Sri Lanka Economy

ECONOMIC AND SOCIAL
INFRASTRUCTURE

3.1 Overview

T
he government has taken measures to
step up investments in infrastructure
by both public and private sectors and
has commenced a series of projects including
several major infrastructure projects across the
country as highlighted in the Ten-Year Horizon
Development Framework 2006-2016 and its
‘Randora programme’ (infrastructure development
programme). The continuous budgetary support for
infrastructure development, despite fiscal constraints,
is laudable, while more efforts to catalyse greater
private financing through Public Private Partnerships
(PPPs) are needed to supplement government
investments and for a sustained development of
infrastructure. Consistent policy, good governance
and transparency, institutional capacity building,
effective regulations and efficient financial markets
are pre-requisites in promoting private investments in
both economic and social infrastructure projects.
The government’s policy on infrastructure
development is designed with a view to developing
a regionally balanced economy, addressing the
economic and social disparity in the urban and
rural areas. With the liberation of the Eastern and
the Northern provinces, the country faces a huge
challenge of developing basic infrastructure facilities
as fast as possible for the people in those areas
to start their original livelihood and to recoup the
development in other areas and to fuel economic
activities. In respect of the Eastern province, the
government has already prepared a three-year
comprehensive development plan, the ‘Nagenahira
Navodaya’ (Eastern Revival), which is now being
implemented with a total investment expenditure of
Rs. 200 billion. Similarly, the government is preparing

Central Bank of Sri Lanka Annual Report - 2008

a development plan for the Nothern province, As revealed by social indicators, the key social
the ‘Vadakkin Wasantham’ (Uthuru Wasanthaya/ infrastructure facilities in the country continue to

3
Florishing North), which includes the construction be satisfactory, though the current achievements
of roads and bridges, railroads, transport services, are threatened by paucity of resources. Accordingly,
electricity transmission lines, water supply schemes, financial constraints for expanding and improving
ECONOMIC AND SOCIAL INFRASTRUCTURE

housing development, telecommunications services the service quality, maintaining equity in service
and irrigation facilities in the province. distribution and maximizing the utilization level
In 2008, the government engaged in of existing strong institutional framework and
the implementation of mega infrastructure physical and human resources have threatened
development projects highlighted in the Randora, the sustainability of the health and the education
at the national level and the ‘Gama Neguma’ and sectors, making it vilely necessary to address the
‘Maga Neguma’ programmes at the regional issue urgently at national level.
level. Under the Randora programme, major
Infrastructure services showed mixed
infrastrcture projects such as the Upper Kotmale
performance in 2008. A rapid growth was seen in
Hydropower Project, the Puttalam Coal Power
Plant, the Colombo Port Expansion Project, the the telecommunications industry with the continuous
Hambantota Sea Port Development Project, the adoption of improved technology, higher competition,
Galle Port Development Project, the Oluvil Port increased capacity and coverage as well as
Development Project, the Southern Expressway and conducive policies. Port services grew at a healthy
the Colombo-Katunayake Expressway were under rate, particularly during the first three quarters,
various stages of implemetation in 2008.There are a benefitting from increased trade and productivity
few other projects such as the Northern Expressway, improvements. Energy sector continued to suffer
and the Trincomalee Coal Power Plant, the Greater from historically high oil prices in 2008. The electricity
Dambulla Development Project, the Habarana- sector, which heavily depends on thermal power
Trincomalee main road, the Puttalam-Anuradhapura was badly affected by high oil prices. However, the
main highway and the Jaffna Peninsula Water and reduction of oil prices in the international markets
Sanitation Project at planning or project negotiation from mid-July, 2008 mitigated the impact of high oil
stages. Maga Neguma (Development of roads) prices to some extent on the Ceylon Electricity Board
and Gama Neguma (Development of villages) (CEB), but could not take the CEB completely out
programmes are implemented to improve small scale of its tough financial constraints. The adjustment
infrastructure facilities, covering all regions to ease of domestic petroleum prices to reflect high
infrastructure bottlenecks for rural development. international prices, instead of subsidizing, helped
to reduce the subsidy burden on the government
Table 3.1 Government Investment in
Infrastructure budget. Adjustments of prices in the transport,
petroleum and power sectors in response to rising
Year Economic Social costs mainly due to high oil prices and, thereby,
Total
Services Services
reducing unproductive direct and indirect subsidies
Rs. bn. % of Rs. bn. % of Rs. bn. % of
GDP (a) GDP (a) GDP (a) were policy measures taken in the right direction in
1999 44.9 4.1 17.5 1.6 62.4 5.6 achieving macroeconomic stability. The passenger
2000 54.7 4.4 16.5 1.3 71.1 5.7
2001 54.9 3.9 14.6 1.0 69.5 4.9 transportation registered a moderate growth in 2008.
2002 51.7 3.4 15.7 1.0 67.4 4.3 The civil aviation sector, which was badly affected
2003 58.7 3.2 19.2 1.1 77.9 4.3
2004 61.3 2.9 29.0 1.4 90.3 4.3 by high fuel prices in the first half and downturn in
2005 77.5 3.2 60.4(b) 2.5 137.9 5.6
2006 106.8 3.6 48.4 1.6 155.2 5.3 the tourism industry, registered a negative growth
2007 141.2 3.9 55.0 1.5 196.2 5.5 in 2008. Some policy initiatives have been taken to
2008 (c) 168.9 3.8 60.2 1.4 229.1 5.2
(a) From 2003, data based on estimates Sources: Ministry of Finance and Planning
improve the education sector specially the tertiary
compiled by the Department of Census and
Statistics
Central Bank of Sri Lanka
education while, the health sector continued its
(b) Inclusive of Tsunami related capital
expenditure
efforts to achieve the goals identified in the Health
(c) Provisional Master Plan.

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3.2 Economic Infrastructure Chart 3.1 Telephone Density
Policies, Institutional Framework

3
80
and Performance Fixed Access Total (Including Cellular Phones)
70

Communications Services

Telephones per 100 persons
60

50
Telecommunications sector has shown a
40
remarkable progress during the last few years in
30
terms of improvement in technology, capacity and 20
coverage, which have led to a higher subscriber 10
network and higher service quality. The growth 0
2004 2005 2006 2007 2008
in the telecommunications sector was facilitated by
intensified competition in the industry with the arrival and promotion of motor and life insurance policies
of new service providers, expansion of coverage, for agreed insurance providers and selling pre-paid
reduction of initial cost to an affordable level and the phone cards through post offices have been carried
adoption of new technology. The subscriber network out to diversify the services offered by the postal
of the telecommunications sector grew by 35.5 per network, thereby generating additional revenue. While
cent in 2008, following the 47 per cent growth in 2007. it is encouraging that the postal service is venturing
Fixed access telephone connections expanded by into providing value added services, given the
25.7 per cent during the period, largely due to an extensive post office network and easy accessibility
expansion of the wireless network with Code Division of the public, coupled with rising demand for a variety
Multiple Access (CDMA) technology, which along of services, the post office network need to be further
with Global System Mobile (GSM) technology helped modernised and encouraged as a vital point of sale
people in rural areas to have easy connections. The for a variety of services across the country.
mobile telephone network increased by 38.8 per cent
in 2008, compared to the previous year. The mobile Financial performance of the Department of
telephone penetration (mobile connections as a per Posts (DOP) has slightly improved in 2008. The
cent of total population) increased significantly to operating loss of the DOP continued to remain high,
54.8 per cent in 2008 from 39.9 per cent in 2007
Growth of Telecommunications and
surpassing the level of penetration in other countries Table 3.2
Postal Services
in the region. With these developments, the telephone
density (telephones per 100 persons), including
Growth Rate (%)
cellular phones, increased to 71.9 in 2008 from 53.6 Item
2007 2008(a) 2007 2008(a)
in 2007. By end 2008, the telecommunications sector
1. Telecommunications services
consisted of 4 fixed line operators, 4 mobile operators, 1.1 Fixed access services
33 external gateway operators and 22 internet service Wireline telephones in service (‘000) 932 934 2.4 0.2
Wireless local loop telephones (‘000) 1,810 2,513 85.8 38.8
providers. Another mobile operator commenced its Cellular phones (‘000) 7,983 11,083 47.5 38.8
Telephone density
operations in Sri Lanka in January, 2009. (Telephones per 100 persons, including
cellular phones) 53.6 71.9 46.1 34.1
Postal services showed mixed performance in
1.2 Other services
2008. The post office network, including private Public pay phones 8,526 8,500 12.8 -0.3
agency post offices, has not grown in 2008. Internet & e-mail (‘000) 202 234 55.7 15.6
2. Postal service
However, two sub post offices have been upgraded Delivery areas (No) 6,729 6,729 0.0 0.0
to main post offices in 2008. The average population Post offices (No) 4,737 4,737 0.2 0.0
Public 4,053 4,053 0.2 0.0
served by a post office stood at 4,268 in 2008. Several Private 684 684 0.0 0.0
new services such as providing banking facilities Area served by a post office (Sq.km) 13.8 13.8 0.0 0.0
Population served by a post office 4,252 4,268 2.0 0.4
including accepting savings and fixed deposits Letters per inhabitant 23 21 -4.2 -8.7
and promotion of credit cards for several banks, (a) Provisional Sources: Telecommunications Regulatory
Commission of Sri Lanka
insurance services including premium collection Department of Posts

61


though it declined to Rs. 2,143 million in 2008 from
Table 3.3 Power Sector Performance
Rs. 2,893 million recorded in 2007. The revenue of

3 DOP has increased significantly by 71.2 per cent due
to an upward revision of postal charges with effect
from mid-2007. The operating expenditure of DOP has
Item
2007 2008(a)
Growth Rate (%)

2007 2008(a)

declined by 20.8 per cent, due to the implementation Installed capacity (MW) 2,444 2,644 0.4 8.2
Hydro 1,324 1,344 0.8 1.5
of a cost management programme. The measures Thermal (b) 1,115 1,285 0.0 15.2
taken to improve the financial position and to generate Wind 3 3 0.0 0.0
Other 2 12 100.0 500.0
additional funds by venturing into non-traditional Units generated (GWh) 9,814 9,901 4.5 0.9
services should be continued until it becomes self- Hydro 3,947 4,128 -14.8 4.6
Thermal (b) 5,864 5,763 23.4 -1.7
supporting to avoid being a burden on the budget. Wind 2 3 0.0 50.0
Other 1 6 -36.7 500.0
Total sales by CEB (GWh) 8,276 8,417 5.7 1.7
Energy Domestic and religious 2,771 2,799 5.7 1.0
Industrial 2,627 2,678 0.8 1.9
General purpose and hotel 1,626 1,703 16.6 4.7
The energy sector suffered from soaring oil Bulk sales to LECO 1,144 1,130 3.0 -1.2
prices in the international market during the Street lighting 108 108 10.2 0.0
LECO sales (GWh) 1,099 1,070 5.3 -2.6
first seven months of 2008. International oil prices Domestic and religious 499 478 3.1 -4.2
increased to a historically high level of US dollars 146 Industrial 267 237 5.1 -11.2
General purpose and hotel 303 328 8.6 8.3
per barrel by July, 2008. However, due to the price Street lighting 27 25 0.0 -7.4

decline in the latter part of the year, the average import Overall system loss of CEB (%) 15.7 15.0 -5.6 -4.3
Number of consumers (‘000) (c) 4,307 4,518 6.0 4.9
price of crude oil (C&F) by the Ceylon Petroleum o/w Domestic and religious 3,811 4,001 6.1 5.0
Corporation (CPC) increased only by about 34.7 per Industrial 41 44 2.5 7.3
General purpose and hotel 450 469 4.9 4.2
cent to US dollars 97 per barrel. However, historically (a) Provisional Sources: Ceylon Electricity Board
high oil prices clearly indicated the importance of (b) Inclusive of Independent Producers (IPP)
(c) Inclusive of LECO Consumers
Lanka Electricity Company (Pvt) Ltd.

adopting a multi-faceted strategy to address the issue,
by way of developing alternative energy sources;
Electricity sales had been growing by an average rate
including renewable energy, adhering to energy
of 7-8 per cent per year in the recent past. However,
conservation measures and adopting country-wide
it has been observed that the demand for electricity
demand management measures.
has been declining in recent years mainly due to
tariff increases as well as high growth in less energy
Electricity intensive sectors in the economy. An upward revision
Total electricity generation increased of electricity tariff at a higher rate has led to economise
marginally by 0.9 per cent to 9,901 GWh in electricity consumption and encouraging consumers
2008. The share of hydropower in the total electricity to conserve electricity by shifting to use energy
generation increased to 42 per cent in 2008 from efficient equipments, lowering the electricity sales
40 per cent in 2007 due to conducive weather growth substantially. The electricity consumption in
conditions. Out of the total power generation, the domestic sector, general purpose and hotel and
about 58 per cent was generated by CEB and the the industrial sector increased by 1.1 per cent, 4.7
balance by the private sector. The system losses per cent and 1.9 per cent, respectively, in 2008.
as a percentage of total generation which was 15.7
The electricity sector continued to suffer from
per cent in 2007 declined to 15 per cent in 2008.
escalating oil prices as well as other institutional
However, the system losses are still high in terms
and structural weaknesses. The CEB continued
of international best-practices level.
to depend heavily on thermal power, mainly from
The sales of electricity, which excludes system the private sector. In 2008, about 58 per cent of
losses out of the total generation, increased electricity demand was met by thermal power. The
marginally by 1.7 per cent to 8,417 GWh in 2008. fuel bill of the CEB increased by 45.7 per cent. On

62


average, the CEB incurred Rs. 19.17 to generate a as a national policy and take all other remedial
unit of electricity at its thermal power plants in 2008, measures to deal with any oil price shock in the
which is an increase of 45.8 per cent compared
to 2007. The average purchase price of private
power increased by 37.9 per cent to Rs. 20.58 per
future. Any delay in the planned low cost power
generation projects will incur high expenditure on
petroleum imports for electricity generation. Energy
3

unit in 2008. However, the decrease in oil prices in conservation by curbing the growth of unnecessary
the international market towards the latter part of energy intensity in the economy and developing
2008 mitigated the heavy pressure on electricity renewable energy sources are also important to arrest
generation cost, thereby easing the burden on the the high oil import bill in the country. However, these
already weakened financial position of the CEB. types of micro measures will not help sufficiently to
deal with future energy crises. Therefore, it should
The sustainability of the power sector entirely
be noted that a sustainable energy policy should be
depends on shifting towards low cost power
based on shifting towards low cost power generation
generation in the medium-term to bring electricity
methods coupled with a flexible pricing policy.
tariff to an affordable level and increase the
competitiveness of export-oriented industries. The government has identified the importance
Several power projects were at various stages of of rural electrification which helps many villagers
implementation in 2008. The first phase (200 MW) of generating self-employment activities, thereby
the Kerawalapitiya combined cycle power plant with helping to alleviate poverty in rural areas. The
a capacity of 300 MW was completed in November, CEB has been able to provide grid connected
2008 and added to the national grid, while the electricity to level of 83 per cent of households and
remaining 100 MW is expected to be added to the the future rural electrification projects are expected
national grid in 2009. The Norochcholai coal power to enhance the electrification level to 86 per cent
plant (900 MW) which was started in 2007 is expected by end 2010. Although, the financial benefits to the
to add 300 MW to the national grid in the first stage by CEB is low due to high transmission cost, since
2011 and 600 MW in the second and third stages. The the economic and social benefits of electrifying
cost of power generation from coal fired power plants rural areas are high, the government with the
is relatively low compared to oil fired power plants, collaboration of funding agencies has launched
which may result in reducing the overall cost of power several programmes to connect the rural households
generation. Meanwhile, the construction work of the to the national grid. Six rural electrification projects
Upper Kothmale hydropower plant was in progress in have been completed in 2008 with an estimated cost
2008 and is expected to add 150 MW to the national of US dollars 189 million.
grid by 2011. Negotiations were also in progress with Several changes were introduced to the
foreign investors to set up a coal power plant with a electricity tariff in 2008. The CEB revised its
capacity of 1,000 MW in Trincomalee. In addition, tariff structure to a flat tariff system in March, 2008
four medium scale hydropower plants namely, Uma and increased electricity tariff by an average of 30
Oya (120 MW), Ginganga (49 MW), Broadland (35 per cent. However, as per a Court ruling the CEB
MW) and Morogolla (27 MW) have been identified for reverted to its block tariff system from November,
implementation. These power plants, once completed, 2008. In addition, the fuel adjustment charge of 30
would provide a space for the country to rationalize its per cent was levied across all the tariff categories
power generation mix, thereby helping the country to from March, 2008. However, a waiver on the fuel
cope with internal and external shocks and maintain adjustment charge was granted to the religious
the stability in the power system. category with effect from May, 2008. Further, a
It is imperative to take necessary measures waiver of the fuel adjustment charge was granted
to expedite low cost power generation projects for the industrial and hotel categories for a period of
without any delay and discourage the installation 11 months from January, 2009 under the Economic
of high cost thermal power projects in the future Stimulus Package, considering the difficulties faced

63


by industries in this category due to the global amounted to Rs. 64 billion by end 2008. This
economic slowdown. In addition, a discount of Rs. fragile financial position of the CEB highlights the

3
30.00 per household, which consumes less than 90 importance of quickly dealing with this problem, as
units per month was granted by the Budget 2009. otherwise the CEB may have to be bailed out by tax
These cross-subsidies have led to significant financial payers’ money.

losses to the CEB, burdening the government budget
The Sri Lanka Electricity Bill was passed by the
and tax payers. This situation, therefore, calls for an
Parliament in March, 2009. The Sri Lanka Electricity
implementation of a cost-reflective tariff system in
Act provides the basic legal framework for separation
order to make the CEB viable and thereby sustain
of policy, regulatory and operational aspects allowing
Sri Lanka’s energy sector.
the Public Utilities Commision of Sri Lanka (PUCSL)
The tariff increase was not sufficient to cover to regulate the electricity sector. Nevertheless,
the cost of power generation. The average tariff the Act still imposes certain constraints on private
in 2008 was Rs. 13.22 per unit, while the average sector participation in key areas of operation such
cost was Rs. 14.94 per unit. The estimated average as generation and distribution, whereby either
purchased cost of private power was Rs. 20.58 per complete or partial involvement of the government
unit in 2008. The already high electricity tariff in the in the generation and distribution is compulsory.
country suggests that there is no room for a further Further, under the provision of the Act, the CEB will
tariff increase without hampering competitiveness continue to function as a vertically integrated utility
and, hence, the rationale for shifting towards low with powers to hold generation, transmission and
cost power generation methods and implementation distribution licences simultaneously.
of necessary reforms in the power sector aiming at
bringing down the cost of power generation as a
Petroleum
national priority. International oil prices reached record high
levels towards the middle of 2008. Oil prices in the
The financial position of the CEB further
international market reached its highest level of US
weakened in 2008. The CEB’s operating losses
dollars 146 per barrel in July, 2008. Several factors
increased to Rs. 35 billion in 2008. An increase
including a steady increase in demand from emerging
of expenditure due to high oil prices was the main
economies such as India and China, low OPEC spare
reason for the increase in losses. The CEB’s
capacity in oil production, weakened US dollar, supply
accumulated short-term borrowings from banks
constraints resulted from geo-political uncertainties,
and other outstanding liabilities to the CPC and to
low inventories and refinery bottlenecks led to high
Independent Power Producers (IPPs) amounted
oil prices during the first seven months of 2008.
to Rs. 57 billion, while, CEB’s long-term loans
However, oil prices declined rapidly to a lowest level
in four years to US dollars 34 per barrel in December,
Chart 3.2 Average Tariff and Cost of Electricity 2008 with the restoration of supply from Brazil and
14 Nigeria, coupled with a declining world demand for
12 oil due to financial turmoil and slowingdown of the
10
world economy. The average crude oil price (Brent)
8
increased by 35 per cent to US dollars 97 per barrel
Rs./unit

in 2008 in comparison to US dollars 72 per barrel in
6
2007. The average price of crude oil (C&F) imported
4
by CPC stood at US dollars 97 in 2008, reflecting an
2
increase of 34.7 per cent.
0
2004 2005 2006 2007 2008

Domestic Tariff Average Tariff Domestic petroleum prices were adjusted in line
Industry Tariff Average Cost with the changes in international prices in 2008.
Commercial Tariff
Accordingly, prices of petrol (90 octane), auto diesel

64


and kerosene were raised by 34.2 per cent, 46.7 per
Table 3.4 Petroleum Sector Performance
cent and 17.6 per cent, respectively, to Rs. 157.00,
Rs.110.00, and Rs. 80.00 per litre, respectively, in
two steps during the first half of 2008. The 15 per Item 2007 2008(a)
Growth Rate %
2007 2008(a)
3
cent Value Added Tax (VAT) on petrol was reduced

to 5 per cent with effect from January, 2008 to ease Quantity imported (Mt ‘000)
Crude oil 1,938 1,853 -9.9 -4.1
the pressure on consumers. However, in line with Refined products (b) 2,216 2,145 15.1 -3.2
L.P. gas 156 144 -1.3 -7.7
declining international oil prices, petrol, diesel and Domestic L.P. gas production (Mt ‘000) 16 16 5.4 4.5
Value of imports (c&f )
kerosene prices were reduced to Rs. 120.00, Rs. Crude oil (Rs. mn) 113,584 143,159 6.5 26.0
70.00 and Rs. 50.00 per litre, respectively, during (US dollars mn) 1,025 1,323 -0.4 29.1
Refined products (Rs. mn) 150,390 202,144 31.0 34.4
the latter part of 2008 in several steps. In addition, (US dollars mn) 1,358 1,863 26.0 37.2
L.P. gas (Rs. mn.) 12,027 15,301 27.6 27.2
VAT on petrol was increased to 12 per cent from (US dollars mn) 111 141 2.8 27.0
January, 2009 and the full duty wavier of Rs. 20.00 Average price of crude oil (c&f )
(Rs./barrel) 8,113 10,226 21.7 26.0
per litre on importation of petrol was suspended (US dollars/barrel) 72.01 97.01 12.0 34.7
Quantity of exports (Mt ‘000) 283 310 -11.3 9.5
in May 2008. The total sales of major petroleum Value of exports (Rs. mn.) 18,693 27,542 -4.5 47.3
products declined by 6.4 per cent responding to the (US dollars mn.)
Local sales (Mt ‘000)
169
3,965
255
4,391
-10.1
11.6
50.9
10.7
price hike in 2008. Petrol consumption registered o/w Petrol (90 Octane) 487 490 7.3 0.6
Petrol (95 Octane) 31 29 29.2 -6.5
a marginal growth of 0.2 per cent, while diesel and Auto diesel 1,752 1,613 7.3 -7.9
Super diesel 14 9 55.6 -35.7
kerosene consumption decreased by 7.9 per cent Kerosene 168 151 -18.4 -10.1
and 10.1 per cent, respectively. Furnace oil 986 973 8.1 -1.3
Avtur 199 189 -22.0 -5.0
Naphtha 97 142 61.7 46.4
The CPC reported operational losses in 2008. L.P. gas 197 174 15.9 -11.7
Local Price (at period end) (Rs./litre)
Non-revision of oil prices on time was the main Petrol (90 Octane) 117.00 120.00 27.2 2.6
Petrol (95 Octane) 120.00 133.00 26.3 10.8
reason for the CPC’s losses recorded in 2008. Auto diesel 75.00 70.00 25.0 -6.7
The non-payment of outstanding bills by several Super diesel
Kerosene
80.30
68.00
85.30
50.00
23.0
41.7
6.2
-26.5
institutions, particularly a sum of around Rs. 45 Furnace Oil
500 Seconds 54.30 54.30 17.3 0.0
billion from the CEB, placed additional burden on 800 Seconds 53.90 33.90 17.7 -37.1
1,000 Seconds 52.70 52.70 18.7 0.0
the CPC in its attempt to function as a commercially 1,500 Seconds 51.70 31.70 19.4 -38.7
viable institution. The Government of Iran granted 3,500 Seconds 46.65 25.00 13.8 -46.4
L.P. Gas (Rs./kg)
an interest free credit facility, initially for 120 days Shell gas 105.04 129.52 36.8 22.9
Laugfs gas 97.12 109.60 33.6 12.9
which was extended to 210 days to purchase crude
(a) Provisional Sources: Ceylon Petroleum Corporation
oil from Iran. The CPC had utilized this facility up to (b) Imports by Ceylon Petroleum Lanka IOC Ltd.
Corporation, Lanka IOC Ltd. and Lanka Marine Services (Pvt) Ltd.
US dollars 1,226 million in 2008 and has repaid US Lanka Marine Services (pvt.) Ltd. Shell Gas Lanka Ltd
Laugfs Gas (Pvt) Ltd.
dollars 845 million by end 2008. Sri Lanka Customs

International Crude Oil (Brent) Prices
Progress was made in respect of oil exploration
Chart 3.3 in the Mannar Basin in 2008. The Ministry of
(Monthly Average) 2007/2008
140 Petroleum and Petroleum Resources Development,
130
120 called for bids from international oil companies
110
for petroleum exploration in Blocks 2, 3 and 4 in
100
the Mannar Basin. Cairns India Ltd was selected
US$/bbl

90
80
70 as the successful tenderer and has been offered
60
the licence for exploring oil in the Block 2. Cairns
50
40 Lanka Ltd, the local subsidiary of Cairns India Ltd
30
07' Mar May Jul Sep Nov 08' Mar May Jul Sep Nov
is to commence exploration activities during the first
Jan Jan quarter of 2009.

65


Box 5 Commodity Hedging: Risks for Buyers and Sellers

3 This Box Article discusses the potential risks Why has the principle of suitability become

of entering into hedging transactions and ways of important in the modern hedging deals? That is because
mitigating the risks involved1 . A hedging transaction is of the existence of a crucial problem called ‘information
a sub-product in the wider market for derivative products asymmetry’ in markets. In the case of hedging deals,
which have been developed and offered on the basis the seller may be well equipped with knowledge, but
of an available ﬁnancial product to generate liquidity, the buyer needs to be educated. The disparity in the
mitigate risks and raise the depth of the market. knowledge of the two parties would elevate the seller
to a superior position, thereby enabling him to get
A long established legal principle relating to business himself enriched unduly. When the buyers became
deals has been the ‘caveat emptor’ or ‘let the buyer victims of this information asymmetry, the hedging
beware’. This principle simply enunciates that buyers markets on their own devised a code of good practices
of a transaction should take the requisite measures to to minimise its occurrence. In markets where there is no
protect themselves and the sellers have no responsibility such market developed code for hedging transactions,
for the losses incurred by buyers. When applied to a it is the responsibility of the regulators to introduce a
hedging product, it means that the buyer should learn mandatory code of best practices to ensure fair deals in
of the risks involved and enter into the transaction with the derivative markets.
full knowledge. The principle holds even if the sellers
have deliberately and intentionally misled the buyers In order to ensure fair deals in the derivative market
into accepting a product that would bring them potential and protect the interests of all the parties, the Central
losses. However, the application of this legal principle Bank of Sri Lanka, in 2005 and 2006, after following
for the derivative transactions has been withheld by an elaborative consultative process, introduced a set of
courts in the wake of a plethora of cases in which the directions to be followed by banks intending to enter
buyers in derivative transactions had incurred substantial into hedging deals. These directions, among other things,
losses persistently. That was after the issuers of hedging speciﬁcally required the banks or authorized dealers to
products, mainly investment banks, were accused educate the clients of the pros and cons and the risks
of ‘mis-selling’ or ‘mis-labelling’ of products to the involved in hedging deals. According to the directions,
detriment of the buyers. “authorized dealers shall obtain an undertaking from
the customers interested in using the derivative products
Therefore, the accepted principle relating to that they have clearly understood the nature of the
derivative transactions today is not the caveat emptor, products and their inherent risk”, and “authorized
but ‘suitability’. The principle of suitability casts dealers shall provide adequate information on the
upon the seller the responsibility of ascertaining the transaction especially with regard to the conditions and
appropriateness of the buyer of a product before entering clauses to be incorporated into the product-determined
into a formal deal with him. Since many financial benchmark interest rate, strike price, premia if any and
products and derivatives are complex in nature, not all risks involved to their customers and ensure highest
buyers could adequately assess the risks they are taking level of transparency”. In terms of a set of guidelines
when buying such products. In view of the fact that issued in 2007, in the case of corporate customers, the
such derivative products are of high value, the resultant bank that proposes the hedging deal should inform all
losses to buyers could also be substantial. Hence, it is the the board members of the nature and the level of the
responsibility of the seller to make the buyer ‘suitable’ to risks involved in the proposed hedging and get a signed
enter into a deal with him. In other words, the two parties acknowledgement from the board to that effect. In this
to a derivative transaction should be well-informed of manner, the corporate client who is to sign the hedging
the risks faced by each other and participate in the deal agreement with the bank would do so as an equal partner
as equal partners. Bringing up the buyer to that status fully aware of the risks involved. It is mandatory for
is the responsibility of the seller. Thus, the principle of banks in Sri Lanka to follow these directions. If the
suitability precludes the seller from ‘unjustly enriching banks fail to comply with the directions, the hedging
himself out of the ignorance of the buyer’. contracts involved will become ‘tainted and materially
defective’. In such a situation, courts may discharge
the buyers from the responsibility for honouring the
1
The rationale and the product range available for commodity hedgers with
special reference to hedge oil for mitigating price risks were presented in Box
hedging contracts. Hence, the appropriate dictum in the
No. 4 in Annual Report 2006 (page 47).

66


current circumstances should be, not that the buyer be Regulations alone cannot prevent the occurrence of
aware as pronounced by the principle caveat emptor, but mis-selling or mis-labelling in the hedging markets. If the
that the seller be aware as pronounced by the principle
‘caveat venditor’, in order to avoid losses and costly
banks do not comply with these regulations, a regulator
is not in a position to prevent mis-selling or mis-labelling
before it occurs. Any detection of such an incident after it
3
legal battles.

has occurred would not ensure a fair deal for the buyers.
The principle of suitability has been criticised on the Hence, banks should make an extra effort to build suitable
ground that it would spawn ‘moral hazard practices’ by governance structures within them to make their hedging
buyers, put the selling banks in the defensive and stunt clients suitable parties for the transactions.
the risk taking behaviour of clients. In the long run, While hedging is a product that can be used by
such adverse developments would discourage financial a customer to insulate himself from adverse price
innovations and weaken market resilience. It also raises fluctuations, it should be undertaken by them with full
the cost of financial transactions by requiring lending knowledge and understanding of all the risks involved,
banks to maintain elaborative client profiles. so as to prevent a major financial catastrophe.

Transportation The improvement of the road network would
help reduce the disparities between and within the
With the regional development efforts and
provinces and districts. The development of the road
increase in economic activities, the demand
network helps improve the connectivity between rural
for transport sector continued to increase.
and urban centres and opens access to services as
An efficient and convenient transportation system
well as to physical and human resources. Further, it
will accelerate economic growth by facilitating easy
would improve people’s access to markets and services
and faster mobility of people, goods and services
such as education and health. Thus, improving access
and reducing disparities in regional development.
to remote areas is important to create new markets, to
Recognising the importance of the expansion and
improve mobility of labour from regional areas thereby
improvement of the road network, the government has
generating more employment opportunities for the
prioritised the development of the existing road network
rural masses, helping to reduce poverty and achieve
and improving the road network by way of constructing
a regionally balanced economic growth.
highways and expressways and construction of rural
roads under the Maga Neguma Programme. Though the coverage of the road network in
Sri Lanka is relatively satisfactory with 1.8 km of
Road Transportation roads per km2, the conditions and the capacity
of roads are inadequate to cater to the rapidly
Road Development
growing demand for freight and passenger
Roads are the backbone of the transportation transportation. The government has commenced
system. The country has an extensive road network; several road development projects to address these
the total length of road network is about 116,862 km issues. The Southern Expressway, which is under
comprising 11,902 km of national highways (classes construction, is expected to boost economic activities
A and B), 16,532 km of provincial roads (classes in the Southern province including potential growth
C and D), and 88,428 km of roads maintained by in industries, tourism, fisheries and agriculture in
Local Authorities, estates and state agencies. The lagging areas. The construction work of the Southern
government policy on road development emphasises Expressway is expected to be completed by 2011. It
building a national highway system and an is expected to rehabilitate approximately 620 km of
integrated road network, improving the management national roads and 160 km of rural roads under the
of the existing road network, strengthening traffic Road Sector Assistance Project. The project loan
management and implementing measures to agreement was signed for the construction of the
minimise road accidents by regulatory agencies and Colombo-Katunayake Expressway with the Exim Bank
promoting private sector participation in investment of China and the land acquisition and major utility
in new roads. shifting works were in progress in 2008. The Colombo

67


Outer Circular Highway Project is planned to link all Road Passenger Transportation
major roads radiating from Colombo with a view of
The road passenger transportation showed

3
reducing traffic congestion within the city of Colombo
some improvement in 2008. The average number
by providing a high mobility road outside the city. The
of buses operated per day by the Sri Lanka Transport
project is planned to be implemented in three stages

Board (SLTB) increased by 2.9 per cent to 4,247,
and the land acquisition and the preparation of tender
while the average number of buses operated by
documents were in progress in 2008. The negotiation
the private sector increased by 6.8 per cent to
on the concession agreement was in progress for the
12,929 in 2008. The total operated kilometres and
Colombo-Kandy Alternative Highway Project, while
passenger kilometres of SLTB increased by 2.5
the feasibility study of the Kandy - Badulla alternative
highway was carried out in 2008. per cent and 2.3 per cent, respectively, during the
year. The total operated kilometres and passenger
The government has initiated a project to kilometres by private bus operators increased by
construct 21 flyovers to avoid traffic congestion 6.8 per cent. However, in 2008 new registration of
in the city of Colombo and its suburbs. The flyover passenger buses has decreased substantially by
at the railway crossing at Kelaniya was completed 55.3 per cent.
in April, 2008 and the flyover at Nugegoda junction
was opened for traffic in January, 2009. Flyovers In terms of the national bus fares policy,
at Orugodawatte, Pannipitiya, Panadura and bus fares were revised several times in 2008.
Gampaha were under construction during 2008. The Passenger bus fares were increased by an average
construction of these flyovers would help reduce the rate of 4.6 per cent in February, 2008 mainly to
road congestion significantly, thereby generating compensate for the increase in fuel prices. Bus fares
economic benefits such as saving fuel and time were again increased in May, 2008; private sector
spent for travel. by an average of 27.2 per cent, and the state sector
by a lower rate of 17.4 per cent. However, in line
Road development sector faces several
with declining petroleum prices, private sector bus
issues in fast implementation of planned
fares were reduced by 11.6 per cent in November,
projects. Delays in land acquisition and resettlement
2008. This has made the private sector bus fares
activities, resistance from parties affected by land
comparable with the state sector by end 2008.
acquisition, inadequate resources allocation,
increase in price of road construction material, Several projects have been launched to
problems related to enforcement of laws are the address the weaknesses in the road passenger
main issues confronted in this sector. Uncontrolled transportation sector in 2008. The National
traffic and unauthorized roadside developments Transport Commission has prepaired a strategic
have also caused underutilization of the capacity of
plan for traffic management with a view to reducing
the existing road network.
vehicles entering the city and reducing emission
levels to mitigate traffic congestion and environmental
Passenger Transportation
pollution in the Greater Colombo area. Under this
It is a long felt need to upgrade the services of plan, a new bus service was launched in early 2009
the public transport system comprising railway with the help of the private sector in Colombo and
and road passenger transportation to cater to suburbs to divert private vehicle users to a more
the rising demand for a quality and convenient comfortable public transport system. The Nisi Seriya
passenger mobility. To cater to this requirement, night time bus service, Sisu Seriya School bus
it is important to improve the facilities and quality of service and Gemi Seriya to provide transport facilities
the public transportation. An efficient mass transport in uneconomic and remote areas were continued
system can reduce the traffic congestion on main in 2008. Operation of bus services in uneconomic
roads and thereby saving time and expenditure on routes were subsidised at a cost of Rs. 372 million
petroleum imports. by the Treasury.

68


The financial position of SLTB continued to taken to improve the signaling and communication
remain weak in 2008. The total revenue of SLTB systems and infrastructure including re-construction
for the year 2008, increased by 16.8 per cent to Rs.
17,150 million mainly due to increase in bus fares.
Reflecting high fuel prices, operating expenditure
of several railway bridges. With the increase in
rolling stock position of SLR, new service between
Colombo-Nanuoya was commenced while several
3

also increased by 21.8 per cent to Rs. 20,704 sub-urban services which remained suspended were
million which led to an operational loss of Rs. 3,554 recommenced.
million in 2008. The operational loss has increased
Several measures have been taken to upgrade
by 53.8 per cent in 2008 compared to the previous
the railway services to meet customer demand
year, indicating the need for measures to improve
and to attract passengers to the railway. Under
the financial position of SLTB to reduce the burden
Stage I of upgrading the Colombo-Matara Railway
on the government budget.
line, while improving the rail track, selected railway
stations including Panadura, Kalutara, Galle and
Railway Transportation Matara are to be developed. The loan agreement
The railway sector showed mixed performance for this project has already been signed with the
in 2008. Passenger transportation and goods Government of India. Under Stage II, the second
transportation decreased by 2.1 per cent and line will also be constructed from Kalutara South to
9.4 per cent, respectively, in 2008 mainly due to Matara. Meanwhile, the land acquisition for the first
cancellation of train operations between several 27 km of the new Matara-Kataragama Railway line
areas due to security reasons and curtailment of
unproductive train operations as well as increase in Salient Features of the
railway fares and freight charges. At present, the Sri Table 3.5
Transport Sector
Lanka Railways (SLR) contributes only around 5 per
cent and 1 per cent, respectively, to the passenger Growth Rate (%)
transportation and goods transportation in the Item
2007 2008(a) 2007 2008(a)
country. Though, the railway network of Sri Lanka 1. New registration of motor vehicles (No.) 297,892 265,199 -0.9 -11.0
Buses 2,637 1,180 -21.2 -55.3
consists of 1,640 kilometres, it operates only 1,200 Private cars 22,603 20,237 -18.0 -10.5
kilometres due to the closure of several sections in Three wheelers 43,068 44,804 -33.2 4.0
Dual purpose vehicles 5,193 2,856 -28.3 -45.0
the North and the East. However, with the liberation Motor cycles 182,508 155,952 16.5 -14.6
Goods transport vehicles 18,408 14,038 -9.9 -23.7
of the North and the East and reconstruction of the Land vehicles 23,475 26,132 12.7 11.3
destroyed rail track, the SLR will be able to start 2. Sri Lanka Railways
Operated kilometers (‘000) 9,560 8,960(b) 22.6 -6.3
railway operations to those areas. Passenger kilometers (mn) 4,769 4,669 10.6 -2.1
Freight ton kilometers (mn) 133 121 -3.5 -9.4
The SLR initiated several projects in 2008 to Total revenue (Rs.mn) 2,999 3,671 20.4 22.4
Operating expenditure (Rs.mn) 7,297 8,225 12.7 12.7
improve the railway operations which has been Operating loss (Rs.mn) 4,298 4,553 8.0 5.9
constrained by non-availability of a sufficient 3. Sri Lanka Transport Board
Operated kilometers (mn) 305 313 16.2 2.5
number of passenger carriages, locomotives and Passenger kilometers (mn) 14,694 15,037 14.2 2.3
Total revenue (Rs.mn) 14,687 17,150 18.6 16.8
diesel multiple units. Though the SLR has a fleet Operating expenditure (Rs.mn) 16,999 20,704 13.9 21.8
of 98 engines, 75 per cent of this fleet is more than Operating loss (Rs.mn) 2,312 3,554 -9.0 53.7
4. SriLankan Airlines
30 years old and subject to frequent breakdowns. Hours flown (hrs.) 69,184 67,796 2.9 -2.0
With a view to relieving this situation, the SLR has Passenger kilometers flown (mn) 9,841 9,169 5.2 -6.8
Passenger load factor (%) 79 74 3.8 -5.9
set up a workshop to repair coaches locally. Under Weight load factor (%) 60 59 1.6 -2.0
Freight (Mt. ‘000) 98 87 0.0 -11.2
this re-furbishing programme, 15 coaches were Employment (No.) 5,213 4,874 -2.8 -6.5
refurbished by end 2008. Further, the SLR imported (a) Provisional Sources: Department of Motor Traffic
(b) Estimates Sri Lanka Railways
100 passenger carriages and 15 diesel multiple National Transport Commission
Civil Aviation Authority of Sri Lanka
units under a concessional loan from China by end SriLankan Airlines

2008 to upgrade its fleet. In addition, actions were

69


extension has been completed. The SLR is planning The government has highlighted in its
to upgrade 281 km of railway track in the Eastern policy framework that it will maintain a liberal

3 province with new sleepers and other infrastructure
facilities. With a view to reducing the traffic congestion
and competitive civil aviation industry in Sri
Lanka with efficient and modern facilities to
ensure safety and security in accordance with
and to popularise mass-scale transportation, it is

planned to introduce a Light Rail Rapid Transit System international standards. Accordingly, BIA will be
in Colombo Metropolitan area. The feasibility study of developed as an international aviation hub and
the project has already been completed. the institutional framework will be re-engineered
to ensure high level of efficiency in landing aircraft
Railway fares were revised upward in 2008 and passengers at BIA. Stage 2 of Phase II of the
after a lapse of three years. Railway fares were Bandaranaike International Airport Modernisation
increased by an average rate of 70 per cent in project was in progress in 2008. This project aims
June, 2008 mainly considering increased fuel prices. at constructing a new passenger terminal facility
However, fares were adjusted downward by about 9 to accommodate the increasing number of air
per cent in line with the reduction in diesel prices in passengers.
December, 2008. Accordingly, the average railway
Several developments have been taken place
fare has been increased by 42 per cent in 2008.
in the civil aviation sector in 2008. The Government
However, the fare revision in 2008 was not sufficient
of Sri Lanka took over the management of SriLankan
to mitigate the already weakened financial position of
Airlines from April, 2008 from Emirates Airlines,
the SLR. The total revenue of the SLR increased by
at the end of the ten year management contract
22.4 per cent to Rs. 3,671 million, while the current agreement. International Air Transport Association
expenditure increased by 12.7 per cent to Rs. 8,225 has introduced a complete electronic ticketing
million, resulting in a 5.9 per cent increase in an system replacing the traditional paper tickets.
operational loss to Rs. 4,553 million in 2008. Several new airlines started their operations to Sri
Lanka. Mihin Air, the second national carrier and a
Civil Aviation budget airline suspended its operations from May,
The performance of the civil aviation sector 2008 and re-commenced operations from January,
was hindered by the slowdown in the tourism 2009 with government budgetary allocations to
sector in 2008. A total of 4.7 million passengers meet its capital requirements. While it is important
were served at the Bandaranaike International to have a budget airline, it is necessary to maintain
Airport (BIA) in 2008, reflecting a 5.8 per cent its operations in a commercially viable manner. In
decrease over the number of passengers in 2007. this regard, it is important that the budget airline
Air freight also decreased by 7.5 per cent during the should put in place a medium-term business plan
year. The share of the national carrier, SriLankan taking into account, the global trends in air traffic,
Airlines, in passenger and freight operations cost cutting experiences of other budget airline
remained at 62.7 per cent and 59.7 per cent, operations and the high cost of acquiring aircraft for
respectively, in 2008. The domestic air passenger operations. Meanwhile, Sri Lanka participated in five
transportation reflected a substantial growth and bilateral air services negotiations with five countries
passenger kilometreage grew by 28.2 per cent in and entered into new agreements with Turkey and
2008. A significant progress can be expected in Madagascar.
the civil aviation sector, with the North and the East
conflict reaching its final phase, and peace returning
Port Services
to the country. However, the performance of the civil The growth momentum in port services
aviation sector is not expected to show a speedy continued in 2008 despite some impact from
recovery in 2009 due to the anticipated prolonged slowdown in global trade during the latter part
world economic recession. of the year. Total cargo handling grew by 9.1 per

70

Sri Lanka Economy

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