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Double Blow

The loss of obtaining a new IMF loan has had a negative impact on local investor sentiment, while the second US resolution against Sri Lanka’s human rights (HR) record due to be tabled in Geneva next month is having a negative impact on foreign investor sentiment too, a stockbroker told this reporter recently.

The source said that the IMF loan (said to be US$ ($) 1.5 billion according to Senior Monetary Cooperation Minister Dr. Sarath Amunugama as reported in the state controlled Daily News on its Wednesday’s publication) being a “no go” factor meant, in the minds of local investors, that the Government will then have to depend on local resources to meet its borrowing needs.
That will translate to the advent of a high interest rate regime fuelled by the demand for rupees, due to the state borrowing from the local money market to meet its expenditure requirements, thereby leaving very little manoevrability for the market to also borrow from the same to meet its own borrowing requirements. That then causes a liquidity crunch, leading to an environment that will push rates up due to the illiquid situation that exists in the market.

However if the IMF money “came,” which, generally is in the form of concessional aid with its last facility of $ 2. 5 billion having had an interest component of under 2%, that would not only have had helped Sri Lanka to meet some of its external obligations, but with the conversion of some of those inflows into rupees,  that would also have had helped the Government of Sri Lanka (GoSL) to meet some of its domestic commitments as well.

But with the non receipt of IMF monies, that, according to my source, has had caused local investors to think twice before investing in the stock market, due to expectations that rates would be on an ascent, due to GoSL borrowing from domestic sources, thereby making the money/interest rate market a more attractive proposition for investment rather than the bourse.

When illiquidity overtakes the market, that in turn causes pressure on interest rates to rise in order to attract deposits to the financial system (banks, etc.), which would then, from an investor perspective, make the money market, especially the fixed income market a more lucrative form of investment rather than the bourse, resulting in local investors shying away from the Colombo stock market and moving into  the fixed income market, thereby resulting in the former’s contraction and not its expansion, on the economic theory of less demand for stocks and shares, which would then result in the prices of such declining, an action and an activity that was visible  in the market last week.

The source further said that next month’s HR sessions in Geneva where once again the spotlight will be on Sri Lanka on the back of a second, US sponsored resolution to be tabled against the island, was also having a negative impact on the market, vis-à-vis foreign investments in the country.

In recent related developments, foreigners not being allowed to have ownership even in freehold property, would not only impact foreign inflows into the stock market, but foreign direct investments (FDI) as well, a situation created by President Mahinda Rajapaksa and his Government, by not making the right moves to fix a looming balance of payments crisis which has appeared on the horizon, by creating roadblocks to such foreign inflows.

On the HR issue, last year the USA successfully passed a resolution against the country at the HR sessions in Geneva. The second resolution to be brought against the island this year complements the first, ie of alleged HR abuse in the closing stages of its war against the LTTE and the non investigation of the same by GoSL.

The war ended more than three years ago.A sizeable, if not a major chunk of foreign investments in the Colombo bourse are from funds which are headquartered in the West, though their operations in this part of the world may be directed through their regional offices in Singapore and Hong Kong, and not directly from their main hqrs.

So if Sri Lanka stands condemned in the eyes of those governments from where those funds emanate for whatever reason (in this instance for alleged HR abuse), that doesn’t augur well for investments from that quarter. The same may also be true in relation to FDI and the reason for its paucity these days, despite the fact that Sri Lanka finished off its 26 year old terrorist war more than 3½ years ago.

Who would want to invest here, whether he is an investor from the West or from the East, if he is not sure as to whether he would be able to sell his products in the export markets due to possible sanctions being imposed on the island due to alleged HR abuse?

The case in point is the loss of the GSP + facility which previously allowed the country duty free exports to the EU region. It was lost because Sri Lanka didn’t allow the EU to investigate alleged HR violations committed during the closing stages of the aforesaid war. The EU, from a regional perspective is also the country’s single biggest export market.

And this was “rubbed on” to this reporter by no less a person than UK’s Deputy Foreign Secretary Alistair Burt who visited Colombo recently.
To a question posed by this reporter as to whether the second US sponsored resolution to be brought against the island in the forthcoming UN’s HR sessions in Geneva was a prelude to sanctions being imposed on the island, he said that sanctions were not a part of the menu.

But he alluded to the fact that the loss of the GSP+ facility was a form of sanctions imposed on the island (see also the business pages of The Sunday Leader issue of 3.2.13.).

No investor worth his salt will want to put his hard earned money in a country where sanctions,  whether it be in the form of the loss of the GSP + facility or in any other similar mode or characteristic, hangs over its head like the sword of Damocles.

Investors want certainty not only in regard to the internal situation of a country, but also in relation to its external situation as well, especially of its relations with the governments of its major export destinations, where, in Sri Lanka’s case it’s the West and with which it currently has an acrimonious relationship due to the aforesaid alleged HR violations and the non investigation of the same.

Sri Lanka’s internal market is small, just 20 million and its per capita GDP is also relatively insignificant, not a magnet to draw foreigners to invest here, unless to sell essentials like milkfood, wheat flour and petroleum products, which no more may be deemed as being luxuries, and which will certainly sell in varied forms in the domestic market inspite of the economy.

However that may be, in regard to foreign investments in the island in the backdrop of a hostile external environment as explained above, those may also hold true even in regard to foreign investment in risk free government securities, which, on an average offer an attractive 1,100 basis point (bp) return, after borrowing from those markets (such as in the West and in Japan) at near zero interest rates to invest in those GoSL securities.

Despite the attractiveness in investing in such Treasury (T) Bonds and T Bills due to the aforesaid reasons, ie  by obtaining a 1,100 bp return after borrowing for nothing, coupled with such investors being also offered a virtual risk free return together with the capital invested, unlike say investing in the stock market or in FDI, where certain factors, both external and internal may result in the loss of such investments, investing in  GoSL securities however assures the investor of no rupee loss, as those investments have been underwritten by  it.

If it comes to a push, GoSL may print rupees and honour such commitments, ie the guarantee that comes in investing in T Bills and T Bonds. But foreigners are not interested in rupees, they are interested in profits, which is the natural psyche of an investor, whether he be foreign or local.
But if there is a fear of an exchange rate (ER) risk due to the aforesaid reasons, which may not only result in such inflows being reduced to a trickle, but foreigners exiting their investments in the island, whether it be from the stock market or from the government securities market and even from their FDI, the first two will have an immediate impact on the ER, causing it to depreciate, thereby eroding profits in foreign exchange (forex) terms, such fears don’t give peace of mind to foreign investments in T Bills and Bonds.

Disastrous will it be not only for the ER, but for the economy as a whole, if such circumstances, such events, lead to the exodus of foreign investments in GoSL securities as well. And if foreigners start withdrawing from the government securities market, that will not only have a negative impact on yields (interest rates), but will also boomerang on the ER, causing it to depreciate.

So these are the ramifications that may/are besetting the stock market, the money market and the forex market due to the 2nd US resolution on alleged HR abuse by the GoSL and of its non investigation, to be tabled at the UN’s HR sessions in Geneva next month and possibly made worse by GoSL placing a ban on foreign ownership of local properties, even if they may be freehold.

On the issue of the non receipt of the $ 1.5billion IMF loan and its impact on the bourse: GoSL has its own expenditure programme for which commitments have to be met and kept. With no fresh infusion of money forthcoming from the IMF at least in the near future, this would mean the GoSL will have to borrow from the money market to meet these commitments, thereby causing a strain on market liquidity.
When the money market is not so liquid, that tends to make interest rates to appreciate, thereby making the fixed income market a better proposition for investment rather than the bourse, thereby placing another nail on the coffin which is the bourse.
However a rising interest rate environment brings with it its own set of problems as elaborated on these pages before.  It tends to make investors to either abandon their programmes, or to place them on hold, thereby retarding development and heaping more burdens on the suffering masses of this country.

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