COLOMBO : Sri Lanka no doubt has been able to combat the spread of COVID-19 successfully than its regional neighbors. However, like other emerging economies, Sri Lanka is facing a painful recovery from an economic aspect especially due to the foreign exchange suffering, capital market dips, large foreign borrowings.
The COVID-19 seems to be continuous battle till a vaccine is found, which means the economy has to surge forward if to keep people and businesses afloat. The Government has made efforts to curb the destruction by rolling out tax concessions, low interest loan schemes, loan interest payment deferments etc. Unless effective business revival is experienced these measures taken may not be enough for survival in the medium and long term.
The Sri Lankan capital markets which anyway had its limitation due to small market size, scarcity of liquidity and limited product diversification faced the worst during April & May 2020 due to COVID 19 where the CSE ALL Price Index, fell to its lowest level in mid-May. The recovery from that point onwards has been slow and steady.
To understand the limitations, opportunities and strategies for finance and capital market resurgence during this COVID 19 recovery phase, we spoke to Mr Ravi Abeysuriya who has vast experience in finance and capital markets.
Mr Ravi Abeysuriya currently functions as an Independent Non-Executive Director of Seylan Bank PLC, HNB Assurance PLC, & Bio Foods (Pvt) and Director/CEO of the Candor Group. He is also the Advocacy Chair and Board Director of CFA Society Sri Lanka, Council Member of Sri Lanka Institute of Directors and Co-Chair of the National Agenda Committee, Ceylon Chamber of Commerce. Formerly, he was the Head of Strategic Business Development at Hayleys Group, Managing Director of Amba Research Lanka and Managing Director of Fitch Ratings Lanka. Mr Abeysuriya also functioned as a permanent member of the Financial Sector Reforms Committee (FSRC), a Prime Ministerial Task Force appointment and was twice appointed as a commission member of the Securities and Exchange Commission of Sri Lanka. He was also a Director of Sri Lanka Insurance Corporation Ltd (SLIC) and was the Chairman of its Investment Committee. He is a Fellow Member of the Chartered Institute of Management Accountants, UK, Chartered Global Management Accountant, USA and a Chartered Financial Analyst, USA and has an MBA from Monash University, Australia
Q1: In your view, what ails the Sri Lankan capital market?
A1: Over the last few years, the capital market has seen its collective brand suffer greatly. The capital market has not been very successful in doing its primary function of mobilizing long term savings for productive investments of the private sector and providing a reasonable return to the investors. For example, returns in CAGR of popular investment products over the last ten and half years from 1 Jan 2010 to 30 Jun 2020 are Colombo Land 11.3%, Fixed Deposits (AWFDR) 10%, Savings Accounts 4.6%, Gold 2.2%, ASPI a negative 2.6% (Inflation during corresponding period being 4.8%).
The market infrastructure and product offerings have not kept in pace with global developments. The market is not deep and liquid for companies to raise equity and debt capital. The investors have lost trust and confidence on the market and perceive as it to be too risky to get a reasonable return by investing in the capital market. Investor participation in Colombo Stock Market (CSE) is very low. Despite there being more than 800,000 accounts at the Central Depository System (CDS), many of those are dormant. It is estimated that only about 18,000 accounts trade actively on a yearly basis. It is a vicious cycle, as low participation makes the market less attractive to investors, leading to yet less participation.
Investors and market players in Sri Lanka are crying out for innovative and versatile financial products such as Exchange Traded Funds (ETF), Real Estate Investment Trusts (REITS) and Derivative securities. Sri Lanka currently is largely an equity centric economy with largely institutional investors active in the primary debt market. CSE currently offer only cash market products, namely equity, warrants, closed-end funds and corporate debt securities.
Currently, the CSE operates as a self-regulatory organization, formed as a mutually owned company limited by guarantee owned by 15 member firms. COVID-19 pandemic highlighted glaring shortcomings of the CSE having archaic practices such as sending trade confirmations and contract notes by post and using cheques to make settlements in an era where the World had moved into fully online markets and digital banking.
The Sri Lanka capital market require several short and long-term strategies to address its main challenges, archaic infrastructure, practices and products, democratizing the market for broad investor participation and winning investor confidence as a trust worthy and lucrative investment vehicle for their hard-earned money, solving the smaller size and lower liquidity puzzle, etc. Solving these issues is imperative to unlock the true potential of the capital market and requires bold and visionary reforms.
Q2: Given the current context, what should be the short term strategies that should be adopted for the resurgence of the Sri Lankan capital market?
A2: The short-term strategy would be to address the archaic market infrastructure, practices, introduce new products such as trading of Government Securities, REITS, ETFs, Commodities, Short Selling, Futures & Options and democratize the market. Derivative markets have grown leaps and bounds in emerging markets. Financial derivatives could include futures contracts and options contracts on securities, indices, interest rates, currency, futures and commodities. Derivatives securities can strengthen capital market of Sri Lanka, both in terms of boosting returns & risk mitigation for portfolio management and creating alterative investment vehicles for financial market development. This strategy will offer an increased portfolio of choices and enhanced ability to hedge against risks from an investor perspective and broader choice of financing options from an issuer perspective. The diversity of products offered through the exchange will make Sri Lanka economy stronger as well as attract more investors.
I am very pleased to say that the Securities & Exchange Commission of Sri Lanka (SEC) has made swift progress to make it mandatory for the stock market investors to provide their email address, mobile number and bank account so that the stock market can be fully online with effect from 10 September. Trade confirmations and contract notes will be sent via email only and settlements to be by digital banking and cheques would be done away with. An iOS and Android trading app are being developed for all stock brokers to onboard clients without the laborious physical form filling to democratize the market.
A Gazette has been already issued with regulations for a lucrative a new listed product, REITS. A timely and very popular asset class among institutional investors such as pension & insurance funds and retail investors who wish to benefit from attractive returns real estate provide. REITS provide significant diversification benefits that can both reduce risk at the portfolio level and increase returns when held in a portfolio due to low correlation with other asset classes.
The amended SEC Act will be soon passed in Parliament to put Sri Lankan capital markets at the level of international standards recommended by the International Organization of Securities Commissions (IOSCO). Facilitating infrastructure improvements long overdue such as the Demutualization of CSE, implementation of Central Counter Party (CCP) through a new clearing house for true Delivery vs. Payment System (DVP) to function. DVP settlement system ensures that delivery will occur only if a payment occurs. The system acts as a link between a funds transfer system and a securities transfer system.
Q3: What should be the long term outlook at this point?
A3: The long-term strategies should include winning investor confidence on the stock market. The lack of investor confidence is just a symptom of broader challenges faced by the industry. for example, I hope to see in the distant future, people who contribute to Employees’ Provided Fund (EPF) demand a portion of their balances to be invested in the stock market because they will have higher nest egg when they retire, contrary to the situation today, where they are very cynical about EPF investments in the stock market.
In order to have a properly functioning capital market, undertaking supply side and demand side reforms is imperative. On the supply side, public enterprise reforms and listing of key commercial enterprises are essential to increase the size of the stock market. On the demand side, reforms at institutional investors enabling investment of long-term assets in broadly diversified portfolios to generate sustainable demand for investing and trading is required.
Lack of market liquidity is a major constraint for the proper functioning of the market leading to pump and dump theatrics and low foreign investor participation. CSE is still classified as a lesser developed “Frontier Market” with characteristics such as low market capitalization, low liquidity, and higher volatility warranting a higher premium for foreign investors to invest. The government represents a major share of the Sri Lanka economy, controlling banking, insurance, port, aviation, transport, and energy sectors. It is therefore imperative that the government undertake indispensable State-Owned Enterprise (SOE) reforms by listing at least 10% of few large SOEs. This in turn would lead to the CSE being classified as a more developed and mature “Emerging Market” that is widely tracked by foreign investors and considered to be active and liquid than a “Frontier Market”. If CSE is included in the MSCI Emerging market Index by listing of a few SOEs and large companies, foreign investors that replicate the MSCI Emerging market Index (tracked by investors managing about USD8 trillion in assets) would be investing in the CSE.
In the long-term, I would like to see, listed companies that truly follow Environmental, Social, & Governance (ESG) principals. Today, unfortunately, what is reported in the ESG space may not be exactly the reality. We should see independent third-party verifications of ESG. True adoption of Corporate Governance principals such as separation of Board Chairman and the CEO, accurate disclosure of all related party transactions and truly Independent non-executive directors doing a proper job at the Board, sincerely looking after the interest of minority shareholders, encouraging high dividend payouts instead of keeping profits as retained earnings etc.
Q4 :The Government supported by Central Bank of Sri Lanka has pushed interest rates down to stimulate the economy impacted by the COVID-19 pandemic. In your view has the low interest rates helped to meet the objectives set by the Government?
A4: The Government thought that the best way to help people is to flood them with bank credit at low interest rates by putting pressure on banks to reduce interest rates. However, when the central bank allows interest rates to approach, or fall below, what is quaintly termed “the zero-lower bound” there are clear losers. The Central Bank is presuming that households, obedient to monetary policy theory, will borrow more money at still lower rates. In fact, the reality is that “lower for longer” prevents a robust recovery because it makes economic inequality worse.
Interest paid on fixed deposits by banks have been drastically reduced to around 5.5 per cent per annum from around 11.5% one year ago, resulting in a reduction of interest income by 52.2% for non-tax payers. This has a serious impact on the disposable income of bank and Finance Company depositors who comprise over 60% of their client base, other 40% being borrowers. While borrowers may have benefited, god knows how hard the other 60% are working to make ends meet. Those who live from interest income, senior citizens and pensioners, are specifically harmed by low interest rates. The so-called Government senior citizen (over 60 years) scheme that pays Rs.17,575/- income monthly (AER 15% p.a.) for one Rs.1.5 million deposit at any bank is grossly inadequate for most of the depositors. Unfortunately, up to now the banks have not been even reimbursed by the Government for this interest subsidy.
There is clear evidence that despite maintaining ultra-low interest rates, central banks of the world’s leading economies have largely failed to bring about steady and healthy growth.
There is a growing consensus among economists and a strong body of evidence that, traditional monetary measures to stimulate the economy do more harm than good. They contribute to rising inequality, for lower interest rates benefit mostly the wealthy, who already have large financial holdings, and hurt middle-class families and retirees who depend on their investments and savings for a living. It is doubtful that current lowering of interest rates will boost investment and help the economy.
The current problems in the world economy are the result of the shock produced by the COVID-19, both on demand and supply sides, as it disrupted global supply chains, prompted governments around the world to close borders and severely restrict people’s movement. Therefore, it is unlikely that interest rate cuts will generate productive investments at a time when companies prefer to save rather than to invest not due to high costs of borrowing and “high” interest rates but because of the uncertainty associated with the pandemic.
Fixing interest rates arbitrarily by a regulator should be done carefully. This is because there are two parties involved in the determination of interest rates and when the Central Bank reduces interest rates, one party is benefitted while the other party is harmed. No economy can move forward on a sustainable basis when one party is benefiting at the expense of the other party.
The low interest rates have surely harmed savers. At the same time, they have not benefitted micro and meso borrowers. In my view, in today’s day and age, simply lowering interest rates will not help the economy; it is the time for more active measures. There should be more targeted lending, to those who are worst affected such as micro and meso – meso are those between micro and SMEs – borrowers. They have no access to the traditional funding sources such as banks and finance companies and therefore have to resort to informal money lenders for their credit needs.
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(Interviewed and compiled by Rifka Ziyard, Director – Tax & Regulatory, at KPMG. She is a Fellow Member of the Chartered Institute of Management Accountants, UK, Chartered Global Management Accountant (CGMA), Fellow member of the Sri Lanka Institute of Taxation, and has a MBA and a Bachelor of Commerce from the University of Colombo)