Volatility will reign at CSE in short term; tough reforms needed to improve market – Analysts
In the wake of a new government, the Colombo bourse will show some instability in the short term with analysts calling for some tough reforms in the financial markets and a strong will to do so in the ensuing months. Murtaza Jafferjee, CEO JB Stockbrokers told the Business Times that the macro economic situation along with the local currency coming under a ‘bit of an attack’ warrants some hard hitting reforms to fill the state coffers.
He added that the local rupee will have to adjust in line with other emerging marker currencies, such as the Indian rupee, which has also been depreciating. “Foreign institutional investors have been selling and/or not rolling over their bond/bills creating pressure on the local rupee and the rate has not adjusted since the Central Bank has been intervening in the market propping up the rupee at 134,” he said, adding that this will drive up the cost of imports – a good thing since it will partly curtail domestic demand.
Statistics show that gross foreign reserves had dropped to US$6.8 billion by end-May 2015 from $7.5 billion a month earlier, further highlighting pressures on external balances. Mr. Jafferjee pointed out that the government tax revenue to GDP is only 11 per cent, which is one of the lowest in the world for a middle income country. “This will have to go up mainly through direct taxes – higher rates, wider tax base and better enforcement,” he added.
He said that the interest rates will go up when the currency depreciates. ”There are about Rs.100 billion in Treasury bonds due in September that will create roll over risk placing further pressure on the interest rates. This could be mitigated if the government goes for a further sovereign issue, ideally of 10 year duration.”
Volatility
According to him there will be short term volatility in the equity market while political stability and a strong will to do the necessary reform in financial markets stands as major components in the medium term for the new government. “Also facilitating and promoting more competition that are the key tenets of the social market economy will bode well for equities in the medium term.”
A recent Fitch Ratings report on Sri Lanka also said that greater clarity over economic policy matters is needed. The new administration inaugurated in January under President Maithripala Sirisena has made some progress in addressing perceived governance shortcomings, in particular by adopting a constitutional amendment limiting presidential powers and launching anti-corruption investigations.
“However, there has been no corresponding strengthening in economic management. A populist budget was introduced in February that raised public sector wages and reduced publicly administered prices. The government has also disclosed that the 2014 budget deficit was higher than previously thought, owing to revenue shortfalls. This indicates that fiscal consolidation has stalled. Sri Lanka has the fourth-highest share of government debt – 72 per cent of GDP – of any country in the ‘BB’ range, after Portugal, Hungary and Croatia.”
Monetary policy has also been accommodative, the report added, noting that credit growth was allowed to accelerate sharply to 17.6 per cent year on year in May 2015, from almost 0 per cent in 3Q14. “This has fuelled a 45 per cent year on year rise in consumer goods imports in the first five months of the year at a time when exports were unchanged owing to stagnant agriculture and textiles. A rise in tourism receipts and remittances has acted as a buffer, although the trade deficit widened to $3.4 billion in May, up from $3.1 billion in May 2014. The current account deficit had narrowed to 2.7 per cent of GDP in 2014 from 7.8 per cent in 2011, but should widen back to 3 per cent this year.”
It said that the authorities indicated that reserves had been bolstered back up to $7.5 million by end-June through a $650 million fore reign dollar debt issue and $338 million Sri Lanka Development Bond, though the latest data for end-July show reserveshad fallen back down to $6.9 billion. “External liquidity has been buffered by a million $1.1 billion swap facility with the Reserve Bank of India in July. These factors have buffered external liquidity recently, though it is not a sustainable way of improving the stability of the external accounts.”