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Lanka violence to hit economy, drive inflation

Analysts say the security situation might be enough to make the Govt put off foreign currency bond issues planned by the end of May.

india Updated: May 05, 2006 11:34 IST

Renewed violence in Sri Lanka could push up inflation and interest rates while hitting economic growth, analysts say, and any return to bombings in the capital could prompt serious economic hardship if foreign investors flee.

A suicide attack in Colombo's army headquarters and government air strikes on Tamil Tiger targets have already prompted rating agencies to downgrade their outlook and unless peace talks resume diplomats fear violence could get worse.

"It would be a bit of a crisis if we went back to full-scale war," said economist Hasitha Premaratne at Hatton National Bank. "It would have an impact on foreign investments, shipping prices would go up and defence expenditure would go up in a big way."

Already, analysts say, the security situation might be enough to make the government put off foreign currency bond issues planned by the end of May, particularly after the rating moves.

"If the government wants to raise dollars overseas, it's going to be harder," said Vajira Premawardhana, head of research at Lanka Orix Securities. But more serious could be the impact on inflation and growth in the island's $20 billion economy.

Inflation fell to a 12-month moving average of 9.2 per cent in April, its lowest rate since January 2005, from 9.6 per cent the previous month, but analysts say it has probably bottomed out, especially with oil prices rising.

The government is gradually cutting fuel subsidies in the face of rising oil prices, saying it needs to spend the money elsewhere, and analysts said that could show through eventually in higher prices for consumer goods.

"If they decrease the subsidy too fast, inflation will increase," said Hatton's Premaratne. "If they do not take away the subsidy, there will be budget constraints."

But it is the country's increasingly dicey security situation that provides the real worry. In the event of attacks on civilian or economic targets in Colombo, analysts fear a widespread flight of foreign investment.

In April, the central bank held interest rates at 8.75 per cent, already the highest since May 2003. If violence continues, few expect rates to be cut and most expect increases in an attempt to hold down inflation.

Analysts also fear freight carriers will slap a "war premium" on deliveries to the island, driving up prices. Tourists will probably stay away, as will buyers in the textile and tea sectors.

Last week, the central bank said it expected 6.9 percent economic growth in 2006, but analysts say that looks unlikely in the current climate. Any return to wider fighting could shave a couple of points off growth, they say.

Sri Lanka's financial community continues to hope a return to total war can be avoided and that the government and Liberation Tigers of Tamil Eelam (LTTE) can overcome logistical hurdles to meet for talks in Switzerland that the government wants on May 10.

The stock market has fallen with each new attack but traders say they remain optimistic that talks will happen. All the same, some are looking for jobs outside the country and brokerages have begun cutting costs.

Traders say most players are simply keeping out of the market rather than selling outright when bad news comes, keeping volume low.

"People are living in hope but the market is very cautious," said Prasanna Chandrasekera, assistant manager at John Keells Stockbrokers.