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FACTBOX-Key political risks to watch in Sri Lanka

[Reuters, Tuesday, 4 May 2010 07:52 No Comment]

Recently re-elected Sri Lankan President Mahinda Rajapaksa last month secured the strongest parliamentary majority in the country in more than a decade, barely a year after he declared victory in a 25-year civil war.

Now is the time for long-awaited economic and political changes, and Rajapaksa has considerable power to push his agenda.

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

* UNCERTAINTY OVER IMF LOAN

In March, the International Monetary Fund delayed the release of the third tranche of Sri Lanka’s $2.6 billion loan, saying it wanted to see the fiscal reforms in the budget first.

That had been delayed until May, to give time for the new parliament to sit. Instead, the president will unilaterally approve the next three months of expenditure and parliament will pass a mini-budget for the rest of the year in July.

Sri Lanka’s treasury secretary said fiscal and tax reforms will only be in the full-year 2011 budget. [ID:nSGE63S07Z]

Given that Sri Lanka missed by a wide margin the 2009 budget deficit targets agreed with the IMF, and said it wants to negotiate less demanding targets, it is uncertain when the tranche will be released.

What to watch:

- The IMF’s reaction after a mid-May mission to the island, where both the budget and the revised targets will be negotiated.

- Some allies of the president say the loan is no longer necessary, given that it was intended to solve a balance-of-payments crisis when foreign reserves dipped to just $1.27 billion. They have now climbed to over $5 billion.

- The reaction of credit ratings agencies if the IMF or government cancels the loan. It was a key factor in getting Sri Lanka’s credit rating raised after the war, and this gave foreign investors the confidence to come in. If the loan is cancelled, capital flight could be a risk.

* THE RAJAPAKSA FACTOR

The president, like many in Sri Lanka and south Asia before, has made politics a family affair. His elder brother is the parliament speaker, and his youngest brother is in charge of the new economic development ministry responsible for tourism, nation building and investment promotion. Another brother, the defence secretary, is also tipped to be put in charge of the agency responsible for developing prime government real estate in Colombo, by moving buildings to the administrative capital of Sri Jayawardenapura just out of town.

The president is also the finance minister, so in short, any big investment decision needs the blessing of the Rajapaksas.

What to watch:

- Whether Rajapaksa and his family show evenhandedness in the development of public-private investment partnerships.

- Whether Rajapaksa can shake off concerns that investments can be interfered with by the government. Privately, some wealthy local investors say they are afraid to commit because they worry the government could interfere.

* CONSTITUTIONAL CHANGE

The president’s ruling alliance has 144 seats in the 225-member parliament, just six shy of the two-thirds majority he needs to change the constitution.

He has been vague about proposed changes, aside from saying he might create a second house of parliament, do away with the problem-plagued preferential voting system and abolish the powerful executive presidency he now enjoys.

However, Sri Lanka has had a relatively disastrous history of changes wrought by constitution, and there is already talk from inside the president’s party that he would change it to allow himself a third term in office.

What to watch:

– The crossovers Rajapaksa engineers to give himself the two-thirds majority. Already, there is talk he will not do this until he takes his oath for his second term in November.

– The concrete reforms the president proposes, and whether they tend to favour him or the polity as a whole.

* THE RUPEE AND INFLATION

Under Central Bank Governor Ajith Nivard Cabraal, inflation has fallen from more than 28 percent in 2008 to single digits. But it has been rising again, and the governor says he is willing to tighten monetary policy to keep it in check, after loosening it last year to spur private-sector credit growth.

Still, credit growth is negative year-on-year. The rupee currency LKR= is being pushed upwards by economic fundamentals and the central bank says it will not allow any swift movement.

What to watch:

– Any monetary tightening, and the corresponding reaction of the inflation and credit growth rates.

– A change in regulations to boost banks’ statutory reserve requirements, which Cabraal said in April was an option.

- Any move to relax currency controls, and the reaction of the exchange rate. Most currency traders expect it to rise, which would not please exporters.

* 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 human rights or commit war crimes, but international disquiet 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, and India remains a close ally.

U.N. Secretary-General Ban Ki-moon has said he will appoint a panel to advise him on war crimes, but that has not gained any traction and diplomats say it is unlikely to do so any time soon.

What to watch:

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

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