The most important domestic problem in Sri Lanka remains the ethnic conflict between the Tamils and the Sinhalese. In January 1995, the LTTE Tamil rebels agreed to a "cessation of hostilities" with the government of Kumaratunga, then a newly-elected SLFP president who was perceived as being a moderate. Within three months, this truce collapsed and the LTTE resumed its attacks on government forces. The Sri Lankan army went on the offensive, and by early 1996 appeared to have control of the northern peninsula. Tamil resistance continued, however, with attacks on the military in the north and bombings elsewhere on the island. After a 1998 suicide bombing at Sri Lanka's most sacred Buddhist shrine, the Temple of the Tooth in Kandy, the government formally outlawed the LTTE. President Kumaratunga continued to offer the Tamils limited regional autonomy, a position that was opposed by the UNP opposition and rejected outright by the Tamils.
By late 1999, the LTTE had regained much of its lost territory in the north, inflicting a series of major defeats on government forces. Despite this, Kumaratunga was elected to her second term as president in December 1999. Following several years of on-and-off attacks by both military factions, Kumaratunga's government placed the country on an emergency war footing in 2000. Separatist violence was largely confined to the north and eastern provinces, but terrorist bombings directed against politicians and civilian targets occurred in Colombo, Kandy, and elsewhere in the country. By mid-2000, the government's position in the Jaffna peninsula had deteriorated alarmingly, with some 40,000 soldiers isolated in the north by Tamil rebels. Not surprisingly, the Tamils rejected a renewed effort by Kumaratunga to begin peace talks. In July 2001, an LTTE suicide squad attacked the Bandaranaike International Airport outside of Colombo and destroyed a large number of military and civilian aircraft, as a show of ability to strike anywhere, anytime.
At last a breakthrough occurred, after as many as 64,000 deaths in decades of insurgency and counterinsurgency. In February 2002 a ceasefire was negotiated as the newly elected Prime Minister Ranil Wickramasinghe agreed to consider ending sanctions on rebel-held areas and lifting the ban on the LTTE. Wickramasinghe indicated that the government would consider all conditions except a separate homeland for the Tamils. Norway was brought in as the "facilitator" for the talks, which were scheduled to commence in May 2003, and preliminary discussions were held, but the actual negotiations were stalled when the Tamil negotiators suspended their participation in April 2003. With the process on hold, Kumaratunga castigated both Norway for going too far in acting as a mediator and Japan (which has a "peace envoy" to Sri Lanka) for meddling in the peace process. She also accused Wickramasinghe of making too many concessions to the Tamils and conducting the process secretively. In May 2003, the peace envoy from Norway, Eric Solheim and his team held talks with all concerned parties in an effort to revive the peace negotiations. The LTTE was demanding an interim council to administer its territory, as a precondition to re-engaging in the talks, while Kumaratunga has conditioned such an interim council on the LTTE disarming and renouncing separatism.
Despite the fits and starts of the negotiation process, the cease-fire has held, enabling a "peace dividend" revival of economic development not only in the war zone, but throughout the island, with an encouraging 4% growth rate in 2002. Loans from the Asian Development Bank and international aid enabled reconstruction of infrastructure and agriculture in the Tamil-majority north. However, the rebuilding proceeded slowly. The program for returning internally displaced persons to their old homes was also slow and difficult, which caused particular discontent among the north's Muslim minority which had been forced out by the LTTE.
During her first term (as president and prime minister) Kumaratunga was a proponent of establishing a British-style government, with power concentrated in the hands of a prime minister. Constitutional reforms require a two-thirds majority in the Sri Lankan Parliament, and the UNP succeeded in blocking such changes. In her second term as president, now with an uneasy "cohabitation government" with Prime Minister Wickramasinghe, Kumaratunga has constantly wielded the threat of using her power to dissolve the Parliament, although she insists that she would only do so if it threatened national security. At the same time, Wickramasinghe, backed by his parliamentary majority, has tried to decrease Kumaratunga's presidential powers, using his own threat of calling new elections. The relationship reached a low point in July 2002, when scuffles broke out in Parliament over apparent accusations that Kumaratunga had brought a recording device, or even an explosive device, into a cabinet meeting. In October 2002, Kumaratunga attempted a more conciliatory approach, asking the political factions to put aside their differences so as not to endanger the peace process. By the start of 2003, the wrangling and war of words had resumed full force, as Kumaratunga and Wickramasinghe traded accusations of sabotaging the peace negotiations. When Kumarasinghe took over the Development Lotteries Board from the Economic Ministry in May 2003, there was renewed conflict with the Parliament, controlled by Wickramasinghe. Kumaratunga appeared to be engineering an agreement between her People's Alliance and the left-wing Sinhalese-nationalist JVP, for an attempt to gain control of Parliament.
On the economic front, Kumaratunga has abandoned most of her socialist beliefs and is a firm supporter of Sri Lanka being a free-market economy. During her administrations she has promoted privatization, financial reform, and restructuring of the tax system. Great disparities in production, employment and income now exist in Sri Lanka, with gaps between rich and poor regions, as development projects have favored the island's west over other regions during recent decades. Kumaratunga and her People's Alliance party have opposed attempts by Wickramasinghe's government to equalize development and to distribute more aid to rural areas. In spite of economic inequality and chronic warfare, Sri Lanka has a high life expectancy, and has made gains in health care and education. Clearly, the future growth of Sri Lanka's economy and the well being of its people depend on a peaceful and lasting resolution of the country's ethnic conflict.