2009 Index of Economic Freedom

Quick Facts

Population:

• 19.9 million

GDP (PPP):

• $74.5 billion
• 7.4% growth
• 5.8% 5-year compound annual growth
• $3747 per capita

Unemployment:

• 5.7%

Inflation (CPI):

• 19.7%

FDI Inflow:

• $480.0 million

Sri Lanka’s economic freedom score is 56, making its economy the 111th freest in the 2009 Index. Its score is 2.4 points lower than last year, reflecting declines in six of the 10 economic freedoms. Sri Lanka is ranked 22nd out of 41 countries in the Asia–Pacific region, and its overall score is slightly lower than the world average.

Sri Lanka scores well in business freedom, government size, and labor freedom. Opening a business is relatively easy under the regulatory environment. Government expenditures are still moderate; however, military spending in reaction to political instability has pushed total government spending to a quarter of GDP. Although improvements are still needed, the labor market is relatively flexible.

Sri Lanka's trade freedom and fiscal freedom scores are just below average. The average tariff rate is not extremely high, but non-tariff barriers and corruption increase costs associated with trade. Monetary freedom, investment freedom, financial freedom, property rights, and freedom from corruption are all weak in Sri Lanka. Inflation is very high, and prices are unstable. The government generally welcomes foreign capital, but formal restrictions and the security situation are deterrents to investors. The financial system is small but growing and would benefit from greater transparency.

Background Back to the top

Sri Lanka maintains a democracy despite a three-decade civil war. In January 2008, the government of President Mahinda Rajapakse announced its withdrawal from a 2002 cease-fire agreement with the Liberation Tigers of Tamil Eelam and stepped up its campaign against the rebels. Despite the violence, the economy has grown between 6 percent and 7 percent annually in recent years. Textiles and garments account for most export growth, but Sri Lanka remains poor, and about 31 percent of the workforce is employed in agriculture. Sri Lanka depends heavily on foreign assistance, and China has become a significant lender for infrastructure projects.

Business Freedom 73.7 Back to the top

The overall freedom to conduct a business is relatively well protected under Sri Lanka's regulatory environment. Starting a business takes about the world average of 38 days. Obtaining a business license takes less than the world average of 225 days, but costs are high. Closing a business is relatively simple.

Trade Freedom 71.0 Back to the top

Sri Lanka's weighted average tariff rate was 7 percent in 2006. Import bans and restrictions, services market barriers, import taxes, import fees, import licensing, restrictive standards, non-transparent government procurement, weak enforcement of intellectual property rights, export subsidies, and corruption add to the cost of trade. Fifteen points were deducted from Sri Lanka's trade freedom score to account for non-tariff barriers.

Fiscal Freedom 73.2 Back to the top

Sri Lanka has burdensome tax rates. The top income tax rate and the top corporate tax rate are 35 percent. Other taxes include a value-added tax (VAT), a property tax, and a tax on interest. In the most recent year, overall tax revenue as a percentage of GDP was 15.3 percent.

Government Size 80.5 Back to the top

Total government expenditures, including consumption and transfer payments, are moderate. In the most recent year, government spending equaled 25.5 percent of GDP. No significant progress has been made in privatization during the past year. Political instability has driven up military expenditures and prevented the implementation of needed fiscal governance reforms.

Monetary Freedom59.4 Back to the top

Inflation is very high, averaging 16.4 percent between 2005 and 2007. The government influences prices through regulations, state-owned enterprises, and subsidies for a wide array of goods. Fifteen points were deducted from Sri Lanka's monetary freedom score to account for policies that distort domestic prices.

Investment Freedom20.0 Back to the top

In general, foreign investment is welcome. The government allows 100 percent foreign ownership in certain sectors and imposes ownership limits in others. Investment is screened and may need approval in some cases. Major investments, such as infrastructure projects, require approval from the full cabinet. Foreign investment is disallowed in a number of services sectors. Security concerns, inconsistent and non-transparent regulation, burdensome labor laws, inadequate infrastructure, and cumbersome bureaucracy are other impediments to investment. Outward direct investment must be approved by the government. Residents and non-residents may hold foreign exchange accounts subject to requirements, including government approval in some cases. There are strict reporting requirements and limits on payments and transfers. Capital transactions are subject to many restrictions and government approval in some cases. Private land ownership is limited to 50 acres per person. Foreign investors can purchase land, but there is a 100 percent tax on such transfers.

Financial Freedom40.0 Back to the top

Sri Lanka's financial system is growing but remains vulnerable to government influence. Banking dominates the financial sector, but high credit costs discourage more dynamic business activity. Regulations permit 100 percent foreign control of banks, insurance companies, and stockbrokerages. Reforms in 2004 helped to improve banking regulation. Regulations are largely consistent with international standards, but supervision and enforcement are insufficient. The central bank is not fully independent. The government influences the allocation of credit and uses half of domestic financial resources to finance government borrowing. The two largest commercial banks are state-owned, and the government opened a new development bank in 2006. Capital markets are centered on the Colombo Stock Exchange, which is modern but relatively small and affected by the ongoing political violence.

Property Rights40.0 Back to the top

The judiciary is influenced by other branches of government, and extensive delays lead investors most often to pursue out-of-court settlements. Intellectual property rights come under both criminal and civil jurisdiction. International recording, software development, motion picture, clothing, and consumer product companies claim that lack of IPR protection damages their businesses.

Freedom From Corruption32.0 Back to the top

Corruption is perceived as widespread. Sri Lanka ranks 94th out of 179 countries in Transparency International's Corruption Perceptions Index for 2007. Anti-corruption laws and regulations are unevenly enforced. The police and the judiciary are viewed as the most corrupt public institutions. Corruption in customs clearance enables wide-scale smuggling of certain consumer items.

Labor Freedom70.8 Back to the top

Sri Lanka's relatively flexible labor regulations could be further improved to enhance overall employment and productivity growth. The non-salary cost of employing a worker is moderate, but the difficulty of firing a worker creates a disincentive for additional hiring.