FACTBOX - Key political risks to watch in Sri Lanka

COLOMBO (Reuters) - Sri Lanka has flagged rising oil prices as the only risk to economic growth the central bank forecasts at a record 8.5 percent this year, a threat now made real by crises in Libya and elsewhere in North Africa and the Middle East.

Following is a summary of key risks to watch in Sri Lanka:

FOOD AND FUEL PRICES

Although official numbers for inflation are low, there is almost universal agreement that food prices are among the highest in recent memory, prompted by the global rise in commodity prices, to which the island nation is acutely sensitive.

Although there have been complaints about the cost of living since late 2009, none of it has bubbled up into serious agitation. Sri Lanka has no real history of food riots, but the opposition has threatened that it could become a possibility.

On top of that, he government has said that at least 35 percent of the rice crop was destroyed by two rounds of flooding in January and February, but assured that it has adequate reserve stocks to prevent any supply shocks.

Added to that is the spike in oil prices after the Middle East-North Africa unrest.

The government is also removing fuel subsidies paid to the state-run power generation company, which will inevitably mean even higher power prices for consumers.

The government has structured billing so most of Sri Lanka's poor and middle class will be spared big increases, but that has infuriated industrial leaders who see their costs rising.

What to watch:

-- Any signs of organised political agitation over food prices, and the government's response. The central bank has said it may intervene if supply-side inflation spikes

-- Further military involvement in food distribution, or any application of subsidies which could affect the government's plans to tame its budget deficit gap under a $2.6 billion International Monetary Fund loan programme.

-- Impact on industrial output, and if the government will give in to demands made by factory owners and industrialists that it cushion the shock.

POLICY RESPONSES

The flooding came soon after the central bank surprised almost everyone by cutting its monetary policy rates even further and pushing commercial banks to cut the interest rate spread.

Even though the government says it expects inflation to remain between 4 percent and 6 percent this year, many economists and analysts believe it will rise further than that, especially after the rice crop was damaged and oil leapt Libya's crisis.

The government will change its inflation basket again this year, a move the main opposition United National Party (UNP) says is a ruse to artificially lower inflation numbers and cool rising discontent over spiralling food prices. Crucially, both the energy and food portions of the basket are expected to be lowered.

What to watch:

-- Any shift in the central bank's monetary policy toward tightening.

-- Signs that external investors or analysts are beginning to question official numbers, which could erode confidence Sri Lanka's government has worked hard to build since the end of its three-decade separatist war in May 2009.

INVESTOR PERCEPTIONS

Sri Lanka's 2011 budget, released in November, was full of tax and regulatory changes designed to make it easier for offshore investors, while doing away with the blanket tax holidays that existed under the old investment promotion scheme.

Foreign direct investment fell in 2010, despite post-war economic optimism and sound macroeconomic fundamentals, plus some big-ticket tourism deals.

The IMF forecasts it will rise to $725 million this year.

Some analysts believe the government has been inconsistent in its investment promotion message and too slow to give assurances that investments will not be subject to political interference. That has kept wealthy local investors wary of committing capital in the post-war environment.

Most foreign investors have stuck with treasury securities. Even the booming Colombo Stock Exchange has seen foreign outflows since the end of the war in May 2009, partially fuelled by lack of confidence in regulatory oversight.

What to watch:

-- More big investments by private foreign companies, a clear sign of growing investor comfort.

-- The pace and scope of bilateral investments from countries such as India and China, which are competing for influence. -- The enforcement of new regulations in capital markets, and whether that prompts more foreign inflows.

(Editing by Daniel Magnowski)