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23rd January 2000

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The brighter side of the economy

What are the bright spots in our recent economic per-formance? We are told that there is a trend of improvement in the economy, which commenced somewhere in and around mid 1999. Consequently the economic growth in the fourth quarter is expected to be around 5 per cent, a considerable improvement from the first quarter's performance of only 2.7 per cent growth.

Exports, which fared very badly in the first two quarters have picked up. This is particularly so with our main industrial export, garments. Tourist arrivals exceeded the magic four hundred thousand mark and tourist earnings were about 20 per cent higher than last year.

Perhaps the most important favourable development was the improvement in prices of both, tea and rubber. Last year also saw an increased production of paddy and other food crops and a continuation of the up trend in Tea production to reach a peak production of around 283 million kilograms.

Once again we had an increase in net foreign remittances to the country. Not only are these remittances an important component of our balance of payments, they also constitute a significant source of income for our people and an important source of national savings and investment. Last year these remittances grew by about 10 per cent.

Despite all these favourable developments in the latter part of the year, our export performance was poor and our economic growth of perhaps slightly less than 4 per cent for the year was disappointing. Although export performance improved in the latter part of the year, total export earnings for the year are likely to record a decline of around 4 to 5 per cent.

Official statistics also indicate other improvements. The rate of inflation, measured by the Colombo Consumers' Price Index shows a healthy drop to below two digits. The rate of unemployment too has declined to around 9 per cent of the labour force, the lowest one could remember for a long time.

There are several questions one must ask about this performance. First, some of the improvements are a betterment from rather poor performances earlier in the year. This is particularly so with respect to our vital and important export performance.

The export performance was so dismal in the early part of this year that the more recent gains in export earnings could not offset the decline in exports. Similarly, the economic growth rate of less than 4 per cent is one of the lowest, barring the crisis years, like 1996, when everything went wrong.

The second and most important question is whether there would be a continuous improvement in these indicators. Have our industrial exports recovered and become competitive?.Will we be able to gain from a global upturn. Or are we facing a situation where the crises affected countries have emerged stronger and more competitive and could compete more effectively in international markets?

The most promising prospect appears to be with respect to the improved prices for our tea and rubber, where the indications are that the upward trend in prices is likely to continue. In the case of tea, global supplies are likely to be below global demand for tea and consuming countries appear to be more stable. In the case of rubber,the rise in petroleum prices, increased demand for tyres and other rubber based goods are expected to support improved prices.

The third issue is to what extent the figures of a reduced rate of inflation and unemployment are reliable and whether the reduction in inflation is a sign of reduced economic activity, as can be seen from the import figures.

Apart from these qualifications, what most persons are interested in is whether the favourable developments would hold up this year. The external environment has certainly improved and it is our task to ensure that we could respond to it. Can we regain our competitiveness in our industrial exports? Can we continue to attract a larger number of tourists? Would we be able to attract more foreign investment this year?

The most important question is whether we could provide an environment conducive to investment. The answer to these questions will be the deciding factors for our long term economic growth.

We can only hope that the glimmer of brightness that was shown in some aspects of our economy would be seized upon to put the economy on a faster momentum than we have witnessed last year.


Exchange rate policy

How the float is managed

Sri Lanka's exchange rate regime falls in the category of managed floats. The Sri Lankan rupee has been floating since 1977. The rupee exchange rate is basically determined by demand and supply in the foreign exchange market, but the Central Bank of Sri Lanka (CBSL) attempts to guide and smooth it on a path towards a medium-term target that maintains export competitiveness. The Bank does not provide forward exchange cover.

At the beginning of each trading day, the CBSL announces the rupee rates at which it is prepared to buy or sell US dollars, which is its only intervention currency. Since 1995 these rates have been two percentage points apart. Banks are free to trade at any rate but will usually turn to the CBSL when they find the intervention rates advantageous. Thus, the intervention band limits intra-day volatility to two percentage points.

The CBSL intervenes only passively; it responds to bids or offers but does not initiate trades. While officially banks may only buy from or sell to the CBSL for trade-related purposes, this is not strictly enforced nor enforceable. On occasion banks will prefer to trade in the market at rates outside the band. Daily information on CBSL interventions is being published.

The intervention band is neither preannounced nor predetermined. The way it is adjusted from day to day is the crux of the managed float. In deciding on its medium-term path, one important input for the CBSL is an internally produced real effective exchange rate (REER) index for 24 trading partner countries published in graph form in the Annual Report which reflects competitiveness. The policy is to avoid any large trend appreciations, but just as important in judging competitiveness is the actual performance of the export sector.

Meanwhile the daily setting of the intervention band is guided by an alternative REER index, for a smaller group of countries but kept up-to-date with inflation projections. The daily changes in the dollar-rupee rates necessary to keep this REER index stable are dominated by movements in the dollar-yen cross rate, the two currencies with the largest weights. Finally, the way the CBSL pursues its medium-term target is by routinely depreciating more and appreciating less than those daily calculations indicate. How much more or less depends, among other things, on behaviour of the market exchange rate.

Given the shallowness of the market, the best measure of the market exchange rate is a rate the CBSL computes daily, namely the weighted-average rate for all transactions on the previous day. The position of this rate within the intervention band is an indicator of market pressures. In practice, the market rate tends to lie very close to the CBSL's selling rate for extended periods, suggesting that the market is often guided by the intervention band.


Eagle and NAMAL to manage largest private sector provident fund

By Dinali Goonewardene

In a landmark decision, the Mercantile Sector Provident Society (MSPS) decided to partly outsource its portfolio to two private professional fund managers.

MSPS which has a Rs. 3 bn portfolio, signed up with Eagle NDB Fund Management Co. Ltd and National Asset Management Ltd (NAMAL) to manage Rs. 50 mn each to be invested in equities and fixed income instruments for a one year period, Senior Fund Manager, Eagle NDB Fund Management Company Ltd., Channa de Silva told The Sunday Times Business.

He believes the two funds together can achieve a better return than the MSPS is presently achieving. MSPS currently earns a 13.5%-14% return.MSPS funds are presently invested in fixed income securities. The Fund has set the All Share Price Index as the benchmark for the two fund managers. "We will initially invest only in treasury bills but are looking for a reversal in stock market sentiment to invest in equities," de Silva said.

The fund managers were chosen on a competitive basis and were evaluated by KPMG Ford Rhodes Thornton and Co. MSPS was established in 1939 with the Ceylon Chamber of Commerce as its custodian trustee. The Fund presently has 9,366 employees belonging to 80 firms, including Hayleys, Unilevers, Singer Sri Lanka, Maharaja and DFCC Bank. The Employees' Provident Fund Special Provisions Act prohibiting the establishment of private provident funds was enacted in 1976. The Act was gazetted in 1996 and the establishment of private provident funds is now illegal.

Industry analysts are hopeful that the MSPS decision may prompt the two state provident funds, EPF and ETF to outsource part of their portfolio to professional fund managers.

The fund management industry has been lobbying the government for many years to allow the two state pension funds to outsource part of their portfolio. However, the state funds continue to manage their portfolio inhouse while simultaneously training their employees in fund management activities.

Over the years, EPF and ETF have become a major source of funds for the government to source much needed finance. Despite continuous lobbying by the financial community for EPF and ETF to increase their investments in the private capital markets, the funds have continued to invest in small proportions compared to their investment in government securities.


Tea update

No response from Iraq yet

Iraqi officials had not responded as of last Friday in response to the tender proposals by local companies which closed January 15.

Tea Board officials said they had not got any proposals by Thursday (Poya day. However, they said that they expected Iraqi officials to make their proposals on Saturday.

However, Asia Siyaka said that if quantities are announced prior to next week's auctions, it was likely that successful buyers would take the opportunity of building up a good value stock from next week's large quantities on offer.

Asia Siyaka said that inspite of this week's record quantity of 7 million kilos on offer last week's auctions witnessed exceptional demand, dispelling fears that there may be a reluctance on the part of buyers to pay up in view of the larger quantities coming up this week.

Other brokers said that in fact, buyers might have been worried as a large variety of teas from the same estate are expected to be on offer at this weeks auctions and hence the increase in demand.

The low growns in particular showed a strong demand along with better teas that showed an improvement in prices.

This helped widen the gap between the best teas and the poorer teas that shrunk in the previous weeks.


Commodities

World trends push prices up

Increasing world commodity prices and an estimated eight percent depreciation of the rupee this year is expected to push up the cost of living. Analysts said that while rice and sugar prices were around 20 percent down, wheat, soybean, corn and oil prices were picking up. They said that this was mainly due to a correction in wheat, soybean and corn prices that crashed two years ago.

Analysts said that sugar and rice prices might maintain the same level due to good crop harvests in the world. They said that since local production of rice in the Yala harvest was good and expectations of a good Maha harvest would help keep prices intact. However, analysts said that sugar prices would not change because the government would revise the tax on imported sugar to protect the loal industry.

Local sugar prices are relatively higher than world prices because of low productivity, low sugar recovery rates and frequent labour problems. Hence the government imposes taxas on imported sugar. However, local production is sufficient to meet only around 10 percent to 12 percent of domestic consumption.

However they said that this could change if there was any drastic changes in the weather due to the weather phenomenon El-nino. They said that speculation could move prices either way because the market traded in future prices.

Meanwhile, in the world market, soybeans for March delivery rose 6 cents, or 1.2 percent, to $5.0225 a bushel on the Chicago Board of Trade, the highest closing price since Sept. 13. Earlier in recent trades prices fell as much as 9.75 cents, or 2 percent, to $4.865 a bushel, as rains in Brazil eased concern about drought damage to crops from the world's second-largest grower after the U.S.

The rally also helped push corn prices higher. Corn also was helped by a strong weekly shipments report by the U.S. Department of Agriculture and by concerns about spring planting conditions. Wheat futures, however, slipped backward on pressure from Egypt's decision not to buy wheat despite several offers over the weekend. Wheat for March delivery fell 1/2 cent to $2.64 1/2 a bushel; March corn rose 1 cent to $2.20 a bushel; March oats were unchanged at $1.12 a bushel; March soybeans rose 6 cents to $5.02 1/4 a bushel.

Wheat, soya, corn and oats are imported by government tender. Wheat is the largest imported commodity at 880,000 metric tons.

Commodity 94 95 96 97 98

Metric tons

Rice 58 9 341 306 168

Wheat 826 1,057 913 789 880

Sugar 491 417 381 545 444


Market Wrap

Short week for CSE

The market remained flat in the three days of trading with interest centering around plantation stocks.

The week saw a marginal increase in foreign activity and 88 per cent of market turnover on Monday was attributed to a foreign purchase of 652,000 shares of Hatton National Bank. The share closed at Rs 85.

Net foreign inflows for the week was Rs 12.8 mn. The All Share Price Index gained 0.5 per cent to close at 552.7 while the Milanka Price Index rose 0.7 per cent to close at 899.2. The MBSL Midcap Index closed 0.5 per cent lower to register 971.47. Average daily turnover during the week was Rs 53.1 mn.

"Although the market is expected to remain at current levels over the next couple of weeks, emerging fourth quarter corporate results which should show considerable improvement over the previous year, should help reactivate retail buying," Head of Research, Asia Securities, Dushyanth Wijaysingha said.

"Plantations will show momentum over the next couple of weeks," Head of Research, CDIC Sassoon Cumberbatch Stock Brokers, Diluk Desinghe said. "There will be solid tea prices in the first quarter due to shortfalls of production in Kenya and India and with this news coming in there will be active trading.

We are recommending the plantation stocks next week for short term gains," he said.

"The market activity next week is likely to be similar to last week and we do not expect much movement in the near term," Strategist, Jardine Fleming HNB Securities, Amal Sanderatne said.

"We however continue to favour the plantation sector and high dividend yielding stocks," he added.


Lanka could be among the top-ASJ

Sri Lanka's Central Bank governor says the country's economy is expected to grow by five percent this year from four percent in 1999 with sectors like agriculture and telecommunications showing a lot of potential. In an interview with the Sunday Times Business, Mr. A.S. Jayawardene dealt with a range of issues like agriculture practices, budget practices, the world economy and the benefits of the Indo-Sri Lanka trade pact. Excerpts from the interview with Feizal Samath

STB: Economic growth ... how do you see it moving?

ASJ: I think economic growth will move at five percent this year compared to four percent last year. The same growth sectors as in 1999 will maintain their momentum.

For example we expect good growth in agriculture. We expect production to rise in tea, rice, vegetables and other domestic crops.

STB: If rice output is favourable this year, would there still need to be some rice imports this year, as has been the practice in the past?

ASJ: It depends on seasonal shortages. So far the rains are alright. The Maha crop is good but we don't know how the Yala crop would be. We expect some reasonable weather. There have been some productivity increases in rice.

STB: Other sectors where growth is expected?

ASJ: There is tremendous growth in the telecom sector this year. We would probably see the biggest expansion in this sector this year with something in the region of 100,000 lines being installed.

STB: On Tea, what are your expectations this year? Also other industrial exports?

ASJ: We expect an increase in volume, rising prices and earnings to go up to 665 million US dollars from 625 million US dollars last year. Exports are expected to rise from 277 million kg from 271 million kg in 1999.

In rubber too, we expect foreign earnings to pick up - it has been in the doldrums in recent times - to 38 million US dollars from 35 million US dollars while coconut earnings would rise to 133 million US dollars from 121 million US dollars.

In industrial production, garments export values are seen growing to 2.6 billion dollars this year from 2.4 billion dollars in 1999, petroleum exports to 86 million dollars from 70 million dollars and diamonds to 71 million dollars from 65 million.

The total worth of industrial exports this year is seen rising to 3.8 billion dollars from 3.4 billion dollars last year. Other export sectors expected to do well are leather, rubber and wood products.

Also remember this is the year when we hope to put the Indo-Sri Lanka trade agreement into practice. That will open up new vistas of trade, which are still not being anticipated now when we discuss growth scenarios.

STB: Is there finality reached on the items on the negative list of the trade pact?

ASJ: The Trade Minister told me that he was travelling to India very shortly to finalise the list. There have been problems on tea and garments and in both cases there would be a quota. Earlier these were non-quota items.

India was reluctant to allow tea and garment imports ... so now we are trying to work out quotas for the two products. Outside the negative list, everything else would be freely traded.

Originally tea and garments were not in the list. But after the agreement was signed, India wanted these items included in the list.

STB: When do you see this agreement taking off?

ASJ: I think if (both sides) finalise the list in March, trade can start in April.

STB: Could the fast-track agreement, once launched, galvanise Sri Lanka's economy this year?

ASJ: It is very difficult to say ... very difficult to predict. According to some studies that we did, if the trade starting moving, the gains to Sri Lanka would be an increase of about eight times in the amount of exports to India. It would be substantial. Sri Lanka now exports goods worth 35 million dollars to India.

STB: How is the world economy seen faring this year?

ASJ: It is expected to perform better than last year. Of course we are coming out of a recovery. The biggest problem has been the Japanese economy - the engine that drives Asia. Korea also had some major problems but if these are sorted out, then there would be a slow and steady recovery.

The Japanese economy is recovering compared to earlier when it had negative growth and when this picks up, Asia will grow. Asia would then purchase more from Sri Lanka. The Japanese recovery would also help to improve the Korean situation.

STB: What about foreign investment into Sri Lanka from South and East Asia?

ASJ: If one looks at how the global investment moved before the East Asian financial crisis, it came from the United States and Europe to Asia in large doses. But 80 to 90 percent of this investment went only to China, Taiwan and Korea. Most of it went to few of the big Tigers. What others got was very little.

The investment is now returning but it is returning to countries that are recovering fast from the crisis.

STB: Where does Sri Lanka stand in this scenario?

ASJ: This country should be an attractive place ... it should be amongst the top investment-seeking countries in Asia like Singapore, Hong Kong, etc but because of the war there is a negative image.

What we get as investment is the type of investment that comes to South Asia and India for instance. Most people who like to invest in India like to invest in Sri Lanka too.

With the Indo-Sri Lanka trade agreement we become a more attractive place to invest. One can invest in Sri Lanka and trade in India because Sri Lanka is a better place to operate than in India. I think this agreement would draw some additional investment.

So you believe it is less bureaucratic to invest here than in India?

There is much less regulation, and Sri Lanka is a cheaper place to invest. Communications are better and English is more widely used. There are a lot of attractions in Sri Lanka as an investment base.

STB: Are there any major international companies that have expressed interest in investing here - as a window to India - once the fast-track agreement gets off the ground?

ASJ: I don't have any details and it may be too premature but we have heard of some companies who may be interested, those who have a global perspective of Asia.

STB: How is the forward market in agriculture working?

ASJ: Looking at agriculture in Sri Lanka, farmers have enormous resources like bank credit, water, land, fertilizer and subsidies. But with all these resources available, agriculture productivity is growing very slowly which means there are many other problems in agriculture that must be tackled.

Land tenure or ownership may have to be addressed but I believe one of the most important issues that have been neglected is the marketing of agriculture produce. We give the farmer fertilizer, water and many other things but when the crop comes, prices are left to the mercy of the market.

Fluctuating prices, which makes it uneconomical to the farmer, is a common problem in many countries including Sri Lanka and this has resulted in limited scale forward markets here like in gherkin, passion fruit and tobacco.

Forward markets is not a new concept in Sri Lanka and this practice is now being extended to old crops like rice, so that when a farmer starts growing his product he can contract to sell it in three to four months time to a buyer.

For instance if it costs a farmer 30 rupees per kg to produce a particular commodity, he can - after keeping a 50 percent profit margin - sell it forward at 45 rupees to the buyer.

He is then assured of a realistic price for his produce.

The buyer also benefits because he pays 45 rupees for a product that, during the off-season, may cost 75 rupees. He has an assured supply; he can plan production, set up cold storage facilities because production has been planned.

The consumer is also benefited by stable prices with little or no fluctuations.

This forward market concept sets up a whole range of possibilities in the market. In the case of the farmer, if he knows he can get a solid 50 percent return on his crop - unlike today when he is eternally in debt or barely makes profits - he will put more fertilizer, produce newer varieties, use more expensive seed and generally improve the quality of his product. Agriculture can then become much more productive and cost-effective.

Banks, who act as mediators and facilitators in these forward arrangements, can recover their loans instead of forever seeing farmers in debt. These forward contracts are legally valid and can be enforced in a court of law in case of default.

These arrangements also help banks because they have a solid contract in hand compared to earlier when they gave loans on the premise of a return on crops. The system is already in place and banks are interested and getting involved. For instance, the CIC group and seed farmers have set up forward arrangements under this scheme.

STB: How do you see the services sector faring this year?

ASJ: This is the biggest growth sector. Tourism is up while telecom is growing substantially. Internationally some countries are routing their calls through Colombo because of the expert services available here. Bangladesh routes international calls to Pakistan through Colombo instead of India for instance because Sri Lanka is a more efficient gateway.

STB: What is the progress on pension reforms?

ASJ: Things are moving slowly on this front. It has to come with public sector reforms. More public servants must be trained and they should be more skilled.

Since two years ago, the Central Bank launched its own contributory pension scheme for new entrants to the bank. Now this could be a start in the area of pensions reforms.

STB: What is happening on the budget front? Is a budget being presented this year as planned or is there provision for a rolling Vote on Account?

ASJ: We need to present a budget by March when the Vote on Account - approved in November 1999 for a four-month period from January - ends.

The budget deficit, as a percentage of GDP (gross domestic product) is 7.9 percent and our target is to bring it down to 7-7.5 percent. Our budget deficits are high due to the war.

The budget would have to be passed before March because there is no money for the government after March.

If you ask me whether another Vote on Account can be passed, technically that is possible. But I don't think it is a good thing because you lose your long-term perspective.

When a government is re-elected for a second term, it is important that they set out their vision in the budget. The budget would be prepared on a three-year budget cycle on a five to 10 year planning cycle as in the past.

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