A. Executive summary

Sri Lanka is a country whose democratic heritage has been wasted by

chauvinist majoritarian policies, leading to the progressive

discrimination of the Tamil minority, the dismantling of the secular

state character, a full-fledged civil war from 1983 to 2002 and the

widespread violation of human rights. The government is only slowly

re-building the democratic fabric, by conceiving a federal solution to

the ethnic conflict, calling for international mediation and

safeguarding the cease-fire. To find a sustainable solution is

difficult, due to coalition partners and powerful interest groups

opposing a truly federal political set-up on the one side and the poor

conciliatory and democratic credentials of its radical Tamil opponents

on the other.

Thus, problems of stateness persist, the military has become

independent to a certain degree, the monopoly of the state on the use

of physical force is not assured in the Tamil areas, where rebels have

installed a parallel administration. Political participation has always

been remarkable in the country, and freedom of association is secured,

although freedom of opinion is restrained by heavy political influence

on the media. The separation of powers leaves much to be desired, as

parliament has been partly deprived of its authority, the independence

of the judiciary has been eroded and the introduction of a

semi-presidential system has created two centres of political authority

and legitimacy. Democratic institutions have nevertheless remained

stable, supported by an equally stable, but fragmented and slightly

polarized party system.

The economic record of the country is excellent, despite the recently

concluded civil war. Rising exports, remittances and foreign direct

investment allowed a narrowing of the balance of payments deficit and a

moderate build-up of foreign exchange reserves. This is mainly a result

of market-friendly policies, deregulation and a comparatively

well-skilled workforce. There are some reform deficits with regard to

the land and labor market and the privatization of remaining state

enterprises. Foreign trade is nearly deregulated, the tax regime is

liberal, the authorities are pursuing sound macroeconomic policies and

inflation rates have fallen markedly. The budget deficit remains

however excessive and is due to untargeted subsidies, overstaffing in

the public sector and high defense expenditures. Private property is

well protected, except the agricultural sector. Social exclusion of

women is non-existent, whereas poverty is still relatively widespread

despite a whole gamut of (poorly targeted) anti-poverty programs.

The level of difficulty for political transformation is considerable,

because quite a few veto players can and do obstruct the peace process

and ethnic harmony. The steering capability of the government in

economic matters has been remarkable, although recently there was a

slight relapse into populist policies. The steering capacity in

democratic and peace consolidation suffered from the veto power of

important actors. This also made consensus-building rather difficult.

B. History and characteristics of transformation

Economic and political transformation in Sri Lanka happened at

different times. General, free and fair elections were already

introduced under colonial administration (from 1931 onwards), leaving

Ceylon at independence (1948) as a democratic regime copying the

British model and politicians socialized in this tradition. These

politicians took care in the first years after independence to

safeguard this heritage. They drafted a pluralist constitution

protecting the minorities, educationally put into an advantage by the

British. The Sinhalese majority was however soon mobilized by the

opposition with the aim to revise the plural character of the state by

introducing Sinhala as the only official language (1956), abolishing

Christian (but not Buddhist) schools, elevating Buddhism to the rank of

state religion (with the new constitution in 1971) and by impeding

university access for Tamil students. This laid the basis for the

radicalization of the Tamil youth and the civil war later.

The next constitution in 1977 (after the victory of the conservative

UNP) brought the introduction of a semi-presidential system and limited

decentralization. This could not stop the escalation of the “ethnic”

conflict, which was first dealt with by special anti-terrorist laws and

a massive military build-up against several militant Tamil

organizations, later on by calling an Indian intervention force (1987)

and the offer of a quasi-federal solution by way of the introduction of

provincial councils. The democratic heritage was damaged during this

period by the extra-constitutional extension of the sitting parliament,

the more or less permanent invocation of the state of emergency, the

arming of paramilitary forces to fight against the Tamil rebel forces

and militant Sinhalese youth in the southern part of the country and

the massive violations of civil rights.

Increasing war fatigue on both sides brought a first formal cease-fire

under the new left government of the People’s Alliance in 1994. During

the following years the government adopted a two-pronged strategy

against the Tamil rebels by offering a federal solution and

simultaneously intensifying military pressure. The federal solution was

frustrated by the Sinhalese opposition, the military solution by the

fighting strength of the main rebel group Liberation Tigers of Tamil

Eelam (LTTE). In 2001 a new cease-fire agreement was achieved by

Norwegian intermediation, followed by several rounds of peace

negotiations between government and LTTE. Slow implementation of the

negotiation results by the government and different conceptions of an

interim administration in the Tamil provinces led to the suspension of

peace negotiations, rendered more difficult by the electoral advances

of chauvinist parties in 2004.

Economically, the British left Sri Lanka with an efficient plantation

economy, financing a system of free education and health care, but also

with a stagnant agricultural and weakly diversified industrial sector.

The government adopted a strategy of import substitution (financed by

consumers and the plantation sector) and public sector companies. The

results were mounting payment deficits, weak export and employment

growth, fuelling the first youth rebellion of 1971. The election

victory of the UNP in 1977 brought a first modest modification of that

model: the rupee was devalued, exports were subsidized, free export

zones created, price controls abolished and a massive debt creating

public investment program was launched. Later on, in spite of the civil

war and handover of government to the left parties, market-oriented

reforms became more broad-based, by massive privatization, reform of

the public sector and liberalization of trade and capital movements. Of

late, a moderate return to a more people-oriented economic policy was

announced.

Contrary to popular perceptions, Sri Lanka never followed a basic needs

policy. Social programs were introduced early and did improve social

indicators substantially to the level of some developed countries, but

were never targeted at the poorest sections or concentrated on basic

services.

C. Assessment

 

1. Democracy

 

1.1.    Stateness

There are several problems of stateness in Sri Lanka: First regarding

the question of national identification, a majority of Ceylon-Tamils

would opt for independence, as long as substantial autonomy is not

constitutionally provided. Practically, not all citizens enjoy equal

civil rights, which are suspended against suspected terrorists and in

military zones. There is secondly no clear separation of religion and

politics as long as Buddhism remains state religion, monk orders and

Buddhist universities are supported by the government (and allowed to

obstruct the peace process). Although the constitution unequivocally

establishes civil control over the military, during the civil war and

because of numerous exceptional laws, not to mention through the

establishment of a special task force and militias, the military has

gained extensive independence and has long promoted the militarization

of the ethnic conflict. In addition, the establishment of private

armies of politicians, acting as subsidiary agencies of crime

prevention must be mentioned. Administrative efficiency is slowly

improving; the public sector is however still massively overstaffed,

thus acting as a labor market-buffer, recruitment follows a political

and clientelistic logic, corruption is still widespread.

 

1.2.    Political participation

Sri Lanka has always shown very high participation rates in elections

(often above 80%) in spite of sometimes militant boycott initiatives by

rebel organizations and decreasing violence during elections. There was

a frequent change of government and elections were frequent;

manipulation of election schedules and massive indoctrination through

the state media are still common phenomena. Candidates of minority

parties in the Tamil areas (sometimes also in the Sinhalese South)

still run a considerable personal risk. Part of the press and the media

is under state control. Critical journalism on government initiatives,

human rights violations etc. are therefore rare. Quite often,

journalism is subject to censorship, especially during periods of

intensified fighting. In addition, attacks on foreign or critical

journalists occur occasionally.

1.3. Rule of law

 

In relation to the separation of powers, Sri Lanka deteriorated in

maintaining the rule of law in the late 1970s. The introduction of a

semi-presidential system in 1977 led to the centralization of power in

the executive, while parliament was degraded to a rubber-stamp

institution and members of parliament were forced to underwrite undated

letters of resignation. This tendency was reinforced by the fact that

the president also acted as leader of the ruling party, which weakened

during periods of cohabitation of dual offices (2001-2004). The

division of powers is also restricted by the high number of ministers,

making nearly every second member of parliament wearing two hats.

The independence of the judiciary eroded after the constitutional

reform of 1977. For instance, a Supreme Court sentence declaring a law

unconstitutional, can be overruled by a two-thirds majority in

parliament. During this period, the Supreme Court was filled with

adherents of the ruling party, with judges who pledged allegiance to

the preceding constitution being forced to retire. Of late the court

has once again become more proactive. The president is authorized to

install special investigation commissions, whose recommendations cannot

be questioned by the courts. Intimidation and transfers of judges have

become routine procedures. The level of corruption in Sri Lanka is

moderate, but higher in government procurement and public transfer

payments. Political interference in the working of the administration

and in recruiting personnel is common. Respect for human rights did

suffer a lot during the civil war. After 1983 the security forces were

granted special powers and immunities, the Northern and Eastern part of

the country were under near permanent emergency. In addition a Special

Task Force (consisting to a great extent of unemployed and lowly

disciplined youth) and home guards for the defense of Sinhalese settler

colonies were established. In combination with the inevitable

brutalization ensuing from civil wars, this explains the massive scale

of human rights violations, torture and “disappearance” of suspected

people. The activity of international human rights organizations was

forestalled, and violations brought to the knowledge of national human

rights commissions did not entail judicial sanctions for quite some

time.

1.4. Stability of democratic institutions

 

Democratic institutions were more or less stable, leaving aside defects

in the rule of law, the observance of human rights and election-related

violence. As governments often only commanded a thin and unstable

majority, they were not able to push through wide-ranging plans for

bringing about peace and reducing interethnic tensions. Different views

of the president and the prime minister regarding concessions toward

Tamil militants during the period of cohabitation played an important

role, becoming an additional obstruction to the resolution of the

conflict. Nevertheless, democratic procedures are widely regarded as

the only ones conferring legitimacy. They are not questioned by any

major party or group, although sometimes subverted in practice. Voter

participation is very high and voters do even accept risks to cast

their votes.

1.5. Political and social integration

 

Sri Lanka possesses a relatively stable, but fragmented party system,

where two major Sinhalese parties and their allies are the main blocks,

completed by minor Tamil and Muslim parties. Party polarization is less

than their oft revolutionary mottos would suggest, but is significant

in the question of a federal solution to the civil war. Party

membership is wide, exact data are however not available. Party

discipline is lower, cross-over of individual members of parliament

between parties after elections is not uncommon. Union coverage is also

broad (approximately 45%), but unions are organized at the company

level, affiliated to political parties (except unions in the plantation

sector which became parties in their own right) and their space of

action is limited in the public sector. Nevertheless, the incidence of

labor disputes is high but declining. The power of employers’

federations is considerable; they forcefully support economic reforms

and the peace process. There is also a wide range of NGOs actively

engaged in the upliftment of poorer sections and in the creation of

ethnic harmony.

 

2. Market economy

Sri Lanka is a full-fledged market economy. The remaining

transformation deficits relate mainly to the finance sector, reform of

the public service, cutting of subsidies and the necessary reduction of

the still massive public deficit.

2.1. Level of socioeconomic development

 

The central development indicators classify Sri Lanka as a

middle-income country. In regard to the Human Development Index, the

country surpasses comparable economies, albeit at a diminishing rate.

Basic social exclusion in regard to education or gender aspects hardly

exists, apart from the war-inflicted regions. Absolute poverty is

slowly declining to about 25% of population and is concentrated

regionally on provinces in Central and Eastern Sri Lanka, which are

also poorly provided with public services. Income distribution became

slightly less egalitarian since the civil war, but is still moderate.

The civil war is partly to be blamed for less satisfactory outcomes in

terms of poverty reduction and social indicators in recent years.

Poverty is most widespread in the countryside and among less educated

people, ethnically among Muslims. There is no correlation between

unemployment and poverty, as only better educated and more affluent

people can wait for better job opportunities.

 

2.2. Organization of the market and competition

The basis of market competition in Sri Lanka is assured and stable. The

formerly high regulation density of the economy was reduced, the

discrimination of foreign investors completely eliminated. There are

still some liberalization deficits in regard to the labor and land

market, the pricing of public services and

privatization/commercialization of public enterprises. Foreign trade is

nearly de-regulated, tariffs have been reduced to two standard rates

(10 and 25%). There is a free trade agreement with India, allowing

tariff-free imports of several hundred items. Sri Lanka can boast of

the most free trade regime in South Asia. This also applies to the

investment regime of the country, serving foreign investors with a

uniform administrative set-up and dispensing of too liberal incentives.

The formerly rigid labor laws of the country were streamlined in 2003

with the aim of making the labor market more flexible, new labor courts

were installed and mandatory severance payments for dismissed employees

were introduced. The local tax regime is quite liberal, maximum rates

for income taxes have progressively been reduced to 30%, while the

resulting revenue shortfall was compensated by higher indirect taxes

(especially for luxury goods).

 

2.3. Currency and price stability

Since some years, Sri Lankan authorities have pursued sound money and

exchange rate policies, trying to contain inflation without unduly

obstructing economic growth. This development commenced after 2002,

supported by some improvement in the fiscal position along with

structural adjustment and a concomitant Fiscal Management

Responsibility Act. Inflation rates fell continuously till 2004 (to

3.9% in the first half of the year), which helped to sustain

international competitiveness of Sri Lankan exports and led to a

remarkable easing of balance of payments problems. This also went along

with bringing in line banking practices (liquidity requirements,

calculation of assets) to international standards and with the

transition to open market transactions by the Central Bank.

Traditionally high credit rates came down, although the gap between

savings and credit rates is still considerable. Part of these

achievements are in danger with the more profligate policies of the new

government, especially the massive wage hike and recruitment spree in

the public sector. International debts of the country are not excessive

(58% of GDP), capital service even less so (11.6% of exports) as most

of debt is of official, long-term character. The level of international

reserves has become comfortable during the period of this review.

2.4. Private property

Property rights and acquisition are adequately secured in the

industrial and service sector. The situation is different in

agriculture where 80% of arable land is state-owned, but usually leased

to private farmers. Their rights to the land are however ill-defined,

part of it cannot be sold and is in addition badly demarcated, although

there is some progress in upgrading land registration, reform of land

rights and abolition of restrictions for selling and leasing land.

Mobility of farmers is therefore still limited.

Privatization of public enterprises made some headway, albeit at

certain stages. During a first wave, plantations, parts of the national

airline, hotels etc. were privatized, earning the government

considerable income. During the period of cohabitation there was first

a slowing down of the process, reversed with the signing of adjustment

programs with the IMF and the World Bank. After the victory of the new

alliance in 2004, a return to the (unsuccessful) policies of the early

1990s was proposed, trying to make public enterprises self-sufficient

without privatizing them. Labor laws are traditionally very complex,

rigid and worker-friendly; dismissals in the formal sector nearly

impossible. Wages in the public sector (in less qualified positions)

ranged above those in private companies. In the last few years a reform

effort was made to streamline laws and to reduce overstaffing in the

public sector.

 

2.5. Welfare regime

 

Sri Lanka has a long-standing, progressive, comprehensive system of

social services and poverty programs. That is why social indicators

range still above the level of comparable countries. Food subsidies

were introduced early and replaced in the late 1970s by targeted but

still widely distributed food stamps. In addition, several poverty

programs of self-help character exist. This social heritage has seen

some erosion in the last decade because available resources for these

programs stagnated, while the disease and education pattern (in

accordance with the ageing of the population and the saturation at the

primary educational level) shifted to more expensive services. There is

factually no gender gap in educational enrolment or achievement,

outlays are however too low to allow the expansion of the tertiary

sector or quality improvement. Poverty programs are still poorly

targeted, since half of the population benefits from them, allocation

is politically influenced and the poor do not participate in the

implementation of programs. As their costs are considerable, very less

is left for the really vulnerable (widows, orphans of the civil war

etc.).

 

2.6. Economic performance

In spite of the ongoing civil war, growth rates of the economy were

very satisfactory from the late 1990s onward, apart from the crisis

year 2001. This is due to the dynamics of slowly diversifying exports,

buoyant remittances and increasing transfers of foreign private capital

as well as relatively generous development assistance. This

satisfactory performance was possible because of sound macroeconomic

policies, moderate inflation and – as a result – a remarkable record of

private investments. After signing and implementing market-friendly

adjustment programs with the IMF and the World Bank, thus giving a

boost to privatization, deregulation of the labor market etc., the

record improved even further, supported by the positive effects of the

lasting cease-fire in terms of mounting international assistance, the

revitalization of the transport sector and of tourism and the increase

of arable acreage in agriculture. This demonstrates the even greater

potential effects of a lasting peace solution.

2.7. Sustainability

 

Environmental degradation in Sri Lanka has reached a serious level due

to deforestation and soil erosion, use of wood for cooking and

encroachment on natural reserves. This is connected with adverse

effects for biodiversity, cleanliness of ground water and the

maintenance of coral reefs. Water consumption in agriculture is

enormous, due to subsidies for canal irrigation. Consequently, fields

often become salinated and marshy. Natural tropical forest cover has

shrunk to small sizes. Damage from ecological degradation was

calculated at 2.5% of GDP per annum. In reaction to this, the

government has adopted a comprehensive action plan and earmarked large

areas as natural reserves.

3. Management

3.1. Level of difficulty

The level of difficulty faced by the government in creating lasting

peace was considerable. In relation to the majority, the last

government was confronted with a powerful presidency of the opposing

party blocking peace efforts regarded as too conciliatory toward the

Tamil rebels and using its constitutional powers to undermine the

government. In theory the level of difficulty should have diminished

with the victory of the presidential party and its partners in 2004;

the new government was however dependent on the support of the

traditionally chauvinist JVP and the even less conciliatory party of

the monks (JHU). The tension eased with the party of plantation workers

(CWC) joining the government and the renewed pressure exerted by the

international community on the new government for finding a lasting

peaceful solution. On the side of Tamil rebels the peace process was

obstructed by proposing a federal solution falling only very short of

full secession (interim administration under full and sole authority of

the LTTE, including taxation, allocation of development assistance,

foreign trade, law and order etc.) and declaring these proposals as

non-negotiable. Accepting this would have meant a revision of the

constitution and political suicide for the government.

The difficulties for continuing market-oriented reforms were less, as

the government can rely on a well-educated workforce, sufficient

international transfers of capital and a solid coalition of groups

benefiting from market-friendly policies. It has to be acknowledged

however, that quite a few sections of the population felt overlooked by

these policies and therefore voted the last government out of office.

Most vocal among these groups are thousands of educated unemployed,

traditionally backing the radical JVP. Therefore the new government

could not help but to present a budget with a human face, doling out

benefits for the poorer and rural sections, public employees and the

unemployed, thereby also trying to suppress popular frustration about

mounting prices of essential food items.

3.2. Steering capability

The steering capability of the government in market transformation

until recently was remarkable. Agreed structural adjustment programs

were nearly fully implemented, labor laws were streamlined to make the

market more flexible, privatization of public enterprises (including

large and profitable companies) made headway, reduction of overstaffing

in the public sector was planned and implemented, tax administration

improved, the Central Bank was reduced to oversight and regulation

functions and last but not least, the budget deficit was curtailed in a

significant way. After the takeover of the new government in April

2004, economic steering capacity did however suffer. Privatization was

stalled, prices for public goods and services were only inadequately

raised, emergency measures to stop price increases of essential food

items were implemented, agricultural debts restructured or cancelled,

tariff rates for non-essential items were raised, a massive wage and

pension hike in the public sector was granted and a likewise massive

recruitment program in several agencies for unemployed graduates was

started. This, together with some reasonable new programs (for poverty

alleviation) led to an immediate slippage in regard to budget targets.

In regard to the peace process, the steering capacity of the previous

government was obstructed by the showdown between the president and the

prime minister, solved only by the dissolution of parliament and new

elections. Steering capacity afterwards was limited by the veto power

of the alliance partners, an internal rebellion in the ranks of the

Tamil rebels and the temporary retreat of the Norwegian peace

intermediaries. Later efforts of the president to bypass parliament by

establishing a National Advisory Council on Peace and Reconciliation

for the elaboration of peace proposals were doomed to failure as the

opposition did not participate. Government and LTTE kept to their

respective extreme positions.

 

3.3. Resource efficiency

Resource efficiency in employing financial and manpower resources was

limited. The public sector became heavily overstaffed, subsidies and

poverty programs were badly targeted, defense expenses simply went out

of control. Generous development assistance could not be used

adequately. This brought massive public deficits and a reduction of

public investments to the bare minimum. After 2002 the situation slowly

improved with the promulgation of the Fiscal Management Responsibility

Act and efforts to streamline the public sector, only to deteriorate

again later. Contributing to moderate resource efficiency are massive

irregularities in the use of public funds and the politically

influenced allocation of resources. Land transactions benefited friends

and relatives of politicians, resources of the poverty program were

simply frittered away.

 

3.4. Consensus-building

Efforts for consensus-building regarding interethnic peace were made by

the government in proposing its version of an interim administration in

the North and East of the country, which however fell short of rebel

demands. Their counter-proposals were hardly negotiable, as it meant de

facto secession. Dim prospects for a compromise solution were never

tested. The government instead relied on a certain military build-up

(as did the Tamil rebels) whilst simultaneously creating a parallel

discussion body for peace proposals outside the parliament.

Consensus building for economic reforms was rather effective under the

last government, as no important interest group opted for a reversal of

reforms. The election outcome in 2004 was interpreted by the government

as a verdict against “neo-liberal economic policies” creating only

growth enclaves amidst countrywide poverty. Consensus-building for a

new growth cum poverty eradication program was easy, as costs of this

new paradigm were imposed on the few consumers of luxury items, while

subsidies were left intact, wages and recruitment in the public sector

were increased in a big way.

 

3.5. International cooperation

The improvement of macroeconomic indicators after 2002 was due in no

small part to the agreement on and enforcement of stand-by and

structural adjustment programs with the IMF and the World Bank,

demanding massive cuts in budget and balance of payments deficits

through a host of reform measures. Due to slippages in some areas

(privatization, labor laws ) and the mounting budget deficit, some

programs were discontinued in Autumn 2003. As the new government is

critical of neoliberal policies in general, collaboration with foreign

donors might become rather difficult. This is also likely because

massive commitments of donors for post-war reconstruction and

rehabilitation were made contingent on progress in peace negotiations

with the Tamil rebels, now stalled since early 2003. In addition, the

government was traditionally not able to absorb foreign aid

productively. Currently more than $3 billion of international aid are

still not used. International collaboration was more constructive in

the use of and calling for international peace mediation.

4. Trend of development

4.1 Democratic development

With regard to democratic development, the suspension of the peace

process was unfortunate, caused by intransigence on the part of the

rebels concerning their demand for a state-like interim administration

controlled only by the LTTE, which were also divided internally for

some time, due to a rebellion of the eastern wing. The government on

its part was unable to secure the support of the opposition and the

president for a generous federal solution and was practically made

immobile after the dismissal of three ministers by the president in

Autumn 2003. The Norwegian mediators retired temporarily, the

government abandoned peace negotiations. The stalemate was only

partially unblocked after the victory of the new left coalition which

initially did not command a majority and was composed of parties averse

to a genuine federal solution to the civil war. The president tried to

bypass the parliamentary process by installing a new forum for the

debate of peace solutions, but without success as the opposition did

not participate.

4.2. Market economy development

 

The Srilankan economy grew in 2003-2004 at a highly satisfactory rate,

supported by the cease-fire and the enforcement of structural

adjustment measures, which both brought an increase of arable area, a

resumption of transport and tourism, a remarkable growth of exports,

remittances and international capital inflow and some easing of budget

and balance of payments pressures. Inflation and unemployment came down

to moderate levels, debt indicators improved. There was however some

slippage in executing of structural reforms, leading to the suspension

of IMF-support. The newly installed coalition government changed track,

proposing a strategy based on national priorities, on the elevation of

rural areas with a focus on health and education, self-sufficiency in

food, a cautious policy toward privatization and trade liberalization,

complemented by a generous increase in wages and pensions for the

public sector. This went along with a certain economic downturn, caused

by rising international oil prices and support shortages due to the

drought. Inflationary pressures were sought to be contained by ad hoc

measures, which, together with the wage hike in the public sector and

softening fiscal discipline, brought again some deterioration in the

budget and balance of payments deficits.

^a Provisional estimates for 2004 are based on information available up to October 2004.
Source: Central Bank of Sri Lanka: Recent Economic Developments. Colombo, Nov. 2004; www.lanka.net/centralbank/index.html: Sri Lanka Socio Economic Data. 2003


D. Strategic perspective

The Srilankan economy has nearly all the prerequisites to play an active role in the international division of labor. It commands a highly qualified, motivated and comparatively cheap workforce (often educated in the English medium), a solid base of national and foreign export-oriented companies, operating in efficiently managed free trade zones and can boast of a rather liberal, not too cumbersome investment regime. The economy was thriving in spite of the ongoing civil war. With decreasing defense expenses, the disbursement of promised rehabilitation and reconstruction assistance by the international donor community, the revitalization of the agricultural and tourism sector in the Northern and Eastern part of the country and increasing international private investment a still higher growth rate is on the horizon.

In addition, Sri Lanka has still untapped potential in broadening its export base toward services and non-traditional agricultural products and becoming a transit base for international trade. These promising prospects are highly dependent on the pursuit of sound macroeconomic policies, market-friendly reforms and above all on efforts to find a lasting solution to the civil conflict. The international community can support this process by binding support to earnest peace efforts of both sides (the government and the LTTE) and insisting on good governance and the maintenance of human rights in using international resources. Sector-wise international assistance should be concentrated on the reconstruction of infrastructure in the war-torn zones, on assistance to bring the public deficit under control, on encouraging labor-intensive growth (with focus on small and medium enterprises), on the control of high electricity costs (by new investment and restructuring of the sector) and on the diversification of agriculture.