The key Colombo all-share index fell 17.52 points, or 1.26 percent, to 1,371.09. The bourse has gained 29 percent so far this year.
The state media reported deputy defence minister Ratnasiri Wickremanayake said the government would be compelled to take a hard decision if killings in the north and the east of the country did not stop. Killings related to a split among the Tamil Tigers have raised concerns over the two-year cease-fire agreement, making it difficult to restart stalled peace talks between the government and the rebels. Brokers said stocks were sold across the board.
Conglomerate John Keells Holdings Ltd fell 1.9 percent to 103 rupees, despite some foreign buying. Development banker DFCC Bank Ltd fell 2.17 percent to 225 rupees. Sri Lanka Telecom Ltd fell 2.7 percent to 18 rupees.
Smaller stocks also took a beating as retail investors exited the market. C.T Land Development Ltd fell 3.51 percent to 13.75 rupees. The Colombo Fort Land and Building Co Ltd dropped 2.17 percent to 22.50 rupees.