Relations between Sri Lanka's two main governing parties have deteriorated since local elections in February, meaning that further consensus on key policy objectives is unlikely.

• The no-confidence motion against Prime Minister Ranil Wickremesinghe is likely to fail, but relations between the two main coalition partners, the United National Party and the Sri Lanka Freedom Party, are likely to become increasingly strained over the next two years.
  
• The two sides are unlikely to co-operate on policy issues henceforth, meaning that major policy objectives - including free-trade agreements, energy tariff adjustments, and constitutional reform - are unlikely to be achieved.
  
• Nevertheless, we expect that the government will continue to adopt small measures towards improving Sri Lanka's business environment, including deregulation and digitisation of business procedures.

On 24 March, Sri Lanka's Joint Opposition presented a no-confidence motion signed by 55 parliamentarians against Prime Minister Ranil Wickremesinghe. The Joint Opposition is probably seeking to exploit strained relations in the ruling coalition of the United National Party (UNP) and the Sri Lanka Freedom Party (SLFP) since local government elections in February 2018: both parties contested the election separately, and were routed by the Sri Lanka Podujana Peramuna (SLPP) led by former president Mahinda Rajapaksa, who also leads the Joint Opposition, which consists mainly of dissenting SLFP members.

Wickremesinghe has since faced calls to step down as prime minister and UNP leader from within his party, suggesting that some UNP members could vote against him. However, IHS Markit assesses that the 113 votes required to pass the no-confidence motion in the 225-member parliament are unlikely to materialise - particularly as the governing SLFP faction led by President Maithripala Sirisena has not demonstrated any significant support for the motion. Moreover, it is likely that Sirisena remains wary of strengthening Rajapaksa, who rivals the president for control of the broader SLFP. At least within the two-year outlook, the tenuous nature of the relationship between the president and prime minister - and in turn the UNP and SLFP - is likely to continue, but a permanent split is unlikely.

Nevertheless, it is clear that the coalition government has become deeply unpopular amongst the public. The ruling coalition is widely regarded as ineffective in its main promises to crack down on corruption, boost job creation, and reduce living costs.

Paralysed policy-making

The February local elections took place amid an escalating dispute over economic policy between Wickremesinghe and Sirisena. Crucially, the president has blamed the Cabinet Committee on Economic Management (CCEM) - which is chaired by Wickremesinghe and is responsible for key economic policy decisions - for the government's loss of popularity. In August 2017, the president announced the formation of a rival economic decision-making body under his leadership - the National Economic Council (NEC) - but this has since remained largely dormant. The two bodies currently operate concurrently, but it is likely that Sirisena intends the NEC to supersede, if not fully replace, the CCEM.

The CCEM's demise would be detrimental to Sri Lanka's policy environment: the committee has to date successfully approved difficult economic reforms with bi-partisan support. These include the Inland Revenue Act, the Exchange Management Act, and the Hambantota Port lease deal. In contrast, the NEC has made decisions that involved reversing past policies, particularly regarding agriculture.

Outlook and implications

Even if the CCEM is not disbanded, it is unlikely to foster further bipartisan support for key economic policies as it has done in the past, primarily because the acrimony between the UNP and SLFP has reached unprecedented levels since the local government elections. Although the NEC is unlikely to retrospectively amend policy decisions taken by the CCEM, Sirisena will probably focus his policies on protecting the interests of local farmers and small businesses.

Nonetheless, the government will probably persevere with small measures towards improving the climate for doing business and foreign investment, including moving ahead with deregulation and digitisation of business procedures. Investment promotion in key markets such as East Asia and Europe will also pick up, with the intention to boost foreign direct investment inflows and create new jobs that match the aspirations of younger Sri Lankans. However, major reforms that are unlikely to materialise include:

Energy tariff reforms: A new energy pricing formula is a key condition of Sri Lanka's 2015 International Monetary Fund loan. The current administration cut fuel prices in January 2015 when global oil prices fell to USD30 per barrel; however, no further adjustment has since been made, despite global oil prices having risen. This has severely strained the finances of the monopoly oil importer, state-owned Ceylon Petroleum Corporation (CPC). Without a prompt fuel price adjustment and a pricing formula for the future, CPC will pose a long-term fiscal challenge for the government.

Trade and investment: Although the coalition government has committed to conducting substantial trade policy reforms - including new free-trade agreements (FTAs) and cutting protectionist tariffs - it is unlikely to implement this agenda. The SLFP has already voiced concerns about the UNP's support for pro-foreign investment and liberalisation policies, most notably stalling plans to lift foreign ownership limits for Sri Lankan shipping agencies and logistics services in late 2017. Similarly, the new and expanded FTA with India - the Economic and Technology Cooperation Agreement - is now unlikely to be finalised.

Constitutional reform: The government is unlikely to proceed with the proposed new constitution - which envisages a greater decentralisation of power to Sri Lanka's provinces and increased representation for minorities - during the remainder of its term to 2020, given its lack of political capital. Moreover, Rajapaksa's claim that the new constitution would divide the country gained significant traction during the local government elections, indicating that pursuit of such reform would only strengthen the former president's political standing.

A key indicator of government stability will be defections of SLFP members in government to the Joint Opposition. This would probably signal Sirisena's diminishing influence over the party, and would increase the likelihood of supporting future Joint Opposition attempts to remove the prime minister. Conversely, a formal agreement on co-ordination between the NEC and the CCEM would suggest greater scope for consensus between the president and the prime minister on key reforms.