Key political risks to watch in Sri Lanka

By Shihar Aneez

COLOMBO | Wed Apr 17, 2013 

(Reuters) - President Mahinda Rajapaksa is under fire from the U.N. Human Rights Council, which has adopted a second United States-sponsored resolution demanding that Sri Lanka ensure government troops who committed war crimes during the final stages of its war against Tamil rebels are brought to justice.

Washington and London are trying to exert more pressure on Colombo, expressing concern at continuing attacks on journalists, activists and lawyers.

Meanwhile, simmering antipathy between the government and the judiciary threatens a destabilising confrontation.

Rajapaksa's opponents say he has carved the country up into a family fiefdom, a situation which is discouraging foreign investment.

RATINGS: (Unchanged unless stated)

S&P: B+/B (Affirmed March 1 with stable outlook)

MOODY'S: B1 (Affirmed March 13 with positive outlook)

FITCH: BB- with stable outlook

Following are the key political risks to watch:

WAR CRIMES, U.N. RESOLUTION, RIGHTS SQUEEZE?

This year's resolution, similar to one in 2012, has urged Sri Lanka to implement the recommendations of an official Sri Lankan probe. That commission called for the prosecution of soldiers guilty of misconduct.

The government said last July it would take up to five years to try those accused of atrocities, a step critics said would lessen international scrutiny.

Though the U.S. has acknowledged that progress has been made, it says there is still much work still to be done and Sri Lanka must take meaningful action on reconciliation and accountability.

Tens of thousands of civilians were killed in 2009 in the final months of Sri Lanka's 25-year civil war, a United Nations panel has said, as government troops advanced on the northern tip of the island controlled by Tamil forces fighting for an independent homeland.

Washington along with some other Western nations wants to force Colombo to address allegations of war crimes as part of wider reconciliation to prevent renewed conflict, while Sri Lanka wants more time to pursue its own domestic process.

Adding to worries that the government is taking a heavy-handed approach to human rights, it has said it would tighten its media law to regulate all websites, not just printed material.

Attacks over media critical of the government have continued. Armed men set fire to a Tamil-language newspaper office in mid-April, just days after gunmen attacked another office of the same paper in northern Sri Lanka.

In March, Sri Lanka's security forces blocked hundreds of mostly ethnic Tamils from travelling to Colombo for a protest about relatives missing after the war.

A new line of confrontation has opened after Rajapaksa in January sacked the country's first woman Chief Justice, Shirani Bandaranayake. Rajapaksa appointed his ally and Cabinet lawyer as her successor despite protests by lawyers, a move that has raised concerns about the rule of law and judicial independence.

The government also barred a panel of lawyers from the International Bar Association's Human Rights Institute visiting Sri Lanka to assess the rule of law after Bandaranayake's removal.

What to watch:

- How Sri Lanka will respond to this year's U.N. resolution, and whether it comes under greater international pressure if it fails to address its poor human rights record.

- Whether Sri Lanka fully implements the local commission's report, and if international pressure recedes when the government implements some of those recommendations.

- Whether the government investigates the recent media attacks, and what its findings are.

- Judicial independence and the rule of law under the new Chief Justice.

- Tension between the judiciary and government, which may rise further.

BUDGET, IMF WARNING, ENERGY REFORMS

In its annual budget announced in November, Rajapaksa said Sri Lanka aims to reduce its fiscal deficit to 5.8 percent of GDP in 2013, while attaining 7.5 percent economic growth.

Sri Lanka aims to speed growth of its $59 billion economy by pumping money into post-war infrastructure works.

In April, the central bank last week conceded the country has missed its 2012 budget deficit target of 6.2 percent.

Construction and rebuilding projects in ports, roads, railways and other infrastructure, worth around $21 billion, are lined up over the next three years.

Another key lender is Beijing. In August 2012, the government said it would borrow more than $1.12 billion from China for a new port and railway construction.

Last month the government said China will lend another $278.2 million to Sri Lanka to help lay a railway line to a port which Beijing is building, and which has stoked concern in India.

At street level, higher costs of living have led to greater demands from trade unions for pay rises. Rajapaksa announced higher pay for public sector workers in the budget, though much less than they have demanded. The opposition, weakened by Rajapaksa's two-thirds parliamentary majority, has some traction with the public on the issue.

The central bank kept policy rates unchanged for a fourth straight month in April as expected.

Sri Lanka is seriously considering raising electricity tariffs, having hiked diesel and gasoline prices twice since December as a result of losses at state-run energy firms.

The central bank has shrugged off concerns over a spike in inflation due to expected increase in power bills, saying annual inflation in April is estimated at 6.3 percent, easing from last month's 7.5 percent.

Inflation accelerated to a near record high of 9.8 percent year-on-year in January and stayed there in February due to a lack of vegetable supply after flash floods in major farmlands in December.

In early 2013, the International Monetary Fund warned that Sri Lanka's economic growth is slowing more than the government expects, and faces additional risks from high inflation, lower tax revenue and slow structural reforms, factors which could endanger its strong post-war growth.

Ratings agencies S&P and Moody's echoed those concerns.

What to watch:

- Appetite in global capital markets for lending to Sri Lanka.

- Whether the government can find a balance between growth and fiscal discipline.

- How quickly the government can address the cost of living issues.

- Impact of a power tariff hike on inflation and the cost of living

THE TEHRAN-WASHINGTON OIL SQUEEZE

Oil import-dependent Sri Lanka reduced its Iranian crude deliveries by more than 20 percent in 2012 but disagrees with Western sanctions which are punishing countries that rely on its oil, Sri Lanka's foreign minister said last October.

Officials at the state-run Ceylon Petroleum Corporation (CPC) say that despite U.S. exemptions from sanctions on Iranian crude imports, in practice it is unable to bring any cargoes from Iran as a result of difficulties obtaining insurance and letters of credit.

Last year CPC was forced to shut Sri Lanka's only refinery for 10 days, restarting it after receiving a crude shipment from Dubai. The refinery is configured to run solely on Iranian crude.

The central bank has said the cost of oil imports rose 5.1 percent to a record $5.04 billion last year, mainly because the price of refined oil products also rose after sanction on Iranian crude were imposed.

In 2011, Sri Lanka imported 93 percent of its crude from Iran. Sri Lanka has raised its gasoline price three times since the sanctions were imposed last January.

What to watch:

- How Sri Lanka reduces Iranian imports further, and how it pays for imports from elsewhere. Deals with other nations for crude cargoes.

- If it increases purchases of refined products.

- If Sri Lanka further raises fuel prices, and the popular response to that.

(Editing by Daniel Magnowski)