Investment risks are lower now than during the conflict, right? So what ails the economy and capital markets? Persistently high budget deficits and external risks are a big part of the challenge facing capital markets. Dependence on external financing, like grants and concessionary loans, is greater because Sri Lanka has a low savings rate. However, as Sri Lanka rises up middle income league tables, concessionary loans become dearer. Predictably, it has now become a regular issuer of sovereign bonds at a much higher cost. This increases external exposure, and is paid for by export earnings and remittances from Sri Lankans overseas.
Things were a little different in the past. Government debt, corporate bonds, stocks and property were all more attractive to investors. Most of the debt was short term. Equity was a medium-to-long term investment, and property had the longest horizons. Rewards compared to risks appear reasonable. Fixed income returns ranged 12-15% and 20-25% for equity. Corporate debt issuances were limited, mostly two to three year debentures. The exception was banks, which issued five-year debentures because those qualified for Tier II capital.
So what’s changed now? Interest rates are lower (they are in the range of 8-12%), corporate issuances raise more money and debt tenures are longer, even up to 10 years.
Is the government borrowing less? No, they are issuing longer tenure bonds instead, up to 30 years, and borrowing more. Stock market returns have declined. Risk-adjusted returns on equity are no longer attractive. So where are we investing now? In government securities (mainly institutional), corporate bonds (wholesale), land and value-added property like condominiums, and commodities such as gold and possibly art.
A lot of the infrastructure was funded by the government over the last eight years and did not afford any opportunity for the private sector. Value-added property is led by condo construction, and post-conflict demand for urban housing is also rapidly rising. A lot of investments in the past were highly incentivised with concessions such as income tax and duty-free tariff waivers. Much of that is not sustainable anymore.
What lies in store for the future? A broad-based capital market to begin with. Retail investors need alternative investments and in a disclosure-led regulatory environment. That is most efficiently and effectively served via co-mingled funds such as mutual funds and REITs. The key to co-mingled funds is technology and reach. There is plenty of space for these funds if one looks at long-term return prospects. Opportunities to invest in infrastructure will definitely be high, although a better part of that capital will have to come from abroad. Returns in this space are long term, and long-term liability intermediaries such as life insurance funds, pension/provident funds and infrastructure funds should be looking in this area.
What is the enabling requirement? Policymakers, regulators and market participants must facilitate a capital market that is regulated, efficient and transparent; and a secondary market that serves as an exit mechanism and helps in pricing assets. With a proposed new SEC Act, a Securitization Act, a demutualised stock exchange and debt/commodity exchange, investment opportunities in Sri Lanka should be tremendous.
The mindset has to shift from short term to longer-term real returns. Trading in financial assets such as stocks and bonds are both short-lived and not sustainable. Policymakers and managers of the economy must reduce the volatility that is within their control. This would be reflected in the volatility of the rating.
Ratings have paved the way for better risk/reward pricing. While ratings do signal where risks are rising, exit mechanisms are poor. Ratings would be very useful to facilitate investment in infrastructure financing for long-term and trust receipts or mortgage obligations in medium-term investments. These types of securities are currently not under any regulatory purview, and lack transparency or disclosures.
If the private sector is the engine of growth, an enabling environment is all that is required. One does not need to build a network of highways or buildings to enable investments to find its way into other asset classes. A level playing field, a regulated environment and accessibility increase confidence. Investments will follow, led by private equity funds, infrastructure funds,investment funds and pension funds. These are the investment vehicles of the future.
Maninda Wickramasinghe is Chief Executive of Fitch Ratings Lanka. The views in this article are those of the author and not of the organisation for which he works.