By Channa Fernandopulle
Sri Lanka’s macroeconomic outlook, potential investment opportunities in mid-cap stocks and potential movements in the Sri Lankan rupee were among a range of topics analysed at an investor forum – the first in a planned series of workshops – organised by stockbroking firm SMB Securities Ltd.
Commencing the evening’s proceedings with a staunch defence of the Sri Lankan market, SMB Chairman Rohan Senanayake focused his address on criticisms surrounding the Colombo Bourse.
“Many people believe that our market is not worth investing in but I disagree. Over a 30-year period, it has given returns of 5.5% above the risk-free rate which is a reasonable rate of return over the long-term. Unfortunately our market is still interpreted by the Sri Lankan saving community as being a gambling centre. This is a myth that has to be removed,” Senanayake asserted.
Noting that the Colombo Stock Exchange (CSE) only amounts to 35% of GDP, he stated that the market still had a long way to go to match the performance of Eastern emerging and frontier markets such as Thailand and Malaysia which were valued at over 100% of GDP.
“Taking the capital market forward is the responsibility of all stakeholders. This is not only up to the regulators and intermediaries but also with the fund managers and investment community. I recall when I visited India in 1991 and met with the Ahamadabad Exchange CEO.
“He was confused and surprised that we were moving ahead with scripless trading at a time when no one in the Indian region was. Since those times I’m sad to say that we have lagged behind the region in most developments,” Senanayake observed.
In that context he reiterated the need to educate the wider investing community on the importance of informed investing through building better relationships between listed companies and the investing public.
“As a small stockbroking arm thought he should introduce investor forums not only in Colombo but also outstation and bring the investors closer to the companies and help companies to understand that if they’re in the public domain and you require their company to be listed then they need to be receptive to the investors and the investors need to be aware what they’re up against.
“We have seen situations throughout the history of the market where a lot of retail investors burn their fingers and lose a lot of their funds over a period – not for any fault of the market or the instrument but because of ignorance,” he cautioned.
Echoing Senanayake’s concerns, CSE CEO Rajeeva Bandaranaike commended the efforts of SMB Securities in organising investor forums to in order to provide investors with the data and expertise required to make informed investment decisions.
“Workshops such as these are important as they lead to the identification of and investment in midcap stocks. I’m a strong advocate of mid-cap stocks and a firmly believe that we have some uncut diamonds within the listed company space which we can highlight. Unfortunately our market has undergone a rather turbulent period in the last few years culminating in a rather painful correction. This era has brought a bubble, scandals and scapegoats but we must remember that the underlying themes and human motives are really interlinked. The associations between market bubbles and fear and greed are interlinked.
“If one steps back and takes a look at what happened and what the factors were, post-war euphoria, investors and traders trading almost indiscriminately and almost always on credit. What comes out of this exercise as a painful lesson in the risks on uninformed investing,” Bandaranaike asserted.
Elaborating further on the point, he stated that periods of scandal nevertheless had the positive effect of underlining just how important the proper analysis of the fundamentals factor into an informed investment decision.
“Periods like these have underlined the critical importance of quality securities research and effective communication of this research to investors. We know for a fact that a lot of retailers follow and invest in market trends. While this is normal in any market, there is a risk associated in this. What we find missing in this market is a lack of awareness and an inadequate grasp of the principles of risk and return.
“The CSE has conducted more than 420 programs all over the country. The main theme of these workshops targeting investors was the principle of risk and return and the need for informed investing. Past experiences therefore show us the need to look at fundamentals when looking at companies to invest in,” Bandaranaike stressed.
In that context, he stated that concepts of good governance also ought to factor into the investment decision.
“A good understanding of corporate governance issues and the manner in which companies are being managed is becoming increasingly important as you can see in the media, publications and other media that you see today.
“Corporate governance issues such as social responsibility, executive compensation, equal treatment of shareholders, related party transactions and the role of independent non-executive directors should be part of the research that we do. It is more than just analysing numbers. That decision is up to the individual investor but you need to be in the position to make an informed investment decision so you need the tools to make quality investments,” Bandaranaike noted.
He went on to state that the CSE was expending significant efforts in improving infrastructure at the Colombo bourse, particularly with the implementation of the long-awaited Delivery Versus Payment (DVP) system which will be set-up within the next two years.
Subsequently, Frontier Research Founder and CEO, Amal Sanderatne delivered a presentation on the subject of Sri Lanka’s macroeconomic outlook particularly in the context of relative political uncertainty following Presidential elections last January and in the lead-up to General Elections next month.
“The stimulus package of the American Federal Reserve is often referred to as the ‘punchbowl’ and the discussion in that regard becomes a question of who is going take away that punchbowl. Through budgets to the Sri Lankan consumer, our overall feeling is that the Sri Lankan consumer is going to have a really good year.
“But with all that punch the question in the Sri Lankan context question is: ‘who is going to take away the punchbowl?’ We’ve had a tremendous boost to the consumer in the last two budgets and the overall feeling is that the Sri Lankan consumer is going to have a good year but it won’t last. Someone is going to have to take it away, slow things down and cut the party,” Sanderatne predicted.
He nevertheless acknowledged that the boost to the Sri Lankan consumer was a necessary step, noting that despite strong GDP growth figures, consumers had suffered very depressed times in the past few years.
“So despite very strong GDP growth, the consumption number within GDP was the worst you’d seen in 15 years! Household real income – and this is something the current Government talks about a lot – the growth rate was dismal so the GDP was driven by other factors other than the household and the consumer,” Sanderatne explained.
In that context he stated that policymakers must have been aware of the need to restructure the Sri Lankan economy towards a more consumer-friendly paradigm.
“If you want to understand the political change that happened, this might be one explanation for it, the household did not feel the benefits of the GDP growth that was seen. But we saw things improving in 2014 and that started before the election process.
I think there was recognition that changes were required. We saw energy prices being cut, you saw give-aways in the previous budget, prices of food being cut, a low interest rate environment, to improve the situation for the consumer and so we saw credit growth pick up,” he observed.
Moving to his forecasts for consumer spending, Sanderatne projected one of the strongest years for consumer spending for the country since the immediate post-war boom however he noted that given the difficulty in sustaining domestic consumption, 2016 and 2017 would see a decline in consumer spending.
Citing the generally established link between consumer spending and credit growth, Sanderatne also predicted that consumer spending would also spark a rise in credit growth which would also improve substantially in 2015 and into 2016.
“We don’t think this level of growth can continue. The Sri Lankan economy suffers from varied structural issues and one of the things that causes such structural issues is the savings-investment gap. As a developing economy, we have a high need for investment to keep growing fast. At least some of that investment should be funded by our savings.
“If we don’t have our savings we have a savings investment gap which requires capital from overseas, which means borrowing or FDI but when that gap grows big you get what is called the current account deficit becomes very big and then investors get worried and it causes pull back and overheating,” Sanderatne noted “The issue with the Sri Lankan economy is that every four-five years we have this episode where the savings-investment gap becomes too much and then we overheat and then some pull back has to be done. As you can guess, in a situation where you’re supercharging consumption, savings might get hurt a bit,” he added.
He further noted that the historic drop in international oil prices in addition to cuts on government capital expenditure would also allow facilitate the rise in consumption figures by working against the consequent effect of economic overheating.
Commenting on the potential negative impact of Government debt on the macroeconomic perspective, Sanderatne stated that ballooning debt repayments would prevent the country from growing quickly and would restrain consumption as well.
“At some point there’s going to have to be some cut backs. Beyond that in terms of the issues we have, there is some policy uncertainty and some investors have seen the brunt of it over the last two months that was created by the regime change.
“What we’re talking about here of course is the one-off taxes which clearly have not been interpreted too positively by markets and I would agree that it’s not particularly a great sign,” he noted.
Moving to the subject of interest rates and exchange rates, Sanderatne complained of confusing signals emanating from the Central Bank of Sri Lanka.
“Certain influential policymakers are talking about an overvalued rupee thought they leave it to the Central Bank to decide and the Central Bank itself seems to be giving out two messages, so that leaves us in a rather confusing situation in terms of the direction on interest rates and exchange rates,” he cautioned.
Prior to issuing his projections for the country’s macroeconomic outlook, Sanderatne warned that on-going and dramatic shifts in the island’s political dynamics will frustrate any attempts to analyse the country’s medium-long term economic prospects.
“Sri Lanka is now the land of the completely unpredictable to me. I was joking about how after the election and the transition of power and then the ‘Robin Hood’ budget by the right-wing UNP, all we need now is for the JVP to jump sides and support the private sector. Now I was making a joke about it at the time but then to my shock they actually come and say that this budget is not supporting the private sector!
“So this is what we’re left with really, you have the Rajapaksa regime ending peacefully, the big-business friendly UNP hammers big business, and then the JVP starts fighting for the private sector!” Sanderatne quipped
Thereafter, he issued three possible scenarios for exchange and interest rate movements, the first being a pressure on interest rates downward by approximately 100 basis points and a 3-8% depreciation in the currency over a 12-month horizon.
The first scenario was based on assumptions of outflows from frontier and emerging markets and the continued strengthening of the US-dollar, all of which would see the savings-investment gap worsen as domestic demand improves, potentially leading to a tightening of interest rates from the Central Bank.
The second possible scenario envisioned by Sanderatne was a more substantial depreciation of the rupee while T-bond yields could rise slightly above current rates. “I’m getting some hints that the policymakers see the rupee as being overvalued and it’s a typical type of thing that the IMF looks for in adjustments. They talked about it being the right value at the last review but since then there has been other currency changes so I wouldn’t discount a depreciation after the election but keep in mind that this is only a 20% probability and given the uncertainty about Sri Lanka at the moment, none of these numbers aren’t set in stone,” Sanderatne stated.
For his final projection, he cited the example of India which saw significant improvements in terms of foreign direct investment consequent to a substantial reform agenda from the modi regime.
“I don’t think some of the signals put out by the Government were very good in the last budget but this is something that I can see the current Government fixing. Post-election – assuming the current regime stays in power – I can see them coming up with a more global investor friendly picture that could lead to greater capital inflows leading to an appreciation of the rupee and lower interest rates in a manner similar to India,” Sanderatne predicted.
Shifting to a longer-term perspective, Sanderatne devoted some analysis to the potential outcomes of the current UNP-led policy direction.
“I think they actually do believe in the social market economy that they’ve been talking about. It’s no longer cut-throat capitalism, it’s not state capitalism like what we saw in East Asia. A nice term that I heard for it is ‘cuddly capitalism’. It’s a European model, it’s not the East-Asian model, it’s not the American model.
“President Kumaratunga also used to talk about it and in fact many people talk about capitalism with a human face. We’re looking at a redistributive society where markets are important and the private sector can produce goods without interference and low touch regulation but as a society, particular individuals cannot create disparities, which will be cut down with the tax system and the redistributive nature to ensure more fairness in society,” Sanderatne observed.
He noted prominent success stories of such a brand of capitalism which had been pioneered by Scandinavian countries – many of which were relatively small in size and yet produced world-class companies which were even recruited to carry out portions of social spending.
“The only issue is that we’re spending some time trying to understand this, this kind of model was done in Europe and most people say it’s a model that works once you’ve gotten to a certain level of prosperity. Whether this works for a country as this level of development I do not know.
“There aren’t many successful examples but if it does work in this kind of country then great! So that’s the point to think about and figure out as it goes along but there are good examples from a very interesting region of the world,” Sanderatne stated.
www.ft.lk
“Sri Lanka is now the land of the completely unpredictable to me. I was joking about how after the election and the transition of power and then the ‘Robin Hood’ budget by the right-wing UNP, all we need now is for the JVP to jump sides and support the private sector. Now I was making a joke about it at the time but then to my shock they actually come and say that this budget is not supporting the private sector!
“So this is what we’re left with really, you have the Rajapaksa regime ending peacefully, the big-business friendly UNP hammers big business, and then the JVP starts fighting for the private sector!” Sanderatne quipped
Thereafter, he issued three possible scenarios for exchange and interest rate movements, the first being a pressure on interest rates downward by approximately 100 basis points and a 3-8% depreciation in the currency over a 12-month horizon.
The first scenario was based on assumptions of outflows from frontier and emerging markets and the continued strengthening of the US-dollar, all of which would see the savings-investment gap worsen as domestic demand improves, potentially leading to a tightening of interest rates from the Central Bank.
The second possible scenario envisioned by Sanderatne was a more substantial depreciation of the rupee while T-bond yields could rise slightly above current rates. “I’m getting some hints that the policymakers see the rupee as being overvalued and it’s a typical type of thing that the IMF looks for in adjustments. They talked about it being the right value at the last review but since then there has been other currency changes so I wouldn’t discount a depreciation after the election but keep in mind that this is only a 20% probability and given the uncertainty about Sri Lanka at the moment, none of these numbers aren’t set in stone,” Sanderatne stated.
For his final projection, he cited the example of India which saw significant improvements in terms of foreign direct investment consequent to a substantial reform agenda from the modi regime.
“I don’t think some of the signals put out by the Government were very good in the last budget but this is something that I can see the current Government fixing. Post-election – assuming the current regime stays in power – I can see them coming up with a more global investor friendly picture that could lead to greater capital inflows leading to an appreciation of the rupee and lower interest rates in a manner similar to India,” Sanderatne predicted.
Shifting to a longer-term perspective, Sanderatne devoted some analysis to the potential outcomes of the current UNP-led policy direction.
“I think they actually do believe in the social market economy that they’ve been talking about. It’s no longer cut-throat capitalism, it’s not state capitalism like what we saw in East Asia. A nice term that I heard for it is ‘cuddly capitalism’. It’s a European model, it’s not the East-Asian model, it’s not the American model.
“President Kumaratunga also used to talk about it and in fact many people talk about capitalism with a human face. We’re looking at a redistributive society where markets are important and the private sector can produce goods without interference and low touch regulation but as a society, particular individuals cannot create disparities, which will be cut down with the tax system and the redistributive nature to ensure more fairness in society,” Sanderatne observed.
He noted prominent success stories of such a brand of capitalism which had been pioneered by Scandinavian countries – many of which were relatively small in size and yet produced world-class companies which were even recruited to carry out portions of social spending.
“The only issue is that we’re spending some time trying to understand this, this kind of model was done in Europe and most people say it’s a model that works once you’ve gotten to a certain level of prosperity. Whether this works for a country as this level of development I do not know.
“There aren’t many successful examples but if it does work in this kind of country then great! So that’s the point to think about and figure out as it goes along but there are good examples from a very interesting region of the world,” Sanderatne stated.
www.ft.lk
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