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FACTBOX-Five political risks to watch in Sri Lanka

[Reuters, Wednesday, 7 October 2009 09:45 No Comment]

logo_reuters_media_us Sri Lankan President Mahinda Rajapaksa’s ruling coalition looks set to win polls in his native Southern Province on Saturday, seen as the last political step he wants to clear before calling an early presidential election.

Following is a summary of five key risks in Sri Lanka, which won a 25-year war against the Tamil Tigers in May:

* GOVERNMENT EFFECTIVENESS

Saying that Rajapaksa will win re-election to a second six-year term is one of the safest political bets in the world now. His popularity is legion because of the war victory, and allies say a presidential election is likely to take place in January, with parliamentary polls in March. His camp is already talking about trying to get a two-thirds majority in parliament. That will give him the power to the change the constitution and mean he will have a lot less pressure to please coalition partners, including Marxists and hardline nationalists.

Key issues to watch:

- Size and composition of the post-election cabinet. A leaner cabinet with fewer hardliners and Marxists would be a positive sign for investors. Any moves to change the constitution should be closely watched, with an eye on whether Rajapaksa will resist the temptation to alter it for his own benefit.

* ECONOMIC REFORM

Although foreign direct investment into Sri Lanka has picked up now the war is over, investors say there are plenty of reforms that need to be made on both the macro- and microeconomic levels. Doing business can be a tricky affair in Sri Lanka. The bureaucracy and tax code are what one might expect from a former colonial shipping outpost with a post-independence history full of socialist policies. The corporate tax rate is over 60 percent. Corruption exists, but is lower than in regional peers.

The government has not been shy about reversing privatisations done by the United National Party, now the main opposition. Monetary policy is seen as having been well communicated, but some criticise the government for micromanaging the currency. But it has brought down inflation from record levels to single digits and is driving interest rates lower.

Key issues to watch:

– Look for corporate credit growth once market interest rates come down in line with the central bank’s policy rates. Market interest rates are around 13 percent, while the central bank is targeting closer to 11 percent.

- Watch for compliance with the targets laid out in a $2.6 billion International Monetary Fund loan. There is speculation the government may not follow the full 20-month plan now that foreign exchange reserves are up. Credit analysts say that would cost Sri Lanka some of its hard-won investor confidence.

* PRESSURE OVER WAR’S FALLOUT

Western countries, and groups in the Tamil diaspora who supported the Tamil Tigers, are pressing for some kind of accountability for thousands of civilian deaths at the end of the war. Sri Lanka’s government is adamant its soldiers did not violate international law and the president has vowed to defend the country at any such tribunal.

The U.S. State Department, at the behest of Congress, is preparing a war crimes report due in the next month. And the European Union is reviewing Sri Lanka’s rights record to decide whether to let it keep a special trade preference called GSP Plus. The preference has been a boon to the island nation’s textile industry, its top source of foreign exchange, and the government is now lobbying to keep it after dismissing the need for it earlier. [ID:nCOL456956]

Key issues to watch:

- The contents of the State Department report in the next month, and the European Commission’s recommendation on GSP Plus, due by mid-October. The government’s willingness to show compromise on both will be welcomed, diplomats say. However, expect little public compromise before the elections.

* REFUGEES

One big risk is how the government handles roughly 260,000 Tamil war refugees who fled fighting in the waning months of the war, and are now being held in military-run camps. Western countries, India and the United Nations are pressing the government hard to send them home, and Rajapaksa has said 70-80 percent will be resettled by January. So far, about 15,000 have been sent home, and the onus is on the government to make good its pledge. Those pressuring Sri Lanka say holding them too long will only breed resentment that could harm reconciliation between the Tamil minority and the Sinhalese majority.

Key issues to watch:

- Look for the rate of returns to pick up, or for countries paying for the camps to stop funding them if the government does not keep on target.

* SECURITY

The Tamil Tigers are finished as a guerrilla fighting force, but there are still well-financed members of its international network out there and no shortage of Tamils raised on the LTTE’s virulent propaganda who are furious at how the war ended.

Sri Lanka says there is minimal threat, but military and police checkpoints are ubiquitous in the capital, Colombo.

The broad message is that the military and intelligence agencies are not finished capturing and eliminating remnants of the Tiger networks responsible for assassinations and suicide bombings in and around the capital.

Key issues to watch:

- Watch for a gradual easing of security — this will indicate greater government confidence it has truly tracked down all Tigers operatives.

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