Business Times

Annals of policy: directing capital where it’s needed most

Everyone in Sri Lanka, and overseas for that matter, seem to have an opinion on the behaviour of the local stock market. Worse, more people seem to have policy prescriptions on how to manage “speculation” in the markets than the regulator.

The latest episode in this drama has now shifted to the impending budget and speculation as to whether it would provide a silver bullet solution. Anyone waiting for the budget to provide guidance on neutralising the stock market rise is in for a major disappointment. The budget’s purpose is to outlay government expenditure and revenue, regulating and signalling the market is the duty of the SEC, and rightly so.

That said, the budget is an opportunity to fix the current credit and investment imbalance in the country. A first step in this direction is to make all investment vehicles tax agnostic, except when the government wants to specifically direct investment flows to an area. The current investment landscape in Sri Lanka provides an unfair advantage to two asset classes at the expense of others. In the process it causes significant damage to the broader economy. Shares and foreign currency accounts are completely tax free, while local fixed income investments (bank deposits) and other assets are unfairly taxed. In the process, the banking oligopoly are milking the funding spreads, investors are piling money into an illiquid and highly concentrated share market depriving credit to smaller businesses.

It’s hard to believe that in the 21st century local policy makers and government believe that supporting large corporations will guarantee high employment along with economic growth. Research shows the opposite to be true. While high quality data is hard to come by, the SME and informal sectors of the economy employs 50-60% of total workers. These unfortunately are also the very firms struggling for credit as they aren’t listed to tap into the growth in the share market, and banks refuse to take the credit risk.

The government should take a radical approach to fix this system. While levelling the playing field (in terms of taxes) is a start, they should use the budget to increase credit to small businesses and entrepreneurial start-ups. One way to do this is to actually use the funds being directed to the share market.

The government should create a sovereign backed (privately run) listed investment company (LIC) or unit trust. Essentially it will be a close-end fund(s) traded as a share in the CSE, but the underlying pool of money will be exclusively directed as credit to deserving applicants. The structure helps increase credit supply, and investors get all the benefits currently attached with share investing. The trading value of the LIC will be a function of both liquidity and the Net Asset Value (NAV) of the underlying pool.
This will be a serious challenge to banks that currently refuse to lend as the LICs can offer competitive rates given the cheap funding source available via the CSE. Second, investors can redeem their investment without actually causing a run on the undrlying pool of assets, due to the trust being closed-end.

Using a LIC approach the government gets to resolve the three largest policy concern of the moment (an overheated share market, unresponsive highly profitable banks and lack of credit growth to small businesses).

In the 1950s as the US was falling behind in the space race against the USSR, it was a strategic policy decision to provide research funding for engineering, that led to the birth of the innovation behemoth that became the “Silicon Valley”. Many countries have tried to copy the model and failed by not understanding the roots behind its success. Private entrepreneurship grew because the government arranged cheap funding along with tax advantages, and kept away from directing the kind of research and innovation that took place.

Sri Lanka must get out of the cult of favouring big businesses, by providing both tax breaks and supporting cheap credit (via the stock market). It should instead focus on the small business sector that is going to be responsible for the highest growth and employment opportunities. This should also extend to a policy revision of the “attracting large foreign companies at any cost” culture. If policy makers want to truly attract high quality FDI, all they need is build basic infrastructure around the country. After speaking with over 300 listed firms worldwide, tax breaks came out much lower than high quality roads, fast trains and uninterrupted and cheap electricity. Surprisingly, this was consistent for both service as well as manufacturing firms.

The share market may well be the ultimate symbol of capitalism, but capitalism runs the real risk of killing competition, which is why sensible regulation is needed to drive capital to those who deserve it most.

(Kajanga is an Investment Specialist based in Sydney, Australia. You can write to him at

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