SPECIAL ISSUE
Two Model Stock Portfolios Gain In 2017
INVESTOR’S GUIDE
JANUARY 2018
THE HAMBANTOTA PORT DE AL IS DISADVANTAGEOUS FOR SRI LANKA . BUT, WAS A BET TER ONE POSSIBLE?
TWO UNPRICED STOCK OPPORTUNITIES: A SMALL BANK AND A GOOD GOVERNANCE PREMIUM
HOW ONE COMPANY’S JOURNEY CHANGED A UNIVERSIT Y’S THINKING ON STARTUPS
Contents
INVESTOR’S GUIDE 2018 Tumbling corporate profits and bond yields have sparked a frantic search for safe heavens P67
4 1 T W O M O D E L ST O C K P O RT F O L I O S G A I N IN 2017
Three model portfolios built for Echelon by top fund managers had two winners outperforming the market
4 9 T W O U N P R I C E D ST O C K
O P P O RT U N I T I E S : A S M A L L BA N K A N D A G O O D G OV E R N A N C E P R E M I U M
We asked two stockbroker chief executives to identify a trend they think is not yet priced in
53 CONSUMERS CUT DOWN O N D A I LY E S S E N T I A LS
A sneak peek into consumers’ shopping carts reveals a lot about the direction of the economy
6 3 STA N D A R D C H A RT E R E D
BA N K S E E S O P P O RT U N I T I E S B E YO N D C H I N A’S O N E B E LT, ONE ROAD
Countries like Sri Lanka can deepen economic ties beyond China’s mega initiative, which promises to transform global investment and trade, and the global bank is exploring these opportunities one country at a time
2 Echelon.lk | January 2018
Contents
TO O LAT E FO R R EFO R MS? The 2018 budget was the best in recent memory for its direction and reforms. However, it’s not good enough to make a serious impact, says Frontier Research P24
3 Echelon.lk | January 2018
55 WHERE THE WIND B LO W S
When the country’s power generation sources drain out, investors look elsewhere
60 EN ROUTE TO G R E E C E?
The debt crisis in Greece was long known and predicted. But, it did happen. With elections ahead, is Sri Lanka heading the same way?
Contents 70
7
• AGENDA
T H E H A M BA N T OTA P O RT D E A L I S D I S A DVA N TA G E O U S F O R S R I L A N K A . B U T, WA S A B E T T E R O N E P O S S I B L E?
A poor choice to build an unequipped port has been compounded by ill-thought-out tax breaks and mysterious concessions. Can anything good possibly come out of the Hambantota port deal?
• AGENDA
1 1 E C O N O M I C N AT I O N A L I S M O N T I L E S BA C K F I R E S O N T E A
Most people believe asbestos was banned on health grounds, but that’s not the whole story
35
124
• GOVERN
1 5 H I G H C O N ST R U CT I O N
C O ST S : D O P R I C E C O N T R O L S ON CEMENT HELP?
An intervention-eager state neglects its regulatory role
• LEAD
1 8 S O A R I N G A B OV E
How one company’s journey changed the university’s thinking on startups
• GOVERN
70 JERUSALEM AND THE 40
C E Y LO N C I V I L S E RV I C E US President Donald Trump, by announcing that the American Embassy in Israel would move to Jerusalem, completes a journey that began when Britain opened the first modern diplomatic office there in 1838
• ZEN
7 6 A K R A M CA S S I M The Chief Executive of Colombo Jewellery Stores may deal with precious stones all day, but his wife and daughter are the real jewels in his life
4 Echelon.lk | January 2018
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Can we think long term?
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hat should investors expect from a longterm portfolio? The stock market has been brutal over a couple of years, and bonds have been the safe harbour. However, that equilibrium could wobble in 2018. Equity investors have been choosy about investments; however, corporate earnings have been rising. Asset allocation is about to get a little trickier in 2018. Corporate profit growth, notwithstanding stock prices, has remained low. Shocks came from three unexpected areas: falling consumer optimism, the crushing tax increase and extreme weather. Combined, these affected spending directly, and hit consumerexposed companies the hardest.
6 Echelon.lk | January 2018
Twitter @EchelonMag Equity investors will be watching US tax policy now, as the announced cuts are expected to generate a $1.5 trillion deficit over time. What will be the impact of refinancing dollar debt? In Echelon’s special Investor’s Guide 2018, we look at the challenges facing the economy and markets in various angles through the experience of seasoned investors and commentators. Here’s wishing you a fantastic year of investing in 2018!
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INVESTMENT POLICY
The Hambantota port deal is disadvantageous for Sri Lanka. But, was a better one possible? A poor choice to build an unequipped port has been compounded by ill-thought-out tax breaks and mysterious concessions. Can anything good possibly come out of the Hambantota port deal?
Illustration by: Leyanvi Mirando
By Shamindra Kulamannage
For centuries, until European occupiers developed Galle, a port by the Walawe river estuary was Sri Lanka’s main gateway to the rest of the world. The port called Magampura in Hambantota, straddling the east-west shipping route, was a centre for trading spices, the most sort-after commodity from the island. For hundreds of years, the spice trade flourished due to great demand and limited supply. During the reign of Ruhuna’s kings, advanced irrigation management had made growing rice and other crops possible year-round. However, unlike rice, farmed with managed water in the dry zone, spices required January 2018 | Echelon.lk 7
Agenda
Investment Policy
rain. It’s the twin monsoons that rained on the slopes of the island’s central hills and valleys that provided conditions for growing spices. Magampura was the gateway from where Ruhuna’s salt and food crops traded for inland spices were shipped overseas. With hundreds of ships, weapons and a willingness to use both, Chinese Admiral Cheng Ho’s fleets visited the island a few times. A stone plaque at Galle records that Admiral Ho kidnaped the local ruler and took him and his family back to China. The island’s international nature can be understood by the fact that the Galle plaque is in four languages – Chinese, Persian, Arabic and Tamil. At the time, Sri Lanka was clearly globalised. Long before Europeans discovered Asia’s cosmopolitan, intellectual and commercial life, the island now called Sri Lanka was integrated with these. After the occupying Dutch and British shifted activity to the Galle harbor, the port at Hambantota went into quiet decline. Hambantota’s present day revival reinforces the importance of thousand-year-old commercial links and networks across the seven seas. Ominously or not, China, whose Admiral Cheng Ho humiliated a kingdom by kidnapping the monarch, is playing the critical role in the emergence of Sri Lanka’s deep South. China’s gigantic government-controlled businesses have taken over the development and management of the modern Magampura seaport, and propose to establish industries in the 400-acre complex, and another almost 3,000 acres outside the port it will receive as part of the agreement. In vision, scale and potential impact, the project is unsurpassed by any in the region. After plundering European occupiers left 70 years ago, Sri Lanka’s fortunes somehow became linked to South Asia. In a laggard region, the island was the best place for a long time. Home to around a sixth of the world’s people, one by one, South Asian nations led by India, Bangladesh and then Sri Lanka started dreaming of a better future. Bangladesh has firmly ditched crisis-prone politics, India resolutely pursues structural reforms and Sri Lanka prioritised building infrastructure. The first ships entering Magampura Mahinda Rajapaksa Port, the spiritual successor to the wellknow ancient harbor in the same region that no longer existed, was to be a game changer. However, the colossal construction cost, equipment unavailability and the absence of any other strategy resulted in no economic contribution from the port, and loan repayment threatened to bankrupt the government-owned Sri Lanka Ports Authority, the port’s owner. To overcome the loan service difficulty, the government was compelled to swap its debt for equity with the Chinese in a deal involving entities controlled by the two states. T COMPLETION of the second phase, the port financed by China cost $1,316 million. Its first phase, although not equipped to handle containers, consists of two 600-meter long berths, a 310-meter bunkering berth and a 120-meter small craft berth, all at a 17-meter depth alongside the quay. Phase two of the development would
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8 Echelon.lk | January 2018
add six more berths, making a total of eight berths, excluding ones for bunkering and small crafts. Critics of the debt-to-equity swap suggest the deal is disadvantageous for Sri Lanka in four areas: the valuation, the extent of tax breaks, its impact on the Colombo port, and the Hambantota port’s unproven backward integration for job creation and generating business opportunities for companies here. Hyperbole is not unexpected from a government. But, in the choices made about the establishment and operation of the Magampura port, the Mahinda Rajapaksa administration’s incompetence and disregard of any commercial sense was beyond any hype. The case for a Southern port was well-established, and a 2005 feasibility study by a Danish consultancy proposed a three-stage development. Construction commenced in January 2008 by China Harbour Engineering Company and Sinohydro Corporation, financed on commercial terms by China’s Exim Bank. Vanity quickly trumped commercial sense. No investors were secured for establishing the services needed to operate a non-containerised port. Instead, an incomplete port was readied for opening five months ahead of schedule in November 2010, before the contractor could remove rocks from the port’s mouth, to coincide with then-President Mahinda Rajapaksa’s birthday. Of course, the rocks prevented large ships from entering the port’s deep basin. Underwater blasting to clear the obstructions later cost the government an additional $40 million, raising the first phase’s cost (including admin building and tank farm for bunkering) to $650 million and requiring almost two more years to complete. Almost a decade since Magampura’s construction commenced and seven years since the first ships sailed in, the port’s revenue was not even remotely adequate to service the loans obtained for construction, when its sale (99-year lease) to China was finalised. In 2015, the port’s total income was
$16.5 million (Rs2.4 billion). In 2016, revenue was around the same. When loan repayment commences on the $1.27 billion borrowed, following the initial grace period, one estimate calculated the annual repayment at $96 million. Given the tough financial choices facing the country, swapping equity for a debt settlement was inevitable. The Chinese expect to invest $600 million to equip the port, a level of funding Sri Lanka couldn’t afford on its own. Given SLPA’s poor record in managing businesses, compared to private competitors, it’s also an unnecessary risk for taxpayers. At Hambantota, everything was bungled. A ship fuel supplying service (called bunkering) with a loan-funded investment of 14 tanks and a 1.2 kilometer pipeline connecting them to the waterfront was suspended due to heavy losses resulting from ‘bunkering irregularities’. Aside from dominating banking, the government operates an unprofitable airline, owns hotels, an insurance company, a telecoms firm and most utilities. Many of these investments are loss-making, even with a monopoly, while profits at others are sub-optimal. The port sale to China is controversial due to the transaction’s unconventional nature. Ports aren’t assets governments sell outright (a 99-year lease is as good as a sale for anyone living today). Instead, like at Colombo, the government (SLPA) remains the owner and public-private partnership concessions are awarded to private consortia to invest, build and operate container or other terminals. Colombo’s privately controlled terminals SAGT and CICT are 35-year concessions compared to Hambantota’s 99 years. Few private companies have the ability to invest up to $2 billion as the Chinese have now undertaken to do to purchase an equity share and equip the port. For all its posturing about regional security, the Indian government cannot match Chinese financial or management heft, and could not take on the port. Hopes that public-private part-
nerships might return to their heights from the 1990s, when Sri Lanka Telecom was listed and the SAGT deal was signed, have dimmed. Instead, an unconventional deal, a questionable valuation and lack of transparency cloud the Hambantota port deal.
C
ENTRAL TO GROWING foreign investments will be com-
panies seeking a foothold in South Asia as India emerges a major consumer and economic power. Offering inducements such as land to build factories and a low corporate tax are usual. However, sweeping corporate tax breaks to the Hambantota port investment are questioned for their long tenure. Private investments in ports aren’t new. SAGT and CICT managed terminals have set the precedent on taxation, royalties and dividends, generating a steady cash flow to the government and port owner SLPA. Hambantota International Port Group and Hambantota International Port Services Company, the two firms investing and managing the port and its service infrastructure, have been granted a 25-year corporate tax holiday, which commences seven years after the concession agreement’s signing, thus extending the tax break to 32 years. Usually, large Despite the tax breaks, infrastructure projects the purchase price is are loss making in the not foreign investment early years. that flows into the The longest income ‘real’ economy. tax holiday allowed Instead, it’s one big under the Strategic Development Act is 25 company horizontally years. acquiring another Other tax breaks for the two companies developing the port include exemptions from dividend tax for 26 years, withholding tax for seven years, VAT for seven years and Port & Airport Development Levy for seven years. In addition, it’s exempt from CESS charged under the Export Development Act, NBT, excise taxes and customs duty on the import of project-related items and expatriate staff exempt from PAYE, all for seven years. Tax breaks were approved in parliament after the Hambantota concession was granted. Despite its poor economic utility, the Hambantota port was an existing business. By valuing it at $1.4 billion and accepting $1.12 billion as sales (lease) proceeds for majority stakes in two companies controlling the port results only in an ownership change. Despite the tax breaks, the purchase price is not foreign investment that flows into the ‘real’ economy. Instead, it’s one big company horizontally acquiring another. The acquisition itself will not change anything. To argue that the Chinese plan to invest up to $600 million is what got the tax break then needs to be linked to the investment when it happens. January 2018 | Echelon.lk 9
Agenda
Investment Policy
For an investment even larger (an estimated $800 million), the John Keells-promoted Waterfront hotel, condos and project received a 10-year income tax holiday and a further 15 years of income tax at half the rate prevailing for the hotel sector or 6% annually, whichever is lower. As South Asian economies expand, interest from foreign investors is only likely to grow to invest in businesses that can reach these newly affluent consumers. Then, prospects for the kind of foreign investment that lifts productivity will start to look even brighter. Generous tax breaks, without links to investment, employment or productivity outcomes, and going beyond those available for Sri Lankan businesses, may appear ill-conceived. A source familiar with the negotiations concedes that the Chinese were demanding. With few other options left, which the Chinese would have appreciated, Sri Lanka’s negotiating position was weak. Without the support of specialists, developing countries usually also make poor deals for themselves. NCE EQUIPMENT has been installed, Hambantota will have eight deep water berths compared to the nine at the Colombo port. So far, it’s not publicly announced how fast its new Chinese owners will containerise the port. The concession agreement includes a condition to prevent Hambantota from undercutting Colombo port on domestic cargo, but naturally all other services and transshipment cargo is open to market pricing. More than the geographical advantage against Colombo, the Southern port under complete Chinese control will have the freedom to recruit talent from anywhere in the world, and may not suffer the disruption of unions and bureaucracy that affects even the private sector-managed terminal in Colombo. Due to the lack of space, the 300-acre Colombo port is challenged with accommodating any logistic-related services in its premises. Logistics firms say red tape and the lack of space are major obstacles for developing the industry. Foreign investment, even when it’s due to selling an existing asset like the Hambantota port, make a country more productive. Investors from overseas bring know-how and cutting-edge capital assets. Chinese companies are also likely to invest in the new port, which is adjacent to a 3,000-acre industrial zone. Since the project has long-term tax breaks and an ability to hire foreign workers, the only foreseeable benefit will be for Sri Lankan businesses to invest in ventures within the Chinese port and in the industrial zone that will link them to global supply chains. Otherwise, if productivity growth is low, wage growth will be too. Creaky infrastructure will compound the issue in the country, while an efficient setup in the Hambantota port and zones will create an oasis of wealth due to its efficiency. If many Sri Lankans don’t work there and local businesses haven’t invested, the industrial renaissance will pass the rest of the country by. But that’s conjecture. Nothing so far suggests that the Chinese will be as unwise to close the port and industrial zone
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10 Echelon.lk | January 2018
to the rest of the country, operating it as an enclave. However, they will also not be able to compel businesses here, many of which are protected from competition, to seize the opportunity. If businesses cannot get things done themselves, even the most energetic politician will struggle to set up factories and generate one million jobs over the next few years. Resentment to globalisation will rise if foreigners are seen to benefit disproportionately from the opportunity here. The problems snowball from there: jobs with poor productivity retard peoples’ prospects for advancement. Sri Lankans also have a peculiar attitude to work, complain employers. Their expectations on rewards are disconnected from productivity. When British occupiers grew tea, they had to import labour as Sri Lankans refused to work in plantations since they were established 150 years ago. If the Chinese receive a different reaction to the British will be known in a few years.
I
N ANCIENT EGYPT, cassia and
cinnamon fetched a high price as they were essential for embalming. More widely, spices were used to preserve food and make the poorly preserved palatable. Today, however, spices are seasoning and flavouring for food. They are still essential to prepare a good meal, but no longer difficult to obtain. Once in decline, the ancient Magampura harbour never regained its place as other agricultural produce, like tea, began to take precedence in exports, and decades later, industrial goods began to fill ships. However, for the Southern port, its reemergence as a trading post may bring the story full circle as Sri Lankan businesses now have an opportunity to become part of global supply chains. Shipping spices formed the backbone of early international trade. That role has now been taken over by global supply chains; and with the Chinese port, Sri Lanka has an opportunity to join the global trading order.
Agenda
The Price Signal
Illustration by: Leyanvi Mirando
Economic nationalism on tiles backfires on tea Most people believe asbestos was banned on health grounds, but that’s not the whole story By Bellwether
Classical liberal economists have long argued that free trade leads to peace, and economic nationalism and protectionism (which usually also involves minority oppression and ethno religion fascism) lead to soured international relations and war. Russian tactics to block the import of Sri Lanka tea over dubious allegations of ‘beetles’ is a case in point.
P R E S S I N G B U T TO N S
Soon after President Maithripala Sirisena came into office, various lobbies began to persuade him to block imports, institute bans or intervene in the lives January 2018 | Echelon.lk 11
Agenda
The Price Signal
of people through the coercive powers of the state with various motives. President Sirisena is particularly vulnerable to making well-meaning interventions due to his being a former health minister, which may backfire. This administration’s interventions on sugar and beer have been questioned. As a former health minister praised frequently by the World Health Organization for his interventions, President Sirisena is vulnerable to various lobby groups on health grounds. Most people believe asbestos was banned on health grounds, but that was not the whole story.
T I L E N AT I O N A L I S M
Even though asbestos was banned ostensibly due to health concerns, there was also an underlying force of protectionism and economic nationalism behind the move. Officials of the Sri Lanka Ceramics and Glass Council, an archetypical protectionist lobby that built monopolies in ceramic tiles and sanitary-ware, claimed big success in influencing President Sirisena to ban asbestos after it Protectionism is was made. the bedrock of The Ceramics and false economic Glass Council, which philosophies such as had seen its members the German Historical gain massive profits Economics that led to from protectionist interventionism and duties to rob the National Socialism economic freedoms (Nazism) of homeless people and force them to use high-priced sanitary ware and tiles, wanted to force people to use roofing tiles, an industry that was in decline. In 2015, for example, the then-head of the Ceramics and Glass Council Mahendra Jayasekera “expressed his satisfaction with the government’s move to ban the use of asbestos roofing sheets in the country by 2018,” Daily News, a state-run newspaper, reported. “He said the ban will help revive the red clay roof tile manufacturing industry to a greater level,” the report said. With the Donald Trumps and Steve Bannons of this world, with open tribalist nationalism like in Sri Lanka (based on white people rather than Sinhalese who believe they own the country), there is now greater focus on economic nationalism and the harm it does to consumers, innovation and most importantly, the freedom of all people. 12 Echelon.lk | January 2018
ALIEN CONCEPT
Economic nationalism is not an Asian or Sri Lankan concept followed by ancient monarchs, but a false doctrine based on tribalism and dehumanisation that emerged in Eastern Europe with the popular vote and the breakdown of monarchies and empires. It has elements of classical Mercantilism, but is much more damaging to freedom and human values. The idea behind the asbestos ban was to use the state and its law-making power and customs (inherited from British rule) to bring greater profits and market share to clay tile manufacturers by ending the use of roofing sheets made with imported asbestos. Protectionism is the bedrock of false economic philosophies such as the German Historical Economics that led to interventionism and National Socialism (Nazism).
E C O N O M I C N AT I O N A L I S M
“It is the aim of nationalism to promote the well-being of the whole nation or of some groups of its citizens by inflicting harm on foreigners,” Ludwig von Mises, an economic philosopher who had studied Eastern Europe extensively, wrote in his book ‘Omnipotent Government The Rise of the Total State and Total War’. “The outstanding method of modern nationalism is discrimination against foreigners in the economic sphere. Foreign goods are excluded from the domestic market or admitted only after the payment of an import duty. Foreign labour is barred from competition in the domestic labour market. Foreign capital is liable to confiscation. This economic nationalism must result in war whenever those injured believe they are strong enough to brush away the measures detrimental to their own welfare by armed violent action.” The injured party, Russia believed it was strong enough to take retaliatory
action, not through military warfare but through economic warfare on Ceylon tea. Russia is hardly a free-trading nation with rule of law. Putin has his own brand of nationalist-authoritarianism. Its institutions are not transparent or independent.
H E A LT H C O N C E R N S
Leaving aside the question of Russia and nationalism, there is a question of health concerns. There are strong claims that asbestos causes cancer such as Mesothelioma and other types in people working with asbestos, those living near factories or asbestos workers. Factory or construction workers who may inhale dust while producing or cutting asbestos sheets without adequate protection are also at risk. Using grinders to cut asbestos is particularly dangerous. No education campaign has been carried out among carpenters and roofing workers to educate them on using grinders to cut tiles. Some types of asbestos are already banned in many countries. In Sri Lanka, chrysotile asbestos had been allowed, mainly for roofing sheets. Some countries like Russia and Canada are big exporters and users of this material.
Sri Lanka no longer has an evidence-based policy-making process involving green or white papers, which makes the country vulnerable to ad hoc decisions by presidential decree such as in the case of the glyphosate ban. To improve health grounds, a broad-ranging study is needed with solutions. The phase-out period for asbestos can be made longer. In the meantime, a study must be done to find out whether there is an increase in the prevalence of asbestos-related cancer near factories. Carpenters and workers need to be educated urgently not to use grinders to cut asbestos sheets. Manufactures should also produce shorter lengths of sheets (5 feet etc.), so the need to cut them can be reduced or eliminated. It will be easier to There is nothing to phase out asbestos be won that cannot ceiling sheets first, be won by a better where economical product, eliminating substitutes are now the need for war or available. Free trade intervention or a broad study can also identify and bring in alternative roofing material. At the moment, many materials are subject to excessive taxes due to import protection. Taxes on steel beams or Malaysian timber may need to be re-examined. Tile roofs require more timber than asbestos.
F O R E I G N P O L I CY F L AW E D P U B L I C P O L I CY
The whole affair shows that there is a deep flaw in policy formulation in Sri Lanka. The government did give a few years before the ban came into effect, which was a good move, but clearly the time period was not enough. In the case of asbestos, there had been no studies done domestically to find out or whether asbestos was increasing the risk of cancer in residents near factories or among workers, which would have helped strengthen the case to ban asbestos. There has been no policy process or public consultations on asbestos use before making the decision.
Free trade and evidence-based policy will also have other impacts on foreign policy. When there is free trade, a foreign producer has to offer the cheapest and best product to win customers in a foreign country. The customer alone decides. There is nothing to be won that cannot be won by a better product, eliminating the need for war or intervention. This is why free trading nations like Singapore or Canada find it easy to have good foreign relations. It is important to have free trade with India, for example. Sri Lankan nationalism will always lead to Indian interventions. “A nation’s policy forms an integral whole,” explains Mises. “Foreign and domestic policy are closely linked; they are but one system; they condition each other. Economic nationalism is the corollary of the present day domestic policies of government interference with business and national planning, as free trade was the complement of domestic economic freedom.” January 2018 | Echelon.lk 13
Govern
Construction
High construction costs: Do price controls on cement help?
The president of Sri Lanka’s Chamber of Construction Industry has complained that construction costs in Sri Lanka are higher than in the region. Players in the tourism industry have claimed that high construction costs inhibit capacity expansion in the tourism industry.
An intervention-eager state neglects its regulatory role
Photography: Diloshan Leon
By Ravi Ratnasabapathy
January 2018 | Echelon.lk 15
Govern
Construction
Why are construction costs so high? The government imposes price controls on cement, an important factor in construction, supposedly to keep costs low; but is this working? Price controls distort markets, causing shortages and creating black markets. But, these obvious market distortions are not visible in cement. This may be because of industry involvement in setting prices, which are based on cost estimates provided by manufacturers. This seems likely, given that cement prices in Sri Lanka are higher than in the region. According to the JUBM & Arcadis Construction Cost Handbook (2017), the cost of ordinary Portland cement in Malaysia is between RM19 and RM20 per 50kg bag, which is about Rs715-750. The cost in Indonesia is around Rs845. The regulated price in Sri Lanka is Rs870-930 per bag. Naturally, producers If price controls would be quite happy were removed, the to supply a product if price of cement the price was set high would probably enough and no shortages fall, as it would give would occur. cheaper imports Promoting competition and allowing marthe opportunity to kets to work properly are compete on price the best ways to lower prices, but in 2013, the government imposed a new restriction that curtails competition. The number of cement plants that may be operated in a port was limited to one per port. If a new factory is to be set up, priority has to be given to existing operators in the port. This limits new investment and competition, and prevents prices from falling. If price controls were removed, the price of cement would probably fall, as it would give cheaper imports the opportunity to compete on price. Would this affect quality?
QUALITY
The local cement industry has complained of low-quality (and low-cost) cement imports in the past. This is a problem because consumers cannot detect poor quality. Substandard cement on construction work is a serious matter, as the consequences may manifest after construction is completed. This issue needs to be addressed through a comprehensive building code, which is lacking. A proper code is needed for consumer protection and public safety. Although old regula16 Echelon.lk | January 2018
tions such as the Factories Ordinance exist, these are not up-to-date and enforcement is weak. A standard Code of Practice to regulate and enforce design, construction and compliance requirements is necessary. While a uniform code is absent, a multiplicity of approvals exists: at provincial, district, pradesheeyasabaha, urban and municipal level. These become even more complex given several central agencies such as the Urban Development Authority (UDA), the Sri Lanka Land Reclamation and Development Corporation, and the Department of Agrarian Development. This leads to overlaps of authority, conflicts of instructions, contradictory regulations and compliance loopholes. There is a lot of red tape, but it does not improve safety or ensure quality. The government needs to replace these old regulations with a single comprehensive code, legally enforceable, covering all classes of buildings and including safety, structural stability and accessibility. Along with a code, building contractors and architects should be licensed and carry professional indemnity insurance. The objective of licensing is to ensure that work is done by people who are conversant with the standard (which should carry statutory force), and conduct their duties competently and professionally. In the event of any failure in buildings, they may lose their license to practice. This is apart from any action taken in courts. The insurance ensures that consumers can receive compensation for shoddy work. The code is self-enforcing; if there is a failure, they will not be able to practice, which gives the incentive to ensure quality. Specialist licenses should be necessary for more complex work, including the following: (a) Piling work (b) Ground support and stabilization work
Govern
Construction
(c) Site investigation work (d) Structural steel work (e) Pre-cast concrete work (f ) In-situ post-tensioning work
OV E R A L L C O N S T R U CT I O N C O ST S
Cement is only one part of the construction cost; policy with regard to other construction materials significantly increases costs. The government imposes high taxes on many imported construction materials to protect domestic industries. These include steel bars and rods (taxed at 89.66%), ceramic tiles (107.6%), and sanitarywear (72.4%). Aluminium extrusions, granite, electrical fittings, furniture and carpets are also heavily taxed. This results in high overall construction costs. For example, steel costs around $723/mt in Sri Lanka, but only $500/mt in Thailand and $470/mt in China. By some estimates, the construction cost of an average (non-luxury) high-rise apartment block in Sri Lanka may be as much as 60% above that of Thailand or Malaysia due to these protective taxes, despite Sri Lanka’s lower labour costs. Apart from protective The policy is a mudtaxes, the lack dle of ad-hoc intervenof scale among tions. contractors, low Contrast this with the UK government, labour productivity, which in partnership outmoded methods with the industry has and long delays developed a strategy to in approvals also improve the performance contribute to high of the construction secoverall costs tor by 2025. Objectives include lowering costs: a 33% reduction in the initial construction of a new building and the whole life cost of built assets, a 50% reduction in the overall time from inception to completion of a construction, and a 50% reduction in greenhouse gases. The UK industry is focused on reducing costs through efficiency, better methodology, technology and innovation. The focus is on overall cost reduction, and not trying to protect local producers of construction material. Apart from protective taxes, the lack of scale among contractors, low labour productivity, outmoded methods and long
delays in approvals also contribute to high overall costs. Improvements in these areas will also reduce costs. Ordinary citizens are unable to afford housing, while the government intervenes to protect the industry. According to a report by Jones Lang LaSalle (2014): “High project development costs, coupled with the high borrowing costs for housing loans, have breached affordable limits and restricted home buying prospects for Sri Lanka. Based on our understanding from the affordability assessment, only the top income-earning resident Sri Lankans can buy homes in Colombo. Residents with limited income are forced to opt for properties that are at least 20-25km away from city limits.�
CONCLUSION
Price controls for cement are clearly not helping to reduce construction costs. Restrictions on competition deter investment and contribute to raise, rather than lower, cement prices. Other interventions to protect the local industry have resulted in raising overall construction costs. While the State is eager to intervene in unnecessary areas, it has neglected its role as a regulator. Although in most circumstances the best protection is the common sense of an individual consumer, in instances where technical knowledge is needed to detect poor quality, there is a case for regulation, particularly if public safety is involved. The government should stop controlling the price of cement, and focus on drawing up and enforcing a proper building code. To lower costs, taxes on construction materials must be reduced and competition facilitated.
The writer is a Fellow of the Advocata Institute, a free-market think tank based in Colombo.
Lead
Education
Soaring
18 Echelon.lk | January 2018
Above How one company’s journey changed a university’s thinking on startups By Devin Jayasundera
Prof. Rohan Munasinghe and his team at Future Drones at the intelligent machine labs at University of Moratuwa January 2018 | Echelon.lk 19
Lead
Education
Inside the dimly-lit hallways of the building that houses the electronics and telecommunication engineering department at the University of Moratuwa, Prof. Rohan Munasinghe’s bright fluorescent-lit office sits in a recluse corner on the first floor.
On the side of his table, a whiteboard adorning the wall displays a mixture of erratic blue and red markings of wind speed equations and rotor lengths. In front of his desk on a large boardroom table, a pack of raspberry pi circuits languishes underneath a heave of administrative files splattered with student assignments and a set of newly printed brochures of his company. The company, Future Drones designs and produces locally manufactured drones and had its commercial launch early this year. In the first few months itself, the Land Use Policy sought the company’s drone services. The objective was to map in pinpoint precision a 100 square kilometer area in Kekirawa to figure the land utilization habits of its inhabitants. Subsequently, another contract was offered to digitally map the terrain of a surrounding land of 86 square meters near the Kanthale Sugar Cooperation. In just ten months, the company’s five-member crew and a revolving set of trainees raked in Rs6 million from these two contracts alone. Munasinghe is quick to point out that he saw the coming of drones as early as the rise of the new millennium. “We have been talking about various technologies, but have never invented anything,” he says. “So, I thought drones as one avenue that we could make a mark in as far as back as 2000.” After finishing his Phd in control systems, the study of commanding movements in machines in Japan, he joined the faculty in 2005. He was the first to offer a course in robotics at the University of Moratuwa. Every second semester, he conducted robotics competitions for first year students, inventing games, where competing teams have to develop a robot 20 Echelon.lk | January 2018
that could navigate symbols on the ground to arrive at a set destination. In 2007, the competition was levelled up by introducing drones. For Munasinghe, this provided the ultimate sandbox to also dabble in his passion with the students. These competitions eventually matured to be a part of final year undergraduate projects. “A couple of days back, I sent an email to the upcoming final year batch saying that I want four people to design the next generation auto pilot and the ground control station for drones.” Every year, a new set of people build upon the work of the previous batch of students. “One group designs the autopilot. The next group designs the drone, and the next air speed sensors and propellers,” he says. “I try as much as possible to produce a sellable and marketable product at the end, and that is not possible in one year.”
While these mini research assignments started evolving into something beyond a student project, Munashinghe felt the need to establish a company. But, this was no ordinary startup. The company had firm roots at the University of Moratuwa. A countless number of students have been part and parcel of the early R&D years of the company, and the university had also provided unfailing support in terms of laboratory services and equipment. “I wrote a short letter to the vice chancellor,” says Munasinghe. “It simply said that we are ready to have a startup, please advise.” This was two years ago at a time when the company was nothing more than a hobbyist pursuit practiced in the afterhours between a professor and his students. Munasinghe’s request to the then-Vice Chancellor Prof. Ananda Jayawardane triggered a snowball effect, leading to a series of initiatives to provide a more concrete platform for the university to spin off startups. The first among them being introducing a policy detailing each step in the formation of a university startup from equity allocation, stipulating fees for university services to patent applications. In addition, a product incubator was set up for each department in the faculty of engineering to refine and harness infant stage ideas. “Everything had to be thought up from scratch,” he says. Future Drones was the first company to be initiated under this policy. This also leads to its most striking feature. Apart from its four founders, the other stakeholder who owns an ownership stake is the University Moratuwa, the literal birthing ground of the company. The university’s investment does not come in monetary form, but is considered as a fee for incubation, laboratory services, office space and R&D efforts of countless students who have roamed the halls of the department of electronics and telecommunication. Such initiatives are unprecedented in the local uni-
GOING SOLO A recent series of initiatives at the University of Moratuwa are set to invigorate an entrepreneurial and research-focused culture against the humdrum state enveloping most state universities, charting a league of its own
1. IP policy The university is finalising its own intellectual property policy to promote commercial research projects. This will be the first of such initiatives in the entire university system.
2. Mora Ventures The recently set up incubation programme and startup competition has set an audacious goal to turn out the first startup over the next 10 years.
3. International recognition The university created two posts, Director International Relations and Director Research, to foster postgraduate collaborations with reputed foreign universities in its efforts to raise its international ranking.
4. Enterprise A 24-hour working space that could incubate 15 startups and mentorship services.
5. Industry Collaboration Dialog, DSI, Cargills, Zone 24x7 and Sysco Labs have already partnered with the University for industry-funded research and development.
versity system as a whole. Most state universities are passive and languid participants in its effort to develop a fledging startup ecosystem. While most work goes into including compulsory entrepreneurship courses to student curricula and vice chancellors delivering frequent harangues on the importance of innovation and creative thinking, no other university has a comprehensively laid out plan that actually works, until now. “This is naturally a very difficult thing to do. Most people either don’t try or give up in the process,” says Munasinghe. State universities are notorious for endless bureaucracy bottlenecks, frequent student unrest, uninspiring academia and flailing infrastructure. These situations are frustrating and particularly take a toll on industrious professors and zealous students. The University of Moratuwa is also not immune from such cases. “We have a lot of red tape in the system. Even that one percent who wants to go beyond the line gets discouraged. I have faced a lot of hard times. It is disheartening at times,” says Munasinghe. “Some even ask why universities should foster a company. Even that kind of obvious questions are asked.” Universities are considered hotbeds for innovation and experimentation. But, this is rarely the case. Some critique that state universities today have denigrated to mere teaching sweatshops. This is unsurprising in the advent of a perennial resource constraint towards higher education in the country. Scant finance debilitates upgrading laboratory equipment and keeps out promising scholars from joining academia in the face of pitiful salary schemes. The reverberation of this ill effect is felt more acutely at technology-focused universities like Moratuwa. “There were lot academics in the past who wanted to do research, but didn’t have the luxury to do it because we didn’t have the funds,” says Munasinghe. “The government’s mandate was to maintain the status quo; teach and graduate students.” Munasinghe sometime still feels like he is swimming upstream. “Every step I took has been going forward. Maybe I have not been fast enough,” he says. “If I was in a developed country, I could have done better.” But, he feels an optimism more than ever of the University of Moratuwa’s ability to be in the constellation of the world’s leading technology universities. He also believes that the University could show a sense of direction and example for other state universities. “If there is hope at all, it is at Moratuwa obviously,” he says. January 2018 | Echelon.lk 21
INVESTOR’S GUIDE
T U M B L I N G C O R P O R AT E P R O F I T S A N D B O N D Y I E L D S H AV E S PA R K E D A F R A N T I C S E A R C H F O R S A F E H E AV E N S
22 Echelon.lk | January 2018
SHOULD INVESTMENT F U N D A M E N TA L S B E C A S T ASIDE NOW? S E R I O U S E Q U I T Y P O R T F O L I O M A N A G E R S are a consummate bunch, as they should be. Stock prices are primarily impacted by views about future profitability; and many things – including interest rates, consumer spending and extreme weather – can impact future profitability. For these reasons, asset allocation in 2018 is about to become trickier. A rebound in corporate profits – hit by the double whammy of high consumption taxes and extreme weather last year – is forecast for 2018. However, consumption taxes and extreme weather have accentuated the cyclical nature of company profits in Sri Lanka. It’s not clear if these will impact earnings in 2018 as they have in the last two years. (See info graphic) In a key piece of the Investor’s Guide 2018, the team at Frontier Research discusses another cycle: the political one. They are forecasting that the approaching elections, the lead up to which commences in late 2018 when the budget proposals are presented, will commence a reversal of fiscal consolidation. Portfolio managers must keep these two cycles in the reckoning.
CYC L I CAL E ARNINGS Quarterly earnings for the total market 80
74 . 8
Earnings (Rs bn)
70
65
60 50
75.8
Mar’15
Jun’15
Sept’15 2015
5 3 .7
49.8
48.2
46.5
40
60
60.2
55.6
5 0.1
Dec’15
Mar’16
Jun’16
Sept’16 2016
Dec’16
Mar’17
Jun’17
Sept’17
2017
Source: Acuity Stockbrokers
January 2018 | Echelon.lk 23
INVESTOR’S GUIDE 2018 | ECONOMIC TRENDS
TOO LATE
Frontier Research Founder and Chief Executive Amal Sanderatne
Frontier Research Product Head Trisha Peries
The 2018 budget was the best in recent memory for its direction and reforms. However, it’s not good enough to make a serious impact, says Frontier Research
24 Echelon.lk | January 2018
Frontier Research Product Head Travis Gomez
Frontier Research Product Lead Thilina Panduwawala
FOR
REFORMS? January 2018 | Echelon.lk 25
INVESTOR’S GUIDE 2018 | ECONOMIC TRENDS
FTER TWO YEARS OF UNCERTAINTY AND LOW GROWTH, SRI LANKA’S ECONOMY IS E XPECTED TO HAVE A BETTER RUN IN 2018 AND BEYOND, DRIVEN BY CONSUMER DEMAND, INCREASING GOVERNMENT SPENDING AND A PICK-UP IN EXPORTS WITH GSP PLUS TRADE CONCESSIONS TO THE EU TAKING E F F E C T, A C C O R D I N G TO FRONTIER RESEARCH. 26 Echelon.lk | January 2018
Amal Sanderatne
Around Rs600 billion of the government’s domestic debt is expected to mature during 2018, exerting pressure on interest rates. Inflation which peaked at record highs in 2017 doesn’t show signs of easing either. However, Frontier Research believes these will not ‘shock’ the economy. On the positive side, FDI will recover after declining over the last two years and fiscal performance is improving. Frontier Research says the 2018 budget is the best in recent memory. However, the budget comes two years too late, it argues. Debt repayment obligations, national elections and eroding political capital will make it difficult for the government to push through its reforms agenda. Frontier Research’s Founder and Chief Executive Amal Sanderatne, product heads Travis Gomez and Trisha Peries,
and Product Lead Thilina Panduwawala took part in a roundtable discussion to explain the underlying trends in the economy, the impact of the budget, and asset allocations for 2018 and beyond. Excerpts from the discussion are as follows: How would you describe 2017 and what’s the outlook for 2018? Trisha Peries: There were several positive trends emerging in 2017 in terms of fiscal and monetary policy, and exchange rate management. The Central Bank governor assures there will be no sugar-highs and that credit growth is controlled. The Central Bank is maintaining flexibility, giving the market space to determine the exchange rate.
January 2018 | Echelon.lk 27
INVESTOR’S GUIDE 2018 | ECONOMIC TRENDS
The positive effect of this is that foreign exchange reserves have grown to over $7 billion during the year from about $5.5 billion at the beginning of 2017. The fiscal performance is improving, with promising revenue and expenditure numbers. According to fiscal data available for the first eight months of 2017, the government seems to be on track with its fiscal consolidation goal. Heading into 2018, interest rates are expected to ease. In Sri Lanka, we experience up-down cycles in terms of interest rates. Since 2006, Sri Lanka has been through two up-down cycles, and going into 2018, we believe we’re in the downward leg of a third such cycle. So interest rates will ease during the first half of the year, but there will be pressure for rates to rise as domestic debt repayment pressure builds up in the second half. Around Rs600 billion of the government’s domestic debt is expected to mature during the year, most of this in the second half. We expect interest rates to continue to move upwards in 2019 as well as on debt commitments, and because of increasing government handouts ahead of national elections. On the other hand, we expect the exchange rate will continue to be more market determined. We don’t expect any shocks, but could see 3-6% annualised depreciation of the rupee against the US dollar within the next two years. Consumer demand has been sluggish over the last two years due to monetary policy tightening, tax increases and reducing disposable incomes. However, we believe consumer demand will improve in 2018. Business sentiment has been low, and this is reflected in corporate earnings, but we’ll see a pick-up this year. This positive trend will continue into 2019, with the budget expected to give a further boost before the presidential and parliamentary elections. A rise in handouts before the elections will increase consumer spending and contribute to overall growth. What about economic growth? What’s your outlook for 2018? Peries: At Frontier Research, we don’t really treat Gross Domestic Product (GDP) as a useful economic indicator, because it does not represent what businesses do. We believe that companies don’t rely on GDP forecasts when
28 Echelon.lk | January 2018
Travis Gomez
they plan strategies. We rather focus on consumer demand because that’s what businesses want to know: it’s a better indicator than GDP growth. We tell our clients that GDP growth rates can be volatile and fairly inaccurate in terms of capturing the dynamics of the market. Consumer demand is a better indicator. The economy will have a better run in 2018 and beyond, driven mainly by consumer demand, increasing government spending and a pick-up in exports with GSP Plus trade concessions to the EU taking effect. The main driver will be household consumption, which was low in 2017.
So, you don’t have a forecast for economic growth? Peries: We do, but we rarely share it with our clients because, in our opinion, this is not a very useful indicator. Our clients are more concerned about business growth and where it will come from: the consumer. There can be problems when GDP is estimated, and when base years are revised, growth rates change significantly. For instance, high growth rates recorded for 2013 and 2014 fell sharply to around 3-4% when the base year was revised to 2010. What’s your view on inflation? Peries: Over the past year, inflation has peaked to record highs on the new index staying at over 7% levels over the past few months. As is well known now, this was driven very much by poor supply side conditions due to droughts experienced and the floods, which caused food inflation to rise sharply. Going into 2018, this trend doesn’t yet seem to show signs of easing, with droughts expected to persist in the beginning of next year as well. Further adding to possible upside pressure on inflation in 2018 are energy pricing reforms that are due to come in March and September. These elevated levels of inflation are particularly concerning given that the central bank is expected to move into an inflation targeting monetary policy framework next year as recommended by the IMF. However, despite the acceleration in headline inflation, core inflation – which excludes volatile items like food, energy and transport – has not followed this rising trend, and is therefore somewhat of a positive in this worrying inflation outlook.
So, our advice right now to investors is to increase equity allocations. So, investors should start increasing equity allocations. Many hold the view that equity should be a long-term investment. Does this hold up in a market like ours? Sanderatne: Our view on equity is a shortterm position. If the stock market performs as we expect and by June 2018 investors have made their money, we will have to make a call on what to do next. The Sri Lankan economy is very cyclical, so fundamentally, asset allocation needs to be dynamic. I know a lot of people believe in this buy-and-hold strategy, but the Sri Lankan dynamic is very different. We believe in timing market cycles and making aggressive calls on asset allocation whenever appropriate. Timing markets requires a high degree of skill, like choosing the right advisors. Given the current economic conditions and interest rates trajectory, we believe the greater opportunity lies in listed equities. We’re not talking about buying and selling, or holding for the long term, but timing the market cycle. In any case, for a market like Sri Lanka, one to two years can be considered the investment holding period, which we often advice because of short market cycles. For instance, our view for 2016/17 was bullish on fixed income and not equity. Back then, we estimated inflation to average 4-5% over five years, which meant that real returns on fixed income investment would be high. At that time, the equities outlook for 2016/17 was dull compared to fixed income, especially because the IMF demanded a narrower budget deficit. There was an expectation that there would be a greater focus on austerity and taxation, and this was expected to negatively impact corporate profits. We believed this was factored into
“From a macroeconomic perspective, the new laws are good, but they’re also too late, so we won’t see significant near-term gains from these.” – Travis Gomez
Interest rates will ease before rising again. What does this mean for money and equity markets? Amal Sanderatne: Our view is that interest rates will ease during the first half of 2018 before increasing, slowly at first, and picking up in 2019. However, it will not be a shock and volatility will be less. There will be a positive story on volatility. At the same time, demand conditions are improving with spending related to the budget in 2019 due to elections. For this reason, we’re more bullish on equities right now than we’ve been for the last one and a half years. We also feel that the market will take time to adjust to the falling interest rate cycle. Not all investors can see what we do. There will be more inflows into the equity market from domestic investors during the first half of 2018. The Colombo Stock Exchange is poised for a strong performance. The equity market here is undervalued compared to most emerging markets, which is why foreign investors are already attracted by cheap valuations. Also, improving consumer demand will translate into better earnings for listed companies. Interest rates rising after the second half of 2018 won’t be a shock to the equity market, either.
January 2018 | Echelon.lk 29
INVESTOR’S GUIDE 2018 | ECONOMIC TRENDS
the equity market in 2016 and would continue into 2017. If our clients took our advice then, they’d now be sitting on substantial capital gains. Some of them have now allocated more into equity based on our current view. There are still those holdings on to long bonds. As interest rates fall this year, they should be looking to cash out. What are the hot stocks to go for? Travis Gomez: We don’t look at individual listed stocks but focus on sectors we can recommend allocations to. One sector with upside potential is banking. Given our view of interest rates weakening during the first half of 2018, a key indicator of banks’ performance, net interest margins, will be under pressure. However, despite the squeeze in margins, we don’t expect to see “a significant decline. Banks can quickly adjust their deposit rates down while keeping lending rates steady, so net interest margins are unlikely to decline sharply. Banks also maintain conservative positions on non-performing loans and their loan books are fairly diversified so risks are spread. Banks will be fairly stable in 2018 and returns will continue to be consistent. Larger banks have been making average return on equity of about 15%, which is quite high compared to most other sectors In terms of valuations, banks are trading at relatively cheap prices. So banks are a good investment to have. It’s the same for non-bank finance companies, their loan books are growing at a similar rate to banks. However, there’s one advantage finance companies have over banks. When interest rates ease, people tend to shift their deposits from banks to finance companies. During the third quarter of 2017, banking sector deposit growth slowed, while finance companies saw a 10% increase. While this shift is a positive for finance com-
panies, there is a worry that their tendency to be overexposed to vehicle leasing and hire purchase compared to banks could lead to some pressures on performance. We’ve already seen their loan impairment provisions increasing over the last few quarters. So, with regard to finance companies, the larger firms are good to look at because their asset bases are growing; it’s the smaller companies that will face some pressure. Property development and real estate is another interesting sector although there are varying opinions about the condominium sector as to whether or not a bubble is forming. However, if you look at the listed companies in this sector, most of them focus on the commercial property space, which has a lot going for it including policy support for investments in BPO and KPO businesses to set up here. Demand for office space is growing, particularly high-quality spaces that conform to international standards. So there is good potential there. Some of the listed companies within this sector have somehow managed to maintain high occupancy levels too, and rental yields have been steadily improving; so that’s another sector to look at. Finally, given the amount of activity that is going on in the construction sector, listed manufacturing companies supplying to this sector can plug in to this construction boom.
“At Frontier Research, we don’t really treat Gross Domestic Product (GDP) as a useful economic indicator, because it does not represent what businesses do.” - Trisha Peries
30 Echelon.lk | January 2018
What’s your view on the condominium market? Is there a bubble? Sanderatne: We don’t have a view on this, not at the moment. We are working on research to help people in real estate asset allocation, but nothing we can reveal right now.
We have mounting debt servicing obligations and FDI has not flown in as expected over the last couple of years. Will this trend continue? Thilina Panduwawala: Sri Lanka needs policy consistency. If policy keeps changing from government to government and within the same Cabinet, FDI will obviously remain at low levels, hovering around $1-1.5 billion a year. FDI has declined over the last two years, but is inching up now. During the first eight months of the year, FDI was around $700 million and the Hambantota Port deal could bring in an additional $300 million. The bottom line is, for FDI to take off, Sri Lanka needs policy consistency. The government is pushing for liberalisation and economic reforms, but there’s opposition to these from even within the government.Not only are investors getting mixed signals but confidence in the system isn’t improving as much as is needed. Sri Lanka has had issues with bureaucratic red tape, bribery and corruption, which must be dealt with by improving processes and transparency that allow implementing agencies assisting investors to work seamlessly across the different ministries and government agencies. The government announced plans in the 2018 budget to set up a single
Trisha Peries
window to attract FDI, which will be linked with over 30 other government institutions and a one-stop-shop at the Registrar of Companies. These are all very encouraging. Improving the ease of doing business is a good short-term measure to improve FDI. However, consistent policy is what will sustain robust long-term FDI growth, because investors will have confidence about the future. That’s what is needed to increase annual FDI from around $1.5 billion now to the $5 billion that the government aspires to. You say FDI has improved slightly in 2017; will this trend continue in 2018?
Panduwawala: That will depend not just on policy consistency, but the government’s ability to communicate a coherent, consistent message. For instance, the 2018 budget proposed liberalising the shipping sector, but the minister in charge of the sector claims he was not consulted and is opposing the move and preventing its passage. Things like this will not attract FDI. We’re not arguing for or against liberalisation here, but it helps if the government speaks in one voice. If Sri Lanka is to be taken seriously, then policy decisions must be well thought out, and, announced and defended in one voice. What’s Frontier Research’s view of the 2018 budget? Panduwawala: The 2018 budget is not bad, but it’s not good enough either. It’s not bad because it’s the best budget in recent memory. The forecasts and expectations are more realistic, especially revenue estimates. We say it’s not good enough because this budget is coming too late. Had the government proposed a budget like this two years ago when public sentiment was also high, it would have been easier to push the reforms agenda and steer the economy closer to where we all want it to be. However, right now, with debt repayment obligations and national elections expected after 2019, the direction and reforms of this budget may be difficult to achieve. The budget also lacks focus. It has 200 proposals that account for only 10% of the expenditure allocations. The government is also challenged when it comes to implementation because state institutions often don’t have the operational capacity. Political capital is another challenge. Many good proposals are opposed not just by parliamentarians, but bureaucrats and trade unions, too. On top of that several proposals of the previous budgets have also not been implemented, which has created a lot of uncertainty. The 2018 budget has direction, but achieving 6-7% GDP growth rate and FDI targets will not be easy because it’s coming too late; it has little space to maneuver. Sanderatne: In a simple sense, if a similar level budget was done at the beginning when this government came in, a lot more could
January 2018 | Echelon.lk 31
INVESTOR’S GUIDE 2018 | ECONOMIC TRENDS
have been achieved. Now, we see too many challenges building up in 2018 and beyond. Had this budget come earlier, the government would have got the momentum going and the country’s actual growth trajectory would have been the goal we’re now talking about. We would have had high growth and high FDI. Sri Lanka would have broken away from the up-down cycles. It’s better late than never, but now with all these challenges, progress is difficult. So, this budget is two years too late. Heading into 2018 we have a new Inland Revenue Act and a Foreign Exchange Act. What can investors expect with these two coming into play? Gomez: The core message that I think the government has been trying to push forward with these acts is to create an environment of transparency and stability in terms of the policy environment. The new Inland Revenue Act is an attempt to introduce transparency into taxation and processes. Definitions and guidelines on corporate tax and taxable profits are very clear, which will make investment and business decision making easier. There is also a shift from granting tax concessions to attracting investment. The new act proposes benefits in the form of capital allowances. There is also an attempt to end the practice of giving tax concessions by guessing which sectors in the economy are doing well. The government is trying to move away from that and from the discretion that is given to the finance minister, replaced now by this very clear system. A positive thing about the 2018 budget is that the government did not deviate from this course. They did not try to change the corporate tax structures of the Inland Revenue Act. The tax concessions were limited to a very few things like renewable energy and dairy. It’s evident that the government is intent on achieving consistency in the taxation policy, which is something that foreign investors want rather than particular benefits to set up industry here. That’s really what they want to see if policies are in place, so they have the confidence that things won’t change dramatically. It’s the same with the new Foreign Exchange Act. There’s a shift in attitude: from a mindset of control to management, from con-
32 Echelon.lk | January 2018
Thilina Panduwawala
straints to facilitating within the systemic framework. This opens many opportunities for Sri Lankan businesses to venture overseas. The new act has increased limits on how much can be invested and where. For example, listed corporates can invest up to $2 million to access international markets to buy stocks and investment bonds, and this helps diversify risks. The act also broadens the inward investment categories for foreign investors. This is an investor-friendly move. Despite the positives, it all comes down to how affectively the Inland Revenue Act and the Foreign Exchange Act are implemented,
whether or not they generate growth, or if they dent the government’s fiscal position or lead to a flight of foreign exchange. From a macroeconomic perspective, the new laws are good, but they’re also too late, so we won’t see significant near-term gains from these. Our short-term forecast won’t change because of them. The impact of these will be long term, and again, a lot depends on implementation. The government is proposing to overhaul the Customs law to improve trade facilitation. How important is this? Gomez: The government seems to have a strong commitment to improving trade despite the opposition. The proposed new Customs law is broadly in line with that. They’re also looking at employment and land reforms. The government is looking at trying to make it easier for firms here to employ foreigners. These initiatives are positive, but very challenging. Panduwawala: There are other reforms on the table, but it requires managing political capital. For instance, the government has expressed an interest in allowing Bank of Ceylon and People’s Bank to list to raise equity capital. Trade unions are likely to oppose this, and if not managed properly, it could lead to strikes and political fallout. Dealing with corruption and investigating the previous regime has political risks, too. Sri Lanka has agreed with the IMF to change the way fuel and electricity prices are determined here, but with elections in 2020, these reforms will have a negative political impact. So 2018 and beyond, the government is beset by political complications.
Gomez: China’s ‘One Belt, One Road’ initiative and the fact that it’s increasingly looking for qualitative investment opportunities offshore should be opportunities for Sri Lanka. China is also rebalancing its economy for more consumption-led growth. In this regard, a free trade agreement with China will open opportunities for Sri Lanka, provided businesses are competitive to export there. Another big opportunity is from Chinese tourists. Arrivals from Western Europe have been growing slowly each year. We’re seeing faster growth from East Asia and China in particular.
“There are other reforms on the table, but it requires managing political capital. In 2018 and beyond, the government is beset by political complications.” - Thilina Panduwawala
Gomez: That’s why we say the reforms are also too late, especially after the government has busted a lot of political capital with the bond scandal. Your projections are based on the parliamentary elections due in 2020. What about the local government elections in 2018? Sanderatne: In 2018, we don’t envisage much. Our base case on the political side is that the government will increase spending and look to build up some credibility leading to the 2020 elections. We are asking investors to look forward to that. We want people to realise that 2019 will be far more definite in terms of the political economy. Consumer demand will surge and government spending will increase. It will be a good year for businesses and the economy. Consumer demand will be good in 2018, but it will be much better in 2019. What about the reforms?
Panduwawala: Fiscal consolidation may be eased to an extent heading into the elections to shore up electoral support amid the political backlash to certain reforms. The opportunities on the reforms sides will depend overall on how the government manages its now-limited political capital. There are other opportunities, too. On the FDI side, we have the Chinese investment in Port City, which will also attract other investments, and FTAs with a number of countries in the pipeline.
Panduwawala: On the risk side, there are global risks that could materialise. On one side, there is the global monetary policy carried out by the US Fed and shrinking balance sheets as other central banks fall in line with Fed policy. Over time, that will have an impact on how markets behave. However, for the moment, we don’t expect any global shocks. Global oil prices are increasing. This will have two outcomes for Sri Lanka. First, remittances from the Middle East will stabilise or improve. Second, the import cost will rise, so there won’t be much of a shock. Another risk is the rise in ethnic tension. If this happens, it will considerably erode the government’s political capital and dampen foreign investor sentiments.
January 2018 | Echelon.lk 33
INVESTOR’S GUIDE 2018 | BRANDED CONTENT
Gearing up for an optimistic 2018, the Colombo Stock Exchange is on an ambitious drive to transform
Strategy In Action
Colombo Stock Exchange accelerates steps to
Transform P
eaks and troughs are nuances of any market the world over. Closely linked and influenced by geopolitical and economic implications, markets often have a story to reveal. Understanding the dynamics and forging ahead with game-changing new initiatives is what will take Colombo’s stock market to the next level of competitiveness, both locally and internationally. The Colombo Stock Exchange team’s mission is to usher in a promising 2018, inspired by the trends on Wall Street and other markets across the world. Embarking on a transformation has been the cornerstone in driving the initiatives taken by the management of the Colombo Stock Exchange (CSE), as the bourse’s long-term growth potential depends on its ability to attract new companies, infuse liquidity and diversify its product range. Several initiatives in areas of market development, risk management, market infrastructure, market regulations and human resources have been already initiated. CSE Chairman Ray Abeywardane and Chief Executive Officer Rajeeva Bandaranaike spoke to Echelon about their plans to transform the exchange.
34 Echelon.lk | January 2018
CSE Chairman Ray Abeywardane
“The declining trend in indices over the last two years was reversed, with both indices moving into positive territory.� Ray Abeywardane January 2018 | Echelon.lk 35
Chief Executive Rajeeva Bandaranaike
Excerpts from the interview are as follows:
“Capital markets globally position themselves as important economic centers. Sri Lanka is no different.” Rajeeva Bandaranaike 36 Echelon.lk | January 2018
Sri Lanka’s stock market has seen some exciting times and also had its fair share of lows, post-war; 2017 has been a year of mixed sentiments. What are your views on this? Ray Abeywardane: There was a lot of hype and expectations soon after the war; everyone expected and believed the landscape would change and sustain. So, the Bull Run in 2011/12 strongly reflected expectations of accelerated growth. In 2017, we had a comparatively better year. Daily average volumes increased by over Rs200 million per day to Rs930 million per day on average. The declining trend in indices over the last two years was reversed, with both indices moving into positive territory. Foreign investment hit an all-time high, with foreign purchases over Rs110 billion, the highest in any given year. Net foreign inflows were in excess of Rs39 billion when both the primary and secondary market inflows are considered. To offer some regional perspective, markets like Korea, Vietnam and India are doing exceptionally well. In terms of daily turnover, approximately, Vietnam does around $80 million, while Malaysia is at $200 billion and Singapore around $800 billion. We are at $6 million. True, we are a smaller market and economy in comparison, but we believe we have the potential to grow much more, and we are aiming at doubling this figure to over $12 million over the next year. We have the vision and the strategies to grow our size and volumes.
What do you think we as an exchange need to get right if we are to be as competitive and attractive as other exchanges in the region? Abeywardane: The Colombo Stock Exchange’s vision is to play a competitive role and be among leading regional markets. CSE developed a solid infrastructure well ahead of others in the region. In
We are fully committed to facilitating the important role of channeling savings to investment. fact, we were the first in the South Asian region to implement a Central Depository System. However, market size and inadequate liquidity restrained CSE from offering new products and achieving market growth. Currently, we are aligned in the right direction with the setting up of the Financial City, which serves as a catalyst to position the CSE as a financial services center. Another advantage is our geographic positioning, as there aren’t any other financial centers within the region. As an initial step, we need to increase market capitalisation and liquidity, and diversify our product portfolio. There is limited scope for growth or competitiveness if we remain as a single equity market while others speed up on multiple tracks. We need to work on certain drawbacks, even though we have adequate infrastructure, knowledge and passion for what we do. The CSE was formed in 1985, and it’s now time to change the way we have been doing things. We need to move ahead with the times, and leverage the learnings and advancements happening globally. Having been in this industry for the last 30 years, I have immense attachment and passion for the equity market, and am keen to see the CSE becoming an outperforming market like others.
Is market size a constraint? How can this can be addressed? Abeywardane: Yes, indeed. Market size is our fundamental problem. We need to increase market capitalisation. Listing state-owned enterprises and attracting large private sector companies will improve the size of our market, and also impact market liquidity favourably. If we are able to increase the size, then we will be able to attract more institutional funds. Second, our goal is to get ourselves into the MSCI Emerging Markets Index. This is important for us to attract foreign inflows. Recently, the Pakistan market was elevated from frontier to emerging market status. I believe we too can aspire for this if we implement our planned strategies.
What do you think is holding the CSE back from advancements?
Abeywardane: We have a well-defined, ambitious action plan based on a strategic plan recommended by Mc Kinsey and Co. But for this to work, all stakeholders need to come together to implement it. People keep asking why we cannot develop our stock market like those in other countries. But, the CSE cannot do this journey on its own. We have studied how others have developed their capital markets. We can learn from their experiences. Other developed stock exchanges have come forward to assist us. We believe we have the skills, the knowledge and the capability to do it. But we need support. We need an enabling environment and we all need to move in one direction. We need to form a high-level multi-stakeholder committee consisting of the CSE, regulators like the SEC and CBSL, the government, investors, market intermediaries, and listed companies. We need this collaborative effort by all stakeholders to drive these initiatives to successful completion. Such an apex committee can have a defined time period with a specific mandate for market development to clear bottlenecks and get things moving.
What will be immediate launches in 2018? Abeywardane: On the market development side, we are looking at launching a multi-currency board. The new Foreign Exchange Act is the boost we needed. We are hoping to launch it during 1Q of 2018. Additionally, we will also launch an SME Board to support the growing small and medium-sized enterprises sector. These are the two key initiatives we plan to implement during the 1st quarter of 2018. We are continuing our foreign and local investor promotion activities. In 2018, we have planned road shows in Singapore and London, as these are two longstanding investor destinations for our market. Locally, we will continue our very successful regional investor forums in principal towns and the weekly seminars conducted by the CSE branch network. We do these in partnership with the SEC and stockbrokers. On the risk management side, the regulator introduced minimum capital requirements for member firms and moved to risk based-capital adequacy. We plan on implementing a Delivery vs Payment (DVP) system for the market. This has January 2018 | Echelon.lk 37
We need this collaborative effort by all stakeholders to drive these initiatives to successful completion. been a long time coming, but will finally be done during the course of 2018. The market can expect a few new products like stock borrowing and lending with DVP. We are quite optimistic here.
Can you elaborate on CSE’s plans to launch a multi-currency board? Abeywardane: The plan is to provide a platform for foreign issuers and local companies to raise equity and debt capital in foreign currency. In respect of foreign companies, we are looking at dual listings. The board will be open only to those who are permitted to invest in foreign currency. We are targeting Maldivian and Chinese companies, and encourage firms in India, Pakistan and Bangladesh to capitalise on the strong relationship we share. We are also targeting local companies, listed and unlisted, to make use of this platform to raise equity and debt capital in foreign currency. We are already developing the necessary technology platform for this and are in the process of getting regulatory approvals.
Are there any plans to attract a younger generation of investors and expand the market base? Abeywardane: We need to work on them from a young age. We are working towards introducing ‘Investing in Markets’ as a subject for Advanced Levels, focusing on stock markets and the benefits of investing. In countries like Thailand, children are taught about investing in equity markets from a very young age. For example, there is educational material for children of all ages developed by the Thailand Stock Exchange. This is something we could do here as well. We also conduct over 500 seminars per year to create awareness and expand the domestic investor base. Numerous workshops were conducted at several principal towns and in the outskirts of Colombo. We have held these investor forums in areas like Negombo, Galle, Jaffna, Colombo and Kandy, with a commitment to increase investor awareness.
There is a noticeable increase in foreign activity, indicating that international investors have identified 38 Echelon.lk | January 2018
opportunities in Sri Lankan stocks. Has this impacted the number of domestic investors? Abeywardane: We had over $100 billion in foreign inflows. However, we did not see the same kind of enthusiasm among the local investor community. Local institutions and retailers are not as active as they ought to be. It’s a pity, as foreigners have been the first movers, and they will benefit. We also need to increase local retail investor penetration. I think many people are not attracted to the market as they don’t understand the market dynamics. You need to understand the risk-reward principle. Another reason is the high interest rates that provide a stress-free sleep. People feel it’s safer to invest in fixed income instruments because the returns are fixed and it’s perceived as less riskier. Investing in equities is for the long term, and that’s what many don’t understand. What small scale or individual investors should do is look at unit trusts. This is fairly common in India, and a significant number of people have invested in the equity market through unit trusts. This is an ideal entry point for individuals. We need to make unit trusts to be more accessible and serve as a suitable vehicle for those with funds less than Rs100, 000 to gain exposure to equity markets. They can gradually come directly to equity markets thereafter.
Individual investors are more focused on short-term gains. Why is this? Abeywardane: People are used to short-term investments and gains, primarily due to high interest rates. Domestic investors prefer relatively or entirely risk-free investments, generating higher returns. If you look at other countries with lower interest rates, within the range of 1-2%, investors would turn towards equity markets, generating around 5-6% returns. Risk takers consider it an ideal investment. The stock market is for long-term investors looking at a 5-10 year horizon. In fact, long-term funds are essential to stabilise the market. Sri Lanka lacks retirement plans where a part of your money is invested in the stock market. In the US, pension funds are huge investors in the stock market, simply because the contributor has a say in where the funds are being invested. We have engaged local institutional investors like pension funds, insurance funds and state banks to invest in the stock
market, as it is a suitable time to enter the market. There are fundamentally good stocks to invest in. Policymakers need to address these. For example, the management of these funds can be outsourced to professional fund managers who can decide where to invest, which will be evaluated on an annual basis with pre-defined investment targets. When professional fund managers are active, there will be confidence.
What plans do you have to increase the number of listings in the future? Abeywardane: We are engaging the government to list stateowned enterprises. This will be a win-win for all stakeholders. It will be a partial divestiture, only while the government retains control of the enterprise. Funds for government shares for employees of those institutions, investment opportunities, for the institution itself giving them the freedom to reach out to capital markets to raise equity and debt capital, and these listings will help deepen the stock market. We are continuously engaging companies in the private sector. We conduct workshops for family owned businesses stating the benefits of listing. We will continue to hold a series of such engagements with prospective companies.
Can you speak about how a demutualised exchange in 2018 will advance the CSE’s operations within the capital market? Rajeeva Bandaranaike: Demutualisation would bring about a separation of ownership rights from trading rights of brokers. Presently, the exchange is perceived to be the domain of stockbrokers, although in reality, it may not be so. Demutualisation will therefore dispel this notion. Once demutualised, the exchange would operate as a more independent company on commercial terms and be listed. What it will mean to market users is that the exchange will represent all stakeholders and not be skewed towards one stakeholder group. The original 15 member firms of the CSE, who are members as at the date of demutualisation, will be allocated shares in the demutualised exchange. The Board composition will change. The brokers will form a minority on the Board, unlike now. The majority will be independent directors who would be selected through a nominations committee of the Board. The chairman will be non-executive and independent. Since the exchange will be operated solely on a commercial basis, the regulator will impose certain controls to ensure that the exchange retains its status as a front line regulator and that it does not dilute any its regulatory functions for profit. As far as institutional development is concerned, we have already been working on building an efficient organisation, and you don’t necessarily have to wait for demutualisation to do this. From the Exchange’s perspective, the greatest benefit of demutualisation is that we will be able to shake off the perception that this is a broker-controlled institution and
the CSE will be viewed as a more independent organisation, which will have a favourable impact among all stakeholders, including investors and the government.
Expansion of the market through growth could also result in a more complex market. How do you prepare and manage this process to create a win-win? Bandaranaike: Markets are becoming more complex. Over the years, we have built resources within the exchange. We have the requisite skills, knowledge and capabilities. But, we also need to invest in emerging disruptive technologies that are challenging the status quo. We cannot rely on traditional technology and a plain vanilla equity product any longer. Otherwise, we will become irrelevant. Sri Lanka is moving to a more relaxed investment regime and we will face competition on our home turf. We have to diversify our product offering and offer liquidity in the market. Demutualisation will push us to become lean and generate returns for shareholders. We are already actively looking at cloud hosting solutions and blockchain technology to trim costs, as well as mobile applications with face recognition account openings and mobile-based trading capabilities for stockbrokers. We are also looking to improve our post-trade processing efficiencies to bring about a shorter settlement cycle. So, we are responding proactively to these challenges, but we cannot do this alone. Stakeholder and regulatory support is key.
How can the capital market contribute to the larger picture in terms of national economic growth and development? Bandaranaike: Capital markets globally position themselves as an important economic center. Sri Lanka is no different. We have established infrastructure and a name built globally over 30 years, and we must start leveraging this. The government requires massive capital, both debt and equity, and state-owned institutions must reach out to capital markets. We have access to a wide investor base globally and the capability to rapidly scale this up to required levels. Capital markets perform two key functions: price discovery and capital formation. Second, it provides wealth creation for investors as a long-term investment instrument by investing their savings. State-owned institutions must use the capital market for their capital requirements and not burden the government. When a higher growth phase in the economy begins, corporates will soon find that bank financing or internally generated funding cannot fulfill their capital requirements and they must reach out to the capital market to fund their requirements. We are fully committed to maintaining a fair, transparent and orderly market for the secondary trading of securities and facilitating the important role of channeling savings to investment. January 2018 | Echelon.lk 39
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INVESTOR’S GUIDE 2018 | MODEL PORTFOLIOS
TWO MODEL STOCK PORTFOLIOS GAIN IN 2017
THREE MODEL PORTFOLIOS BUILT FOR ECHELON BY TOP FUND MANAGERS HAD TWO WINNERS OUTPERFORMING THE MARKET By Devan Daniel
DISCLAIMER: This story is not meant to represent advice or suggest transactions in securities referred to. It is not a substitute for the exercise of independent judgment, and readers should consult independent investment advisers prior to making investments. Neither Echelon nor the investment funds mentioned in this story accept any liability whatsoever for any loss arising from the use of the information presented here.
ISTED EQUITIES SEEMED to reverse the 15% decline of the previous two years, gaining 3% during the year ending 30 November 2017. The market was weighed down by policy uncertainty, mute business confidence and low consumer spending despite encouraging foreign inflows in search of attractive valuations. The All Share Index (ASPI) gained 2.74% during the reference period, and two of the model portfolios returned 10.5% and 6.3%, while the third gave a negative 7% return. Fund managers are restricted from buying and selling stocks during the year. The rules of this exercise also prevent them from maneuvering funds to any other income assets for better returns as they would normally do for portfolios they manage in the real world. Only year-end allocations were allowed. Four years ago, three top fund managers built hypothetical stock portfolios valued at Rs10 million each for Echelon’s January 2013 edition in an exercise to understand how long-term portfolio investments worked. Ramesh Schaffter of Janashakthi Insurance, Sumith Perera of Guardian Acuity Asset Management and Kanchana Karannagoda of Ceybank Asset Management manage these model portfolios. By end-2017, the Rs30 million combined portfolio has grown to Rs45 million, gaining Rs1.5 billion from last year. We take a look at how each portfolio performed and the present reallocated portfolios, which will be reviewed next year.
January 2018 | Echelon.lk 41
INVESTOR’S GUIDE 2018 | MODEL PORTFOLIOS
SUMITH PERERA
2 0 1 7 WA S A YEAR FOR SETTING THE P L AT F O R M
Opening Value 30-11-2016 (Rs) Closing Value 30-11-2017 (Rs) Portfolio Gain ASPI Gain
14.5 M 16 M 11% 3%
Portfolio’s 4-Year Annualised Return ASPI’s 4-Year Annualised Return
13% 2%
Portfolio Performance - 2017
Reallocated Portfolio - 2018
Stock
Stock
Allocation Share price gain 30%
“ 2 0 1 7 H A S B E E N A M I X E D year with the stage being set for structural changes in the economy, and thereby markets. We had a positive return on ASPI of 2.74%. When we look at the negative performance of the previous two years, it seems reasonably good, but I don’t think anyone can be happy with an ASPI return of 2.74%. My model portfolio returned 10.5%, which is commendable given the dynamics that shaped the overall market performance. The ASPI performance was largely influenced by heavy foreign inflows both to the bond and
42 Echelon.lk | January 2018
equity markets, so it’s been a marginally positive year ending 30 November 2017. As an equity investor looking at the long-term perspective since we started this exercise in 2014, the ASPI has given a CAGR return of about 2.31%, but my model portfolio yielded a return of 12.6%, outperforming the ASPI by about 10.3%. The companies in this portfolio enjoy a combination of strong fundamentals, businesses exposed to growth sectors in the economy or they’re attractively priced with good upside potential. However, overall economic progress has been slow, and this is reflected in how the overall market has performed. Low consumer demand and rising inflation have impacted earnings, resulting in domestic investor sentiment continuing to be weak. However, foreign investment inflows were encouraging because global investors were more risk-on
Hatton National Bank (Non-voting)
Sampath Bank 12%
12%
8% Hatton National Bank (Non-voting)
Nations Trust Bank
12% -3%
Softlogic Holdings
Cargills
10% 25%
Dialog
Ceylon Guardian Investment Trust has expertise in investment management and provides investment solutions for its clientele in varying asset classes. Head of Portfolio Management Sumith Perera discusses the performance of his model portfolio and reasons for reallocation.
Allocation
10% -3%
Access Engineering
Central Finance 10%
10%
8%
Hemas Holdings
6%
Central Finance Cargills
-1%
Sampath Bank
-32%
People’s Leasing and Finance
8%
32%
Aitken Spence Hotel Holdings
8%
Chevron Lanka Lubricants
8%
Access Engineering
8%
8%
Aitken Spence Hotel Holdings
-5% 6% 17% 6%
Melstacorp
6%
Hayleys Fabric
6%
10%
Dialog
10%
People’s Leasing & Finance
10%
-4% -5%
Melstacorp
8%
8%
Inclusions: Nations Trust Bank, Chevron Lanka Lubricants. Exclusions: Softlogic Holdings, Hemas Holdings, Hayleys Fabric
and attracted by cheap valuations. I expect foreign inflows to continue into 2018, with global trade improving as well.” Portfolio performance “Aitken Spence Hotels was the biggest decline. The local hotel business has experienced intense competition from the informal sector,
which exerted pressure on room and occupancy rates on star-class properties. The company’s properties in the Maldives, India and the Middle East did not perform up to expectations either. I continue to hold this stock in the portfolio for 2018. Although challenges may persist, in terms of valuations, I see upside opportunity as
Sumith Perera Head of Portfolio Management at Ceylon Guardian Investment Trust
the company trades at a discount to replacement cost. I don’t expect high returns in 2018, but over the next three to five years, the company will yield high returns on the strength of its hotel properties and locations, and growth in tourism. Softlogic Holding’s businesses are exposed to the right growth sectors like retail and healthcare, but weak consumer demand and regulatory pricing on private healthcare proved challenging. The group leverage continues to increase to uncomfortable levels, which could be challenging. This will eat into bottom-lines
and shareholder returns, which is why I’ve exited the position for 2018. If Softlogic can raise capital and divest its non-core businesses, it could place the group on a better footing. Despite low consumer demand and taxation eroding disposable incomes, Cargills’ share price returned nearly 17%. The company too has gearing concerns, but with its recent disposal of property, we witnessed a significant reduction in its borrowings. This reinforced my positive view of the company, as it was focused on its core businesses. I feel
the stock has much more upside potential. Sampath Bank retuned 30% largely because of the bank’s aggressive branch expansion strategy a few years ago allowing it to grow its loan book by 18% during the year, faster than any of its peers. It’s ROE at 19% is impressive. The stock is trading at book value, which is very attractive, and hence remains in my portfolio. Hemas Holdings has returned 31%. We’ve actually caught the tail-end of the performance because this was a share priced at Rs30 levels a while back, now it’s Rs125. I haven’t included the stock in the reallocated portfolio for 2018 as its existing business will probably grow at a slower pace with competition increasing in Bangladesh and more regulation in the healthcare segment. Dialog yielded 25%, which is not surprising given the growing penetration of data in our day-to-day lives. However, with capital intensity of the business, I am cautious of exposure to the company. I’m maintaining my position in People’s Leasing and introducing the allocation of Central Finance. I expect net interest margins to improve because of lower interest rates, but slow growth in vehicle leasing due to high taxes will be something to watch out for. Both finance companies are attractively priced. People’s Leasing is trading close to its book value, whereas historically, the stock has traded at twice book. Central Finance is
trading at a steep discountto-book value, indicative of good upside potential.” Outlook for 2018 “It’s going to be an interesting year. The new Inland Revenue Act will come into force. Some sectors may feel the added tax burden more than others, but more importantly, the act will relieve some of the pressures on the fiscal side, which was much needed. It may be a painful year of adjustments, but there is opportunity to get the economy on a firmer footing. I expect foreign investment flows to continue from last year. The question is whether local investors will become active; this will be a function of interest rates and general confidence in the economy. I’ve included Chevron Lubricants despite declining margins. The company found it challenging to increase prices along with its input base oil prices. Market share fell because of heavy competition. The share price declined steeply during the year. However, the price weakness is an opportunity to invest in the company, which provides a high dividend yield. I’ve picked Nations Trust Bank because of its unique banking model compared to peers. It’s more retail driven and customer centric, engaging in cross selling across their customer base. They have good focus on SMEs and salaried employees. The share is trading close to book value with a good upside.
January 2018 | Echelon.lk 43
INVESTOR’S GUIDE 2018 | MODEL PORTFOLIOS
KANCHANA KARANNAGODA
Ceybank Asset Management Limited manages five open-ended unit trust funds, two of which are directly in the stock market – Ceybank Unit Trust and Ceybank Century Growth Fund. The model portfolio is managed by the firm’s fund manager Kanchana Karannagoda.
EQUITIES COULD R A L LY I N 2 0 1 8
“ 2 0 1 7 W I T N E S S E D a degree of volatility. List-
Kanchana Karannagoda Fund Manager of Ceybank Asset Management Limited
44 Echelon.lk | January 2018
ed equities returned 2.74% during the year ending 30 November 2017, and my model portfolio was able to return 6.3%. Compared to the market’s four years annualised return of 2.44%, the portfolio achieved 13.3%. The year began on a negative note. Investor sentiment was low due to policy uncertainty, the absence of an investor-friendly budget for the year and interest rates rising after the Central Bank tightened monetary policy rates following the US Fed hike. Stocks rebounded in the second quarter as foreign investments improved as a result of the reallocation of funds to emerging markets with attractive valuations. Institutional investors were also seen consolidating their positions in value counters. It seemed as if they were selling to create an opportunity to buy at lower levels. However, the upward trend couldn’t be sustained because domestic investors weighed in uncertainties in the economy due to the lack of clarity about the 2017 budget—several proposals were not implemented—and the proposed new Inland Revenue Act that was being drafted. Some confidence returned towards the end of the year after the passage of the Inland Revenue Act, which was mostly viewed as being positive. Tokyo Cement was the growth catalyst in the portfolio, gaining 33% in line with the construction boom and capacity expansion through a grinding and bio-mass power plant. ACL Cables was expected to ride the construction boom, but its stock price fell 29%. This was due to rising aluminum and copper prices eroding margins. Fabric maker Teejay Lanka was also impacted by rising raw material prices. The stock declined 15% as the company’s
Opening Value 30-11-2017 (Rs) Closing Value 30-11-2017 (Rs) Portfolio Gain ASPI Gain
15.5 M 16.5 M 6% 3%
Portfolio’s 4-Year Annualised Return ASPI’s 4-Year Annualised Return
13% 2%
Portfolio Performance - 2017
Reallocated Portfolio - 2018
Stock
Stock
Allocation
Access Engineering
10%
Allocation Share price gain -3%
Access Engineering
12% 33%
Tokyo Cement
Tokyo Cement
10%
12% -29%
Textured Jersey
ACL Cables 10% -15% Textured Jersey
5%
HNB (N/V)
8%
JKH
5%
Softlogic Holdings
5%
12% Commercial Bank (N/V)
-3% 8% 10%
HNB (N/V)
Dialog
8%
Lanka IOC
6%
Hemas Holdings
5%
10% Lanka Hospitals
5%
JKH
3%
Softlogic Holdings
5%
Dialog
5%
Lanka IOC
3%
Nations Trust Bank
5%
Hemas Holdings
7%
Singer Sri Lanka Mandatory Offer
-6% 5% -3% 25% -17% 1%
Sampath Bank
13%
8%
Chevron Lubricants
32% 3%
10%
Commercial Bank (N/V)
15% Commercial Bank - Voting
5%
Inclusions: Commercial Bank (Voting), Sampath Bank, Chevron Lanka Lubricants. Exclusions: ACL Cables, Lanka Hospitals, Nations Trust Bank, Singer Sri Lanka
bottom-line took a hit due to a surge in cotton prices. Administrative overheads, capacity expansion and its tax holidays ending contributed to falling earnings. However, Teejay Lanka will benefit from rising demand due to GSP Plus going forward. Hemas Holdings returned 32% backed by heavy
foreign investor interest. The group’s earnings declined towards the latter part of the year, with businesses segments in FMCG, leisure and healthcare impacted by falling consumer demand, intense competition and regulatory price ceilings. Lanka Hospitals attracted considerable interest earlier when
the government announced plans to divest its stake. However, this never materialized, cooling demand for the stock, which declined 6% during the year. Hatton National Bank returned 28% on improving net interest margins and fee incomes, translating into bottom-line growth. This was despite higher trading losses due to increasing swap rates and rising impairment provisioning due to higher volumes. Dialog gave a return of 25%. The telco had a strong financial performance driven by growth in data and broadband earnings, and improved cost efficiency. Lanka Indian Oil Company was impacted by high taxes and the inability to adjust prices due to price controls. The stock returned a negative 17% in 2017, but I’m confident the company will report a strong performance in 2018 when the government introduces a fuel pricing formula in accordance with its commitments to the IMF.” Looking ahead “The 2018 budget proposals announced in November 2017 improved sentiments further. It proposed to list the largest two state banks, and if this happens, the market could rally. The budget was positive overall, but implementation will be challenging. I’m holding on to Hatton National Bank and Commercial Bank because of sound fundamentals and attractive valuations. The Commercial Bank voting
share is trading at a slightly higher premium than the non-voting share. The bank commands a dominating position in the corporate banking segment, which will drive loan growth, while its extensive reach supports deposit mobilization. I’ve included Sampath Bank, which is trading at attractive valuations supported by potential growth in earnings from its rapid branch expansion, strong loan growth through SMEs and mortgage financing, improved cost efficiencies and strong risk management processes. Its ROE at 19.5% is impressive compared to the banking sector average of 13.7%. Chevron Lubricants is in the portfolio despite falling turnover and profits because its dividend yield is above the market at 9-10% and the stock is trading at attractive medium-term valuations. A turnaround is expected in 2018 as it regains competitiveness in the market, with a downward revision of lubricant prices. Access Engineering saw earnings fall due to the sluggish performance of its construction and property segments. However, the construction company will have a better year with several projects to take off in 2018. Dialog will see growth in data and broadband usage after the government removed the 10% levy on internet usage. However, the implementation of the Cellular Tower Levy will have a negative impact on the telco’s bottom-line.”
January 2018 | Echelon.lk 45
INVESTOR’S GUIDE 2018 | MODEL PORTFOLIOS
RAMESH SCHAFFTER
A VICTIM OF P O L I T I CA L INTERFERENCE Ramesh Schaffter Director of Janashakthi Insurance
Janashakthi Insurance has the third-largest market share in general insurance premium and fifth-largest in life insurance in a highly competitive market of 22 players. Ramesh Schaffter, a director of Janashakthi Insurance, is the outlier in this group. He discusses the reasons behind his model portfolio’s bleak performance and reallocation strategy. “ M Y M O D E L P O R T F O L I O gave a negative 7% return in 2017, which underperformed the All Share Price Index by 10%. The portfolio was a victim of political interference like ad hoc taxes, restrictions and price controls. The market promised much, but did not deliver. Expectations were high that the economy would pick up after two years of uncertainty. Political issues have affected business sentiment. Being a coalition government, budgets gave mixed signals and the bond scandal dampened sentiment and the market drifted. During the year, interest rates moved up before settling at current levels. Various policy measures impacted businesses negatively; for example, non-bank finance companies, which had a heavy weightage in my portfolio, were impacted by loan-toasset ratios that stifled credit growth along with the increase in motor vehicle duties. The sector also experienced increasing non-performing loans. The economy was recovering from the 2016 floods when floods hit us again in 2017. The market was affected by John Keells Holdings, which is the single major stock in the exchange. While many of its businesses are doing well, there is some doubt about the group’s major exposure to the Cinnamon Life mixed development project. A few sectors have done well, but many have been affected adversely by government policy or international market conditions such as rising oil and raw material prices.”
Long overdue corrections “I’ve tended to take a contrarian approach. I could always allocate to
banks and safe stocks, and yes, some of them did perform despite difficult market conditions. There was too much uncertainty in 2017, even with regard to the Inland Revenue Act. No business likes uncertainty. It’s better to have bad news with certainty than deal with the uncertainty of good news. I believe fundamentals are just one aspect. Many companies are fundamentally sound. But this is just one aspect of valuations. External market conditions—which are completely beyond Sri Lanka’s control— create some instability in the market here because of how global funds decide to invest, or not. Valuations are also impacted by local sentiments: uncertainty, scandals and political instability. Retail investment in the Colombo Stock Exchange has dried up. We see PE multiples for a lot of companies dropping to very low levels. Some companies are valued at below asset value despite making profits. The market is due for a correction. The correction will come. In my portfolio, Nations Trust’s valuation is almost flat. I believe the bank’s major shareholders John Keells Holdings and Central Finance will trim their holdings, which will create liquidity and more interest in the share. I believe, with its track record and profitability, the share has a tremendous upside. I have vested interest in Janashakthi Insurance. It’s consistently churning out profits and has a good dividend yield, but it’s on a low PE multiple and
low price-to-book valuation, so I believe a correction is due. Access Engineering was my big bet for the year and I will continue to hold the stock. Profits have declined, but it’s the only company with liquidity for an investor looking for exposure to any form of large industry. Around 35% of my portfolio was exposed to finance companies. I expected this sector to outperform banks. However, in its attempt to reduce foreign exchange outflows and contain vehicle import growth, the government took measures that negatively impacted finance companies. Floods and low consumer spending also had a negative impact on the microfinance businesses of finance companies. Commercial Credit and Bimputh have considerable exposure to microfinance. Swisstek was affected by global aluminum prices, but the company is a turnaround success story. Despite the fall in share price, Royal Ceramics has performed well. It has a large market share and is growing, and the construction sector is booming, so the stock has good upside potential. Bairaha Foods was a disappointing stock, which I will continue to hold nonetheless. The removal of price controls and import restrictions on chickenfeed could result in a better performance. I’m including Hemas Holdings given its strong performance and growth over the last few years. It’s a good long-term investment.
Opening Value 30-11-2017 (Rs) Closing Value 30-11-2017 (Rs) Portfolio Decline ASPI Gain
13.5 M 12.6 M -7% 3%
Portfolio’s 4-Year Annualised Return ASPI’s 4-Year Annualised Return
6% 2%
Portfolio Performance - 2017
Reallocated Portfolio - 2018
Stock
Stock
Allocation Share price gain
Allocation
1% Nations Trust Bank
Nations Trust Bank
14% Janashakthi Insurance
10% -3%
Access Engineering
Janashakthi Insurance 15% Citizens Development Business Finance
20% Citizens Development Business
15%
-3%
-11%
15%
8% -29%
Hemas Holdings 15%
Bimputh Finance 12% -30% Commercial Credit and Finance Swisstek Ceylon
LB Finance
15% 4%
Access Engineering
-6% -2%
Royal Ceramics
Royal Ceramics 11% Bairaha Foods
6%
-16%
10%
10%
10%
Bairaha Foods
6%
Swisstek Ceylon
4%
Inclusions: Hemas Holdings, LB Finance Exclusions: Bimputh Finance, Commercial Credit and Finance
LB Finance is another inclusion. It’s managed well. Growth and profitability have been extremely good, but the share’s valuation is unjustifiably low. It’s difficult to make decisions based on fundamentals if the goal posts keep shifting. Businesses don’t mind paying more taxes as long as there is policy consistency. I hope this is the case for 2018 then we will see more invest-
ments flow into the market. The future looks bright. The 2018 budget was a good one. The governor of the Central Bank also brings stability to the financial system and monetary policy. I believe interest rates will be steady and fiscal management will be better. The Inland Revenue Act will considerably improve the business environment and build the economy. January 2018 | Echelon.lk 47
INVESTOR’S GUIDE 2018 | STOCK OPPORTUNITIES
TWO UNPRICED STOCK OPPORTUNITIES: A SMALL BANK AND A GOOD GOVERNANCE PREMIUM WE ASKED TWO STOCKBROKER CHIEF EXECUTIVES TO IDENTIFY A TREND THEY THINK IS NOT YET PRICED IN
ARKETS NEVER STRIKE EQUILIBRIUM. They underperform or overshoot, and when faced with wildly unfamiliar conditions, react with similar unpredictability. In 2018, listed equity investors are heading into unchartered territory. Candor Group Director Ravi Abeysuriya and Asia Securities Chairman Dumith Fernando weighed in on two opportunities, one market-wide and the other a company, they felt weren’t priced in.
January 2018 | Echelon.lk 49
INVESTOR’S GUIDE 2018 | STOCK OPPORTUNITIES
THE LITTLE BANK THAT COULD
Dumith Fernando
DUMITH FERNANDO, CHAIRMAN AT STOCKBROKER ASIA SECURITIES, SPOTS A SMALL BANK AT THE CUSP OF A WAVE
As far as financial indicators are concerned, Sanasa Development Bank (SDB) highlights its high risk appetite. In banking, a conservative business as depositors’ money is used in the business, a high risk appetite is usually frowned on. Sanansa is a small, specialised bank. Unlike commercial banks, it cannot offer checking accounts that can provide other deposit and lending products. Smaller local banks often build a business case by lending to the sub-prime segment: consumers and small businesses. SDB’s strategy has a similar focus. However, the consumer and small business segments have many niches, and SDB’s aggressive growth focuses on niches that other financial institutions aren’t serving, according to stockbrokerage Asia Securities Chairman Dumith Fernando. “Their penetration into areas where others don’t compete, combined with great
50 Echelon.lk | January 2018
Investment Case
80% PERCENTAGE OF BRANCHES OUTSIDE THE WESTERN PROVINCE
6% NET INTEREST MARGIN
6.9% RETURN ON EQUITY (SEP ’17)
15% ASIA SECURITIES’ FORECAST ROE IN THREE YEARS
shareholders and a strong management team, has positioned the bank well.” Despite its relatively small size, at a market capitalisation of Rs5.5 billion, SDB is a stock researched by Asia Securities due to its large public holding and strong growth position. In May 2017, Dutch investment firm FMO and IFC, the private funding arm of the World Bank, invested Rs1.4 billion in Sanasa, a significant development, due to the profile of its new shareholders,
raising the bank’s capital closer to a level required by the new minimum capital rules that will be effective soon. Capitalisation is a challenge for any bank with rapid loan growth. Sanansa, led by lending to small businesses mostly in rural areas, has been growing its loan book by around 20% annually, compared to 15% at large banks. Its net interest margin of 7%, Fernando believes, will decline a notch during the next three years, but even at 6%, it’s
double what large banks are able to achieve. “Its strong small business focus is the principle reason we like the bank. We project loan growth to continue at 20% for three years,” he forecasts. Around 15% of bank credit is to small businesses, but SMEs contribute around half of GDP and account for over 75% of private ventures in the island. Of the island’s cooperative societies, SDB is associated with 600 active ones, which introduce new customers and help establish their creditworthiness. Recent technology upgrades have resulted in leaner branches and staff have been re-trained to take up sales roles. However, its cost-to-income ratio, a key measure of productivity, at 70% suggests that the bank has not yet benefited from the new systems or restructuring. Asia Securities forecasts the ratio will decline to 50% in three years, a competitive level for a bank with high net interest margins and focused on small businesses. High operating and credit costs have impacted the bank’s return on assets, which at 0.8% are below industry levels. Eighty percent of Sanasa’s branches are outside the Western province, compared to the industry’s only 60% of branches outside the province. SDB’s high risk appetite may not suit every portfolio. However, Asia Securities forecasts that earnings will grow 50% in the next financial year, by 40% in the year after and around 25% in the third year, raising return on equity to around 15%.
INDEPENDENT DIRECTORS AND STOCK PRICES By Ravi Abeysuriya
Ravi Abeysuriya
The Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka) released the latest Code of Best Practice on Corporate Governance in December 2017. The Code of 2017 builds on the previous codes to strengthen best practices in governance rele-
January 2018 | Echelon.lk 51
INVESTOR’S GUIDE 2018 | STOCK OPPORTUNITIES
vant to Sri Lanka. Some significant changes from a capital market perspective identified in the Code are board composition, the role of the audit committee, the introduction of a related party transaction committee and expanded corporate reporting. The criteria for identifying the independence of directors have been clearly defined. An annual review has been proposed by the code of the board composition against pre-defined criteria such as skills and knowledge, consideration of being fit and proper, and an increase in the number of independent directors. The role of the audit committee has been enhanced on internal controls and risk reviews. Corporate reporting has been expanded to integrated reporting, where directors and key management personnel are required to make an The change of affirmative declaration directorships in the annual report and share price that they are compliant performance of with the Code of Busicompanies that ness Conduct & Ethics. got into difficulties This code expressively amply demonstrate prohibited “conflict of that stock market interest”, “bribery and corruption”, and actively investors, financial soliciting or demanding analysts and the any form of “entertainfinancial press have ment and gifts”. failed to highlight the Truly, independent lack of independent directors have become directors in these a mandatory element of companies during the new corporate govtheir heydays ernance paradigm. An “independent director” is defined as a director who does not have a material or pecuniary relationship with the company/majority shareholder or related parties, except sitting fees. The composition of boards has dramatically shifted towards independent directors, from 20% to 75%, in companies listed in major stock exchanges internationally. For example, the New York Stock Exchange requires listed companies to have boards with majority independent directors, and audit and compensation committees comprised solely of independent directors. The standard for independence has also become increasingly rigorous over the period. The objective is to commit the firm to a shareholder wealth maximizing strategy, best measured by stock price performance. In this environment, independent directors are more valuable than insiders. Listed companies in Sri Lanka appoint independent board 52 Echelon.lk | January 2018
directors largely based on the close relationship the individuals have with the management or the majority shareholder, and not based on independence, skills and knowledge. Incidents of the government or Central Bank appointing independent directors to listed entities who do not qualify or fit proper criteria were not uncommon in the past. Except for a few insiders, the fact that such directors are appointed and are not truly independent is difficult for analysts to identify and may go unnoticed. An affirmative board announcement to the CSE that a purportedly independent director has “no material relationship with the listed company” – including “as a partner, shareholder or officer of an organization that has a relationship with the company” – may be a solution. The claim here is that poor governance practices, like not having truly independent directors, aren’t reflected early in the share price of Sri Lankan listed companies until it’s revealed by the company itself. Although stock prices are considered the most reliable measure of a firm’s performance, it may not get reflected if the market does not price in the governance aspects as a result of financial analysts and the financial press failing to expose them. The change of directorships and share price performance of companies that got into difficulties such as Touchwood Investments PLC (TWOD) and Central Investments & Finance PLC (CIFL) amply demonstrate that stock market investors, financial analysts and the financial press have failed to highlight the lack of independent directors in these companies during their heydays.
INVESTOR’S GUIDE 2018 | CONSUMER SPEND
CONSUMERS CUT DOWN ON DAILY ESSENTIALS
A sneak peek into consumers’ shopping carts reveals a lot about the direction of the economy
Illustration by: Leyanvi Mirando
By Mithula Guganeshan
Frugal and prudent consumers held their wallets tightly and made conscious efforts to cut down grocery spend throughout last year. They used their limited money mindfully to often purchase daily use products like rice, tea, milk powder etc., while resisting any impulse-based decisions. As the year proceeded, consumers increasingly felt the pinch of soaring food prices and started to reduce quantities of products consumed on a daily basis as well. A broader pattern emerged as lavish spending styles
were replaced with thriftiness. FMCG’s overall growth dropped from 11% in the March quarter of 2016 to 1% in September 2017, according to a retail study administered by Nielsen among 4,500 mom & pop stores spread across the island. The nominal growth of 1% in the FMCG sector was driven by inflation, as volumes dropped. “Government workers received the first tranche of four-year pay hikes in early 2016, boosting sales across sectors in early 2016,” says Sharang Pant, managing director of Nielsen Sri Lanka. January 2018 | Echelon.lk 53
INVESTOR’S GUIDE 2018 | CONSUMER SPEND
S P E N D I N G PAT T E R N People bought fewer food & beverage items as prices spiked Milk powder & milk food drinks
Rice
Impulse items (soft drinks, ice cream)
Spent the same amount & bought fewer items
3%
4%
7%
Reduced the cash spent & bought fewer items
12%
29%
53%
51%
38%
21%
Spent more cash to buy the same items
Note: The Consumer Confidence Index Survey was conducted among 300 individuals from the Western, Central and Southern provinces
Sales volume growth
Price growth
4% 4.3%
4.5% -1.2% -3.2% Q1 17 (Jan-Mar)
Q2 17 (Apr-Jun)
-2.8% Q3 17 (Jul-Sep)
Note: Retail audit administered for all FMCG categories including soft drinks. The study was conducted across 4,500 retail shops spread across the island. Source : Nielsen Sri Lanka
However, the upsurge in consumption couldn’t be sustained for a longer period, even when state workers received their second tranche payments in 2017. Consumers were deprived from spending due to fiscal tightening measures, higher taxes and increasing food prices mainly due to drought-led supply constraints. In November 2017, the consumer price index – the measure of the change in prices of a basket of consumer goods and services purchased by households – was at 7.6%. People started cutting down on the consumption of rice, fruits, vegetables, cooking oils and poultry, according to a Nielsen consumer confidence index survey conducted among 100 people from the Western, Central and Southern provinces. “Even in the food and beverages sector, a majority of consumers have stated that either their spending or their consumption had been affected during this period. Around a third of consumers surveyed mentioned that they reduced spending on essentials like milk powder in September 2017,” says Therica Miyanadeniya, director of the Emerging Verticals and Qualitative Research at Nielsen Sri Lanka. 54 Echelon.lk | January 2018
“In an ideal inflationary situation, consumers shift to smaller pack sizes, but we don’t see it happening in Sri Lanka. The limited portfolio consists of only around 3-4 pack sizes, so consumers are left without much of a choice when there is pressure on prices,” adds Pant. The Central Bank also reported a drop in the average debit card transaction value at stores. Agriculture recorded negative growth of 3.3% during the September 2017 quarter, the lowest since 2010 due to floods and drought. For food companies, failing crops led to supply constraints and rising production costs. Falling margins and a consumption tax (VAT) introduced in 2016 pushed businesses to increase retail prices, which in turn led to shrinking sales. One in three consumers reduced spending on processed food and beverages like coconut milk, dairy products and malted drinks, according to Nielsen. Listed food company Nestlé Lanka has seen a drop in sales of its products like Nestomalt and Milo. Around 60% of consumers surveyed by Nielsen said they had reduced spending on impulse products like fizzy drinks, ice cream and chocolate. A sugar tax of 50 cents per gram has resulted in increasing prices and falling demand. Listed Ceylon Cold Stores, which manufactures ice cream and fizzy drinks, saw profits decline 29% in the September quarter, despite revenue growth from its supermarket chain business, which saw incremental sales at new retail outlets and higher customer footfall. Supermarkets benefitted from growth in basket value driven by rising prices and additional revenue from newly opened stores. Margins were further improved with the removal of deemed VAT, a sales tax that retailers weren’t allowed to pass down to consumers. The economy, weighed down by the agriculture sector, is also challenged by rising public debt obligations, policy uncertainty and higher global commodity prices. The growth potential of businesses will depend on how soon consumers will fill their shopping carts again.
INVESTOR’S GUIDE 2018 | RENEWABLE ENERGY
WHERE THE WIND BLOWS When the country’s power generation sources drain out, investors look elsewhere
Illustration by: Leyanvi Mirando
By Devin Jayasundera
Hydro energy in Sri Lanka is on the verge of being squeezed to the last drop. From being the largest energy source contributing 35% of the generation capacity mix, it is expected to trickle down to around 19% by 2020. Experts point out that hydropower potential in Sri Lanka has already reached its theoretical limit. For energy power plant companies, this offers a serious predicament. With fewer suitable sites to build new hydropower plants, some energy generation firms and investors have already begun venturing beyond our shores to diversify risks and ensure a steady stream of profits for shareholders. The allure of investing in areas like electricity generation lies in its ability to produce reliable returns. Some even call it ‘recession resilient’, given unhinged public demand for utility services like electricity, even in the most unnerving times. But, the Sri Lankan experience of investing in energy generation companies has been January 2018 | Echelon.lk 55
INVESTOR’S GUIDE 2018 | RENEWABLE ENERGY
Changing Trajectory Listed energy and power firms are now seeking to invest overseas given fluctuating weather conditions, the lack of investment opportunities and a more conductive regulatory environment VALLIBEL POWER
VIDULLANKA
PANASIAN POWER
RESUS ENERGY
LANKA ENERGY FUND
NUMBER OF PLANTS
3
9
3
5
10
GENERATING CAPACITY
21.85 MW
21.44 MW
8.55 MW
9.9 MW
42.5 MW
MARKET CAP
Rs5.6 billion
Rs4.1 billion
Rs1.3 billion
Rs1.1 billion
Rs5.8 billion
EXPANSION PLANS
One of the most profitable mini hydro firms has already started exploring potential investments in Nepal, Myanmar, Bhutan and Africa
The company invested $13.5 million on its first overseas hydropower plant, with a generation capacity of 16.5 MW in Uganda
Announced plans to invest Rs400 million to construct two mini hydro plants in Nuwara Eliya
The company worst affected from the yearlong drought divested half of its ownership of PanAsian Power and scrapped its planned biomass project
The new kid on the block, the venture capital firm is one of the few to also invest in thermal power. The company also has a relatively higher regional presence with its investment in Nepal
quite the contrary. CSE-listed power and energy firms are dominated by auto-fuel and LP like retailing firms Lanka IOC and Laugfs Gas, which make up almost 70% of the total market cap in the sector, while the rest consists of five mini-hydro companies. Hydropower has become an increasingly volatile business given the frequent change in weather patterns experienced over the years. This attaches a significant risk. For investors, such a seesawing performance indicates the exact antithesis of the primary motivation to invest in utility services, which is the promise of steady returns. To avoid this case, firms built their plants in different geographical locations in the country to diversify the risk in the case of bad weather. But this too has been limiting, given that suitable sites are concentrated in the central highlands, resulting in server scarcity of locations to set up new hydropower plants. In 2016, the drought made this case more apparent. Due to the lower 56 Echelon.lk | January 2018
rainfall, each listed hydro power generation company recorded a decline in net profit. Cumulative net profits of all companies plunged 30% compared to the previous year. In fact, Resus Energy PLC, controlled by Hemas group, which fully owns six hydropower plants around the country, incurred a loss in its short history. Hydropower generation was Sri Lanka’s major power source from the time electricity became a ubiquitous utility in the country. In 1996, the government relinquished its monopoly in hydropower, allowing the private sector to participate in building mini hydropower plants to boost existing capacity. The Ceylon Electricity Board granting power purchase agreements, which generally extends beyond two decades, ensured a steady stream of revenue. Enticed by this, investing and developing mini hydropower became a lucrative pastime for high-net-worth businessmen and diversified conglomerates in the early years. But, as Sri Lanka neared the full exploitation point of hydropower, the once bullish market is now gasping for its last breath of fresh air. If hydropower is out of the equation as a potential energy investment in the country, wind and solar are perceived as the next big bets. But, there is a hitch. As much as investors are eager to invest in these renewable technologies, oppor-
tunities are scarce within the country, as the infrastructural landscape is yet to mature to accommodate more projects. Among the renewables, wind power is expected to be the major source of power for the country in the future. But currently, the Kalpitiya peninsula, which already harnesses 128 MW, is at its peak because of limits in the grid. When it comes to solar, land acquisition is the major deterrent. It is estimated that 10 acres of unobtrusive flat terrain is required to generate one megawatt of electricity. In April this year, under the ‘Soorya Bala Sangramaya’ programme, the Ceylon Electricity Board issued a worldwide tender for the construction of 60 solar power plants with a capacity of 1 MW each. However, according to sources, the reception for the tender was lackluster, and proposals were submitted only for 30 solar power plants. The limitations for investment in wind and solar, and the hypersensitivity of hydro have made some companies look towards thermal energy. Lanka Energy Fund, a venture capital company that went public recently and is primarily focused on investing in power plant projects, invested in two thermal power plants in Bangladesh, owning a 20% and 33% stake in each. The company’s foray into thermal power had provided a hedge against the fluctuating performance of the large base of hydropower plants in its portfolio. “Thermal power brings a broader degree of stability to our income streams,” says Sumith Arangala, chief of the LVL energy fund. The company’s motivation behind investing in thermal power plants in Bangladesh has been the acute electricity deficit in the country. As a result, the Bangladesh government is far more accommodative towards investment in its power and energy sector. More importantly, this gives the company the flexibility of not depending on just one buyer. “We diversify in terms of buyers as well. So, you mitigate the risk. What if payments don’t arrive? Nothing can be taken for granted,” says Arangala. Investing in power plants in Sri Lanka, especially in the renewable energy frontier, is still less lucrative than in the region. In lieu of this view, Nepal, Bhutan, Bangladesh and East African countries have become sought-after destinations for investment in hydropower. The choice for Nepal is unsurprising. The abundance of glacial water trickling down from the sky, scathing the Himalaya mountain range, has made it a mecca for hydropower investment. Nepal’s hydropower potential is estimated to be 80,000 MW, of which only 700 MW has been exploited. The Lanka Energy Fund has already planned to invest Rs465 mil-
lion on a hydropower plant in Nepal from the funds raised in the IPO. VidulLanka PLC has already started construction of a 6.5 MW hydropower plant worth $13.5 million in Uganda. The overwhelming vision to focus beyond our shores is widely evident given a reading of the annual reports of listed power generation companies. This makes economic sense, but could have ill-intended consequences for the country’s long-term power generation plans. However, non-traditional power and energy sector companies like Aitken Spence, Akbar Brothers and Hirdaramani Group have entered the fray, investing in wind power projects in the country. The dependence on fossil fuel is based on the reasoning that it is the cheapest alternative available, but the question is how long it would serve the purpose, especially when electricity demand keeps escalating exponentially. Further investment in thermal and coal could be argued as being a step back. The progress in technology has made wind and solar power move beyond the periphery from a mere footnote of a feel good fantasy narrative to an actually affordable and pragmatic energy source. But, the problem at face is unique. Sri Lanka has become a crowded market for wind and solar energy development. While there is no scarcity of motivation, the opportunities for investment for the private sector is limited. The capacity of the grid is a major barrier for further development, especially in the case when the high wind and hydro seasons coincide. It is only when and how efficiently these issues will be resolved that will dictate energy and power firms’ vision to look inward once again.
As much as investors are eager to invest in these renewable technologies, opportunities are scarce within the country. Among the renewables, wind power is expected to be the major source of power in the future
January 2018 | Echelon.lk 57
Landmark INVESTOR’S GUIDE 2018 | BRANDED CONTENT
Revolutionizes Affordable Living in
Sri Lanka ‘Comfort Dwellings’, a series of suburban housing projects by Landmark Developers, is establishing a benchmark about what it means to buy a contemporary, affordable home
Landmark Developers’ Managing Director Eksith Hapangama 58 Echelon.lk | January 2018
A
ffordable, minimalist, contemporary, smart home, millennial and family friendly are just some of the superlatives that can be used to describe Landmark Developers’ new project in a popular Colombo suburb that targets a market niche. Branded ‘Comfort Dwellings’, the homes constructed on six perches of land are modern, high tech, customizable and yet affordable. Landmark Developers’ Managing Director Eksith Hapangama speaks to Echelon about the position of the ‘Comfort Dwellings’ project and why it’s a unique housing proposition. Excerpts from the interview are as follows: What’s different about ‘Comfort Dwellings’ compared to any other real estate development? Comfort Dwellings are affordable, modern and self-sustainable houses built on a six-perch plot, yet with ample space for amenities such as a car park and garden. The locations will be strategic, outside Colombo to ensure affordability, but also accessible to the city. We actively incorporate elements of practicality and affordability. We are certainly out with luxury and in with affordability. You can feel the earth, live among lush greenery and have access to renewable, clean energy at our homes. In fact, the extra 10% spent on constructing self-sustainable houses will significantly reduce electricity- and water-related expenses over the long term. As these homes can be set up with solar panels, you can even connect to the net metering system and provide energy to the grid when unoccupied.
properties are strategically located in highly accessible places in the outskirts of Colombo to take advantage of the government’s Megapolis Plan. We are mainly targeting mid-level professionals, first-time home buyers and senior citizens. Our properties would be a better and affordable solution also for people already commuting long distances, leaving home as early as 4am, from locations as far as Ratnapura. We see a shift in the expectations of young people, especially millennials. Our houses are designed in such a way to cater to the needs of millennials, potentially first-time home buyers. Millennials prefer ‘smart homes’. They want to control their homes through a mobile phone. Some even want motorised curtains, controllable remotely with a simple tap of their smartphone. We will incorporate high-tech components in addition to tech that ensures these homes are sustainable. You will be able experience one of our projects firsthand in Battaramulla in three to four months when the model home is completed. This house can think. There are sensors to monitor body temperature, and it can control lighting based on the number of people in the room. We are building for the future. If our clients wish, we will make the houses futuristic for them. Will people prefer houses instead of apartments? Houses are undoubtedly the better option, as you gain freedom, fresh air, ample space, a garden and it’s practical, like being able to dry your laundry. In an apartment, the walls are close around you, and usually ventilation and light are poor. Why would you want to live in a concrete jungle, in a box in the sky? We are a family-oriented company and want to build affordable houses where our clients can enjoy life at home. We are also enthusiastic about applying minimalistic and contemporary design to the houses we construct. Our clients have the flexibility to customise houses according to their preferences at the planning stage itself. Why do you want to stay in a house designed according to someone else’s taste? You can choose a wooden, cement or even a tile floor? the choice is up to the customer. It’s very common for people to move from one place to the other because they don’t have a special love or connection with a house. So, we actively encourage our clients to get involved during construction, to get a feel of the house and breathe the air inside the house. Landmark is all about love.
We pay close attention and cater to the needs of market segments. In fact, the next 12 months will be game changing. Eksith Hapangama
What changes to people’s housing-related needs are you addressing through these homes? We pay close attention and cater to the needs of market segments. In fact, the next 12 months will be game changing. Our
January 2018 | Echelon.lk 59
INVESTOR’S GUIDE 2018 | RENEWABLE ENERGY
EN ROUTE TO GREECE? The debt crisis in Greece was long known and predicted. But, it did happen. With elections ahead, is Sri Lanka heading the same way? By Chanuka Wattegama
Dr. Indrajit Coomaraswamy, before he commenced his tenure as the head of that old fashioned institution at Janadhipathi Mawatha, was a frequent speaker at many business events in Colombo. One prediction he repeated resolutely went like this: Sri Lanka spends more than it can afford; we cannot continue this lavish behavior forever. If we don’t take action, we might end up being another Greece. Economics is a dismal science, we know, but Dr. Coomaraswamy was surely not the most pessimistic economist in the land. It was not difficult to follow his reasoning. If the nation were a family, it was one with an unemployed father buying the children sweets with borrowed money. One does not have to be an economist to figure where this is going to end. Today, Dr. Coomaraswamy chairs the monetary board. I 60 Echelon.lk | January 2018
hope I do not embarrass him by making this observation; Hardly anything has changed since then and now. As a country, our income hasn’t risen by much. Spending continues. We borrow more. We waste more. We risk more. Our debt is massive, like the Seven Kingdoms of Westeros in the world’s most viewed TV series. They at least had a Jamie Lannister to fight wars to plunder gold for debt repayment. We have no Lannisters. This is, in a snapshot, where we stand in January 2018, nearly eight years after the end of the 30-year conflict and nearly two and half years of the, so-called, coalition government, leaving a seven-month interim period aside. Where we would be in 12 months from now is anybody’s guess, but we have some clues.
Illustration by: Leyanvi Mirando
First, what happened in Greece? The Greek debt crisis commenced in 2008, as a consequence of increasing public debt. Even before it became widely noticed, investors feared the Greek economy was in trouble in two ways: the ability to repay the debt and substantial interest. The last straw was the global financial crisis of 2008. Greece suddenly found itself handicapped by a high level of indebtedness (around 177% of GDP at the end of 2014) and a large budget deficit (more than 13% of GDP). What worsened the crisis was the Greek government’s own efforts to conceal and present a rosier picture using notably a collection of off-balance sheet funds and financial instruments developed by an international investment bank in its attempt to enter eurozone. The failure of few national infrastructure projects, snags in tax collection, an oversized military budget and its reliance on European structural funds were other causes of the Greek crisis. The tension in Greece came in three peaks. The first happened in 2010. To prevent the crisis reaching Portugal and Spain, eurozone countries and the IMF decided to financially assist Greece. An agreement in May 2010 provided for loans with strict conditions seeking a structural adjustment by the government of Greece. The second came at the beginning of May 2011, when Greece was once again appealing to the IMF and European community. The Greek government was under pressure then, with people protesting on the streets. In June 2011, a United Nations report directed a drastic reduction in fiscal deficits that threated jobs, social spending and left economic growth uncertain. The third: tense negotiations took place in early 2015, with the election of a left-wing political party to the government, which had promised a programme hostile to reforms suggested by European authorities. The government of Aléxis Tsípras organised a referendum in July 2015 on the acceptance or rejection of the creditors’ plan, which received a ‘NO’. Nevertheless, a similar plan was accepted in the following days after bitter negotiations and was ratified by the Greek parliament. It wasn’t the end of the world, but the consequences were by no means palatable. Why would Sri Lanka follow the same path? The debt-to-GDP ratio in Sri Lanka was 79.3% in 2016, very high compared to other frontier markets and peer countries in the region. The Central Bank’s annual report not just makes that observation but illustrates the fact with comparisons. In India, it was 67.2%, Vietnam 59.2%, Malaysia 57.4%, Thailand 43.1% and Bangladesh 34%. In Indonesia, a country that stands in par with Sri Lanka in its per capita GDP, the debt-to-GDP ratio was just 27.3%. We have not come to the levels of Greece, but without stern measures, it wouldn’t be too long before we suddenly find ourselves in a mess we cannot easily get out of. We are also making the same mistakes. One of Greece’s mistakes was colossal government spending. We too, like them, continue to run state institutions, heavily burdening the treasury. In 2016, Sri Lankan Airlines alone incurred a loss of Rs14.1 billion. We cannot be complacent about reducing the
airlines’ 2014 loss of Rs29 billion by half. As somebody calculated, it would be more economical for the government to finance all Sri Lankan passengers’ travel on other airlines rather than running a national carrier. Other state institutions appear to justify their losses with ‘we did better than last year’, but the slip is still visible. Sri Lanka Railways made a loss of Rs6.8 billion. Ceylon Electricity Board made a loss of Rs13.2 billion. Only the National Water Supply and Drainage Board reported a marginal operating profit in 2016. These figures will not vary for 2017, while their employees, especially the executives, receive compensation packages, some above market rates, with fat year-end bonuses. Some state institutions like the CEB are bound to pay annual bonuses to all employees using public money even if their performance is pathetic and when the organisation continues to lose money. Ironically, these are the very institutions that are supposed to fill treasury bins with their enviable position as monopolies. If the same organisations empty the treasury, rather than supporting it, the country has no other option than borrowing internationally at unfavorable rates. The same Central Bank report also reveals that expenditure on salaries and wages in 2016 was Rs576.5 billion (nearly 5% of GDP). Salaries and wages paid to central government employees, including defence personnel, have seen a sharp increase mainly due to higher overtime and other allowances as a result of the commencement of the conversion of interim allowance to the basic salary with the implementation of the new salary structure from 1 January 2016 for public sector employees. The share of salaries and wages in total recurrent expenditure was 32.8% in 2016, the second-largest recurrent expenditure item. The fact that 2019 is an election year will not ease fears. Sri Lankan elections are famous for providing subsidies with resources that don’t exist. The hit will not be felt in the 2018-19 period, during which the government will try to soothe the difficulties, but we might possibly pay with arrears after the elections end. That will be the time we should most be scared of – simply because we know our governments too well. January 2018 | Echelon.lk 61
INVESTOR’S GUIDE 2018 | INVESTMENT AND TRADE
Standard Chartered Bank sees opportunities beyond China’s One Belt, One Road Countries like Sri Lanka can deepen economic ties beyond China’s mega initiative, which promises to transform global investment and trade, and the global bank is exploring these opportunities one country at a time
Jim McCabe Chief Executive of Standard Chartered Bank Sri Lanka
Standard Chartered Bank is on a mission to link emerging economies across Asia, Africa and the Middle East through trade and investments even beyond the scope of China’s One Belt, One Road initiative. The bank’s chief executives for Malaysia ($9,500 GDP per head) and Sri Lanka ($3,835 GDP per head) met in Colombo in December 2017 to figure out how they can get their clients to discover opportunities in the two countries.
China’s ambitious One Belt, One Road (B&R) initiative is building connecting infrastructure across 60 countries that’s home to more than half of the world’s people and accounts for a third of global GDP. Standard Chartered has offices in over 40 of these countries, and the bank believes the One Belt, One Road initiative presents corporations unique opportunities far beyond laying the foundations for infrastructure. Trade among the B&R countries topped $3 trillion in 2016, with China accounting for less than a third. Trade between ASEAN countries is less than a third, signifying the potential for intraregional trade. China has already invested more than $130 billion, rising 12% year-on-year. Standard Chartered Bank believes the investment could reach $300 billion by 2030. January 2018 | Echelon.lk 63
INVESTOR’S GUIDE 2018 | INVESTMENT AND TRADE
As part of the bank’s broader strategy of growing its business by helping emerging countries connect at a deeper level, Standard Chartered Bank Malaysia Chief Executive Abrar Anwar and the bank’s Sri Lanka Chief Executive Jim McCabe, along with key team members from the two countries, held internal deliberations and met important clients in order to discover new opportunities for trade and investment that flows both ways. Malaysia is already invested in Sri Lanka, albeit in a small way. Total Malaysian FDI to Sri Lanka amounts to about $3 billion, which includes investments in listed telco Dialog Axiata PLC, and external trade, which amounts to half a billion dollars. Speaking to Echelon, the two CEOs discuss the potential to grow these numbers further and the importance of opening up Sri Lanka’s economy. Excerpts from the interview are as follows: Sri Lanka has only two bilateral trade agreements, with India and Pakistan. The country has been slow to open up. How important is it for Sri Lanka to be more open? Jim McCabe: The newspaper headline about the 3.3% third quarter economic growth is a wake-up call. Sri Lanka is the slowest growing economy in South Asia. The government seems to understand that there needs to be structural changes, but everyone must get onboard. It’s about true economic behaviour and direction, and everyone has to participate in changing, adjusting or developing this country. To be fair, change is never easy for anyone, especially if you have been used to something for a long time, and it fed and protected you. But, it’s unlikely to sustain improved growth and development. What is needed is very serious structural change. The economy is vulnerable to bad weather. One bug and 26% of your tea is put into question. There is a vulnerability in the economy that is uncomfortable. People need to understand that. We have to wave the greater-good flag and get things done. There’s plenty of growth in this part of the world, plenty of interest in Sri Lanka, but Sri Lanka has to want it to be there. At the end of the day, you have to take that leap of faith and make changes. Folks are arguing in 64 Echelon.lk | January 2018
Opportunities: Malaysia vs Sri Lanka
$10 BILLION ANNUAL FDI INTO MALAYSIA VS
$450 MILLION FDI INTO SRI LANKA IN 2016
$420 BILLION VALUE OF MALAYSIA’S IMPORTS AND EXPORTS VS
$29 BILLION VALUE OF SRI LANKA’S IMPORTS AND EXPORTS
$9,500 MALAYSIA’S GDP PER HEAD VS
$3,835 SRI LANKA’S GDP PER HEAD
the street about this and that, but we have to get through it. It’s really easy for me to say these things, and I am not trying to be disrespectful, I would be the last person to think that way, but there’s got to be that voice that encourages people to change, even if it’s uncomfortable. There’s an opportunity to improve the economy and everyone’s lives. Foreign investors will also find Sri Lanka attractive. Malaysia had to overcome fears about attracting foreign investors. Singapore did not have that problem because they had to rely on external investments from the start. Sri Lankans are used to lower foreign investor influence, so it will take some time to accept them. Sri Lanka’s economy is too small. The private sector accounts for only half of the GDP. If we want this economy to grow at 6% or 7%, which we all do, it cannot come from internal generation alone. The economy is not big enough, it’s not physically possible. This is why Sri Lanka needs to develop economic and trade relationships with the outside world. To do this, Sri Lanka needs to create a transparent, business-friendly environment facilitating both investment and cross border trade. Associations that are stronger and bigger economies can give a knowledge base, an ideation that will help propel internal growth in areas like technology and education. There’s a lot that Malaysia has accomplished there, and Standard Chartered is helping our clients in both countries discover these synergies. Sri Lanka shouldn’t fear engaging with other economies. There’s a lot to learn. There will be joint ventures and opportunities for people to identify additional activities that can take place and help in diversifying opportunities. That is a process and it won’t happen quickly. It’s critical that Sri Lanka creates more jobs here, because then, people will be more accepting of FDI and trade. What about Sri Lanka interests Malaysian investors and businesses? Abrar Anwar: Malaysian FDI into Sri Lanka is around $3 billion, including investments in listed telco Dialog, but there’s potential to grow this. We’re here to help our clients uncover more opportunities. Malaysia’s economy is expected to grow
for some time now. It’s now looking at digitalising the economy and exploring industries of the future around technology. In this regard, Sri Lanka has an educated and skilled workforce that Malaysian firms may be interested in tapping into. Malaysia has built capacity around infrastructure development, energy including oil and gas, and telecommunications, areas that Sri Lanka is trying to develop. There will be opportunities for both countries. Sri Lanka is poised for strong growth over the next few years. Seeing is believing, so when people come here and see the opportunities, they will know. By 2020, Malaysia will be a high-income country. It’s also the 24th largest trading nation in the world, with export and import trade totaling $420 billion a year. Their corporates have been maturing over the years, and there are many outbound investors in the market. That is why Sri Lanka is important to us at Standard Chartered Malaysia. Standard Chartered Bank has offices in over 70 countries. We’ve been in Asia for more than a hundred years, so we have unique perspectives and insights about the markets here. What we find is that success stories occurred where there is private sector collaboration, supported by governments. Standard Chartered can facilitate that process.
5.5% and South Asia by 6%, so the engine of growth is in this part of the world. The time has come to deepen connections through trade and investments. The global economy is expected to have a less volatile year compared to 2017. The Malaysian ringgit appreciated 10% against the US dollar over the last two months, a sign that confidence is returning to the market. FDI into Malaysia is growing. The annual investment inflow is around $10 billion. Malaysian companies are looking for more opportunities to invest. In November 2017, Malaysia recorded its highest export earning for any month at $20 billion. The country has been sustaining a trade surplus
Abrar Anwar Chief Executive of Standard Chartered Bank Malaysia
Why is Standard Chartered interested in facilitating investment and trade between the two countries? Anwar: Our footprint is extended across Asia, Africa and the Middle East, where we try to connect customers across these regions by facilitating trade, investment and capital flows. Intra-ASEAN trade is around 24%, so there’s a lot more potential for growth, versus 70% intraregional trade in the EU. We are present in 45 countries connected to China’s One Belt, One Road initiative. We are leveraging our positions in these markets so we can have a positive role in shaping the dynamic economic future of the region. That is why the Sri Lankan visit is also our priority, to see how we can connect with the whole team here, and facilitate clients and customers at both ends, and see some fruitful outcome in the days to come. Trade between Malaysia and Sri Lanka is probaJanuary 2018 | Echelon.lk 65
INVESTOR’S GUIDE 2018 | INVESTMENT AND TRADE
bly half a billion US dollars, but there will be opportunities to grow this if we create better opportunities at both ends. McCabe: It’s also in Sri Lanka’s best interest to diversify its economic relationships without being restricted to a few countries, which can be risky. Sri Lanka is discussing a trade agreement with Singapore, and Thailand is talking about a huge investment in a special economic zone here as opposed to Vietnam where they were initially looking. These countries have been where Sri Lanka is today, so they see the growth potential. As a bank, we want to help the region connect, and we’re uniquely placed to do that. What are some of the key lessons Sri Lanka can draw from Malaysia? Anwar: Malaysia’s GDP profile has changed over the years. It’s moved from manufacturing white goods to semi-conductors. The services sector accounts for more than half of GDP. One thing Malaysia did successfully was to project the future so it could formulate appropriate policy to exploit emerging opportunities. Second, it connected with appropriate partners from different countries. At the end of the day, all countries have to depend on each other. It’s a globalised economy. How each country engages its trading partners in terms of the comparative advantage and capital flows determines how successful they become. Malaysia attracted foreign investments by establishing special economic zones in villages so people have jobs, because it was critical to have public support. Local businesses were initially fearful of losing out to foreign companies, but Malaysia decided the best thing to do was to encourage competition because it tends to lift productivity across the economy. If local companies could quadruple economic growth, then there would be no need for foreign investments. Sri Lanka recently relaxed its foreign exchange rules. Do you see increasing interest among your clients about investing overseas? McCabe: Yes, no question about it. The new foreign exchange law is a step in the right direction. You can’t keep your money locked up forever and expect it to grow. You need to invest where the opportunities are. Right now, we’re trying to understand the new rules 66 Echelon.lk | January 2018
China’s One Belt, One Road
60
NUMBER OF COUNTRIES
1/2 THE WORLD’S POPULATION THAT MAKE B&R THEIR HOME
1/3 B&R COUNTRIES’ CONTRIBUTION TO WORLD GDP
45 B&R COUNTRIES THAT STANDARD CHARTERED BANK SERVES
$130 BN INVESTMENTS IN B&R PROJECTS
$3 TR VALUE OF TRADE AMONG B&R COUNTRIES (CHINA ACCOUNTS FOR LESS THAN A THIRD)
and making sure our staff are able to advise clients. For many years, we found our staff saying, they didn’t know and had to call compliance. This won’t do now. Where do you see Sri Lanka five years from now? What will the banking sector look like? McCabe: Sri Lanka will be a dynamic place. The Port City will be taking shape on top of other major developments around the city. Hambantota will be alive, and will become a growing industrial and manufacturing area not seen before. The east coast is already seeing signs of development. Internal road networks will be developed to facilitate more tourism. There’ll be smaller airports. There will be quite a bit of change, but dynamic and exciting change. The banking sector is a consolidating industry. The requirement of capital in a larger scale makes many financial institutions unviable. The regulator has been talking about this for a long time, that they’d like to see a small number of bigger and stronger banks. That’s the trend everywhere in the world, and Sri Lanka is not an exception. Anwar: From a global perspective, the financial industry is changing fast with the digital economy and fintechs making inroads to traditional banking businesses. Increasingly, financial transactions are moving onto mobile platforms, so successful banks will be those that can embrace technology quickly enough and establish collaborations with fintechs. Regulations are tightening globally. Apart from capital and prudential requirements, there are increasing demands on how banks are geared to counter money laundering and terrorism financing. So, governance structures will need to be really looked at. The challenge for banks is embracing these changes and adapting quickly. Operational risk is becoming a critical area. Credit risk is relatively easier to monitor, as you can see it. But operational risks like money laundering, cyber-attacks, sanctions and data security breaches are not easy to monitor. I believe banks that have enough capital to mitigate all these risks with sound operational structures and maintain the confidence of their clients will survive in the long run.
Agenda
Development
PRIVATE SECTOR AS A DEVELOPMENT PARTNER Targets intended to shape development in the years up to 2030 are attracting private sector interest in Sri Lanka. Businesses are counting on bottom-line impact of development goals
Illustration by: Leyanvi Mirando
By Veronika Halamkova
Five companies announced partnerships with a UN agency and the government in order to assist Sri Lanka achieve development goals around reducing poverty, sustainable agriculture and renewable energy. The UN adopted 17 Sustainable Development Goals (SDGs) in 2015 covering a vast number of areas from world peace and clean energy, to education and more. Unlike the Millennium Development Goals (MDG), the 17 SDGs have 169 associated targets, which made it possible for business- and market-driven measures to be more useful to the overarching aim of poverty reduction. Aid lobbies January 2018 | Echelon.lk 67
Agenda
Development
Private sector for SDGs Supporting the Sustainable Development Goals of poverty reduction, agriculture productivity and renewable energy have piqued private sector interest
ON POVERTY
Over the past 15 years, the number of people living below the poverty line in Sri Lanka has decreased from nearly onefourth of the population (22.7%) to the current 6.7%. Despite the achievement, nearly 1.5 million Sri Lankans are still poor. The government’s Grama Shakthi, which aims to eradicate poverty by sparking entre-
preneurial potential, is focused on 1,000 villages with high poverty. Public-private partnerships present a great opportunity to give the ambitious yet vague plan a clear direction. For instance, Unilever’s Saubhaguya project has been extending rural women an opportunity to gain extra income by selling products
in their locality. This project, which offers some trainings so these women can sell Unilever’s products, is now focused on select villages under Grama Shakthi. The initiative is now self-funded, with expenses for trainings, delivery and monitoring paid from the participant’s sales. Unilever is also able to build its future rural customer base.
ON SUSTAINABLE AGRICULTURE
More than a quarter of agriculture’s 8.5% GDP share is from tea. Of the tea crop, 70% is grown in small backyard plots. Despite the abundance, potential smallholders often lack knowledge to optimise yields. Dialog’s Govi Mithuru programme educates smallholder farmers
on cultivation practices and provides timely, location-specific advice. The project has assisted to improve yields and prevent weather-related losses. A project called Sustainabilitea, jointly run by Aitken Spence and Unilever, focuses on retaining for
producing better tea crops, but not at the expense of the environment or the living conditions of plantation workers. Land degradation and fertiliser misuse are issues in the tea industry, and Aitken Spence has exposure to plantations and Unilever markets tea.
ON RENEWABLE ENERGY
Sri Lanka’s yearround sunny climate makes it widely suitable for solar energy. That is the focus of project Sunlight. Named after Unilever’s famous
soap brand, it will introduce solar panels across the country, starting with its own retailers. “When they hit their targets, we want to sponsor the first installment of
the solar panels and persuade them in this way.” Commercial Bank will support the initiative by offering low interest rate loans to retailers.
68 Echelon.lk | January 2018
and governments are less hostile to private sector- and market-driven approaches. Businesses can directly benefit from reduced poverty, too. According to the Business & Sustainable Development Commission (BSDC), success with the SDGs will generate business opportunities worth $5 trillion and create 230 million jobs in Asia by 2030. It says the large economic potential lies in four main areas: food & agriculture, cities, energy & minerals, and health & well-being. In December 2017, Aitken Spence, Commercial Bank, Dialog Axiata, MAS and Unilever joined the government, United Nations agency UNDP and the UN’s Global Compact to unveil an action plan to make progress on three selected goals: ending poverty, sustainable agriculture and renewable energy. “We want to create a movement of companies to align their sustainability projects with the country’s SDGs,” says Saumya Perera, Unilever Sri Lanka’s head of sustainability. Unilever’s local office initiated the public-private partnership initiative. It’s requesting other companies to join to help achieve Sri Lanka’s SDG goals. As the non-profit and private sectors are also enthusiastically backing the SDGs, these targets will shape development strategy more than any others in the years to 2030. However, there are many associated target donors and private businesses putting greater emphasis on collecting data and measuring results. Without data, it’s challenging to understanding where the poor are and the type of opportunities that are most useful. However, private companies need to track their own actions anyway, which should make it easier to see the big picture. “When we join a project, there needs to be measurement. We really had to push the government to give us the numbers, so we can see where we are now,” adds Unilever’s Mayanthi Wickremetilleke.
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Govern
Wailing Wall, East Jerusalem
70 Echelon.lk | January 2018
Civil Service
JERUSALEM AND THE CEYLON CIVIL SERVICE
US President Donald Trump, by announcing that the American Embassy in Israel would move to Jerusalem, completes a journey that began when Britain opened the first modern Diplomatic office there in 1838 By Vinod Moonesinghe
January 2018 | Echelon.lk 71
Govern
Civil Service
ONE DAY IN 1839, TWO YOUNG Englishmen set out from Brussels to travel overland to Sri Lanka. One of them, the 32-year-old Edward Ledwich Osbaldeston Mitford, scion of a gentry family from Northumberland, ostensibly feared the long sea journey. However, having served in the British foreign service, its seemed more likely that he wanted to gather intelligence along the way. His companion Austen Henry Layard, ten years his junior, had links to Sri Lanka. His father, Henry Peter Layard, served the Ceylon Civil Service (CCS) and his nephew, Charles Peter Layard, later became the first mayor of Colombo. However, he never completed the journey: at Jerusalem, he made a detour, and become enamoured with the Middle East.
At Hamadan, Layard stayed behind; gained fame by “discovering” the ruined city of Nineveh, the capital of the ancient Assyrian empire; and went on to be a diplomat and parliamentarian. Mitford continued his journey to Sri Lanka, and to a long and successful CCS career. Forty years later, he described his 7,000 mile (11,000km) horseback journey in ‘A Land March from England to Ceylon’.
T H E G R E AT G A M E
At the time Mitford and Layard visited Palestine, there were hardly any Jewish people there. This posed a problem for Britain’s foreign policy mandarins for rather complex reasons. In 1798, Napoleon Bonaparte invaded Egypt in order to threaten the British position in India. Alarm bells began ringing in Whitehall, and British forces 72 Echelon.lk | January 2018
Jerusalem from the Mount of Olives in 1858, by Edward Lear (courtesy of Wikipedia)
France also crept in to defend Roman Catholics. Britain, a Protestant country, found hardly any Protestants to protect in the Levant. Jewish people proved to be welcome candidates for protection under the British aegis. Various British Christians and Jews had pushed for the settlement of European Jews in Palestine, with no success. Now, a top establishment figure, Earl of Shaftesbury Anthony Ashley-Cooper, a close relative of the British Foreign Secretary Lord Palmerstone, intervened. Although he considered Jews to be “stiff-necked, dark-hearted people, and sunk in moral degradation”, Shaftesbury strongly favoured establishing Jewish settlements in Palestine. He presented a plan for doing so to Palmerston. The foreign secretary now prevailed on the British Ambassador in Constantinople “to urge… the Turkish government to hold out every just encouragement to the Jews of Europe to return to Palestine.” He established a vice-consulate at Jerusalem in 1838, the first diplomatic representation in the city in modern times.
ROAD MAP
were dispatched, which defeated Napoleon. However, the Egyptians managed to expel the British shortly afterwards. Paranoid about other powers gaining control of India, British worries about Egypt revived following a Franco-Egyptian alliance in the late 1830s. In 1840, the Peninsular and Oriental Steam Navigation Company (P&O) began mail and passenger services between Britain and her Asian possessions via a land crossing of Egypt. This meant that Palestine—then part of the Ottoman Empire—being adjacent to Egypt, became important to the British empire. This importance increased when the Russian empire began expanding southward into Caucasus and Central Asia. The British began playing what came to be known as the “Great Game”, to keep Russia at a safe distance from India’s borders.
“ E N C O U R A G E M E N T TO T H E J E W S ”
Russia began intruding into the Ottoman Empire, and particularly into Palestine, as a “protector” of the Orthodox Christian minority.
However, the small Jewish population (only 40,000 out of 300,000) remained a problem, and expanding it appeared vital to British interest. In 1845, Mitford wrote ‘An appeal on behalf of the Jewish Nation in Connection with the British Policy in the Levant’, wherein he laid out the British “road map” for Palestine for the next century. A cogent and prescient work, it proposed the establishment of a Jewish state, under British protection. The indigenous Palestinian population would be deported. The Jewish colony, he argued, “would retrieve our affairs in the Levant and place us in a commanding position… at the same time that it would place the management of our steam communications entirely in our hands.” An able propagandist in the cause of a Jewish homeland, Mitford repeated his message indirectly in his 1866 novel, ‘An Arab’s Pledge’, in which he outlined Arab perfidy against Jews in Morocco – essentially a fictional account of some of the material in his “Appeal”. January 2018 | Echelon.lk 73
Govern
Civil Service
Map of Jerusalem
of the newly opened Suez Canal, and began an intrusive policy into Egypt. In order to bolster Britain’s position in the Levant, he appointed Layard as ambassador to Constantinople. Almost immediately, war broke out between Russia and the Ottoman empire, which went badly for the latter, despite covert British support. Layard warned that the Ottoman collapse would enable Russia and France to penetrate the region.
OLIPHANT
DISRAELI
The outbreak of the Crimean War in 1854 re-emphasised the importance of Palestine to Britain. James Finn, a British consul in Jerusalem, sent the foreign office a scheme “to persuade Jews in a large body to settle here as agriculturists on the soil.” Finn had already established training schools for Jewish farmers, funded by the Society for the Promotion of Jewish Agricultural Labour in the Holy Land— the members of which included Galle-born Captain Henry Lewis Layard (Austen Henry Layard’s cousin), a merchant at Darley Butler and Company; and Thomas Goodwin Hatchard, later Bishop of Mauritius, whose family published Mitford’s books. In 1862, Prince Albert (later King Edward VII) visited the Holy Land, the first British Prince to do so since Edward the Black Prince in the 13th century, signalling to the world Britain’s intent in the Levant. Three years later, a quasi-military organisation, the Palestine Exploration Fund, came into being, which mapped the area and gathered intelligence. Layard, one of the founders, shaped the focus of the Fund’s research, pushing it in the direction of a specifically Jewish history. Benjamin Disraeli, a close friend of Layard’s maternal relatives, became British prime minister in 1874. He recognised the importance 74 Echelon.lk | January 2018
At this point, another Sri Lankan connection entered the Levantine equation. Laurence Oliphant, son of Sir Alexander Oliphant, Chief Justice of Ceylon, had been brought up in Sri Lanka. He served as Lord Elgin’s secretary during the Second Opium War and as a war correspondent, before being elected to Parliament. He set up an organisation called Christian Lovers of Zion, to lay the basis for Jewish immigration to Palestine and attempted to persuade Jewish organisations promoting migration to America to switch their focus to Palestine. Following the Turkish defeat, he suggested planting a European Jewish population in Palestine to reinforce the Ottomans against the Russians. An enthusiastic supporter of Jewish settlement in Palestine, Disraeli jumped at the suggestion. In Constantinople, Layard backed Oliphant’s efforts to persuade the Ottoman sultan to back the creation of a Jewish colony, which however, did not meet with success. After a tour of the region, Oliphant sent a report to the Foreign Office, setting out proposals for the settlement of Jews in the region, and for its economic and political growth, advocating industrial and agricultural development of the area, using Palestinians as cheap labour. He himself moved to Palestine and provided support for established Jewish settlements.
ZION AND ZIONISM
Despite all these efforts, as late as 1882, Jewish people comprised only 8% of Pales-
Austen Henry Layard
Laurence Oliphant
EL Mitford
tine’s population: 24,000 people, compared to 80,000 in New York city alone. The biggest obstacle to Jewish settlement in Palestine remained Jewish reluctance, which Oliphant had found in his efforts to dissuade Jews from going to America. Many considered the US a “Promised Land”: by 1927, when the Johnson-Reed Law put a cap on Jewish immigration, nearly 4.3 million Jews lived there, up from 200,000 in 1870. Even Oliphant’s secretary, Naftali Herz Imber, who wrote the poem that became the Israeli anthem, moved from Palestine to the US. Although Jewish people would say “next year in Jerusalem”, very few actually intended to go there. Jerusalem (also known as Zion) had more a mystical meaning, in the sense of the afterlife. Religious Jews believed that “Israel” would only be established after the coming of the Messiah. In 1845, a conference of Rabbis in Frankfurt deleted all prayers for a return to Zion and a restoration of a Jewish state from Judaic rituals. A relative change came about after extensive pogroms in Russia beginning in 1880. Over the next 34 years, there would be 4,000 Jewish immigrants to Palestine, mainly from Russia. In this climate emerged a secular Jewish nationalism, which looked to the establishment of a Jewish state: Zionism. A curious phenomenon, it remained non-religious, while depending on Judaism to define its basis; while at the same time, its primary aim of a Jewish homeland being at odds with the Judaic religion.
Jerusalem (also known as Zion) had more a mystical meaning, in the sense of the afterlife. Religious Jews believed that “Israel” would only be established after the coming of the Messiah
A R A B I PA S H A
The Zionists looked for support from European governments. Only the Tsar of Russia responded, seeing them as a means for ridding Russia of its Jews. Disappointed, they experimented with schemes to create colonies in Argentina and East Africa. They faced a major problem: The British, formerly the sponsors of a “Jewish Homeland”, now did not feel any urgency. In 1882, they crushed Arabi Pasha, the leader of Egyptian patriots, and sent him to exile in Sri Lanka, so they now Egypt and Palestine held less importance. They did suggest a Jewish colony in the Sinai Peninsula – where it would serve as a buffer between the Ottomans and the Suez Canal – but this failed because of Egyptian objections. This situation changed when, in 1905, Sri Lankan-born Admiral John Fisher converted the Royal Navy’s ships from coal to oil. The Middle East gained new importance as a source of petroleum. The establishment of a Jewish colony in Palestine returned to the British agenda, being articulated as official policy in the 1917 Balfour declaration. In December that year, the British captured Jerusalem, finally opening the road to a Jewish homeland. January 2018 | Echelon.lk 75
Zen
Akram Cassim The Chief Executive of Colombo Jewellery Stores may deal with precious stones all day, but his wife and daughter are the real jewels in his life
What do you wish you had right now? A magic carpet If you could change one thing about yourself, what would it be? To chill a bit more If you were to die and come back as a person or thing, what do you think it would be? Marilyn Monroe!! Or a nice 20-carat flawless diamond
What are you most passionate about? Elephants and jewellery
Which historical figure do you admire most? Walt Disney. He was able to create happiness and joy in kids and adults, and it all began with a mouse
What do you fear the most? Dogs
What would you be doing in 20 years? Hopefully still annoying my daughter and having fun
Which words or phrases do you most overuse? “Do it fast”? “Bring it soon”
What is the first thing you do when you wake up? Drink a mug of water
What is your favourite journey? A gondola ride around Venice
What was one of your life-changing moments? The birth of my daughter Hanaa
What do you consider the most overrated virtue? Piousness
What do you think has been the strength behind your success? Believing in and pursuing my visions
On what occasion do you lie? When someone unknown asks, “Do you know me?” Who or what is the greatest love of your life? My family What do you dislike most about your appearance? A taller Akram might be interesting... Can look down on a few people I have been looking UP to! Which talent would you most like to have? To be an amazing cook What is your greatest extravagance? I enjoy splurging on travel, from interesting hotels to fab restaurants, to VIP tours
If you could eliminate one weakness or limitation in your life, what would it be? Would love to be able to speak more world languages like Mandarin, French and Hindi When you’re 90 years old, what will matter most to you? Whether my 85-year-old wife is still around to help me enjoy our life together What was your favourite food as a child? Chocolate (still is)
Illustration by: Oshadi Paranawithana
What is the trait you most deplore in others? Backbiting and arrogance
If you had to change your name, what would you change it to? Cassim Akram
76 Echelon.lk | January 2018