JAFFNA: For most of 2005, Sri Lanka’s stock market was Asia’s best performer, but fears that a two-decade old civil war may restart are making investors worried and some hoteliers and shop owners are already feeling the pinch.

Even before a series of attacks on troops raised concerns of a return to war, analysts were already sceptical of new President Mahinda Rajapakse’s pledge to boost economic growth to 8.0 per cent in 2006 from an estimated 5.5-6.0 per cent last year.

There is no question that this target will become impossible to reach if a 2002 truce with the Tamil Tiger rebels breaks down completely, they say.

“War ... is not going to cripple the economy,” said Chinthaka Ranasinghe, head of research at John Keells Stock Brokers in Colombo.

But he added: “It’s going to hamstring the economy alright. You’re going to see 4.5-5.0 per cent growth on paper. But when you’re looking at growth possibilities of 7.0 per cent, then it’s serious business.”

Dollar aid after Asia’s tsunami boosted both the local rupee and the stock exchange — but the bourse has fallen sharply after the string of attacks on the military last month.

In the government-held northern Jaffna peninsula, cut off from the rest of the island by a de-facto rebel state, store owners say clashes between troops and Tamil youths coupled with suspected rebel attacks have already hit trade.

“Business has been very badly affected,” said 28-year-old shopkeeper Rajah Rajeswaran. He is considering joining a growing number of people heading south, even if it means abandoning his stock of food and toiletries. “People are fearful. Earlier, I would sell about 10,000 rupees ($98) a day. Now it is 5,000.”

In the capital, Colombo, analysts hope key export earners in the textile and tea sectors would be largely unaffected by new conflict in the poor, minority Tamil dominated north and east. But some hotel owners — many still rebuilding after the 2004 tsunami — say recent violence has already hit bookings.

Sri Lanka’s stock market started to nosedive after the Liberation Tigers of Tamil Eelam (LTTE) torpedoed the election chances of the moderate market favourite candidate by boycotting November’s presidential vote, helping perceived hardliner Rajapakse to power.

Some analysts say the boycott, as well as a string of deadly claymore fragmentation mine attacks that killed 39 soldiers in December alone, show the Tigers have used the truce to regroup and rearm — and are prepared to resume a war that killed over 64,000 people in their push for autonomy.

The bourse was up 70 per cent for the year just before the election, but closed 2005 with a gain of around 25 per cent.

Sri Lanka’s rupee, which like the stock exchange rallied on dollar inflows after the tsunami, has remained relatively stable at about 102 to the dollar despite the violence — but traders say that is only because state banks regularly intervene.

“If peace doesn’t prevail, there will be some fall on the aid front and that will hit the currency,” said Hasitha Premaratne, head of research at Hatton National Bank. “We could see inflation rising and interest rates coming under pressure.”

Sri Lanka is striving to bring down inflation, which moderated to 11.6 per cent in December after hitting its highest level since Feb. 2002 in August, and any rise in defence spending would also hit the budget deficit.

But the full impact of any return to war would likely be felt more markedly in 2007 than this year as investment pledges dry up, Premaratne said. Hatton National Bank is targeting 6.1 per cent economic growth in 2006 if peace prevails, but war could cut that to 5.6 per cent.

“We have seen war before and the economy is very resilient,” he said. “We could do 4 per cent on autopilot. The garment sector would go on despite war, telecommunications would keep going and unless they target transportation, that should also grow.”

But the big fear, both for the tourism sector that makes up 6-8 per cent of the economy and the two largest dollar earners — tea and textiles — is that the Tigers might use suicide bombers against civilian targets in Colombo as in the past.

Feared Black Tiger bombers are blamed for destroying half of the Sri Lankan Airlines fleet in a 2001 airport attack. The garment sector says past attacks scared away European and American fashion buyers.—Reuters