Sri Lanka's chance to put on Asian tiger stripes

October, 30th 2014

London: Sri Lanka is grooming itself to be Asia’s next tiger only five years after a bloody civil war.

But while economic reforms are fuelling astounding growth, democratic reforms are taking root more slowly, clouding investment prospects.

Since 2005, when the government’s quarter-century war against Tamil rebels ended with the rebels’ suppression, the country’s gross domestic product has surged 175 per cent, to $67 billion (Dh246 billion), and is projected to top $76 billion this year. Real GDP, adjusted for price changes, is up by two-thirds over the period, to 6.7 per cent, and is projected to remain in that range for the medium term.

Inflation is in check, falling from 11 to 6.9 per cent, and investment is building. The Colombo Stock Exchange’s capitalisation has more than quintupled since 2005, to Rs2.94 trillion (Dh83 billion).

“The market is on a positive trajectory, and we expect a period of exponential growth,” said Vajira Kulatilaka, chairman of the Colombo Stock Exchange, during a Sri Lanka investment forum in New York last month. “A lot of companies that went through a bad patch now have started investing, retail has picked up and economic activity is taking place in the country.”

Foreign investors have taken notice. More than a third of investments in the CSE are from abroad, and foreign direct investment inflows came to $1.4 billion last year, from $300 million in 2005. Last month US-based TPG Capital Management reached terms to buy a majority stake in Union Bank of Colombo for $113 million in what would be the country’s biggest buyout deal.

Foreign retail investment remains thin, but access is widening. Kulatilaka says no western firms are known to be working on country-specific funds, though many US and European index funds and exchange traded funds tracking frontier markets have Sri Lanka exposure, and Kulatilaka expects the bourse will have its first ETF launch next year.

Unit trusts are accessible to foreign investors through domestic custodian banks. In July the domestic house Ceylon Asset Management launched Sri Lanka’s first US dollar-denominated mutual fund, which invests in sovereign debt and securities issued by rated banks and companies in Sri Lanka.

“It is a stockpickers’ market,” says Gustavo Galindo, portfolio manager at Russell Investments, which operates indices as well as active funds with exposure. “You have to have a long-term perspective because liquidity will be tight since there are not that many investors, but precisely because there are not that many investors, you have these big stock fluctuations and valuations that create opportunity.”

The infrastructure, tourism and consumer sectors are especially promising, Galindo says.

Sri Lanka’s government bond market is its biggest for foreign investors. However, the public debt burden remains high, at more than 78 per cent of GDP as of last year, despite the rapid economic growth and debt service expenditures. Government commitments to chip away at debts are promising but not concrete, according to a Fitch Ratings report affirming Sri Lanka’s currency bonds this year.

“The process is slow and to a large extent built on revenue projections that may turn out too optimistic,” the report says.

Sri Lanka’s most pressing challenge is improving market transparency, says Galindo.

“This is precisely the concern with Sri Lanka,” he says. “You have a government that started in 2009, but some of the institutions have been around way longer than the government, and these institutions themselves have developed their own opaque controls within them. There are a lot of positive cycles going on [in Sri Lanka], but it would be that much better if you would not have all those issues with transparency and corruption.”

In the past 18 months, two heads of Sri Lanka’s Securities and Exchange Commission have resigned, one alleging he was pressured by influential investors who were under investigation for market manipulation, while the other said she had stepped down “upholding her principles”. In December 2012, a special parliamentary committee impeached the country’s chief justice over corruption charges, in a process that the Supreme Court described as unconstitutional.

Last month, President Mahinda Rajapaksa said the country would refuse entry to a UN team charged with investigating alleged war crimes by government forces during the civil war. Investors are not interested in these internal disputes, says Ajith Nivard Cabraal, governor of Sri Lanka’s central bank.

“We have been doing a series of roadshows right across the world each year since 2007, and we talk to investors and field their questions, and we have actually not had that question come up,” Cabraal says.

The impeachment was conducted constitutionally, he maintains, and the SEC’s new chairman resumed the investigations cited by his predecessor, but without any obstructions. “That matter has also now been resolved, and I believe there have been no concerns expressed by the persons thereafter,” Cabraal says.

Sri Lanka functions as a quasi-dictatorship but paradoxically with widespread popular support, theoretically insulating the government from the influence of rich investors more so than in a full-fledged democracy, Galindo says.

“Because the government is closer to a dictatorship than it is to democracy, I think that they have more levers to manage that kind of situation,” he says. “If at some time we start to see more resignations or start to see more signs that things are getting difficult, we have to start considering whether it is going to put a brake on the economy or the capital markets, but to be frank, I don’t think we are there yet.”

Source: Gulfnews.com