Tiger rebels disguised as fishermen staged the attack on Wednesday against the southern port on the island's "Riviera", a major tourist destination that was hoping to drew some 600 000 visitors annually, many of them foreigners.

"Achieving targets for this winter season will be a problem," tourism ministry secretary Prathap Ramanujam predicted after the attack that killed two people and wounded 25 others.

The number of holidaymakers to the entire island fell 11.6 percent to 38 485 in September from the same month in 2005 amid stepped-up bloody clashes between troops and Tigers fighting for a separate homeland for the Tamil minority in the north and east.

Southern tourist centres such as Galle, which was recovering from the devastating 2004 Asian tsunami, have largely escaped the violence. The attack in Galle was the first since a December 1997 truck bombing targeting the navy commander at the time.

"We're banking on peace talks (slated for late October) to salvage the situation, but until they really take place, we have to wait and see," Ramanujam said.

Foreign peace envoys have arrived in Sri Lanka to try to salvage the talks aimed at ending the violence which has surged since December killing more than 2300 people, according to official figures.

A hotelier near Galle said he feared cancellations following Wednesday's suicide bombing even though there were no reports of any foreign casualties in the attack. Suspected suicide bombers infiltrated Galle harbour where the naval base is located and destroyed three naval craft.

A frenzy among foreigners to buy centuries-old houses prompted the government to slap a 100 percent property tax on non-nationals in 2004. Galle Fort is a UNESCO world heritage site. The city got its name from a Portuguese fleet that landed there in 1505.

Authorities were now revising down the forecasts but gave no numbers.

Travellers warned to stay away

The Australian government has warned its citizens to reconsider travel plans to Sri Lanka. The United States has warned there could be attacks in Colombo soon.

"Without today's attack, we were expecting occupancy of 50 to 60 percent this winter, lower than our usual average of 75 to 80 percent," said Malin Hapugoda, managing director of the Aitken Spence hotel chain.

Sri Lanka has witnessed in the past week the worst fighting between the army and Liberation Tigers of Tamil Eelam rebels since a 2002 ceasefire halted the three-decade civil war.

The Galle attack came two days after a suicide attack against a naval bus convoy northeast of Colombo killed at least 103 people.

The government which last week also suffered a major battlefield defeat in the northern peninsula of Jaffna with the loss of at least 133 soldiers has hit back with air strikes.

"Things seem to have gone from bad to worse," said Alastair Corera, director of Orion Fund Management.

Some 60 000 people have been killed in the conflict in which the Tamils are fighting for a homeland in the Sinhalese-majority island.