Years

Annual Average GDP growth rate

1. 1983-2002 (20 years of civil war)

The average annual growth of the GDP during the 20 year period of ethnic conflict (i.e.1983-2001) was 4.35 per cent, whereas in the 20 year period prior to the ethnic conflict (i.e., 1963-1982) it was 4.55 per cent (Table 2). The average annual conflict-time growth rate was marginally lower than the average annual pre-conflict growth rate. With profound economic liberalisation since 1977, the economic growth rate in the 1980s and 1990s should have been much higher than the previous two decades, but that did not happen. The primary reason for this relatively low growth rate during the post-liberalisation period could be attributed to the negative effects of the ethnic conflict since 1983.

According to M. Sarvananthan (2002a): ‘The average annual conflict-time GDP growth rate of 4.35% is an over-estimation, because since 1990 the national income accounts of Sri Lanka do not include the North East province. As the government lost control of vast areas of the North East province to the rebels, the economic and social data gathering in that province became impractical. Most of the statistical tables in the Department of Census and Statistics and the Central Bank publications have a footnote mentioning that the North Eastern province is excluded. If the supposedly negative growth rates of the North East province were added to the positive growth rates of the rest of the country, the overall growth rates would have been lower than the official figures of the Central Bank. Therefore, the conflict-time economic growth rates may be considerably lower than the pre-conflict rates in spite of economic liberalisation. Thus, the notion that the Sri Lankan economy has been resilient in spite of a deadly conflict could be a myth.’

Defence Expenditure
The Sri Lankan government deficit is over 8% per annum, which could have been managed in a much better way had it curtailed its defence expenditure. The government was forced to spend heavily on the defence sector to recruit the army, pay salaries and pensions to the soldiers and purchase arms and ammunition, etc. But there are also contradictions in data on government spending on defence.

(Sen & West, 1992) argue, “the data on defence expenditures of most developing countries are unreliable; usually they are underestimations. There are legitimate methodological problems in the measurement of defence expenditures.”

(M. Sarvananthan, 2002b) opines, “There are also deliberate attempts to camouflage defence expenditures supposedly to maintain secrecy. Sri Lanka is a country where defence expenditure data are unreliable due to both the aforementioned reason. The defence budget of Sri Lanka does not include disability

benefits and pensions of soldiers, which is a further source of underestimation.”

Defence Budget
The breakdown of Sri Lanka's defence budget into recurrent and capital expenditures from 1991 to 2001 is provided in Table 3.

According to the above table, 80 per cent of the defence budget during 1991-2001 went into recurrent expenditures, while only 20 per cent was allocated to capital expenditures. This clearly shows that it is a labour intensive military expenditure which is incurred largely by the Sri Lankan government.

Budget Deficits and Expenditure on Defence
(M. Sarvananthan, 2002a): ‘The defence expenditure, which was minuscule in the pre-conflict period, has shot up enormously since the early 1980s. For example, the defence expenditure shot up from Rs. 16 billion in 1991 to Rs. 77 billion in 2000, i.e. nearly fivefold increase in just a decade.’ The breakdown of Sri Lanka's budget deficits, defence expenditure and total government expenditure from 1982 to 2001 is provided in Table 4.

The defence budget went up drastically due to the breakdown of the peace talks between the government and the LTTE and the outbreak of the war in June 1990.
According to Samam Kelegama (2000): ‘a number of military operations in early 90's escalated the defence budget to about 4.5 % of GDP. This led the government to introduce a defence levy, later termed as national security levy, of 1 % as a source of defence financing in 1992.

The overall deficit went up by over 10 per cent by the year 2001, a dangerous sign for the economy. The government had the biggest setback in early 2000 as the LTTE captured a major part of the North Eastern region and it was felt that the governement was losing control of the situation. The government was forced to make huge expenditure commitments to purchase defence equipments and ammunitions. Therefore, the defence budget amounted to over 6 per cent of the GDP – the highest since 1983.

Defence Expenditure vis-à-vis Social Expenditure
The breakdown of Sri Lanka's defence expenditure as a proportion to total public expenditure from 1991 to 2001 is provided in Table 5, which indicates that the government's expenditure on social spending decreased drastically in 2000 1nd 2001.

(M. Saranvananthan, 2002a) opines, ‘In 1995 the civil war entered a vicious phase with the strategy of 'war for peace' or 'peace through war'. One of the outcomes of this strategy is the acceleration of defence expenditures and the deceleration of social expenditures. Since 1995 the gap between defence expenditures and social expenditures widened considerably. This had profound negative impact on the human and social development indicators of Sri Lanka, which historically had an impressive record among the developing world.’

Outcome of High Defence Expenditure
Heavy military expenditure has a negative impact on the growth of the economy.

Empirical Studies
(Smith 1977, Lindgren 1984, Chan 1985, Knight et al. 1996, Galvin 2003) have found that ‘increased military expenditure (milex) reduces investment which in turn decreases economic growth. That higher military expenditure reduces investment has empirically been established and is one of the few robust conclusions from research on the economic consequences of military expenditure.’

In Table 6, all five empirical studies have been conducted during the war period in Sri Lanka and revealed the impact of cost of war on the economic growth (during the war period) expressed in terms of percentage of GDP either with the staring or the ending year of their study.

Foreign Direct Investment
Sri Lanka attracts foreign investors. When compared to its Asian counterparts, there is the potential to build on the country's rich natural resource base to develop higher-value-added agricultural and manufacturing products and tourism and related services. More than anything else, Sri Lanka offers an abundant supply of trainable workers. The adult literacy rate of 92 per cent is the highest in South Asia.

But the biggest drawback for Sri Lanka is its infrastructure. It fares very badly when compared to other Asian economies like Thailand, Malaysia, India and even Pakistan. It needs a significant boost in order to attract private investments into infrastructure area.

• The following factors are important for attracting FDI:
• An educated and skilled labour force.
• An efficient and fair legal system.
• An adequate transportation system and other infrastructure facilities.
• A strong anti-monopoly policy.
• A sound macroeconomic policy and
• Government policies.

Table 7 shows the FDI inflows into Sri Lanka from the year 1992 to 2002

Incentives to Attract FDI
Governments generally use some form of marketing techniques to attract FDI into the country. The most common type of incentives used by many nations include:

• Direct Cash grants (capital grants).
• Subsidies on land and building purchases.
• Interest subsidies.
• Tariff protection.
• Exemption of imports and export duties.
• Exemption or Lower rates of income taxes, dividend and capital gain taxes.
• Guarantee for profit and capital repatriation.

Minimum Incentives Model
This model states that the level of incentives provided by a government would come down as the market opportunities goes up. If the investors' Minimum Required Rate of Return is 20 per cent and the market opportunity provides only 15 per cent, there is a shortage of 5 per cent. Moreover, the value of incentives package should at least be equal to or more than 5 per cent, otherwise no foreign investor will consider the country for investment. Whether a country offers a high, average, low or negative incentive depends on the market opportunity. In some cases, no incentives may be required if the market opportunities are very high. Generally, developed countries need to offer very low incentives and under developed and developing countries need high incentives to attract FDI.

Explanation
Required Rate of Return: The rate of return needed to induce investors or companies to invest in something (stocks, projects etc).
Market Opportunity: Marketability of a product in an economy. The market opportunity for a product is determined by the purchasing power of consumers in the country.

Fig. 2. High growth leading to investments

It is time for the Government of Sri Lanka to take stringent measures to attract FDI into the country. To attain a growth rate of over 6 per cent, Sri Lanka should attract investments up to 40 per cent of its GDP.

A strong publicity mechanism needs to be adopted by the Government of Sri Lanka which can project the success stories in various sectors. The government should focus on highlighting the cases of successful FDIs and it should present a well-designed publicity campaign bringing out the advantages that foreign nations could reap from investing in Sri Lanka.

The following recommendations can be used to attract FDI:

a) There is an urgent need from the state governments in Sri Lanka to provide separate investment laws relating to infrastructure and making private participation in infrastructure mandatory.
b) The existing strategy of attracting the FDI should be more of company oriented in specific sector than broader ones.
c) The Government of Sri Lanka should create separate investment fund for the purpose of attracting FDI into the nation. (In India the state government of Andhra Pradesh has Infrastructure Development Enabling Ordinance).
d) There is no clear-cut policy framework in India for attracting FDI. Hence there is an urgent need to frame policy, which should sepal out ways and means to attract FDI.
e) Sector-wise targets should be set and sector ministries must be made responsible for achieving these specified targets.
f) Separate 'Investment Commission' can be created which should include eminent experts from national and international forum. The commission would work on