By Peter Apps
LONDON, Jan 3 (Reuters) - Sri Lanka's unilateral withdrawal from an already moribund ceasefire with Tamil Tiger rebels will likely deepen its international isolation, but it may do little to dent investor sentiment towards the island.
The Norwegian-brokered 2002 ceasefire halted two decades of conflict, but effectively collapsed in late 2005 and early 2006 into outright war across swathes of the minority Tamil dominated north and east, with occasional bombings in the southern Sinhalese heartland and capital.
But the truce continued to exist on paper until Wednesday, when the government announced it would pull out of after the latest in almost daily bombings by suspected Liberation Tigers of Tamil Eelam (LTTE).
"We already knew the ceasefire was over," said Jennifer Harbison, South Asia desk head for London-based consultancy Control Risks. "It is perhaps a curiosity ... but I don't think it makes any actual difference."
After a government air raid killed the Tiger political leader and chief negotiator in November, shadowy rebel leader Velupillai Prabhakaran said he no longer held out hope of a negotiated settlement with President Mahinda Rajapaksa's government. He renewed his call for an independent Tamil state.
Other analysts and diplomats said the official end of the ceasefire might usher in further escalation in a conflict that has killed more than 5,000 people since early 2006, bringing the war's total death toll to around 70,000.
Colombo's stock market .CSE, lost 6.7 percent last year on weakened international and domestic sentiment, while the rupee LKR= fell nearly one percent against a falling dollar.
But the central bank is forecasting growth of 7 percent for the $26 billion economy in 2008 and the sale of a $500 million Eurobond in October was heavily subscribed. Economists say the war has had relatively little impact on activity in the south.
"It appeals to quite a few emerging market specialists," said strategist Stuart Culverhouse at brokerage Exotix. "I don't think it will have a knee-jerk reaction, but what matters now is what happens going forward."
In the short-term, analysts expect heightened fighting in the north where the rebels run a de facto state, combined with guerilla and bomb attacks in the south and east. Security forces drove the Tigers from their eastern strongholds last year.
If attacks are stepped up in Colombo, that could hurt a tourism industry which is still trying to put the legacy of the 2004 tsunami and the conflict behind it.
The government notified the press before it officially told facilitator Norway it was withdrawing from the truce. Norwegian development minister Erik Solheim, who brokered the original truce over years, was told of the development by journalists.
"It is going to be very hard for all of us to see how we can engage usefully, but I suppose that was part of the point," said a senior Western diplomat. "The peace process has long been gone."
With Western powers privately and publicly disapproving, Sri Lanka has intensified diplomatic efforts in Asia and elsewhere, with high-level visits to or from the leadership of Iran, Pakistan and even Myanmar, more commonly known as Burma and generally seen as an international pariah.
The Tigers, with a small navy of attack boats, fledgeling air force of a few light aircraft and mastery of suicide bombing, are blacklisted as terrorists by Europe, India and the U.S.
But more long-term damage to the national economy and image may come from non-war related developments.
In December, Sri Lanka cancelled the work permit of the British boss of national carrier SriLankan Airlines after it refused seats to President Rajapaksa and his entourage on a return flight home from a private trip to Britain, saying the seats were booked up due to heavy holiday traffic.
"It shows a level of capriciousness that is a concern," said Control Risks' Harbison. "It is the sort of thing that worries business far more than the occasional bombing." (Editing by Simon Gardner)