By Shihar Aneez
COLOMBO, Feb 13 (Reuters) - President Mahinda Rajapaksa is under fire from the U.N. Human Rights Council, which last year adopted a 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.
The U.S. believes it has failed to do that, and this March will repeat its actions the same forum. Washington and London are trying to exert some pressure on Colombo, expressing concern at attacks on journalists, activists and lawyers.
Meanwhile, simmering antipathy between the government and the judiciary threatens to intensify into a destabilising confrontation, while 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)
MOODY'S: B1 with positive outlook
FITCH: BB- with stable outlook
Following are the key political risks to watch:
WAR CRIMES, UN RESOLUTION, RIGHTS SQUEEZE?
Last year's UNHCR resolution 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.
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.
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 responds to last year's U.N. resolution, and whether it comes under greater international pressure after the March UNHRC sessions.
- Whether Sri Lanka fully implements the local commission's report, and if international pressure recedes when the government implements some of those recommendations.
- Judicial independence and the rule of law under the new chief justice.
- Tension between the judiciary and government, which may rise further.
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.
The government has said it would meet last year's fiscal deficit target of 6.2 percent, the level agreed with the International Monetary Fund under the terms of a $2.6 billion loan, which was fully disbursed in July. The government expects to negotiate a fresh IMF loan in February 2013.
Sri Lanka aims to accelerate the growth of its $59 billion economy by pumping money into post-war infrastructure works.
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.
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.
In July, after selling a $1 billion, 10-year sovereign bond, the central bank said Sri Lanka would maintain a flexible exchange rate, allowing flows to determine trends, but the bank would intervene should fluctuations in the value of the rupee become too sharp.
Inflation accelerated to a near record high of 9.8 percent year-on-year in January due to lack of vegetable supply after flash floods in major farmlands in December.
What to watch:
- How quickly the government can address the cost of living issues.
- The scope of protests and whether opposition parties can find common ground to target the government.
THE TEHRAN-WASHINGTON OIL SQUEEZE
Oil import-dependent Sri Lanka has reduced its Iranian crude deliveries by 20 percent but disagrees with Western sanctions that are punishing countries that depend 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.
In 2011, Sri Lanka imported 93 percent of its crude from Iran. Sri Lanka has twice raised its gasoline price 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 the purchase of refined products. (Editing by Daniel Magnowski)