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Wednesday, 23 July 2014 00:00 - - {{hitsCtrl.values.hits}}
Holistic approach required
Responding to this question in his keynote address, Dr. Nalaka Godahewa, Chairman of the Securities and Exchange Commission, stated that a holistic approach is required to mould the economy into one that can support and sustain growth at a rate of over 8% for the next three or four years, including sculpting the nation into a commercial hub.
Current investment levels are lower than what would be required for this and he warned that the capital market is not the answer to everything, stating however, that the capital market can act as a facilitator on several levels to foster the necessary growth.
Citing other countries which invest heavily both at national government level and at municipal council levels as examples, Dr. Godahewa pointed out that there are opportunities for the public sector to make use of the capital markets for infrastructure development even in Sri Lanka, although these are currently not being taken advantage of at present.
Capital markets also allow entrepreneurs to raise long term capital, easing pressure on the banking system, help foreign investors to mitigate risk through diversification and promote public-private sector partnerships. Sri Lanka’s real estate sector which is currently not seeing enough investment can also benefit from what capital markets have to offer.
Sri Lanka is no stranger to the field, with over a hundred years of experience, having first engaged in trading in 1896. The keynote speaker also reminded those present that the country has a proud legacy: “Sri Lankan technology was even bought by the London Stock Exchange to sell to other exchanges, such is the expertise we had.”
Positive outlook
The outlook for the future is also positive as Sri Lanka’s capital market grew 300% in five years. Unfortunately, there has been a lack of strategic development in the years after the war, the fertility of which could otherwise have been harnessed and converted into long-term success. He revealed that there is still a clear positive trend compared to global and regional indices and so, the country is on the right track.
Foreign participation which has been encouraged through promotion throughout the world is at an encouraging 40%. On the other hand, this is not sustainable in the long run, and the ideal ratio is 30:70, with 70% local participation which will not be achieved until local investors who were severely affected by the downturn regain their trust. The EPF too has invested only 5% of the authorised 20%, and has come under fire for this, and unit trusts are still not utilised to maximum potential.
Looking to the future, Dr. Godahewa said that initiatives are being taken to combat the lack of strategy, and six essential areas are now being tackled, in the hope of bridging the gaps. Regulations are being strengthened with a comprehensive Act having been drafted and submitted for approval.
This Act, the Chairman of the SEC believes, will bring Sri Lanka on par with global entities. Measures are also being taken to increase market liquidity. At present, market liquidity presents an issue and a minimum public float regulation may be introduced to address this.
Product portfolio and equities
It is also crucial that the product portfolio offered is expanded, he said, going on to elaborate that in sophisticated markets, instruments are available that the knowledgeable can use to make money whether the market is trending up or down. Sri Lanka does not yet have the infrastructure necessary to support such products, for example, the Central Counterparty (CCP) system required for derivatives and its introduction, hopefully by end 2015, will allow for greater diversity.
Existing products, however, show positive developments, with the corporate bond market which was 
virtually non-existent two years ago having grown 400%. A dollar bond has also been introduced to allow diaspora in foreign countries to invest in bonds in Sri Lanka.
The Chairman was also optimistic about equities showing that while the huge surge of fundraising through equity in 2011 reduced when the market took a downturn, companies are reconsidering now that conditions are improving. He stated that the decision making process for companies involves time, so results will be seen in 2014/2015.
The SEC and CSE have also approved a measure which allows the BOI to use a Board to bring new investors in, he said, but it remains to be seen how this will be utilised. In the face of the plans underway to foster new products, it is vital that local investors too explore their options, instead of the country relying only on foreign participation, whilst that is a crucial part of economic growth. To facilitate this, education and awareness are important and form the next area of the six-pronged plan. This, along with upgraded infrastructure, will help increase market activity.
Addressing challenges
Taking an objective stance, Dr Godahewa allowed that whilst opportunities abound, the challenges are all too clear, and must be addressed for true progress to be made. One of the areas for improvement he highlighted was that the vision is clear but the difficulty lies in implementation, as was underscored in the panel discussion, ably moderated by Murtaza Jafferjee, Director/CEO, JB Securities Ltd. Rather than this being a barrier, the panellists pointed out that it could be viewed as an opportunity for strategic consultancy to create an implementation plan.
Asked about claims that the Government is crowding out the private sector, and whether there is demand for capital, Dr. Indrajit Coomaraswamy, former Director, Commonwealth Secretariat Economic Affairs Division, allayed concerns about a tendency toward State capitalism but emphasised that for the hub strategy to work there would no longer be the fiscal space for the government to drive the process and there needs to be demand from the private sector for capital. The excess liquidity in banking system combined with the fact that cash-rich companies are not investing as much, point to a confidence issue he said.
Mentioning that macroeconomic risks have been reduced he indicated that signs are positive, but if the private sector is to be the engine for growth, clarity of message and clear communication regarding the relative roles of the private and public sector, as well as consistency and predictability of policy is required.
Equities over bonds
Taking a quick poll of the audience present at the forum, Jafferjee found a larger percentage having invested in equities than bonds, representative of the predominant focus on the focus on equity market in years past, with the debt market only coming into play within the last few years. 
Referring to the perception of the bond market not being an instrument for the masses, Dr Godahewa clarified that it is a matter of time – the bond market has already shown immense growth – with infrastructure put in place and continuous education, in the next two to three years the secondary market will get activated.
Vajira Kulatilaka, Chairman, Colombo Stock Exchange, bolstered this with the statement that there is a retail element, because through the EPF and life funds which were amongst the highest ranked investors, benefits reached grassroots levels. He also made the point that the cost of promoting a five-year bond as a retail product would be too high.
Dr Coomaraswamy noted that it is a positive step as the long term debt market will open up a lending bottleneck in the system that banks have been unable to contend with as there is a maturity mismatch.
The mortgage game
Ajit Gunewardene, Deputy Chairman, John Keells Holdings PLC, remarked that mortgage game would be revolutionary, making it viable to issue long-term debt, spawning a derivatives market which is currently non-existent. The panellists concluded that a mixture of institutional architecture and products has been responsible for holding this sector back as it is a specialised area.
It was suggested that the industry could be developed through the medium of middle income apartments that would then drive demand for the products. A securitisation process was referred to as another major potential driver for demand of mortgages, but it was noted that the Securitisation Act and an enabling regulatory framework has up to now been held back due to lack of political will.
Key issues
When the panel was posed a question on what key issues could be addressed to bring about the most change to situations such as this, it was suggested that a unified effort from the private sector and professional bodies to push for critical issues rather than industry specific concessions would create a much-needed voice.
Another issue referred to that would aid capital market development was the listing of State-owned enterprises which faces opposition due to being perceived as privatisation.
It was noted that the listing of these entities could contribute to improved productivity and efficiency because of the disclosure required, with the State Bank of India alluded to as an example of SOE reform.
A market-based banking system rather than the existing institution-based system would improve capital allocation and productivity of investments in the economy. It was mentioned as well that the high spread because of the heavy state banking presence acts as a drag, driving interest rates higher than they need to be. Legislation was another area that was mentioned, stating that existing legislation needs to be closely examined in order to maximise efficiency with the BOI given as one body that has lost its effectiveness.
Speaking of the skills gap in financial market development, the panellists observed that skills in finance proper are essential- that too often in obtaining qualifications, finance is considered an addendum to accountancy - and a wider range of specialisations is required. It was recommended that the private sector is more involved in the education sector.
Globalisation places a very high premium on competitiveness, and for the hub strategy to work, this is an underlying requirement. However there is no need to reinvent the wheel – Malaysia and Singapore when faced with this problem brought in experts while augmenting local skill. Remarking on mobilising financial savings and the challenge of reengineering the distribution system, the panel mentioned that technology has a role to play in growth and making it more viable.
Unit trust and insurance are most needed in the furthest corners of the country, but hitherto have been confined to the cities because of the difficult environment; there is hope this mindset will now change, with the banking and finance sector getting involved.
In addition the days of non-contributory pensions in the public sector are numbered due to demographics, creating a flow of money to cater to which products can be developed.
Mutual funds will also give economies of scale, and risk diversification for the retail market.
Reducing market abuse and insider trading is a priority with investigations taking place when early signs are spotted. A system based on transparent rules and regulations is needed to combat lack of confidence. A long-term view needs to be taken, the panellists conclude, stating competition must reign, but a balance must be maintained. Overall, whilst the outlook for the future is positive, the market is but one part of a whole that will facilitate the long term growth of Sri Lanka’s economy.
