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Public Disclosure Authorized SRI LANKA DEVELOPMENT UPDATE Public Disclosure Authorized MORE AND BETTER JOBS FOR AN UPPER MIDDLE-INCOME COUNTRY Public Disclosure Authorized www.worldbank.org/sldu June 2018 #SLDU2018 Public Disclosure

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www.worldbank.org/sldu #SLDU2018

SRI LANKA DEVELOPMENT UPDATE

MORE AND BETTER JOBS FOR AN UPPER MIDDLE-INCOME COUNTRY

June 2018

Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized

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Recent Developments, Outlook, Risks and Policy Priorities

2 Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Main takeaways

  • 1. Sri Lanka’s improvement in its macroeconomic performance was masked by inclement

weather.

  • 2. Fiscal and monetary policy measures contributed to stabilization; however, a prolonged

drought took a toll on growth while contributing to raising inflation.

  • 3. Despite a widening deficit of the external current account, exports recovered after

shrinking for two consecutive years.

  • 4. Strengthened capital flows improved external buffers. The overall improvement in

macroeconomic performance was recognized by rating agencies.

  • 5. To sustain growth, create more and better jobs and reduce poverty Sri Lanka needs to

implement reforms that the country has already announced; the outlook will remain stable, provided the government is committed to the reform agenda.

  • 6. Risk balance is tilted towards downside; the key one being the domestic political risk

3 Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Main changes from the last update

  • 1. The government recorded a primary fiscal surplus in 2017, a first-in-decades
  • 2. Official reserves reached an all-time-high in April 2018 thanks to capital flow
  • 3. The new Inland Revenue Act came into effect
  • 4. Active Liability Management Act was passed
  • 5. Cost-reflective pricing formula for fuel was implemented
  • 6. 1,200 lines of para-tariffs removed
  • 7. SWIFT, a single web portal for investors, was launched to facilitate investments
  • 8. Some reforms slowed down: further debt management reforms, National Audit Act,

Secured Transactions Act, Customs Ordinance, and SOE reforms

  • 9. With the impending election cycle elevating political risk, the window for further

reforms is narrowing

4 Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Global environment continues to be benign

5

  • Global growth has softened but remains robust despite signs of moderation in trade and

manufacturing

  • Faster withdrawal of monetary policy accommodation in advanced economies have led

to rising global interest rates, capital inflows to EMDEs are likely to moderate as global financial conditions tighten

  • Risks to the outlook remain tilted to the downside: Trade restrictions, disorderly

tightening of global financing conditions, a further rise in oil prices Takeaway: Need to rebuild monetary and fiscal buffers and restore policy space to mitigate negative external shocks

World Bank Global Economic Prospects, June 2018; South Asia Focus, April 2018

2016 2017 2018 2019 2020 Key financial flow s to Sri Lanka Actual Estimates World 2.4 3.1 3.1 3 2.9 United States 1.5 2.3 2.7 2.5 2 Textiles, Portfolio flow s Euro Area 1.8 2.4 2.1 1.7 1.5 Textiles, Tourism, Portfolio flow s China 6.7 6.9 6.5 6.3 6.2 Tourism, FDI, Official financing India 7.1 6.7 7.3 7.5 7.5 Tourism, Remittances Saudi Arabia 1.7

  • 0.7

1.8 2.1 1.7 Remittances Russia

  • 0.2

1.5 1.7 1.8 1.8 Tea United Arab Emirates 3 2 2.5 3.2 3.3 Remittances Japan 1 1.7 1 0.8 0.5 Official financing Projections

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Growth has decelerated and is still largely driven by non-tradable sectors

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  • Annual average growth decelerated from 8.5% (2010-12) to 4.2% (2013-17)
  • Inward orientation is reflected with 70% of the total growth coming from 6 non-tradable

sectors Takeaway: Reforms needed towards a more private investment-tradable sector growth model to sustain growth, jobs and poverty reduction

8.5 4.2 1 2 3 4 5 6 7 8 9 10 2010 2011 2012 2013 2014 2015 2016 2017 Percent

GDP growth and inflation

GDP growth Average GDP growth of the period Inflation, annual average

12 12 12 12 11 9 8 4 4 4 3 2 2 1 1 1 1

  • 2

2 4 6 8 10 12 14

Financial services Transportation &… Construction Other personal services Wholesale & retail trade Real estate & ownership of… Other industry Mining & quarrying F& B and tobacco Other services Other agricultural Accommodation, food &… Professional services Textiles & leather Health, residential care &… Education Marine fishing Tea (Green leaves) Rice

Percent

Contribution to growth 2010-2017

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Zooming in on 2017, natural disasters were a drag on macroeconomy

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  • Agriculture and related industry/service sectors decelerated growth in 2017 to a 16-year

low.

  • Inflation rose due to supply disruptions, demand pressures, and one-off impact of VAT

changes before slowing down in mid-2018 Takeaway: growth performance could have been better without the impact of natural disasters

  • 2

2 4 6 8 10 2011 2012 2013 2014 2015 2016 2017 Percent Agriculture Construction Other industry Services Net taxes Overall growth

2 4 6 8 10 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Percent Food Housing, Water & Energy Health Education Communication Restaurants & Hotels Alcoholic beverages Others Headline (YoY) Core-yoy

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Fiscal performance improved; however, significant risks remain

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  • A primary fiscal surplus was recorded in many decades
  • New Inland Revenue Act is expected to increase revenues structurally
  • However, overall fiscal deficit was higher than projected, as interest expenditure rose
  • Central government debt fell to 77% of GDP; contingent liabilities remain a significant fiscal risk

Takeaway: fiscal & debt numbers moving in right direction, but important to manage quality

  • f tax & spending, and composition/risks of debt & contingent liabilities

(5.5) 13.8 19.4

  • 8
  • 6
  • 4
  • 2

2 5 10 15 20 25 2012 2013 2014 2015 2016 2017 Percent of GDP Percent of GDP

Key fiscal aggregates

Overall balance (RHS) Primary balance (RHS) Total revenue and grants Total expenditure 77.6 62 64 66 68 70 72 74 76 78 80

  • 10
  • 5

5 10 15 2011 2012 2013 2014 2015 2016 2017 Percent of GDP Percentage point contribution

Drivers of central government debt

Real interest effect Growth effect Primary deficit effect Exchange rate effect Residual Change in debt Public debt (RHS)

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Implementation of fuel price formula will reduce fiscal risks

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  • Cost-reflective pricing of fuel will make CPC less vulnerable to global oil shocks and bring in

additional benefits to the economy

  • The removal of the fuel subsidy is progressive, even after accounting for indirect effects
  • On-going work on targeting is critical to protect the poor and vulnerable from the impact of the

reform

Takeaway: Targeting is critical to protect the most vulnerable

(1,500) (1,000) (500)

  • 500

1,000 2012 2013 2014 2015 2016 2017 USD million

Drivers of refined petroleum bill

Price Volume Change in total cost

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

5 10 15 20 25 30 35 1 2 3 4 5 6 7 8 9 10 Percent Poorest Richest Direct Indirect

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Debt level falls, but portfolio shows risks

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  • Central government debt to GDP ration declined in 2017 although it remains high by peer standards
  • The government has taken some important steps to deal with refinancing risks related to Eurobonds

maturing from 2019 (Active Liability Management Act)

  • There are important structural challenges that require attention: legal framework, debt management

strategy, institutional fragmentation. Proposed reforms need to accelerate

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

10 20 30 40 50 60 70 80 90 2012 2013 2014 2015 2016 Percent of GDP

Non-guaranteed debt of 7 SOBEs Letters of comfort Other guaranteed debt Guaranteed debt of 7 SOBE RDA guaranteed debt Central government debt

7 SOBEs included in the graph are Ceylon Petroleum Corporation, Ceylon Electricity Board, Sri Lankan Airlines, Sri Lanka Ports Authority, National Water Supply and Drainage Board, Ceylon Fertilizer Company, Airport and Aviation Services Company. 500 1000 1500 2000 2500 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031

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External sector reported mixed messages

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  • External trade balance weakened due to increased petroleum and food imports while remittances

shrank and tourism slowed down.

  • FDI hit a historic-high (Port City and Hambantota)
  • Official reserves recorded an all-time-high in April 2018 with forex purchases and external

borrowings.

  • External debt related risks remain high.
  • Exchange rate: depreciation pressures amid global financial tightening; felt by many EMEs

Takeaway: to strengthen external account, important to strengthen exports and FDI by implementing investment climate, trade and FDI reform agendas, use GSP+ as window of opportunity

(10,000) (5,000)

  • 5,000

10,000 15,000 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 USD million Gross official reserves Reserves net of swaps and ISBs Reserves net of short-term liabilities

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

  • 5

10 15 20 25 30 35 40 Australia Chile Israel Indonesia Tunisia Canada Sri Lanka Poland Mexico Hungary Sweden Nepal India Philippines South Africa Russia Pakistan Brazil Turkey Argentina

Depreciation from the beginning of 2018

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Sri Lanka’s macro outlook continues to be steady

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  • Expected to reach 4.4 percent in 2018, driven by private consumption and

investment.

Growth

  • will stabilize around mid-single digit level, although the upward trend in oil

prices may exert some upward pressure with the implementation of fuel-price formula; inflation targeting in the medium-term is expected to help

Inflation

  • Will narrow to 5.0% of GDP for 2018, the budgeted fiscal target of 4.8% is likely

to be missed

  • Primary surpluses supported by the ongoing implementation of revenue

measures will reduce the overall fiscal deficit in the medium term

Fiscal deficit

  • Projected to gradually fall, supported by primary fiscal surplus and growth

Public debt

  • Will benefit from tourism, and GSP+ in 2018; however, imports of petroleum will

mask the improvement

  • FDI and debt flows to close the financing gap

External sector

  • Expected to improve with forex purchases, a more market-determined exchange

rate, monetary policy and divestment/lease out of some government assets

Reserves

Outlook will remain stable, provided the government is committed to the reform agenda .

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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External risks:

  • Disappointing growth performance in key countries
  • Tightening global financial conditions
  • Faster than expected rises in commodity prices

Balance of risks is tilted towards downside

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

Domestic risks:

  • Political-economy

related risks closer to an election cycle

  • Delay in implementing

revenue and debt management reforms

  • Natural disasters
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Policy priorities

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  • Improve tax administration
  • VAT reforms
  • Align spending to priorities

Stay on fiscal consolidation

  • Trade policy & facilitation
  • FDI attraction
  • Innovation & business environment
  • Institutional capacity and coordination
  • Communication, trade adjustment package

More private investment and export-led growth model

  • Implementation of Right to Information
  • Public Financial Management reforms
  • State-Owned Enterprise reforms
  • Audit function

Governance & Accountability Manage risks

  • Macroeconomy stability
  • Debt sustainability
  • Fiscal space for health,

education, social protection, disaster management and

  • ther public investment
  • Prepare for ageing
  • A competitive economy
  • Sustained growth towards UMIC

status

  • More and better jobs
  • Poverty reduction
  • Public sector effectiveness
  • Improved service delivery
  • Improved citizens engagement

and public trust

  • Debt and contingent liabilities (PPPs and

SOEs)

  • Natural disasters
  • Impact of reforms on households
  • Resilient economy

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Special Focus: More and Better Jobs for an Upper Middle- Income Country

15 Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Labor supply The labor markets in Sri Lanka

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Retirement age Labor force participation Migration Education and skills

Job supply

Growth & competitiveness: Trade, FDI, investment climate Innovation & Entrepreneurship Labor laws Informality Public and private sectors

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Characteristics of the Sri Lanka’s labor market

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  • Low employment rate
  • High informality
  • Absence of many working-age women from both the informal and formal labor market

(i.e., low female labor force participation)

  • High unemployment rates amongst young people and those with higher education
  • High share of the service sectors across the country
  • A high share of workers in the public sector including state-owned enterprises
  • Low average productivity in agriculture sector
  • Regional disparities in employment

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

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Employee: Public sector 7.5% Employee: Private sector 22.3% Employer 1.4% Own- account worker 16.3% Contributing family worker 4.0% Unemployed 2.3% Not in labor force 46.2%

Overall

Start with the working-age population

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AFG BGD BTN IND NPL PAK Sri Lanka 30 40 50 60 70 80 90 20000 40000 60000 80000 100000 Total employment rate (Percent) GDP per capita (constant USD, PPP adjusted)

Sri Lanka’s LFP below what can be expected from GDP per capita, along with other South Asian countries

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

Share of informal in total, per sector:

  • Overall: 60%
  • Own-account: 94%
  • Family worker: 90%
  • Employer: 59%
  • Employee: 37%

Public sector: 14% of labor force

Source: DCS Labor Force Survey Annual Report 2016

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Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

Large differences in working population between men and women

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Employee: Public sector 9% Employe e: Private sector 34% Employer 3% Own- account worker 25% Contributin g family worker 2% Unemploye d 2% Not in labor force 25%

Male

Employee: Public sector 6% Employee: Private sector 12% Employer 0% Own- account worker 9% Contributin g family worker 6% Unemploye d 3% Not in labor force 64%

Female

  • Men: mainly private sector and own account
  • Women: mainly not in labor force, relatively high public sector
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  • Men: mainly education, retired
  • Women: mainly housework

Title of Presentation 20

Engaged in studies, 38.4 Engaged in housework , 6 Retired/Ol d age, 32.5 Physically illness/Disa bled, 15.9 Other, 7.2

Male

Engaged in studies, 14.3 Engaged in housewor k, 62.2 Retired/O ld age, 15.6 Physically illness/Di sabled, 5.2 Other, 2.6

Female

10 20 30 40 50 60 70 80 90 100 15 19 23 27 31 35 39 43 47 51 55 59 63 67 71 75 79 83 87 Age Male Female

Large differences in economically inactive (out of labor force) population between men and women

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  • Men: wholesale/retail, transport, public admin, tourism
  • Women: wholesale/retail, education, public admin, HHs, health
  • Manufacturing: male 14%, female 24% of labor (textiles)

21 Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

Large differences in service sector employment between men and women

Wholesale/r etail, repair

  • f motor

vehicles 31% Transportatio n/storage 20% Public admin/defen se/compulso ry soc. sec. 16% Accomm/foo d services 5% Activities of HHs as employers/o wn use 5% Other 23%

Male

Wholesale/r etail, repair

  • f motor

vehicles 27% Education 19% Public admin/defen se/compulso ry soc. sec. 18% Activities of HHs as employers/o wn use 7% Health&socia l work 7% Other 22%

Female

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Unemployment: high amongst youth and young graduates

22 Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

2 4 6 8 10 12 14 Total Grade 5 & Below Grade 6- 10 G.C.E. (O/L) (Gr 10-11) G.C.E. (A/L) & above (Gr 12-13) Male Female 5 10 15 20 25 30 35 Total 15 - 24 25 - 29 30 - 39 Over 40 Male Female

  • High unemployment graduates and young people
  • Skills mismatch and challenges in education access and quality
  • Low unemployment rates for grade <5, 6-10: largely informal
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What is the informal sector?

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

2,000,000 4,000,000 6,000,000 8,000,000

By employment

Informal Formal

60% 4.8m 3.2m Informal if:

  • not registered with EPF and IRD and
  • does not keep formal accounts and
  • total number of regular employees below 10

Otherwise formal

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Title of Presentation 24 Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

What is the informal sector?

20 40 60 80 100 Total Below Grade 6 Grade 6 - 10 G.C.E. (O/L) (Gr 10-11) G.C.E. (A/L) & above (Gr 12-…

By level of education

20 40 60 80 100 Total Employees Employer Own account worker Contributing family worker

By type of employment

20 40 60 80 100 Education Manufacturing Accommodation and food… Construction, utilities,… Non-agricultural, of which: Agriculture, forestry and…

By sector

20 40 60 80 100 Total Male Female

By gender

1.5m 3.3m 1.7m 2.4m 1.1m 2.7m 1.9m 2.9m 507k 118k 692k 67k

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Regional disparities in employment: in Northern and Eastern Provinces typically amplified

25 Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

10 20 30 40 50 60 70 80 90 100 Northern Province Eastern Province Western Province Other Provinces Agriculture Industry Services

44 42 50 54 10 20 30 40 50 60 70 80 90 100 Northern Province Eastern Province Western Province Others Provinces Employed Unemployed Student Housewife Others not working

  • Lower employment, lower female labor force participation than national

average

  • But more workers in service sector than anywhere but Western Province
  • Skills and access to finance seem to be greater constraints to employment

Newhouse, David Locke; Silwal, Ani Rudra. 2018. The state of jobs in post-conflict areas of Sri Lanka (English). Policy Research working paper; no. WPS 8355. World Bank Group. http://documents.worldbank.org/curated/en/443541519651773814/The-state-of-jobs-in-post-conflict-areas-of- Sri-Lanka

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Job supply (or labor demand)

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  • 497,000 vacancies in 2017
  • Of which 210,000 hard-to-fill vacancies
  • More vacancies than unemployed: mismatch between supply & demand

Constructio n 4% Industry except constructio n 35% Trade 22% Tourism 2% Services except tourism 36% Plantation 1%

Vacancies

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

Sewing Machine Operators 22% Security Guards 22% Commerci al and Sales Represent atives 15% Other Manufactu ring Labourers 8% Cleaners and Helpers in Offices, Hotels and Other Establishm ents 4% Other 29%

Hard-to-fill vacancies

Source: DCS Labor Demand Survey 201

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Labor supply

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Retirement age

Labor force participation

Migration Education and skills

Job supply

Growth & competitiveness: Trade, FDI, investment climate

Innovation & Entrepreneurship Labor laws Informality Public and private sector

What is the agenda?

Sri Lanka Development Update – More and better jobs for an Upper-Middle-Income Country - June 2018

Job supply = largely competitiveness agenda Update labor laws to promote flexibility of private sector to respond to changing market demands Innovation: Improve ecosystem, early-stage funding, incubation, intellectual property rights Encourage large informal firms to formalize; assess how to support subsistence firms; protection for formal and informal sector workers Level playing field between public and private sectors to encourage more mobile labor force (pensions) Pools of underutilized labor: encourage female and youth employment, Sri Lankans abroad Improve education/TVET to reduce skills mismatches and adapt to new types of jobs Female:

  • Barriers to work
  • Career

development

  • Gender equality

in labor market

  • Education/skills
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Full report at: www.worldbank.org/sldu Previous editions:

  • November 2017: Creating opportunities and managing

risks for sustained growth

  • June 2017: Unleashing Sri Lanka’s trade potential
  • October 2016: Structural challenges identified in the

Systematic Country Diagnostic, Stay in touch with World Bank Sri Lanka! www.worldbank.lk @WorldBankSAsia Follow the discussion at #SLDU2018

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