Public Disclosure Authorized CONFIDENTIALdocuments.worldbank.org/curated/en/961041468914494503/pdf/SD… · Budgetary Gains from Food Subsidy Suspension ... Is not it possible to

CONFIDENTIAL

PUBLIC FINANCE DIVISION PAPER NO. 20

FOOD DISTRIBUTION PROGRAM OF SRI LANKA

BY

KAZUKO K. ARTUS

Development Economics DepartmentDevelopment Policy Staff

June 1976

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FOOD DISTRIBUTION PROGRAM OF SRI LANKA

Table of Contents

Page

I. Summary and Conclusions ............................... 1

II. Economy of Sri Lanka .................................. 6

III. Food Subsidy/Food Distribution Program ................. 8History of the Program .............................. 8Present Food Ditribution Program .................... 8Food Subsidy ........................................ 10

IV. Balance of Payments ................................... 12

Food Import Bill .................................... 12

Resource Allocation ................................. 16

V. Government Budget ..................................... 20

Criticism of Food Subsidy ............................ 20Budgetary Gains from Food Subsidy

Suspension ........................................ 21

Effect of Food Subsidy Suspensionon Resource Allocation ............................ 24

Budgetary Revenue ................................... 25

Budgetary Resources and Foreign Exchange ............ 28

Industrial Public Corporations ...................... 30

VI. Food Subsidy for Development Policy ................... 32

Tables

Table 1: Rice DistributionTable 2: Flour DistributionTable 3: Sugar DistributionTable 4: Per Capita ConsumptionTable 5: Rice Cost and SubsidyTable 6: Annual Rice Ration and Subsidy

Per CapitaTable 7: Import of Rice, Flour and Sugar

for Distribution Program

Table 8: Food Imports - Quantity and Price

Table 9: Sources of Food ProcurementTable 10: Paddy Production and GPS Purchase

Table 11: Paddy PricesTable 12: Food Stocks of the Food CommissionerTable 13: Budgetary Operation

Annex: Technical Note on Food Subsidy StatisticsFood Subsidy Statistics and Government Accounts

Composition of Food Subsidy

I. Summary and Conclusions

The government of Sri Lanka has maintained for three decades a

food ration scheme combined with food subsidies to "guarantee the supplyof basic foodstuffs at prices that everybody can afford." Although its

favorable effect on the distribution of personal consumption has been

recognized, the program has also elicited critical attention from various

quarters.

The critics argue that the program constitutes an obstacle to

the growth of the Sri Lanka economy because (i) the food subsidy preempts

budgetary resources available for the developmental programs and projectsof the government, and (ii) the food import bill for the program preemptsforeigh exchange available for investment and production. 1/

As the economy tended to stagnate after the mid-1950s, suchcriticisms gained momentum. By now, it has become a commonly held viewthat the food subsidy/food distribution program is a policy that may begood for the welfare of the present population but bad for economic growthand therefore bad for the welfare of the future population.

However, the government has found it extremely difficult toremove the program. With the unemployment rate exceeding 20%, the suspen-sion of the food subsidy/food distribution program would bring about thestarvation of a large number of people. 2/ Furthermore, there is a fearthat an attempt to remove the program would seriously weaken the popularsupport of the government. 3/

1/ The annual food subsidy amounts to over 20% of budgetary revenue, andthe annual food import bill for the food distribution program amountsto over 30% of foreign exchange earnings from exports.

2/ At present, the food subsidy provides practically everybody with anincome in kind equivalent to 4% of the legal minimum wage.

3/ The fear is based on the observation that attempts to reduce rice ration,which has been the core of the program, were usually followed by periodsof political instability, ending in the fall of the government or theresignation of major cabinet members. The extent to which these wereattributable to the proposed reduction in rice ration cannot be determined.

The program has been operated as a welfare state measure, for the benefitof the general public, and not as a poor relief scheme. It is difficultfor outsiders to imagine the social and psychological impact of withdraw-ing the program. It might be similar to the impact of withdrawing agovernment financed compulsory education program.

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The critics argue that nevertheless the program has to be with-

drawn in order to accelerate the economic growth, which would reduce unem-

ployment and the continuous threat of mass starvation. Their view is (i)

that the growth can accelerate if and only if resources are released from

the food subsidy/food distribution program, (ii) that the accelerated growth

will be accompanied by a substantial increase in employment, and (iii) that

the gains of the future population from the accelerated growth justify the

hardship that the suspension of the program will bring about to the present

population. This paper attempts to examine the validity of .critics' argu-

ments and see if it is indeed necessary for Sri Lanka to abandon the food

subsidy/food distribution program.

The principal source of the difficulty of the Sri Lanka economy

is its inability to increase foreign exchange earnings through exports.

The country is very much dependent on imports both for production and con-

sumption; its mineral resource base is narrow, little machinery is manufac-

tured locally, and the country is not self-sufficient in staple food (riceand wheat flour). 1/ Superimposed on this is the unfavorable market con-

dition for the traditional exports (tea, rubber, and coconut products),

which constrains the import capacity of the country.

* As this market condition is likely to continue, Sri Lanka has to

diversify its exports to increase foreign exchange earning in order to ac-

celerate the economic growth. This would involve a substantial investment

for the restructuring of the economy.

The view that the food subsidy is a major issue stems from the

recognition of the need for such investment. As the political climate in

the country is unfavorable to private businesses, the private sector cannot

be expected to undertake substantial productive investment. 2/ Therefore,

the investment for the economic restructuring has to be undertaken by the

public sector. The critics of the food subsidy assume that such investment

has to be financed by the saving of the public sector, and argue that the

food subsidy prevents the investment because it absorbs a large portion of

budgetary revenue.

However, in fact the investment of the public sector does not have

to be financed by public sector's saving. It is not the size of public sec-

tor's saving but the size of the national saving that potentially constrains

1/ Historically, the Sri Lanka economy had been structured to grow tea,

rubber, and coconuts for exportation and to fill the consumption needswith imports.

2/ This is an oversimplified description of the state of the economy. Thebusiness climate is unfavorable to the creation or expansion of large

private businesses, but small entrepreneurs and co-operative societiesare not discouraged.

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the investment of the public sector. 1/ Admittedly, the saving of the

private sector is not immediately available for public sector's investment.

It has to be transferred to the public sector before the latter can use it

for public sector's investment. For a given level of public investment

expenditure, the required amount of the transfer would be larger with a

larger food subsidy (or general administration expenditure, or defenseexpenditure, for that matter) . Thus, the food subsidy can be an issue if anincrease in the transfer is undesirable.

This is not the case in Sri Lanka at present. The available

statistics show that close to 50% of the gross national saving is invested

in "buildings and certain other construction" by the non-government sector,

most of which is residential construction in the private sector. Thus,

there is a considerable room for increasing resource transfer from the

private sector to the public sector without adversely affecting the produc-

tive investment of the private sector. Therefore, the food subsidy is not a

major issue, although the low level of productive investment by the public

sector is one. 2/

The binding constraint on production and investment in-Sri Lanka

is the very limited availability of foreign exchange. Therefore, theprincipal issue is how to break the vicious cycle of low foreign exchangeearnings and low investment using the available foreign exchange.

The large food import bill makes the situation difficult. How-ever, since doemstic food production falls short of the consumption require-ment, the suspension of food imports will cause hardships to the popula-tion. 3/

The view of the critics of the food distribution program isthat saving on the food import bill is the only way to relax the foreign

exchange constraint on production and investment. But is that really so?Is not it possible to reduce the import requirement for production andinvestment?

1/ "Potentially," because the bindig constraint on productive investmentis not saving but foreign exchange availability at present.

2/ A more important issue, however, is the low level of total productiveinvestment (probably below 10% of GNP).

3/ Per capita rice consumption since 1972 has been about 8% lower thanthe level in the earlier years. The estimated per capita sugar con-sumption in 1975-1976 is only 25% of the level in 1970-1971. Withoutimports, the per capita consumption of rice and sugar in 1976 would be

77% and 7% of the 1970-1971 level, respectively, and no wheat flourwould be available.

The country has a large reserve of idle labor. If the economycan convert this idle labor into exports or import substitutes, then theforeign exchange constraint on growth will be relaxed. 1/ However, theexploitation of this potential is prevented by the minimum wage rate settoo high relative to labor productivity.

This barrier could be overcome through a massive investment,which will raise the productivity of labor. However, the prevailing factorprices attract entrepreneurs to capital intensive industries. and capitalintensive technology, and also to capital intensive forms of investment. 2/Thus, under the prevailing factor prices, this strategy will be frustratedby the foreign exchange constraint. The situation may be somewhat relievedin the absense of the food import bill, but even then the limited exportearnings will not be able to support such imports.

Alternatively, the relative factor prices can be altered tomake the use of labor more attractive, i.e., by raising the prices ofmachinery and plants on one hand and by reducing the real minimum wage rateon the other hand. The use of capital goods can be made less attractive byincreasing taxes on capital good imports and revising income tax concessionsagainst machinery and plants. However, these measures taken alone cansimply discourage productive investment in general, rather than encouragelabor absorbing investment.

It is necessary to reduce wage rate at the same time in orderto compensate for the negative impact of the increased cost of machineryand plants on the profit expectation of entrepreneurs. In particular, thereal minimum wage rate has to be reduced to encourage new investment inlabor intensive industries with labor intensive methods. 3/

1/ The foreign exchange "requirement" for production can be divided intothe part associated with productive investment and the part associatedwith inputs such as raw materials. In a given industry, the lattercannot be reduced easily, although in some cases it would be possibleto develop domestic substitutes for imported inputs. Therefore, thesubstitution of labor for foreign exchange would, at the initial stage,have to be effected by substituting labor for machinery and plantsfor investment (e.g., factory construction mainly with labor and usingvery little machinery) and production (i.e., development of labor inten-sive industries and adoption of labor intensive technologies ratherthan industries and technologies requiring machinery and plants).

2/ The past investment pattern of public corporations show that they arealso subject to the influence of prevailing factor prices. Therefore,the problem of factor prices cannot be ignored even if it can be assumedthat only the public sector will undertake investment.

3/ For the purpose of affecting the new investment, the critical factoris the reduction of the real minimum wage rate, as this will permitemployers to offer workers with low productivities for correspondinglylow wages. This would have to be effected through a general priceincrease, as a (legislative) reduction in the nominal minimum wagerate is politically infeasible.

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The major constraint to this measure is that the real wage ratecannot be reduced beyond a certain subsistence level. However, if workers'earnings are augmented with non-wage income, the scope is enhanced forreducing the real wage rate. The food subsidy program does indeed provideeverybody a supplementary income, and makes it possible for real wage rateto fall short of the subsistence income level.

The suspension of the food subsidy program removes this supple-mentary income, and fixes the lower limit for the minimum wage rate. More-over, the initial effect of food subsidy withdrawal will be an increasein wage rate. As the prices of imported capital goods will not be affectedby the wage increase, the relative factor prices will move further againstthe use of labor and in favor of the use of imported capital goods. Further-more, the domestic inflation that would follow the wage increase will weakenthe competitiveness of Sri Lanka exports and will prevent an increase inexports. In short, the impact is undesirable.

Thus, this paper concludes that the food subsidy/food distributionprogram should be retained as a part of a general strategy for restructuringthe economy. However, efforts should be made to minimize the food importbill to the greatest extent possible without causing a serious hardship. I/Even when the import requirement for production is reduced through a changein relative factor prices, the need for imported capital goods cannot beeliminated. Moreover, because of the resource endowment of the country, themanufacturing sector will continue to depend on imports. The size offoreign exchange available for productive imports will remain the majordeterminant of the growth rate for some time to come.

1/ A reduction in food imports leading to a starvation must be avoided,for then the productivity of labor will be affected adversely.

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II. Economy of Sri Lanka

The controversy over the food subsidy/food distribution programstems from the concern upon the state of the Sri Lanka economy. The pro-blems associated with the program have to be examined against this back-ground.

The income level in Sri Lanka is low, with per capita GNP ofabout US$200 at the official exchange rate. 1/ What is more significant,however, is its low growth rate. In the period from 1961 to 1969, GNP grewat about 4.6% a year on average, and per capita GNP grew at about 2% ayear. In the 1970s the growth further slowed down. The average GNP growthrate declined to 2.9% a year, and the average per capita GNP growth rate toonly 1% a year. The labor force expanded at 2% a year in the last fouryears, but the economy was able to absorb only a fraction. The rate ofunemployment rose from 18% in 1971 to 20% in 1975.

The saving rate has been about 13% for a decade and half, andthe investment rate has been about 16%. These figures are low by inter-national comparisons. Nevertheless, the low saving rate does not seem tohave been the factor limiting the growth rate.

In the period from 1961 to 1974, ICOR with one year's lag fluc-tuated between 1.9 and 24, averaging at 5.9. 2/ A major factor accountablefor the extremely high ICOR is that a large proportion of investment isnot productive. For a decade and a half, non-government investment in"building and certain other construction" accounted for about 40% of thegross domestic acpital formation. Most of this represents residentialconstruction in the private sector. The average ratio of productive invest-ment to gross national saving has been about 75%. It may have been possiblefor the economy to grow faster, with the same saving rate, had the composi-tion of investment differed.

However, the size of productive investment has been constrainedbecause little foreign exchange was available for the importation of capital

1/ The official rate is Rs. 7.7 per US$. However, a large part of foreigntrade is subject to FEECs, which raises the effective rate to Rs 12.7 perUS$.

2/ Calculated as IR(-1)/[GDPR-GDPR(-1)J, where IR and GDPR stand forgross domestic capital formation and GDP in constant market prices,respectively. The negative figures for 1970 and 1971 associated withdeclines in GDPR have been excluded.

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goods. 1/ Moreover, productive investment did not always bring about asignificant increase in output, also because the limited availability of

foreign exchange prevented an increase in the importation of inputs required

for production. 2/

The major short-run constraint on the growth has been the inabilityof the economy to increase foreign exchange earnings. Sri Lanka is endowedwith very little mineral resources. Its agriculture, which had been struc-tured to specialize in tea, rubber and coconuts for exportation, does not

produce quantities of staple food crops enough to meet the consumptionrequirement. Very little capital goods are locally manufactured. Further-more, the manufacturing industries require all sorts of imported inputs.Thus, the country is very much dependent on imports for both production andconsumption, which makes the level of economic activities highly sensitiveto the import capacity of the country.

Historically, Sri Lanka earned foreign exchange almost exclusivelythrough the exportation of tea, rubber, and coconut products. The stagnationof the economy began when the condition of the markets for the traditionalexports tightened and the terms of trade began to move against Sri Lanka,which constrained the import capacity of the country. 3/ Unfortunately,the unfavorable market condition for the traditional exports is likely tocontinue in the foreseeable future.

Therefore, the long-term economic growth depends on the successin the development of new export industries; as it is the only way toexpand the import capacity. This strategy requires a large investment forthe restructuring of the economy. However, such investment also tends to beconstrained by the limited import capacity.

1/ In the 1970s, the unfavorable business climate seems to have furtheraffected the composition of investment. The average ratio of the"buildings, etc." to total investment increased significantly from37% in 1961-1969 to 42% in 1971-1974.

2/ This tendency became apparent in the 1970s, after the suspension of theOpen General License (OGL) Scheme, which was replaced by import quotasystem in 1970.

3/ The world price of tea began to decline after mid-1950s. The averageprice in the 1970-1974 period was 76% of the average price in the 1954-1958 period. The decline in world rubber price began in the early 1960s.The ratio of exports to GNP followed a downward trend after the mid-1950s,when it was about 37%. In the 1970-1974 period, the average ratio fellshort of 17%.

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III. Food Subsidy/Food Distr*,bution Program

History of the Program

The food subsidy/food distribution program has its origin ina wartime ration scheme introduced in 1943. The scheme was inheritedby successive post independence governments, which expanded it to covera variety of subsidiary foodstuffs in addition to rice. These post inde-pendence governments all committed themselves to a welfare state policy,in which the "guarantee of the supply of basic foodstuffs at prices thateverybody can afford" was incorporated.

In the early post independence years, the food distributionprogram depended almost exclusively on imported food, as the domestic

agriculture sector produced little surplus food crops. The food import billwas financed by the foreign exchange earnings of the traditional exportsector. A major part of the government expenditure for the program was alsofinanced by export taxes collected from the traditional export sector.

The market for the traditional exports was buoyant, and so wasthe income of the traditional export sector. As there were very few manu-facturing industries to produce consumer goods in the country, the risingincome of the traditional export sector tended to flow out for foreignconsumer goods; without benefitting the rest of the country, which wasengaged in subsistence farming. Food subsidy financed by the export taxesfunctioned as a convenient vehicle for diffusing the gains of the traditionalexport sector to the entire population.

However, developments in the export markets after the mid-1950saffected the means of financing the food import bill and the food subsidy.Critical attention began to focus on the program for its impact on govern-ment budget and on the balance of payments. 1/

Present Food Distribution Program

The scale of the food distribution program was reduced over timeafter the mid-1960s. Since 1974, only four items have been on the program;rice, wheat flour, sugar and infant milk food. The principal item isrice, as it always has been.

Rice is distributed on a two-tier ration basis, at (i) one pounda week, free of charge, to everybody except for income tax payers and theirdependents, and (ii) another pound a week to everybody at a price not much

1/ Concern over the food subsidy was present even earlier. The governmentmade its first attempt to reduce the scale of the program as early as inFY 1952/53.

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below the purchase cost (Table 1). 1/ Wheat flour is distributed in unlimit-

ed quantities at a price also not much below the purchase cost (Table 2). 2/

Sugar is distributed partly on a ration basis, but the government also

undertakes off-ration sales. The ration quantity is 0.75 pound a month for

everybody at Rs. 0.72 a pound (Table 3). Milk food is distributed for

infants and expecting mothers at sub-market prices.

The present annual ration package for the majority of the popula-tion thus consists of 104 pounds of rice and 9 pounds of sugar. This ration

package covers about 50% of per capita rice consumption and about 75% of

present per capita sugar consumption. 3/

Ration Quantity and per Capita Consumption(Pounds)

Rice Sugar

Ration Quantity 104 9

Per Capita Consumption 207 /a 12 /bRation Quantity

as % of Per Capita Consumption 50 75

/a 1972-1974 average./b Estimate for 1976.

Source: Central Bank of Ceylon; Food Comissioner's Department; and Table 4.

Although the policy to "guarantee the supply of basic foodstuffs

at prices everybody can afford" has been maintained for three decades, no

explicit rules have been established concerning the determination of the

parameters of food distribution program such as ration quantities and food

distibution prices. The decision on these parameters is at the discretion of

the government. "Prices that everybody can afford" are not defined explici-

tly, either. The government is therefore under no legal obligation to

distribute foodstuffs at below-cost prices.

1/ The price of the second pound has been Rs. 1.00 since November 1975.

The residents of rice defict areas are entitled to two pounds a week of

paid ration.

2/ The present price is Rs. 1.10 a pound, which slightly exceeds the

estimated average cost in 1976. Previously, wheat flour was alsorationed in the period from October 1973 to March 1975.

3/ Available statistics show that the annual per capita rice consumptionhas been about 210 pounds since 1972, which is 8% lower than theaverage in the period from 1960 to 1971. Per capita sugar consumtpionwas about 50 pounds in FY 1969/70 and FY 1970/71, the last two yearsbefore the introduction of sugar rationing. The quantity declinedlater, and fell to 10 pounds in 1975. In 1976, it is estimated at 12pounds (Table 4).

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The responsibility of administering the food distribution programrests with the Food Commissioner's Department (FCD). 1/ The FCD is thesole importer of rice, wheat flour and sugar. Domestic products are pur-chased from the following three public corporations: Paddy Marketing Board(PMB), which purchases paddy from farmers at prices fixed under the Guaran-teed Procurement Scheme (GPS), and mills rice for the FCD; 2/ Ceylon StateFlour Milling Corporation (CSFMC), which is the sole wheat grain importerand also the sole wheat flour miller; and Sri Lanka Sugar Corporation(SLSC), which is the sole sugar manufacturer. 3/

Food Subsidy

Foodstuffs distributed by the government are often priced atlevels below the cost of acquisition and distribution, as the principalpurpose of the food distribution program is to ensure that everybody canobtain some basic food. However, the government has not always subsidizedall foodstuffs ic distributed. 4/ In most years since the beginning of thefood distribution program, the government derived some profits on the saleof certain foodstuffs.

Rice has been the most heavily subsidized item. In the periodfrom FY 1970/71 to 1975, the FCD receipts from rice sales covered less thanhalf of the cost for rice purchase and distribution. 5/ However, the paidration rice was not always subsidized. In a short period in 1973 the priceof paid rice was set at 175% of the average cost of rice distributed (Table5). At present, the price (Rs. 1.00 a pound) is about 90% of the estimatedaverage cost of rice to be disbributed in 1976.

1/ Except for infant milk food, the distribution of which is administeredby the Controller of Imports and Exports.

2/ Legally, the PMB is the monopoly purchaser of domestic paddy. However,as it does not usually exercise the monopoly right, private paddy trad-ing exists openly most of the time. The PMB has some rice milling facil-ities, but a substantial amount of paddy is contracted out to privaterice millers.

3/ The SLSC grows some sugar cane, but it also purchases cane grown byindependent farmers.

4/ The term "food subsidy" used in the Sri Lanka government accounts refersto the excess of the actual cost incurred by the FCD for purchasing anddistributing foodstudds over the proceeds from the sale. It is not theexcess of the current market value over the sales proceeds. Therefore,it is possible, when food prices are falling, for the "food subsidy" tobe positive even though the government were charging prices above whatit is paying. Furthermore, the "cost" includes taxes and other paymentsfrom the FCD to the government. Hence the "food subsidy" does not reflectthe net cost to the government of the policy to maintain food prices lowfor consumers. Further details are described in the Annex.

5/ However, this ratio t-nded to rise in this period. Rice sale proceedscovered about 30% of the total cost for acquiring and distributing therice rationed in FY 1970/71 and FY 1971/72. In 1975, the ratio was 48%.

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Ration sugar has been subsidized always since sugar ration was

introduced in late 1971. The present ration price (Rs. 0.72 a pound) is

about 29% of the estimated average cost for acquiring and distributing sugar

in 1976. However, the average cost includes import duty and FEEC charge,

which together account for 31% of the cost.

Off-ration sugar was rarely subsidized after 1971. The average

off-ration price in 1974 exceeded 300% of the average cost, of which 20%

was accounted for by FEEC charge and import duty. The present off-ration

price (Rs. 6.00 a pound) is about 240% of the estimated average cost.

The amount of subsidies on a standard ration package has been

about 4% to 5% of per capita GNP at factor cost since FY 1970/71 (Table

6). 1/ The present standard ration package carries subsidies of about Rs.

82 as shown below. 2/ The estimated subsidies on wheat flour and off-ration

sugar under the present food distribution parameters are negative, at Rs.

-0.11 a pound and Rs. -3.53 a pound, respectively.

Estimated Per Capita Subsidy on a Standard 1976 Ration Package

Quantity to be Subsidy per Annual Subsidy

Distributed Pound on Ration

(lbs.) (Rs.) (Rs.)

Free Rice 52 1.14 59

Paid Rice 52 0.14 7

Ration Sugar 9 1.75 16

Total 82

The results of the 1973 consumer finance survey indicated that

the average ratio of the number of persons to number of income earnersin a family was about four. In the case of a non income tax paying familyof four persons in a non rice deficit area, the total annual subsidy on

ration rice and ration sugar would be about Rs. 330. This exceeds 15% of 12

month earnings of a person employed at the present minimum wage rate (Rs.

180 a month).

1/ "A standard ration package" refers to the combination of rations forwhich a non tax paying person in non rice deficit area is entitled.

2/ This refers to the standard ration package that became effective onNovember 6, 1975.

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IV. Balance of Payments

The drain of foreign exchange associated with the food distri-bution program has been one of the major reasons for the criticism of theprogram. The imports of rice, wheat flour, sugar and wheat grain forthe food distribution program exceeded 30% of the foreign exchange earningsfrom exports in most years since the mid-1960s (Table 7). However, it isnot only the size of the food import bill that causes the criticism.

Since the present exchange rate does not clear foreign exchangemarket, the government allocates foreign exchange through a foreign exchangebudget. In this allocation, the food imports for the food distributionprogram receive the top priority. Therefore, the food imports indeed preemptforeign exchange available for productive purposes.

Food Import Bill

Domestic food production, though it has increased significantlyafter the mid 1950s, still falls considerably short of the consumptionrequirement. Since the FCD is the sole importer of rice, wheat flour andsugar, it has to import these foodstuffs not only for ensuring the operationof the food distribution program but also for filling the gap between theconsumption requirement and domestic production. Therefore, the importcontent of the FCD food procurement tends to be much higher than the importcontent of domestic food consumption. In the period from FY 1969/70 to1975, the import content of the FCD food procurement was 45% to 70% forrice, over 80% for wheat flour, 1/ and over 70% for sugar (Table 9).

The size of the annual food import bill for the food distributionprogram depends mainly on three factors: (i) FCD's food requirment, (ii)the supply of domestic foodstuffs to the FCD, and (iii) world market foodprices. The government cannot control world food prices. The possibilityfor controling the food import bill by buffer stock adjustment is alsolimited at present, because of the tight foreign exchange situation thatprevents the FCD from receiving a sufficiently large foreign exchangeallocation for food stockpiling even at times of low food prices in worldmarkets. FCD's stocks are usually maintained at the minimum levels requiredfor the smooth operation of the distribution program. 2/

I/ In addition, domestic wheat flour production depends entirely onimported wheat grains.

2/ Table 12 shows the size of FCD food stocks in the recent years.In the 1973-1975 period, the opening stock of rice was less than 10%of the annual distribution. The highest ratio for flour was 17%.The ratio for sugar in 1973 and 1974 was high, at 42% and 47% respec-tively, but this was due to the reduction in sugar distribution inthese years.

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FCD's food requirement is determined, given the population of thecountry, by the quantities of food that the government promises to distributeto each person. Theoretically, the government can manipulate the latterfreely, as there is no legal basis for the determination of food distributionparameters. However, because of the committment to the welfare state policy,

the government has actually only a limited degree of freedom in reducingthe food distribution.

At times of rising or high food prices in world markets, the govern-ment has attempted to control the food import bill by reducing the distribu-tion quantities. However, such attempts have been frustrated because of

this limitation. Fluctuations in world food prices have been far widerthan the feasible changes in food distribution quantities. Furthermore,there is a strong parallelism among the import prices of rice, wheat grain,wheat flour and sugar, which tends to intensify the fluctuations in the FCDfood import bill. 1/

Domestic procurement depends not only on domestic production butalso on the willingness of farmers to sell paddy and sugar cane to PMB andSLSC, respectively. In the case of paddy, PMB is subject to competitionfrom private paddy/rice traders. In the case of sugar cane, SLSC is subjectto competitions from private jaggery manufacturers.

The PMB offers price fixed for paddy under the GPS, which is usuallyset somewhat above the paddy-price-equivalent of rice import price at the

official exchange rate. This paddy purchase price is fully reflected in

the price at which the PMB sells rice to the FCD. Thus, the paddy GPS priceaffects the budgetary cost of rice rationing directly. For this reason,the government tends to be somewhat reluctant in raising the paddy GPS price.

Since there exists private paddy/rice trading, attempts to minimizethe budgetary cost of rice subsidy tend to reduce PMB paddy procurement, and

hence to increase the rice import requirement of the FCD. This tendency is

1/ The coefficient of correlation calculated from the statistics for the1965-1975 period is 0.98 between rice import price and wheat flour im-

port price, and 0.94 between rice import price and sugar import price.

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strong when rice ration quantity is less than four pounds a week, which hasbeen the customary level of per capita consumption. 1/

Thus, there are some possibilities for reducing rice imports by adoptingthe principle of the full utilization of domestic paddy in a stricter manner.This would require that PMB purchase paddy at prevailing open market prices,instead of any fixed prices. In fact, there is not much justification forfixing the paddy purchase price at the GPS level. Originally, the GPS wasconceived as a measure to guarantee farmers of a minimum paddy price andto encourage farmers to increase production; it was particularly intendedto free farmers froi temptation to hold back production increase out of thefear that an increased output might cause a fall in the price and theirincome. It would be best to reserve the GPS for the original purpose, and letthe PMB purchase paddy at open market prices as long as the latter remainabove the GPS level. Although this strategy may increase the budgetary costof the rice subsidy, the additional foreign exchange allocation for productiveimports it allows is likely to generate an additional budgetary revenuegreater than the additional food subsidy cost. 2/

The domestic production of sugar is still small. Sugar productionin Sri Lanka began in 1960, and the output increased from 522 long tonsin the first year of production to estimated 19,000 long tons in 1974.However, this was still only 6 percent of the quantity needed to permit thelevel of per capita consumption at 50 pounds a year, to which the populationwas accustomed. In 1976, the production is estimated as 21,000 long tons.

1/ For two reasons. With rice ration quantity below the customary con-sumption level, farmers tend to retain a larger portion of their paddycrops for home consumption. The demand for open market paddy/ricefrom consumers other than paddy farmers is also stronger, and thistends to raise the open market paddy price above the GPS price. Inthe period from 1960 to 1966, when weekly ration per person was 4 pounds,the open market paddy price remained below the GPS price (Table 11),and the ratio of GPS purchase to paddy production exceeded 50%. At theend of 1966, weekly rice ration was reduced to 2 pounds a person. Theopen market paddy price rose by 23% in 1967, and exceeded the GPS price.The GPS purchase ratio fell from 61% in 1966 to 28% in 1967. The GPSprice was raised by 17% at the end of 1967, but the open market paddyprice also rose by 17% in 1968, and the GPS purchase ratio continuedto decline. In September 1970, the rice ration quantity was restoredto 4 pounds. The open market price fell in 1970 and 1971, althoughit still remained above the GPS price. The GPS purchase ratio rosefrom 21% in 1969 to 34% in 1970 and 48% in 1971. In the period fromOctober 1973 to March 1974 the weekly rice ration quantity fluctuatedbetween 1 pound and 2 pounds. The data are not available on the openmarket paddy price after 1973, but the GPS purchase ratio declined inthe period from 1973 to 1975.

2/ This point is elaborated in Section V.

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The major constraint on the increase in domestic sugar production isthe difficulty in increasing sugar cane production. The factories of theSLSC are operating at about 40% of the capacity. A recent study suggests thatsugar cane production is constrained by the limited foreign exchange availablefor sugar land development (mainly machinery) in addition to insufficientirrigation facilities available for sugar cane cultivation. I/

Nevertheless, sugar cane production has responded fairly well to therise in sugar prices in 1973-74. The increase in the off-ration sugar priceby 230% from Rs. 1.50 a pound in January-May 1973 to Rs. 5.00 a pound inMarch-September 1974 was accompanied by a 60% increase in sugar outputin 1974. 2/ Therefore, it may be possible to induce further output in-crease by an adequate pricing policy. 3/

No attempt is being made to grow wheat domestically. It is believedthat the climatic condition in Sri Lanka does not permit economic cultiva-tion of wheat. 4/ Therefore, the government distribution of wheat flouris entirely dependent on imports, either imported wheat flour or wheat grainsimported and milled by the CSYMC.

The import bill for the distribution of a given quantity of flour can,. nevertheless, be marginally reduced by importing wheat grains rather than* wheat flour. 5/ In some cases, the budgetary cost of flour purchase can also

1/ R. C. Wanigatunga, "Some Problems Faced by Sri Lanka's Sugar Industry,"Central Bank of Ceylon Bulletin, February 1975, pp.110-127.

It is estimated that in 1975 prices the foreign exchange component ofsugar land development cost exceeds 75% of the total cost. The estimatedforeign exchange cost of sugar land development for allowing an increasein sugar production by one long ton was about Rs. 9,000 in 1975 prices.

2/ In addition, there is an indication that the production of jaggeryalso increased substantially.

3/ However, the price elasticity indicated above is only 0.4. Further-more, the increase in sugar cane output was probably achieved at theexpense of other products. A large increase in sugar cane productionwould have to come from an extension of sugar cultivation to new lands.

4/ For this reason, wheat flour was not consumed in any significant amountuntil recent decades. However, since foreign aids brought about largequantities of wheat flour, it has become the second staple food inSri Lanka. It is observed that in working class households bread ispreferred to rice because the preparation of a meal with bread is farless time consuming than the preparation of one with cooked rice.

5/ The ratio between the import price of one long ton of wheat grain tothat of one long ton of wheat flour has been about 0.7. The grainto flour conversion rate of CSFMC is estimated as about 100/72. Hence,the foreign exchange cost of one long ton of domestic flour is about97% of that of imported flour.

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be reduced by using the flour milled domestically. For example, it is ex-

pected on the basis of standing contracts that the flour price of the CSFMC in

1976 (Rs. 1,916 per long ton) will be Rs. 96 per long ton lower than the

landed cost (c & f) of flour to be imported from Australia (Rs. 2,012 per long

ton). However, the potential for increasing domestic flour milling is con-

strained by the factory capacity of CSFMC, which is 72,000 long tons at

present.

Resource Allocation

Thus there are some possibilities for zeducing the food import bill

for a given set of parameters of the food distribution program, and they

have to be fully exploited. However, such possibilities are limited, for

domestic food production falls short of the consumption reqtirement. It

has been observed that Sri Lanka has good potential for increasing the pro-

duction of paddy and sugar cane, 1/ but it will take several years before

the potential can be realized.

If the food import bill were to be reduced substantially, and to be kept

small in the near future (no matter how food prices may behave in world

market), the total consumption of rice, wheat flour and sugar must be reduced

in Sri Lanka. This means hardships for the public, and particularly for the

low income segment of the populaton; the unemployed and their dependents will

be forced immediately, by the increased prices, out of the consumption pattern

to which they have been accustomed. 2/

Would this be the only course Sri Lnaka can take for accelerating its

economic growth? Moreover, would the sacrific ensure the immediate accelera-

tion of economic growth? The reduction of the food import bill will increase

foreign exchange available for productive purposes. However, it is not

likely that this will increase export earnings substantially in a short

period. Even with a tight foreign exchange situation, entrepreneurs with

good export opportunities would not be prevented from increasing production

and exports. They can borrow foreign exchange for the importation of re-

quired equipment and raw materials. The fact that the production of cer-

tain goods is constrained by the lack of foreign exchange suggests the low

1/ IBRD Report No. 579a-CE, "Republic of Sri Lanka: Agricultural Policy

and Program Review," February 19, 1975. The increase is contingent

upon the expansion of irrigation systems and the improvement of cul-

tural practices.

2/ The burden of adjustment will be born mainly by the poor in any case,

but their hardship will be particularly severe if the food rationing

is suspended at the same time as the reduction or the suspension of

food imports.

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exportability of the goods in question. 1/ Thus, the import capacity ofthe country is not likely to expand fast immediately after the suspension

of the food imports, and hence the foreign exchange constraint on growth

is likely to stay for sometime, as long as the import requirement for produc-

tion remains large.

Therefore, a thought should be given also to reducing the importrequirement for production in order to accelerate economic growth. It is

too simplistic to assume that imports for consumption can be spared but

not imports for production. The notion of foreign exchange "requirement"for development may not be justified.

The list of imports for production in Sri Lanka covers machineryand plants, parts, equipment, tools, raw materials and other inputs. The

possibility is limited for import substitution in raw materials becauseof the narrow mineral resource base of the country. 2/ Very little machinery

and plants are locally manufactured. However, the need to import machinery

and plants could be reduced.

At present, over 20% of the labor force is unemployed, .despite

that most workers in Sri Lanka are literate and susceptible to skill-training.If entrepreneurs can be pursuaded to adopt production methods that dependmainly on labor rather than machinery, the import content of productiveinvestment will be reduced substantially.

It has been observed that labor intensive methods are not neces-

sarily less efficient than capital intensive methods. For example, in themanufacturing of edible oils and fats, production costs of small establish-ments using labor intensive technologies have been lower than the cost ofa large establishment using a capital intensive technology. In the presentSri Lanka situation, industrial production with capital intensive methodscan be quite inefficient because the foreign exchange constraint tends toprevent the importation of raw materials needed for the optimal scale opera-tion of plants.

1/ This is not to say that an additional foreign exchange allocationfor productive imports will have no effect on exports. There maybe potential new exporters who could not take recourse to supplier'scredit for variety of reasons such as the additional cost this financ-ing would involve, the lack of experience and the lack of confidencein the exportability of their products either on their part or onthe part of suppliers.

2/ There is, nevertheless, some room, in the case of industries basedon non-mineral raw materials. The paper industry has succeeded indeveloping domestic raw material, and has reduced the input import ratiofrom 79% in 1971 to 64% in 1974.

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Nevertheless, entreprenuers have not been attracted much to labor

intensive industries and labor intensive production methods. 1/ There are

a number of factors that account for this. First, wage rates are subject

to the minimum wage legislation, which prevents downward adjustments often

needed for inducing entreprenuers to hire additional workers. 2/ Second,

because of the overvalued Rupee, the prices of imported capital goods are

kept artificially low. 3/ Third, income tax concessions for investment

incentives favor the use of machinery and plants on a large scale.

Even with these inducements for the use of machinery and plants,

the use of labor could be made more attractive by raising the labor pro-

ductivity through a massive investment. However, under the prevailing factor

prices, investment will continue to be attracted to projects requiring

machinery and plants. It is necessary to take measures at least for making

labor intensive forms of investment attractive. 4/ The success of such

measures depends basically on the success in reducing the real cost of labor.

Tax concessions favoring capital intensive investment or production

can be removed by a mere legislation. However, the negative impact of such

a measure on profit expectation will depress all sorts of productive investment,which is not the purpose of the measure. 5/ To prevent this consequence,

1/ It has been observed that most large scale establishments in the manu-

facturing sector use labor saving and capital intensive methods. While

they account for about 70% of industrial value added, their share in the

sectoral employment is only about 30%. Thus, the labor to value added

ratio in the large establishments is about 18% of the ratio in the small

scale industries.

2/ The nominal minimum wage rate index for workers in the private sector

rose by 74% in the period from 1971 to the third quarter of 1975, partly

due to adjustments for the cost of living increases. The Colombo cost

of living index rose by 44% in this period. It is likely that the

real minimum wage rate increased substantially, while the rate of unemploy-

ment increased from 18% in 1971 to 20% in 1975.

3/ In the period from 1971 to 1974, the import price index for "invest-

ment goods" rose by 40.5%, while the nominal minimum wage rate index

rose by 56%. Most "investment goods" are machinery and equipment.

4/ A factory can be built mainly with labor. Infrastructure such as irriga-

tion systems and industrial sites can also be constructed with little

machinery.

5/ The business climate is unfavorable to productive investment by theprivate sector. Nevertheless, it cannot be assumed that the productiveinvestment of the private sector would be insensitive to this change. It

was observed that the application for industrial investment of the

private sector declined in number after the announcement in the fall of

1975 to withdraw various tax concessions for investment promotion. The

announcement was cancelled recently.

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the measure must be accompanied by a compensatory measure that would encourageinvestment in labor intensive industries or with labor intensive technologies,i.e., a measure to reduce the cost of labor.

An adjustment of the exchange rate is needed for many reasons, 1/and particularly for an efficient foreign exchange management. The governmenthas made some attempts to adjust the exchange rate by devaluations and theintroduction of the Foreign Exchange Entitlement Certificate (FEEC) Scheme.However, as the government permitted the adjustment in wage rates for theincreased cost of living, these measures failed to lower the prices of do-mestic products relative to import/export prices, and hence failed to reducethe degree of Rupee overvaluation significantly. Unless labor cost canbe reduced in real terms, further adjustments in the FEEC rate or exchangerate will again turn out to be abortive.

Thus, measures are needed to reduce the real wage rate, whetheror not the food import bill remains as large as it is. Such measures areneeded, inter alia, for inducing new productive investment into industries andtechnologies which would utilize the available resources most efficiently.

A question then arises as to whether it would be a good strategyto,attempt a reduction in food imports at the same time as a reduction inreal wage rate. Reduced food imports means, for a short period in any case,a reduction in the supply of principal staple food in the country, and henceprobably a serious deterioration in the nutritional intake of the populationand particularly among the poor. This would lower the potential productivityof the unemployed as well as the actual productivity of workers, and wouldtherefore necessitate a larger reduction in real wage rate. The processseems to be self-defeating.

1/ There are probably potential new exports which are left unrecognizeddue to the overvalued Rupee. The development of domestic industrialinputs is also hampered by the overvalued Rupee.

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V. Government Budget

The drain of budgetary resources caused by the food subsidy hasbeen another major reason for the criticism of the food subsidy/food dis-tribution program. In fact, the program initially drew critical attentionbecause of the large share of budgetary resources that the food subsidyclaimed.

Criticism of Food Subsidy

It has been argued that in Sri Lanka, where political climateis unfavorable to the economic activities of the private sector, the publicsector has to invest in productive capital to expedite economic restruc-turing, but that such investment is constrained by the low level of publicsector saving. Most critics of the food subsidy share this view, and arguethat the food subsidy is an obstacle to the development of Sri Lanka economybecause it prevents an increase in public sector saving.

However, these arguments contain considerable confusion as wellas assumptions that are not substantiated. First, the level of public sectorsaving is not known. What is known is only the size of the current accountsurplus of the central government budgetary transactions (or the budgetarysaving of the central government). The budgetary saving has been small,showing negative figures in some years. However, this does not necessarilyimply low government savings (because the government has various extrabudge-tary revenues and expenditures) or low public sector savings. In the restof this paper, it is assumed that the "concern over low public sector saving"expressed by the critics of the food subsidy is a concern over low budgetarysaving.

Second, the view that the food subsidy prevents an increase inbudgetary saving implicitly assumes that budgetary revenue is fixed or anincrease in budgetary revenue is not desirable. Neither of these has beensubstantiated.

Third, public sector's investment does not have to be financedby public sector saving or budgetary saving. The public sector can use thesavings of the private sector for its investment. In the present Sri Lankasituation, it is quite appropriate for the public sector to borrow fromthe private sector for financing its investment. Since the required invest-ment projects are of the nature that can be undertaken by the private sectorin a better business climate, they will begin to generate income flows in ashort period. Thus, the borrowing is not likely to cause any serious debtservice difficulty. Because of the business climate, there is little riskthat public sector's borrowings strain the productive investment in theprivate sector. Instead, the publc sector borrowing can prevent frustratedprivate saving from leaking out for excessive consumption or non-productiveinvestment.

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Budgetary Gains from Food Subsidy Suspension

Thus, food subsidy is a minor issue compared to the food importbill. Unlike foreign exchange required for the food imports, budgetary

resources required for food subsidy can be replaced fairly easily. Further-

more, the saving in budgetary resources from the withdrawal of the food

subsidy is not likely to be quite as large as the critics of food subsidy

seem to believe.

Current expenditure for the food subsidy/food distribution programabsorbed 20% of budgetary revenue in 1973, 23% in 1974, and 29% in 1975(Table 13). 1/ These were unusual years in the sense that world food priceswere extraordinarily high. The budget estimates indicate that the ratio

.will decline to 12% in 1976. However, the wide fluctuation shows that such

exogenous factors as weather conditions in foreign lands can seriously affect

government budget through the food subsidy/food distribution program.

Therefore, the suspension of the food subsidy program might affectbudgetary saving favorably in two ways. If current revenues and currentexpenditures other than those directly related to the food subsidy can bekept unchanged, budgetary saving will increase and also will be freed from

.the impact of fluctuations in world market food prices. 2/

As mentioned in Section III and explained in the Annex, "foodsubsidy" in the government accounts of Sri Lanka is defined as the excessof the actual cost of foodstuffs over the sales proceeds. Such "subsidy"can be eliminated in a number of ways. 3/ For an illustrative purpose,this section considers only a case where food ration is maintained as atpresent and the FCD charges on ration foods the prices that cover exactlythe cost for acquiring and distributing them. It is also assumed that off

1/ The term "current expenditure for the food subsidy/food distribution

program" is defined as the sum of the operating deficit of FCD (on acash basis) and the subsidy on infant milk food. It differs from''gross food subsidy" or "net food subsidy," which are irrelevant forgovernment accounts as explained in the Annex.

2/ However, it is most unlikely that "other current expenditure" can be

kept unchanged.

3/ Food ration can be maintained without subsidy but it can be suspended.

Food import also can either be continued or suspended. The FCD maycontinue to be a food distributor or the sole importer of rice, wheatflour and sugar, but these trading may be handed over to public cor-

porations or private traders. The only condition is that foodstuffsshould be priced to cover the cost.

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ration items will be priced as at present. Thus, the FCD can incur onlya surplus over a long period. 1/

Budget estimate shows that in 1976 the ration rice and rationsugar will carry subsidies of Rs. 921 million and Rs. 215 million, respec-tively. If the quantities of ration distribution were not affected by theincreased ration prices, then the FCD food sale proceeds would be Rs. 1,136million higher than the budget estimate in the absence of "subsidized"ration, as shown in the following table. 2/ The operating balance of theFCD would change from a deficit of Rs. 638 million to a surplus of Rs. 498million. With an additional saving of Rs. 6 million from the eliminationof subsidy on infant milk food, budgetary saving in 1976 would increasefrom Rs. 558 million envisaged in the budget estimate to Rs. 1,700 million.

However, it is mostly unlikely that the assumption of "no changesin other current expenditure" would hold. The actual gain in budgetarysaving from the suspension of food subsidy would be much less than Rs. 1,142million derived above. As the suspension of subsidies on the ration reducesthe real income of civil servants, as well as of everybody else, the govern-ment would have to raise their salaries. For an average government employeewith three non-income earning dependents, a salary increase of about Rs. 330is-required to compensate for the increase in food ration prices. 3/ Sinceabout 450 thousand persons are currently employed by the government, theadditional government salary in 1976 would amount to about Rs. 150 million.This is more than 13% of the saving from the suspension of food subsidy.

The effect that the suspension of food subsidy frees budgetarysaving from the impact of fluctuations in world market food prices is alsoweakened because of the need to adjust government salary, which would arisemore frequently in the absence of the food subsidy. The disturbance due tothe cost of living adjustment would be smaller compared to the disturbanceassociated with food subsidies. However, because of the ratchet effect,the nominal wages for government employees are likely to move only upward,unlike "food subsidy," which sometimes moves also downward.

1/ It is still possible, when food prices are rising, for the FCD to incuran operating deficit in a year. However, since the sale proceed atleast covers the previous payments on the distributed food and the dis-tribution services, the operating accounts of the FCD for an infinitelylong period cannot be in deficit.

2/ The additional FCD food sale proceeds would be Rs. 1,100 million if theprices of ration rice and ration sugar were set at the average purchaseprices plus distribution costs in 1976 instead of the average actualcosts. The difference of Rs. 36 million is attributable to the expectedfall of rice and sugar prices in world markets.

3/ The explanation is given in Section III.

Direct Impact of Suspending Food Subsidy(Rs. million)

Food Subsidy Account Cash Basis AccountBudget Without Budget Without

Estimate Food Subsi Estimate Food Subsid

Cost of Rice, incl. Distribution 1,679 1,679 Payment for Rice, incl. Distribution 1,621 1,621Less: Rice Sale Proceeds -758 -1,679 Leos: Rice Sale Proceeds -758 -1 679Subsidy 921 - Deficit on Rice 3

Cost of Wheat Flour, incl. Iayment for Wheat Flour, inclDistribution 1,068 1,o68 Distribution 914 914

Less: Flour Sale Proceeds -1,174 -1,i174 less: Flour Sale Proceeds -1,174 -1 174Subsidy -106 -106 Deficit on Wheat Flour 2-260

Cost of Ration Sugar, incl. Payment for Sugar, incl.Distribution 298 298 Distribution 372 372

Less: Sugar Ration Proceeds -83 -298 Less: Ration Proceeds -83 -298

Subsidy 775 - Less: Off Ration Proceeds -254 -2546Deficit on Sugar 35 -70-

Coat of Off-Ration Sugar, incl.Distribution 112 112

Less: Sale ceeds -254 -254Subsidy -12 -2

Net Subsidy through FCD UU6 -256 FCD Operating Deficit E7f -1 9

Subsidy on Infant Milk Food 6 - Subsidy on Infant Milk Food 6 -

Net Food Subsidy 13947 Current Expenditure for the

Program -6I1T -498

Net Increase in Budgetary Saving 1,1112

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Effect of Food Subsidy Suspension on Resource Allocation

As shown above, the net gain in the budgetary saving from suspendingthe food subsidy in 1976 is at most Rs. 990 million in nominal terms. However,since the suspension of food subsidy will also cause wage rates for nongovern-ment workers to increase, an inflationary wage-price spiral is likely tofollow, and the purchasing power of the increased budgetary saving will beeroded substantially.

What is more important is that the suspension of food subsidy willfirst cause an increase in nominal wage rates. As import prices will not beaffected by this, the initial effect is most likely to be a change in relativeprices of labor and imported capital goods that would make the use of laborless attractive than at present. Furthermore, the domestic inflation resultingfrom the initial wage increase will tend to weaken the competitiveness oftraditional exports as well as to reduce export incentive for all potentialexporters. 1/ Therefore, the foreign exchange constraint on production andinvestment is likely to tighten as the result of food subsidy suspension.

The adverse impact of the food subsidy withdrawal on small scaleindustries should also be recognized. In 1974 and 1975, when the productionof large manufacturing industries was seriously strained by the shortage ofimported raw materials, small scale industries demonstrated their viability byincreasing output substantially. The available statistics suggest that thevalue added of the small scale industries increased by 25%, while that oflarge manufacturing establishments stayed at the 1974 level. The share of thesmall scale industries in manufacturing value added increased to 30% in 1975.The strength of these small scale industries is that their production dependsmainly on indigenous raw materials and labor, and hence is independent of theimport capacity of the country. However, when wage rate increases as theresult of the withdrawal of food subsidy, these labor intensive small scaleindustries will be hurt seriously. Moreover, they will be hurt more seriouslythan capital intensive large producers with high import requirements. 2/

Thus, the suspension of food subsidy is likely to aggravate thedifficulty that the Sri Lanka economy has been experiencing. Budgetarysaving may increase to some extent, but it is very questionable that the

1/ It is estimated that in the tea industry wage bill accounts for about50% of production cost. Cash wage rate in tea estates is about Rs. 95a month on average. Even if an average tea estate worker supports onlyone non-income earning dependent, their wage bill will have to be raisedby about 14% to compensate for the suspension of food subsidy. Thus thecost of tea industry will increase by about 7%.

2/ Some small scale industries have been competing, successfully, withlarge establishments (e.g., edible oils and fats and mammoties), butthe wage rate increase will reduce the competitiveness of small scaleindustries.

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additional budgetary saving can be used to increase productive investmentsubstantially. Since the suspension of food subsidy does not increase foreignexchange earnings at best, and more likely reduces, the country's capacity toimport capital goods and raw materials does not improve. In addition, thesmall scale industries that have been viable under the food subsidy will beaffected adversely by the increase in wage rates that the food subsidy with-drawal necessitates.

Budgetary Revenue

As it has been pointed out, it is not necessary for the governmentto generate a large budgetary saving for financing the productive investmentof the public sector. Nevertheless, expenditures for government servicesthat are not directly productive must be financed by budgetary revenue.If budgetary revenue cannot be increased, then the maintenance of welfareservices such as the food subsidy/food distribution program will becomedifficult as the population increase will tend to expand the scale and costof such programs. 1/

The implicit assumption of the critics that budgetary revenuecannot be increased seems to be based on the observation that the revenuehas not been increasing fast. However, the slow revenue increase does notnecessarily mean that there is no potential for a larger budgetary revenue.At present, tax revenue depends very much on the country's import capacity,partly due to the structure of the economy, which is dependent on imports,but partly also due to the lack of initiatives on the part of the govern-ment to extend the tax net to the domestic agriculture sector, where produc-tion is fairly independent of imports. The increase in tax revenue hasbeen very slow in the last few years, because the country's import capacityfailed to expand fast.

An important revenue instrument in the fiscal system of Sri Lankais still taxes based on imports. As tax administration offices cannot obtaina large manpower (probably due to an excessive concern over budgetary saving),the government is somewhat reluctant to modify the tax system and expanddomestic economy-based taxes, which would be lass manageable than foreigntrade-based taxes.

The revenue from import based taxes naturally depends on the importcapacity of the country, but the fluctuation of the revenue is more thanproportional to the fluctuation in the import capacity. The "basic goods,"which are given the top priority in the foreign exchange budget, are importedmainly by the government, and levies on such imports do not generate truebudgecary revenue representing a resource transfer to the government from therest of the economy. With a given amount of foreign exchange available forall imports, import-based tax revenue can be increased either by reducingbasic good imports or by raising tax rates on non-basic good imports. However,the scope for the first is limited as basic good imports are related towelfare state measures such as the food distribution program.

1/ This applies to most services of the government proper; it is not confinedto social and welfare services.

- 26 -

After the "basic goods," the second priority in the foreign exchangebudget is given to capital goods and industrial inputs. These are subjectto FEEC requirement, but import duty rates are low, at 5% on capital goodsand 25% on industrial inputs and machinery parts, compared to the standardor "revenue" rate of 60%. When the foreign exchange position is tight,these items absorb most foreign exchange left after the allocation for thebasic goods. Thus, in 1974-75, the ratio of import duty revenue to thec.i.f. value of merchandise imports was only 6%. If the rates on capitalgoods and industrial inputs had been 60%, the import duty revenue in 1974-75would have been about four times the actual revenue. I/

Thus, there is a considerable scope for increasing revenue 'romimport duty by raising the rates on "productive imports," 2/ without neces-sitating any changes in the tax system or complicating tax administration.An increase in rates on "productive imports" would help not only to increasebudgetary revenue but also reduce the undue incentive, caused by the over-valued Rupee, to use imported machinery and imported raw materials. There-fore, although this measure taken alone may produce some undesirable sideeffects, it is considerably superior to the suspension of food subsidy asa measure to increase budgetary saving.

1/ In 1974, import duty revenue was Rs. 280 million. Of this, 19% wascollected at the rate of 5%, and 39% at the rate of 25%. If the standardrate of 60% had been applied to capital goods and industrial inputs,the total import duty revenue would have been over Rs. 1.0 billion.In 1975, the import duty revenue was Rs. 320 million. About 25% wascollected at 5% and about 33% at 25%. With 60% rate applied instead ofthese concessionary rates, the total import duty revenue would have beenclose to Rs. 1.4 billion.

Since FEEC charge of 65% is applicable to the foreign exchange cost ofcapital good and raw material imports in any case,--the use of 60% importduty rate on them would raise the Rupee price of imported capital goodsand raw materials at most by 32% and 18% respectively. As there wasclearly a large excess demand for the imports of this type at theprevailing tax rates, the increase in the Rupee prices by the tax in-crease would not have affected the volume of such imports significantly.(This is not to say that demand for productive imports is insensitive tothe prices. The total demand, not all of which was satisfied, wouldhave been affected, but its impact would have been mainly a reduction inthe excess demand.)

2/ The rates do not have to be raised to 60% immediately. Moreover, thebest target rate may not necessarily be 60%.

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This measure can, as the withdrawal of food subsidy, initiate

an inflationary cost-price spiral on one hand and depress domestic production

on the other hand. However, unlike the withdrawal of the food subsidy, the

negative impact of this measure would be least felt in the sectors that do not

depend on imported raw materials or imported capital goods.

The possible adverse effect of the cost increase on the competitive-

ness of import-dependent exports can be prvented by the use of a tax rebate

scheme tied to exportation. In the case of cost increase due to a wage

increase, the restoration of the competitiveness in export markets requires

an outright export subsidy, which is prone to invite an increase in customs

duties by importing countries.

In addition to the import-based taxes, the revenue from business

turnover tax (BTT) is also dependent on the capacity to import raw materials.

Although BTT is a form of general sales tax, the actual base is narrowed

down to sales receipts associated with import-based manufacturing products

(and a few types of professional services) because agricultural sales proceeds

and the receipts of small businesses are exempted. Furthermore, the revenue

from the corporate income tax is also considerably dependent on the capacity

to import raw materails, since most large scale manufacturers are dependent

on imported materials.

The activities of the agriculture sector and small scale manu-

facturers are considerably independent of imports, and hence on the country's

import capacity. However, the tax system at present fails to derive revenue

from these sectors. The personal exemption limits set extremely high relative

to the income level of the country exclude most incomes of the domestic

agriculture sector and small scale industries. 1/ Furthermore, tax admini-

stration offices have been reluctant to use their limited manpower for the

enforcement of the Inland Revenue Act in rural areas.

However, it has been observed that, as the result of import substitu-

tion in agriculture, the income level in the domestic agriculture sector

has risen considerably, particularly since the government imposed a restric-

tion on the importation of subsidiary farm products at the beginning of the

1970s. Moreover, the agricultural import substitution is expected to continue.

Therefore, a substantial. additional revenue can be derived from measures to

tax the income of the domestic agriculture sector.

Admittedly, the administration of agricultural income tax isdifficult. It may be necessary to introduce a system of presumptive income

tax based on land holding, instead of the straightforward application of

income tax, which is the present arrangement. Nevertheless, it must benoted that the collection of tax from the agriculture sector is relatively

easy in Sri Lanka, compared to most other developing countries. Because

1/ The personal exemption limit for a single person is Rs. 9,000 on employ-ment income, and Rs 6,000 on other income. The 12 month earning of a -worker employed at the minimum wage is Rs. 2,160, and per capita GNP atfactor cost is about Rs. 1,500.

- 28 -

of fairly extensive activities of the government in rural areas in Sri Lanka,including the food subsidy/food distribution program, land reform program and

agricultural credits, farmers are reasonably familiar with the concept of thegovernment, which they lack in the remote areas of most other developingcountries. The difficulty due to the manpower constraint in tax administrationoffices can be removed easily, as a large number of college graduates areunemployed. 1/

Investment incentive measures warrant a substantial revision notonly from revenue viewpoint but also from economic view point. The con-cessionary arrangements consist of tax holidays of five to eight years,lump-sum depreciation allowance, and the development rebate scheme (a schemeto allow the deduction of the cost of the acquisition of fixed capital).The period of tax holiday is too long and it is likely to give undue incen-tives for tax avoidance. 2/ The favorable tax treatment of the acquisition ofcapital assets unduely encourages the creation of capital intensive industriesand the adoption of capital intensive methods, and aggravates the distortionof factor prices caused by the overvalued Rupee and the minimum wage legisla-tion.

Given the already unfavorable business climate, some measureswould be necessary to encourage private entrepreneurs to invest in productive

capital. However, such measures should be designed to encourage investmentin labor intensive industries and the adoption of labor intensive methods.From this viewpoint, a system of tax credit based on the number of workersor direct wage bill subsidy would be superior to the present incentive schemes.

Budgetary Resources and Foreign Exchange

An excessive concern over the food subsidy has also tended tolimit budgetary revenue unnecessarily. As the paddy GPS price is usually kepthigher than the paddy-price-equivalent of rice import price, the budgetarycost of rice subsidy tends to be smaller with a higher import content of FCDrice procurement. For this reason, the attempts of the government to controlthe budgetary cost of the food subsidy program have tended to cause riceimports a little in excess of the minimum requirement (excess of the consump-tion requirement and domestic production, adjusted for stock changes).However, such an attempt not only constrains imports for production andproductive investment unduely, but also restricts budgetary revenue unneces-sarily.

I/ In this sence, the situation is quite different from that which existsin many other developing countries.

2/ A long tax holiday tempts entrepreneurs to close down their businessesat the end of the tax holiday period and start new businesses to obtaina new round of tax holiday.

- 29 -

As noted earlier, tax revenue under the present tax structuredepends very much on the country's capacity to import the items of "secondarypriority" in the foreign exchange budget (mainly capital goods and industrialraw materials). One rupee of foreign exchange allocated for such importsprobably generates tax revenue of 80 cents to one rupee. I/ Thus, by sub-stituting imported food for domestic food, the government not only reducesthe amount of foreign exchange available for productive purposes but alsoloses tax revenue.

The FCD estimates that in 1976 the average rice import price willbe Rs. 2,080 per long ton, consisting of Rs. 2,035 of foreign exchange com-ponent and Rs. 45 of customs duty and customs handling charges. As the secondportion accrues to the government Treasury as a budgetary revenue, the netcharge to the budget is Rs. 2,035. Compared to this, the estimated averagelocal rice purchase price is Rs. 2,550 per long ton, and no part of this

directly flows back to the Treasury. Thus, the budgetary cost of one long tonof domestic rice exceeds that of one long ton of imported rice by at leastRs. 515.

An attempt to increase domestic rice procurement beyond a certainquantity will have to be accompanied by an increase in the PMB paddy purchaseprice, and hence will cause an increase in the FCD domestic rice purchaseprice. However, even then such an attempt is likely to increase budgetarysaving. If an additional rupee of foreign exchange allocated for "secondarypriority" imports increases tax revenue by 90 cents, then import substitu-tion in rice increases budgetary saving as long as the price of additionaldomestic rice remains below Rs. 3,866.5 per long ton, 2/ which is more than150% of the domestic rice purchase price envisaged in the 1976 budget forthe procurement of 340,000 long tons.

Paddy production is expected to reach 90.7 million bushels in1976, making about 1,149,000 long tons of domestic rice available for consump-tion. 3/ Since rice of about 1,294,000 long tons is required to satisfy a percapita consumption of 210 pounds with a population of 13.8 million, the

1/ Consisting of: (i) FEEC revenue of 65 cents, (ii) customs duty revenueof 5 cents (capital good imports) to 25 cents (raw material imports),and (iii) business turnover tax revenue of about 10 cents.

2/ If P is the price that the FCD has to pay for purchasing one additionallong ton of domestic rice, the additional budgetary saving from importsubstitution in rice is equal to 1.9*2,035-P, which is positive if Pis less than 3,866.5.

3/ IBRD Report No. 1019a-CE, "Sri Lanka: Country Economic Memorandum,"March 15, 1976.

- 30 -

minimum rice import requirement is about 145,000 long tons. 1/ However, thebudget for 1976 envisages a rice import of 300,000 long tons. If the paddyproduction reaches the projected level, the budgeted rice imports will create

a surplus rice of 155,000 long tons (12% of the consumption requirement in

1976) at a foreign exchange cost of Rs. 315 million, which amounts to 7% of

the projected export earnings in 1976.

Industrial Public Corporations

Public corporations engaged in industrial activities represent

another potential for increasing budgetary revenue. The public corporationsector of Sri Lanka is large, accounting for about 15% of grossdomestic fixed investment in the period from 1970 to 1974. In the manu-

facturing sector, public corporations now account for more than 50% of the

sectoral value added. Moreover, the expansion of manufacturing publiccorporations will continue. Given the prevailing business atmosphere, the

economic restructuring has to be effected largely through the creation of

new industries as public corporations.

So far, however, the budgetary contribution from the public corpora-

tion sector has been small. In some cases, the lack of budgetary contribution

- or 2ven recurring need for financial assistance from the government is attri-

* butable to government directives on their pricing that prevent the adjustment

of output/input prices. However, in the majority of industrial public corpora-

tions, the low profitability seems attributable to their inefficiency.

Detailed information on the operation of industrial public corpora-

tions is not available, and the inquiry into the factors causing their low

efficiency is prevented. However, available information indicates that the

problem is largely attributable to the lack of careful investment planning.

Several public corporations were created with foreign loans thatbrought with them capital intensive methods of production requiring large

plants. The plants were often too large for the narrow domestic market,

and optimal scale operations required that products be exported. And yet,the exportability of the products was not studied carefully, and most indus-trial public corporations have failed to export. Being unable to export,many plants created in this manner operate, due to market constraint, atsub-optimal scales. 2/ In some cases, the nonexportability is attri-butable to the fact that the selected technology was obsolete from the outset.

1/ The import requirement is smaller if a reduction of FCD rice stockby 20,000 long tons, envisaged in the budget, is taken into considera-tion.

2/ The steel plant established in the late 1960s is one of such cases. Itscapacity is 300% of domestic demand, but exportation is prevented by thehigh price and low quality of products. Other examples of this type arethe hardware plants and leather processing factories in the publicsector.

- 31 -

There are also many that operate at sub-optimal scales due to

the inability to secure inputs sufficient for full capacity operation.

In some cases, large plants are justified by the expected increase in the

production of domestic raw materials. 1/ However, in other cases the source

of the problem is the combination of dependency on imported inputs and the

inability to export, which prevents the plants from acquiring sufficient

inputs for optimal scale operation. 2/

As the foreign exchang is a critical factor affecting the investment

and production in the economy, the best solution to the cases of low capacity

utilization would be to find a way to export the outputs. It is quite possi-

ble that some public corporations, like probably many private manufacturers,

have been unable to recognize the potential exportability due to insufficient

marketing research and the overvalued Rupee. For some entities, the develop-

ment of domestic inputs may provide a solution, as it has for the paper

mill and the ceramic industry. However, there are some that are probably

better closed down. If a plant requires imported inputs, fails to generate

profits, and produces little domestic value added, then its viability is very

limited. The suspension of its operation would release foreign exchange for

other imports, which can be used for more viable production.

. Another factor preventing public corporations from generating

profits is the Retrenchment Act, which prohibits them to lay off employees

freely. Its adverse effect tends to be large on the corporations with

large number of employees.

In the absence of active private sector, a substantial budgetary

contribution must come from industrial public corporations. Therefore,

the government should allow them to operate as profit maximizers. It should

not interfere with their operation in such a manner as to disrupt their

efficiency. In order to use public corporations for labor absorption, the

government should create entities in labor intensive sectors and make them

adopt labor intensive methods.

1/ Sugar mills are the example of such cases. However, it would take a

considerable time to increase sugar cane output to allow a full

capacity operation of the sugar mills.

2/ However, a recent survey of the industrial sector observed that there

are public corporations capable of exporting. It was noted that about

50% of the industrial exports of Sri Lanka is attributable to four

public corporations. Furthermore, the survey noted that three of the

four were based on domestic raw materials, and require little imports.

Cf. K. S. Lee, "State Industrial Corporations," draft, December 23,

1975.

- 32 -

VI. Food Subsidy for Development Policy

Very little attention has been paid to the potential utility ofthe food subsidy/food distribution program as a tool for development policy.The merit of the supplementary income that the program gives all individualshas been appreciated only in the context of social welfare. It has beenrarely recognized that the government could utilize the supplementary incomeas a means for wage rate adjustment, which is badly needed.

Wage rate reduction is subject to a constraint that the real wagerate cannot, in the basence of supplementary incomes, fall below a certainsubsistence level. The food subsidy provides everybody a supplementaryincome, and hence enlarges the scope for wage rate adjustment.

Under the present ration parameters, the standard ration packagefor a family of four embodies an income of Rs 330, equivalent to about 15%of the 12 month earnings of a worker receiving the legal minimum wage.If the real minimum wage rate is reduced by 25%, but the real income throughthe food subsidies is kept as it is, then the real income of the averagehousehold of a minimum wage worker declines by 23%, :nstead of 25%, from thepresent level. The difference between the rate of decline in the real wageand the rate of decline in the real household income is obviously larger for ahigher initial ratio of food subsidies to the wage income.

A larger food subsidy allows a larger reduction in the wage rate,naturally. If a pound bf free rice is added to the present ration, the subsidy on thestandard ration package for a family of four will be about Rs. 560. Theminimum wage rate for 12 months can be reduced to Rs. 1,930 or 89% of thepresent level without affecting the real income level of a worker's family.Then the ratio of the food subsidies to the minimum wage earning will be29%. When the real minimum wage rate is reduced to 75% of the reduced initiall,vel (i.e., to Rs. 1,448), the real household income remains above 80% of theinitial level (Rs. 2,490).

The direct impact of an increase on budgetary saving is clearlynegative. For example, an additional free rice ration of one pound a weekwill reduce budgetary saving in 1976 by about Rs. I billion, even if thegovernment reduces the salaries for government employees on account of theincreased subsidy. However, the increase in rice subsidy does not increasethe food import requirement of the FCD, and hence it does not reduce theamount of foreign exchange available for the importation of goods requiredfor production. Additional revenue should be generated through measuresto raise the cost of capital goods such as the increase in import duty rateson capital goods and the suspension of the development rebate on labor savingmachineries and plants.

- 33 -

Reduction of Minimum Wage Rate and Emaily Income

Real income (Rs.) Index Total

Pinimum Food Total Minimum TozaL IncomeWage Subsidy Wage Income Link

Index

Base 2,160 330 2,490 100.0 100.0

1976 Ration ParametersYear 0 2,160 330 2,490 100.0 100.0Year 1 2,039 330 2,369 94.4 95.1 95.1Year 2 1,925 330 2,25o 89.1 90.6 95.2Year 3 1,818 330 2,148 84.1 86.3 95.3Year 4 1,716 330 2,046 79.4 82.2 95.3Year 5 1,620 330 1,950 75.0 78.3 95.3

With Free Rice DoubledYear 0 1,930 560 2,490 89.4 100.0Year 1 1.822 560 2,382 84.4 95.7 95.7Year 2 1,720 560 2,280 79.6 91.6 95.7Year 3 1,624 560 2,184 75.2 87.7 .8Year 4 1,533 560 2,093 71.0 84.1 95.8Year 5 1,448 560 2,008 67.0 80.6 95.9

1/ This table illustrates two sets of adjustment in real minimum wage rate.The base is set as the actual situation at the beginning of 1976. Underthe 111976 Ration Parameters", the real minimum wage rate is reduced to75% of the base level over five years. In the bottom half of the table,ahown as "With Free Rice Doubled", the initial total income is set equalto the base income, but the initial minimum uage rate is reduced. Theminimum wage is reduced to 75% of this level over five years. Index forthe minimum wage is calculated by taking the "base" level of Rs. 2,160 as100.

- 34 -

What is suggested here is a shift in development strategy from

one that emphasizes an intensive use of capital, and particularly imported

capital goods, to another that emphasizes an intensive use of labor, which

is available in Sri Lanka but has been left underutilized. The use of fiscal

tools must also change, accordingly. It is justified to increase current

expenditure for the promotion of productive labor absorption on one hand and

to reduce the revenue loss hitherto incurred for the encouragement of an

intensive use of capital on the other hand.

The reduction of wage rate would be a politically difficult task.

Although the level of the nominal minimum wage rate is a matter of legis-

lation, a proposal to reduce the nominal minimum wage rate will be resisted

by employed workers. Therefore, the government can effect a reduction in

real wage rate only by preventing the increase in nominal wage rate in the

face of general price increase, which may be initiated by a devaluation

or a FEEC rate adjustment.

Even such an attempt will meet a resistance from employed workers.

However, unlike the decision to suspend the food subsidy/food distribution

program, wage control does not deny the poorest population their subsistence.

The government should use all means available, including the food subsidies,

to persuade employed workers to accept a reduction in the real wage rate.

-35-

Table 1: Rice Distribution

Basic Ration Additional RationQuantity Price (Rs/lb) Quantity Price(lbs/ ) Non-Income Income (lbs/ W) (Rs/lb)

Tax Payers Tax Payers

Ehd of 1959 2.0 0.125 0.125 2.0 0.225April 9, 1960 2.0 0.125 0.125 2.0 0.125December 19, 1966 2.0 Free Free NoneSeptember 26, 1970 2.0 Free Free 2.0 0.375November 10, 1971 2.0 Free Free 2.0 0.50December 4, 1972 2.0 Free 0.50 2.0 0.50February 19, 1973 2.0 Free 0.80 2.0 0.80March 12, 1973 2.0 Free 0.70 2.0 0.70October 1, 1973 1.0 Free 1.00 NoneOctober 29, 1973 1.0 Free 1.00 1.0 1.00November 11, 1973 1.0 Free 1.00 NoneDecember 10, 1973 1.0 Free 1.00 1.0 1.00February 1, 1974 1.0 Free 1.00 NoneFebruary 18, 1974 1.0 Free 1.00 1.0 a/ 1.00March 18, 1974 1.0 Free 1.00 2.0 b/ 1.00April 15, 1974 1.0 Free 1.15 2.0 1.15April 29, 1974 1.0 Free 1.15 1.0 1.15May 6, 1974 1.0 Free 1.15 2.0 c/ 1.15July 15, 1974 1.0 Free 1.25 2.0 F/ 1.25August 5, 1974 1.0 Free 1.10 2.0 / 1.10November 6, 1975 1.0 Free 1.00 2.0 c/ 1.00

a/ Colombo and suburbs only. No additional ration in the rest of thecountry.

b/ Colombo and suburbs onlybefore April 1. In this period, additional rationwas 1 pound in the rest of the country.

c/ In 21 deficit districts. Additional ration was 1 pound in the rest of thecountry.

Source: Onetral Bank of Ceylon.

- 36 -

Table 2: Flour Distribution

Ration Off-Ration

Quantity Price Price

(lb/week) (Rs/lb) (Rs/1b)

.1960 0.23

August 1961 0.28

August 1963 0.23

August 1966 0.28

Deceaber 1967 0.33

January 1973 0.38

June 1, 1973 0.48

October 1, 1973 1.00 0.70 0.70-a/

March 18, 1974 - - 0.70 a/

April 8, 1974 0.50 0.70 0.70 a/

April 15, 1974 - - 0.70 a/

April 29, 1974 0.50 0.70 b/ 0.70 a/

May 6, 1974 0.50 0.70 c/ 0.70 a/

August 5, 1974 1.00 1.10 1.10 a/

March 31, 1975 1.10

a/ Off ration sale to bakeries only.

b/ One pound a fortnight.

c/ E&cept those in Colombo and its suburbs, who received an

additional pound of rice weekly in lieu of fortnighly flour

ration.

Source: Central Bank of Ceylon

- 37 -

Table 3: Sugar Distribution

Ration Off-Ration Price

Quantity Price Brown White(1s/o)*(Rs./1b.) (R'./1b.)

1960 0.55 0.62August 1961 0.55 0.67December 1961 0.55 0.62July 1962 No Ration n.a. 0.62Yarch 1963 n.a. 0.67November 1963 0.63 0.67March 1966 n.a. 0.67December 1967 n.a. 0.72November 13, 1971 3.00 0.72 1.50 1.50March 1, 1972 2.00 0.72 1.50 1.50November 11, 1972 2.00 0.72 2.50 2.50January 12, 1973 2.00 0.72 1.50 1.50February 1, 1973 1.00 0.72 1.50 1.50May 31, 1973 1.00 0.72 1.65 1.75October-1, 1973 0.75 0.72 2.00 2.00March 1, 1974 1.00 0.72 5.00 5.00September 20, 1974 1.00 0.72 7.50 a/ 7.50 a/October 1, 1974 0.75 0.72 7.50 a/ 7.50 a/April 28, 1975 0.75 0.72 7.50 7.50November 6, 1975 0.75 0.72 6.00 6.00

a/ Off-ration sale was not available to general consumers.Figures show the price used for sales to canteens, hotels,confectioneries and hospitals.

Source: Central Bank of Ceylon.

- 38 -

Table 4: Per Capita Consumption(Pounds)

Rice FIour Sugar

1965 223.1 52.5 n.a.1966 213.0 54.0 n.a.1967 210.2 82.9 n.a.1968 221.5 79.1 n.a.1969 215.4 73.3 n.a.1970 247.7 74.4 52,1 a/1971 235.8 64.0 49.2 a/1972 206.1 746.5 40.9 b/1973 198.1 76.1 33.41974 216.4 69.6 17.21975 c/ n.a. 75.8 10.1

1976 c/ n.a. 77.9 12.0

1Q65-74 Average 218.8 70.0

a/ Fiscal year ending on September 30.5/ Fiscal year covering 15 month period through

December 1972. The figure is adjusted pro rata to a

12 month period.c/ Estimate.

Source: Central Bank of Ceylon,Food Commissioner's Department,Ministry of Finance.

Table 5: Rice Cost and Subsidy(Rupee per Pound)

Cost = Subsidy on Free Rice Price of Subsidy on Paid Rice

FCD 1/ Gov't 2/ Public Thid Rice nco 1/ Gov't 2/ ubic

Sector 3/ Sector 3/

1970/71 Average 0.-3 0.42 n.a. 0.375 0.05 0.0 n.a.

1971/72 Average 0.42 0.41 n.a. 019 -0.07 -0.08 n.a.

Oct. 1, 1971 - Nov. 9, 1971 0.375 0.o5 0.01 n.a.

Nov. 10, 1971 - Dec, 31, 1972 0.50 -0.08 -0.09 n.a.

1973 Average 0.57 0.56 n.a. 0.71 -0.14 -0.15 n.a.

Jan. 1 - Feb. 18 0.50 0.07 0.06 n.a.

Feb. 19 - March 11 0.80 -0.23 -0.21[ n.a.

March 12 - Sept. 30 0.70 -0.13 -0.j4 n.a.

Oct. 1 - Oct. 28 No Paid Rice Ration

Oct. 29 - Nov. 10 1.00 -0.43 -0.44 n.a.

Nov. 11 - Dec. 9 No Pid Rice Ration \o

Dec. 10 - Dec. 31 1.00 -0.43 -0.44 n.a.

1974 Average 1.08 1.07 1.05 1.10 -0.02 -0.03 -0.0

Jan. 1 - Jan. 31 1.00 0.08 0.07 0.06

Feb. 1 - Feb. 17 No Paid Rice Ration

Feb. 18 - Apr. 14 1.00 0.08 0.07 0.06

Apr. 15 - July 14 1.15 -0.07 -0.08 -0.09

July 15 - Aug. 4 1.25 -0.17 -0.18 -0.19

Aug. 5 - Dec. 31 1.10 -0.02 -0.03 -0.04

1975 Average 1.15 1.111 1.13 1.08 0.06 0.05 0.04

Jan. 1 - Nov. 5 1.10 0.05 o.o4 0.03

Nov. 6 - Dec. 31 1.00 0.15 0.14 0.13

1976 Average (Estimate) 1.14 1.13 1.11 1.00 0.14 0.13 0.11

1/ Average loss of FCD. Average cost, including distribution expense, customs duty and customs handling

charge, less average sale price.

2/ Average loss of the government. Average cost, exclusive of customs duty and customs handling charge,

less average sale price.

/ Average loss of the public sector. Average cost, exclusive of customs duty, customs handling charge,

and 1jj13 profit, less average sale price.

Source: Central Bank of Ceylon,Food Commissioner's Department, and

Ministry of Finance

- 40 -

Table 6: Annual Ration and Subsidy Per Capita

1970/71 1971/72 1973 1974 1975 1976(12 mo.) Estimate

Free RiceAnnual Ration (Found) 104 104 91 52 52 52

Subsidy per Pound (Rs.) 0.43 0.42 0.57 1.08 1.15 1.14

Annual Subsidy (Rs.) 45 44 52 56 60 59

Paid RiceAnnual Ration (Pound) 104 104 83 50 52 52

Subsidy per Pound (Rs.) 0.05 -0.07 -0.14 -0.02 0.06 0.14

Annual Subsidy 5 -7 -10 -1 3 7

R.Ltion Wheat FlourAnnual Ration (Pound) * * 13 40 13 *

Subsidy per Pound (Rs.) * * -0.10 a/ 0.08 a/ -0.02 a/ *

Annual Subsidy (Rs.) j c -1 2 neg. *

Ration SugarAnnual Ration (Pound) * 25 12 11 9 9

Subsidy per Pound (Rs.) * 0.08 0.54 1.02 2.29 1.75

Annual Subsidy (Rs.) * 2 7 11 21 16

Total Subsidy on Ration (Rs.) 50 39 48 68 84 82

As / of GNPfc 5.4 4.1 4.2 4.6 4.9 n.a.

Memorandum:bUb,sid on off Ration Sales (Rs. per Pound)

Wheat Flour -0.02 0.16 0.10 0.10 -0.02 -0.11

Sugar -0.13 -0.74 -o.47 -3.48 -4.26 -3.53

* indicates"not applicable".a/ Average subsidy for the periods when flour was rationed.

Table 7!: Imports of Rice, Flour and Sugar for Distribution Program(Rs. Million)

1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 19761. Imports, c.i.f.- -- - - - - - - - - - - - - 17

a. Rice 342 266 244 345 211 353 188 142 322 771 1,021 736b. Flour 136 121 234 218 230 226 208 216 458 909 1,056 607c. Sugar 84 75 71 91 1h2 152 239 250 334 136 268 131d. Wheat Grain c/ - - - 7 10 12 23 44 61 1171 140 205e. Sub Total 767 6 W97 F6T 7 M7 -Of8 F72 1,175 T-,M 9 2T5 1767

2. Total Imports,c.i.f. 1,474 2,028 1,738 2,173 2,543 2,312 1,987 2,042 2,721 4,570 5,805 6,390

3. Exports 1,949 1,700 1,690 2,035 1,916 2,033 1,948 1,926 2,502 3,456 4,168 h,555

4. Food Imports as % of Total Importsa. Rice 123.2 13.1 14.0 15.9 8.3 15.3 9.5 7.0 11.8 16.9 17.6 11.5b. Flour 9.2 6.0 13.5 10.-0 9.0 9.8 10.5 10.6 16.8 19.9 18.2 9.5c. Sugar 5.7 3.7 4.1 4.2 5.6 6.6 12.0 12.2 12.3 3.0 4.6 2.1d. Wheat Grain c/ - - - 0.3 0.4 0.5 1.2 2.2 2.2 2.6 2.A 3.2

e. Sub Total -37[ I 2T6 31. 6 3T YTJ '7 2JI 3T7 T U-7 -473 1ThT X.3

5. Food Imports as %of Exports 28.8 27.2 32.5 32.5 30.9 36.5 33.8 33.9 47.0 55.9 55.6 36.9

a/ Food import figures are derived from the revised estimate accounts of the Food Corinissioner 's Departaint.Total import and export figures are the provisional actuals provided by the Ministry of Planning andEconomic Affairs.

b/ Projection by the Ministry of Planning and Economic Affairs.

c/ Wheat and spelt. Imports of the Ceylon State Flour Milling-Corporation.

Sources: Central Bank of Ceylon, Food Commisioner's Dept., Ministry of Finance, Ministry of Planning andEconomic Affairs.

Table 8j. Food Imports - Quantity and Price'

1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976a/ b/

A. Quantity (1,000 long tons)Rice 642 494 381 344 260 526 334 262 338 297 451 300

Flour 312 264 517 359 388 369 330 324 365 442 472 300

Sugar 218 233 226 220 308 240 283 214 191 42 61 52

Wheat Grain c/ - - - 17 25 29 46 n.a. 86 80 89 155

B. Price, c.i.f. (Rs./ long ton)Rice 533 538 641 1,003 811 671 563 554 953 2,594 2,265 2,035Flour 436 459 453 608 592 611 631 667 11254 2,058 2,236 1,886

Sugar 386 323 314 413 h60 634 845 1,168 1,752 3,231 4,bl6 3,120

Wheat Grain c/ 4 * * 428 402 423 535 n.a. 699 1,b41o 1,565 1,320

a/ Revised estimate.E/ Budget estimate.c/ Wheat and spelt. Imports of the Ceylon State Flour Milling Corporation.

Sources: Central Bank of Ceylon, Food Commissioner's Dept., Ministry of Finance.

- 43 -

Table 9: Sources of Food Procurement(Thousands of Long Tons)

Total Domestic Imports Imports asProcurement Procurement % of Total

Rice Procurement197/70 a/ 331.9 220.7 31.-71970/71 9/ 920.2 456.4 463.8 50.1971/72 9/b/ 814.1 I5.4 368.7 45.31973 -- 674.5 336.8 337.7 50.11974 556.7 259.6 297.1 53.41975 650.6 200.0 450.6 69.31976 640.0 340.0 300.0 46.9

Wheat Flour1969/70 a/ 426.6 46.1 380.6 89.21970/71 T/ 370.4 54.1 316.4 85.41971/72 T/b/ 425.0 75.6 349.4 82.21973 430.4 65.1 365.4 84.91974 487.6 45.8 441.8 90.61975 544.2 72.0 472.2 86.81976 426.0 126.0 300.0 70.4

SugarT97770,a/ 290.9 8.9 282.0 97.01970/71 7/ 278.8 9.8 269.0 96.51971/72 T/b/ 237.9 10.2 227.4 95.71973 202.2 11.7 190.5 94.2

1974 59.8 17.8 42.0 70.21975 72.9 12.0 60.9 83.51976 773.2 21.0 52.2 71.3

a/ Figures show quantity distributed, rather than purchased.

b/ Pro-rata adjusted 12 month figure.

Sources: Central Bank of Ceylon;Food Commissioner's Department; andMinistry of Finance.

Table 10: Paddy Production and GPS Purchase

(Million Bushels)

(1) (2;) (3)Production GPS (2) as %

a/ Purchase of (1)

1960 43.0 22.4 52.01961 43.1 22.5 52.21962 48.0 25.7 53.61963 49.2 25.7 52.21964 50.5 29.4 58.21965 36.3 23.1 63.61966 45.7 28.0 61.21967 54.9 15.4 28.01968 64.5 14.9 23.11969 65.9 13.7 20.81970 77.4 26.2 33.81971 66.9 32.4 48.41972 62.9 26.4 41.91973 62.9 22.9 36.41974 76.8 20.9 27.21975 54.5 b/ 11.2 / 20.6

a/ Harvest during the year.

b/ Estirate asswing 20 million bushels ofYala harvest..

c/ Estimate based on January-October GPSpurchase, which accounted for about

97% of annual GPS purchase in 1972-1974.

Source: Central Bank of Ceylon.

- 45

Table 11: Paddy Prices(Rupees per Bushel)

(1) (2) (3)Open GPS Ratio

Market Price (2) as %Price of (1)a/

1959 11.56 12.0 103.81960 12.49 12.0 96.11961 11.53 12.0 104.11962 10.59 12.0 113.31963 10.59 12.0 113.31964 10.60 12.0 113.21965 11.25 12.0 106.71966 11.05 12.0 108.61967 13.61 12.0 b/ 88.21968 15.86 14.0 88.31969 15.22 14.0 92.01970 14.80 14.0 94.61971 14.45 14.0 96.91972 14.83 14.0 94.41973 n.a. 18.0 c/ n.a.1974 n.a. 30.0 3/ n.a.1975 n.a. 33.0 _/ n.a.

a/ Average during a year.

b/ Rs. 14 from December.

c/ Rs. 14 in January; Rs. 18 from February toSeptember (90% of GPS purchase); andRs. 25 from October.

d/ Rs. 25 in January to March (17,Oof GP SPurq4ase).

e/ Rs. 30 in J,tnuary to mid-July.

Source: Central Bank o' Ceylon.

Table 12-: Food Stocks of the Food Commissioner(1,000 long tons)

1973 1974 1975 1976Revised EstimateEstimate

RiceOpening Stock 52.8 54.1 58.2 100.4Closing Stock 54.1 58.2 100.4 80.4

Distribution 673.2 552.5 608.4 660.0

.Opening Stock as % of Distribution 7.8 9.8 9.6 15.2

Closing Stock as % of Distribution 8.0 10.5 16.5 12.2

FlourOpening Stock 43.2 11.7 79.9 130.3

Closing Stock 11.7 79.9 130.3 76.3

.Distribution 461.9 419.4 460.2 480.0

Opening Stock as % of Distribution 9.3 2.8 17.4 27.2Closing Stock as % of Distribution 2.5 19.1 28.3 15.9

SugarOpening Stock 2.? 46.8 3.9 15.3

Closing Stock 6. 3.9 15.3 14.3Distribution 197.4 102.7 61.5 74.2

Opening Stock as % of Distribution 21.3 45.5 6.3 20.6

Closing Stock as % of Distribution 23.7 3.8 24.9 19.3

Sources: Central Bank of Ceylon and Food Cormissioner's Department, and

the Ministry of Finance.

-47

Table 13: Budgetary Operation(Millions of Rupee)

1973 1974 1975 2976

Current Expenditure forFood Distribution Program 731 1,037 1,306 644

FCD Operating Deficit (726) (1,032) (1,300) (638)Subsidy on Infant Milk Food (4) (5) (6) (6)

Other 1/ (1) (-() ()Other Current Expenditure 2,89 3,297 3,668 3,980

Current Expenditure 3,55 4,334 4,974 4,64

Capital Expenditure and Lending 1,192 1,357 1,915 1,976

Total Expenditure and Lending 4T77b 3,691 6,669 F700

Revenue from FCD 290 137 236 147Taxes on Food Imports (267) (117) (211) (131)Customs Handling Chg. on Food Irr.rc.rrs (23) (20) (29) (16)

Other Revenue 3,382 4,304 4,267 5,o35Total Revenue 3,572 4,441 4,503 5,162

Overall Deficit 1,106 1,250 2,366 1,418Of which: Impact of

Food Distribution Program 441 900 1,07C 497

1/ Payment under the voluntary family allowance scheme and familyallowances for marginal tax payers.

Sources: Central Bank of Ceylon;Food Commissioner's Department; andMinistry of Finance

ANNEXPage 1

ANNEX: Technical Note on Food Subsidy Statistics

Food Subsidy Statistics and Government Accounts

Discussions of the food subsidies of Sri Lanka often refer to

terms "gross food subsidy" and "net food subsidy." The purpose of thisnote is to show the details of these terms and to point out the problems

related to the use of them in government accounts. The "gross food subsidy,"which is a current expenditure item in budgetary accounts, 1/ is the sum

of the losses from the purchase and sale of individual items incurred by

the Food Commissioner's Department (FCD) plus the subsidy on infant milk

food. If the FCD generates any profits on some items, then the sum of such

profits is recorded as a current revenue item with a revenue head "profits

from sale of foodstuffs." The "net food subsidy" is used for "gross food

subsidy" minus "profits from sale of foodstuffs." However, neither "gross

food subsidy" nor "net food subsidy" is an indicator of the net cost of the

food subsidy/food distribution program to the government.

The loss or profit of the FCD associated with an individual item

X, e.g., sugar, during a given fiscal year is calculated as follows (illus-

tration is given in Table Al):

(1) The value of the opening stock of X, which is the

actual cost incurred for acquiring the opening stock,

including indirect taxes;

(2) Plus: Payment for the purchase of X during the fiscal

year, also including indirect taxes;

(3) Less: Value of the closing stock of X, calculated in

the same way as the opening stock (Opening stock of X

for a fiscal year equals the closing stock for the

previous year);

(4) Plus: Distribution expenses and depreciation of equip-ment attributable to item X;

(5) Less: Proceeds from the sale of X during the fiscal

year.

1/ The term "budgetary accounts" refers to the government accounts published

in the Estimates of Revenue and Expenditure of the Governrent of the

Republic of Sri Lanka (Est. R & E).

AnnexPage 2

Table Al: Food Subsidy Account, 1976 (Budget Est.)

(Millions of Rupee) 1/Taxes Other Total

RiceOpening Stock 1 237 238

Plus: Purchase 6 1,485 1,491

Less: Closing Stock -1 -179 -180

Plusi Distribution Expenses - 130 130Cost of Rice Distributed 6 1P73 1,679Less: Sale Proceeds - -758 -758

Loss/Profits(-) from Rice Sale 65 915 921

FlourOpening Stock 5 295 300Plus: Purchase 12 815 827

Less: Closing Stock -3 -143 -416

Plus: Distribution EKpenses - 87 87lost of Flour Distributed 1,U54 1 ,7

Less: Sale Proceeds - -1,174 -1,174

Loss/Profits(-) from Flour Sale 71 -120 - 10b

Sugaropening Stock 46 68 114Plus: Purchase 113 258 371Less: Closing Stock -31 -45 -76

Plus: Distribution Ekpenses - 1 1Cost of Sugar Distributed 0 TTLess: Sale Proceeds - -337 -337

Loss/Profits(-) from Sugar Sale -55

Food Commissioner's Balance 148 740 888Total Losses -9

Total Profits 106

Subsidy on Infant Milk Food - 6 6

Net Food Subsidy 148 746 894Gross Food Subsidy: Current Ecpenditure -0

Profit from Sale of Foodstuffs: Current Revenue 106

1/ Taxes on food imports, consis:ting of import duties and FEECs.

Sources: Central Bank of Ceylon and Ministry of Finance.

ANNEXPage 3

If the figure x thus derived is positive, then x is the loss on X;

if x is negative, then -x is the profit on X.

The definitions of "gross food subsidy" and "profits from sale

of foodstuffs" are somewhat arbitrary. Nevertheless, these figures are

treated in the budgetary accounts as current expenditure and current revenue

items, respectively, subjecting the total current expenditure and total

current revenue figures also to the arbitrariness. The source of the arbi-

trariness is the spearation of the balance of FCD's operations into loss

balances and profit balances.

As shown in Table Al, losses and profits are calculated for individ-

ual items distributed by the FCD. However, the accounts for rice and sugar

transactions can be further divided as in Table A2. This does not affect

the magnitude of "net food subsidy," but "gross food subsidy" and "profits"change by an equal amount. The changes in this example are caused by the

separation of sugar account into a loss section and a profit section; if the

estimated result of paid rice ration were a profit, the separation of the rice

account would also affect the sizes of "gross food subsidy" and "profits."

Table A2: Alternative Food Subsidy Account, 1976(Millions of Rupee)

Taxes Other Total

Cost of Free Rice Distributed 3 811 814

Cost of Paid Rice Distributed 3 862 865Less: Sale Proceeds - -758 -758Loss/Profits(-) on Paid Rice 3 104 107

Cost of Flour Distributed 14 1,054 1,068Less: Sale Proceeds - -1,174 -1,174Loss/Profits (-) on Flour 14 -120 -106

Cost of Sugar Rationed 93 205 298Less: Sale Proceeds - -83 -83Loss/Profits(-) on Ration Sugar 93 122 215

Cost of Off Ration Sugar Distributed 35 77 112Less: Sale Proceeds - -254 -254Loss/Profits(-) on Off Ration Sugar 35 -177 -142

Subsidy on Infant Milk Food - 6 6

Net FoQd Subsidy 148 746 894Gross Food Subsidy: Current Expenditure 1,142Profit from Sale of Foodstuffs: Current Revenue 248

ANNEXPage 4

There are other ways to sub-divide the accounts of the FCD; e.g.,into imported items and domestic items. The choice between various sub-

divisions of the FCD's account is arbitrary. "Gross food subsidy" and

"profits" can change, by an equal amount, relative to the figures shown

in Table Al, for each variation of sub-division. Such changes in "gross

food subsidy" and "profits" affect the sizes of total current expenditure

and total current revenue, although the difference between the two, i.e.,

current account balance, remains unaffected. "Net food subsidy" is the

only quantity that is independent of this arbitrary decision on the sub-

division of FCD's accounts.

Therefore, from the viewpoint of the stability of the government

accounts, the use of "net food subsidy" as a single current expenditure

item is superior to the use of "gross food subsidy" and "profits" as separate

expenditure and revenue items. However, "net food subsidy" is also subjectto some problems.

For the purpose of the following discussion, one should note that

the FCD is a public enterprise in its function. Institutionally, the FCD

is integrated with the central government, but it supplies goods to the

public on a large scale. For statistical O'%':pose, following the recommen-

dation of the GFS Manual, 1/ the accounts of the transactions of the FCD

should be treated as those of a public enterprise that sells goods at con-

trolled prices and receives government transfers to cover the operating

deficit.

Table A3 shows that in 1976 the FCD's expected expenditure is

Rs 2,907 million. The expected revenue, all of which is operating receipts,

is Rs. 2,269 million. Thus, the expected operating deficit of the FCD is

R3. 638 million.

1/ IMF, A Manual on Government Finance Statistics, June 1974.

ANNEXPage 5

Table A3: Cash Accounts of FCD Operation, 1976(Millions of Rupee)

Operating ExpenditureFood Purchase: Excluding Payments to Gov't 2,543

Rice (1,479)Wheat Flour ( 807)

Sugar ( 257)

Customs Handling Charges on Food Imports 16

Taxes on Food Imports 131

Import Duties ( 25)FEECs ( 106)

Distribution Expenses 218

Total Operating Expenses 2,907

Sale Proceeds 2,269

Operating Deficit 638

Sources: Central Bank of Ceylon and Ministry of Finance.

It is most likely that the government would transfer this amount

to the FCD, if the FCD were an independent agency outside the institutional

1central government." In that case, the current expenditure of the government

related to the food subsidy/distribution program would be Rs. 644 million

(transfer to FCD of Rs. 638 million plus infant milk food subsidy of Rs.

6 million), instead of Rs. 1,000 million, which is included in the current

expenditure figure in the budgetary accounts -s "gross food subsidy." IfFCD were an independent agency, then it would not remit any money to the

government in this situation, i.e., in the absence of any remittable surplus.

Therefore, the current revenue of the government from food distribution

would be nil, instead of Rs. 106 million shown as the "profits from sale of

foodstuffs."

The amount of food subsidy on a cash basis of Rs. 644 million,derived above, differs from "net food subsidy" of Rs. 894 million. Thedifference is the net loss of FCD on the sale of foodstuffs not purchased

in 1976 but taken out of the stock built up earlier.

"Net food subsidy" less subsidy on infant milk food is the

difference between the cost of FCD for acquiring all foodstuffs distributed

in a fiscal year, inclusive of distribution expenses and import taxes, and

the total sale proceeds of FCD in the same fiscal year. Therefore, "net

food subsidy" correctly reflects the amount of subsidy that accrues in that

ANNEX

Page 6

fiscal year to the public, which in this context includes domestic paddy

growers and sugar cane growers and the three public corporations processing

rice, flour and sugar, as well as consumers. Even if FCD were a private

merchant, the government would give this amount to FCD for the same services.

Nevertheless, "net food subsidy" statistics does not fit into

the rest of the government accounts. The accounts of budgetary transactions

are recorded basically on a cash basis in Sri Lanka. However, in "net food

subsidy" cash basis accounts and accrual basis accounts are mixed; FCD's

receipts are recorded on a cash basis, but its expenditures for food purchase

are recorded on an accrual basis, 1/ i.e., they are recognized as expenditures

when the corresponding goods are distributed.

As the mixed use of cash basis accounts and accrual basis accounts

creates various confusions, it would be desirable to change the budgetary

accounting practice and show the current or operating deficit of FCD as

a current expenditure item, i.e., as government current transfer to FCD.

For the purpose of showing the scale of "subsidies," memorandum entries

can be devised for "gross food subsidy," "profits" and "net food subsidy."

Table A4 shows how the change in accounting practice would affect the current

accounts of budgetary operation. Budgetary account figures in the first

section of this table differ from those published in Est. R & E to some

extent, as explained in the footnotes.

The current account surplus figures in the "modified accounts"

differ considerably from those in the "budgetary accounts." The difference

is equal to the difference between current expenditure for the food distri-

bution program on a cash basis (line 2.d) and the "net food subsidy" (line

1.d less line 1.b). For 1973-1975, current account surplus is much smaller

in the "modified accounts" than in the "budgetary accounts," as line 2.d

reflects the impact of high food prices in this period more fully than the

"net food subsidy"; the relationship is reversed in 1976, as line 2.d re-

flects the impact of expected food prics downfalls more fully than the "net

food subsidy."

1/ In an ordinary terminology, expenditure account on an accrual basis

would mean the recording of expenditure at the time the object for

the payment is delivered. Here, this term in used differently.

AnnexPage 7

Table A4: Alternative Current Account.s(Millions of Rupee)

1973 1974 1975 1976Rev.Est. Bud.Est.

Budgetary Accounts 1/l.a Current Revenue72/ 3,671 4,438 4,501 5,177l.b Of which: Profits from Sale of Foodstuffs 22 - 5 106

l.c Current Expenditure 3/ 3,556 4,222 4,659 4,980l.d Of which: Gross Food-Subsidy 7(,1 925. 991 1,000

l.e Current Account Surplus 115 216 -158 197

Modified Accounts2.a Current Revenue (l.a less 1.b) 3,649 4,438 4,496 5,071

2.c Current E=enditure (1.c less l.d plus 2.d) 3,586 4,334 4,974 4,6242.d Of which: Fcod Distributicn Progran 4/ 731 1,037 1,306 644

2.e Current Account Surplus 63 104 -478 447

MemorandaGross Food Subsidy 701 925 991 1,000Less: Profits from Sale of Foodstuffs -22 - -5 -106Net Food Subsidy 679 925 986 894

1/ Adjusted for the accounts of Government Enterprises and current-capitaldefinitions of the UN 5EA system.

2/ Including revenues from taxes on property, which are treated as capital revenuein the budgetary accounts. Gross receipts of Government Ehterprises havebeen removed, and only positive current surpluses are included.

3/ Including outpayments of advance account activities. Gross current expenditures ofGovernment Enterprises have been removed, and only positive current deficitsare included.

4/ Operating deficit of FCD, payments under the family allowance schemes (1973), andsubsidy on infant milk food.

ANNEXPage 8

Composition of Food Subsidy

As shown above, "losses" on rice, flour and sugar in the budgetaryaccounts refer to the shortfall of FCD receipts from the sale of these food-stuffs relative to the cost that FCD incurs for acquiring distributed food-stuffs and the services involved in purchasing and distributing them. Such"cost" includes import duties, FEECs and customs handling charges, whichconstitute a part of government revenue. If any of the three public corpora-tions engaged in domestic food processing (PMB, CSFMC and SLSC) generatesprofits, the "cost" includes also such profits.

Therefore, the net transfer from the government to the publicembodied in foodstuffs distributed by FCD in a given year is smaller thanthe total net loss of FCD. The net transfer from the public sector differsin turn from the net transfer from the government by the amounts of theprofits of the three public corporations.

Food imports by the FCD are subject to import duty as follows:Rs. 20 per long ton of rice, Rs. 40 per long ton of wheat flour, and Rs. 130per long ton of sugar. In addition, sugar imports are subject to FEECs at65%. As shown earlier, "net food subsidy" does not mean "food subsidy net ofthe indirect taxes."

The budget estimates for 1976 indicate that import duties andFEEC revenue of the government collected on the food imports of the FCDwould amount to Rs. 131 million, which is about 6% of the estimated totalgovernment revenue from import duties and FEEC sales. Furthermore, thesetaxes amount to 5% of the estimated payments by the FCD for food purchase(Table A5).

Table A5: Food Commissioner's Tax Payments, 1976 /1(Million of Rupee)

Import Duties 25Rice ( 6)Wheat Flour (12)Sugar ( 7)

FEECs 106

Total 131

FCD's Total Payment for Food Purchase 2,689

Government Revenue from Import Duties & FEEC Sales 2,055

/1 Estimates shown in the "Taxes" column of "Purchase" lines in Table Al.

Table A6: Net Transfers Associated with Food Dititribution Program

(Millions of Rupee)

1970/71 1971/72 1973 1974 1975 1976(12 mo.) Rev. Est. Estimate

RiceCost to FCD 877 771 865 1,335 1,566 1,679

Less: Sale Proceed -273 -244 -305 -523 -753 -75Loss of FCD bS -3S -3S b-gS T3 92

Less: Import Duty -9 -7 -7 -6 -8 -6

Customs Handling Chg. -12 -9 -8 -8 -10 -8

Net Transfer from Government -77 3U. -3w 79 907

Les: YMB Profit n.a. n.a. n.a. -17 -8 -22

Net Transfer from Public Sector n.a. n.a. n.a. 781 786 885

Wheat FlourCost to FCM 256 330 611 903 1,193 1,068

Less: Sale Proceed -259 -304 -500 -864 -1,199 -1,174

loss of FCD -4 -76S 11 SS --- P --- TrS

Less: Import Duty -13 -14 -16 -15 -17 -14

Customs Handling Chg. -8 -9 -10 -10 -11 -9

Net Transfer from Government - 83 1

Less: CSF4C Profit n.a. n.a. n.a. -21 -9 n.a.

Net Transfer from Public Sector n.a. n.a. n.a. n.a.

SugarCotto FCD 366 1127 555 1100 4l4 410

Less: Sale Proceed -428 -4711 -577 -357 -242 -3378Loss of FCD -- 22T S 1S - 7 3 S

Less: FEEC Charge -135 -130 -221. -76 -139 -121

Import Duty -35 -30 -24 -11 -6 -7

Customs Handling Chg. -7 -6 -5 -2 -1 -1

Net Transfer from Government -39 71 -4 26 ---56

Less: SLSC Profit n.a. n.a. n.a. -28 -1k n.a.

Net Transfer from Public Sector n.a. n.a. n.a. -74 n.a.

S: Component of "gross food subsidy".

ANNEXPage 10

If FCD imports were exempted from import taxes, then governmenttax revenue would be smaller. In that case, the operating deficit of FCD

would also be smaller by the same amount for given food distribution prices.The government current transfer to FCD on a cash basis would also be smallerby the amount of FCD import taxes. Therefore, the current account position

of the government on a cash basis would be the same whether or not FCD im-ports are subject to import taxes. The same argument applies to customshandling charges.

The accounts of the three public corporations show that in therecent years they have been generating small but positive profits. If thesecorporations are made to sell their outputs to FCD at cost, instead of genera-ting profits, the current account position of the public sector on a cashbasis would not be affected; although "gross food subsidy" would be smaller,and "profits from sale of foodstuffs" would be larger than the actual.

In the case of rice, the difference between the loss of FCD andnet transfer from the public sector (to the private sector) has been small.However, in the case of sugar, the difference has been substantial-due mainlyto the FEEC requirement on sugar imports. The details are shown in TableA6. These figures show transfers on an accrual basis.