PRE ELECTION BUDGETARY POSITION REPORT

2010 PRE ELECTION BUDGETARY POSITION REPORT Issued under Section 16 of the Fiscal Management (Responsibility) Act No. 03 of 2003 Secretary, Ministry of Finance & Planning

PRE ELECTION BUDGETARY POSITION REPORT 2010 Issued under Section 16 of the Fiscal Management (Responsibility) Act No. 03 of 2003 Secretary Ministry of Finance & Planning 01 st March 2010 1

CONTENTS # Topic Page No. 1. Introduction 4 2. An overview of Fiscal Performance 5 3. Government Revenue Performance 2009 10 3.1 Income Tax 10 3.2 Value Added Tax 12 3.3 Excise Tax 12 3.4 Import Duty 13 3.5 Other Taxes 14 3.6 Non Tax Revenue 14 4. Government Expenditure 15 4.1 Salaries and Pension Cost 17 4.2 Interest Cost 17 4.3 Welfare and Subsidy Payments 18 4.4 Public Investment 20 5. Foreign Financing 21 5.1 Foreign Financing Commitments 21 5.2 Committed Undisbursed Balance 25 5.3 Foreign Fund Disbursements 26 5.4 External Debt and Service Payments 26 6. Treasury Operations 27 2

7. Government Debt 28 8. External Finance 30 9. External Trade 30 9.1 Exports 31 9.2 Imports 31 10. Current Account 33 11. Monetary Developments 33 12. Capital Market Activities 34 13. Real Economy 35 14. Inflation 38 15. Unemployment 38 16. Vote on Account 38 17. 2010 Budget Outlook 40 17.1 Revenue 40 17.2 Expenditure Estimates 41 17.3 Borrowings 42 17.4 Statement of Risks 44 18. Stand By Arrangement with the IMF 44 Statement by the President as the Minister of Finance and Planning under Section 19(a) of the Fiscal Management (Responsibility) Act No. 3 of 2003 47 Statement by the Secretary, Ministry of Finance and Planning under Section 19(a) of the Fiscal Management (Responsibility) Act No. 3 of 2003 48 3

PRE ELECTION BUDGETARY POSITION REPORT 2010 Issued by the Secretary, Ministry of Finance and Planning in terms of Section 16 of the Fiscal Management (Responsibility) Act No. 3 of 2003 1 Introduction This report is issued in terms of Section 16 of the Fiscal Management (Responsibility) Act No. 3 of 2003, which requires the Secretary to the Ministry of Finance to present to the public, within three weeks of publication of Proclamation or Order requiring the holding of a general election for the election of members of Parliament, a Pre-Election Budgetary Position Report containing information on the fiscal position of the country. 1 Accordingly, this report contains provisional figures of Government revenue, expenditure and borrowings in 2009 and a broad fiscal outlook for 2010, based on legal arrangement prevailing pertaining to collection of revenue and commitment for public expenditure 2. The estimates of Government revenue, expenditure and borrowings for the 4 months ending April 2010, as approved by the Parliament under the Vote on Account pending the approval of the 2010 Budget by the new Parliament, are presented in this report to reflect the immediate fiscal position of the Country. The key macro economic developments in 2009 are also provided to facilitate the understanding of the overall economic situation within which fiscal operations have been conducted 3. This Report also refers to the basis of information on economic and other assumptions used in the preparation of estimates, risks, and such other information that may have a material effect on the fiscal performance, so as to reflect the financial position of the Government. 1 His Excellency the President made a proclamation to dissolve Parliament on 9 th February, 2010 by gazette notification no. 1640/16. 2 Fiscal outlook for 2010 will eventually depend on the Budget to be presented by the new Government. 3 Statistics are being collected for 2009 by relevant authorities and are expected to be finalized by end March 2010. Hence this Report is based on provisional figures available as at end February 2010 and is subject to change once all accounts are finalized. However, such changes are not expected to make a material impact to the overall contents in this report. 4

2 An Overview of Fiscal Performance Fiscal adjustments towards containing the Budget deficit below 7.0 percent of GDP in 2009 suffered a setback due to less than expected recovery particularly in trade based activities and due to more than envisaged adverse impact of the global economic crisis of 2008/09 on the Sri Lankan economy 4. The Budget deficit of Rs. 469,627 million turned out to be 9.7 percent of GDP in 2009. This is primarily due to the decline in projected revenue by Rs. 23,580 million or 0.5 percent of GDP, rise in interest payments by Rs.38,464 million or 0.8 percent of GDP and increase in public investments by Rs. 48,074 million or 1.0 percent of GDP over the projected level for 2009. Consequently, Government revenue declined from the estimated level of Rs. 725,708 million to Rs. 702,128 million while total expenditure increased from Rs.1,091,566 million or 22.2 percent of GDP to Rs. 1,197,240 million. The aberration in revenue outcome in 2008/2009 was a result of a continued deterioration in revenue collection from VAT, import duties and excise taxes levied at the point of import, due to the erosion in the value of imports as the tax base. The revenue from these 3 major sources declined to 8.2 percent of GDP in comparison to 9.5 percent in 2007 in spite of some offsetting measures taken through the introduction of high CESS rates underpinning the impact of an erosion in import based revenue collection as well as the vulnerability of the fiscal performance of the country to global economic fluctuations. The value of imports declined from Rs.1,516,681 million in 2008 to Rs.1,135,368 million in 2009. In the wake of tight monetary policy stance adopted by the Central Bank of Sri Lanka to counter demand pressures in the economy which resulted in the rise in interest rates in excess of 18 percent on one year Treasury Bills, interest payments on Government debt increased 4 The Budget deficit for 2009 was targeted at 7.0 percent of GDP and a deviation up to 7.5 percent of GDP on account of post conflict rehabilitation and reconstruction work was agreed under the Stand - By Arrangement (SBA) of the International Monetary Fund (IMF). The SBA of the IMF was formulated to stabilize international reserves of Sri Lanka in the wake of the global financial crisis and to minimize Sri Lanka s vulnerability in external trade and finance. This was realized by raising External Reserves from US$ 3,640 million in 2008 to US$ 7,030 million in 2009 and reducing inflation as measured by the GDP deflator from 16.3 percent in 2008 to 5.6 percent in 2009, while maintaining an average growth rate of 3.5 percent in GDP in comparison to 6 percent in 2008. However, planned recovery in external trade has been lagged behind and budget deficit and domestic borrowings have been in excess of programme benchmarks. 5

from Rs. 212,474 million or 4.8 percent of GDP to Rs. 308,292 million or 6.4 percent of GDP in 2009. High interest rates together with a depressed global economic outlook reduced credit growth to the private sector by the banking system from 7.8 percent in 2008 to -5.2 percent in 2009, compressing private sector investment from 21.1 percent of GDP to 16.6 percent of GDP, but raising domestic savings from 14.1 percent of GDP in 2008 to 17.2 percent of GDP in 2009 which in turn facilitated stability in the wake of a high fiscal deficit, which primarily stemmed from high public investments in major infrastructure projects essential for private investment in the long run. Although recurrent expenditure at Rs. 884,664 million which is 18.4 percent of GDP, is in excess of the targeted level of Rs. 829,641 million (16.9 percent of GDP), this increase was almost entirely explained by the overrun in interest payments which was in excess of Rs. 38,464 million (0.8 Percent of GDP). The non interest recurrent expenditure moderately increased from the targeted level by Rs.16,559 million reflecting pressure for salaries and welfare expenditure in the wake of high inflation till the end of the first half of 2009 and additional claims on account of immediate post conflict rehabilitation and humanitarian expenditure. Expenditure on account of public sector wages and pension and operational costs of public services reflected the cost of the expanded public services. The momentum gained in public investments in recent years kept pace of progress as there was a conscious commitment by the Government not to allow public investments to be vulnerable to temporary fiscal aberrations considering the medium and long term benefits of public investments, to the national economy. Public investments targeting infrastructure development in ports, roads & bridges, water supply and irrigation, power generation, rural infrastructure, education and health services as well as the sudden demand encountered to facilitate de-mining operations in the newly liberated areas in the North and post-conflict rehabilitation and resettlement expenditure, have resulted in raising public investment to 6.5 percent of GDP in 2009. It is pertinent to note that public investment has been above 6 percent 6

of GDP throughout the post 2005 period, which shows a significant policy shift from the pre 2005 period. Total net Foreign Financing to GDP that rose to Rs.83,132 million or 1.7 percent of GDP from a net repayment of Rs. 100 million projected under the Stand-By Arrangement target, is largely attributable to the reduction in debt re-payments from Rs.114,000 million to Rs.111,040 million and also due to increased disbursement of foreign funds consequent to speeding up the implementation in several key projects. Gross borrowings increased from Rs. 123,900 million to Rs. 204,435 million. Consequently, the corresponding domestic counterpart expenditure increased by 0.9 percent from the targeted level of 7 percent of GDP in 2009. The successful mobilization of US$ 500 million from international capital markets enabled the Government to reduce pressure on domestic funds particularly at a time when tax revenue contracted owing to the global impact on the domestic economy and efforts taken to facilitate the smooth implementation of on going infrastructure development programs. Accordingly, the overdraft balance of the Government which was around Rs. 90 billion in June 2009 was reduced to Rs. 50 billion at end 2009. The overall net domestic borrowings including the overdraft balance of the Government totaled Rs. 386,495 million or 8 percent of GDP in comparison to Rs. 342,958 million or 7 percent of GDP programmed for the year. The overall debt to GDP ratio which continued to decline from over 100 percent prior to 2005 to below 82 percent by 2008, increased to 86.3 percent in 2009 owing to more than planned borrowings during the year and less than projected - nominal growth in GDP. However, 75 percent of the debt stock continued to reflect a medium to long term maturity structure in the debt profile. The short term foreign currency debt exposure remained below 7 percent of total reserves while short term tradable domestic debt remained below 25 percent of total domestic debt. The fiscal outcome of 2009 particularly the large revenue deficit appeared to be a one-off aberration as it was primarily attributable to the effects of the global financial instability of 2008-2009, adverse external demands, uncertain security environment 7

that prevailed till end May 2009 and the decline in economic growth. The growth in GDP in the first half of the year decelerated to 2 percent compared to 6 percent of the corresponding period of 2008. In the backdrop of a sharp drop in petroleum prices from US$147 to US$60 per barrel, petroleum based taxes specified on quantity basis were increased to Rs. 35 per liter but was reduced to Rs. 1 per liter during the second half of the 2009. The motor vehicle imports which generated 18 percent of excise tax revenue up to 2007 eroded to 3 percent in 2009 due to the sharp drop in motor vehicle imports. The fiscal stimulus introduced through the removal of the Economic Service Charge, reduction in VAT, reduction of import duties and the concessionary electricity tariff structure and industrial fuel that was introduced, resulted in a shortfall in revenue. The introduction of various safeguard measures to assist domestic industries during the global economic crisis also affected the volume growth of imports which in turn resulted in a revenue loss to the Government. In the wake of rising cost-of-living, duties and taxes of several commodities were also removed or reduced from time to time to ease the pressure on cost-of -living, during 2009. The circumstances led to all these changes have begun to disappear with the economy showing signs of recovery reflecting peace dividend and post war economic prospects on top of which the global economic recovery also providing an impetus. The overall economic growth has bounced back to 4.5 percent in 3 rd quarter and 6 percent in the last quarter of 2009 reflecting a short-lived aberration in the performance of major revenue sources and Government finance. However, continued progress achieved in the efforts to discourage public consumption of liquor and cigarettes have narrowed the scope of gaining revenue advantages from excise tax on cigarettes and liquor, which at one time were an easy source of revenue in the Government Budget, underscoring the need to find alternative revenue sources for medium term fiscal consolidation and to sustain high public investment in excess of 6 percent of GDP. A summary of the overall revenue, expenditure and debt of the Government is presented in Table 1. 8

Table 1 Summary of Government Fiscal Operations (Rs. Mn) 2007 2008 2009/ Target 2009/(Prov.) Total Revenue and Grants 595,559 686,482 748,708 727,613 Total Revenue 565,051 655,260 725,708 702,128 Tax Revenue 508,947 585,621 655,779 619,579 Non Tax Revenue 56,104 69,639 69,929 82,549 Grants 30,508 31,222 23,000 25,485 Total Expenditure 841,603 996,126 1,091,566 1,197,240 Recurrent 622,758 743,710 829,641 884,664 Salaries and Wages 214,160 239,078 261,286 268,246 Interest 182,681 212,474 269,828 308,292 Subsidies and Transfers 147,445 170,908 187,128 194,290 Other Goods and Services 78,472 121,250 111,399 113,836 Capital and net lending 218,844 252,416 261,925 312,576 Public Investments 229,273 263,828 266,580 314,654 Other (10,429) (11,412) (4,655) (2,078) Revenue Deficit (57,707) (88,450) (103,933) (182,536) Budget Deficit (246,044) (309,644) (342,858) (469,627) Total Financing 246,044 309,645 342,858 469,627 Total Foreign Financing 63,780 12,934 (100) 83,132 Net Foreign Borrowings 7,546 12,934 (100) 25,727 Foreign Borrowings-Gross 87,867 80,415 123,900 147,030 Debt Repayments 64,115 54,797 114,000 111,040 SME Sector 16,206 12,684 10,000 10,263 Foreign Commercial 56,234 57,405 Total Domestic Financing 182,264 296,711 342,958 386,495 Net Non-Bank Borrowings 111,308 114,809 152,458 132,331 Foreign Owned T Bills and Bonds 37,126 (17,578) 34,500 146,922 Bank Borrowings 15,369 195,234 151,000 101,942 Other 18,060 4,618 5,000 5,300 Revenue and Grants/GDP (%) 16.6 15.6 15.2 15.1 Revenue /GDP% 15.8 14.9 14.8 14.6 Tax/GDP (%) 14.2 13.3 13.3 12.9 Non Tax/GDP (%) 1.6 1.6 1.4 1.7 Grants/GDP (%) 0.9 0.7 0.5 0.5 Expenditure/GDP (%) 23.5 22.6 22.2 24.8 Current Expenditure/GDP (%) 17.4 16.9 16.9 18.4 Capital Expenditure/GDP (%) 6.1 5.7 5.3 6.5 Public Investment/GDP (%) 6.4 6.0 5.4 6.5 Revenue Deficit / GDP (%) (1.6) (2.0) (2.1) (3.8) Budget deficit / GDP (%) excluding (6.9) (7.0) (7.0) (9.7) grants Total Foreign Financing /GDP (%) 1.8 0.3 (0.0) 1.7 Domestic Financing/ GDP (%) 5.1 6.7 7.0 8.0 Non bank Financing/GDP (%) 3.1 2.6 3.1 2.7 Source: Department of Fiscal Policy 9

3 Government Revenue Performance 2009 Total revenue collection in 2009 totaled Rs. 702,128 million, an increase of Rs. 47 billion over 2008. With the slowdown in domestic economic activities and the shrinking of imports which provide a strong tax base in a normal economic environment, Government revenue recorded a negative growth during first six months of 2009. However with the post war economic recovery and the positive global environment, the last half of 2009 showed a positive revenue growth of 19 percent. Accordingly, total revenue recorded an overall growth of 7 percent for the full year compared to 2008. A significant drop in the volume and value of vehicle imports liable for excise duty, the impact of the implementation of Free Trade Agreements, continuous decline in cigarette sales and the slowdown in liquor production were the main contributory factors for the large decline in revenue. Income Tax Income tax revenue at Rs. 139,555 million recorded a growth of 10 percent over 2008. However, the income tax /GDP ratio continued to remain stable around 3 percent of GDP. Even in the backdrop of the slowing down of economic activities starting from the latter part of 2008, the policy measures taken by the Government to broaden the tax base coupled with other administrative improvements helped to increase income tax revenue. However, the overall collection from income tax by way of personal and corporate income tax, Economic Service Charge and tax on interest, was lower than the projected amount of Rs. 149,717 million due to an 8 percent shortfall from tax on interest and a 7 percent decline in corporate and non corporate income taxes owing to the slow-down in the economy and cost escalations. 10

Table 2 Government Revenue - Economic Classification (Rs.Mn) Item 2007 2008 2009 Tax Revenue 508,947 585,621 619,579 Income Tax and Corporate Tax 107,169 126,541 139,555 Personal & Corporate Tax 59,659 72,225 72,161 Economic Service Charge 12,203 14,366 14,207 Tax on interest income 35,307 39,950 53,187 Taxes on Goods & Services 328,604 356,161 353,978 VAT 186,991 203,646 171,479 Domestic 85,490 102,815 103,752 Imports 101,501 100,831 67,896 Excise Taxation 96,651 100,970 98,848 Liquor 23,723 27,434 28,524 Cigarettes 31,414 37,288 37,601 Motor Vehicles 17,415 11,067 3,268 Petroleum 19,124 18,977 24,204 Other 4,975 6,204 5,251 Other Taxes and Levies 44,962 51,545 83,651 Stamp duty 4,026 3,751 3,328 NBT - - 27,276 Debit Tax 7,187 8,410 8,036 Port Devt. Levy 26,700 31,017 36,618 Other 7,049 8,367 8,394 Tax on External Trade 73,174 102,919 126,046 Imports 56,017 63,844 78,574 Cess 17,157 24,472 28,507 Special Commodity Levy - 14,603 18,965 Non Tax Revenue 56,104 69,639 82,549 Property Income 22,633 26,720 42,452 CB Profits 4,000 8,000 20,000 Interest 9,242 9,305 9,043 Profits and Dividends 7,682 7,365 11,981 Rent 1,709 2,050 1,428 Fees and Charges 18,437 32,259 27,223 Other 15,034 10,660 12,874 Social security contribution 8,777 9,791 11,164 Other 6,257 869 1,710 Total Revenue 565,051 655,260 702,128 Source: Department of Fiscal Policy 11

Value Added Tax (VAT) VAT revenue declined by 16 percent to Rs. 171,479 million in 2009. On a net basis the decline of VAT revenue was reflected in the VAT collected from imports due to the erosion in the base. However, even with a reduction in the general VAT rate from 15 percent to 12 percent and the slowdown in economic activities, the domestic VAT collection recorded a marginal increase in 2009 which is consistent with the growth in domestic manufacturing activities. In relation to GDP, the growth in overall VAT revenue remained unsatisfactory as the ratio declined to 3.6 percent in 2009 from 4.6 percent in 2008 which was already low compared to its potential value of about 5 to 5.5 percent of GDP. Excise Taxes Excise taxes generated from cigarette, liquor, motor vehicles, petroleum and selected consumer durables totaled Rs. 98,848 million in 2009 recoding a decrease of 2 percent over 2008, reflecting a decline in the volume growth of traditional excise items such as cigarettes and liquor as well as a substantial reduction in such taxes on motor vehicles. In line with 'Mathata Thita", the Government policy initiative to discourage tobacco and alcohol consumption, the enforcement of related legislation and implementation of awareness programs, the declining trend in cigarette sales and hard liquor production that was witnessed in the 2 consequent years, continued in 2009. Cigarette sales dropped by 5.6 percent over 2008, but the revenue collected recorded a marginal increase due to the rate revision in March 2009, while hard liquor production declined by 10 percent. However, increase in malt liquor production and upward rate revisions helped to mitigate the drop in hard liquor production and enhanced the revenue collection by 4 percent. 12

The major contributory factor for the decline in excise duty was the decline in excise duty collected on motor vehicle imports by 37 percent in 2008, and by 71 percent in 2009 eroding its revenue potentials due to prohibitive rates of taxation and excessive deposit requirements introduced on imports to counter rising oil prices in 2007/2008. Although import restrictions imposed by the Central Bank of Sri Lanka through Letter of Credit margins for vehicles were removed, the expected improvement did not materialize due to the slow-down in business activities in the backdrop of the global economic crisis and still high taxation. Import Duty Revenue from import duty increased by 23 percent to Rs. 78,574 million during 2009. Even though total imports declined, imposition of specific duties and scaling up of specific rates in the context of falling commodity prices to provide safeguards to local economic activities and the imposition of specific rates on petroleum imports in the backdrop of low petroleum prices that prevailed in mid 2008 to mid 2009, had a positive impact on revenue collection. Although, the slowing down of motor vehicle imports and other consumer durable curtailed revenue growth, specific rate of Rs. 35 per petrol liter and Rs. 15 per diesel liter were introduced while duty of Rs. 10 per kg on wheat grain and Rs. 145 per kg on milk powder were introduced while specific rates applicable on edible oil, bicycles, tiles etc. were scaled up to recoup part of revenue loss from the decline in import prices. However the import revenue growth from import duties was stalled as the Government scaled down such duties when international oil and commodity prices moved up from the second half of 2009. This enabled the economy to stabilize prices without permitting imports to hurt domestic economic activities. With the coverage of Free Trade Agreements between Sri Lanka and India, Pakistan, the South Asian Region and the Asia Pacific expanding over a period of time, the bulk of imports have also enjoyed duty free or nominal duty status exerting a negative impact on revenue from import duty. The estimated revenue loss due to concessions granted under these agreements was around Rs. 5.9 billion in 2009. 13

Revenue generated form Special Commodity Levy which was introduced to replace multiplicity of taxes by single commodity tax on selective commodities amounted Rs 18,965 million in 2009 in comparison to Rs. 14,603 million in 2008. However the revenue collection was lower than the estimated amount of Rs. 23,460 million due to reduction in tax rates on sugar, onions, potatoes, dhal, sprats etc considering the cost of living and the availability of domestic supply during the latter part of 2009. Other taxes Revenue from Ports and Airport Development Levy generated Rs. 36,618 million recording a 18 percent growth over 2008. The raw materials used for pharmaceutical manufacturing and certain machinery were placed at a lower rate of 2 percent while the general rate was increased to 5 percent with effect from 1 st January 2009. CESS revenue at Rs. 28,507 million grew by 16 percent over 2008 mainly benefiting from a scaling up of existing Cess rates and the expansion of the coverage by imposition of Cess on certain items to give price incentives for local value addition. Imposition of Cess on selected items contributed towards easing the adjustment burden of the local economy from comparatively low priced or substandard imports on domestic production and also recoup revenue slippages that have arisen consequent to low international prices in the first half of 2009. The newly introduced Nation Building Tax generated Rs. 27,276 million in 2009. The rate applicable was revised upwards from 1 percent to 3 percent in May 2009, to meet post-war rehabilitation and reconstruction expenditure. Non-Tax Revenue Non-Tax Revenue in 2009 amounted to Rs. 82,549 million compared to Rs. 69,639 million in 2008. This increase was mainly due to Central Bank profit transfers of Rs. 20 billion, compared to Rs. 8 billion in 2008. The increase in social security contributions arising from higher salaries of Government employees increased to Rs. 14

11,164, million in comparison to Rs. 9,791 million in 2008. Profit and dividends form state enterprises especially from State Banks contributed to enhance revenue from such sources from Rs. 7,365 million in 2008 to Rs. 11,981 million in 2009. However, interest income from Government lending to state enterprises declined to Rs. 9,043 million from Rs. 9,305 million as large borrowers such as CEB, water supply and Drainage Board have not been able to generate required surplus to service their obligation to Government. Revenue from various fee levying activities of the Government at Rs. 27,223 million was not only remained below the estimated level of revenue at Rs. 30,800 million but also below Rs. 32,259 million in 2008 due to the decline in transaction volumes. 4 Government Expenditure According to the provisional data, the overall expenditure at Rs. 1,197,240 million in nominal terms recorded a 20 percent growth in 2009. This constituted recurrent expenditure of Rs. 884,664 million and public investment of Rs. 314,654 million. The recurrent expenditure increased by 19 percent. Major contributory factors were enhanced relief assistance provided to internally displaced persons after liberating the North from terrorists, enhanced public investments, an increased cost - of - living allowance for public servants and pensioners and more than expected cost of interest payments on public debt. Even under a difficult fiscal environment mainly created by external factors the Government was able to embark on a public investment programme sustaining public investment at 6.5 percent of GDP, reflecting its commitment to the ongoing infrastructure development programmes and the completion of such projects on schedule, is considered economically advantageous to sustain long term growth and private investment. 15

Table 3 Government Expenditure - Economic Classification - (Rs. Mn) Item 2007 2008 2009 Current Expenditure 622,758 743,710 884,664 Goods and Services 292,632 360,328 382,082 Central Government 87,524 112,265 116,629 Salaries 61,799 65,315 72,844 Other 25,725 46,950 43,785 Defense 101,856 134,710 144,210 Salaries 60,185 73,509 88,800 Other 41,671 61,201 55,410 Police & Public Security 32,470 36,487 42,078 Salaries 22,810 26,463 30,547 Other 9,660 10,024 11,531 Provincial Councils 70,782 76,866 79,165 Salaries 69,372 73,791 76,055 Other 1,410 3,075 3,110 Interest Payments 182,681 212,475 308,292 Domestic 161,370 188,166 276,808 Foreign 21,311 24,208 31,484 Subsidies & Transfers 147,445 170,908 191,290 Public Corporations 10,639 12,942 11,552 o/w Railways & Postal 6,592 6,520 7,328 Public Institutions 25,746 26,407 27,990 Local Authorities 150 217 - Households 110,910 131,342 151,748 Pensions 68,822 74,920 85,139 Disabled Soldiers 7,428 8,694 9,796 School Uniform/ Books/ Nutrition 4,625 6,036 7,535 Samurdhi 9,200 9,995 9,267 Fertilizer Subsidy 11,000 26,450 26,935 Fuel Subsidy 632 - - Refugee Assistance 1,666 1,457 10,638 Other 7,537 3,790 4,538 Public Investment 229,273 263,828 314,654 Capital Expenditure-Grants 206,161 232,575 261,831 To Ministries & Departments 111,510 135,534 93,362 To Public Corporations 23,737 22,470 28,685 To Public Institutions 50,408 53,334 115,704 To Provincial Councils 20,346 21,237 23,780 Other 160-300 Capital Expenditure-Lending 12,684 19,841 50,745 To Government 23,112 31,253 52,823 Corporations Repayment of on Lending (11,677) (13,526) (11,978) Other 1,249 2,114 9,900 Total Expenditure 841,603 996,126 1,197,240 Source: Department of National Budget 16

4.1 Salaries and Pension Cost Expenditure on salaries for public servants including those attached to the Provincial Councils and security services increased to Rs. 268 billion, an increase of 12 percent over 2008.An increased cost-of - living allowance of Rs. 4,500 per employee/ per month, compared to Rs. 3,500 per month in 2008, the full year impact of new recruitments especially for security services and Police and a number of all Island Services during 2008 and 2009 and correction of various salary anomalies influenced the increase in the salary bill in 2009. Total pension payments increased to Rs. 85.1 billion an increase of 14 percent over 2008. The full impact of around 12,000 retirees in 2008 and further over 21,000 in 2009 updating pension scales for pensioners corresponding to salaries in January 1997 and increasing the monthly cost of living allowance to 2,375 per person in 2009 contributed to this increase. 4.2 Interest Cost Interest payments on foreign and domestic debt amounted to Rs. 308,292 million, an increase of 45 percent. Interest cost of foreign debt rose to Rs. 31,484 million in 2009 from Rs. 24,208 million in 2008 largely due to the exchange rate impact, while interest cost of domestic debt increased to Rs. 276,808, million owing to high rates of interest as well as enhanced volume of domestic debt. The heavy borrowings on short term basis from domestic markets during the latter part of 2008, in the absence of envisaged foreign capital market borrowings pushed up the interest cost. Also revenue shortfalls warranted heavy borrowings from the domestic market to finance rupee funds needed for capital and other expenditure. The positive impact of retirement of certain high cost debt from funds received through the Sovereign Bond issued in October 2009 and the reduction of interest rates of Government securities, is likely to moderate interest payments on Government debt in 2010. 17

4.3 Welfare and Subsidy Payments The total expenditure on welfare payments and subsidies amounted to Rs 82,973 million in 2009 compared to Rs 71,527 million in 2008. The expenditure in relation to social security provided to disabled soldiers increased from Rs. 8,694 million in 2008 to Rs. 9,946 million in 2009. The welfare assistance provided in support of displaced persons under World Food Programme and related resettlement and disaster relief programme amounted to Rs. 15,176 million. The cost of welfare programmes implemented for the benefit of school children through the provision of free school text books, uniforms, season tickets and free dhamma school text books amounted to Rs. 7,438 million in 2009. The cost of the fertilizer subsidy scheme targeting small holder agriculture with a view to assist low income farmers amounted to Rs.26,935 million in 2009. Paddy farmers enjoyed all varieties of fertilizer at a subsidized price of Rs. 350 per 50 kg bag while small holder tea plantation sector was given urea at Rs. 1,000 per 50 kg bag. The stimulus package introduced by the Government in December 2008 to strengthen the economy, granted additional benefits to the agricultural sector by way of an interest subsidy for working capital losses, subsidies for price stability in tea, rubber and cinnamon. The resources provided to railways, CTB and postal services to meet their operational losses totaled Rs. 11,078 million in 2009 in comparison to Rs. 10,620 million in 2008. A list of various welfare expenditure and subsidy payments implemented by ministries are given in Table 4. 18

Table 4 List of Major Welfare and Subsidy Payments (Rs. Mn.) 2007 2008 2009 Religious Affairs Moral Upliftment Dharma School Text Books and Uniforms to Teachers 102 99 108 Nation Building and estate Infrastructure Development Food Distribution under World Food Programme 2,466 4,437 7,783 Samurdhi Relief & Kerosene Oil Allowance 9,200 9,995 9,267 National Food Package for Expectant Mothers (Poshana Malla) 418 386 505 Health Care and Nutrition Thirposa Programme 488 652 1,155 Transport School & Higher Education Season tickets SLTB uneconomical routes Subsidy 500 150 600 113 1,366 294 Agricultural Development and Agrarian Services Fertilizer Subsidy Interest Subsidy for Agriculture Loans etc 11,000 100 26,499 155 26,935 379 Power and Energy Street Lighting subsidy Fuel Subsidies 1,000 632 1,300-1,300 900 Child Development and Women's Empowerment Infant Milk Food Subsidy & Fresh Milk Senehasa Programe/Poshana Manpetha 13 22 33 24 168 19 Public Administration and Home Affairs Social Security for Disabled Soldiers 7,426 8,694 9,946 Social Service and Social Welfare National Secretariat for Elders National Council Secretariat for Person with Disabilities 41 24 49 75 48 74 Education School Text Books 2,250 3,387 2,196 School Nutritional Food Program 1,308 1,649 2,251 School Uniforms 1,067 582 1,260 Scholarships 185 193 183 Handicapped Students 71 70 74 Vocational and Technical Training Student Stipends, Bursaries & Scholarships 15 15 11 Re-settlement and Disaster Relief Services Distribution of Cooked Meals and Dry Rations for Displaced People 1,666 1,457 4,538 Flood & Drought Relief 345 323 738 (RAPPIA) 244 74 253 Water Supply and Drainage Subsidy on water 30 46 144 Losses of Public Enterprises Railways 4,578 4,553 4,988 CTB 3,653 4,087 3,541 Postal 2,294 1,980 2,549 Total 51,288 71,527 82,973 Source: Department of National Budget 19

4.4 Public Investment The Government continued its commitment to accelerate development programms, targeting the rural sector especially through rural development initiatives such as "Gama Neguma" and "Maga Neguma", "Uthuru Wasanthaya" and other pro poor development programmes. The momentum gained in respect of key national infrastructure development projects consisting of roads and bridges, power generation, ports, irrigation, water supply and human resource development during the past years was maintained in 2009. The total public investment amounted to Rs. 315 billion in 2009 an increase of 19 percent over 2008. A summary of Public Investments by key areas of investments is given in Table 5. Table 5 Pubic Investments (Rs. Mn) 2008 2009 Roads and Bridges 63,427 86,659 Electricity 16,952 27,859 Ports and Aviation 7,875 28,976 o/w Ports 7,356 23,884 Irrigation 10,753 14,000 Agriculture & production 15,773 12,030 Water Supply 25,374 22,514 Education 22,942 16,934 Health 18,674 12,664 Rural Infrastructure 50,130 57,000 Transport (Railway/CTB) 13,000 11,252 Administrative/Police/Judicial/Other 18,928 24,766 Total 263,828 314,654 Rural Infrastructure 50,130 57,000 o/w Gama Neguma 11,695 13,294 Jathika Saviya 1,670 1,400 Decentralized Budget 1,034 1,080 Uthuru Wasanthaya 0 4,050 Tsunami area developments 1,439 1,616 Trinco Integrated project 497 550 Plantation community development 901 677 Fishing Community development 666 724 North and East Community development 7,472 7,385 Provincial Grants 9,104 9,660 Gemi Diriya/Samurdhi 1,674 1,772 Source: Department of National Budget 20

5. Foreign Financing Foreign funding has been the main source of support for large infrastructure development undertaken by the Government. Gross foreign borrowings and grants supported 5.5 percent of public investments and they are on average 15-20 year repayment periods with low rates of interest. The weighted average interest rate of foreign funding mobilized during the year from multiple sources for public investment is around 1.5 percent reflecting a favourable mix of long term funding for development. 5.1 Foreign Financing Commitments The total commitment made by donor agencies and lenders to Sri Lanka during the 2009 was US$ 2,221.7 million which is the highest commitment recorded so far. Until 2009, the highest commitment of US$ 2,069 was reported in 2008. Of the total commitments, loans accounted for US$ 1,942.1 million and grants accounted for US$ 279.6 million. Table 6 Foreign Financing Commitments-2009 Donor US$ mn Bilateral 1,505.5 Australia 18.5 India 20.1 China 1,206.7 Japan 19.5 Korea 76.3 Kuwait 34.1 Germany 2.8 Netherlands 36.7 USA 1.0 Sweden 19.6 Hungary 70.2 Multilateral 716.2 Asian Development Bank 423.7 World Bank 241.8 UN Agencies 50.7 Total 2,221.7 Source: Department of External Resources The Government of China, Asian Development Bank and the World Bank were the three main donors who accounted for US$ 1,872.2 million or 84.3 percent of the total 21

commitment in 2009 5. Apart from the grant of US$ 2.4 million, Chinese assistance was in the form of preferential buyer s credits and buyer s credits and accounts for 54.3 percent of the total commitment. Details of Loan and Grant Agreements signed in 2009 are given in Table 7. Table 7 Foreign Financing Commitments 2009 Grant US$ mn Donor Project Name In Loan/Grant Currency (mn) Loan US$ mn Total US$ mn Australia ADB China Germany Hungary North-East Community Restoration and Development Project Emergency Northern Reconstruction Project Dry Zone Urban Water & Sanitation Project Dry Zone Urban Water & Sanitation Project Clean Energy and Access Improvement Project Clean Energy and Access Improvement Project Technical Assistance for Capacity Development of the Provincial Road Agencies Eastern and North Central Provincial Road Project Greater Colombo Wastewater Management Project Greater Colombo Wastewater Management Project Bunkering Facility & Tank-Farm Project at Hambantota Colombo - Katunayake Expressway Donation of machine and Equipment Puttalum Coal Power Project - Phase II Reconstruction of Water Supply Galle District - Phase II Labugama Water Treatment Plant AUD 8 7.4 7.4 AUD 12 11.1 11.1 XDR 40.05 62.0 62.0 US$ 25.2 25.2 25.2 US$ 137.2 2.2 135.0 137.2 XDR 16.8 26.1 26.1 US$ 0.8 0.8 0.8 XDR 45.3 71.8 71.8 US$ 80 80.0 80.0 XDR 12.76 20.6 20.6 US$ 65.1 65.1 65.1 US$ 248.2 248.2 248.2 CNY16.5 2.4 2.4 US$ 891 891.0 891.0 EUR 1.96 2.8 2.8 EUR 16.71 23.6 23.6 5 Commitment refers to the agreements signed during the year : pledges are not included in this figure although Memorandum of Understandings have been signed to proceed with negotiations. 22

India Japan Korea Kuwait Netherlands Sweden USA Food and Agriculture Organization Kalatuwawa Water EUR 17.4 24.5 24.5 Treatment Plant Supply of one Dredger and related Equipment EUR 15.8 22.1 22.1 Humanitarian Assistance US$ 20.1 20.1 20.1 for North and East Provinces Improvement of JPY 390 4.3 4.3 Anuradhapura Teaching Hospital (Phase II) 2KR Food Security JPY 520 5.4 5.4 Project for Underprivileged Farmers Introduction of Clean JPY 860 9.8 9.8 Energy by Solar Electricity Generation System Ruhunupura Water US$ 76.3 76.3 76.3 Supply Kaluganga Development KWD 10 34.1 34.1 Project Conservation and LKR 62.1 0.5 0.5 Restoration of the Ancient Dutch Fort in Jaffna Extension of a Disaster EUR 3.74 5.4 5.4 Management and Emergency Response System Extension of a Disaster EUR 21.2 30.8 30.8 Management and Emergency Response System Forth Rural EUR 14.6 19.6 19.6 Electrification Project Improved Integration of US$ 1 1.0 1.0 Targeted Disadvantaged Groups in to the Community - Additional Financing Emergency Agricultural US$ 0.4 0.4 0.4 Support for IDPs Regional Fisheries US$ 1.9 1.9 1.9 Livelihood Programme for South and South - East Asia Sustainable Management US$ 4 4.0 4.0 of the Bay of Bengal Large marine Ecosystem Enhancing Food Security EUR 5.1 7.5 7.5 among Farm Families in Eastern Sri Lanka Aquaculture US$ 0.4 0.4 0.4 Development in Southern Province Emergency Agricultural US$ 0.6 0.6 0.6 23

and Food Assistance International Post-tsunami Coastal US$ 6.9 6.9 6.9 Fund for Agriculture Development Rehabilitation & Resources Management Project Post-tsunami Resources US$ 1 1.0 1.0 Management and Coastal Rehabilitation Project UNDP Support Efforts and US$ 0.3 0.3 0.3 Action Against Corruption Conservation of US$ 0.3 0.3 0.3 Biodiversity in the South- West Rainforest Capacity Building US$ 0.1 0.1 0.1 through South-South Cooperation Social Development in US$ 0.1 0.1 0.1 the Plantation Community Equal Access to Justice - US$ 7.8 7.8 7.8 Phase II Transition Recovery US$ 16.8 16.8 16.8 Programme Local Governance Project US$ 0.1 0.1 0.1 Control of Alien Invasive US$ 0.2 0.2 0.2 Species Human Rights Joint US$ 0.3 0.3 0.3 Programme UNHCR Jungle Cleaning & Land US$ 2 2.0 2.0 Preparation Grants to Returnees Families World Bank Information and Communications Technology Regulatory Capacity Building Project US$ 0.5 0.5 0.5 Additional Financing for XDR 16.3 25.3 25.3 Health Sector Development Project Second Community XDR 50.4 79.6 79.6 Development and Livelihood Improvement Project Project Preparatory Assistance for Proposed Local Services Improvement Project US$ 1 1.0 1.0 Improving Monitoring US$ 0.5 0.5 0.5 and Evaluation of Samurdhi Safety Net Programme World Food Programe Protracted Relief and Recovery Operation US$ 134.9 134.9 134.9 Total 279.6 1,942.1 2,221.7 Source: Department of External Resources 24

5.2 Committed Undisbursed Balance The total Committed Un-disbursed Balance of foreign financing available for Government development programmes as at 31 st December 2009 was US$ 6.4 billion. The project implementation duration of these commitments is in the range of 2-5 years and hence the utilization will be on that basis. Table 8 indicates the sector-wise classification of the committed un-disbursed balance. Table 8 Committed Undisbursed Balance as at 31 Dec 2009 Sector US$ mn Roads, and Transport 1,236.1 Ports 620.0 Water Supply & Sanitation 623.3 Tsunami Rehabilitation 231.4 Health, Education & Vocational Training 263.9 Power & Energy 1,589.5 Private Sector Development 93.6 Agriculture, Fisheries, Irrigation and Land 729.2 Rural Development 153.2 Environment & Natural Resources 139.9 IT, Science & Technology 38.2 Housing & Urban Development 49.7 Other 608.2 Total 6,376.10 Source: Department of External Resources Table 7 shows that more than 75 percent of the foreign financing to be disbursed during the next 2 5 years is for infrastructure development. This reflects the Government s commitment on the development of an island wide road network, port facilities, water supply and power generation and transmission to provide needed infrastructure for rapid developments and earning sources to the people. 25

5.3 Foreign Fund Disbursements The total foreign fund disbursement up to end December 2009 was US$ 1,521.5 million in comparison to a disbursement of US$ 1,255 million in 2008. Of the total disbursement, project loans accounted for US$ 1,271.5 million (83.6 percent) and grants US$ 250 million (16.4 percent). Table 9 Disbursement of Foreign Financing* 2009 Donor Loan Grant Total Bilateral 525.3 99.4 624.7 China 292.4 2.4 294.8 Denmark 40.6 44.9 France 19.4 19.4 United Kingdom 96.8 96.8 Netherland 8.8 8.8 Sweden 21.7 21.7 Austria 15.7 15.7 India 30.2 17.2 47.4 Japan 295.8 15.6 311.4 Korea 7.3 3.7 11.0 Kuwait 7.6 0.3 7.9 Netherlands 49.7 49.7 Spain 10.8 10.8 Saudi Fund 9.3 9.3 USA 3.6 3.6 Other Bilateral 2.3 6.9 9.2 Multilateral 412.8 150.6 563.4 Asian Development Bank 243.3 40.5 283.8 World Bank 147.6 54.5 202.1 European Investment Bank 21.2 21.2 European Commission 32.6 32.6 UN Agencies 22.8 22.8 Other Multilateral 0.7 0.2 0.9 Total 1271.5 250.0 1521.5 Source: Department of External Resources *Note: US$ 500 million International Bonds issued in 2009 is not included 5.4 External Debt and Service Payments The Government external debt stock as of 31 st December 2009 stood at US$ 15.3 billion (Rs. 1,760.4 billion). This was an increase of 8 percent or US$ 1 billion compared to the debt stock at 31 st December 2008. However, the rupee value of the debt stock has increased by 21 percent or Rs. 311 billion during the same period. The higher rate of 26

increase in rupee terms was due to the depreciation of the Sri Lankan Rupee against the other major currencies. The total external debt service payments made in 2009 amounted to US$ 1,043.2 million. Of this US$ 815.3 million was for principal payments and the balance US$ 227.9 million was on account of interest payments. The debt service forecast based on the existing portfolio is given in Table 10. Table 10 The debt service forecast from 2009 2015 (in US$ million) Item 2009 Actual Forecast 2010 2011 2012 2013 2014 2015 Principal 815.3 544.3 652.3 1,224.1 830.3 855.7 1448.9 Interest 227.9 266.3 302.2 315.3 275.1 269.5 247.4 Total 1,043.2 810.6 954.5 1,539.4 1,105.4 1,125.2 1,696.3 Source: Department of External Resources *Note: The higher debt service forecasts for 2012 and 2015 are due to the maturing of US$ 500 million each international bonds issued in 2007 and 2009 respectively. 6 Treasury Operations There was a shortfall in receipts as against estimated receipts of Rs.162.1 billion for the year 2009, which led to a higher net cash deficit. Cash deficit after operating and investment activities was Rs. 478.8 billion which shows an increase of around Rs.143.0 billion compared to the corresponding figure for the year 2008. This was mainly due to the decrease in estimated revenue for the year 2009. The overall closing balance (deficit) was Rs.74.8 billion, an increase of Rs. 14.4 billion compared to the previous year with additional investments of Rs. 39.4 billion in 2009. 27

Table 11 Source: Department of Treasury Operations The Government total gross borrowing amounted to of Rs.984.4 billion by way of Treasury bills, Treasury bonds, Foreign bonds, advances provided by the Central Bank for the year 2009 including Rs. 57.0 billion (USD 500Mn.) raised in the international capital market. The repayments of public debt, which included loans from Foreign Currency Banking Unit, Development Bonds and foreign loans, amounted to Rs. 514 billion thus limiting net borrowings to Rs. 472 billion. Foreign loan repayments amounted to Rs.111 billion. The total gross borrowings were within the approved limit of Rs.1,050 billion for the year 2009. The value of Bank Guarantees issued and remained operational as at 09.02.2010 amounted to Rs.193.7 billion which is 4.4 percent in comparison to 4.5% of three year GDP average as prescribed in section 3(e) of Fiscal Management (Responsibility) Act, No.3 of 2003. A detailed statement of Guarantees issued by the Treasury is provided in Annex 1. 7. Government Debt. The total debt of the Government amounted to Rs. 4,161 billion at end 2009 in comparison to Rs. 3,589 billion at end 2008. The increase in total debt exceeded the nominal growth in GDP. The total debts consist of Rs. 2,401 billion of domestic debt 28

and Rs. 1,760 billion foreign debt. Foreign debt constitute of 42.3 percent of the total debt. Table 12 Outstanding Government Debt (Rs.Mn) Item 2007 2008 2009 Provisional Total Domestic Debt 1,715,197 2,140,228 2,400,955 Short term 363,198 516,365 560,646 Medium and long term 1,351,999 1,623,863 1,840,309 Total Foreign Debt (a) 1,326,487 1,448,734 1,760,467 Concessional loans 1,099,911 1,227,222 1,271,142 Multilateral 565,320 590,776 623,174 Bilateral 534,591 636,446 647,967 Non - Concessional loans 226,576 221,511 489,326 Multilateral 15,399 27,405 41,866 Bilateral 29,909 30,087 36,783 Commercial Loans (b) 181,268 164,020 410,677 Total Debt 3,041,684 3,588,962 4,161,422 Source: Central Bank of Sri Lanka Department of Treasury Operations Department of External Resources (a) Data related to foreign debt has been adjusted to clear the arrears (b) Include the outstanding defence loans, Tbond and Tbills issued to non residents Table 13 Government Debt Service Payment (Rs.mn) Item 2007 2008 2009 Provisional Debt Service Payment 500,514 598,225 823,793 Domestic 415,089 440,918 675,274 Foreign 85,425 157,307 148,519 Amortization Payment 317,833 380,330 514,118 Domestic 253,719 258,720 403,077 Foreign 64,114 121,609 111,040 Interest Payment 182,681 217,896 308,292 Domestic 161,370 182,198 276,806 Short Term 53,874 65,364 72,364 Medium and long Term 107,496 116,834 204,444 Foreign 21,311 35,698 31,484 Source: Central Bank of Sri Lanka Department of Treasury Operations Department of External Resources 29

8. External Finance The external finance which suffered severely from third quarter of 2008 particularly due to sharp outflows of foreign investments in Treasury Bills and Bonds, and a significant volatility in several reserve currencies and a large trade deficit due to rising food, fertilizer and oil prices confronted severe imbalance in 2008 and 2009. Under the impact of these disturbances the Balance Of Payments (BOP) recorded a deficit of US$ 1,385 million by end 2008, affecting gross official reserves to decline to US$ 2,402 million. There was a further decline in Gross Official Reserves to US$ 1,373 million by the end of the first quarter of 2009. However, the external sector recovered significantly in the second half of 2009 mainly due to positive sentiments and renewed confidence brought in with the complete elimination of terrorist activities by May 2009, the Stand by Arrangement with the IMF, successful conclusion of US$ 500 million Sri Lanka Bond Issue, favourable improvement in trade balance, sustained improvements in worker remittances and recovery in tourism. Trade deficit declined from US$ 5,871 million in 2008 to US$ 2,799 million in 2009. Earnings from tourism improved from US$ 342 million to US$ 384 following the increase in tourist arrivals during the second half of 2009. Remittance income showed a steady improvement from US$ 2,918 million in 2008 to US$ 3,330 million in 2009. Two tranches were drawn under the Stand by Arrangement, reflecting the progress in achieving economic stability. By end 2009, official reserves increased to US$ 5,357 million while total reserves of Sri Lanka reached US$ 7,030 million. The BOP recorded a surplus of US$ 2,725 million by end 2009. 9 External Trade Sri Lanka s Trade balance improved in 2009 with the reduction in the trade deficit from US$ 5,871 million in 2008 to US$ 2,799 million in spite of the contraction in exports by 13 percent to US$ 7,085 million in 2009, reflecting a lower cost of imports of petroleum products, fertilizer, food items and a substantial reduction in motor vehicles and large savings from cost reductions of imports of intermediate and investment goods. However, import contraction adversely affected the tax base, adversely affecting Government revenue performance. 30