to 15.2% in 2007.7  However, 
substantial inequalities in income between the Western province and the rest of the country continue 
to be a concern, and the Gini coefficient has rema ined between 0.4 and 0.5.  Hence the particular 
emphasis on achieving equitable development in  the Government's Ten-Year Development 
Framework (2006-16) (TYHDF).   
14. The sectoral composition of Sri Lanka's economy has not changed significantly since its last 
Review (Table I.2).  The services sector continu es to be the driving force of economic growth, 
accounting for some 57.7% of GDP at current prices  in 2009.  Some service activities (i.e. wholesale 
trade, transport, telecommunications and banking) have expanded more rapidly than agriculture and 
manufacturing in recent years.  Mining and quarryin g (including gem mining) and construction have 
also been particularly dynamic.  The manufactur ing sector remains the second largest determinant of 
economic growth, accounting for 18.1% of GDP in 2009;  the largest contributor has been the food, beverages, and tobacco products category, while the contribution of textiles and garments has 
decreased slightly.  After years of progressive d ecline, the share of agri culture in GDP remained 
virtually unchanged during the review period, at  12.6% in 2009 (12.5% in 2004).  However, 
agriculture remains a cornerstone of Sri Lanka's economy as around 70% of the rural population depend on it for their livelihoods.   
Table I.2 
Basic economic indicators, 2004-09  
    2004 2005 2006 2007 2008 2009a 
Real GDP (Rs billion, 2002 prices) 1,827.6  1,941.7  2,090.6  2,232.7  2,365. 5  2,449.3  
Real GDP (US$ million, 2002 prices) 18,059.3  19,320.1  20,108.7  20,182.6  21,835. 3  21,308.5  
Current GDP (Rs billion) 2,090.8  2,452. 8  2,938.7  3,578.7  4,410.7  4,825.1  
Current GDP (US$ million) 20,662.9  24,406. 0  28,266.9  32,350.3  40,713.7  41,977.3  
GDP per capita at current market price (Rs) 107,432.0  124,709.3  147,776.3  178,845.0  218,167.0  235,945.5  
GDP per capita at current market price (US$) 1,061.6  1,240.9  1,421.1  1,616.7  2,013.8  2,052.7  
GDP by economic activity at constant 2002 prices  
Agriculture, livestock, and fishing 0.0 1.8 6.3 3.4 7.5 3.2 
Mining and quarrying 5.5 17.8 24.2 19.2 12.8 8.2 
Manufacturing 5.2 6.2 5.5 6.4 4.9 3.3 
 Processing (tea, rubber, and coconut) 4.5 1.4 0.8 2.4 5.3 0.7 
 Factor industry 5.2 6.4 5.7 6.7 5.0 3.4 
      Food, beverages and tobacco  products 5.7 6. 7 5.8 6.6 5.2 5.9 
      Textiles, clothing and leat her products 1.5 6. 0 4.0 7.3 3.1 0.6 
      Wood and wood products 2.4 8.2 4.2 3.4 2.3 3.7 
      Paper products, publishing and printing 7.3 7.5 6.5 8.5 6.3 2.3 
      Chemical, petroleum, coal, rubber and 
     plastic products 8.8 7.7 8.0 6.6 6.4 1.8 
      Non-metallic mineral pr oducts 7.3 4.1 10. 9 6.3 5.2 -3.3 
      Basic metal products 2.0 9.9 2.4 2.6 3.0 0.7 
      Fabricated metal products, machinery and 
     transport equipment 5.9 4.3 4.3 5.8 5.6 3.4 
      Manufactured products, n.e.s. 3.4 8.5 7.5 9.7 11.2 5.1 
 Cottage Industry 5.7 6.3 5.7 5.6 4.5 3.3 
Table I.2 (cont'd) 
                                                      
 7 The Central Bank of Sri Lanka points out that compared to the PHCI of 15.2% in 2007, the 
percentage of beneficiaries under the main poverty alleviation programme, Samurdhi, at 32% is substantially 
higher, which underlines the need to further streamline this programme to better target the needy people (Central Bank of Sri Lanka, 2009a). WT/TPR/S/237 Trade Policy Review 
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    2004 2005 2006 2007 2008 2009a 
Electricity, gas, and water 6.0 14.0 14.8 4.6 2.7 3.7 
Construction 5.9 9.0 9.2 9.0 7.8 5.6 
Services 6.7 6.4 7.7 7.1 5.6 3.3 
 Wholesale and retail trade 7.4 6.4 7.1 6.1 4.7 -0.3 
 Hotels and restaurants  21.5 -14.1 2.4 -2.3 -5.0 13.3 
 Transport and communication 9.7 9.6 12.6 10.5 8.1 6.6 
 Banking, insurance, and real estate 5.8 7.0 8.5 8.7 6.6 5.7 
 Ownership of dwellings 1.1 1.1 1.1 1.1 1.1 1.2 
 Government services 4.1 5.4 5.0 6.0 5.7 5.9 
 Private services 4.6 6.4 7.8 7.8 6.5 5.8 
Share of GDP, current prices       
Agriculture, livestock, and fishing 12.5  11.8  11.3  11.7  13.4  12.6  
Mining and quarrying 1.4  1.5  1.6  1.6  1.6  1.6  
Manufacturing 18.7  19.5  19.2  18.5  18.0  18.1  
 Processing (tea, rubber, and coconut) 0.8  0.7  0.6  0.6  0.7  0.8  
 Factor industry 16.8  17.7  17.6  16.9  16.3  16.5  
      Food, beverages and tobacco prod ucts 7.6  8.3  8.2  7.9  7.9  8.2  
      Textiles, clothing and leather pr oducts 4.1  4.2  3.9  3.7  3.4  3.2  
      Wood and wood products 0.1  0.0  0.0  0.0  0.0  0.0  
      Paper products, publishing and pr inting 0.1  0.1  0.1  0.1  0.1  0.1  
      Chemical, petroleum, coal, rubber and 
     plastic products 2.8  2.9  3.2  3.2  3.1  3.0  
      Non-metallic mineral products  0.6  0.6  0.6  0.6  0.5  0.5  
      Basic metal products 0.0  0.0  0.0  0.0  0.0  0.0  
      Fabricated metal products, machinery and 
     transport equipment 1.4  1.4  1.3  1.3  1.3  1.3  
      Manufactured products, n .e.s. 0.1  0.1  0.1  0.1  0.1  0.1  
 Cottage industry 1.2  1.1  1.1  1.0  0.9  0.9  
Electricity, gas, and water 2.3  2.4  2.5  2.5  2.4  2.3  
Construction 6.1  6.8  7.4  7.4  7.4  7.6  
Services 58.8  58.0  58.0  58.4  57.2  57.7  
 Wholesale and retail trade 24.6  23.2  22.4  22.1  21.5  19.6  
 Hotels and restaurants 0.6  0.6  0.6  0.5  0.5  0.5  
 Transport and communication 11.5  11.7  11.7  11.8  12.0  12.6  
 Banking, insurance, and real estate 8.5  8.4  9.1  9.2  9.4  10.3  
 Ownership of dwellings 3.7  3.6  3.5  3.5  3.2  3.3  
 Government services 7.8  8.4  8.8  9.3  8.6  9.2  
 Private services 2.2  2.1  1.9  1.9  2.0  2.1  
Share of sector in total employmentb       
Agriculture, livestock, and fishing 33.5 30.7  32.2  31.3  32.6  32.6  
Manufacturing 17.7  18.4  19.2  18.9  18.5  17.7  
Electricity, gas, and water 6.4 7.2 7.4 7.7 7.7 7.4 
Services 42.4  43.7  41.2  42.1  41.2  42.3  
 Wholesale and retail trade, repair of motor 
vehicles and personal household goods 12.3 12.0  13.4  13.2  12.9 12.9 
 Hotels and restaurants 1.6 1.8 1.8  1.7  1.4 1.9 
 Transport, storage, and communication 5.6  6.6  6.1  6.5  5.9  5.9  
 Finance, real estate, and business activities 2.4 3.3  3. 1  3.1  3.2 3.0 
Table I.2 (cont'd) Sri Lanka WT/TPR/S/237 
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    2004 2005 2006 2007 2008 2009a 
 Public administration and defence, compulsory 
social security 7.2 6.8  5.6  6.1  6.7 6.9 
 Education 3.7  3.7  3.9  3.7  4.3 4.4 
 Health and social/community/personal 
activities 3.1 3.5  3.3  3.1  3.4 3.4 
 Other services 6.5  6.0  4.0  4.7  3.5 4.0 
a Estimates. 
b 2004 figures exclude both Mullative and Kili nochchi districts;  2006 and 2007 figures ex clude Northern and Eastern provinces;   
and 2008 and 2009 figures exclude Northern Province. 
Source: Central Bank of Sri Lanka online information.  Viewed at:  http://www.cbsl.gov.lk [ 06/04/10];  and data provided 
by the authorities. 
15. Sri Lanka's unemployment rate fell from 8.3% in 2004 to 5.4% in 2008, but rose again to 
5.8% in 2009, under the impact of the economic slowdown (Table I.1).  In 2009, services accounted for 42% of total employment, while agriculture employed 32.6% of the total labour force, and 
manufacturing some 17.7% (Table I.2).  Overall la bour productivity (GDP per worker) grew at an 
average annual rate of 3% betw een 2004 and 2009 (at constant 2002 prices).  The increase reflected 
mostly the growth in productivity in the industria l sector (averaging 4.7% per year), followed by 
productivity increases in the services sector (an annual average of 3.6%), while labour productivity in 
agriculture grew at a marginal 0.3% per year duri ng the same period, and is only about one third of 
the level in the rest of the economy.
8    
(4) FISCAL POLICY  
16. One of the major challenges facing Sri Lanka's economic growth is achie ving consolidation of 
its public finances.  Several years of expansionary fiscal polices have resulted in large and persistent 
budget deficits that have been increasingly financ ed through short-term domestic borrowing (some 
two thirds of the total).  The Fiscal Management  Responsibility Act, approve d in 2002, established the 
objective of reducing the budget deficit to 5% of GDP by 2006, but this target has not been met.  
Between 2004 and 2009, the annual deficit of the Central Government averaged around 7.5% of GDP 
(including grants) (Table I.1).  Re venue, which has shown a declining trend since 2006, in part due to 
tax exemptions under various incentive schemes, decr eased further to 14.6% of GDP in 2009, owing 
to sluggish external trade and domestic economic activity, as well as a reduction in the VAT rate from 
15% to 12% introduced in the 2009 Budget.  Although decreasing moderately during 2006-08, 
expenditure picked up again in 2009 to 24.9% of  GDP.  The increase resulted mainly from higher 
spending on defence;  resettlement, rehabilitation, and reconstruction cost s;  larger public investment;  
and increases in salaries and wages, pensions, and inte rest payments.  According to official estimates, 
in 2009 the Central Government deficit reached 9. 8% of GDP (including grants), far above the 7% 
target for that year set under the IMF Stand-by Arrangement.    
17. The Central Government's debt as a percenta ge of GDP showed a downward trend between 
2004 and 2008, but rose to 86.2% in 2009, reflectin g a higher budget deficit and lower GDP growth.  
Some 50% of the Government's outstanding debt is domestic (Table I.1).  Recently, there has been a 
shift in the financing mix from concessionary external borrowing to more costly domestic and 
non-concessionary foreign borrowing, which has increased rollover risks.9   
18. The cornerstone of the IMF Stand-by Arrangeme nt is the reduction of the budget deficit to 
6% of GDP in 2010 and to 5% in 2011.  Specifi cally, the Government is committed to increasing tax 
                                                      
8 Calculated by the WTO Secretariat with data from several issues of the Central Bank Annual Reports. 
9 ADB (2010b). WT/TPR/S/237 Trade Policy Review 
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revenue by at least 2% of GDP by 2011, through measures aimed at broadening the tax base, reducing 
tax exemptions, and improving tax enforcement.  Fiscal measures adopted by the authorities in 2009 to improve revenue collection with immediate eff ect, include raising the Nation Building Tax rate, 
increasing excise taxes on selected consumer items, and raising the Export Development Board Levy 
(Cess) and other taxes mostly falling on imports.  In  June 2010, the authorities indicated that the 
targets set were being revised following the May 2010 IMF staff visit. 
19. The authorities recognize, however, that structural  tax reforms are required in order to raise 
revenue in a sustainable manner and ac hieve their deficit reduction targets.
10  Accordingly, in 2009 
the President established a Tax Commission to revi ew the tax policy and make recommendations on 
strengthening tax collection, improving auditing an d enforcement, and simplifying the tax system, 
including further rationalization of the tax incen tives offered under the BOI Act.  The Commission's 
recommendations were expected to be taken into  account in the preparation of the 2010 Budget.  
However, due to the parliamentary elections held  in April, the submission of the 2010 Budget was 
postponed and it was presented to  Parliament at end-June 2010.11  Therefore, it remains to be seen 
how the Government intends to implement the exp ected tax reforms in 2010 and beyond in order to 
meet its fiscal targets.  
20. Another challenging target of the fiscal pr ogramme is reaching a balanced budget for the 
two state utilities, the Ceylon Electricity Board (CEB) and the Ceylon Petroleum Corporation (CPC), both of which have been running at a loss for years (Chapter IV(3)).  Some measures have been taken 
to this end.  A new Electricity Act entered in to force in 2009 establishing a new regulator for the 
electricity sector and enabling a more liberal prici ng mechanism;  efforts have also been made to 
move towards cheaper electricity generation.  In the petroleum sector, the Government has allowed 
increases in local retail prices for gasoline and diesel  so as to track more closely international oil 
prices, although they still tend to lag behind.
12  In addition, a Joint Review Mechanism has been 
established to monitor the operation of the two state utilities and issue appropriate recommendations for improvement. 
(5) M
ONETARY AND EXCHANGE RATE POLICY  
21. Under Monetary Law (Amendment Act) No. 32 of 2002, the Central Bank's main monetary 
policy objective is to achieve economic and price stability.  The Central Bank sets monetary policy 
independently, through the Monetary Board, and its fi nancing of the fiscal deficit is limited by law to 
10% of estimated revenues.  The Monetary Polic y Committee (MPC), established in 2001, makes 
recommendations to the Monetary Board.   
22. Monetary policy is based on a monetary targeti ng framework in which the final target is price 
stability.  This is to be achieved by  influencing the broad money supply (M 2b), in turn influenced by 
reserve money, which is the operating target.13  The monetary programme sets out the desired path for 
monetary growth through quarterly average reserve m oney targets.  To achieve the target, the Central 
Bank conducts open market operations within a corri dor of policy rates, i.e. the Repo rate and the 
                                                      
10 International Monetary Fund (2009) . 
11 During January-April 2010, fiscal operations were conducted under a "Vote on Account" framework, 
approved by Parliament in November 2009.  For a three-month period from May 2010, the President granted 
approval to incur government expenditure. 
12 In December 2009, one month ahead of the presiden tial election, the Government cut gasoline prices 
by 11%. 
13 Reserve money is currency in circulation and depo sits of commercial banks with the Central Bank.  
Broad money (M 2b) is currency held by the public, and demand, savings, and time deposits held by the public at 
commercial banks.  For further details s ee:  http://www.centr albanklanka.org. Sri Lanka WT/TPR/S/237 
 Page 9 
 
 
Reverse Repo.  Policy interest rates are reviewed usually once a month and adjusted if necessary to 
bring reserve money to the targeted path.  Th e Central Bank's 2010 Monetary Programme is to 
increase both the annual average growth in reserve money and M 2b by 14.5%.14  
23. After a period of monetary expansion, the Central Bank tightened monetary policy in 2007 
and 2008 in several steps.15  In 2009 and 2010, it adopted a more accommodative monetary stance.  
Starting in the last quarter of 2008, the Central Ba nk took measures to counter the spill-over effects of 
the global financial crisis.  These included graduall y reducing the statutory reserve ratio to 7% by 
February 2009, which resulted in a significant injection of liquidity into the money market.16  Also, 
policy interest rates were reduced:  the Repo rate  by 300 basis points to 7.5% and the Reverse Repo 
rate by 225 basis points to 9.75%, leading to lowe r market interest rates, with the average annual 
weighted prime lending rate falling from 19.2% in 2008 to 11.2% in 2009, and the average weighted deposit rate from 11.6% to 8% (Table I.1).  The Ce ntral Bank also lowered and finally eliminated (in 
May 2009) its benchmark "penal rate of interest".
17   
24. The Central Bank's exchange rate policy is ge nerally focused on maintaining an adequate 
level of foreign exchange liquidity in the domestic  foreign exchange market while ensuring stability 
by smoothening out the excessive volatility in the ex change rate.  The Central Bank maintained the 
rupee closely aligned to the U.S. dollar between end 2007 and October 2008, when it moved to more 
exchange rate flexibility.  The exchange rate polic y in late 2008 to 2010 was guided by the need to 
facilitate the adjustment to the global financial and economic crisis while rebuilding international 
reserves, to at least 3½ months of imports.18  Excessive volatility was prevented through the adoption 
of several temporary measures between October 20 08 and April 2009, including the introduction of 
restrictions in the form of margin deposit require ments on importation of a wide range of consumer 
goods, while raising existing margin requirements on vehicles, to reduce pressure on reserves.    
25. The rupee depreciated in real terms by some 6% between 2005 and 2009, corresponding to a 
nominal depreciation of over 10%, with most of the adjustment taking place from 2007.19  T h i s  
depreciation should partly help regain some of the competitiveness lost in previous years, although in 
the first half of 2010 the rupee appreciated  somewhat vis-à-vis the U.S. dollar.  
26. Partly as a result of accommodative monetary po licy, of increasing international commodity 
prices and of domestic demand pressures, inflation,  measured as an increase in the Consumer Price 
Index (CPI), rose during most of the period under review, from an average of 7.6% in 2004 to a peak of 28.2% in June 2008.  A tightening of moneta ry policy in 2007-08 and the easing of commodity 
prices contributed to a deceleration in inflation to 4. 8% by the end of 2009.  A similar declining trend 
was observed in core inflation (excluding the more  volatile items such as food and energy prices), 
which has been declining since June 2009, and reach ed 9.2% in December 2009.  Inflation for 2010 is 
expected to remain at single-digit levels, but to  be higher than in 2009, fed by relatively strong 
domestic demand.  The Government is forecasting the CPI to increase by about 5-6% on an annual 
average basis by end 2010.
20 
                                                      
14 Central Bank of Sri Lanka (2010). 
15  International Monetary Fund (2009). 
16 Central Bank of Sri Lanka (2010). 
17 The penal rate charged on reverse repurchase transactions with the Central Bank once the 
participating institutions exceeded a certain quota, se rved as a ceiling on short-term interest rates and a 
benchmark for short-term market rates.   
18 International Monetary Fund (2009). 
19 At end 2009, the exchange rate of the rupee against the U.S. dollar was Rs 114.9/US$1 (Table I.1). 
20 Central Bank of Sri Lanka (2010). WT/TPR/S/237 Trade Policy Review 
Page 10 
 
 
(6) BALANCE OF PAYMENTS  
27. Sri Lanka's balance of payments is characterized  by a structural current account deficit, which 
increased substantially between 2005 and 2008, when it reached US$3.89 billion, or 9.5% of GDP.  
The resulting loss in foreign exchange reserves, prompt ed the need to resort to IMF financing through 
a Stand-by Arrangement.  A dramatic (27.6%) d ecline in merchandise imports contributed to a 
substantial reduction of the current  account deficit in 2009, to an  estimated US$214 million, or 0.5% 
of GDP (Table I.3). 
28. While the merchandise trade balance has shown a structural deficit, on account of a level of 
imports that is almost double the level of expor ts, the services balance has traditionally shown a 
surplus.  The income balance is traditionally in deficit, partly due to the remittance of profits 
stemming from foreign investment in Sri Lanka.  This deficit peaked in 2008, at US$972 million, 
before declining to US$488 million in 2009.  Tran sfers, mostly remittances  from Sri Lankans abroad, 
are a large and important source of consumption funding.  Net current transfers exceeded US$3 billion in 2009, more than double the level regi stered in 2004.  Sri Lanka imported capital in 
2009 in the form of portfolio investment to make up for the strong fall in foreign exchange reserves;  
all in all, the capital and financial account was in deficit, reversing the trend observed in 
previous years.  
Table I.3 
Balance of payments, 2004-09 
(US$ million)  
    2004 2005 2006 2007 2008 2009 
Current account -648.0 -650.0 -1,499.0 -1,401.0 -3,886.0 -214.0 
Goods and services balance -1,824.0 -2 ,179.0 -3,113.0 -3,354.0 -5,579.0 -2,731.0 
    Trade balance -2,243.0 -2,516.0 -3,370.0 -3,656.0 -5,980.0 -3,122.0 
       Exports 5,757.0 6,347.0 6,883.0 7,640.0 8,111.0 7,085.0 
       Imports 8,000.0 8,863.0 10,253.0 11,296.0 14,091.0 10,207.0 
    Services balance 419.0 337.0 257.0 302.0 401.0 391.0 
       Receipts 1,527.0 1,540.0 1,624.0 1,775.0 2,004.0 1,892.0 
    Transportation 624.0 673.0 751.0 838.0 1,000.0 865.0 
    Travel 513.0 429.0 410.0 385.0 342.0 350.0 
    Communication 43.0 44.0 68.0 72.0 81.0 80.0 
    Construction 26.0 29.0 29.0 33.0 40.0 40.0 
    Computer and information  72.0 82.0 98.0 175.0 230.0 245.0 
    Insurance 50.0 73.0 57.0 55.0 68.0 75.0 
    Other business 178.0 188.0 190.0 196.0 222.0 219.0 
    Government 20.0 21.0 21.0 20.0 21.0 19.0 
       Payments 1,108.0 1,202.0 1,369.0 1,472.0 1,603.0 1,501.0 
    Transportation 336.0 470.0 540.0 596.0 702.0 631.0 
    Travel 296.0 314.0 373.0 393.0 428.0 411.0 
    Communication 10.0 19.0 49.0 54.0 55.0 54.0 
    Construction 6.0 6.0 6.0 6.0 6.0 6.0 
    Insurance 110.0 34.0 37.0 40.0 47.0 46.0 
    Other business 315.0 322.0 329.0 349.0 330.0 319.0 
    Government 35.0 37.0 35.0 34.0 35.0 35.0 
Income balance -204.0 -299.0 -389.0 -358.0 -972.0 -488.0 
       Credit 157.0 35.0 311.0 449.0 -32.0 116.0 
       Debit 360.0 335.0 700.0 807.0 940.0 603.0 
Current transfers  1,380.0 1,828.0 2,004.0 2,311.0 2,666.0 3,005.0 
       Credit .. 2,061.0 2,262.0 2,598.0 3,019.0 3,408.0 
       Debit .. 233.0 257.0 288.0 353.0 403.0 
Table I.3 (cont'd) Sri Lanka WT/TPR/S/237 
 Page 11 
 
 
    2004 2005 2006 2007 2008 2009 
Capital and fina ncial account 837.0 723.0 1,595.0 1,566.0 3,158.0 -131.0 
Capital account 64.0 250.0 291.0 269.0 291.0 233.0 
Financial account 773.0 473.0 1,304.0 1,297.0 2,867.0 -364.0 
 Direct investment 227.0 234.0 451.0 548.0 690.0 384.0 
     Direct investment in Sri Lanka 233.0 272.0 480.0 603.0 752.0 404.0 
     Sri Lanka's direct investment abroad -6.0 -38.0 -29.0 -55.0 -62.0 -20.0 
 Portfolio investment 11.0 60.0 51.0 973.0 -153.0 1,863.0 
     Assets 111.0 276.0 355.0 1,392.0 1,057.0 2,667.0 
     Liabilities -100.0 -215. 0 -304.0 -419.0 -1,210.0 -804.0 
 Other investment 401.0 718.0 875.0 447.0 1,223.0 666.0 
 Reserve assets 134.0 -540.0 -73.0 -671.0 1,107.0 -3,277.0 
Net errors and omission -189.0 -73.0 -107.0 -164.0 728.0 346.0 
Overall balance -205.0 501.0 204.0 531.0 -1,385.0 2,725.0 
.. Not available. 
Source: Central Bank of Sri Lanka online information.  Viewed at:  http://www.cbsl.gov.lk [03/05/10]. 
29. On account of its recourse to foreign indebte dness to compensate for the fall in foreign 
exchange reserves, and in contrast with the trend observed over 2004-06, and to a lesser extent in the 
following two years, the level of external debt incr eased substantially in 2009 , to US$18.66 billion, or 
some 45% of GDP.  The debt service ratio also in creased, to 19% of exports of goods and services in 
2009, compared with a low of 7.9% in 2005.  This  ratio was doubly affected by the increase in foreign 
external debt and by a decline in exports. 
(7) TRENDS AND DEVELOPMENTS IN TRADE AND FOREIGN DIRECT INVESTMENT  
(i) Composition of merchandise trade 
30. The contribution to GDP of both exports a nd imports fell during the period under review, 
from 27.9% in 2004 to 16.9% in 2009 in the case of merchandise e xports, and from 38.7% to 24.3% 
in the case of imports (Table I.1).  The decline in export shares took place throughout the period under 
review, and reflects an erosion in the competitiveness  of Sri Lanka's exports, both in absolute terms, 
and in relative terms vis-à-vis other countries in the region and other developing countries.  Both 
merchandise exports and imports are es timated to have declined in 2009.  The decline in imports took 
place mostly in 2009 as a reflection of the global economic crisis;  their share in GDP remained relatively stable between 2004 and 2008, at 34%.   
31. The composition of merchandise exports changed during the review period, with the share of 
exports of agricultural products and raw materi als increasing, while the share of manufactured 
products declined.  Exports of manufactured products  accounted for 67.1% of total exports in 2008, 
the last year for which full information is availabl e, compared with 73.9% in 2004 (Table AI.1 and 
Chart I.1).  The share of clothing, in particular , declined from 50.6% in 2004 to 42% in 2008.  This 
reflected an erosion in competitiveness in part due to the real appreciation of the rupee in previous 
years, as well as to competition in some markets from countries with a broader level of preferential 
access.  The share of agriculture in total exports , on the other hand, increased from 22.9% in 2004 to 
28.5% in 2008, mainly due to attractive internationa l commodity prices;  tea continued to be the main 
agricultural export, accounting for 15. 4% of total exports in 2008. 
32. The composition of merchandise imports also ch anged during the period, with Sri Lanka's 
imports of fuel and food increasing substantially , and imports of primar y products in general 
representing 39.5% of total imports in 2008, up from 30.7% in 2004.  Manufactured goods accounted WT/TPR/S/237 Trade Policy Review 
Page 12 
 
 
for 59.5% of total imports in 2008, down from 67.5% in 2004 (Table AI.2 and Chart I.1).  The main 
items in 2008 were:  machinery and transport equi pment (17.1%), textiles (12.4%), and chemicals 
(12.2%).  Imports of fuels increased their share, from 14.4% of total imports in 2004 to 23% in 2008 mainly due to a substantial increase in crude oil pr ices, while imports of food increased from 12.1% of 
the total, to 13.7%, partly due to higher wheat and sugar prices. 
(ii) Direction of merchandise trade 
33. The European Union is Sri Lanka's main export market, accounting for 36.9% of its exports in 
2008, up from 32.2% in 2004 (Table AI.3 and Chart I. 2).  Among EU countries, the main destinations 
for Sri Lanka's exports are the United Kingdom (13.3%  of total exports), Italy (5.4%), Belgium (5%), 
and Germany (5%).  The United States received 23. 1% of Sri Lanka's tota l exports in 2008, down 
from 34% in 2004.  Other important destinations  for Sri Lanka's exports are the Middle Eastern 
countries (9.8%), mainly on account of tea exports, as  well as India (5.1%).  Most exports to the EU 
enjoy preferential treatment under the GSP scheme, as do exports to India under a free-trade agreement (Chapter II).  Despite the free-trade ag reement with Pakistan, exports to this country 
remain modest. 
34. The main import sources in 2008 include India (20.8% of total imports, up from 17.3% in 
2004), Middle East (14.7%), the European Union (12.8%), Singapore (11.7%), and China (8.1%) (Table AI.4 and Chart I.2).  With the exception of India, imports from developing countries in the region, with which Sri Lanka has free-trade agreem ents, such as Pakistan, or the SAFTA countries 
(see Chapter II) remain low. 
(iii) Composition of trade in services 
35. Trade in services continues to be dominated by transportation, travel, and computer and 
information services.  These three items accounted  for about 77% of service exports and 69% of 
imports in 2009.  On the export side, there was a sharp increase of exports of computer and 
information services, which tripled between 2005 and 2009, to US$245 million, or 13% of services 
exports.  On the import side, other business serv ices continue to be of importance, totalling 
US$319 million in 2009.  However, their share of to tal services imports declined from 21% in 2004 to 
some 17% in 2009.  Travel receipts declined dur ing the review period, as a consequence of the 
uncertainty created by the armed conflict.  Th ere was, however, a small recovery in 2009 and 
following the ending of the conflict, exports of travel  services are expected to rise.  Sri Lanka's trade 
surplus in its services balance reached US$391 million in 2009 (Table I.3). 
(iv) Foreign direct investment (FDI) 
36. Sri Lanka is a traditional recipient of FDI flows,  in part attracted by the numerous incentives 
granted to investment, particularly in manufacturing and services (Chapter III(4)(iii)).  During the period under review, inward FDI flows were regular;  th ey did not seem to be severely affected by the 
armed conflict.  FDI flows have been between US$200 million and US$500 million a year, with the 
exception of 2008, where inflows peaked at so me US$772 million, although this partly reflects 
exchange rate movements.  The stock of FDI of Board of Investment enterprises (those registered with the BOI, see Chapter III(4)(iii)) has been incr easing rapidly:  it rose from US$2.1 billion in 2004 
to US$4.3 billion in 2009, or some 10.2% of GDP (Table I.4). 
37. In 2009, the FDI stock of BOI enterprises was ma inly in services (67.1% of the total, up from 
59.6% in 2003);  textiles, clothing, and leather products (9.8%);  chemicals, petroleum, rubber, and plastic products (7.2%);  and food , beverages, and tobacco (5.9%). 
 Sri Lanka WT/TPR/S/237 
 Page 13 
 
 
Chart I.1
Product composition of merchandise trade, 2004 and 2008
2004 2008
(a)    Exports (f.o.b.)
Other consumer
goods
3.3
Manufactures
73.9
Total:   US$5,466.6 million Total:  US$8,176.8 million
(b)    Imports (c.i.f.)
Chemicals
9.0Iron & steel
3.1Transport  
equipment
7.1Manufactures
67.5Other mining
3.0
Electrical
machines  
6.5
Non-electrical 
machinery
6.8Non-electrical 
machinery
5.5Other
1.0
Electrical 
machines
6.0Textiles
2.1
Other 
semi-manufactures
10.4Transport equipment
5.7
Chemicals
12.2Manufactures
59.5Fuels
23.0
Total:   US$7,852.1 million Total:   US$13,629.1 millionPer cent
Manufactures
67.1
Clothing
42.0Tea
15.4
Other 
consumer goods 
3.9Other
1.8Agriculture
28.5
Textiles
2.7Other
2.7
Semi-manufactures  
14.0
Machinery & transport 
equipment
5.2Other 
agriculture
13.1Other agriculture
9.5
Source :  UNSD, Comtrade database (SITC Rev.3).Other
  consumer goods
5.6
Mining
24.7Other consumer 
goods
3.8
Semi-manufactures
11.1
Machinery & transport 
equipment
6.2
Other
semi-manufactures
10.0Agriculture
22.8Tea
13.4
Agriculture
14.8Agriculture
13.2
Mining
17.5
Iron & steel
3.4Mining  3.3
Mining 
1.7
Clothing
50.6
Textiles
12.4
Fuels
14.4
Other mining
1.7Textiles
19.5
 WT/TPR/S/237 Trade Policy Review 
Page 14 
 
 
Chart I.2
Direction of merchandise trade, 2004 and 2008
2004 2008
(a)    Exports (f.o.b.)
Asia
17.5
Total:   US$5,466.6 million Total:  US$8,176.8 million
(b)    Imports (c.i.f.)
Other 
2.4
China
5.8EU27
16.1
India
17.3America
4.9
Other Middle East  
5.2EU27
12.8
China
8.1
  Singapore
11.7Singapore
9.3Iran
8.8
Total:   US$7,852.1 million Total:   US$13,629.1 millionPer cent
Asia
16.4
Middle East
9.8Other
6.0
Middle E.
14.7America
5.1United States
34.0United States
23.1Other 
9.8
Source :  UNSD, Comtrade database (SITC Rev.3).Japan
3.1Other Asia
11.3
CIS
4.0
Other EU27
23.6Other Asia
10.4
Middle East 
6.8
CIS
3.5
Other Asia
15.4 Other Asia
20.1
Japan
5.2Other
3.1
Other Middle 
East
5.9EU27
32.2
United Kingdom
14.2
Hong Kong, China
7.9Iran
5.9
Hong Kong, China
5.1Middle E.
        11.1
India
20.8EU27
36.9
Other EU27
18.0
Asia
64.3Asia
65.6India
7.0
India
5.1
United Kingdom
13.3
 Sri Lanka WT/TPR/S/237 
 Page 15 
 
 
Table I.4 
Realized foreign investment stocks of Board of Investment enterprises, 2004-09 
(Rs million and %)  
  2004 2005 2006 2007 2008 2009a 
Total (Rs million) 208,696  233,523  285,366  364,244  440,408  494,461  
Total (US$ million) 2,062  2, 324  2,745  3,293  4,065  4,302  
 (% of total) 
Food, beverages, and tobacco  6.0 7.2 7.1 6.3 6.6 5.9 
Textiles and clothing, leather pr oducts 12.6 13.0 13. 0 12.3 10.8 9.8 
Wood and wood products 2.5 2.4 2.0 1.5 1.3 1.2 
Paper products, publishing and printing 0.2 0.3 0.3 0.3 0.4 0.8 
Chemical, petroleum, rubber, and plas tic products 7.0 8.2 7.7 8.1 8.1 7.2 
Non-metallic mineral products  4.6 4.1 4.0 3.1 1.7 1.6 
Fabricated metal products, machinery and tr ansport equipment 3.4 4.2 4.6 4.0 2.8 2.7 
Manufacture products n.e.s. 3.9 3.6 3.8 3.3 3.3 3.6 
Services 59.6 57.0 57.6 61.2 65.1 67.1 
a Provisional. 
Source : Central Bank of Sri Lanka (2008 and 2009), Annual Report , Statistical Appendix, Table 25.