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FACTBOX-Five political risks to watch in Sri Lanka | Reuters

[Reuters, Wednesday, 3 February 2010 09:26 No Comment]

Sri Lankan President Mahinda Rajapaksa won a landslide re-election on Jan. 26, putting him firmly in charge of the Indian Ocean island nation he led to victory in a quarter-century war in May.

Following is a summary of key risks to watch in Sri Lanka:

* POLITICS

Rajapaksa is proceeding full speed ahead toward parliamentary elections due before April. After he won by a margin of 18 percent over opposition candidate General Sarath Fonseka, the opposition is fractured, demoralised and threatening protests over what it calls a stolen election. Few expect the opposition, a collection of diverse parties that unified only for the purpose of beating Rajapaksa, to succeed in challenging the result nor to stick together at the parliamentary poll. Rajapaksa is aiming to get a two-thirds majority in parliament that would give him a free hand to change the constitution to his liking and trim a cabinet of more than 100 ministers to a more manageable number.

What to watch:

- Whether Rajpaksa can secure two-thirds majority. This would be broadly positive for markets because it would allow decisive policymaking. He is likely to make overtures to some opposition parties to secure this.

- The types of parties Rajapaksa keeps in his rejigged coalition, should he win. That will to a large degree show the types of policies he will follow.

- How the government deals with a coup plot it says Fonseka’s supporters tried to hatch, or any large protests that materialise. If it acts with too heavy a hand, it risks some backlash at home, plus further damage to international ties.

* FISCAL REFORM AND MANAGEMENT

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 — in particular reducing the corporate tax rate and the bureaucracy for starting a business — before it starts to gather steam. Sri Lanka has vowed to bring down its budget deficit to 6 percent in 2010 under targets specified in a $2.6 billion International Monetary Fund (IMF) loan.

What to watch:

– Any sign of an erosion in fiscal discipline. Credit rating agencies say adherence to the IMF plan is crucial for international investor confidence in Sri Lanka.

– Progress in efforts to raise revenue collection or rein in public-sector spending. Rajapaksa pledged pay raises to public employees during the election. How he pays for this will be a good indicator of what tack his government will take.

– The official full-year 2009 budget deficit numbers. They will be the first big measure of how well Sri Lanka is doing against IMF targets.

* THE RUPEE CURRENCY AND INFLATION

Under Central Bank Governor Ajith Nivard Cabraal, inflation has fallen from more than 28 percent in 2008 to single digits. He expects it to stay there for the rest of the year. But it has been rising for five straight months and hit 6.5 percent in January. The governor says he is willing to tighten monetary policy to keep it in check, after loosening policy last year to spur private-sector credit growth. Cabraal has also said he expects to revoke most of Sri Lanka’s strict currency controls to spur investment and allow the rupee .LKR to float more freely, but appeared to back off during the election.

What to watch:

– Any monetary tightening, and the corresponding reaction of both the inflation rate and the rate of credit growth. Both will give a clearer picture of overall economic health.

– Any move to relax the currency controls, and the subsequent reaction of the rupee’s exchange rate.

* INTERNATIONAL RELATIONS

Western countries, and groups in the Tamil diaspora, are pressing for some kind of accountability for thousands of civilian deaths at the end of the war. Sri Lanka is adamant its soldiers did not violate international law, and that for now has cost it enhanced European Union trade preferences known as GSP+ worth $100 million a year. However, Sri Lanka’s willingness to turn to countries like China and Iran appears to have prompted the West to take a softer line. India remains a steadfast ally, and its influence is likely to help that trend continue.

What to watch:

– Whether Sri Lanka can reach a deal with EU to get GSP+ back. The reinstatement of the trade concession would help Sri Lanka’s garment industry, its top foreign exchange earner.

– The extent of Western redevelopment aid, versus that from India and China, largest donors since the end of the war so far.

* TAMIL RELATIONS

The government says 70 percent of more than 280,000 internally displaced people who fled the end of the war against the Tamil Tigers have been relocated from the main refugee camps, but most are still in transit facilities while de-mining work is being completed. This has done nothing to help smooth over the strained relations between the Tamil minority, and the Sinhalese majority to which Rajapaksa belongs. Those were the root of the conflict the Tamil Tigers waged for three decades.

Key issues to watch:

– Concrete steps Rajapaksa takes to address Tamil political demands, something he said he would do after elections were over.

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