Monday Nov 25, 2024
Monday Nov 25, 2024
Thursday, 22 August 2013 00:04 - - {{hitsCtrl.values.hits}}
Presenters included Securities and Exchange Commission of Sri Lanka Chairman Dr. Nalaka Godahewa, NDB Bank Chief Executive Officer Rajendra Theagarajah, The Finance Company Chairman Preethi Jayawardena, HSBC Sri Lanka and the Maldives CEO Patrick Gallagher, Standard & Poor’s Asia Pacific Financial Institutions Ratings Managing Director Ritesh Maheshwari, Standard & Poor’s Asia Pacific Sovereign Ratings Senior Director Kim Eng Tan and Standard & Poor’s Asia Pacific Corporate Ratings Director Mehul Sukkawala.
Surinder Kathpalia, MD and Head of ASEAN for Standard & Poor’s Rating Services opened the session with a basic introduction of Standard & Poor’s existing activity in Sri Lanka and the session at hand, stating: “We at S&P’s have started rating a few Sri Lankan financial bodies and expect to see further interest in the near future. One of the themes we expect to discuss in today’s seminar is how Sri Lankan financial institutions and companies need to engage with the global community.
“The cessation of the civil hostility was followed by a certain euphoria which seems to have subsided now, and as people look for direction for the future, this is a good time to look at what needs to be done to engage the global business investor community. The panel discussion too will cover those themes.”
Noting that the Central Bank Governor at a seminar last week spoke about sovereign ratings, he added that Kim Eng Tang would discuss how S&P’s view and benchmark the sovereign relative to regional peers. “S&P has had a presence in Sri Lanka directly or indirectly via RAM because of our investment in its parent company, RAM Malaysia.”
Sri Lankan banking outlook and regional view
Kathpalia then introduced the first speaker, Ritesh Maheshwari. Maheshwari in his capacity as MD and Lead Analytical Manager for Financial Services Ratings, Asia Pacific discussed the Sri Lankan banking sector and gave a basic regional overview. He outlined the basis of their conclusions as such: “One lesson that we have learnt post the financial crisis is that interconnectivity has gone up significantly across the global. We are connected with each other around the world, via linkages of banking or market sentiment.
“I will be commenting on the Sri Lankan banking system’s outlook and peer systems. Each has been picked out for specific reasons. A high-level overview: We think that banking crises will continue to occur, as pessimistic as it sounds. We can only work towards strengthening the systems in place, thereby delaying and reducing the impact of the crises.
“S&P is continuing to work on its own criteria – we have rewritten our bank criteria. We now start at an entirely different point, using the BICRA, the Bank Industry Country Risk Assessment, and do the whole assessment in one go, doing our ratings from that point. This gives us a helicopter view of the system and keeps our perspective aware of macro elements without getting bogged down with the details, so we do not miss any emerging trends.”
Maheshwari went on to display the BICRA scores for relevant regional countries and the BICRA heat map of the Asia Pacific and key global systems. He stated: “We have seen a huge spectrum shift of late as Europe has gone through its turmoil. Countries like Spain and Italy have continued to move down the scale. The map gives a very good idea of where the risks’ ‘heat’ is. In terms of this, Sri Lanka is very close to Indonesia and the Philippines, while Vietnam is slightly riskier. These comparisons make it easier to relate and interpret Sri Lankan risk and ratings.
“Sri Lanka has been assigned a BICRA of 8/10 on the economic risk scale as of a year ago, with a banking system strength score of 7/10, whereas the economic environment has been given a score of 8/10. From an ICR point of view, Sri Lanka is at the bottom of the heap, but in BICRA terms, the country is doing relatively well.”
Maheshwari then elaborated on S&P’s perspective of the Sri Lankan banking system outlook. “In terms of risk issues, there was a euphoria during which stock markets and credit growth were rendered quite strong. What we’re now witnessing is a bit of moderation in that – although bankers don’t quite enjoy the term moderation in relation to growth! However, if credit growth is slow and steady, it is healthy while if it is rapid it could end in tears.
“We believe that the environment and growth are a little more stable, depending on the Central Bank’s guidance and banks’ zeal to grow. This could determine whether next year could experience a stable trend or another euphoric credit growth.
He added that S&P’s have particularly highlighted Sri Lanka’s unique situation in the banking system’s gold loan sector – commonly known as pawning. With 15% of gold loans, S&P’s haven’t found another banking system in the world that matches up to that of Sri Lanka’s. The closest was India’s, at 4-5%.
Maheshwari noted that while this uniqueness is quite related to the characteristics, it also exposes the sector to a few risks that have been highlighted. It is important to be aware of the concentration in the system. Some mitigations are on the wish list to be put in place, including credit bureau information sharing, valuation thresholds, even some restrictions on liquidation and the improvement of credit discipline.
“We expect Sri Lankan banking funding to continue to be strengthened, as the systems’ profitability continues to be sufficient to take into stride any risks that may arise. We see from the macroeconomic picture and global viewpoint a few risks emerging, and China is the biggest of these. The picture appears to be a little darker as China’s outlook appears to weaken. While a euro zone crash is a much likelier prospect which will affect Asian markets, the severity is less than the effect of a Chinese hard landing.”
Rapid credit growth key risk for Sri Lanka
He noted that economic imbalances are building up in Sri Lanka post-civil war, while credit growth has accelerated to 28% annually for two consecutive years – which is rapid by any stretch of imagination. However, it is slowing down now, which means there is a correction happening before it becomes an unsustainable problem.
“With moderate credit growth continuing for a year or two, we can get into a phase where credit growth can gradually be raised and penetration can be increased from the current 25% credit to GDP levels and still be on a very stable growth plan for the economy. Any faster and we’ll be taking a huge risk.”
Evolving risk management practices and gold price volatility could hurt banks’ asset quality, he added. S&P’s expect loan growth coupled with rising competition; relaxed regulations and evolving risk management practices could expose the sector to increased credit risk.
The recent volatility in gold prices could expose Sri Lanka’s banking industry to risk of defaults in the pawning segment, which is the largest sectoral exposure for Sri Lankan banks. NPLs may also rise in other segments as the operating environment remains challenging and the loan book seasons. In S&P’s base-case scenario, they expect the earnings of Sri Lankan banks to absorb the higher credit costs associated with the rise in defaults.
The final section of Maheshwari’s comments covered the banking system outlook for key peers in relation to Sri Lanka, in order to give a basic comparison. He stated: “Increasing risks for the Indian banking sector are due to the economic outlook. We have downgraded India’s rating as of this year, owing to a weakness in credit profile of Indian banks. They require a lot of capital because they are growing very well. Going forward, the weakness will continue due to the capital buffer, given the legal restrictions in place.”
Indonesia also went through a very rapid and euphoric rate of credit growth. Like Sri Lanka, it was also a thoroughly underpenetrated system and saw a rapid credit growth. Credit risk means low NPLs but underlying vulnerabilities. As of now, there is a far more stable rating even though it is a high-risk economy. It is quite reasonably placed, with no risk of sudden downfall facing their banking system.
However, the Philippines on the other hand, is experiencing a lower rating despite all of the incentive and pushes from the Filipino government. The banks’ risk appetite directly affects the credit risk and economy assessment of S&P. Vietnam too would be in a very bad spot should the world economy collapse.
All the malaise in the Vietnam banking sector books exists because of the rapid growth they undertook, he explained. The system’s ability to appropriate credit efficiently and to the sectors that actually need it doesn’t rise rapidly. The moment credit is freely available and in abundance, it ends up going to the wrong place. “It needs to be channelled well. The other aspect is the system’s ability to absorb credit and go down the right utilisation path, and the same person ends up leveraging. That’s why credit is very different from equity and stock.”
Maheshwari wrapped up his session with a few final remarks: “To sum up, we view rapid credit growth as the key risk for Sri Lanka. However, the trend for the past year has been encouraging. Our BICRA assessment for Sri Lanka is continually watched and reviewed on a few months basis, as we see an improvement reflected in the scores.”
Issues in the future
Rtiesh Maheshwari’s comments on the Sri Lankan banking sector were followed by Sri Lanka Central Bank Governor Ajith Nivard Cabraal’s keynote speech.
The Governor expressed confidence in Sri Lanka’s progress, saying: “We are currently at levels at which we can afford to be a little more liberal, although the trends have to be watched. I’m happy that the Sri Lanka’s banking and business community is getting an insight into how credit is rated and how they stand in relation to other regional economies, as we get into the internationalisation of our community. Thus it is important we are aware of the conditions of the evaluation.
He noted that the sectors can understand together what the weaknesses of the economy are, which could help grow and develop the country’s own sectors. Over the last seven years, Sri Lanka has been connecting itself with the global economy, so naturally, global factors have to be taken into consideration and there is a need to tell others what the country’s thought process is and what is being done in our own backyard, so that the message gets across.
“Thus, I see today as an important occasion of showcasing ourselves as well as understanding what is happening in the rest of the world. I’d like to take the opportunity today to give a basic understanding and rationale behind Sri Lanka’s key issues and how we see our issues for the future,” he stated.
The Mahinda Chinthana development plan that has been in place for the past six years envisages an 8% growth, and for a country that has been used to a comfortable 4% growth, and sometimes has taken 17 years to double per capita income, that signifies a huge transformation. Cabraal pointed out that we are used to people saying that we could never achieve those numbers, and that the 8% was a pipe dream. Back in 2005, when this plan was first articulated, people pointed out that the savings the country had were not sufficient to facilitate this sort of growth.
However, there was a conscious decision taken by this country, to enter a new phase of development and enter a new trajectory but that required a huge change in the way the country did business and managed its economy. “We realised we needed at least 30-32% investment to achieve this growth. We calculated that with a little bit of stretching, Sri Lanka could comfortably move to about 24% of investment based on the savings that we have – that is, with the Government investing about 6%, and another 24%.
That leaves a gap of another 6% or so, he stated. If the country was to improve capacity utilisation and productivity, it could increase by another 1.5%. That still left about 4.5% required in real hard cash, which could only come through foreign capital. FDI is not the only instrument to attract investment into a country. “We took a slightly broader view – foreign investment per se was necessary in order to bridge that gap. It could come not only in the form of direct investors but also in the form of infusions of capital in the loan market, the corporate bond market and the stock exchange.”
He further stated: “Thus, we opened things up and created a platform to invite foreign capital into the country. FDI, we hoped, would provide about 2-3% of this. This is our target by 2016. Even if we were to miss it by a bit, it doesn’t matter, because it is our overall objective of our thrust in order to attract FDI.”
Sufficient control over monetary sector
Cabraal added that they realised that the banks have sufficient space to accommodate tier 2 capital. It was an important source that was opened out and has worked well for the past two years. It was a latent strength that was possible due to the framework created. It is believed that in the next two years, it will get even stronger.
“We also encouraged the stock market to also rake in foreign investment, which is gradually taking shape now. At the same time, we relaxed some of the exchange control restrictions that we had. Earlier, there were stringent regulations for borrowing. In that way, we have made changes allowing the freely available capital from outside to reach us under certain conditions.”
He stated that with those numbers, it seemed that there could still be sufficient control over the monetary sector and prudency evaluation has been done. “When you open out, you need to ensure you still maintain control. As a result, we noticed certain buoyancy in the markets. Whilst this was being done, we recognised that in order to ensure that corporate issuers can continue with issues, it is not only a relationship between the issuer and the person who is contributing the capital. There are a lot of other players involved in this scenario.”
Even a country like Sri Lanka will be impacted by events happening in US or Japan, he pointed out. Global economic conditions are vital while we are opening up as a market. When Sri Lanka first entered the global market, a small window was found which could let the country in within a week. It was both a national and international window.
The Governor stressed on the importance of global conditions whilst making issues. Sri Lanka went to the markets, conducted road shows and was able to attract US$ 500 million, albeit at a slightly high interest rate, and was oversubscribed and was able to move out with the money as well. Thus, the global economic conditions can either be benign or adverse – what is required is just an awareness of that fact.
The sovereign situation is also vital for any issue. Today, regardless of how good a company in Egypt is, they will meet with difficulty in attracting foreign capital because country conditions have a direct impact on issuers as well, Cabraal observed.
The third issue is the local regulations, he noted, which are about making the regulatory environment suitable for issuers, so that they can easily enter and take up a position in the country. The fourth area is industry specifications that have to be looked at – banking, mining, tourism etc. These sectors need to identify specific areas, standards and ratings that investors look at and raise their own levels.
“The fifth is the strength of the intermediaries and support agencies. Are your ratings known to the rest of the world? Are your underwriters sound? These are factors people consider before entering a market,” he said. “Another key area is the strength and ability of the issuers themselves. How good is their balance sheet? What are their housekeeping rules and how sound are their governance structures? About five or six years ago, Sri Lanka introduced a large number of governance measures, which are important as overall structures. These help show off a country or banking system to the world in a positive light.
Country rating
Next, he noted, is the country rating, which is absolutely important because every issue is dependant and guided by it. When certain regulatory measures are introduced, the point is to safeguard the country’s rating. Problems were raised in the previous session in relation to the dangers of rapid credit growth. But at the time, the euphoric feeling of the country spurred the momentum and growth, which was allowed.
“But immediately after early 2012, we took certain measures, such as imposing the credit ceiling of 18%. The IMF themselves insisted it was not a prudent move. We took the view that the banks will be more careful and not allow the rate to go too high. It was a risky move, but today, people realise it was the right view. Due to this we were able to bring rates to a reasonable level and the banks to a level through which they could continue at a stable pace,” Cabraal pointed out.
As per the Central Bank’s tagline, it wishes to see both stability and growth. A balance needs to be struck between these, whilst keeping in mind that stability needs to come first.
He then questioned: “Will this change? Sri Lanka is undergoing a gradual structural shift, as mentioned in this year’s roadmap. After the next four years, Sri Lanka is on the path to becoming a current account surplus economy. Tourism is doing a lot better than it has before. The ICT and BPO industries are on the way up – these new industries were irrelevant a few years ago, and are gaining traction now. These are areas we did not have in the past but do now. Oil and gas exploration is also taking place. The second wave of bids for the new areas is underway. Education, health and sports are also areas that will see growth. These are ideas mentioned in the five-hub plan for the country, as mentioned in this year’s roadmap.”
“This means we will probably be a net surplus country,” he assured. “While some of you will be looking at investments abroad, and countries progress outside, we have allowed the structure within the foreign exchange regime to allow that, and give companies an appetite to do so. You have to have a learning curve and be able to appreciate and understand what’s taking place.”
Ensuring sustainability
He then questioned as to how the country could ensure sustainability, even after Sri Lanka becomes a current account surplus economy. Cabraal stressed on the importance of ensuring that the house is always kept in order, which is why we macrofundamentals have to be maintained at reasonable levels.
Cabraal pointed out that the country does not need to always have the same figures, but must see improvements. Sri Lanka has had four and a half years of single digit inflation, the benefits of which people are starting to realise. People are also becoming a lot more investment-savvy because they realise that by investing you can have an income that will not be eroded by inflation, and it needs to be ensured that things continue along this vein.
“We at the Central Bank along with the Ministry of Finance and all stakeholders, are ensuring both sufficient supply and demand, as well as ensuring that the fiscal deficit is maintained at acceptable levels. So far, there has been a pull each year by the Government, which has helped us with single-digit inflation. Next year, we plan to target a mid-single digit inflation which is a commitment to the local and international communities to keep our inflation between 4-6%.
“In 2003, Sri Lanka’s debt to GDP level was 105%, whereas today, it is 79%. This is still high, but at least it is on an encouraging decreasing trend. We have given ourselves a target of 2016 to bring it down to 65%. Next year, you will see that the Government will benefit immensely by the low interest rates, and by having a low fiscal deficit, inflation becomes low, which also benefits the govt. This will create a virtuous cycle.”
Other areas such as political stability, reserves, business indicators, and employment numbers are all factors that need to be monitored closely to make sure that issuers can issue their own credit at a reasonable interest rate as well, he added. On that journey, the country has to avoid the middle income trap that it may be approaching soon, and is hoping to reach a $4,000 per capita income. Many countries have encountered difficult times and stagnated when they reach that situation whereas some have done extremely well. It is believed that the five-hub way will lead Sri Lanka away from that trap and help going forward. “That would mean that we would have to remain vigilant, have innovative ideas, and focus more on your own balance sheet. Since 2006, we have gotten globally connected. Since 2007, we have raised US$ 4 billion.”
Cabraal pointed out that the mega development that is seen around the city and country are all supported behind the scenes by hard cash. There had to be funds that made that a possibility. So, this platform must be protected. The Government paper was opened up to foreign investors, capped at 12.5%. After the QE was taking place, the Governor stated that people asked why the threshold wasn’t raised to 15% when there is plenty of cash around globally. “But we didn’t fall to that temptation, and kept a certain element of tension in the minds of investors, so there was a demand for the Sri Lankan papers. As QE2 tapers off, we are not seeing an outflow as other countries are. Even if there are one or two investors taking money out, there are enough waiting in the pipeline to put money in. Thus, we have struck a balance which helps us avoid certain imperfections that other countries have faced.”
The CBSL, the SEC and SE are working to develop the corporate bond markets as well, he added. The equity markets are reasonably buoyant now but must reach higher levels once the country reaches the stage of a US$ 100 billion economy. Sri Lanka is at a nascent stage as far as the commercial bond markets are concerned, which is another area which has great potential for which it must be ensured that the necessary regulatory arms are in place.
Cabraal wrapped up his keynote with the following comments: “The global community needs to be aware of what Sri Lanka is doing, because often negative information travels quicker than positive. But all companies have an obligation to do that in their own way – maintaining relationships abroad and keeping investors closely in touch is important. The Central Bank releases over 200 press releases globally to its stakeholders. Preparation has to be long term and sustained.
“We need to build a fresh brand for Sri Lanka too. For 30 years, we had an unflattering brand – we have to change this image, which will take a lot of work, not only by the Government. It needs to be a collective effort and obligation to promote the country overall, the benefit is to everyone. We must reflect on our strengths and weaknesses, and ensure we don’t allow our weaknesses to continue repeatedly. We need to take Sri Lanka to the next threshold and move on at a rapid pace in order to bring prosperity to our nation.”
Credit rating outlook for corporates and S&P’s rating criteria
The CBSL Governor’s keynote was followed by S&P’s Singapore Corporate and Infrastructure Ratings Director Mehul Sukkawala’s address.
He commenced with an overview on global and Asia corporate credit trends, stating: “One reason why there are so many highly rated corporate in the Southeast Asian region is because it is mostly the better reputed and run companies that get rated, which raises the average. In Asia, there is a relatively stronger financial position.”
“Another important and noticeable trend is that in most cases in Asia, the upgrades have superseded the downgrades, which is in opposition with the global general trend. Both in Asia and globally, just under 80% of the ratings are ‘stable’. A look at the Asian corporate portfolio shows that the lion’s share of rated companies is from China and Japan.
Sukkawala then covered the Asia Pacific corporate sector outlook followed by S&P’s analytical framework for rating corporates. He stated that S&P’s analytical framework includes a look at business risk and financial risk first, before a corporate is rated. In this way, there is some overlap with sovereign ratings as to what factors are taken into account.
He explained the proposed framework, which included greater transparency, enhanced global comparability and maintenance of analytical judgment. Sukkawala went on to give a basic overview of the top 15 listed Sri Lankan corporate and their leverage trends. Sector-wise, the telecom industry is moderating growth with stable margins, while hospitality requires strong growth to spur investment.
Sukkawala concluded stating that strong economic growth expectation could support demand, moderate inflation and good demand could support margins, and high capital expenditure should continue. He also mentioned that there is a good existing cash balance but debt would probably continue increasing to support growth, and that diversified businesses were a strong positive.
Sovereign rating outlook: Southeast Asia and Sri Lanka
Kim Eng Tan, Senior Director and Analytical Manager for the sovereign ratings team in Asia Pacific, responsible for evaluating the credit standing for sovereign governments and sovereign-supported issuers in China, Korea and Vietnam, stated that sovereign ratings address the factors that affect a sovereign’s ability and willingness to service financial obligations to commercial creditors on time and in full. The issuer credit rating (ICR) on a sovereign does not reflect its ability and willingness to service other types of obligations.
Tan explained that default and stability are key guidance measures, and that Asian sovereign measures have in fact been strengthening over the past decade. The assessment of sovereign creditworthiness is carried out keeping in mind institutional and governance effectiveness, economic factors, external position, fiscal position, and monetary support.
He also stated that despite the average income in South and Southeast Asia being below US$ 10,000, the average economic growth is relatively high. External payments are typically covered by export earning and reserves, and most lend more than they borrow with net government indebtedness typically below 60% of GDP, with changes generally less than 3% of GDP. He stressed on the fact that absolute size of the corporate bond market does matter for development, and sketched out a basic focus on Sri Lanka.
A summary of Sri Lanka’s comparative rating factors in the region show that its strength is a relatively strong growth prospect in comparison to Southeast Asia, partly supported by public investment. The weaknesses include a larger net external borrower, heavier external financing needs, and significant government debt and interest burden than much of Southeast Asia. Tan termed S&P’s outlook for rating as a balancing act. He mentioned that: “The stable outlook reflects our view that growth prospects for Sri Lanka’s per capita real GDP will be more than 5.5% in the next few years, the Government’s fiscal profile could improve, and the pace of credit expansion and its net external liability position will show improvements.”
He also mentioned a few possibilities for the outlook: “We may raise the rating if Sri Lanka’s external and fiscal indicators improve more than we currently forecast, given well-designed policy and robust implementation.
Conversely, we may lower the rating id the country’s external liquidity deteriorates or if Sri Lanka’s growth and revenue prospects fall below our current expectations.
Pix by Lasantha Kumara
