26-year civil war frees up government spending for investments in infrastructure and agriculture, investor Jim Rogers said.

Sri Lanka’s benchmark index has gained 33 percent in the past three months, the second-best performance worldwide as the army defeated the Liberation Tamil Tigers of Eelam in May. The Colombo All-Share Index was the region’s third-worst performer in the past two years as record spending on defense strained government finances, and the country sought an International Monetary Fund loan.

“When you spend a lot of money on bullets, you don’t get much return,” Rogers, chairman of Rogers Holdings, said in a phone interview with Bloomberg yesterday. “If governments can spend money on infrastructure and developing productive assets, then Sri Lanka’s strengths will become even stronger given that the war is over.”

“If the political process of integrating the minority Tamils is handled well, the economy could grow at above 10 percent per annum for the next decade,” Singapore-based Samir Mehta, a fund manager at Silver Metis Capital Management Pte said.

The Central Bank raised its 2009 growth forecast to as much as 4.5 percent in July from an earlier estimate of 2.5 percent after the separatists’ defeat. Sri Lanka plans to raise $500 million from overseas investors to help rebuild the nation, Central Bank Governor Nivard Cabraal said in an interview with Bloomberg on July 31.

“The capital is ready for coming into the country,” Ajit Gunewardene, deputy chairman of John Keells Holdings Plc, said in an interview on Aug. 5. “I don’t think there is going to be a shortage of investors.”

The nation’s hotels may be fully booked from December to April as tourists return to the island, Gunewardene said. Tourist arrivals in Sri Lanka grew 8 percent in June, the first increase this year, according to the monthly statistical bulletin by the Sri Lanka Tourism Development Authority.

John Keells, which gets about 49 percent of its revenue from transport and tourism, has gained 69 percent in Colombo trading since the war ended May 16. Other stocks have more than doubled, including Ceylinco Housing & Real Estate Co. and Bogawantalawa Tea Estates Plc, leading a rally that has made the benchmark index Asia’s second-biggest gainer after Indonesia.

Trading Volumes Jump

Trading on Sri Lanka’s $7 billion stock exchange, Asia’s smallest, jumped fivefold in May, and average trading increased to 751 million rupees ($6.5 million) from 147 million rupees in April, according to CT Smith Stockbrokers Pvt. in Colombo.

Still, earnings at companies haven’t kept pace, said Talaal Maruzook, an analyst at CT Smith. Overseas investors have also sold shares worth 1.48 billion rupees in the three months ended July 31, his firm’s report showed.

“The ending of the war is a catalyst, but development will take some more time,” Maruzook said in an interview yesterday. Only about 10 percent of the 235 companies listed on the exchange are traded regularly, he estimated. “Even though turnover has picked up, it’s still low and earnings are only marginally up compared with the sharp gains in stock prices.”

Mark Mobius, chairman of Templeton Asset Management Ltd., said he’s looking for private equity or strategic investment opportunities in Sri Lanka as trading volumes remain low.

“The biggest challenge in the public market is liquidity,” Mobius, who oversees about $25 billion of emerging market assets, said in an e-mailed response to questions yesterday. Templeton Asset Management plans to double its emerging-market assets within two years, Mobius had said in an interview on July 29.