This sun kissed island just below India is a minnow compared to its giant northern neighbours, but its emergence from civil war and political crisis has put it on the map for brave investors.
The Sri Lankan Economy
While the Sri Lankan economy has seen decent GDP growth in the last few years, currently it stands at 4.1% growth y-o-y, not impressive, but things could be much worse. The government debt to GDP ratio has risen to 76%, which is uncomfortably high for a small frontier market. The government budget is also faces a deficit of 7.4% – all indicating that the country is living beyond its means and thrift is expected to a feature in the government budget for 2017.
The government is going through an IMF inspired fiscal tightening (in return for a USD 1.5 billion loan), which has helped its finances in the short term, the risk is that this approach will destroy the country’s growth prospects and therefore negate the impact of any reduction in debt and spending. The government is also attempting to push through reforms in tax and regulation which will make it easier for foreign investors.
Compared to (currently) strongly performing Asian peers Pakistan and Vietnam Sri Lanka seems to be lagging behind but there are reasons to be optimistic.
A bright spot for the government has been the inflow of Chinese money into the island, a new seaport and airport at Hambantota, the ambitious Colombo port project which would allow the capital to rise in population to 8 million and become a major financial hub as well as many other smaller infrastructure projects. However much of Sri Lanka’s outstanding debt is in China’s hands and there are fears these projects help Chinese firms but may end up being unproductive and the massive debt burden will cripple Sri Lanka financially and leave the government at the mercy of Beijing.
The challenge for the government is to attain and sustain a growth rate of around 7 percent in order to attain middle income status and keep unemployment low. The economy remains heavily dependent on the agricultural sector, with commodities like tea, rubber and coconuts which along with textiles make up most of Sri Lanka’s exports. Sri Lankan tourism is a success story, its reputation as a mellower version of India is well founded, the country has great beaches, delicious food and a welcoming atmosphere. The end of the civil war in 2009 has meant a sustained increase in tourist numbers rising from 650,000 in 2010 to 1,784,000 in 2015 an impressive rise in just five years.
Stock market performance
The Colombo Stock Exchange CSE has seen a modest performance over the last five years has seen with some highs in 2015, before experiencing a steady decline in the last couple of years, which could make this a good time to buy. The exchange has 295 entities listed, although trading is fairly thin and the market cannot be described as particularly liquid, there is also the S&P SL index tracking the 20 biggest companies.
For those who want to invest directly into the CSE first they should open a securities account with a participant organization (a local Stockbroker or a custodian bank) and also open a Central Depository System account (which can be done via the Bank). Further details can be found here.
Once the paperwork is complete you can instruct your broker to buy and sell shares. Companies in Sri Lanka have a decent reputation for transparency and honesty with much information available in English, nevertheless investors should try and research companies thoroughly before placing their funds as unless you have knowledge of the local market, or are prepared to put time and effort into researching companies you risk putting money into a small illiquid market which is likely to experience a high degree of volatility.
For those brave enough to take the plunge rather than suggesting individual companies I would suggest that certain sectors offer particular advantages:
Finance – banking in Sri Lanka has a long history of success dating back to the colonial period. Banks appear to be well run and well regulated, a solid bet.
Construction – often a good bet in a frontier market experiencing decent growth, a Chinese inspired infrastructure splurge should be a boost to this sector even if Chinese companies are the main beneficiaries.
Telecoms – like most frontier markets Sri Lanka has enjoyed a boom in mobile phone use, this has some way to run as the rollout of smart phones and 3/4G networks continues apace.
There does not appear to be a Sri Lankan focused ETF on the market, surprising in one respect given there are 1000s of ETFs available, but then Sri Lanka is a small market which is too volatile and focused for this type of product.
Merlin Linehan has worked in development finance within Eastern Europe and Asia, and spends much of his time investigating the risks and opportunities that are created from the ongoing expansion of Chinese businesses that invest overseas in emerging markets.