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1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY n Report No. P CE Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC SOCIALIST REPUBLIC OF SRI LANKA FOR A SMALL AND MEDIUM INDUSTRIES PROJECT June 14, 1979 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS US$1 = Rs 15.6 Rs 1 US$0.064 Rs I million = US$64,102 ABBREVIATIONS AND ACRONYMS DSI - Department of Small Industries IDB - Industrial Development Board NDB - National Development Bank SMI - Small and Medium Scale Industries Umbrella - UNDP Multi-sector Program of Project Preparation FISCAL YEAR January 1 - December 31

3 FOR OFFICIAL USE ONLY SRI LANKA SMALL AND MEDIUM INDUSTRIES PROJECT Credit and Project Summary Borrower: The Democratic Socialist Republic of Sri Lanka. Beneficiaries: National Development Bank - Small and Medium Industries (SMI) Fund; Bank of Ceylon, People's Bank, Hatton National Bank, Commercial Bank of Ceylon and Development Finance Corporation of Ceylon; and small and medium industries receiving credit through the credit institutions. Amount: Terms: Relending Terms: Project Description: US$16.0 million equivalent. Standard. Government would relend about US$12.0 million equivalent to the National Development Bank for the account of the SMI Fund on the following terms: (i) 9% interest per annum; (ii) repayment on the basis of a fixed amortization schedule over a 13 year term including 4 years grace; and (iii) Government to bear foreign exchange risk. The SMI Fund would provide refinancing to credit institutions for small and medium industry loans on the following terms: (i) refinancing up to 80% of loan amount; (ii) interest per annum of 10% for loans up to Rs 100,000, 11% for loans over Rs 100,000 to Rs 500,000, and 12% for loans over Rs 500,000 to Rs 1,000,000; and (iii) term of refinancing would be parallel to the term of the individual loans, expected to average 5-7 years. The credit institutions would provide term credit to small and medium size industries on the following terms: (i) uniform 15% interest per annum; (ii) term of the loan determined as appropriate for each loan, but in no case for more than 10 years, including 2 years of grace; and (iii) minimum of 20% equity contribution. The proposed project would provide improved access to credit for a wide range of small and medium scale manufacturing and service industries by providing a structure and additional resources for refinancing and by developing the appraisal and supervision capabilities of the major credit institutions. The proposed This document has a restricted distribution and may be used by recipients only in the performane of their official duties. Its contents may not otherwise be disclosed without World Bank auth-;izal;n.

4 - ii - project would also strengthen the promotion, technical, marketing and management services for SMIs, by developing subsector-specific programs, extending the coverage of existing technical services and training programs, and improving the coordination among service agencies. It is expected that the 1,000 subprojects to be financed would result in incremental direct employment of at least 20,000, with the coverage of the improved technical services to reach about 1,500 firms. The risks inherent in establishing the new organization for the NDB-SMI Fund have been minimized by the actions taken to ensure that key staff are in place and provided with training and institutional support through the UNDP Multi-sector Program of Project Preparation ("Umbrella") for Sri Lanka and under the proposed project. Estimated Cost: /a US$ Million Equivalent Local Foreign Total Credit Term Credit for SMIs Special Capital Facility National Development Bank Administration Subtotal Technical Services Service Agencles Technical Assistance and Training Policy Studies and Other Subtotal Total (of which taxes and duties) Net Project Cost Financing Plan: US$ Million Equivalent Local Foreign Total IDA Government/NDB Credit Institutions Beneficiaries Total /a Price contingencies are included in project costs.

5 Estimated Disbursement: US$ Million Equivalent IDA FY Annual Cumulative Staff Appraisal Report: No CE dated June 8, Map: No. IBRD 3839R2

6 INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC SOCIALIST REPUBLIC OF SRI LANKA FOR A SMALL AND MEDIUM INDUSTRIES PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Democratic Socialist Republic of Sri Lanka for the equivalent of US$16.0 million on standard IDA terms to help finance a Small and Medium Industries (SMI) Project. Of the proceeds of the credit, US$12.0 million would be relent to the National Development Bank (NDB) for the account of the Small and Medium Industry Fund at 9% interest per annum, with repayment over a period of 13 years, including 4 years grace, on the basis of a fixed amortization schedule. PART I - THE ECONOMY 1/ 2. The latest economic report, "Development in Sri Lanka: Issues and Prospects" (Report No CE, March 22, 1978) was distributed to the Executive Directors on March 23, Country Data are provided in Annex I. 3. Sri Lanka has achieved social progress far beyond that of other countries with comparably low per capita incomes. Literacy, health, and life expectancy are high; nutrition is adequate, and mortality and population growth rates have been declining. These impressive gains have been achieved despite generally low output and employment growth. Per capita GDP growth was only 0.9% per annum in the period; it accelerated to 2.1% in the 1960s and then declined to 1.3% per annum in the 1970s. Throughout the 1960s and through much of the 1970s, these modest output gains were eroded by adverse terms of trade trends. This disappointing performance has been accompanied by a disturbing increase in the level of open unemployment. In the 1970s, while the labor force has been growing at about 125,000 per year, employment has been rising by about 85,000, much of it in the form of unproductive jobs. The number of unemployed has, therefore, been rising, and open unemployment is estimated at over one million or 20% of the labor force. 4. The gains in the social field were made possible by favorable initial conditions. Compulsory primary education was introduced as early as The food ration was introduced in Thus, at the time of Independence in 1948, Sri Lanka already enjoyed high levels of adult literacy and life expectancy. These initial gains were consolidated and expanded in the post- Independence period through large expenditures on social services and the food subsidy, which accounted for two-fifths to one-half of government revenues in 1/ This part is substantially the same as Part I of the Report and Recommendation of the President to the Executive Directors on a proposed credit to the Democratic Socialist Republic of Sri Lanka for an Agricultural Extension and Adaptive Research Project (Report No. P-2569-CE, dated May 31, 1979).

7 - 2 - the 1960s and 1970s. These expenditures have been financed by harnessing the surpluses of Sri Lanka's three major tree crops (tea, rubber, and coconut), which provided the Government with both an easy revenue source and foreign exchange earnings. 5. There were both measurable and non-measurable socio-economic benefits flowing from these improvements in health, nutrition, and education, such as the decline in fertility and the relatively low rate of urbanization. At the same time, there were significant costs arising from the firm commitment of successive governments to maintain these social gains. The fiscal burden of these expenditures imposed a high degree of inflexibility on Sri Lanka's policymakers in their attempts to accelerate long-term growth. That inflexibility increased over time as growth slowed down and in particular, the ability of the tree crop subsector to provide the resources for the social programs weakened as commodity prices kept falling and productivity suffered due to inadequate incentives. Moreover, the gains in education had a negative impact in the form of large numbers of educated unemployed who posed a challenge to the established political order. With political parties competing with each other to offer inducements to the electorate, governments have failed to focus social expenditure programs more narrowly on specific groups living in poverty, making these unnecessarily costly. 6. In the period, gross domestic product at constant prices rose by 3.8% per annum. This performance masks a marked deceleration in the growth of the productive sectors of the economy between the 1960s and the 1970s. GDP growth slowed down from 4.4% per annum in the 1960s to 3.0% in the period. Growth fell from 3.4% to 1.9% in agriculture; from 6.2% to 2.3% in manufacturing. 7. The key to the slowdown in GDP growth lies largely in the slow growth of agriculture, which accounts for over one-third of GDP and fourfifths of export earnings. Tea and coconut output has been declining steadily from the mid 1960s; rubber, after showing a rapid increase in the 1960s, stagnated in the 1970s. Erratic weather conditions, declining commodity prices, a rising effective tax burden, and low producer returns combined with the uncertainties caused by a long, drawn-out land reform ( ) depressed producer incentives and, hence investment and production, to new lows. These problems were aggravated by a dual exchange rate, introduced in 1968, which discriminated against traditional exports and in favor of food imports. 8. Paddy production, which grew at 7.4% per annum in the period, and at 4% during the 1960s as a whole slowed down to 0.7% per annum in the period. The decline in yields and cropping intensities is attributable principally to a sharp deterioration in the institutional support for production programs. The only bright spot on the agricultural scene has been the rapid increase in output of subsidiary food crops in the 1970s. This represents gains in acreage rather than yields and is in response to the improved incentives arising from a 1970 ban on imports of these crops.

8 Manufacturing output in the 1970s also decelerated due to the cumulative impact of declining investment levels, severe foreign exchange shortages that necessitated import rationing (with serious consequences for a sector in which imported raw materials account for 70% of the value of raw materials used), the exhaustion of import substitution possibilities, and inefficiencies in management of the public sector, which now accounts for 66% of the gross value of production in organized industry. 10. In general, economic growth was constrained by a persistent foreign exchange shortage throughout the 1960s and 1970s, inadequate levels of saving and investment, and the low efficiency of resource use. Sri Lanka's terms of trade have deteriorated steadily since the early 1960s and worsened sharply in the mid 1970s following increases in the price of imported food, fertilizer, and petroleum. The share of these three items in Sri Lanka's total imports jumped from about 50% in 1972 to 70% in This sharp increase has, to some extent, offset the improvement in export prices (particularly of tea) since Trade policies that discriminated against exports and encouraged import substitution caused a slow growth in exports of 2.5% per annum between 1960 and 1976, which acted as a significant constraint on growth for an economy in which exports account for nearly one-third of GDP. 11. The share of consumption in GDP has remained relatively stable and high (at 86%) over the last decade and a half. Domestic savings, when adjusted for the dual exchange rate, averaged 11.5% of GDP in and 10.5% in Public savings averaged a mere 1% of GDP in the 1960s, shrinking rapidly in the 1970s, and eventually becoming negative. This poor performance is attributable to the large and growing burden of subsidies and transfers, which worsened in the 1970s because of the increasing disparity between import costs and officially determined prices. Private savings were adversely affected in the 1970s by political uncertainties, a confiscatory tax burden, and falling real interest rates. 12. Gross investment has averaged 16% of GDP at current market prices in the period. In real terms, investment has been declining, and there has been persistent failure throughout this period to raise the level of public investment (around 6-7% of GDP), while private investment in productive activities was, on the whole, given little encouragement. The efficiency of investment has also been rather low due to both neglect of some key sectors and a failure to exploit the full potential of past investments. Much of the investment in agriculture was directed to paddy; but the tree crop subsector was neglected, resulting in an erosion of the latter's production base. In the manufacturing sector, capital-intensive import substitution was pursued to the neglect of labor-intensive export-oriented production. Utilization of the potential already established has been uniformly low. This has been reflected in low cropping intensities and yields in the agricultural sector, and low-capacity utilization in manufacturing. 13. In the elections of July 1977, the eighth since Independence, the United National Party won a large majority. In the relatively short period

9 that it has been in office, it has embarked on a major reform of political institutions and economic policies. A new constitution has been enacted introducing a presidential form of government. Proportional representation has replaced the first-past-the-post voting system. A new District Ministerial system has been established and District Ministers have been appointed to each of the 24 districts in Sri Lanka to help increase local level participation in district planning and administration, and improve implementation of development programs. District Ministers are appointed by the President from Members of the Parliament and function as ex officio Deputy Ministers to all development-oriented ministries for development programs in their respective districts. The District Minister presides over a development council comprising Members of Parliament from the electorates in the district and others nominated to the Council. The Secretary to the District Minister is also the Government Agent for the District. The development councils are entrusted with the tasks of planning, coordination, implementation and evaluation of district programs and allocation of the district's share of funds from the decentralized budget. 14. The policy changes introduced by the new government are designed to address the economic problems described in paras 3-12 above. The Government identified its objectives as the revival and resuscitation of the economy and increased employment through (i) increased capacity utilization in the productive sectors, (ii) stimulation of savings and investment, and (iii) efforts to encourage exports and import substitution in foodgrains. A program of policy reforms has been developed in close consultation with the IMF. Its principal aim is to dismantle controls over resource allocations and initiate price adjustments with a view to establishing more realistic relative prices. These reforms were supported initially by an IMF standby arrangement covering 1978 for SDR 93 million. On January 26, 1979, the Fund's Executive Board approved an SDR 260 million Extended Arrangement covering the period. 15. The policy reforms introduced so far include: Exchange Rate Reform: The exchange rate was unified on November 16, 1977, and allowed to float at a depreciated rate of Rs 16 = US$1.00. This implied a depreciation of 46% against the official rate prevailing prior to unification, 11.2% with respect to the Foreign Exchange Entitlement Certificate rate, and 29.5% with respect to a transactions-weighted average rate of the two markets. 1/ Import Liberalization: The trade and payments regime has been liberalized. With the exception of foodgrains and petroleum products, public sector import monopolies have been terminated. Prior licensing of imports has been abolished for all but a handful of commodities. The tariff structure has been revised and simplified. 1/ Prior to unification, all exports other than tea, rubber and coconut products and all imports other than food, fertilizers and drugs were channelled through the certificate market. Since November 1972, the FEEC rate was maintained at a 65% premium over the official rate.

10 - 5 - Interest Rate Reform: To encourage financial savings and discourage speculative imports, interest rates have been raised sharply. Price Controls. These have ended for most commodities. Budgetary Policies: The unification and depreciation of the exchange rate caused tree crops export tax revenues and the cost of food, fertilizer and petroleum subsidies to rise sharply. Export tax rates on tree crops were raised further to mop up windfall profits while attempting to leave adequate producer margins. Business Turnover Tax rates have been substantially lowered and rationalized to be consistent with the new import tariff and exchange rate. To limit the growth in food subsidies, the rice and sugar rations were confined to the poorer half of the population and the subsidy on imported wheat flour was reduced through adjustments in the domestic price. To offset the adverse impact of these changes, public sector wages have been adjusted upwards on two occasions, and an income supplement has been introduced at Rs 50 per month to benefit the poorest households in which one or more persons has no gainful employment. Public corporations have been asked to pass on cost increases, except in the case of fertilizer, petroleum, milk, and public transport, where price increases were initially deferred to cushion the impact on consumers. The Government has subsequently made some adjustments in bus fares, petroleum, and fertilizer prices. These changes, taken together, have enabled an increase in public savings and contributed, together with higher aid receipts, to a sizable step up in capital expenditures. Tax Reform: The tax structure has been rationalized and simplified with a view to increasing the elasticity of revenues. The burden of personal and company taxation has been lowered. Agricultural Pricing Policies: The domestic procurement price for rice has been increased by 21%. With the related increase in flour prices, incentives for paddy and other flour substitutes have been improved. Fresh coconut prices have recently been increased by 30% and the export duty on coconut products has been appropriately adjusted. The unification of the exchange rate also ends discrimination against tree crops; however, the increase in export taxes takes away a substantial part of these gains. These reforms constitute only a beginning, and the Government anticipates the need for further price adjustments designed to reduce the continuing large burden of subsidies and current transfers (currently at over one-third of government revenues). 16. The economy's response to the policy reforms has been encouraging. Real gross national product in 1978 is estimated to have increased by 8.2%. The improved availabilities of inputs following import liberalization, an increased role for the private sector in distribution, and good weather helped attain a record paddy harvest. Industries, other than tree crop processing, benefited from the removal of price controls and increased access to imported raw materials and spare parts. Output of manufacturing industries is estimated to have risen by 8%, and electricity consumption by 13%, in After an initial slow start, private investment has also responded well to the reforms. This is partly reflected in the near threefold increase in capital goods

11 -6- imports from US$83 million in 1977 to an estimated US$230 million in Transport operators, in particular, have rushed to modernize their antiquated fleets, resulting in sizable imports of transport equipment. Others have taken advantage of accelerated depreciation provisions to replace worn out machinery and equipment. Applications for new investments have been encouraging. Public investment has also shown a major increase in 1978, resulting in a total investment level of 20% of GNP. 17. Despite the ending of price controls, policy induced price increases, and related wage increases, inflation in 1978 is estimated at 14%. Money supply growth has slackened, and the budget has had a contractionary effect due to under-expenditure on capital account. Interest rate reform has ensured positive real interest rates, contributing to a shift in asset preferences and easing the task of managing the balance of payments. 18. With import liberalization, merchandise imports in 1978 rose by 40% to US$1,009 million. Merchandise exports rose by 13% to US$847 million. Thus, the current account deficit swung from a surplus of US$77 million in 1977 to a deficit of US$116 million in However, since aid disbursements also rose sharply, net foreign exchange reserves rose by US$94 million in Gross foreign exchange reserves rose to US$397 million, or 4.5 months of imports. Thus, despite import liberalization, Sri Lanka's balance of payments remained well in control. The exchange rate averaged Rs = US$1.00 during 1978, appreciating modestly against the dollar and depreciating against currencies of Sri Lanka's major trading partners. 19. While the overall performance of the economy has been good, there remained several underlying weaknesses, particularly the inadequacy of incentives and the poor quality of management of the tea estates, severe managerial problems in the State industrial corporations, shortages of skilled manpower and inadequate construction capability. The Government is aware of these weaknesses, and technical and financial assistance programs are in the process of being developed to address some of these problems. 20. The economic reforms have been accompanied by a major effort at stepping up public investment. In this context, the Government attaches the highest priority to three major new programs: (i) Accelerated implementation of the Mahaweli Ganga Development Program involving telescoping construction of key remaining works of the 30-year Master Plan for Sri Lanka's largest river into a 7-10 year period. (Three major reservoir projects are to be launched with international assistance in 1979 and 1980 at a cost of over US$1,000 million (in 1978 prices), to be spread over eight to ten years. When completed, these projects will irrigate 215,000 hectares of new and existing land in the dry zone and generate 390 MW of power.) (ii) A 200 square-mile free trade zone north of Colombo, under a newly constituted Greater Colombo Economic Commission. (The first Investment Promotion Zone near Colombo's international airport, Katunayake, is off to a good start, and some 50 proposals involving a total investment of US$100 million have been approved by end-december, 1978.) (iii) A housing and urban renewal program with its main focus on the Colombo metropolitan region.

12 21. Recognizing the enormous financial and manpower burden of these schemes, the Government has, in consultation with the Bank, begun preparation of a medium-term public investment program which will attempt to ensure consistency between the multiple objectives of Government policy and the financial, administrative and manpower resources available for attaining those objectives. An initial outline of the program, incorporating the capital budget for 1979, was presented to the May/June 1979 Aid Group meeting. The program itself is to be completed in late It is seen as a rolling program, emphasizing the annual capital budget, and making such adjustments in objectives and content as are deemed necessary by short-term developments and opportunities that present themselves. 22. The Government has identified three major policy objectives in the medium term: (i) the creation of over one million new jobs between 1979 and 1983 to absorb the 630,000 expected additions to the labor force and make a significant dent in the backlog of the unemployed; (ii) acceleration of economic growth to 5.5% per annum; and (iii) structural improvement in the balance of payments through reduced dependence on tree crop exports and import substitution in food. The program envisages a total public investment of Rs 46 billion over the period ($2,900 million), some 60% of total (gross) investment. Investment is expected to average 24.5% of GNP in the period, as against 16% in the period. To enable this increase to materialize, domestic savings are expected to average about 14% of GNP, a substantial improvement over the 10.5% recorded in the period. The program, however, relies heavily on a substantial increase in net external inflows, which are estimated to average 11% of GNP throughout the period, as against an average of 2.3% in the period. These external flows will finance over two-thirds of the public investment program. 23. The underlying public investment strategy is to balance the large investment requirements of the Government's high priority program against the urgent rehabilitation and fresh investment needs in other sectors. The main thrust of the public sector program is to lay the foundation for longer term development, both by improving the efficiency of use of existing infrastructure investments and by expanding the longer term growth capacity of the economy. The strategy thus implicitly relies on the private sector to respond to the economic reforms and the stimulus of the public sector investment program, and provide much of the short-term growth. 24. The success the Government enjoys in attaining its medium-term development objectives is dependent on the further reforms needed to improve price and export incentives, and management in the public sector. It is also dependent on additional efforts to mobilize domestic resources and address absorptive capacity constraints such as manpower shortages and planning and implementation capability. However, success is ultimately contingent on a well-designed program of external financial and technical assistance. This is particularly because the proposed increase in investment, together with the new import liberalization policy will cause imports to grow much more rapidly than in the past. Moreover, Sri Lanka's terms of trade are expected to worsen over the medium term, due in the main to an expected decline in real tea unit values, and an increase in foodgrain import costs. Thus larger aid

13 - 8 - flows are needed to ensure that an ambitious development program, with a strong rehabilitation component, can be implemented within the framework of a liberalized import regime. Such assistance will also help finance about two-thirds of the public investment program. In this context, local cost financing will be needed to support this effort, particularly in the early years, as domestic resource mobilization efforts begin to gather momentum. 25. Aid donors have responded enthusiastically to the new policy environment in Sri Lanka. Aid commitments in 1978 from members of the Sri Lanka Aid Group totalled $353 million, an increase of 57% over At the 15th Meeting, held in Paris on May 31 and June 1, 1979, donors also expressed firm support for the accelerated Mahaweli Program (para 20). The grarnt element of aid commitments is currently around 63% and is expected to improve further. The debt service ratio in 1978 stood at 10.0%, declining from 15.0% in 1977, due to improved export earnings and the decline in outstanding short- and medium-term borrowings. The ratio is expected to drop further to 8.9% in PART II - BANK GROUP OPERATIONS IN SRI LANKA 26. Since the beginning of its operations in Sri Lanka in 1954, the Bank Group has made eight loans totalling US$73.4 million (net of cancellations) and seventeen credits totalling US$199.2 million (net of cancellations and exchange adjustments) in support of 25 projects. About 56% of Bank Group assistance has been for agriculture (irrigation, agricultural, and dairy development), 22% for power, and the remainder for development finance company operations, highways, a program credit (mainly involving the import of raw materials for industry), and water supply. Seven loans and five credits (including cancellations) have been fully disbursed so far. During FY78, IDA credits for a total of US$33.5 million were approved for a Tree Crop Rehabilitation (Tea) Project, a Tree Crop Diversification (Tea) Project and a credit line to DFCC. IDA credits in the amount of US$20.0 million for a Rural Development Project, US$16.5 million for a Road Maintenance Project and US$15.5 million for a National Extension and Adaptive Research Project have been approved in FY79. Annex II contains a summary statement of Bank Group operations as of April 30, 1979, together with notes on the execution of ongoing projects. 27. An IFC equity investment of about US$100,000 equivalent in DFCC and an IFC non-revolving line of credit of US$2.0 million to the government-owned Bank of Ceylon for on-lending to private small- and medium-scale industrial enterprises were also approved in FY78. An investment of US$3.25 million to the Pearl Textile Mills, Ltd. (Ceylon) was approved by IFC's Board of Directors in 1970, but cancelled the same year because Government approval for the project was withdrawn. IFC has also recently approved an investment of US$3.32 million in a synthetic textile mill, and US$986,000 in a polypropylene bag manufacturing plant. 28. The Bank Group's current strategy is focused on the agricultural sector to support Government efforts to increase food production and reduce

14 - 9 - its dependence on food imports, and to raise productivity, employment, incomes and living standards of the rural population in Sri Lanka. Projects to support industry and basic infrastructure are also included. The Bank Group has agreed to assist the Government of Sri Lanka to accelerate the development of the Mahaweli Ganga development areas by helping to develop an implementation strategy and to coordinate external assistance for project preparation and implementation. It is expected that significant investment opportunities for IDA and other sources of external aid will be associated with this effort. Projects in other fields, including water supply and sewerage, tree crop rehabilitation (rubber), road transport, rural development, and telecommunications are also being prepared for possible IDA financing. 29. The Bank Group presently accounts for 10.3% (IBRD 3.3%; IDA, 7.0%) of Sri Lanka's total debt outstanding and disbursed, and 6.5% (almost totally Bank) of debt service. It is projected that the Bank Group's share in total external debt will increase to 16% by 1985 (with the Bank's share declining to 0.7%). The Bank and IDA shares in the debt service are expected to decline to about 4.4% by PART III - THE SECTOR 30. The industrial sector in Sri Lanka contributes about 13% to GDP and about 10% to total employment. The sector is composed of 29 public sector enterprises, about 7,700 registered private firms, and some 20,000 unregistered small and cottage industries, with each group contributing about one-third of total industrial value added. However, about two-thirds of total employment in the sector is derived from the unregistered group of industries. The largest subsectors within the industrial sector are textiles, food processing and chemicals. After a period of high growth in the 1960s based mainly on import substitution, manufacturing output grew by only 1.8% annually in real terms during the period, while construction output declined by about 2.6% annually. Factors which contributed to this stagnation included: (i) constraints to further growth in viable import substitution; (ii) foreign exchange scarcities that led to severe import restrictions; and (iii) poor management in the public sector. Furthermore private enterprise was adversely affected by the foreign exchange controls, which gave priority to the public sector. The economic reforms initiated in mid 1977 have led to a major industrial resurgence. Output in 1978 is estimated to have grown by about 8% in real terms, and imports of machinery and equipment to rehabilitate and expand capacity increased three-fold over The potential for industrial expansion, especially in export-oriented activities, is good; a 9% annual growth in real terms is possible, provided the economic reforms are continued and extended, public sector management improves, and priority is given to the development of labor-intensive and export-oriented industries. Characteristics and Role of SMIs 31. For the purpose of providing fiscal incentives, the Government currently defines small and medium industries (SMIs) as enterprises with an

15 original cost of plant, machinery, land and buildings of less than Rs l million (US$64,000). However, the Ministry of Industries and Scientific Affairs proposes to raise this ceiling to Rs 1 million (excluding land and buildings). This provides a sound basis for defining the target group for SMI activities since: (i) with inflation, costs of replacement equipment are high; (ii) SMIs should be encouraged to expand production and increase efficiency; and (iii) firms with plant and machinery of up to Rs l million are suitable for simplified appraisal techniques and similar types of outside technical services. According to this definition, the SMI sector would include over 90% of all registered private firms and all unregistered firms, account for about 75% of industrial employment, and constitute about 50% of industrial value added. 32. The six largest SMI subsectors - textiles and garments, light engineering, wood products, rubber products, food manufacturing and paper products - account for over 90% of the employment and 76% of the investment in registered SMIs. In these subsectors, SMIs are relatively efficient users of capital and labor, capable of competing with larger private and public firms. There is significant potential for expanding production in these subsectors for both the domestic and export markets in which SMIs should be able to share, provided they have increased access to credit and services to help improve productivity and product quality. There is also potential for SMI development in rural areas in agro-based industries and construction. At present, most SMIs are located in the Colombo area and to a lesser extent in secondary towns, where credit, markets, and technical services are more readily available. Policy Framework 33. The development of industry, and specifically SMIs, is an integral part of the Government's medium-term development strategy. Accordingly a number of incentives have been introduced including: (i) a tax holiday for new SMIs established outside the main metropolitan areas; (ii) a tax holiday for new export firms; and (iii) a duty rebate on imported components of exported items. To help realize the large potential of SMI development, the Government proposes to study the feasibility of extending the present system of fiscal incentives to existing SMIs and to local manufacturers supplying components of finished products to manufacturers and commercial exporters. Intensified promotion efforts are also being considered to encourage direct and indirect SMI exports; the recently established Sri Lanka Export Development Board is expected to have wider powers and more staff and financial resources than the Export Promotion Secretariat it replaces. 34. As part of the 1977 economic reforms, foreign exchange rationing was dropped, and most quantitative import restrictions removed. The principal means of protection shifted to tariffs. SMIs have done well in this liberalized environment, with better access to imported raw materials and equipment, and the more buoyant domestic market has compensated for any necessary reductions in output prices to compete with imports. Nominal rates of return in most cases have exceeded 25% before tax, suggesting that further reductions in protective tariff rates may be feasible. In late 1978, the establishment of

16 a Presidential Tariff Commission was approved by the Cabinet; one of the Commission's objectives is to design an appropriate tariff system based on the concept of effective protection. 35. The Industrial Development Board (IDB) is the major technical service agency for SMIs. Other institutions providing technical and training support to SMIs include the Department of Small Industries, the Department of Textile Industries, the National Institute of Management, the National Apprenticeship Board, and agencies that provide specific assistance to agroindustries. While all these services are useful, the effectiveness of these services could be improved by refocussing of programs and responsibilities, training of personnel, and improving physical facilities. A program to address these needs would be mounted under the proposed project. Financing SMIs 36. The credit institutions financing industry include the two stateowned commercial banks (Bank of Ceylon and People's Bank), the two largest private commercial banks (Hatton National Bank, and the Commercial Bank of Ceylon), and the Development Finance Corporation of Ceylon (DFCC). The commercial banks account for some 85% of industrial credit; DFCC and smaller finance companies, for the remainder. Traditionally, however, much of private industry in Sri Lanka has had to rely to a large degree on self-financing. Most commercial bank credit is short-term, and in their limited longer-term lending decisions, credit institutions tend to be conservative, lending mainly against collateral rather than on the basis of project evaluation. For the past three years, the People's Bank and the Bank of Ceylon have been financing SMIs through a Joint Credit Scheme with the IDB, which appraises projects and recommends them for bank financing. To encourage credit institutions to participate in the IDB Joint Scheme, the Central Bank has offered a Small Industries Credit Guarantee Scheme for projects prepared under the Scheme. Although the Scheme has helped SMIs obtain credit, most SMI lending continues to be undertaken outside of the Joint Scheme. The IFC has opened a US$2.0 million line of credit with the Bank of Ceylon for on-lending to small and medium industries (para 27 above). This loan provides financing for firms with assets up to Rs 6 million and will be used mainly for the larger range of medium-sized industries. IFC is also providing assistance to the Bank of Ceylon to improve its organization, procedures, and information systems. The Government has recently established the National Development Bank (NDB); its first operation will be to launch the refinance scheme for SMI lending by the credit institutions. 37. Import liberalization has led to a large increase in demand for credit in all sectors of the economy, and despite substantial increases in interest rates for both lending and borrowing, the liquidity position of the banks is strained. Presently, the banks charge 13%-18% on industrial term loans, including loans to SMIs. These rates are marginally positive in real terms, and are expected to remain so for the next few years. Based on conservative assumptions, estimated future investment by SMIs could result in average term credit demand of some US$12 million per year for the period. Assuming the banking system will be able to maintain its present level of SMI

17 financing in real terms from its own resources (about US$4.5 million equivalent in current prices), there would remain a financing gap of about US$23 million over the period. PART IV - THE PROJECT 38. The proposed project was identified by an IDA Industrial Sector Mission and was prepared by a SMI task force composed of Government agencies and public and private credit institutions, with IDA assistance. The project was appraised in February/March Negotiations were held in Washington, D.C., May 23 to 25, The Borrower's delegation was led by Dr. W. M. Tilakaratna, Secretary, Ministry of Finance and Planning. A Staff Appraisal Report (Report No CE, dated June 8, 1979) is being distributed separately to the Executive Directors. A timetable of key events relating to the project and special conditions of the credit are given in Annex III. Project Objectives 39. The principal objectives of the proposed project would be to assist in the development of small and medium industries in Sri Lanka. By addressing constraints hindering growth and productivity improvements of SMIs, particularly in selected subsectors with significant expansion potential, SMIs would be able to increase their contribution to efficient and low cost employment generation, export expansion, and economic growth. To meet these objectives, the project would: (a) increase SMIs access to credit; (b) provide effective promotion and technical, marketing, and management services to SMIs; and (c) encourage policy modifications in areas which affect expansion, export prospects, and efficiency of SMIs. Project Description 40. The proposed project consists of two major components - credit and technical services. The main elements would be: (a) a program by the National Development Bank through the SMI Fund to refinance loans by participating credit institutions to small and medium size industries; (b) strengthening of managerial, technical, marketing and other general and specific subsector services principally for small and medium size industries through provision of staff, training, equipment and facilities for the major technical services agencies;

18 (c) improvement of staff and operational systems of the National Development Bank and participating credit institutions through the training of staff and development of operating procedures and systems; and (d) undertaking studies to assist in the development of appropriate fiscal incentives and tariff structures. 41. The Project would be national in scope (Map No. IBRD 3839R2). While attention would be given to strengthening support for SMIs outside Colombo, a significant portion of the growth is expected in Colombo and secondary industrial towns. New and existing SMI firms engaged in a wide variety of manufacturing, processing and industrial services would be eligible for credit. It is expected that about 1,000 loans would be made under the project; subsector distribution is likely to be roughly: 30% for construction and building materials, 30% for agro-industries, 15% for metal products, 10% for export-oriented garment ancillaries, 10% for rubber products, and about 5% for others. Promotional efforts and technical and management assistance would concentrate on SMI subsectors with significant expansion potential. Credit and Credit Institutions 42. The proposed project seeks to improve the credit system in Sri Lanka to enable credit to be made available to economically and financially viable SMIs, on the basis of project evaluation rather than collateral. To do so, the project addresses major credit constraints to effective SMI lending - ability of credit institutions to expand credit, higher risks and administrative costs associated with lending to SMIs, shortage of suitably trained staff, and operational procedures in the credit institutions which are not fully appropriate for SMI type lending. To fill the projected financing gap, (para 37) the National Development Bank (NDB) is establishing a SMI Fund to provide refinance facilities for loans made to SMI firms by credit institutions (Section 3.02(b) of the Development Credit Agreement (DCA)). The Fund would be managed by a separate SMI Department, and would have an initial capital of Rs 20 million. A draft statement of policies and procedures, which is satisfactory to the Association, has been prepared and reviewed by NDB's Board. Staff of the SMI Department would include about 13 professionals to administer the SMI Fund and one to handle the administrative arrangements for the technical services component of the proposed project. The NDB is actively recruiting staff for the SMI Fund and has already identified suitable candidates, including staff with project review and refinance experience now employed in the Refinance Department of the Central Bank. It would be a condition of credit effectiveness that the Government had entered into a subsidiary loan agreement with the NDB for the use of the funds available under the Credit and completed arrangements, satisfactory to the Association, for the establishment, staffing and operation of the SMI Fund (Sections 6.01(a) and (c) of the DCA). The NDB would apply procedures and criteria satisfactory to the Association in its review of project appraisals by participating credit institutions for loans to be refinanced by the SMI Fund (Section 3.07(a) of the DCA), and would refinance loans on terms and conditions satisfactory to the Association (para 53 and Section 3.07(b) of the DCA). The structure of the refinancing

19 rates would be established to provide a slightly higher margin to the credit institution for lending to the smaller SMIs, and thereby enable them to cover the higher relative administrative costs of such lending. Five credit institutions (Bank of Ceylon, People's Bank, Hatton National Bank, Commercial Bank of Ceylon, and the Development Finance Corporation of Ceylon) would participate in the proposed project (Section 3.09 of the DCA) through their access to the SMI Fund to refinance loans made to SMI firms. It would be a condition of credit effectiveness that at least two participating credit institutions had signed participation agreements for access to the SMI Fund (Section 6.01(d) of the DCA). 43. In order to encourage credit institutions to undertake lending to SMIs, the Central Bank would offer a Credit Guarantee Scheme. It would be a condition of effectiveness that the existing credit guarantee scheme, which is also administered by the Central Bank and is currently restricted to projects which were prepared under the IDB Joint Scheme (para 36), would be modified to accommodate the lending to be made available under the proposed project (Sections 3.08 and 6.01(b) of the DCA). Under the modified scheme, the IDB recommendation would not be required for access to the guarantee facility. The participating credit institutions would be able to obtain a guarantee to cover the loans refinanced by the SMI Fund of up to 60% of the loan amount or Rs 400,000 (whichever is lower) for a premium, which would be borne by the credit institution out of its spread, of 1% per annum. 44. The Government proposes to establish a Special Capital Facility within the NDB, from its own contribution to the NDB, to assist extrepreneurs who are unable to meet the minimum equity requirements for loans from the credit institutions. The facility would be used only in exceptional cases for projects of high economic or financial merit to supplement the financing available from the credit institutions and would cover up to 10% of the total project cost. The terms of lending would be 15% interest per annum, with maximum maturity of 10 years, including a maximum of five-year grace period during which time interest could be capitalized. 45. Initial short-term training for credit institution staff has begun, financed under the UNDP Umbrella for which the World Bank acts as executing agency. The National Institute of Banking Management of India is conducting training sessions in Colombo on SMI project appraisal and supervision techniques for about 100 officers of the five credit institutions. In addition, orientation courses for branch managers will be conducted. Twelve staff members of the credit institutions' head offices will also receive training and apprenticeship in SMI appraisal and supervision techniques at the State Bank of India. Overseas training is being arranged under the Umbrella for six staff members of the SMI Fund at the Industrial Development Bank of India. Similar training activities to be undertaken during project implementation would be financed under the proposed project, including overseas training for 3-5 SMI Fund staff per year. 46. The proposed project would also provide consultancy services for improving the general operation of the NDB and the credit institutions and for the SMI Fund. It is proposed to utilize the expertise of experienced

20 institutions in India to assist NDB in setting up procedures, and establishing systems for finance, supervision, management information, and project appraisal. A senior adviser for about two manyears and 24 man-months of short-term consulting assistance have been included under the proposed project. The proposed project would also provide an adviser to the head of the SMI Fund for about two manyears. The two state-owned banks, People's Bank and Bank of Ceylon, are expected to account for the major portion of the lending operations to be refinanced under the SMI Fund facility. The Bank of Ceylon is improving its overall organization, procedures, and information systems with the assistance of the IFC (para 36). Under the proposed project, studies on personnel policy, planning and management information systems (about 12 man-months) would be financed for assistance to the other credit institutions. Technical Services 47. The proposed project would build on existing programs of SMI technical services agencies, refocussing and upgrading their programs to provide more effective services to priority subsectors. The Industrial Development Board (IDB) is the major SMI technical service agency, with responsibility for most subsector-specific promotion and extension schemes. As part of the proposed project, the IDB would reorganize at headquarters along subsector lines and would increase and upgrade its technical staff. The IDB would also relinquish its responsibilities for appraisal work under the IDB Joint Scheme and focus mainly on extension work. Short-term overseas training for some technical officers, and consultancy services (about 6 man-years) would be provided to help implement the subsector schemes. Multipurpose service centers would be established for rubber products, building materials, and metal products; these centers would provide backup, testing, development, and common service facilities for the specialized extension programs. IDB would also establish a subcontracting exchange to assist SMI's in obtaining procurement and private subcontracting orders. On the basis of the experience in the IDB Joint Scheme, IDB would prepare project profiles outlining the standard appraisal requirements for the major subsectors, which would be used by credit institutions in their project appraisals. 48. Improved technical services for the garments and handlooms subsectors would be provided through the Department of Textile Industries (DTI) in the Ministry of Textile Industries. DTI proposes to establish a garment training center to provide training and plant-level technical assistance to small, medium and large garment units in cutting and pattern making, production supervision, and quality control. About six manyears of expatriate specialist services would be provided under the proposed project. The Ministry of Textile Industries also plans to be a founding member of a private limited handloom production and export company, which would have majority private shareholders from the leading companies in the handloom subsector. This company would provide a mechanism for extending marketing and technical expertise of the leading handloom exporters to the rural areas. The Department of Small Industries (DSI) of the Ministry of Rural Industrial Development is responsible for cottage industry development. Under the proposed project, DSI would strengthen its extension services to the white coir industry, by

21 redeploying its staff, providing training for demonstration units, and utilizing the services of an expatriate coir products expert to assist in the development of demonstration programs. Initial training for demonstrators has been financed under the UNDP Umbrella and additional staff training would be provided under the proposed project. Policy Studies 49. The proposed project would also provide assistance to the Government to undertake studies to assist in the development of appropriate policies of particular relevance to the efficient expansion of the SMI sector. About one manyear of consultancy assistance would be provided to analyze the administrative and technical feasibility of extending fiscal incentives to industrial enterprises which expand and those providing components to exporters. About two manyears of assistance would also be provided for the Presidential Tariff Commission to assist in the development of a tariff system based on the principles of effective protection. The Government would consult with the Association regarding the findings and recommendations of these studies, (Section 3.10 of the DCA) and the Government and the Association would exchange views from time to time regarding the development of incentives affecting small and medium size industries (Section 4.03 of the DCA). Implementation 50. The proposed project would be implemented over a four year period. The implementing agencies would carry out their specific activities and responsibilities autonomously within the broad framework of objectives, guidelines and procedures agreed between the Government and the Association. In view of the complementary nature of the various project components (e.g., extension work to firms in the rubber subsector and the proposed bank lending to these firms to expand their activities), district level coordination of activities would be achieved through regular meetings of bank staff, regional managers of IDB, and field staff of the other relevant agencies. A SMI Coordinating Committee would be established (Section 3.02(a) of the DCA), comprising at least the Additional Secretary, Ministry of Industry and Scientific Affairs; General Manager, NDB; Director of Planning, Ministry of Finance and Planning; Chairman of IDB; and a representative of the private SMI sector. The Committee would review the quarterly progress reports to be prepared by NDB, IDB, and other agencies and make recommendations for the improvement of project implementation. Consultants, with qualifications and terms and conditions of employment satisfactory to the Association, would also be engaged to assist in the implementation of the various project components (Section 3.04 of the DCA). Monitoring and Evaluation 51. Annual work programs would be prepared by the implementing organizations and forwarded to the Association by November 1 of each year for review and comment (Section 3.11(a) of the DCA). Monitoring of the project's progress would be through quarterly reports prepared by the staff of the various implementing agencies (Section 3.11(b) of the DCA). The SMI Fund

22 Reporting and Liaison Section would monitor SMI lending activities of the participating credit institutions, whereas the Analysis and Review Section would maintain supervision of the SMI sector through the refinancing activities. The credit institutions would be responsible for assessing the economic viability of the projects to be financed. For smaller project from the more common subsectors, the credit institutions would use standard project profiles prepare by the IDB (para 47), which include an economic justification for investment in the subsector. The NDB would be responsible for reviewing these project profiles and would also conduct economic subsector analysis on its own. The SMI Fund would review in detail all the appraisals made by the credit institutions of projects requiring loans in excess of Rs 500,000 (US$32,000). In addition to the regular reporting requirements, the Association would also review the project appraisals and review memoranda for loans in excess of Rs 750,000 (US$48,000), expected to amount to about 40 loans over the four year implementation period. A project completion report would be prepared not later than six months after the closing date of the proposed IDA credit (Section 3.06(c) of the DCA). Costs and Financing 52. The total project cost is estimated at US$27.9 million equivalent 1/, including US$22.8 million equivalent for investment in SMIs and US$5.1 million for technical services. The foreign exchange component is estimated at US$14.7 million or about 53% of the total project cost. Price contingencies have been estimated assuming annual inflation of 7% for foreign costs and 14% for local costs in 1979 and 1980 and 10% thereafter. The total cost of individual consultants' services is estimated at about US$1.8 million, or about US$6,800 per man-month, including salary, allowances, travel, and miscellaneous expenses. The proposed IDA credit of US$16.0 million equivalent would finance the full foreign exchange cost of the project and about US$1.3 million equivalent of the local costs, or about 63% of the total project cost (net of taxes and duties). Beneficiaries of loans would provide US$6.45 million equivalent as equity in their own investment proposals. The credit institutions would contribute about US$3.0 million from their own resources, representing 20% of the loan amounts. The Government would contribute the remaining US$2.45 million equivalent. 53. US$12.0 million of the proposed credit would be on-lent by the Government to the NDB via a subsidiary loan agreement for the account of the SMI Fund on the following terms: (i) loan denominated in Sri Lanka Rupees, with Government bearing the foreign exchange risk; (ii) 9% interest per annum; (iii) fixed amortization schedule over 13 years, including four years grace (Section 3.03 and Part A of Schedule 3 of the DCA). The SMI Fund would provide refinancing to credit institutions for eligible SMI loans on the following terms: (i) refinancing up to 80% of loan amount; (ii) interest per annum of 10% for loans up to Rs 100,000 (US$6,400), 11% for loans over Rs 100,000 up to Rs 50u,000 (US$32,000), and 12% for loans up to Rs 1,000,000 (US$64,000); (iii) term would be parallel to the term of the individual loans, expected to average 5-7 years (Part B of Schedule 3 of the DCA). The average spread for the SMI Fund would be about 2%. The credit institutions would provide credit 1/ This includes an estimated US$2.5 million equivalent in taxes and duties.

23 to eligible small and medium industries on the following terms: (i) maximum project size of Rs 2 million; (ii) maximum loan size of Rs 1 million; (iii) 15% interest per annum; (iv) up to 10 years maturity, with up to 2 years grace period; and (v) minimum equity contribution of 20% (Part C of Schedule 3 of the DCA). 54. Inflation over the past four years is estimated at 12-15%. There is no evidence to indicate that the annual rate of inflation will change substantially over the next twelve months. Unlike the inflation prior to 1978, which was mainly caused by excessive budgetary deficits fuelling money supply expansion, the current inflation is largely a result of policy-induced price adjustments, which are designed to produce a major restructuring of relative prices in the economy (see para 15 above). These price adjustments are an integral part of a program of policy reforms introduced by the new Government and are expected to be substantially completed by the end of The Sri Lanka authorities anticipate production to respond positively to these price changes, and, together with a continued tight rein over government budgetary deficits, to cause a slow down in the rate of inflation by Therefore the interest rate to the final borrower should remain significantly positive in real terms. Procurement 55. Through the participation agreements with the credit institutions, the NDB would ensure that procedures are established to ensure that: (i) the goods procured locally for the projects to be refinanced under the SMI Fund would be purchased at reasonable and competitive prices, and (ii) the contracts for goods procured outside of Sri Lanka and estimated to cost Rs 160,000 (US$10,000) or more would be let through international shopping procedures on the basis of at least three price quotations (Section 2.03(a) of the DCA). The SMI Fund, in its review of loans above Rs 750,000 (US$48,000), would also review this aspect of the procurement. SMI Fund staff and IDA missions would review these procedures as part of the regular supervision of the project. Procurement of equipment, vehicles, materials and consultants and technical services for the technical services components would be in accordance with Government procedures, which are satisfactory to the Association. Authorization and Disbursement 56. Disbursements would be made for: (i) 100% of the portion of the loan amounts refinanced by the SMI Fund; (ii) 100% of foreign expenditures, 100% of local expenditures ex-factory, or 80% of other local expenditures for equipment, vehicles, and materials for the technical services component; and (iii) 100% of total expenditures for consultants' and technical services and overseas training. Disbursements under (i) would be made against statements of expenditure for all refinanced amounts not exceeding US$40,000. The records evidencing the expenditures on account of which withdrawals are requested on the basis of statements of expenditure would be retained until one year after the closing date of the IDA credit (Section 4.01(b) of the DCA), and the annual report of the auditors would include a separate opinion in

24 respect of expenditures and relevant withdrawals from the credit made on the basis of statements of expenditures (Section 4.01(c)(ii), (B) of the DCA). All other disbursements would be made against full documentation. It would be a condition of disbursement of funds under the IDA credit for expenditures in respect of the handloom company (para 48) that the company had been established to the satisfaction of the Association (para 3(b), Schedule 1 of the DCA). Prior to submitting the relevant disbursement requests, the Government would submit for review and authorization by the Association: (i) a summary description of each project for which a loan would be refinanced under the SMI Fund; and (ii) a summary description of expenditures to be financed and their intended uses under the technical services components (Section 2.02(b) of the DCA). Benefits and Justification 57. The proposed SMI project would address major constraints hindering expansion and productivity improvements by SMIs by providing suitable access to credit, by strengthening supporting services, and by encouraging policy improvements in the sector. In this way access to credit would be increased for a wide range of economically and financially viable small and medium size manufacturing and service industries (para 32). It is anticipated that about 1,000 projects would be financed with project costs, including sponsors' equity, totalling Rs 335 million (US$21.5 million), with an average loan size of Rs 200,000 (US$11,800). Since incremental fixed costs per job are well under US$1,000 in the priority subsectors to be assisted under the proposed project, these loans to SMIs are expected to result in incremental direct employment of at least 20,000. Although the technical, marketing and management service components are expected to have a significant impact on growth and productivity of SMIs in priority subsectors, benefits are difficult to quantify. In the case of the IDB, it is likely that some 600-1,000 rubber, engineering and building materials firms would benefit from specialized services and the subcontracting exchange, with an additional 1,000-1,500 firms benefitting from improved production, technical advice and district level extension network. The handloom export company is expected to result in significant increases in earnings for at least 2,000 rural weavers. The Garment Training Center would provide training for over 900 production supervisors, cutters and pattern-makers in three years. 58. Finally, the project would improve the capability of five major credit institutions to promote economically and financially viable SMIs. The project would provide advisers to help NDB establish procedures for its overall operations and to improve management information systems and personnel policies for participating credit institutions. The SMI technical service agencies would also be strengthened through the provision of training and improved facilities. Thus the project wouldl yield far-reaching institution building benefits. Risks 59. The risks inherent in establishing a new organization have been minimized by actions already taken by the NDB to ensure that key staff are

25 in place and provided with training and institution building support. The participating credit institutions, as well as representatives of the various concerned government agencies, worked with the project preparation task force to assist in shaping the SMI Fund into an organization which would function well in the current economic and institutional context. Provision is also made for the Project Coordination Committee to review project implementation and progress and to recommend improvements. 60. Another possible risk is that the credit institutions will be slower than expected in moving from collateral to project appraisal-based lending and that access to credit, particularly to smaller borrowers, will be limited. However, the structuring of differential spreads giving a greater margin for the smaller-size loans, the scope of the credit guarantee scheme, the emphasis on short-term practical training for branch-level staff and the diffusion of simplified project profiles should help increase the credit institutions' willingness and ability to make small project loans. 61. Successful implementation of the subsector schemes w-ill require reorientation and expansion of activities by the IDB and the other service agencies. However, specific subsector programs have been developed by the responsible agencies and these efforts have been focused on a limited number of important subsectors. Finally, the rapid development of SMIs envisioned with the proposed project depends on the continuation of the present liberal private investment environment. PART V - LEGAL INSTRIJNENTS AND AUTHORITY 62. The draft Development Credit Agreement between the Democratic Socialist Republic of Sri Lanka and the Association and the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement are being distributed to the Executive Directors separately. 63. Special conditions of the credit are listed in Section III of Annex III. Additional conditions of credit effectiveness would be that: (i) the Government had established the SMI Fund, with capitalization, operating policies and procedures, and required initial staffing, satisfactory to the Association (para 42); (ii) the Government had entered into a subsidiary loan agreement with NDB for the use of the funds available under the proposed credit (para 42); (iii) NDB had completed participation agreements with at least two participating credit institutions for access to the SMI Fund (para 42!; and (iv) that the credit guarantee scheme had been appropriately modified (para 43). 64. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association.

26 PART VI - RECOMMENDATION 65. I recommend that the Executive Directors approve the proposed credit. Attachments June 14, 1979 Robert S. McNamara President

27 -22 - Annex I Page 1 of 6 pages TABLE 3A SRI LANKA - SOCIAL INDICATORS DATA SHEET REFERENCE GROUPS (ADJUSTED AVERAGES SRI LANKA /a LAND AREA (THOUSAND SQ. KM.) - MOST RECENT ESTIMATE) TOTAL 65.6 SAME SAME NEXT HIGHER AGRICULTURAL 24.2 MOST RECENT GEOGRAPHIC INCOME INCOME 1960 /b 1970 /b ESTIMATE /b REGION /c GROUP /d GROUP Le GNP PER CAPITA (US$) ENERGY CONSUMPTION PER CAPITA (KILOGRAMS OF COAL EQUIVALENT) POPULATION AND VITAL STATISTICS TOTAL POPULATION, MID-YEAR (MILLIONS) URBAN POPULATION (PERCENT OF TOTAL) POPULATION DENSITY PER SQ. EM PER SQ. KM. AGRICULTURA LAND POPULATION AGE STRUCTURE (PERCENT) 0-14 YRS /f YRS If YRS. AND ABOVE 4.2 If POPULATION GROWTH RATE (PERCENT) TOTAL URBAN CRUDE BIRTH Ra.TE (PER THOUSAND) CRUDE DEATH RJ,TE (PER THOUSAND) GROSS REPRODUCTION RATE PAMILY PLANNIIUG ACCEPTORS, ANNUAL (THOUSANDS) USERS (PERCENT OF MARRIED WOMEN) FOOD AND NUTRITION INDEX OP FOOD PRODUCTION PER CAPITA (1970=100) PER CAPITA SUPPLY OF CALORIES (PERCENT OF REQUIREMENTS) PROTEINS (GRAMS PER DAY) OF WHICH PNIMAL AND PULSE CHILD (AGES 1-4) MORTALITY RATE HEALTH LIFE EXPECTANCY AT BIRTH (YEARS) INFANT MORTALITY RATE (PER THOUSAND) ACCESS TO SAFE WATER (PERCENT OF POPULATION) TOTAL URBAN RURAL ACCESS TO EXCRETA DISPOSAL (PERCENT OF POPULATION) TOTAL URBAN RURAL POPULATION PER PHYSICIAN POPULATION PER NURSING PERSON POPULAIION PER HOSPITAL BED TOTAL URBAN RURAL ADMISSIONS PER HOSPITAL BED HOUSING AVERAGE SIZE OF HOUSEHOLD TOTAL 5.4 /f URBAN 6.3 1f RURAL 5.2 If AVERAGE NUMBER OF PERSONS PER ROOM TOTAL 2.0 /f 2.5 URBAN 2.1 If 2.7 RURAL 2.0 If ACCESS TO ELECTRICITY (PERCENT OF DWELLINGS) TOTAL 7.5 /f URBAN 35.9 If RURAL 2.3 7?

28 - 23- Annex I TABLE 3A SRI LANKA - SOCIAL INDICATORS DATA SHEET Page 2 of 6 pages REFERENCE GROUPS (ADJUSTED AVERAGES SRI LANKA /a - MOST RECENT ESTIMATE) SAME SAME NEXT HIGHER MOST RECENT GEOGRAPHIC INCOME INCOME 1960 /b 1970 Lb ESTIMATE Lb REGION Le GROUP /d GROUP /e EDUCATION ADJUSTED ENROLLMENT RATIOS PRIMARY: TOTAL FEMALE SECONDARY: TOTAL FEMALE VOCATIONAL (PERCENT OF SECONDARY) PUPIL-TEACHER RATIO PRIMARY SECONDARY ADULT LITERACY RATE (PERCENT) CONSUMPTION PASSENGER CARS PER THOUSAND POPULATION RADIO RECEIVERS PER THOUSAND POPULATION TV RECEIVERS PER THOUSAND POPULATION NEWSPAPER ("DAILY GENERAL INTEREST") CIRCULATION PER THOUSAND POPULATION CINEMA ANNUAL ATTENDANCE PER CAPITA EMPLOYMENT TOTAL LABOR FORCE (THOUSANDS) /f FEMALE (PERCENT) AGRICULTURE (PERCENT) INDUSTRY (PERCENT) PARTICIPATION RATE (PERCENT) TOTAL MALE FEMALE ECONOMIC DEPENDENCY RATIO INCOME DISTRIBUTION PERCENT OF PRIVATE INCOME RECEIVED BY HIGHEST 5 PERCENT OF HOUSEHOLDS HIGHEST 20 PERCENT OF HOUSEHOLDS LOWEST 20 PERCENT OF HOUSEHOLDS LOWEST 40 PERCENT OF HOUSEHOLDS POVERTY TARGET GROUPS ESTIMATED ABSOLUTE POVERTY INCOME LEVEL (US$ PER CAPITA) URBAN RURAL ESTIMATED RELATIVE POVERTY INCOME LEVEL (US$ PER CAPITA) URBAN RURAL ESTIMATED POPULATION BELOW POVERTY INCOME LEVEL (PERCENT) URBAN RURAL Not available Not applicable. NOTES /a The adjusted group averages for each indicator are population-weighted geometric means, excluding the extreme values of the indicator and the most populated country in each group. Coverage of countries among the indicators depends on availability of data and is not uniform. /b Unless otherwise noted, data for 1960 refer to any year between 1959 and 1961; for 1970, between 1969 and 1971; and for Most Recent Estimate, between 1973 and /c South Asia; /d Low Income ($280 or less per capita 1976); /e Lower Middle Income ($ per capita, 1976); /f September, 1978

29 - 24 Annex I DEFINITIONS OF SOCIAL INDICATORS Page 3 of 6 pages Note: The ad,usted group averages fur each indicator are popolation-weighted g-ometric means, excluding the extreme values of the indicator and the most populated country in each group. Coverage of countries among the indicators depends on availability of data and is not uniform..e to lack of data, group averages for Capital Surplus Oil Exporters and indicators of access to water and excreta disposal, housing, income distribution and poverty are simple population-weighted geometric means without the exclusion of extreme values. LAND AREA (thouanod sq. km) Population per hospital bed - total, urban, and coral - Population (total, Iotal - Total ourface area comprising land area and inland caters. urban, and rural) divided by their respective number of hospital bhds Agriculcural - Most recent estinate of agricultural area used temporarily available in public and private general and specialieed hospital and reor permanently for crops, pastures, market and kitchen gardens or to habilitatien centers. Hospitals are establinhments permamently staffed by Ion fallow. at least one physician. Establishments prnviding principally custodial care are not included. Rural hospitals, however, include health and medihip FiR CAPITA (100) - GNP por capita estimates at corrent market pr-ces, cal centers not permanently staffed by a physician (bht by a nedical ascalcuaated by sane conversion method as World lank Atlas ( bausi); sistant, ma-se, midwife, etc.) which offer in-patient acroeeodation and 1960, 1970, and 1977 data. provide a lumitod eange of medical facilities. Admissions per hospital bed - Total number of admissions to or discharges ENERGY CONSUMPTION PER CAPITA - Annual consumption of commercial energy from h_spitals divided by the number of beds. (coal and ligoite, petroleum, natural gas and hydro-, nuclear and geothermal electricity) io khlograms of coal equivalent per capita. ROUSING Average sioe of household (persons per household) - total, urban, and rural- POPULATION AND VITAL STAIISTICS A hbusehold consists of a grosp of individuals win share living quarters Total population, pld-year (nillions) - As of July 1; if not available. asnd their main meals. A boarder or lodger may o1 may not be included in average of two end-pear estimates; 1960, 197,. and 1977 data. the household for statistical purposes. Statistical definitioas of house- Urban population (percent of total) - Ratio of orban to total popula- hold nary. tion; different definitions of urban areas nay affect comparability Average number of Derons per room - total, urban, and rural - Average nunof data among countries. her of persons per room in all, urban, and rural occupied conventional Population density dwellings, respectively. Dwellings enclude non-ermanenc structures and Per sq. km. - Mid-year population per square kilometer (100 hectares) unnoccpied parts. Of total area. Access to electricilty (pement of dwelliogs) - torta, rban, and rural - Per so. he. agric. tore land - Computed as above for agricultural land Conventional dwellings with electricity in living quarters an percentage only. of total, urbhn, and rural dwellings respectively. Population age stroc tare (percent) - Children (0-14 years), working-age (15-64 years), anu retired (65 years and over) as percentages of mid- EDtCATION year population. Adjusted enrollment ratios Population growth r.,te (percent) - total, and urban - Compound annual Primary school - total, and female - Total and fem.le e.rolloent of all ages growth rates of tc.tal and urban mid-year populations for , at the primary level as percentages of respectively primary schoor-age , and populatiuo-; normally includes children aged 6-11 yearn but ad-usted for Crude birth rate (per thousasd) - Annual live births per tuon.and of different lengths of primary education; for countries with oniversal eduid-pear pnpulati-n; ten-year arithmetic averages ending in 1960 and cation enrollment map enceed ll0 percent since none pupils are below or 1970 and five-yea average - ending ih 1971 fr most ret n.t estimate. above the official schoni age. Crude dea~th rate (per thousand) - Annual deanhs per thousand of mid- Snuondary schoo - n, and femle - Computed an abov; secondary edocayear populhatio; tnyeariarithmetic averagen ending in 960 and 1970 tio require aestl t four years of approved pimas ry istructieon; prand fie-year ave'age ending in 1975 for most recent estimate. ndes general vocational, or toucher training in-tructions for pupils Irons reproduction -ate - Average nomber of daughtera woman will bear usually of 12 to 17 years of age; c-rrespondence cou s are generally ic bet normal cep-od-oti-e period if she experiences present age- excluded. specific fertilit3 rates; Usually five-year averages ending in 1960, Vocational onrollment (percent of neaneduryl - Cocational inntitcttons is- 1970, and dlude technical, indcstriol, or oiher programs which operate independently Psmily planning - acceptors, annual (thousands) - Annual number of or an departments of secondary institutions. acceptors of birtf-control devices under auspices of national family Pupil-teacher ratio - primary, and secondary - Total students enrclled so planning program. prinary and secondary levels divided by numbers of teachers in the corre- Fanily planning - users (peroent of married women) - Percentage of sponding levers. married women of child-bearing age (15-i4 yours) who use birth-cotrol Adu1t literacy rate (percent) - Literate adulct (able to read and wrion) ao devices to all macrid women in same age group. a percentage of total adult popalation aged 11 pears and over. FOOD AND NUTRITION CONSLRPTION Indes of food prod-ction per capita (197D100) - Iden comber of per Passonger tars (per thousand population) - Pansenger cars comprise motor cart oapita amnual production cf all food coemodities. seating less than eight persons; excludes ambiances, hearses and rilit-ar Per capita supply of calories (percent of requirements) - Cnmputed from vehicles. energy eqsivalent of net food nupplien available in country per capita Radio recoivers (per thousand population) - All types of rnceivers for radio per day. Available supplies comprise domestic production, imports ioss broadcasts to general public per thouannd of populationi; ecludes unlicetned exports, and changes in stock. Net supplies exclude animal feed, seeds, re"iioersincountrien and in years when vogistratio of radio sets was Os quantities uoed in food procesning, and losses in distribution. Re- effece; data for recent yearn nay not be comparable since moss countries quir-tents were ennimated by FAO based on physiological needs for nor- abolished licensing. eel activity and health consider ing environmental temperature, body TV receivers (per thousand p-oluation) - TV receivers for broedcast to generai weights, age and distribtion f pplatin, an llod ir.g 10 pen- public p_e thousand population; excludes unlicensed 7'1 receivers cv cootcent for waste at household level. tries and in years wh-n registration of TV' sets was in efiect. Per capita supply of protei (rams per day) - Protein content f per Newnpapercir ul7oon (per thousand populatipon - iws te aerage circulacopita net supplp of food per day, lt upply of food is defined as tion ofdiy gnera neetnwppr,define`d supriadical publoi above. Requirements for all countries established by VitA provide foe catio devoted primarily to recording general news. it is considered to anminium allowance of 60 grams of total protein per day and 20 grams be daily" if it appears at Inane four rives a week. of aninal and pulse protein, of which I grams should he animal protein. Cinena aenual atondance per ca-ita per year - Baed on the number of tickets Those at-sdards are lower th-a those of 71 grass of toral protein and sold during the year, includiog udtiesioss to drive-c- cinenau aod bole 23 grans of snimal protein as an average for the -orld, proposed by omits. FAO in the Third World Pood Rurvey. Per capita protein supply from animal an 6 - Protein supply of food EMPLOYPCENT derived firo animals and pols i graman pepr day. Total abor force (thousanon) - Economically actors pesons, ixcludoog armed Child (ages 1-4) mortality rate (per thousand) - Annual deaths per thous- fr-c-s and serpl y..d bht -ocluding housewives, students, ec. Deiniand in age group 1-4 years, to children in this age group. tions in various countries are not comparable. Female (percent) - Female labor force us percentage v tnral lahcr icece HEALTH alt (ppecn ern -Labor force in farming, forestr, urting aend fiohoog Life nopectancy at birth (years) - Averagn number nf years of life as p-rfnnagm nf total labor force. remaining at birth; _soully five-year averages ending is 1960, 1970, Industre (percent) - Labor force in minieg, coestructios, manufacturing cnd and electricity, water and gas as percentage of total labor force. Infant mortality rate (per thousand) - Annual deaths of infants under Participatin rate (perceet) - total, male, and female - Total, male, and one year of age per thousand live birhts. 'emule labor ore as percentagcs of these respective popat ilons. Access to safe water (percent of population) - total, urban, and rural - Those are ILO's adjusted povticgpuriop rates reds ecrn- age-see Number of people (atotl, urban, and rural) with reasonable access to otructure of chr populatio-. end 10ng rive tend. safe water supply (inolodos treated surfane waters or untreated but Economi^ drpendenco ratic - Rator of populatio- cnder 15 nd 65 and vercie uncontaminaced water such as that fron protected boreholes, springs, the labcr force in age group of pears. and sanitary cello) an sercentagos of their respective populations. Is an urban area.au pblic founnain or stamdpost located not nore INCOME DI1TRIBUTION than 200 meters from a house may be considered an being within rea- Percentage of private income (both oi cash and kiod) received by richest 5 sonable access of than house. In rural areas reasonable access would percont, richest 20 percert, poorest 20 percent. and poorest 40 pecce-c inply that the housewife or nenbers of the household do nor have to no hoseslds spend a disproportionate part of the day it fetching the famly's cater needs. POVERTY TARGET GROUPS Aucess on ex-reta disposal (perento of population) - total, urban, and Eitimated absolute poverty income loo 1 ('.S5 per capit.a) -uroan and coral - vrurl - Number of people (total, urban, and rural) nerved by e.cresa Absolute pov..py inccme lnvet is that income level below which a vcnoeal disposal as percentages of their respective populations. Excreta nutritionally adequate diet plus essentia' mon-food recuire.ents in now disposal nay include the collectio and disposal, with or without affordabl. tresonoet, of human excrets and waste-water by water-borne systems Intimated relative poverty income level (US5 per capita) - urban and cural - or the use of pit pr-vien end similar installations. Ri.cni-e poverty income le-el is that income level less than one-third Populacion physicians pee physician qualified - Population from a medical divided school by number of practicing or university Level. per capita per soal income f the coont r. istimated population ot) belo pvrt i l (per - rban and meal Population per nursing person - Populaticn divided by number of teroer of population (urban and rural) who are either "absointe poor" practicin.g male and fmale grodust nunsen, psactical nurses, and "relative poor" whichever is greater. asuistant nurses. E.onomic and Social DIta liviocon Econoic Analysis and Projectiors Depactoret

30 Annex 7 -, 25 - Page 4 of 6 pages SRI LANKA E C O N O M I C D E V E L O P M E N T D A T A S H E E T S A C T U A L EST NATIONAL ACCOUNTS (1) (MILLIONS OF US$ AT 1975 PRICES) GROSS DOMESTIC PRODUCT 1783, GAINS FROM TERMS OF TRADE GROSS DOMESTIC INCOME IMPORTS EXPORTS - VOLUME EXPORTS - TT. ADJUSTED RESOURCE GAP - TT. ADJUSTED TOTAL CONSUMPTION ,1 INVESTMENT NATIONAL SAVINGS DOMESTIC SAVINGS GOP AT CURRENT USS SECTOR OUTPUT ISHARE OF GDP AT 1975 PRICES) AGRICULTURE INDUSTRY SERVICES PRICES ( 1975 = 100) EXPORT PRICE INDEX IMPORT PRICE INDEX TERMS OF T'RADE INDEX GDP DEFLATOR (USS) ANNUAL AVERAGE EXCHANGE RATE Growth Rates 1976 SHARE 1965 OF 1977 GOP NATIONAL ACCOUNTS (i) (MILLIONS OF US$ AT 1975 PRICES) GROSS DOMESTIC PRODUCT GAINS FROM TERMS OF TRADE 6.7 GROSS DOMESTIC INCOME IMPORTS EXPORTS - VOLUME EXPORTS - TT. ADJUSTED RESOURCE GAP - TT. ADJUSTED 2.5 TOTAL CONSUMPTION INVESTMENT NArIONAL SAVINGS DOMESTIC SAVINGS GDP AT CURRENT US$ 4.4 PRICES ( 1975 = 100) EXPORT PRICE INDEX 5.1 IMPORT PRICE INDEX 6.2 TERMS OFD TRADE INDEX -1.0 GDP DEFLATOR (US$) 0.5 SElECTED INDICATORS ICOR 4.37 IMPORT ELASTICITY AVERAGE NATIONAL SAVINGS RATE MARGINAL NATION4L SAVINGS RATE 0.32 IMPORTS/C;DP 0.44 INVESTMENT/GDP 0.16 RESOURCF GAP/GOP 0.04 (1) CUMPONENTS MAY NOT ADD UP BECAUSE OF ROUNDING

31 -26 - Annex I Page 3 of 6 pages SRI LANKA BALANCE OF PAYMENTS AND EXTERNAL ASSISTANCE A C T U A L E S T SUMMARY OF BALANCE OF PAYMENTS (US$ Million) 1. EXPORTS (INCLUDING NFS) , IMPORTS (INCLUDING NFS) RESOURCE BALANCE ,5 81i NET FACTCR SERVICE INCOME -17, NET INTEREST PAYMENTS OF WHICH ON PUB M&LT LOANS DIRECT INVESTMENT INCOME WORKERS REMITTANCES (NET) CURRENT TRANSFERS (NET) BALANCE ON CURRENT ACCOUNT , PRIVATE DIRECT INVESTMENT GRANTS & GRANT-LIKE FLOWS ,9 PUBLIC M&LT LOANS 9. DISBURSEMENTS AMORTIZATION il. NET DISBURSEMENTS OTHER M&LT LOANS 12. DISBURSEMENTS AMORTIZATION NET DISBURSEMENTS USE OF IMF RESOURCES SHORT-TERM CAPITAL TRANSACTIONS CAPITAL TRANSACTIONS NEI CHANGE IN RESERVES (- = INCREASE) NET FOREIGN EXCHANGE (1) RESERVES (END OF PERIOD) GRANT AND LOANS COMMITMENTS (US$ Million) 1. OFFICIAL GRANTS , TOTAL PUBLIC M&LT LOANS ,9.1 IBRD IDA OTHER MULTILATERAL GOVERNMENTS , OF WHICH CENTRALLY PLANNED ECONOMIES (2) SUPPLIERS ,7 FINANCIAL INSTITUTIONS BONDS PUBLIC LOANS NEI.0.0 -O OTHER M&LT LOANS (WHERE AVAILABLE) O0 MEMORANDUM ITEMS 1, GRANT ELEMENT OF TOTAL COMMITMENTS AVERAGE INTEREST RATE AVERAGE MATURITY (YEARS) / NET FOREIGN ASSETS: US$ EQUIVALENT OF LINE 31, IFS. 2/ INCLUDES CMEA COUNTRIES, PEOPLES REPUBLIC OF CHINA. NORTH KOREA, NORTH VIFTNAM. DATE OF LATEST UPDATE 05/04/79

32 - 27 Annex I SRI LANKA Page 6 of 6 pages D E B T A N D C R E D I T W O R T H I N E S S A C T U A L E S T. MEDIUM AND LONG TERM DEBT (DISBURSED ONLY) TOTAL DEBT OUTSTANDING (DOD END OF PERIOD) INCLUDING UNDISBURSED PUBLIC DEBT SERVICE , INTEREST OTHER M&LT DEBT SERVICE TOTAL DEBT SERVICE DEBT BURDEN _ DEBT SERVICE RATIO DEBT SERVICE RATIO (1) DEBT SERVICE/GDP PUB. DEBT SERVICE/GOV. REVENUE TERMS INT. ON TOTAL DOD/TOTAL DOD TOTAL DEBT SERVICE/TOTAL DOD DEPENDENCY RATIOS FOR M&LT DEBT GROSS DISB./IMPORTS (INCL,NFS) NET TRANSFER/IMPORTS(INCL.NFS) NET TRANSFER/GROSS DISB EXPOSURE IBRD DISB./GROSS TOTAL DISB , BANK GROUP DISB./GROSS TOTAL DISBURSEMENTS IBRD DOD/TOTAL DOD BANK GROUP DOD/TOTAL DOD IBRD DEBT SERVICE/TOTAL DEBT SERVICE BANK GROUP DEBT SERVICE/TOTAL. DEBT SERVICE OUTSTANDING DEC, EXTERNAL DEBT (DISBURSED ONLY) AMOUNT PERCENT IBRO BANK GROUP OTHER MULTILATERAL GOVERNMENTS OF WHICH CENTRALLY PLANNED ECONOMIES (2) SUPPLIERS FINANCIAL INSTITUTIONS.1.0 BONDS.0.0 PUBLIC DEBT NEI.0.0 TOTAL PUBLIC M&LT DEBT OTHER PUBLIC M&LT DEBT.0.0 OTHER M&LT DEBT.0.0 TOTAL PUBLIC DEBT (INCLUDING UNDISBURSED) TOTAL M & LT DEBT (INCLUDING UNDISBURSED) DEBT PROFILE TOTAL DEBT SERVICE /TOTAL DOD END OF /INCLUDING NET DIRECT INVESTMENT INCOME 2/INCLUDES CMEA COUNTRIES. PEOPLES REPUBLIC OF CHINA, NORTH KOREA, NORTH VIETNAM.

33 ANNEX II Page 1 THE STATUS OF BANK GROUP OPERATIONS IN SRI LANKA A. STATEMENT OF BANK LOANS AND IDA CREDITS (as of April 30, 1979) /a US$ Million /b Loan or Amount (net of Credit cancellations) No. Year Borrower Purpose Bank IDA Undisbursed Seven loans and five credits fully disbursed Sri Lanka Mahaweli Ganga Development I Sri Lanka Dairy Development Sri Lanka DFC - Industrial III Sri Lanka Agricultural Development Sri Lanka Tank Irrigation Sri Lanka Mahaweli Ganga Development II Sri Lanka Water Supply Sri Lanka DFC - Industrial IV Sri Lanka Tree Crop Rehabilitation (Tea) Sri Lanka Tree Crop Diversification (Tea) Sri Lanka Kurunegala Rural Devel. /c Total, of which has been repaid Total now outstanding Amount sold, 3.6 of which has been repaid 3.6 Total now held by Bank and IDA /a Total undisbursed /a Does not include Road Maintenance (USb16.5 M) and National Extension and Adaptive Research (USa15.5 M) approved by the Board in May and June /b Prior to exchange adjustments. /c Not yet effective. B. STATEMENT OF IFC INVESTMENT (as of April 30, 1979) Amount of US$ Million Year Obligor Type of Business Loan Equity Total 1977 The Development Finance Development Banking Corporation of Ceylon Bank of Ceylon Development Banking Total Commitment now held by IFC

34 _ 29 - ANNEX II Page 2 C. PROJECTS IN EXECUTION I/ Ln. No Mahaweli Ganga Development (Irrigation/Power) Project; US$14.5 million of January 30, 1970; Effective Date: April 30, 1971; Original Closing Date: June 30, 1976; Revised Closing Date: July 31, 1979 The project, now complete, is about two years behind appraisal target. Delays were due mainly to foundation problems at Polgolla power house and a slow start at Bowatenna diversion dam. After overcoming these problems, the construction progressed satisfactorily. Good progress has been recorded to date on agricultural extension and research in the project area. The Credit (174-CE) associated with this project has been fully disbursed. An unallocated amount of US$2.0 million from the loan is being utilized for the procurement of badly needed vehicles and equipment. This procurement is underway. The closing date of the loan has accordingly been extended to July 31, Cr. No Dairy Development Project; US$9.0 million of August 9, 1974; Effective Date: February 10, 1975; Closing Date: December 31, 1980 The original project, as appraised in 1973, was designed to increase milk production on about 2,400 dairy farms covering 42,000 acres in the Coconut Triangle and Mid Country of Sri Lanka by providing credit, technical assistance and a strengthened milk collection, transport and marketing system. Complementary objectives were to establish pilot units for commercial calf rearing and pasture management systems; and provide processing equipment to the National Milk Board. However, progress was severely constrained by the poor supply of cattle available for onlending to project borrowers. The poor supply of cattle was due to import problems and an over-estimation of the national herd at appraisal stemming from unreliable Government statistics. Moreover, unrestricted slaughter of cattle was stimulated by a rapid increase in concentrate feed prices which made milk production unattractive plus the relatively high consumer price of fish and poultry meat. It, therefore, became necessary to reformulate the project. The revised project, still under discussion with the Government, would focus on what was a small component of the original project-support to dairy cooperatives. Under this component, dairy farmers would be organized in a manner similar to the successful Anand pattern of Dairy Cooperatives in India. The Government has requested the I/ These notes are designed to inform the Executive Directors regarding the progress of projects in execution and, in particular, to report any problems which are being encountered and the action being taken to remedy them. They should be read in this sense and with the understanding that they do not purport to present a balanced evaluation of strengths and weaknesses in project execution.

35 - 30 ANNEX II Page 3 National Dairy Dc-)elopment Bcard (India) to help evaluate the potential of suerc an :oacn app c en i n-oirman of NDDB -visited Sri Lanka in December 1978 Lo evaluate Sri.anka's Lechimica1 assistance needs for the proposed approach. Consequently, the su pl- of inputs and services would become key activities of the revised pro4ect, 3 jhich would include provision of technical assistance and credit t farmer, and support for milk collection, transport and marketing. Preliminary proposals h-e already been received and accepted by IDA to expand the successful ongoing calf/heifer rearing and pilot Dasture programs. The number of benefii-arv far7m ffamilies would be substantially increased (current escimate approg1raetel vs in the original project) and the project y-oul d o ntrib.te t a considerable increase in income of existing landiess an- sm31l f.-er dairy producers. Government's commitment to the proposed re-rised pr3lect approach is e-videnced by the recent Cabinet approval to provice adequate incentives to dairy production in Sri Lanka. Cr. No. 566 Third Development Finance Corporation of Ceylon Project; US$4.5 million of June 27, 1975; Effective Date: August 22, 1975; Closing Date: September 30, 1979 The credi, was designed to meet the estimated foreign exchange requiremencs of t.he D'eveloD7ment Finance Corporation of Ceylon (DFCC) for lending mainly to expcrt industries and tourism. The credit has been fully committed and is li7sely to be fully disbursed by the closing date. Cr. No t'. nuural Development Project; US$25.0 million of -Esnoer 2-, 1975; Effective Date: March 1, 1976; Original Cl-osing Date: June 30, 1978; Revised Closing Date: September The crigginal closing date of June 30, 1978 was extended to allow full utilization ol credit funds. Disbursements continue to be slow and only if the Project Coordinacing Committee and the participating agencies take quick actions as agreed with IDDA will it be possible to commit the remaining US$4.9 M OU tctal of US$'-.b M undisbursed before the new closing date. Funds still ] a >hle are for import of spare parts for machinery rehabilita- Lion programs?' t-ne Departmeat of Agriculture and the Department of Machinery and Eouiorenr, the imaportation of about 300 tractors for farmers and 75 4-wheel drive -vehicles for the two estate corporations' field supervisory work, Cr. No. (b5 - 'ank 1,rrgation Modernization Project; US$5.0 million of januaryv l, 1977; Effective Date: April 12, 1977; Gllosing Dat'e June 30, ,,-i; ~-~c'c of the first two tanks is now about one year behind schedule but cor-rction equipment has arrived and construction progress has begun tc pick-, 3 rii nt Unfortunately, quality control has been neglectea and so?me I- -e co-mtletqed works are poorly constructed. Some of these

36 -3L - ANNEX II Page 4 works will have to be reconstructed or water losses and O&M costs will be unacceptably high. The Government has agreed to take action to improve quality control and closely monitor future work and will reconstruct those facilities which do not function properly after operation commences. In this regard, a quality control training program was provided by the U.S. Bureau of Reclamation in the USA for three Irrigation Department engineers during November-December = 1978 and it is hoped that construction quality will improve to the levels required. A well-qualified Water Management Specialist has arrived (part-time) to set up a water management training program for Irrigation Department staff and farmers and much improvement is expected in this area. A full-time resident Project Manager has been appointed and coordination and construction progress are expected to improve. Project completion is expected to be delayed about one year. Cr. No Mahaweli Ganga Development II Project; US$19.0 million of of April 21, 1977; Effective Date: December 29, 1977; Closing Date: June 30, 1983 The Government has undertaken development of the project on an accelerated basis and had planned to complete the project within one year. This proved to be an overly optimistic target and the Government now is striving to complete the project by end Unfortunately, in its haste to meet set target dates, Mahaweli Development Board (MDB) initiated work in all areas of the project on an ad hoc basis, by-passed certain work required in preparing lands for settlement, sacrified construction quality standards and practices requisite to works of good quality, changed portions of the main canal alignment where difficulties were encountered and embarked upon settlement actions without ensuring that necessary support programs and infrastructure development would be in place when settlement of the lands was done. The Government has agreed to take action to improve quality control and closely monitor all work in the future. In this regard, a quality control training course was provided by the US Bureau of Reclamation in the USA for four MDB engineers during November/December 1978 and it is hoped that constructior. quality will improve to the levels required. A resident Project Manager has recently been appointed, filling a vacancy that has existed for more than a year, and project implementation and coordination activities are expected to improve considerably. Project completion may be advanced by about 1-1/2 years earlier than estimated at appraisal. Cr. No Water Supply Project; US$9.2 million of May 10; Effective Date: February 9, 1978; Closing Date: March 31, 1982 Good progress has been made in implementing institutional changes, introducing a new bulk water tariff, establishing new accounting procedures both in the National Water Supply and Drainage Board (WDB) and in local authorities. Despite initial delays, the WDB has made excellent progress during the past year, particularly in procurement. Thirty three contracts have been awarded. At present, the disbursement level is low, but is expected to rise rapidly by the end of calendar year 1979.

37 ANNEX II Page 5 Cr. No Fourth Development Finance Corporation of Ceylon Project; US$8.0 million of September 30, 1977; Effective Date: December 16, 1977; Closing Date: December 31, 1981 This credit will meet a substantial portion of DFCC's estimated foreign exchange requirements for lending to private sector industrial projects and tourism. Subprojects for US$4.1 million have been authorized. DFCC remains a competent institution, with a rapidly increasing level of activity, which could increase further provided that DFCC's staffing problems are overcome as well as the constraint caused by the low equity base. Cr. No Tree Crop Rehabilitation (Tea) Project; US$21.0 million of July 12, 1978; Effective Date: December 28, 1978; Closing Date: December 31, 1984 Project progress is satisfactory. Procurement is getting under way; all tender documents have been issued. In the case of housing, awards have been-made and construction is starting. In the case of tractors and vehicles, award proposals were cleared by IDA this month and vehicles and tractors should be delivered by July In the case of factory equipment, tenders should be awarded by August 1979 and delivery is expected in December this year. Field works, replanting and infilling, are on schedule. All other project components, namely health component, training component and tea area measurement, are progressing satisfactorily. Cr. No Tree Crop Diversification (Tea) Project; US$4.5 million of July 12, 1978; Effective Date: December 15, 1978; Closing Date: June 30, The National Agricultural Development and Settlement Authority, the project executing agency, has developed into a mature development organization which is operating efficiently under capable management. Despite some delay in procurement of equipment, progress in field work is impressive. Cluster selection and homestead and farm demarcation are nearly complete and soil conservation work (bench terraces, lock and spill drains, graded stone terraces) well under way and accelerating. Foundations for about 500 houses have been laid. Cr. No Kurunegala Rural Development Project; US$20.0 million of April 26, 1979; not yet effective The project aims to assist the development of the District of Kurunegala in an integrated manner for purposes of raising productivity, employment, incomes and living standards and to develop a replicable model for rural development for other districts in Sri Lanka. The project will provide for rehabilitation of existing irrigation schemes accompanied by improved water management practices to fully exploit the irrigation potential, and for programs for replanting/underplanting, intercropping and fertilizing

38 ANNEX II Page 6 of smallholder coconut plantations. The project will all strengthen agricultural extension services, improve the supply of input services such as fertilizer distribution and seeds supplies, and lay the foundation for a viable agriculture credit system. These directly productive investments will be complemented by investments in transportation, health, education, water supply and rural electrification. Cr. No Road Maintenance Project; US$16.5 million The project was approved by the Executive Directors on May 1, Cr. No. - National Extension and Adaptive Research Project; US$15.5 million The project was presented to the Executive Directors on June 12,

39 ANNEX III Page 1 SRI LANKA SMALL AND MEDIUM SCALE INDUSTRIES PROJECT Supplementary Project Data Sheet Section I: Timetable of Key Events (a) Time taken by the Couutry to prepare the project 4 months (b) The agency which has prepared the project SMI task force composed of Government agencies and public and private credit institutions, with the assistance of an IDA mission. (c) Date of first presentation to the Bank and date of the first mission to consider the project April November 1978 (d) Date of departure of appraisal mission February 1978 (e) Date of completion of negotiations May 25, 1979 (f) Planned date of effectiveness September 1, 1979 Section II: Special IDA Implementation Actions None Section III: Special Conditions (a) The NDB would apply procedures and criteria satisfactory to the Association in its review of project appraisals for loans to be refinanced by the SMI Fund (para 42);

40 ANNEX III Page 2 (b) The Government and the Association would exchange views from time to time regarding the development of incentives affecting small and medium size industries (para 49); and (c) Conditions of credit effectiveness: (i) the Government had entered into a subsidiary loan agreement with the NDB for the use of funds available under the proposed credit (para 42); (ii) the SMI Fund would be established within NDB, with capitalization, procedures and policies, and initial staffing, satisfactory to the Association (para 42); (iii) the NDB had completed participation agreements with at least two participating credit institutions for access to the SMI Fund refinance facility (para 42); and (iv) the credit guarantee scheme had been appropriately modified (para 43). i

41 IBRD 3839R2 82' FERUAtY 1978 Kankesansorot,, 1<g S '\' SRILANKA 9 X ~~~~~~~~~~~~~National roatds ~~~~~~~~~~~~~~+\&.? ->,Xt Xs.., ~~~~~~~~Railwavys. 4 $ +,-3 ~ ~ ~,,~<,-<Agrtn,r. \ N- t bcoundaries Rivers clmotic zone Elevaotio (in feel): o too r. \ \ = tlx \ SOO )ioloimonnar 9$aMonkuom i _ I /<Sn.'. '..: <: > <Over5000 ~~~~~~ Mooo~~~~~~~~~~ ~~~~~~~~~~~~~~~~~ O p 0'. 20 MI LES sp t = X ~~~~~~~ gva~~~vumyf -l\,.comoe eengcl Bay of Ig t \> t N~~~~~~Medawcchchiyc / /n da n 0 c e a bu-ntl N< Nnqonn A C ';I_ ff X ta Sw f WS 0A ~ ~ Kuru ego a Lf~~~~~~~~~~~~~~~~~~~a Kotuooy r- KC0. ' 10. T~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ 7 O' Nuworo '-2 - r t dmomffwsormntismp C clnomr -- 89wrcoewerb, hwpe rg9irittuvit -nptrt a lb.mp prapanad PA notst - tins tn A atnd tcon on att atonatat rnar N 1, 5 arr a 6 / n dt ita n O c e a n < SRd LANKA