‘Peace pays handsome dividend for Sri Lanka’

After years of civil war, Sri Lanka can at last reap the economic benefits of peace. Economic growth of 8% in 2010 and 2011 shines out in a world hampered by low or slowing growth and global bond investors are keen to increase their exposure and support the Sri Lankan story.

Sri Lanka has been nominated by at least one highly respected travel publication as the number one tourism destination globally for 2013. “Now the… conflict is over, investment is fuelling the tourism industry, and visitor numbers are steadily increasing,” said Lonely Planet in its preview of 2013.

Those numbers reached a record 856,000 in 2011, and with about 700,000 tourists arriving by the end of September this year, Sri Lanka is on target to attract one million visitors in 2012.

With leading hotel operators looking to invest in the market, and with airlines such as British Airways preparing to launch new services to Colombo next year, Sri Lanka’s longer-term goals for its tourism industry appear to be within reach.

According to a recent presentation from the Central Bank of Sri Lanka, these include an increase in tourism arrivals to 2.5 m by 2016, and a rise in tourism earnings from $ 830 m in 2011 to $ 2.75 b by 2016.

Positioning Sri Lanka as the world’s number one destination for investors in 2013 would be an equally impressive achievement. In the equity market, to do so would mean recapturing the stunning performance of the years immediately after the cessation of hostilities. In 2009 and 2010, Sri Lankan equities were among the best performing in the world, before retreating modestly in 2011.

In the bond market, meanwhile, when Sri Lanka launched its debut $ 500 m issue in 2007 via Barclays Capital, HSBC and JP Morgan — which was repaid this October — the five year transaction was priced at 8.25% and was three times oversubscribed.

The sovereign’s most recent issue, a 10-year $ 1 b benchmark led in July 2012 by Bank of America Merrill Lynch, Barclays, Citi and HSBC, by contrast, was priced at 5.875%, which was the low end of guidance. In spite of offering no new issue premium, the July 2022 issue generated demand of $ 10.5 b.

Even at this pricing level, and against the backdrop of an uncertain international economic climate, spreads on Sri Lankan sovereign paper have continued to narrow. “There has been genuine buying interest from real money accounts in the secondary market, which is why the July issue has tightened to 5.3%,” says Nick Nicolaou, Chief Executive of HSBC Sri Lanka and Maldives.

“Investors who have been supporting the Sri Lankan story right from the beginning of the Government’s issuing program have seen substantial accretion to their portfolio values over the years.”

Rating agencies’ warm response

It is easy to see why Sri Lankan assets have performed so well in recent years. The peace dividend delivered economic growth of 8% in 2010 and 2011, the first time since independence that Sri Lanka has posted such explosive increases in GDP in consecutive years. Ratings agencies responded warmly, with Moody’s changing its outlook on Sri Lanka’s B1 rating from stable to positive in July 2011, S&P upgrading the sovereign rating to B+ and Fitch lifting its rating to BB-.

“Sri Lanka is one of the most exciting investment stories in Asia, and an economy in the midst of an important transformation,” says Alexi Chan, Managing Director and Head of Asian debt capital markets origination at HSBC. “The country has a strong following among emerging market bond investors globally, who value the highly credible policy framework put in place to enable Sri Lanka to realise the peace dividend fully.”

The 2011 upgrades from the ratings agencies were fortunately timed, as the announcement came while the Government was road-showing its $ 1 b 10 year benchmark led by Bank of America Merrill Lynch, Barclays Capital, HSBC and RBS. Demand for the July 2021 issue, priced at the tight end of its 6.25%-6.375% guidance range, reached $7.5 b.

Unsurprisingly, growth is expected to slow in 2012, with a number of economists having revised their forecasts for Sri Lankan GDP growth this year. In July, for example, when it approved the disbursement of the final tranche of a $2.6 b facility for Sri Lanka, the IMF announced that it was trimming its growth forecast for 2012 from 7.5% to 6.75%.

“Following robust growth in the first quarter of 2012, activity has started moderating in response to policy tightening and weakening global demand,” the IMF said. The IMF’s forecast is broadly in line with the Government’s own revised projection.

“Growth has been higher than originally expected in each of the last two years,” says Central Bank of Sri Lanka Governor Ajith Nivard Cabraal. “Last year’s growth rate was 8.3%, which was at least half a percentage point higher than we originally forecast.”

“But clearly, global economic conditions have become more hostile and we have seen growth slowing across the board, especially in countries such as India and China, which has an effect throughout the world.”

Cabraal adds. “Sri Lanka has also been impacted, which is why we are now expecting GDP to grow by 6.8% this year. We are very satisfied with this rate of growth, which we think compares well with the rates forecast for our peers.”

Encouraging long term trends

More important than short-term fluctuations in the growth rate, however, are the long term trends in social and economic indicators, which are transforming the quality of life for Sri Lankans, creating sustainable job opportunities and lifting millions of people out of poverty.

Unemployment reached a record low of 3.9% by the end of 2011, compared with 15.9% in 1990, while the poverty level — as measured by the head count poverty index — fell from 15.2% in 2006 to 8.9% in 2009/2010.

GDP per capita, meanwhile, which surpassed $ 1,000 in 2004, reached $ 2,014 in 2008 and more than $ 2,800 in 2011. This suggests that Sri Lanka is ahead of the ambitious primary economic goal enshrined in its ‘Vision for the Future (Mahinda Chinthana),’ which is to double per capita income between 2009 and 2016, to $4,000.

“Our assessment is that we are well on track with our aim of becoming a $ 100 b economy by 2016,” says Cabraal. “In fact, our estimates are now slightly more optimistic than they were some years ago. We believe that unless there is a massive and unforeseen global downturn, the necessary conditions are now in place for us to reach a per capita income level of $ 4,000 by 2015, a year ahead of schedule.”

Critically, the increase in GDP per capita that has already been achieved has been evenly distributed across Sri Lanka, rather than being concentrated in the wealthier Western region, which was mostly untouched by the war and has traditionally been Sri Lanka’s principal economic base.

“One of the key objectives of this Government is to ensure that growth is not concentrated only in the Western Province,” says Cabraal.

“We have been very encouraged by the fact that during the last six years the Western province’s share of GDP has diminished from 51% to 45%. This is not because activity in the Western regions has declined in absolute terms, but because of the increase in economic activity in other provinces.”

A step-up in economic activity in the less developed regions of Sri Lanka has dovetailed with a striking decline in poverty, which is regarded as a prerequisite for long term economic and political stability. Cabraal says that he attributes the fall in Sri Lanka’s poverty level to three key developments. “First, access to finance has been much improved,” he says. “Second, electrification has risen from a 72% coverage level in 2005 to 92% today, which represents a massive change in the landscape. And third, concreting of roads throughout rural areas has also created improved economic opportunities.”

Rising consumer spending bolsters FDI

Across-the-board rises in per capita income and consumer spending power has been an important driver of inflows of Foreign Direct Investment (FDI) into Sri Lanka. As one recent example, take the acquisition by the Singapore-based Parkson Retail of a 42% stake in Odel, which is recognised as being one of the most conspicuous success stories in Sri Lanka’s economic development over the last two decades.

Originally established by Otara Gunewardene in 1990, with a single store in Dickman’s Road in Colombo, Odel has rapidly expanded into a chain of 17 retail outlets. Targeted principally at middle to upper income consumers, Odel focused originally on ladies’ clothing, but has since expanded into a wide range of household goods as well as jewellery and souvenirs.

The strength and visibility of the Odel brand was underscored in July 2010, when an IPO of 11.5% of the company’s equity chalked up a new record for the Colombo Stock Exchange (CSE) with an oversubscription level of almost 64 times.

Odel’s CEO, Otara Gunewardene, says that since the end of the war the group has seen a sharp increase in revenue, driven by a rise in consumer income as well as the tourism boom. “A large number of customers who visit our flagship store in Colombo are tourists, and our store in the departure lounge at the airport has also been supported by the strength of the tourism industry,” she says.

Gunewardene adds that Parkson’s investment in Odel is a significant vote of confidence in the prospects for the Sri Lankan economy. Parkson Retail Asia — which was listed on the main board of the Singapore Stock Exchange in November 2011 — has an extensive network of 54 department stores in South East Asia. The Parkson Retail Group, meanwhile, which is quoted in Hong Kong, operates a chain of stores throughout China.

Since the announcement of its original investment in Odel, a mandatory offer has lifted Parkson’s share in the company to 45%, and along with an upcoming rights issue injected some $20m of funding into the business which will be used for further expansion.

“We already have about 120,000 square feet of retail space and we are now looking to expand this significantly over the next few years,” says Gunewardene. “Adding new capacity will allow us to widen our offer to our customers both with our own brands and by bringing more international brands into Sri Lanka.” However, Parkson has also indicated that it sees Odel as potentially providing a springboard into a number of other markets in Sub-continental Asia.

A place to do business

That is an important endorsement of the progress that Sri Lanka has made in the World Bank’s Ease of Doing Business index. In its recently published ranking for 2013, Sri Lanka is the highest-positioned South Asian country, having risen from 98th spot in 2011 to 81st today. Sri Lanka’s projected increase in consumer spending, twinned with the improved outlook for tourism following the 2009 ceasefire, has also underpinned the strategy of a company such as Lanka Orix Leasing Co (LOLC), which dates back to 1982.

Then, its principal shareholders were the IFC and Bank of Ceylon, which between them held 70% of the equity, with Japan’s Orix owning the balance. “The company was originally set up in order to support the liberalisation of the economy by providing the SME sector with leasing and hire purchase opportunities,” explains Kapila Jayawardene, LOLC’s Group Managing Director and CEO.

The IFC and Bank of Ceylon soon exited, leaving Orix as the majority shareholder, and for the best part of the next two decades the company’s focus remained on leasing. From 2000 onwards, says Jayawardene, the group expanded into the market for broader financial services, and today Lanka Orix Financial Services (LOFIN) has a deposit base of Rs. 25 b and is one of the largest non-bank companies in the sector.

“LOFIN is the only non-bank with approval from the regulator to undertake foreign currency business and to access the interbank market to do foreign exchange swaps,” says Jayawardene. LOFIN, he adds, has been a pioneer in areas such as secured vehicle financing, a very profitable market that has posted strong growth mirroring the expansion of the economy and the rise in per capita income and spending. In the capital market, meanwhile, LOFIN has been the standard bearer for the small but growing securitisation market.

The next phase in the LOLC diversification story, Jayawardene says, came five years ago, when, in anticipation of a ceasefire, the company made a strategic decision to expand into the leisure sector. “We compared the growth of the industry in Sri Lanka to Thailand, where between 1983 and 2011, the number of tourist arrivals rose from about 600,000 to over 15 m,” he says.

“In Sri Lanka over the same period they rose from about 450,000 to 800,000.” “I’m not saying we can attract 15 m tourists a year, as Thailand does, but we can easily go from 1m to 3m, which would create a completely new paradigm in terms of occupancy levels, revenues, profits and IPO opportunities for companies in the tourism sector,” Jayawardene adds.

Rather than base its tourism strategy on creating its own brand, as some local operators have done, Jayawardene explains that LOLC will be passing the management of its range of leisure properties over to internationally-recognised operators.

“Although Shangri-La and Hyatt will be opening in Colombo, amazingly none of the global operators are yet active in the resort business,” he says.

That, says Jayawardene, will begin to change in late 2014 or early 2015, which is the target date for the opening by LOLC of a 450-room, five star tourist resort on the Golden Mile, which will be the largest of its kind in Sri Lanka and the first to be managed by a multinational hotel company. With LOLC adopting a similar strategy in the fast-growing construction industry, gaining exposure by acquiring stakes in well established operators rather than creating its own company, the group is now resembling a conglomerate rather than a narrow financial services company.

Today, financial services accounts for about 70% of LOLC’s earnings, and Jayawardene says he expects this share to come down to about 60% as profits from the company’s activities in other sectors start to gather momentum.

(Source: Euroweek, December 2012)