Sri Lanka is good, now become great

If growth and development of an economy is a game of baseball, Sri Lanka is still in the first innings with eight more innings to go. That said, Sri Lanka must not forget that impressive progress has been made within the past couple of months thanks to the end of war, which has put Sri Lanka on the map for frontier markets.

By Cheranka Mendis

The country, which is currently experiencing a rise in economic optimism backed by strong growth prospects, is now recognised as the one of the great economies in South Asia, invariably making it a key attraction for the frontier investors of the world.

Managing Partner of LR Global Partners of New York Don LaGuardia, who has been investing in frontier markets for the past 14 years, yesterday claimed that Sri Lanka was “huge” and on the right path, “so all you’ve got to do is stick with it”.

He claimed that the augment in buoyancy, strong economical growth prospective and high priced Colombo Stock Exchange has done wonders to make Sri Lanka look “good enough to eat”.

“From a foreign investor’s standpoint, Sri Lanka has had a great run so far. Within the past year and a half both the public and private sector has done many things to stir the economy into the right direction,” LaGuardia said, “however you must now be cautious of your actions”.

The increasing optimism that has led Sri Lanka to the frontier investors is backed by many reasons, out of which a 125 per cent stock market appreciation in 2009 making it the second highest in the world takes pride of place.

Increase in stock market volumes from US$ 4 million per day to US$ 20 million per day and total market capitalisation going up to approximately US$ 20 billion has also been a positive contributor. “There have been six Initial Public Offerings since the beginning of 2010 and has seen an oversubscription of 10x with a first day performance of approximately 65 per cent or more.”

LaGuardia expressed that even though Sri Lanka’s market as a whole may not be the cheapest in the frontier market, there were probably some good stocks that are cheap and undervalued.  “The market will correct itself. We see more opportunity at the pre-IPO/IPO level and there is also substantial room for additional listings and secondary offerings to improve free floats.” He asserted that the market was driven by demand and supply and that more supply was needed.

“Overall Sri Lanka is not a market that is set up to crash. However, I would expect lower growth rates in the next few years.”

The Central Bank chugging up the country’s GDP growth forecast to seven to eight per cent and the intelligent, well-educated low cost labour that is in existence have also played its part to uplift the local economy’s status in the world market. The biggest asset is, however, the strategic global location of the country.

As a frontier investor, LaGuardia is closely following the several key sectors of the economy. A construction boom is expected following the integration of the former war torn areas while tourism is regarded as a hot spot in recent times.

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Sri Lanka looks...

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Foreign Direct Investment to the country is increasing from half per cent last year, pushing forward strategic relationships and transportation via all modes is fast being restructured. “What we are looking at intimately are the transport, leisure and construction markets,” he said.

On the stock market, it has been seen that people equate GDP growth with stock market growth. There is, however, no correlation between the two. “Capital structure of the companies will grow with the augmentation of the economy. Again, there might be delusion there and it will eat into the stock market growth. You cannot also just think that when FDI comes in, the stock market goes up.

However, that does not mean that no benefits can be reaped. There is room for capital market development.”

The future growth drivers are built on value addition to the global supply chain and there is still more room for Sri Lanka to develop. Some of the mature markets in the region have more than 120 per cent of revenue as a per cent of GDP from listed companies.

“Using India as Sri Lanka’s benchmark — assuming a similar corporate earnings profile and valuations, we would expect to see, at a minimum, US$ 15 billion of corporate revenues listed on the CSE.”

LaGuardia noted that areas of construction, manufacturing, transport and trading companies were under-represented on the CSE. However, on a positive side, companies are looking to list on the CSE and are working towards standardising their operating and financial reporting procedures to meet the CSE’s listing requirements.

“Frontier markets are the future growth engines of the economy. In that sense Sri Lanka is on the right path. What you must do now is stick with it.”

“In Sri Lanka the age structure of the working population is young — it is an entrepreneurial, highly-educated crowd. Our offices are in Hanoi, Colombo and Dhaka, which shows the importance of these markets, which have manufacturing high on their agendas.”

Speaking of the expected growth from the frontier markets, LaGuardia draws in examples from Bangladesh and Brazil. “We started investing in Bangladesh in 2004 and the liquidity then was about US$ 3 to 4 million per day. Six years later it is close to US$ 300-400 million per day. And in Brazil the market capitalisation to GDP was about 25 per cent in 1996 whereas in 2008 it went up to 80 per cent. That is the growth we expect from frontier markets,” he asserted.

Why invest in frontier markets?

“Investing in frontier markets is all about people, people and more people.” In a frontier marker there is no leverage from a sovereign perspective and personal debt is low; therefore there is no need to go through deleveraging markets. There is growth with statistics showing that frontier markets grow three times faster than developed markets.

There is also diversification, low base effect (infrastructure, privatisation-market cap to GDP), favourable demographics — large source of cheap labour, young population and a large base of untapped natural resources, which is a source of wealth for development.

Risks and challenges

With frontier markets come a whole lot of risks. The biggest, however, is the liquidity problem. Then come political and social stability, which is a huge advantage to Sri Lanka as the doubts of the country’s stability are no longer existent among international businessmen. Lankan political stability is predicted to hold for the next five years, he said.

Whether the regulatory environment is consistent is also a key issue. Moreover, currency and the corruption levels in the country will also be critically analysed.

When it comes to challenges, the access to information and low transparency are top of the list. Most often, the lack of information bridges a gap between the perception and reality. LaGuardia stated that in Sri Lanka, however, the information was freely available, which further calls out for more investors to come in.

Foreign ownership limits, high transaction costs, capital controls, liquidity and developing legal framework (investor safeguards) also poses a hurdle to achieve their goals.

Benefits

Benefits of foreign investors in the market are many. It lowers the cost of funding for companies. Mobilises domestic savings and allocates capital efficiently and facilitates exchange of goods and services.

“The economic benefits from accelerating capital market development are also sizable,” he said. “There is also greater liquidity for market participants and improved corporate governance and transparency.”

Benefits to individual companies through frontier markets include the alternative source of capital to debt to fund expansion and growth, generating greater public awareness, diversifying investor base, owners can monetise part of their ownership stake as well as liquidity guarantee and reducing investment concentration risk.