Second Agriculture Program (Loan 1127-SRI[SF])

7/31/2019 Second Agriculture Program (Loan 1127-SRI[SF])

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ASIAN DEVELOPMENT BANK PPA:SRI 24320

PROGRAM PERFORMANCE AUDIT REPORT

ON THE

SECOND AGRICULTURE PROGRAM(Loan 1127-SRI[SF])

IN

SRI LANKA

August 2002


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CURRENCY EQUIVALENTSCurrency Unit Sri Lanka Rupee/s (SLRe/SLRs)

At Appraisal At Program Completion At Operations Evaluation(October 1991) (October 1997) (March 2001)

SLRe1.00 = $0.0241$1.00 = SLRs41.28

SLRe1.00 = $0.0167$1.00 = SLRs59.85

SLRe1.00 = $0.0117$1.00 = SLRs85.27

ABBREVIATIONS

ADB Asian Development BankAPL1 First Agriculture Program LoanAPL2 Second Agriculture Program LoanCFC Ceylon Fertilizer CorporationCOFC Ceylon Oil and Fats Corporation

IMF International Monetary FundJEDB Janatha Estates Development BoardKMIL Kiriya Milk Industries Ltd.LMFL Lanka Milk Foods LimitedMILCO Milk Industries of Lanka Company Ltd.MOA Ministry of AgricultureMOF Ministry of FinanceMPPI Ministry of Policy Planning and ImplementationOEM Operations Evaluation MissionPCR program completion reportPPAR program performance audit reportPSEL Pelwatte Sugar Enterprise Ltd.

SDR special drawing rightSLSCL Sri Lanka Sugar Company Ltd.SLSPC Sri Lanka State Plantations CorporationSOE state-owned enterpriseTA technical assistanceUSAID United States Agency for International Development

NOTES

(i) In this Report, "$" refers to US dollars.

(ii) The fiscal year of the Government and the Central Bank of Sri Lanka endson 31 December.

Operations Evaluation Department, PE-575


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CONTENTS

Page

BASIC DATA iiEXECUTIVE SUMMARY iii

I. BACKGROUND 7A. Rationale 7B. Formulation 7C. Objectives and Scope at Appraisal 8D. Financing Arrangements 9E. Aid Agency Coordination 9F. Program Completion Report 10G. Operations Evaluation 10

II. IMPLEMENTATION PERFORMANCE 11A. Policy Reform Measures 11

B. Procurement and Disbursement 14C. Organization and Management 15D. Effectiveness of Technical Assistance 15E. Compliance with Loan Covenants 16F. Monitoring 16G. Use of Counterpart Funds 16

III. PROGRAM RESULTS 10A. Performance Indicators 10B. Institutional Development 19C. Socioeconomic Impact 19D. Gender and Development 20

E. Environmental Impacts 20F. Gestation and Sustainability 20

IV. KEY ISSUES FOR THE FUTURE 21A. Revitalizing Agriculture 21B. Self-Reliance versus Commercialization 21C. Complexity of Agro-Divestiture 22D. Sustainability of Policy Reform 15

V. CONCLUSIONS 24A. Overall Assessment 24B. Program Rating 25

C. Borrower and ADB Performance 25D. Lessons Learned 25E. Follow-up Actions 26

APPENDIXES 20


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BASIC DATA

Second Agriculture Program (Loan 1127-SRI[SF])

PROGRAM PREPARATION/INSTITUTION BUILDINGTA No. TA Name Type Person-Months Amount Approval Date

2315-SRI Support to PublicEnterprises Reform in the

Agriculture Sector

SSTA 4 $100,000 29 March 1995

KEY PROGRAM DATA ($ million)As per ADB Loan

Documents ActualADB Loan Amount/Utilization (SDR equivalent) 60.00 (44.06) 30.14 (21.69)ADB Loan Amount/Cancellation (SDR equivalent) 32.27 (22.37)

KEY DATES Expected ActualFact-Finding 24 June-5 July 1991

Appraisal 11-23 August 1991

Loan Negotiations 21-23 October 1991Board Approval 26 November 1991Loan Agreement 20 December 1991Loan Effectiveness 19 March 1992 24 February 1992Loan Closing 30 June 1994 31 December 1996Months (effectiveness to completion) 27.4 58.3

BORROWER: Government of the Democratic Socialist Republic of Sri Lanka

EXECUTING AGENCY Ministry of Finance1

MISSION DATAType of Mission No. of Missions No. of Person-DaysFact-finding 1 36

Appraisal 1 65Inception

21 13

Project AdministrationReview

3 7 73Program Completion 1 30

Operations Evaluation4 1 24

ADB = Asian Development Bank, SDR = special drawing right, SSTA = small-scale technical assistance, TA =technical assistance.1

Later renamed the Ministry of Finance and Planning.2 In conjunction with the fact-finding for the Pigeonpea Adaptation and Production Studies (Phase II).3

In conjunction with the review of TA 1735-SRI: Study on Policy Impact of First Agriculture Program; fact-findingfor the Tree Crop Plantations Project; and inception mission for Loan 1462-SRI(SF): North Central ProvinceRural Development Project.

4The Operations Evaluation Mission comprised Chi-Nang Wong, Sr. Evaluation Specialist/Mission Leader andSteve Tabor, Staff Consultant.


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EXECUTIVE SUMMARY

The Second Agriculture Program Loan (APL2) was follow-on assistance from the AsianDevelopment Bank (ADB) to the first Agriculture Program Loan.1 The objectives of APL2,approved for $60 million on 26 November 1991, were to support the Government of Sri Lankasagriculture program to increase productivity, help the Government in introducing agricultural

reforms, sustain policy reforms and institutional strengthening begun under the first AgricultureProgram Loan, and assist the Government in meeting the continued need for imports ofagricultural inputs.

The overall implementation of policy reform measures under APL2 was partly effective.Despite three extensions to the loan closing, the Governments failure to comply with somepolicy conditions, particularly the divestiture of several fertilizer and sugar companies and theremoval of fertilizer subsidies, led to the cancellation of the second tranche. A few of theimportant policy conditions have remained unfulfilled to date because of a combination ofwaning political support, legal challenges, civil war, and labor disputes.

The most significant results were the elimination of export and turnover taxes on the

plantation crops, and the restructuring and preparation of the two large state plantationcompanies for privatization. The Ceylon Fertilizer Corporation was restructured into fivecompanies, two of which were divested to the private sector. About half of its fertilizer retailstores and two of its regional fertilizer distribution stores were privatized. The Ceylon Oil andFats Corporation and Lanka Milk Foods Limited were privatized. The Milk Industries of LankaCo., Ltd., the largest state dairy company, was twice privatized and twice repossessed by theGovernment in the 1990s. The State Sugar Corporation was divided into three companies, oneof which was privatized during the APL2 period. Two agricultural seed farms were alsoprivatized.

Noncompliance with loan covenants on major policy reforms relates to the failure toprivatize enough state sugar factories, state fertilizer companies and fertilizer storage facilities,

seed farms, and livestock farms. The Governments failure to remove fertilizer subsidies or toreach an agreement with the International Monetary Fund on their removal was a criticalsetback. The lack of quarterly monitoring reports was another area of noncompliance with loancovenants.

In recognition of the institutional constraints to privatization during APL2 implementation,ADB provided a small-scale technical assistance grant to help strengthen the institutionalcapabilities of the Public Enterprise Reform Commission. This technical assistance was highlyeffective and generated the design that was ultimately used in the privatization of 20 stateplantation companies.

The most significant impact of APL2 was the revitalization of the plantation crops

subsector. The elimination of distortionary taxes and the privatization of government plantationshave catalyzed a massive effort to rehabilitate the plantations and allowed tea production andexports to reach historical highs. Other notable accomplishments include a doubling of theprivate sectors share in the domestic fertilizer trade. The benefits, however, appear to beconfined to these subsectors only. Agriculture grew by just over 2 percent per annum in the1990s, much the same rate as in the 1980s. Agricultural incomes have tended to stagnate whilerural poverty remains high. Macroeconomic distress, adverse trends in global commodity

1The first loan for $80 million, approved on 28 November 1989 and closed on 14 August 1991, was rated partlysuccessful.


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markets, and incomplete implementation of market-oriented reforms have limited the spreadand intensity of APL2 benefits.

The elimination of distortionary taxes on tree crops exports and the privatization ofgovernment plantation companies have proceeded beyond the point at which reforms are likelyto be reversed, though this is not attributed to APL2 alone. By contrast, sustainability of reforms

in the agriculture sector that are oriented toward the domestic market is a concern. Since 1994,the Government has reversed its policy on eliminating fertilizer subsidies. The sugar companies,the former Milk Industries of Lanka Co. Ltd., and some fertilizer companies have reverted backto the Government. Little progress has been made in divesting state seed farms or commerciallivestock farms, putting in place a more liberal agro-technology trade regime, or commercializinglivestock services. The extension service remains fragmented, supply driven, and administeredby an unwieldy array of central and local government ministries and agencies. The 2001 Budgetannounced the Governments desire to increase agricultural protection and to establish newstate agricultural marketing companies.

A key issue in Sri Lankas agriculture sector is that its performance is constrained by awide range of policy, institutional, infrastructure, and structural impediments that are too large to

be overcome by APL2 on its own. Another issue is that divestiture is a complex process, whichtakes longer to accomplish than allowed for under a quick-disbursing program loan. A thirdissue is that Sri Lankas agriculture sector remains divided by policy objectives that promotecommercial, market-oriented development on the one hand, and self-reliance on the other. This,plus a tendency for the Government to intervene heavily in the food markets to ensure that foodis available at a price that government administrators regard as reasonable, contributes topolicy inconsistency and volatility. A fourth issue is the great difficulty of forging bipartisanpolitical support for market-oriented agricultural policies, and hence sustaining policy reforms ina fluid political arena.

APL2 is rated as partly successful considering its design, implementation performance,results and sustainability, and achievement of its objectives. While the elimination of

distortionary taxes on plantation crop exports and the privatization of the government plantationcompanies led to the revitalization of the plantation crops subsector, policy reforms relating todomestic-oriented agriculture were not satisfactorily implemented. Failure to comply with someimportant policy conditions led to the cancellation of the second tranche. Sustainability of some

APL2 reforms remains doubtful.

A lesson learned is the need to address the broad policy, institutional, and infrastructureconstraints to agricultural development in a holistic and integrated manner. A lack of consistentgoals and objectives for the sector has led to inconsistency in agricultural policy reforms andcontributed to implementation slippage. Another lesson learned is that realistic time-frames andprocedural considerations should be incorporated into the program design, particularly ifcomplex agro-enterprise divestitures are involved. A third lesson is that a focus on sound and

transparent divestiture, rather than speedy divestiture, may generate more durable results.

In terms of follow-up actions, the Government should continue to implement thedivestiture agenda identified under APL2 and should review its agricultural policies with the aimof deepening the transition to a more market-oriented environment. ADB should support thisprocess through policy dialogue and technical advisory support for a thorough review ofagricultural policies and the divestiture process.


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I. BACKGROUND

A. Rationale

1. Despite record commodity prices, agricultural production in Sri Lanka stagnated in themid-1980s. This occurred notwithstanding the continuing efforts at liberalizing the economy thatbegan in 1977. Faced with mounting budget deficits, a widening current account deficit, andsluggish agricultural growth, the Government requested, in 1989, the multilateral assistancecommunity to help it produce a set of macroeconomic and sectoral reform programs. Theseprograms were aimed at stabilizing the macroeconomic environment while increasing theeconomys capacity for efficient, export-oriented growth. The Asian Development Bank (ADB)responded by providing a loan to support the Agriculture Program (APL1), which wasimplemented from 1989 to 1991.1 The major objectives of APL1 were to (i) revitalize productivityand growth in the agriculture sector; (ii) achieve rice self-sufficiency; (iii) enhance exportearnings from plantation crops and other export crops;2 and (iv) promote agro-industries. APL1was considered successful upon completion since the objectives as set out at appraisal were

substantially met. At postevaluation in 1996,3

APL1 was rated partly successful owing to thereversal of policies on the elimination of fertilizer subsidies and on decreasing the involvementof the Paddy Marketing Board in the paddy and rice trade.

2. To continue one of the policy measures under APL1 (i.e., the phased reduction of exportduties and ad valorem sales tax on tea, rubber, and coconut, and phasing out of otheragricultural export crop subsidies), support the Governments agricultural investment programs,and assist in introducing further extensive policy reforms in the agriculture sector, the Second

Agriculture Program Loan (APL2) was formulated. It was approved in November 1991, almostimmediately following the completion of APL1. The rationale for APL2 was premised on therelative success of APL1 at the time of its completion and on the need to focus on another areaof policy reform, namely, divestiture of government interests in commercial agriculture. The

mode of lending was guided as much by the intent to have a follow-on program to encourageagriculture policy reforms as the desire to have a quick-disbursing mechanism for funds that theGovernment badly needed at a time of macroeconomic instability.

B. Formulation

3. APL2 was formulated in line with the Governments macroeconomic and sectoralobjectives, economic stabilization and adjustment programs, the agricultural programs asreflected in the 1990-1994 Public Investment Program, policy reforms implemented under APL1,the findings and recommendations of various technical assistance (TA) studies financed by

ADB,

4

and the policy dialogue conducted between the Government and ADB. APL2 was anintegral part of the Governments overall strategy to undertake economic adjustment programs

1Loan 994-SRI (SF):Agriculture Program Loan, for $80 million, approved on 28 November 1989.

2Plantation crops, in the context of Sri Lanka, refer to tea, coconut and rubber, which are major exports. Otherexport crops include coffee, cocoa, cinnamon, etc., which are mainly grown by smallholders.

3PPA: 994-SRI:Agriculture Program Loan December 1996.

4TA 1166-SRI: Sugar Sector Rationalization Study, for $387,000, approved on 16 June 1989; TA 1213-SRI:

Agricultural Extension Rationalization, for $350,000, approved on 30 October 1989; TA 1478-SRI: Rationalizationof the Fertilizer Marketing System, for $97,000, approved on 9 February 1991; and TA 1540-SRI: Livestock SectorPolicy Review, for $350,000, approved on 18 July 1991.


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to foster a greater role for the private sector in the market economy, enhance exports, andpromote a more outward-looking and internationally competitive economy. The Governmentscommitment to undertake such reforms was strongly expressed in its development policy letterto ADB at the time of loan approval, though the letter clearly stated that the first goal inagriculture was to optimize the production of basic foods to achieve a high degree of self-reliance in such foods. The implication of this policy was apparently not fully understood at

appraisal or else it was glossed over even if understood, as the government regime at the timedid apparently display a strong commitment to reforms, particularly in the aftermath of APL1.The change in government in 1994 could not have been predicted. A comprehensiveparticipatory approach was not in evidence during the formulation of APL2. Farmers andworkers in state-owned enterprises (SOEs) were apparently not consulted, leading to strongsupport for the Governments later pledge to reverse the removal of fertilizer subsidies and todisputes between management and labor of SOEs after they were initially removed fromgovernment control. With hindsight, it would have been advisable to allow some time to lapseafter the completion of APL1 before APL2 was introduced. It would appear that APL2 wasformulated with undue haste and that the necessary preparation for government divestiture wasnot done.5

C. Objectives and Scope at Appraisal

4. The main objectives of APL2 were to (i) support the Governments agriculture programsto increase productivity in agriculture, (ii) help the Governments endeavor in introducingextensive reforms in the agriculture sector, (iii) sustain the policy reforms and institutionalstrengthening implemented under APL1, and (iv) assist the Government in meeting thecontinued need for imports of agricultural inputs required for agricultural investment.

5. The policy reforms covered seven broad categories: (i) phased reduction of export dutiesand ad valorem sales tax on tea, rubber, and coconut, and phasing out of other agricultural

export crop subsidies; (ii) rationalization of sugar pricing and privatization of three state-ownedsugar companies; (iii) rationalization of agriculture extension services; (iv) rationalization of thefertilizer marketing system and privatization of three state-owned fertilizer companies; (v)rationalization of the livestock subsector, including privatization of three state-owned livestockcompanies; (vi) restructuring of the Janatha Estates Development Board (JEDB) and the SriLanka State Plantations Corporation (SLSPC); and (vii) streamlining of the agricultural seedssubsector. In 1996, as part of the third extension of the APL2 closing date, the Government and

ADB agreed that fertilizer subsidies would either be eliminated or a plan for their eventualelimination would be agreed with the International Monetary Fund (IMF) before the secondtranche could be released. The inclusion of the removal of the fertilizer subsidy as a secondtranche condition was subject to much internal debate in ADB as the condition was not originallypart of APL2.

5The original expected loan closing date of APL1 was 30 June 1992. The actual date was 14 August 1991,apparently brought forward to accommodate APL2, which was approved on 26 November 1991 and madeeffective on 24 February 1992, nearly one month ahead of the planned effectiveness date of 19 March 1992. Theprogram completion date for APL1 was expected to be 31 December 1991 but APL1 was deemed completed onlyin November 1992 when the last policy reforms under APL1, but carried over for implementation under APL2,were accomplished. These reforms included policy recommendations made on crop production incentives andextension services.


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D. Financing Arrangements

6. ADB approved a loan amounting to SDR44.057 million (equivalent to $60 million) fromthe Special Funds resources to support APL2. The size of the loan was determined by therequirements for agricultural inputs to sustain sector development and the adjustment cost

arising from implementation of APL2 reforms. The proceeds of the loan were to be used tofinance the foreign exchange costs of eligible imports. The loan was to be released in two equaltranches: the first tranche after loan effectiveness, and the second on 30 November 1992,provided satisfactory progress was made by the Government with the policy reforms and eightspecific conditions.6 APL2 made a small, but timely contribution to closing Sri Lankas externalresource gap. From 1991 to 1995, Sri Lankas average external financing gap was just inexcess of SDR1 billion ($1.35 billion) per annum. Gross official disbursements of externalassistance averaged SDR481 million ($649 million) per annum, while net official transfers to SriLanka averaged SDR123 million ($165 million) per annum during the same period (see

Appendix 1). Counterpart funds, on the other hand, were to be used to finance the local costrequirements of agricultural development projects. The Borrower was the Government, with theCentral Bank of Sri Lanka as the depository of loan proceeds. The Ministry of Finance7 (MOF),

the Executing Agency, in cooperation with the Ministry of Policy Planning and Implementation(MPPI), was to coordinate with other ministries, agencies, and sector-specific entities inimplementing APL2.

E. Aid Agency Coordination

7. Coordination with other aid agencies during the processing of APL2 involved extensiveconsultations, particularly with the World Bank, IMF, and the United States Agency forInternational Development (USAID). Coordination was important as some of the agencies werealso involved in activities similar to those fostered under APL2. The World Bank had substantial

involvement in the restructuring program for the state plantation corporations, plantation cropstaxation policy, agriculture extension, and land reform. USAID was involved in agricultureextension rationalization and the Governments seed policy. The World Bank had in fact initiallyrequested ADB not to include specific conditionalities on plantation crops export taxes for fearthat its position and future dialogue with the Government would be greatly compromised if theGovernment were to agree with ADB on specific plantation crops taxation measures. The WorldBank was then carrying out various studies on plantation crops taxation. Close consultationamong ADB, the World Bank, and the Government helped resolved the matter, on theunderstanding that reductions in tea and rubber taxation up to 30 June 1992 would followmeasures specified in APL2, while subsequent further reductions would be discussed andagreed with both the World Bank and the Government based on the World Banks study of therestructuring program for the state plantation corporations. USAID was critical of ADBs study on

agriculture extension rationalization that provided the basis for APL2s policy measures on suchrationalization. USAID claimed that the study was inadequate and poorly coordinated with theefforts of other aid agencies. Nevertheless, USAID supported APL2, after exchangingcorrespondence with ADB. While ADB had discussed and provided the consultants draft reportfor comments to interested parties including USAID prior to finalization, the fundamentalproblem was one of approach to the whole idea of agriculture extension. The World Bankprovided a loan for agriculture extension designed to empower extension workers as agents of

6Loan Agreement, Schedule 3, Attachment 2.

7Later renamed the Ministry of Finance and Planning.


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change rather than just technical advisors during the implementation of APL2. ADB and theGovernment tended to view the primary function of extension workers as providing technicalexpertise to farmers. As it turned out, the use of extension workers as agents of change did notprove workable. The World Bank cancelled its second agricultural extension loan before thecompletion of the project.

F. Program Completion Report

8. A program completion report (PCR), prepared by the Agriculture and Rural DevelopmentDivision West, was circulated on 26 March 1998. The PCR presented the objectives and scopeof APL2, and an objective and fair evaluation of its components as well as APL2 performanceand its benefits. At the time of loan approval, it was envisaged that the proceeds of the loanwould be disbursed by 31 December 1993. However, due to delays in compliance with therequirements for the release of the second tranche, the loan closing date of 30 June 1994 wasextended three times. Eventually, the second tranche was cancelled and the loan was closedon 31 December 1996. The PCR could have placed greater emphasis on the fundamental

conflict in government policy regarding export-oriented agriculture and domestic-orientedagriculture. The PCR has rated APL2s performance as partly successful.

G. Operations Evaluation

9. This program performance audit report (PPAR) deals with the key aspects of APL2 andpresents the findings of the Operations Evaluation Mission (OEM) that visited the country from19 to 30 March 2001. The PPAR presents an assessment of the effectiveness of APL2 inachieving its objectives, generating benefits, and sustaining its impact.

10. The PPAR is based on a review of the PCR, the Report and Recommendation of thePresident, materials in ADB files, government reports, and discussions with ADB staff, MOF,other concerned agencies of the Borrower, and representatives of multilateral agencies and theprivate sector. Copies of the draft PPAR were provided to the Borrower, MOF and otheragencies concerned, and ADB staff for review and comment. Comments received wereconsidered in finalizing the PPAR.


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II. IMPLEMENTATION PERFORMANCE

11. APL2 was most successful in reducing distortionary taxes on Sri Lankas main agro-exports and in launching the privatization of the plantations sector.8 Divestiture of sugarprocessing companies, fertilizer marketing companies, the national dairy company, state seedand livestock farms, the rationalization of the extension service, and the removal of fertilizer

subsidies had mixed results. Major factors hindering completion of APL2 reforms included thechange of government in 1994, civil conflict, labor disputes, limited institutional capacity toundertake privatization, long-gestating legal challenges to selected divestitures, the adverseinitial impact of structural reforms on low-income farmers, and the Governments concern forreasonable pricing to both consumers and producers. The last factor reflected the fundamentalconflict between the need to offer protection to producers (and consumers) and theGovernments aspiration to have a commercially viable agriculture sector. The specific APL2reforms and their status at the time of the PCR and OEM are detailed in Appendix 2.

A. Policy Reform Measures

Reduction of Export Duties and Ad Valorem Sales Tax on Tea, Rubber, and Coconut, and

Phasing Out of Other Agricultural Export Crop Subsidies

12. Since 1980, the Government had been reducing the tax burden on the export cropssector. This process was accelerated under APL2 because of a steep fall in internationalcommodity prices in 1990 and 1991 and evidence that Sri Lanka was rapidly losing marketshare to Kenya in tea production and to Thailand and Indonesia in rubber. To help bolstercompetitiveness, plantation crop export duties and ad valorem sales taxes were fully eliminatedin December 1992. Likewise, plantation crop exports were exempted from the value-added taxand the security levy. Under APL2, plantation crops replanting and crop promotion subsidieswere to be narrowed and phased-down. This was partly accomplished. The same concern to

provide relief to smallholders, leading to dismantling of export taxes, also provided the reasonfor the slow withdrawal of the various subsidies. Promotion and replanting subsidies wereconcentrated on a smaller range of crops. The real value of these subsidies declined over the1990s. A small export cess (or specific tax) to provide resources for services (i.e., research andmarket promotion) that are operated quasi-commercially remained and is closely supervised byindustry.

Rationalization of Sugar Pricing and Privatization of Three State-Owned Sugar

Companies

13. Sri Lankas sugar industry operated under a high degree of trade protection in the1980s. In the 1990s, as trade protection was gradually withdrawn, the industry became less

able to compete. This, combined with labor disputes and nontransparent privatization,weakened the industry and led ultimately to a reversal of efforts to increase private participationin the sector. The Government was required to rationalize sugar pricing, commercialize andthen privatize Sri Lanka Sugar Company Ltd. (SLSCL), and restructure the financingarrangements of the Pelwatte Sugar Enterprise Ltd. (PSEL).

8Privatization of plantation companies under APL2 was primarily in the form of private management contractsgranted by the Government, which then made it possible for fuller divestiture of ownership under subsequent Loan1402-SRI: Plantation Reform Project, for $60 million, approved on 9 November 1995.


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14. Refinancing of the foreign loan of PSEL was satisfactorily completed in June 1992, andat the same time, the Government eliminated the Agreed Sugar Price agreement with PSEL.This was initially replaced by a uniform ex-factory sugar purchase price of $500 per ton, whichwas then superseded by import tariff protection for all factories in 1997, set initially at 18percent. The import tariff was raised in 1998 to 25 percent and has now been replaced by aspecific import duty set at SLRs3,500 ($41.00) per ton. SLSCL was commercialized by putting

its assets in three separate companiesSevenagala, Hingurana, and Kantale. Sevenagala wasprivatized in 1992, Hingurana in 1993, and Kantale in 1994. Subsequently all three factorieswere repossessed by the Government due to labor disputes and mounting factory losses. In1998, the Government also assumed ownership of PSEL. At present, the Kantale andHingurana factories are out of operation and are slated for liquidation. The Sevenagala andPSEL factories produce only 10 percent of the countrys requirements and were operated by theGovernment at a loss estimated at SLRs65million ($813,000) in 2000. Except for Kantale, all thefactories were placed under new management this year.

Rationalization of Agriculture Extension Services

15. Under APL2, the extension service was to become more unified and integrated through

several planning committees and staff skills were to be upgraded. Unforeseen at appraisal, acombination of devolution, severe fiscal constraints, and the proliferation of central governmentministries, agencies, and authorities with agricultural program responsibilities eroded extensioneffectiveness and hindered efforts to rationalize the service. Efforts made to rationalize andunify the extension service under the World Banks Second Agricultural Extension Project didnot succeed. Separate extension services remain in effect for various commodity groups. Withdevolution, national extension coordinating mechanisms have been abolished and thoseintroduced at the regional level have become largely defunct or ineffective. Continuedinvolvement in subsidy administration and a shift in the extension orientation toward communityempowerment activities diverted the focus of the extension service away from diffusion ofimproved agricultural technology. Funding shortfalls, weak links between agricultural researchand extension, and limited private sector involvement have reduced the effectiveness of the

extension effort. In 2001, management of minor export crops extension was contracted out tothree private firms on a pilot basis under an ADB loan and TA grant, to instill a greater market-orientation into the delivery of advisory services.9 The effectiveness of such an approach is yetto be proven.

Rationalization of the Fertilizer Marketing System and Privatization of Three State-Owned

Fertilizer Companies

16. The Government was required to privatize three major fertilizer companies, including theCeylon Fertilizer Corporation (CFC). Together with the abolition of fertilizer subsidies (supportedunder APL1), such privatization was intended to introduce competition and provide scope forprivate sector involvement in the fertilizer industry. With the change of government in 1994,

political support for further divestiture of the fertilizer industry diminished and strong politicalcommitments were made to re-introduce fertilizer subsidies. State fertilizer marketing andfertilizer subsidies were re-introduced as part of the nations safety net to help small farmersbear the adjustment costs arising from trade liberalization and other structural reforms.

9Loan 1552-SRI(SF): Second Provincial Perennial Crops Development, for $40 million, approved on 25September 1997 and TA No. 2877-SRI: Privatization of Extension Services for Perennial Crops, for $550,000,approved on 25 September 1997.


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17. In 1992, CFC was converted into five limited liability companies, resulting in sevenfertilizer companies to be privatized. Of the seven fertilizer companies, four were sold. TheColombo Commercial Fertilizer Limited was repossessed by the Government. The JanathaFertilizer Enterprise Ltd. was not privatized due to labor disputes. These last two companies areon the list of public firms slated for liquidation. Some 16 of the 34 district fertilizer storespreviously operated by CFC were sold. Those that were not sold include five stores in the north

and northeast parts of the country, where the civil conflict would render their privatizationimpracticable. The National Fertilizer Secretariat continues to oversee fertilizer subsidies and ischarged with administering the National Fertilizer Act. The removal of fertilizer subsidies inJanuary 1990 led to a near-doubling in fertilizer prices and a modest reduction in fertilizerutilization. In 1994, the Government restored fertilizer subsidies at a cost to the budget ofSLRs630 million ($12.8 million) in 1994 and SLRs1,234 million ($24 million) in 1995. Fertilizersubsidies were capped at SLRs1.5 billion ($18.75 million) per annum until 2000, resulting inlower fertilizer subsidies in real terms over time. For 2001, fertilizer subsidies have beenbudgeted at SLRs2.2 billion ($25.8 million). Starting in 1997, price subsidies have beenconfined to urea to maintain uniform national urea prices.

Rationalization of the Livestock Subsector Including Privatization of Three State-Owned

Livestock Companies

18. Under APL2, the Government aimed to privatize its holdings in Ceylon Oil and FatsCorporation (COFC), Lanka Milk Foods Limited (LMFL), and Milk Industries of Lanka CompanyLtd. (MILCO); establish an appropriate milk-pricing policy; and create more scope for privatesector livestock support services. All of the equity in LMFL was divested in 1991 and 60 percentof the equity in COFC was sold in 1992. MILCO, the largest state dairy company, was in factprivatized twice during the early 1990s, but both efforts ended in failure. A lack of institutionalexperience in preparing the company for privatization, selecting suitable investors, andstructuring an appropriate privatization arrangement contributed to the failure. Legal and labordisputes have ultimately sidelined this process. The lack of proven approaches and limitedpolitical support for privatizing livestock support services have contributed to a lack of progress

in increasing private sector participation in these areas. The assets of MILCO were transferredto Kiriya Milk Industries Ltd. (KMIL), which was acquired by a joint venture of the nationalGovernment and the National Dairy Development Board of India. KMIL was repossessed by theGovernment in 2000 following labor disputes. There are no plans currently to privatize it.

19. No statutory milk pricing formula was put into effect, although KMIL did establish asystem of quality-based milk prices. Tariff reforms have created greater scope for private sectorinvolvement in the livestock sector, particularly in feed and poultry production. Tariff protectionfor powdered milk products has been progressively reduced. The Government has movedcautiously to reduce its role in providing livestock support services.

Restructuring of the Janatha Estates Development Board (JEDB) and the Sri Lanka State

Plantations Corporation (SLSPC)

20. In the early 1990s, the state plantation companies were operating at huge losses. Thestate banks were no longer willing to roll over their loans and the budget could no longeraccommodate the losses. The plantation unions were well aware that the plantation workforcecould face massive layoffs if the state plantation companies were forced into bankruptcy. TheGovernment, banks, unions, and the private sector recognized their common interest inaccelerating the divestiture of the state plantation companies. The Government restructured thetwo large plantations sector state companies, JEDB and SLSPC, injecting SLRs780 million($15.70 million) into these two SOEs between 1992 and 1996 to cover past losses and preparethem for privatization. Some 450 out of 500 plantations were handed over to 23 regional private


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companies, initially under five-year management contracts. In 1995, together with an ADB loanand a TA grant, the Government privatized the regional companies by selling their equity andextending lease terms to 50-year leases with renewal options.10 Twenty of the 23 companieshave been privatized. Some residual marketing and warehousing facilities remain with JEDBand SLSPC. Plans are being discussed for the eventual liquidation of these assets and for theeventual use of nonviable plantations, but the Government has yet to announce specific plans.

Streamlining of the Agricultural Seeds Subsector

21. During the APL2 period, the Government published an expanded list of approved seedvarieties for import; three seed farms were divested in 1993 and a committee was established toreview the seed import permit system. In March 1997, a new Seed and Planting Material PolicyStatement was issued. Import restrictions for planting material were eased as part of the tariffreforms of 1998 and 1999. The assets of the Hingurakgoda Paddy Seed Farm were sold in1998. The introduction and domestic multiplication of hybrid maize seeds by the private sector,using an out-cropper arrangement, was made possible by the easing of seed importrequirements. A new Seed Law was submitted to Parliament in 2000, clarifying the role of theGovernment in seed production, inspection, and quality control.

22. Despite the progress made, complex quarantine regulations and an elaborate seedinspection procedure continue to inhibit private sector involvement in the domestic seedindustry. The Government continues to dominate the production and sale of improved paddyand other food crop seeds, which are sold with a subsidy, though the government prices forseeds have been increasing. A committee of representatives from the private and public sectorshas been established to revise the seed and planting material prices of the Department of

Agriculture, which has plans to phase out its commercial seed production activities. However,limited progress has been seen in opening-up the seed sector to private sector participationbecause of the distribution of subsidized, publicly provided seeds to smallholders and becauseof the Governments fear that greater private sector involvement could degrade the integrity ofSri Lankas seed and planting material supply.

B. Procurement and Disbursement

23. The loan of $60 million was scheduled to be disbursed in two equal tranches of $30million equivalent, the first tranche to be made available following loan effectiveness and asecond tranche after a number of policy reform conditions were satisfied. The conditions for thefirst tranche were met quickly and the loan was declared effective on 24 February 1992. Theconditions of the second tranche were not fully satisfied despite three extensions to the closingdate. The actual cost of APL2 was therefore $30.14 million (SDR21.684 million).

24. Procurement contracts were made in accordance with government proceduresacceptable to ADB. A positive list was used for financing eligible imports from the foreignexchange proceeds of the loan. The loan proceeds were used for the procurement of items foragriculture or agriculture-related industries from ADB member countries. Some 97 percent ofthe loan proceeds were used for the import of fertilizers, of which $23.56 million were importsregistered by two public sector firms. Other imports were disinfectants, insecticides andfungicides (2 percent of the loan proceeds), plywood tea chests (0.76 percent), and jute bags

10Loan 1402-SRI(SF): Plantation Reform, for $60 million, approved on 9 November 1995; and TA2315-SRI: Supportto Public Enterprise Reform in the Agriculture Sector, for $100,000, approved on 29 March 1995.


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(0.1 percent). Four years were required to secure a clean audit of the utilization of the firsttranche proceeds and that only after much follow-up action from ADB.

C. Organization and Management

25. MOF as the Executing Agency, in cooperation with MPPI, was responsible forimplementation of APL2 together with the ministries, agencies, and parastatal bodiesconcerned. While MOF did have some capable staff, these few staff were swamped by theextent of policy measures and covenants they had to coordinate and monitor, in addition to theirregular work. Lack of timely response from ministries or agencies concerned contributed to theproblem of coordination. MOF failed to provide quarterly monitoring and progress reports to

ADB, notwithstanding constant reminders. An effective monitoring and evaluation system asrequired under APL2 would have facilitated the production of such reports and contributed toeffective policy dialogue during APL2 implementation.

26. Lack of clear and consistent sector policies, limited capacity to design and manage

complex public enterprise divestitures, limited stakeholder consultation, and lack of publicawareness of APL2 reforms all hampered program implementation. Legal challenges and labordisputes inhibited completion of several planned divestitures. The Government did not providesustained support in rationalizing the extension service, fostering private sector participation inthe seeds sector, providing livestock support services, and completing the privatization of thefertilizer industry. The devolution process complicated efforts to streamline and rationalizeagricultural support services. That, together with a fragmentation of responsibilities foragriculture and natural resource management among several ministries, complicated the pursuitof policy dialogue.

D. Effectiveness of Technical Assistance

27. ADB provided the TA (footnote 10) when it was apparent that attempts at divestiturewere not progressing well. The TA funded 90 days of international advisory services and severalmonths of domestic expert services on plantation privatization. While the TA was originallyintended to help resolve constraints to privatizing agro-enterprises identified for divestitureunder APL2, it focused instead on accelerating the privatization of the regional plantationcompanies. The TA helped to develop a long-term privatization strategy, formulate divestitureprocedures, and devise the legal framework for eventual plantation privatization. The resultingstrategy was a success, in terms of stemming operating losses, transforming long-termownership rights to the private sector, and securing political, labor union, and public support forthis immense privatization effort. Without the TA, there would have been a significant risk that

progress could have been reversed in the contracting-out of the management of the JEDB andSLSPC estates.


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E. Compliance with Loan Covenants

28. The major loan covenants were partly complied with (Appendix 3). MOF did not providequarterly progress reports and made no final impact assessment. With respect to the policyreform conditions, a lack of satisfactory progress in privatizing state-owned sugar, fertilizer, anddairy companies, and divesting an adequate number of seed farms, and the failure to abolish

fertilizer subsidies were the main reasons for the three delays in the closing date and were theeventual cause for the cancellation of the second tranche.

F. Monitoring

29. No monitoring and evaluation system was in place at the beginning of APL2. MOF andMPPI were charged with monitoring and evaluating progress made under APL2, but theGovernment failed to provide resources to undertake formal monitoring or to execute an impactassessment. Program management was led by the Director, Agriculture from the NationalPlanning Division, MOF. On ADBs part, monitoring was conducted through a series of field

visits, of which 11 were fielded from fact-finding in July 1991 to program completion in October1997. The Governments program completion report was provided in February 1998 but inrather inadequate fashion comprising of only a matrix of policy conditions and their status ofcompliance with no analysis or detailed clarification of the circumstances of compliance, lessonslearned, etc. Under the terms of the loan, the Government was required to provide an impactassessment to ADB, but did not. Instead, it submitted a request to ADB for consultantassistance to undertake an impact evaluation study. In light of the limited number of agreedpolicy reforms that had been fully completed and sustained and the failure to have a monitoringand evaluation system that could provide the benchmark data for comparative purposes, animpact assessment would have been of limited value. ADBs PCR suggested that this requestfor a TA to undertake the impact evaluation study should be taken up during the preparation ofthe PPAR. The OEM believes that adequate expertise is available in the current Ministry of Plan

Implementation and Parliamentary Affairs, which has been the recipient of past TAs from ADBon evaluation-related work11 and that there is no need for ADB to fund a TA.

G. Use of Counterpart Funds

30. The counterpart funds generated from the loan proceeds were used, as agreed, to meetthe local currency cost requirements of ADB-financed agricultural development projects andother such projects. An amount of $11.4 million was released during 1992-1993 to finance thelocal currency cost of ADB projects, with the balance utilized to fund other agriculturaldevelopment projects.

11TA 1579-SRI: Strengthening Post-Evaluation Capability of the Ministry of Policy Planning and Implementation, for$100,000, approved on 17 October 1991 and TA 2810-SRI: Strengthening Project Performance EvaluationCapability of the Ministry of Plan and Implementation, Ethnic Affairs and National Integration, for $350,000,approved on 16 June 1997.


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III. PROGRAM RESULTS

A. Performance Indicators

31. APL2 was designed to help the Government raise agricultural productivity and growthand support the implementation of its market-oriented agricultural policy reforms. Launchedduring a period of balance-of-payments stress, APL2 aimed to assist agricultural imports andaugment budget resources for agricultural development projects. It was expected that a seriesof measures aimed at rolling back the role of the State in commercial activities, reducing the taxburden on export-oriented agriculture, and liberalizing access for private sector investmentwould trigger a revitalization of agricultural growth and development. However, no mechanism,such as a logical framework, was prepared at appraisal that would identify the relationshipbetween the proposed policy reforms and the social and economic objectives, nor were the key

performance indicators identified. The degree to which policy change was accomplished, ratherthan the impact of that change on investment or sector performance, became the defaultindicator of APL2 performance.

32. The abolition of export and turnover taxes for the plantation crops marked theculmination of a 15-year process aimed at reducing the tax burden on Sri Lankas maincommodity exports. Returns to tea, rubber, and coconut producers have been 10 percent highereach year since 1992 than they would otherwise have been had 1990s export taxes beenmaintained. Revenues lost through distortionary plantation crops export taxes have been offsetby the adoption of a value-added tax. Tea production increased by 33 percent during the 1990sto reach a record 300,000 tons in 2000, though this could not be attributed to APL2 alone asother factors, including tighter management control of privatized plantations, were in play. In

value terms, tea exports peaked at $780 million in 1998, compared to $500 million in 1990.Despite weak global market prices, rubber and coconut output has remained stable.

33. The transfer of the public plantations to private companies has led to a revival in theplantation crops subsector. Prior to privatization, the plantations were losing close to SLRs500million ($10 million) per month. With privatization, government fiscal support to the subsectorhas been reduced to very low levels, productivity and product quality have increased, theprofitability of plantation companies has increased, new investments have been made toupgrade field stands and modernize the factories, and wages have been increased forplantation workforces.

34. After a decade of attempted sugar industry divestiture, the Government now owns a

greater share of domestic production capacity than it did at the start of the process. Privatizationand tariff reforms in the sugar industry have, perhaps inadvertently, revealed more clearly thedegree to which Sri Lanka does not have a comparative advantage in producing sugar,especially at quite modest rates of trade protection. Only two of the sugar factories are now inoperation, and are kept this way for social reasons. Sugar recovery rates at the PSEL andSevenagala sugar factories are about 8.5 percent, nearly a third lower than those obtained inIndia. With a decline in trade protection and factory closures, resources have been reallocatedto more productive uses. In the areas in which the factories have closed, farmers havereallocated their lands to paddy and other irrigated crops. Domestic sugar production meets just10 percent of total supply requirements, compared to 19 percent at the start of the decade.


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35. In terms of fertilizer marketing, APL2 reforms have increased the scope for private sectorinitiatives. Four of the largest fertilizer manufacturers and importers are now under privatesector management. Fertilizer use has steadily increased from 453,000 tons in 1991 to 612,000tons in 1999. Urea use has increased from 191,000 tons in 1993 (prior to subsidies beingreinstated) to 280,000 tons in 1999 (postsubsidy). The private sector's share of total fertilizermarket sales increased from 18 percent in 1990 to 65 percent in 2000. Quality control remains,

however, a concern, with nearly a quarter of all fertilizer sold estimated to be adulterated. Bothbulk and bag facilities for fertilizer imports are available, albeit without a special terminal for thelatter as was intended during APL2 formulation.

36. The resumption of fertilizer subsidies in 1994 was aimed at fulfilling an election promiseand boosting paddy output. The subsidy is now confined to urea and its cost exceeds$25 million per annum. Before the fertilizer subsidy was restored, fertilizer consumption in paddyfell from 208,000 tons in 1992 to 148,000 tons in 1993. With the subsidy restored, fertilizerconsumption in paddy doubled between 1993 and 1999, in what appeared to be a retreat intosubsistence-oriented rice production in the mid- 1990s. Further, the subsidy appears to becontributing to nutrient imbalance problems, with farmers overusing urea relative to otherfertilizers.

37. As a result of dairy sector reforms, the private sector has become more involved inproducing milk and diary products, but largely by importing and reconstituting powdered milkrather than through promoting domestic dairy activity. Domestic dairy production meets 22percent of total consumption requirements, with the bulk supplied by imports of powdered milk.Price controls have been replaced by tariffs, and protection rates steadily declined during the1990s. The privatization of COFC has tended to increase its market dominance in the domesticfeed industry.

38. The extension service has witnessed a number of reorganizations but there is noevidence of any improvement in the relevance, impact, or effectiveness of the outreach effort.The extension effort continues to be fragmented, serves under a confusing array of central and

local administrative authorities, is hardly integrated to research, exhibits few signs of clientresponsiveness, has limited private sector involvement, and makes but minimal use of moderncommunications technology. Erosion in the quality of the public agriculture extension effort hasstimulated efforts to search for new approaches to delivering agricultural information.

39. As for performance in the seeds subsector, the Government continues to dominate themarket for improved paddy and food crop seeds, with publicly produced seeds sold at a nominalprice to the farm community. Subsidized seed sales tend to discourage private participation inthe industry. While trade restrictions on seeds and planting varieties have been eased, accessto a wide range of planting material continues to be restricted under the Quarantine Act.Importation of planting materials is subject to complex permit and inspection procedures thatraise costs and discourage private initiative. The proposed national Seed Law, however, is a

major step forward in clarifying the regulatory role of government in establishing and certifyingthe quality of improved seeds.


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B. Institutional Development

40. Outside of the reforms supported for agriculture extension, APL2 did not specifically

provide for institutional capacity building in the public sector. It was, however, recognized byADB and the Government early on during the implementation of APL2 that institutional capacityconstraints limited both the pace and quality of the divestiture effort. ADB responded byproviding a TA to strengthen the Public Enterprises Reform Commission established in 1995(footnote 10). That body has developed the capacity to lead a more professional andtransparent divestiture effort. Through reforms undertaken under APL2, the private sector hasdeveloped the institutional capacity to manage the large state plantations, play a greater role infertilizer marketing, manufacture dairy products under more competitive conditions, and startdomestic seed production activity. In several agriculture subsectors, the Government hasdeveloped the capacity to assume more of a policy oversight and regulatory role, with theprivate sector taking the lead in providing commercial services.

C. Socioeconomic Impact

41. There is no evidence that APL2 has triggered a revitalization of the agriculture sector.The sector grew by some 2.3 percent per annum in the 1990s, almost exactly the same rate ofgrowth achieved in the 1980s. In per capita terms, agricultural incomes rose by some 10percent over the decade, while economy-wide incomes increased by 65 percent. APL2 did notspecifically target poverty reduction. Between 1990 and 1996, poverty levels (measured usingthe higher poverty line) increased from 33 percent to 39 percent of the total population, of whomsome 88 percent lived in rural areas. While 1996 was a drought year, it would be difficult toconclude that APL2 reforms made a positive contribution to rural poverty reduction. Indeed,

some of the APL2 reforms may initially have contributed to higher rates of rural poverty. Thehandover of the government plantations to the private sector was accompanied by a decline inthe quality of social services, particularly in reduced access to health facilities, and availability ofdrugs previously provided by the plantations. The closure of two sugarcane companiescontributed to some hardship for an estimated 14,000 cultivators formerly supplying those mills.However, the elimination of plantation crop export taxes raised the gross returns of smallholdertea, coconut, and rubber cultivators by nearly 10 percent per annum, and in so doing, made apositive contribution to rural poverty reduction.

42. The main fiscal impact of APL2 was the loss in revenues, equivalent to some SLRs2.5billion ($62.4 million) in 1990, when export and turnover taxes on tea, rubber, and coconut wereeliminated. Under that tax regime, plantation losses were approaching SLRs4 billion ($99.8

million) per annum, financed through the banking system. The Government reversed the lossesin the plantations sector and mobilized nearly SLRs8.8 billion ($154.7 million) between 1993and 1999 from the divestiture of firms under APL2, of which SLRs7.5 billion ($131.8 million) wasrealized from the sale of state plantations. Fiscal pressures on agriculture would likely havebeen more severe had APL2 not provided the resources that it did. The first tranche released in1992 financed 2.1 percent of the nation's external resources gap and reduced the Government'sdomestic borrowing requirements by 7 percent.


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D. Gender and Development

43. APL2 did not have a component dealing directly with gender issues. Nevertheless,women are the main employees in the tea industry, which has responded positively to anenvironment of improved incentives. High returns to tea have contributed to wage hikes in a

sector traditionally dominated by female labor.

E. Environmental Impacts

44. Some improvement in land use has been induced thanks to a lower plantation crop taxburden and by reversing the neglect of state plantation lands under the public enterprises.Private sector managers tend to keep marginal plantation lands out of production, whichcontributes to reduced soil erosion.

F. Gestation and Sustainability

45. APL2 reforms have contributed to the process of curtailing the role of the State inagriculture and creating greater scope for private sector initiatives. Some of the most important

APL2 reforms, such as lowered plantation crops export taxes and divestiture of the stateplantations, are bound to realize substantial benefits only with a considerable lag. Under privatemanagement, product quality and productivity can be substantially boosted and much morevalue can be added by exporting more processed plantation crops products.

46. Several of the APL2 reforms have been reversed, particularly those in regard to thedivestiture of the Governments interest in SOEs. In some cases, the appropriate solution for

uneconomic ventures is liquidation rather than sale. For others, a lack of governmentcommitment to handing-over responsibilities to the private sector is apparent. Fundamentally,the domestic agriculture subsector faces a constraint arising from the Governments priority forself-reliance and policy of ensuring reasonable prices for producers and consumers. Such aconstraint translates into a potentially greater incidence of substituting administrative judgmentfor market forces in smallholder agriculture. On the other hand, the tax burden on the plantationcrops subsector, and in fact on all export-oriented agricultural activities, has been significantlyreduced. The plantation crops subsector has been virtually transferred into private ownershipand the link between the budget and the plantations has been severed. Recent publicstatements by the Minister of Plantation Industries and the Chairman of JEDB and SLSPCregarding possible repossession of the regional private companies, however, make the privatesector nervous. The private sector has come to dominate fertilizer marketing and the sale of

liquid milk. Lower tariff protection has encouraged a shift of resources out of sugarcaneproduction, a sector in which Sri Lanka appears not to be globally competitive.


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IV. KEY ISSUES FOR THE FUTURE

A. Revitalizing Agriculture

47. The divestiture strategy has paid off in export agriculture. The plantations have a newlease-of-life and nontraditional agro-export sectors, such as high-value horticulture, are showingsigns of steady growth. But three fourths of Sri Lanka's agriculture is domestic-market orientedand sluggish progress in domestic agriculture is the main reason that agriculture grew by just2.3 percent per annum during the 1990s compared to 5.6 percent for the economy as a whole.

48. Administrative judgment continues to act in the place of market forces in smallholderagriculture. State ownership of some 80 percent of the land, restrictions on technology importsand land use, heavy subsidies for imported wheat, pervasive fertilizer and credit subsidies,

together with high rates of effective tariff protection and frequent changes in agricultural tradepolicies, all stifle innovation, discourage diversification, and promote inefficient resource use. Acomprehensive analysis of the policy and institutional barriers to improved agriculturalperformance is needed to identify the full range of constraints and the inconsistencies likely toimpede the ambitious objective of revitalizing agriculture before any program of policy reformscan be realistically designed. For example, more attention should have been accorded in thedesign of reforms to safety nets for small farmers and workers, and to temporary measuresaimed at ensuring that the provision of essential marketing, agro-input, and technology servicesremained in place for small farmers while greater scope for private sector initiative was created.

B. Self-Reliance versus Commercialization

49. Reversal of a number of the APL2 reforms, including those related to fertilizer subsidy,and the persistence of subsidized rural credit can be traced to the Governments desire toincrease domestic self-reliance in food production. For more than three decades, theGovernment has followed a food self-reliance policy centered on ensuring that about 90 percentof local rice consumption requirements were met from domestic production. Self-reliance targetshave been set for sugar, dairy, and a number of minor food crops. Public investment andsupport services have been focused on achieving self-reliance goals. The 2001 budget speechcalled for Sri Lanka to enhance self-reliance in domestic food production and invoked tradeprotection, agro-input subsidies, state marketing of agricultural commodities, and increasedstate seed production as strategies for achieving this goal. Despite input subsidies and tariff

protection, the profitability of paddy production has been on a declining trend for more than adecade. Paddy farming is characterized by low asset endowments and low returns on assets. Acase may be made that the paddy monoculture bias to ensure food security works against theGovernments efforts to reduce poverty in rural areas. Implementation of the food self-reliancepolicy so far has been inconsistent with the reforms advanced under the APL2, a designweakness of APL2 that may have been perceived as such at APL2 formulation. ADB wasencouraged by the performance of APL1. It might have assumed that the long-standing policy ofself-reliance was more rhetoric than substance. Nevertheless, agricultural growth and ruralincome generation may be better served by encouraging farmers to shift their limited landresources out of low-value food crops. As long as government policy in agriculture is driven bysuch contradictory objectivesi.e., self-reliance and competitive commercial development


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mixed signals are sent to the private sector and reform progress will be difficult and possiblyfleeting.

C. Complexity of Agro-Divestiture

50. The durability of the divestiture effort hinges very much on the quality of the divestitureapproach. Privatizing commercial agro-industries was considerably more complex thanenvisaged at appraisal. Inadequate enabling regulation; lack of company accounts andtransparency in privatization procedures in the early 1990s; investor recourse to the courts todelay divestiture; costly financial restructuring; limited scope for public consultation, confidence-building, and securing political support; and noncompetitive market conditions all contributed todelays in the divestiture process. In retrospect, a two- to three-year program period was far tooshort for mounting a complicated and controversial agro-privatization effort, but that wastypically the time period for a quick-disbursing program loan. A single well-designedprivatization conducted by the Public Enterprise Reform Commission normally requires two tothree years from start to finish. Adequate consideration should have been accorded by ADB and

the Government at the start of APL2 to the Governments capacity to manage divestitures, withTA resources immediately provided to prepare the necessary procedural and legal frameworkand to ensure that sound and transparent privatization practices were adopted. Anaccompanying investment project (as was subsequently provided through ADBs PlantationReform Project) would have facilitated the divestiture process. Given the risk that privatizationsales can be challenged in the courts, and hence effectively placed outside of governmentcontrol, it would have been more appropriate to design divestiture conditionality in terms of ashare of the total net asset value privatized from a set of firms (or other state assets) rather thana set of specifically-identified companies. Further, privatizing uneconomic ventures is not anappropriate strategy, for it only delays the inevitable day of reckoning. Sri Lanka's sugarcaneoperations were known to be uneconomic at appraisal, yet privatization rather than closure wasthe chosen reform strategy. Likewise, KMIL was repossessed in 2000, to avoid closure. Such

SOEs are now slated for liquidation; their asset base deteriorated in the 1990s. TheGovernment should be encouraged to facilitate the closure of uneconomic industries, ratherthan impeding this process by re-nationalizing privatized firms.

D. Sustainability of Policy Reform

51. A fiscal crisis provides a timely opportunity to introduce policy reforms, but they takemany years to fully implement. Outside of the plantation crops subsector, agricultural policyreform momentum has slowed with the closing of APL2. Changing and inconsistent governmentpolicies, a proliferation in the number of central government ministries with responsibilities for

agriculture, and the legal devolution of agricultural development responsibilities to provincialgovernments diffused sectoral responsibilities and made it increasingly difficult to obtain aconsistent and coherent vision for agricultural reform. APL2 did not include sufficient TAresources to assess agricultural progress, foster continued re-assessment and revision ofagricultural reform strategies, or guide sustained policy and institutional reform. As a result, thepolicy dialogue during APL2 focused on meeting conditionalities, rather than on defining andadvancing a more robust agricultural reform agenda. Continued policy and institutional reformswill be needed to revitalize agriculture, but there is neither the analytical base nor politicalconsensus in place to support more sustained reform. Agriculture suffers from being driven byan internally inconsistent combination of self-reliance and commercialization policies.Government leaders are aware of these internal contradictions, but achieving consistency is


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difficult due to the fragmentation of responsibilities for agriculture within government. Acommitment by ADB (and other agencies) to a new generation of sector strategy, publicconsultation, and greater awareness efforts is needed to define and build support for continuedpolicy and institutional reforms in agriculture.


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V. CONCLUSIONS

A. Overall Assessment

52. Program appropriateness and relevance. A major thrust of APL2 was to phase outgovernment intervention in the agriculture sector. Rolling back the commercial role of theGovernment and creating greater scope for private sector initiatives in agriculture wereappropriate reform thrusts, given fiscal pressures and the need to mobilize private investment totrigger higher agricultural growth. The general thrust of APL2 was relevant at the time of itsdesign, though some design elements such as the divestiture measures in the sugar industrywere inappropriate. The prerequisites for successful privatization in a number of the subsectorswere lacking. Divesting the commercial role of the State, and creating greater scope for marketforces and private sector investment in agriculture were necessary, but insufficient, to revitalize

agriculture. Many other structural constraints impede agricultural growth and development in SriLanka. There is a potential conflict of any reform measure with the longstanding policy of self-reliance that was underestimated during APL2 formulation. A failure to address theseconstraints in an integrated manner, and to provide a supportive macro-economic environment,partly explains the sluggish response of the sector to a more private-sector-oriented policyregime.

53. Program impact and efficacy. APL2 exceeded its targets set for export tradeliberalization and divestment of the public sector in the case of the plantation crops and state-plantation subsectors. It was less effective in achieving the targets set for divestment of thepublic sector in domestic agriculture (as opposed to export-oriented agriculture) and in theprivatization of the fertilizer and domestic dairy industry. APL2 targets were not met in the case

of reforms in agriculture extension, the seeds subsector, fertilizer subsidies, and the sugarindustry. Notwithstanding progress achieved in opening all of these subsectors to some privatesector participation, APL2s efficacy was moderate.

54. Program sustainability. The sustainability of APL2 reforms on the whole is doubtful.Plantation privatization has proceeded beyond the point at which reforms can readily bereversed as the subsector has to remain competitive in the export market. Despite a difficultfiscal situation, the Government has not re-imposed export or turnover taxes on plantationcrops. By contrast, the Government has neither sustained the divestment of the sugarcanefactories, MILCO, and various fertilizer factories, nor continued to privatize livestock farms andsome seed farms slated for divestment. The urea subsidy conflicts with a market-orientedpricing environment in the fertilizer industry. Reforms in the dairy and sugar subsectors have

resulted in a considerable increase in the nation's reliance on imported sugar and dried milkpowder. While this may be a more efficient outcome, it hardly suggests that reforms have beensufficient to inspire or sustain domestic productivity growth. The 2001 budget speech reinforcedthe Governments emphasis on food self-reliance and signaled the establishment of a National

Agricultural Produce Marketing Authority to help organize farm trade. There is a risk that agrowing role will be accorded to state enterprises in fostering smallholder agriculturaldevelopment.


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B. Program Rating

55. The Program is rated partly successful considering its design, its implementationperformance, results and sustainability, and achievement of its objectives.12 Considerableprogress was made in reducing the tax burden and boosting private sector participation in the

plantation subsector. This led to the revitalization of plantation crops. Similarly, some progresswas made in encouraging private sector participation in fertilizer marketing. Relative to theirsectoral impact, these were the most important reforms to be addressed. However, lessprogress was made in divesting the public sector role in the fertilizer, dairy, and sugarindustries. The reversals in the divestment of the companies in these industries underscore theproblem of sustainability. Failure to comply with some policy conditions, particularly thedivestiture of a number of fertilizer and sugar companies, and the removal of fertilizer subsidies,led to the cancellation of the second tranche. No apparent progress was made in enhancing thequality of the extension service and private sector involvement in seed production. Privatizationof livestock services has yet to begin in earnest. Sustainability of the limited reforms achieved indomestic agriculture remains uncertain given the divided policy objectives in agriculture thatpromote commercial, market-oriented development on the one hand, and self-reliance in food

crops on the other. The commitment to APL2 reforms appeared to diminish with the change ofgovernment in 1994.

C. Borrower and ADB Performance

56. Even though it failed to provide regular reports to ADB, performance by MOF wassatisfactory under the prevailing circumstances, especially in the aftermath of a change ingovernment when it had to oversee a highly complex reform effort involving more than 12different ministries. MOF exerted leadership reforms and sought to secure continued politicalsupport for highly contentious divestitures, notwithstanding staff constraints. Support from other

government entities was more mixed. Several line ministries were reluctant to divest publicenterprises or cede control to the private sector for agricultural services provision. Indeed, theMinistry of Agriculture (MOA) mobilized political support for a reversal of several key APL1 and

APL2 reforms. A failure to have a full-time program director weakened the ability to monitor andreport on APL2 progress, but this was compensated for by the attention that senior MOFofficials accorded to APL2. ADB performance was satisfactory, but frequent staff turnovercomplicated the policy dialogue. The re-linking of fertilizer subsidy removal to second trancheconditionality was perhaps unrealistic, and did not take into consideration the sharp decline inpaddy production and farm welfare between 1990 and 1993. Despite the frequent staff turnover,

ADB's close supervision did help maintain forward momentum in implementing APL2 reforms.Moreover, timely provision of the small-scale TA to strengthen the Public Enterprise ReformCommission (footnote 10) was essential for Sri Lanka's privatization process.

D. Lessons Learned

57. Need to address the basic causes of agricultural stagnation. Higher agriculturalgrowth can be realized in Sri Lanka by encouraging smallholders to diversify from low-valuepaddy to higher value activities. In conjunction with efforts to enhance the private sector's role,

12On a rating scale of highly successful, successful, partly successful, and unsuccessful.


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more attention needs to be given to structural barriers to sluggish agricultural performanceincluding state ownership of 80 percent of the land and practically all irrigation facilities, anunder-performing research and development system, high-cost market infrastructure, and aninward-oriented agriculture protection regime. A more holistic and integrated approach showingthe main sectoral goals and objectives and the linkages between those and the reformssupported, will result in a more robust reform agenda.

58. Stakeholder consultations during design and implementation. Obtaining continuedsupport from stakeholders for policy reforms is essential for sustaining the reform process.While consultations are necessary during the formulation of a policy reform program, such aprogram should also provide the resources for continued consultation and social safety nets.Ensuring that safety nets and other temporary measures are in place to cushion the effects ofstructural change on smallholder incomes and performance is important to fostering widespreadsupport for the reform process. The vulnerability of policy reform momentum to political changeneeds to be understood and addressed in the program design.

59. Sound and transparent, not rapid, divestiture. Divestiture programs are inevitablytime-consuming and require considerable up-front investigation and preparation to be

sustained. The rapid divestiture of government interests in SOEs within the short span of aprogram loan tends to sacrifice transparency and sound practices of due diligence, and toimpair durability. Establishing realistic divestiture targets, and encouraging use of goodpractices for divestiture, will help achieve better results. Linking divestiture targets to a share ofnet asset values rather than to the sale of specific firms is more appropriate given the risk thatspecific transactions could face legal challenge. Promoting orderly closure, rather thanprivatization of uneconomic agro-industries, is a more appropriate design in noncompetitivesectors. Efforts to advance divestiture should be accompanied by clear, well-defined subsectorpolicies.

60. Necessity to monitor the program and macro-setting. Monitoring the changes in themacro-environment and in the agriculture sector would have alerted ADB and the Borrower to

the need to make mid-course corrections in a number of the policy reforms. Failure to monitorthe evolving incentive environment for private sector initiatives in agriculture contributed to afocus on simply implementing agreed reforms rather than achieving desired results and impacts.

E. Follow-up Actions

61. Government policy in agriculture is torn between a desire to be more competitive andcommercial, on the one hand, and to provide fair and reasonable prices to protect poorconsumers and foster greater domestic self-reliance, on the other. The Government needs toresolve this contradiction to give clear signals to the private sector and to apply a consistent

agricultural policy framework. The Government needs to re-examine agricultural policies toidentify opportunities for progressing toward a more competitive agriculture sector. It should beencouraged to carry out within the next two years a review of public policies affectingagriculture, and to ensure consistency and clarity in its policy reforms. Such a review should beundertaken at the highest government level with the initiative appropriately taken by MOF andMOA.

62. ADB should continue to advocate through policy dialogue the divestiture of stateenterprises, farms, and agro-services that were slated for privatization under APL2, and provideassistance if necessary. The Resident Mission should maintain such dialogue, supported byrelevant operational departments in the course of current and future projects. Assistance could


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include preparation and introduction of the procedure and legal framework specifically tailoredto effect privatization for these enterprises and farms which operate in different circumstancesfrom the plantations. The Government should also be encouraged to seek an orderly liquidationof uneconomic state agro-enterprises. The policy dialogue should also take up the matter ofadverse fiscal and agronomic impacts of fertilizer and wheat subsidies. The dialogue shouldmove away from fertilizer subsidies per se, toward promoting the adoption of a more market-

oriented food policy. During the country programming mission in 2002, ADB should considerproviding advisory TA to help the Government examine opportunities for further agriculturalpolicy reforms.


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APPENDIXES

Number Title Page Cited on(page, para.)

1 Financing of Sri Lankas External Resources Gap 21 2, 6

2 Policy Reform Matrix 22 4, 11

3 Status of Compliance with Major Loan Covenants 35 9, 28


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Appendix 1

Financing of Sri Lankas External Resource Gap, 1991-1995(SDR million)

Item 1991 1992 1993 1994 1995External Resource Gap 1,115 1,036 1,032 1,264 1,008Financed by:Central Government 633 443 449 427 451of which:Grants 148 130 115 117 107Project Aid 422 215 255 281 285

IMF Drawings 56 112 56 56

Note:Net Official Transfers 148 130 115 117 107

IMF = International Monetary Fund, SDR = special drawing right, = not available.Source: Central Bank, Annual Report, 1996 and 1997.


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POLICY REFORM MATRIX

Policy Area andObjective

Measures to be Taken Target Date forAccomplishment

DateAccomplished

Status at Time of

1. Tree Crop TaxationPlantation crops (tea,rubber, and coconut)

are subject to exporttaxes (export duties andad valorem sales tax)and income tax. Thisdouble taxation is notconducive to the long-term development ofplantation cropproduction.

MajorThe Government has agreed to furtherreduce the export duties on tea, rubber,

and coconut as well as phasing out thead valorem sales tax as hereunder:

(i) Export DutyBulk Tea: from SLRe1.00/kg to

SLRe0.50/kgPacketed Tea: from SLRe0.50/kg to zeroTea Bags: from SLRe0.50/kg to zeroInstant Tea: from SLRs6.00/kg to

SLRs4.50/kgRubber: from SLRe1.00/kg to zero

31 Dec 1991

30 Jun 1992

30 Jun 199230 Jun 199230 Jun 1992

1 Oct 1991

7 Nov 1992

22 Dec 19927 Nov 19927 Nov 1992

22 Dec 1992

Complied with.All export duties andvalorem sales tax oncrops removed on dashown.

Desiccated Coconut:from SLRs2,500/ton to SLRs1,000/tonfrom SLRs1,000/ton to SLRs500/ton

from SLRs500/ton to zero

31 Dec 199131 Dec 1992

31 Dec 1993

12 Nov 199112 Nov 1991

22 Dec 1992

(ii) Phased reduction of ad valoremsales tax (currently 50 percent) asfollows:

Bulk Tea: 40 percent

The threshold price (currently atSLRs65/kg) over which the sales tax iscalculated will be reviewed and adjustedas required during the above period.

31 Dec 1991 12 Nov 1991

Rubber: from current 50 percent to 30percent.

The threshold price on which sales tax iscalculated will be reviewed and adjustedas required during the above period.

1 Oct 1991 1 Oct 1991

PCR = program completion report; PPAR = program performance audit report.


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DateAccomplished

Status at Time of

Rubber: from current 50 percent to 30percent.

The threshold price on which sales tax iscalculated will be reviewed and adjustedas required during the above period.

1 Oct 1991 1 Oct 1991

Coconut Oil, Desicated Coconut, andCopra: raising the threshold price fromSLRs20,000/ton to SLRs25,000/ton (31Dec 1991) and phasing out the advalorem sales tax (currently 50 percent)as follows:

40 percent30 percent20 percent10 percent0 percent

31 Dec 1991

31 Dec 199131 Dec 199231 Dec 199331 Dec 199431 Dec 1995

31 Dec 1991

12 Nov 19926 Nov 1992

21 Dec 199221 Dec 199231 Dec 1992

Complied.

After 31 December 1991, the thresholdprice will be reviewed and adjusted asrequired.

Not applicable.

OthersTea:(i) Grants to selected companies forbrand promotion to be abolished.

31 Dec 1991 6 Feb 1992 Complied with.50 percent subsidy nrestricted to promotioLion Logo linked to tbrands in certain maCess funded.

(ii) Interest rate subsidy (at 75 percent)

for purchase of tea-bagging machinery tobe gradually phased out and eventuallyeliminated.

31 Dec 1994 Not complied with.

Subsidy reduced to 5percent; reverted to percent from 1 Nove1995. Applies to newfor purchase of new bagging machines. Cfunded.


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DateAccomplished

Status at Time of

(iii) Infilling subsidy to be graduallyreduced and eliminated.

31 Dec 1995 1 Jan 1991 Partly complied withInfilling subsidy reinfin 1993 for block infixtea lands. Smallholdonly. Cess funded.

RubberCess under the Medical WantsOrdinance (SLRe0.0165/kg) to beabolished

31 Dec 1991 - Not complied with.Rubber cess continube collected underordinance. Ministry oHealth considering reof ordinance andintroducing new bill tcover state workers

Coconut(i) Subsidies for underplanting andrehabilitation (except for moistureconservation) to be abolished(subsidies to be limited to coconutreplanting, intercropping with approvedagricultural export crop, pasture andrehabilitation for moisture conservation).

31 Dec 1991 27 Jan 1992 Partly complied withSubsidies remain forreplanting, new plantrehabilitation, intercrand the installation oirrigation facilities. Fidevelopment subsidalso available for newplanting and replantiCess funded.

Other Agricultural Export Crops

(i) Replanting subsidy will be limited tococoa, cinnamon, and cardamom (out ofeight crops).

31 Dec 1991 1 Jan 1992 Complied with.Revised replanting sscheme, 1997, applifollows:cocoa SLRs26,750cinnamon SLRs40ha,cardamom SLRs25ha, and

java citronella SLRs10,000/ha.

(ii) New planting subsidy to coffee andpepper to be limited.

31 Dec 1991 1 Jan 1992 Complied with.Revised new plantingsubsidy scheme, 199applies to pepper SLRs30,000/ha, andcoffee SLRs25,000under a four-year piloproject.


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DateAccomplished

Status at Time of

(iii) Fruit crop subsidy will be limited tocitrus (orange and lime) and mango (outof 10 crops).

31 Dec 1991 1 Jan 1992 Complied with.Funds (approx. SLRsmillion/annum) allocaprovincial councils, wdistribute free plantinmaterial to farmers f

nurseries.2. Sugar IndustryThe sugar industry inSri Lanka has beenreviewed under theADB-assisted TA onSugar SectorRationalization Studycompleted in June1990.

Major(i) To eliminate the agreed sugar price(about $1,000 equivalent per ton ofsugar) applied for Pelwatte SugarEnterprises Ltd. (PSEL) and applyuniform purchase price equivalent tolong-term international price currentlyestimated at $500 per ton of sugar.

30 Jun 1992 10 Jun 1992 Complied with.Uniform purchase prnow abolished in favduty protection, curreset at 25 percent.

(ii) Conversion of PSELs foreigncurrency loan to rupee loan.

30 Jun 1992 10 Jun 1992 Complied with.

(iii) to privatize three companies asfollows:

- establishment of a TenderCommittee.

1 Oct 1991 1 Oct 1992 Complied with.

(a) Privatize Sevanagala SugarIndustries Ltd.

31 Dec 1996

The main findings andrecommenda

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