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15th November 1998

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Mind Your Business

by Busi Bug
Logo battle

With the present sponsorship contract expiring, there is now hectic bidding to get a sponsorship logo on the cricketers before the year's end. Already allegations and counter-allegations are being bandied about. All we can say is that several top corporate players are in the fray. But for sure, we don't want another Worldtel style scandal...

New laws

The good professor, just as we predicted last week, resisted the temptation to reduce petrol prices in the budget. But, he did announce reforms in duty-free allowances.Close on the heels of these reforms will be a crackdown on outlets selling goods - mostly electronic appliances - in the local market at duty-free prices. Even new laws may be introduced for this purpose, we hear.

Too tempting

Recently, it became a "fashion" among banks to offer lottery style prize draws to attract depositors. After the bank which pioneered this concept recorded a phenomenal deposit base growth with the introduction of such a scheme, others quickly followed suit. Recently, even the usually reticent state banks joined in the fun offering such lotteries but one private bank steadfastly stuck to its decision, 'no lotteries for depositors'. But now we hear, even that bank might have a change of heart.....

New index to replace the 'blue chip' 

By Mel Gunasekera

A new 'blue chip' index, more representative of Colombo's top equities will replace the existing sensitive index. The new index would be christened with a name of local flavour, a top CSE official said.

"The new index will come into effect from January 2,1999," CSE Director General, Hiran Mendis told 'The Sunday Times Business'. "We have constructed the index taking into consideration internationally accepted criteria," he said.

The Sensitive Index, which carries a basket of 25 blue chip companies, is handpicked on selected criteria.

The existing criteria include market capitalisation, healthy P/E ratios, liquidity and returns. The selected companies also have to comply with the CSE's continuing listing rules.

The criteria for the new index would be based on market capitalisation and liquidity, and will feature the top 25 companies listed on the exchange, he said.

The sensitive index which was constructed in early 1990s, was last revised in 1994. "We hope to revise the index on a yearly basis," he said.

The CSE is expected to make a public announcement next month about the features of the new index, the companies that would be listed and the criteria on which they were selected.

The new index may boot out some companies in the sensitive index who fall so short of the qualifying criteria that trading on their shares are even under suspension right now.

Companies in the blue chip index at present are: Asian Hotels, Bata Shoe Company, Blue Diamond Jewellery, Lanka Ceramics, Central Finance, Chemical Industries, Commercial Bank, Ceylon Oxygen, Ceylon Tobacco, Developed Finance Corp. of Ceylon, Colombo Dockyard, Ceylon Grain Elevators, Hayleys Ltd., Hatton National Bank, John Keells Holdings Ltd., Korea Ceylon Footwear, Lanka Orix Leasing, Merchant Bank of Sri Lanka, National Development Bank, Pure Beverages, Richard Pieris, Sampath Bank, Singer (Sri Lanka) Ltd., Aitken Spence and United Motors.

Brokers say the present index holds nearly folding companies like Blue Diamonds Jewellery, Korea Ceylon and Merchant Bank should not be listed on the sensitive index.

East Asian models from developed markets like Hong Kong, and Kuala Lumpur, were used as guidelines to change the criteria to formulate the revised index.

During the last week or so, the sensitive index has been steadily climbing at much higher percentage increase than ASPI.

The CSE was recently elected to full membership status of the FIBV (Federation of International Stock Exchanges). The election made CSE, the first in the South Asian region to obtain full membership. In 1991, the CSE was the first Exchange in the region to set up a Central Depository and automated post trade operations.

The full membership status is an endorsement that the CSE is on par with other stock exchanges worldwide.

CMC bonds to hit the debt market

The Colombo Municipal Council (CMC) is to raise Rs. 600 mn worth of municipal bonds for future development work, city Mayor Karu Jayasuriya said. 

Among the projects being earmarked is a trade and housing complex at the Wellawatte market grounds. The CMC intends to recover the project expenses by selling the houses and trade stalls. The National Development Bank has been called in to prepare a feasibility report, he said. 

"A positive step towards capital market development," USAID Trainer on Capital Market Development, Seth Isaac said.

Municipal bonds are raised to improve the infrastructure facilities within the municipality.

In the USA, the municipal council needs voters' approval prior to floating the bonds and only voters in the municipality can vote for it.

The terms of the bond, par value, maturity, interest rate, the purpose of the loan, underwriters to the issue etc have to be first approved by the voters before the municipal council could go ahead with the issue, Mr. Isaac said.

There are two types of municipal bonds; general obligation bonds and revenue bonds.

In the case of Revenue bonds, the project itself pays the interest and principal. For instance a toll fee would be charged on a roadway from point A to B. Money raised through a bond issue would be used to pay back the interest and principal.

In the case of General obligation bonds, it is the general obligation of the issuer i.e. local government to pay the interest on the monies being raised.

The bonds can be issued either through a government appointed primary dealer or as an Initial Public Offering (IPO).

Some analysts say the government may be against such issues. Government is trying to finance the on going war by selling TBills and TBonds. They feel that if the CMC excels, the government bond market may fall apart as the bond market is still in its infancy. 

"We have got government blessings for the issue," the Mayor said.

Though the opposition CMC members are not too happy with this move, the Mayor said the concept was being misunderstood and he hoped to apprise the members of the situation once the full report was ready.

Debt Market

Doors to open for unlisted companies

The Colombo Stock Exchange (CSE) will soon open its doors to unlisted companies for debt trading.

The CSE is ready with a set of regulations for these companies to list debt.

A brand new index for debt will also be ready soon.

At present only listed companies on the CSE, like Vanik Incorporation, Ceylinco Securities, Overseas Realty, Hatton National Bank, Commercial Bank and Ceylon Glass Company have listed their debentures on the CSE. Seylan Bank is yet to list their debentures. The Stock Exchange lists the debentures on the debt securities board.

The amended rules are expected to encourage greater secondary market activity in debt. 

Preliminary studies done by the CSE indicate, a high potential for the development of the debt market, provided that listing of debt is granted to companies, independent of listing equity, CSE Director General, Hiran Mendis said.

Under the new amendments, unlisted companies could seek a listing provided they obtain a backup credit line or a guarantee from a regulated financial institution for the repayment of capital and interest of the listed securities.

A rating from the soon-to-be-established rating agency would also be required.

This strategy will also provide an incentive to financial institutions to encourage their clients to list debt instruments, since they will be able to effectively diversify their portfolio risk and raise funds in the market.

Clean sweep for Jardine Fleming

Jardine Fleming HNB (JFHNB) has won Asiamoney's coveted title 'best stock broking house in Sri ImageLanka for 1998.'

JFHNB has also topped the list in research, specialist research and sales and tied the second place slot in execution.

"This is the first time we have had a clean sweep like this, although in previous years since 1993 we have always been ranked No: 1 in research," CEO/Managing Director, Anura R Wickremasinghe told 'The Sunday Times Business'.

HSBC Securities have come in second in the overall rankings, though they tied for the first place for execution. Sassoon's is ranked third in the overall rankings. While ABN Amro Asia has been ranked second in research and sales.

Between July and September, Asiamoney magazine polled by telephone, post, facsimile, e-mail and in person more than 700 institutions that invest in Asia-Pacific equities. A total of 193 institutions and an estimated 450 fund managers responded, representing US$ 230 bn in assets dedicated to the Asia Pacific.

Investors nominated their three preferred brokerage houses in 15 markets across the region in the following categories: overall research, specialist research, sales, execution. The results are weighted by the average funds under management for the Asia Pacific in the year to June 1998.

Three points are awarded for the first place, two for second and one for third. In specialist research, the results are weighted according to the rank assigned to each category by the respondent.

Jardine Fleming also won the title of Asia's best Stockbroking House for the fourth consecutive year. Closely trailing JF is CLSA, Warburg Dillion Read, Merrill Lynch and ING Barings. Talking point

Local brokerages have ganged up to ask the question of the day. How did a banking institution (without a broking/research arm) win in stockbrokers' research poll?

The Sri Lankan securities arm of Hong Kong Shanghai Banking Corporation, HSBC Securities has been ranked third in research and specialist research of the Asiamoney poll. 

HSBC General Manager Richard Law told Sunday Times Business, "We don't have a research department. We deal with large custodian banks, and also with certain trust funds (foreign and local). We don't give any broking advice."

A little good in no-harm budget

The budget presented on Novem ber 5 turned out to be a dull one. A dull budget is not necessarily a bad budget. The budget, however, lacked both credibility and pro-activeness. In a situation of a global downturn in economic activity and a climate of low confidence, a more pro-active budget could have inspired the much needed confidence. 

Basically, the budget for 1999 is a re-statement of the earlier framework of economic policies. It adhered to the policies promulgated in earlier budgets, was not harsh in its taxation measures but did little to spur the economy. 

Its main strength was the continuity of policies and further strengthening of the framework of policies to ensure a private enterprise led growth strategy. The organised business community in fact considered it a good budget. They even accepted the increased National Defence Levy as necessary under present circumstances.

The budget discloses the weaknesses in the fiscal situation that we commented on last week. In that context we pointed out that the government's ability to steer a more dynamic role for public expenditures was impractical. 

This is seen in the budget figures that were disclosed. We also pointed out the government's concern for keeping to containable budget deficit in a context of a large public expenditure commitment on defence, administration, welfare and debt servicing.

What is however startling is that the figures presented in this budget lacked credibility in the context of recent expenditures. Could the budget deficit be contained within 6 per cent of GDP? 

Although the budgetary figures demonstrated this, the out-turn is not likely to conform to it. The indications are clear from the very outset. For instance, defence expenditures are placed at around the same level as last year's budgetary provisions on defence, which have already been overtaken. 

How can defence expenditures for 1999 be less than the defence expenditures for 1998? That is most unlikely. One could argue, unconvincingly, that the war would come to an end. If this was so, there is a possibility of expenditures on military hardware being reduced. 

But can one realistically present a budget which incorporates this elusive peace into the budgetary calculations? The country is so familiar with supplementary estimates for defence that the budgeted expenditures are taken with a pinch of salt. 

Similarly, there is every possibility that other expenditures too would have an over-run. This may be particularly so if next year is to be an election year.

There is also doubt that the revenue proceeds would keep to targets. Apart from unrealistic under estimates of expenditure on the current scenario, there is every possibility that revenues would decrease if economic activity slows down. And there is every prospect that there would be such a slow down if global economic conditions continue to be unfavourable. 

In such an event it is most likely that there would be a shortfall in revenues and expenditures would exceed revenues by a considerably larger amount. The anticipated current account surplus of Rs. 15.1 billion or 1.3 per cent of GDP would then remain unrealised and the budget deficit would increase. If, as the government argues, a higher budget deficit would lead to inflation, then it is most likely that the increased deficit would result in higher interest rates and increased prices. The rate of depreciation of the Sri Lanka Rupee could also gain in momentum just as it did in the first ten months of this year. This too would fuel domestic inflation.

The investor community and the international agencies would look at the hard facts and come to conclusions that the original figures that have been presented are not likely to be achieved. Then the government's declared objective of a low budget deficit will not be achieved. 

We would have an economic environment which would not be conducive to growth. Certainly the budget lacks a pro-active role which would have enhanced private investment. In defence of the government it must be said that the possibility of such a role was, in any event, remote and difficult because of the fiscal constraints which we discussed last week.The government must however be congratulated on not making the budget a populist one and thereby ruining the economic fundamentals. In the tight fiscal conditions there may have been little else it could have done. Even if the budget has done little, at least it has done no harm.

Asian markets first to recover

Foreign investors have voted with their feet and pulled out of emerging market equities after suffering extensive cumulative losses over the past year.

A quick turnaround in these markets seems unlikely, but many of them are now extremely cheap, economic fundamentals are slowly improving in some Asian markets, and reforms are underway in Latin America.

We thus expect Asian markets, which have outperformed recently to be the first to recover as recessions bottom and investors become less risk averse.

Latin markets have performed much worse than US markets in recent months, and will continue to be bogged down by the poor commodity price outlook, the prospect of weaker US growth, and policy reforms that are at a comparatively early stage.

Our analysis of past performance suggests that in prioritising countries, investors should pay particular attention to policy reforms, commodity price trends and international liquidity.

Significant returns can be made by correctly anticipating large shifts in economic policy regimes, commodity price fluctuation in markets heavily dominated by only a few commodities and shifts investors sentiment towards emerging markets as an asset class, as well as towards particular countries or regions.

Foreign investors have now turned their backs on virtually all emerging market equities in reaction to the steep cumulative losses suffered by this asset class over the past year.

While the extent and broad spread of losses is unprecedented, the history of emerging market performance is one of extreme volatility.

Therefore, are there any lessons from past performance which would help an investor decide which, if any regions and countries to target? In addition, what are the prospects for these markets?

The experience of recent months has reaffirmed the importance of differentiating investment strategies not only by region, but also by country. Emerging, markets produce premium returns over very long time periods, 10-15 years. If an investor cannot lock away funds for this length of time, premium return can only be achieved by actively trading these markets. In doing this, our analysis of past performance suggests that an investor should pay particular attention to policy reforms, commodity price trends and international liquidity.

Since mid-year, Asian markets have outperformed both Latin America and the S & P, but are still down. Reforms have started to take hold in most crisis countries, and the first signs of economic stabilizations are emerging, 

We expect this region to be the first to recover in 1999 as recessions bottom and investors become less risk averse.

Emerging market equities outperformed US, Japanese and German equities from the mid-1980s to end 1993, but have crashed since then. Overall, from end 1984 to end September 1998, emerging markets returned 8.4% pa to the US dollar investor well down on the return from US (13.4% pa) and German equities (13.6% pa).

Among emerging market regions, Latin America has been the better place to invest since the mid-1980s returning 16% pa, compared to Asia's 60%. 

Equities in Asia also performed best in the period up to 1993 whilst the three-year peak return in Hong Kong and Singapore (which are not part of the IFC regional aggregates) was 1991-93. Not surprisingly most major markets have had their worst three-year performance in 1996-98.

Nevertheless Hong Kong, the Philippines and Taiwan, have still been able to outperform the US since the mid-1980s.

Over the last few months the reputation of emerging markets as a good place to invest has been shattered, first by the Asian crisis, then by the collapse, in Russia, Brazil's problems, and the interventions in the market in both Malaysia and Honkong. But the history of emerging market performance is one of extreme volatility so the chances are that they will bounce back at some point.

Analysis of past performance suggests that three factors, policy reforms, commodity price trends and international liquidity are key drivers of performance. Economic growth is harder to match to periods of outperformance.

Economic reforms influence emerging market performance through various channels. Successful macroeconomic stabilisation policies, lower inflation and interest rates, thus directly increasing the relative attractiveness of equities, whilst also raising the prospect of faster economic growth and corporate earning gains.

Progress on structural reform, especially privatization and trade liberalisation, tends to increase productivity and efficiency thus further underpinning the prospect for improved growth and earnings. Stock markets usually thrive in the early phases of reform programmes and thus seem driven largely by anticipation of future growth and earnings. They can provide attractive returns at such times

Most Latin American countries adopted comprehensive economic stabilisation and structural reform programmes between the mid 1980s and mid 1990s. The period during which equity markets performed strongest in these countries roughly corresponds to the period during which the stabilisation and privatizations efforts were launched. Chilean markets performed best between 1985-87, Mexico's between 1988-90, Argentina's between 1988-91 and Peru's between 1993-95. Eastern European markets followed similar patterns although with a slight time lag. Peak market performance, in Hungary and Poland was between 1993 and 1995, after reforms started to take hold, rather than at the outset of reforms probably due to the greater complexities and higher risks involved in the transition from state-run economies to the free market system.

Commodity price fluctuations can be an important determinant of stock market performance especially to countries where exports and the overall economy are dominated by a few commodities. Commodity price fluctuations are rarely the sole determinant of equity market behaviour. But an illustration of their potential impact is provided by Chile, where a copper price surge between 1993 and 1995 supported strong market performance, and the sharp downturn of copper prices in 1997 and 1998 contributed to the steepest market decline. 

Gold prices in South Africa and oil prices in Venezuela have had similar effects. Anticipating price shifts correctly therefore can provide opportunities for investors.

In countries with more di versified economies the relationship between market performance and commodity price fluctuations becomes less strong. For instance Mexico's best market performance between 1991 and 1993 occurred despite world oil price weakness.

Fluctuations in particular commodity prices tend to be offset by counterbalancing moves in other prices. In the case of oil prices, oil exporter losses will be offset to some extent by oil importer gains.

In 1998, however, the recession in Asia has caused commodity prices to fall steeply across the board and thus has affected many emerging markets simultaneously even those in more diversified economies.

International capital flows to emerging markets surged during the early 1990s and drove the strong performance in some of these markets. 

Several factors were behind this trend including the liberalisation of capital accounts, and the opening up to foreign investment, the extensive privatization of large public sector enterprises attracting capital, and above all - low interest rates and high liquidity in major economies which combined with a perception of reduced emerging market risk and led to a sharp fall in risk premia.

The effect of increased capital flows on stock market performance is especially evident in Asia. Most Asian stock markets had their best 3-year performance period between 1991 and 1994, as capital inflows into the region surged. China due to its later opening benefited from capital flows somewhat later with a correspondingly better stock market performance in 1996-97.

Anticipating the direction of these international capital flows thus offers attractive returns.

International capital flows, however, can go in both directions and given the growing volume, of worldwide flows the contagion risk is now acute.

The first significant instance of contagion since the surge in international capital flows to emerging markets was the Mexico crisis in 1994.

This spread to Argentina which was vulnerable due to its weak banking system and the strictures of its currency board, but had a lesser impact on most other countries of the region, and an even more muted impact elsewhere. 

The very benign risk perception of emerging markets from the early 1990s thus suffered only relatively limited set-back and market losses were largely contained to Latin America.

Economic growth is a poor market guide.

Actual economic growth tends to have a more tenuous influence on stock market behaviour often lagging market trends. In Asia. almost uniformly high GDP growth rates from the late 1970s through the 1980s were only partially linked to equity performance.

However the slowdown in GDP growth in a number of countries from 1995/95 correspondent to the flattening of stock markets that started in 1994. 

In Latin America the strong performance of equities from the late 1980s to 1997 was coupled with a much less spectacular and more volatile DGP gowth performance than in Asia. In several instances, peak market performance occurred during the early phases of economic recovery with GDP growth still or just beyond negative territory. (e.g. Argentina, Brazil and Mexico). 

The stock market rally in Eastern Europe during the mid 1990s was linked to economic recovery from transition, but with GDP growth still weak (e.g. Hungary).

Stock market growth appears more firmly driven by expectations of more spectacular future earnings growth than by actual gowth.

Why the Asia crisis was different

In contrast to the Mexico crisis, the collapse of Asian financial markets in 1997 spread quickly within the region, and has subsequently pulled down Russia and dispersed to South Africa, Latin America and parts of Eastern Europe. The only countries spared have been in Europe and the Middle East and those with partial capital controls. Many factors contributed to the contagion, most importantly the sea-change in risk perceptions amongst investors after Russia's partial default in August 1998.

The accompanying withdrawal of funds from emerging markets exacerbated stock market declines in affected countries as well as spreading them across regions.

Another factor that contributed to the spread of the crisis was the decline in commodity prices caused by the recession in Japan and the rest of East Asia.

The wide range of affected prices weakened equity markets in many countries simultaneously even the normally immune, more diversified, ones.

Finally, sharply collapsing stock markets, hit confidence and spending, pulled down growth and provoked further equity falls.

Whilst emerging markets are being affected by the current risk eversion aross-board, the intensity of the equities contraction varies more in line with economic fundamentals. Thailand, Korea and Indonesia all suffered average market contractions of over 40% during 1997-98 whereas the more solid economic underpinning of Singapore and Taiwan cushioned the stock market contractions, as did partial capital controls in countries such as India and China.

The contagion effect on Latin America has also resulted in less severe market contractions so far, contractions which have also varied in line with relative economic fundamentals; ie. Argentina has suffered less than Venezuela. But given the generalised shift in sentiment against emerging markets better fundamentals have not prevented market losses.

Returns from equity investment in emerging markets are determined by a host of factors, From those analysed here several lessons emerge:

1. Singnificant returns can be made be predicting large shifts in economic policy. Equity markets are likely to outperform at the early stages of comprehensive reforms programmes or vice versa, are like to contract in countries at the verge of severe policy reversals.

The risks are clearly in the timing and in correctly identifying the scope and duration of policy shifts.

In addition, other factors, such as international capital market trends or commodity price shifts can intrude on the linkage between reforms and market performance.

2. Correctly anticipating commodity price shifts can offer attractive returns in some emerging markets, especially where commodities dominate stock market trends.

The more diversified a market becomes, the more is it influenced by international capital markets, and the more it is affected by other domestic trends such as lower interest rates.

3. Probably the most difficult thing to do is to anticipate shifts in investors risk sentiment both towards emerging markets as an asset class as well as towards particular countries or regions. 

Returns on success can be substantial with the experience of this year suggesting that they are likely to be particularly high in predicting the timing of a downturn. Pay-offs can further result from correctly picking countries especially those on both extremes that are either most vulnerable to contagion or tend to have some immunity from contagion effects.

Less comforting is the experience this year that economic fundamentals may influence the scale of losses in a downturn but may not necessarily prevent them.

What are the prospects for a recovery in emerging market equities? Our assessment of global trends suggests a slowdown in most advanced markets that is likely to continue to depress commodity prices and investors risk perceptions.

But the weaker dollar is a support, many markets are now extremely cheap, economic fundamentals are slowly improving in some Asian markets, and additional reforms are underway in many Latin countries that will ultimately strengthen their prospects. Timing and country differentiation will be the key to successfully exploiting these trends.

Since mid-1998 Asian markets have held up well. Reforms have started to take hold in most crisis countries, and first signs of economic stabilization (stable currencies despite lower interest rates, local buying) are starting to come through. 

We expect this region to be earliest to recover once investors are less risk averse. Latin markets, in contrast have performed poorly due to contagion and Brazil worries.

The region will continue to be bogged down by weak commodity prices and policy reforms that are at a comparatively early stages and will require further time to show effect. 

Therefore investors should start building in Asian markets now but stay neutral in Latin America.- 

Courtesy: American Express Bank Global Economics

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