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22nd November 1998

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Colombo stocks should trade higher says Jardine Fleming Brokers

With corporate profits continuing to show positive growth, Sri Lankan stocks should be trading at higher prices, a leading equities research house has said.

During the first half of 1998, profits of the 40 companies included in the Jardine Flemings Tracker Index had grown by 54 %.

Jardine Flemings expects a profits to grow (EPS growth) of at least 30 per cent during 1998 over the previous year. The average return on equity of companies was also healthy. But the market price earnings multiples were at a historic low.

"With a weighted average return on equity of about 15 per cent, the market deserves a higher rating," Jardine Flemings said. " We advise investors to take another look at the market because there are growth and value stocks galore, all at bargain prices."

Though price levels were still low, investors seemed to be broadly following the earnings trends of the various sectors of the Colombo market.

Profits and share prices have grown in the trading, diversified holdings and food and beverage and hotel sectors, while banking, financial, manufacturing and the plantations sectors have suffered a reversal. Banks in particular were suffering because banks elsewhere in Asia were ailing.

"Obviously investor thin, these sectors are undergoing cyclical or structural change, which have had a negative impact thus far," Jardine Flemings observed. Investors have shown faith in the trade and conglomerates, food and beverage and hotel sectors, simply because these sectors are fundamentally strong.

News Briefs

Delta Logistics in joint venture

Delta Logistics (Pvt.) Ltd. recently launched a joint venture with M+R/Spedag group, a Swiss based freight forwarding company, during its first anniversary celebrations. M+R/Spedag operates in many Asian and western countries. Its operations include logistics, freight IT consultancy and a few others.

Delta Logistics provides its customers a fully automated service. Customers can obtain forms and any other information they need through their e - mail network.

The company's short-term goal is to be one of the best five transportation logistics service providers in Sri Lanka and the long term goal is to become one of the best in the world.

New flavour from Lanka Dairies

Lanka Dairies (pvt) Ltd. hopes to introduce a new flavour to the daily range of milk and other products very soon.

Officials declined to mention the flavour but said that it would be available in the market soon.

Another product is yoghurt and Lanka Dairies has invested in a new yoghurt packing plant costing Rs, 10 million.

The dairy industry that provides employment to around 400,000 families is said to be a vast potential market that Lanka Dairies is trying to tap into.

Lanka dairies presently use the services of 2500 families.

Non wash fabric from Creations Lanka

Creations Lanka international private limited recently introduced the Sarah Hughes collection of curtain and upholstery material in Sri Lanka.

The Sarah Hughes collection a product of Lance Court furnishing fabrics, of a cotton polyester blend, is said to be of a high quality material.

Representatives of the firm said that the material needed no washing, but could be kept clean by dusting or vacuvming it.

The material is targeted at the young upper middle class category.

The designs are of all bright and radiant colours and modern designs.

Sri Lanka poised for trade pact

NEW DELHI, Tuesday- India and Sri Lanka are set to sign a free trade agreement soon, the Commerce Ministry said on Tuesday. It said a high-level Sri Lankan delegation held detailed discussions with Indian officials in New Delhi on Monday and Tuesday.

"The discussions were extremely positive and resulted in a constructive exchange of views on the elements of a free trade agreement.

Official discussions will continue in the next few weeks with a view to reaching an early agreement," the ministry said in a statement.

India and Sri Lanka, members of the South Asian Association for Regional Cooperation (SAARC), have been aiming to forge a reduced-tariff regime known as the South Asian Free Trade Area (SAFTA) by 2001.

SAARC also groups Bangladesh, Bhutan, the Maldives, Nepal and Pakistan.


Another addition to the Colombo sky line

A US$ 70 million BOI approved project to build a 35-storied commercial cum residential complex on Galle roa has been planned with Chinese investor particitipation.

Mr. Azmi, manager of Wan Gou real estate development company private limited said that the investee a Chinese real estate company sees Sri Lanka's real estate industr as a potential market for investment.

He said that Sri Lanka has shown strong signs of growth despite the Asian money crisis and the investment environment very attractive for foreign investors.

'Wonder City' as the complex is known would have 200 units graded into five categories, Penthouses, one, two, three and four bed room apartments.

The first four floors would be used as a shopping arcade. Mr. Azmi said that the complex would have all modern amenities including a swimming pool, gym, etc.,. The apartments are designed such that every apartment would have a view of the sea.

He said that the apartments would be priced at around 8 million and above.

Construction of the complex is expected to begin in the first week of January next year and expected to be completed by 2003.

Revenue implications of GST

By D.N.R. Samaranayaka

The Goods and Serv- ices Tax (GST) re- placed the Turn over Tax (TT), in operation since 1964. Revenue was one of the key objectives of the replacement of TT with GST, but the emphasis at the beginning was mostly on non-revenue objectives, like the removal of the cascading effect of TT.

The replacement of TT with GST, therefore, implies that GST does not have the cascading effect. Second, to promote horizontal integration through GST as opposed to vertical integration which is supposed to be taking place under TT.

Third, to transfer the tax burden from the producer to the consumer, since the consumer directly pays GST while TT was paid by the producer although the price that consumers paid often included the TT.

Finally, to broad-base government revenue and reduce the burden from direct taxes such as income and corporate profits.

In comparison with TT, GST can result in three possible revenue outcomes; that is, revenue could be the same as TT, lower than TT or higher than TT. As reported in the budget, GST is expected to be the source with the highest revenue of Rs 58.111 billion in 1999, which appears to be even higher than the Rs. 52 billion that would have been generated by TT in 1999, if the government decided to continue with TT instead of replacing it with GST.

Cascading effect

Cascading occurs when a product or service is subject to the same tax at different stages of the production and distribution process.

This happens because taxing the final value of the product, without removing the intermediate value, results in paying tax on the intermediate value of the product twice. In addition, as the tax on the intermediate product becomes part of the final value of the product, the tax that was paid at the intermediate stage is again taxed at the final stage, which means that the tax is also taxed again.

If a product or service goes through several stages before it reaches the final consumer, then the cascading effect could be much larger. It is generally believed that TT contains these characteristics.

The cascading effect of TT or any other tax is universally regarded as undesirable since it distorts the price of the product by taxing it at various stages of the production process. The cascading does not generally occur if the product is taxed only at the consumption stage as in the case of, GST.

GST however also has some cascading effects. Defence levy is imposed on the price which already contains GST. Cascading normally occurs when the value of the product or part of the value of the product is subject to the same tax more than once.

Although the defence levy is also applied to the GST component of the product or service, the defence levy is different to the GST. Accordingly, the application of defence levy on a product or service, which is already subject to GST, cannot be considered as an example of cascading.

It is important to note that, although the cascading effect of TT has been frequently highlighted, the extent of cascading under TT appears not as large as originally perceived to be. If cascading were significant, then the prices of those products that were subject to TT would have fallen under GST to a noticeable level. It is possible that prices have not fallen because the producers are not keen to pass the tax advantage to the consumers.

Horizontal vs vertical

The assumption is that horizontal integration is better for the economy than vertical integration. The latter is said to be a more prevalent method employed by firms in production of goods or services.

It is difficult to understand how a tax system can drastically influence the production process of an organization. The amount of tax that a firm pays is subject to the decisions and policies of the fiscal authorities. It is very hard to find an organization which is trying to operate their activities as determined by the tax system.

Vertical integration oc- curs when a firm (a) has a significant control over the resources it uses in the production of a product or service, (b) produces a wide range of similar products or (c) takes control of the marketing responsibility of the product or service it produces. The first is known as the backward vertical integration and the last the forward vertical integration. The horizontal integration, on the other hand, occurs when a firm specializes in one or few products and buys its intermediate inputs from other producers.

Transfer of tax burden

The third objective is to transfer the tax burden from the producer to the consumer. Clearly, this objective can be achieved through GST. Even under the TT, it was not mostly the producer who paid the TT, but the consumer. However, the consumer was not aware that he or she was actually paying the tax. Because the tax was part of the price, producers felt that the inclusion of the tax pushes the price up and reduces the demand for the product or service. This has been a strong argument from the business community to replace TT with GST.

It is difficult, however, to arrive at a conclusion as to whether this replacement has altered the demand.


The fourth non-revenue objective of GST is to broaden the revenue base of taxation. In this context, GST has the potential, but it is likely to be weaker when there are a large number of exempted items. While such exemptions are intended to relieve the average consumer from the burden of GST, the expected broad basing may not occur since the direct effect of GST will be confined only to a few products.

Revenue, base of GST

GST is applied to the value added part of a product or service consumed by households, which is subject to this tax. As the tax is applied to consumer spending, the most logical place to consider the computation of the GST base is the consumer expenditure part of the Gross Domestic Product (GDP).

However, because the entire consumption expenditure is not taxed, the exports are zerorated and some of the imports are not subject to the GST, it is convenient to start the computation of the tax base from GDP.

The gross domestic product is the total value added in the domestic production of goods and services in a given year. When GDP is used, the tax base is derived by adjusting GDP by addition and subtraction of various expenditure items. Using the 1997 GDP in market prices, Table 1 shows the computation procedure in deriving the GST base.

Entries in Table 1 need some explanations. The first adjustment to the GDP is the addition of imports and subtraction of exports, which is equivalent to subtracting the trade balance. If the trade balance is positive (revenue from exports exceeds expenditure on imports), the adjustment reduces the GDP by the amount of the trade balance.

The reason being that we export more goods to the outside world from domestic production than we import for our consumption or investment from the rest of the world. If the trade balance is negative, on the other hand (revenue from exports falls below the expenditure of imports), the adjustment increases the GDP by the amount of the trade balance (when a negative value is subtracted, the net outcome is positive).

Capital formation refers to the investment expenditure by both the public and the private sectors in the economy. As this expenditure is not part of consumption, and not subject to GST, it must be subtracted from GDP. However, since residential construction is included under capital formation, the value of the residential construction will have to be added back since the households who constructed houses during the year cannot claim tax credits for any GST that they would have paid for the purchases of building materials which contained GST. In addition, the amount of capital formation of exempt sectors must also be added back since the exempt sectors cannot claim tax credits.

Since salaries and wages of the pubic sector constitute a part of the government expenditure and, since it is not subject to GST, this item must also be removed from the tax base.

The next adjustment involves the subtraction of exempted consumption expenditures and the consumer goods sold by exempted businesses. The exempted consumer items have been separated into domestically produced goods and imports.

Expenditures of both categories will have to be subtracted from the GST base. The expenditure involved in the first category is estimated at Rs. 172,170 million and the other is Rs. 195,020 million. These figures have been derived from various statistical tables of the Central Bank report for 1997.

The amount of Rs. 80.000 million reported against consumer goods sold by exempted businesses is a very rough estimate. The final adjustment is to add back consumer items sold by exempted businesses which contain GST and building materials in residential construction, which again contain GST. The figure of Rs. 50,000 million reported here is again a very rough estimate. The reason as explained above, is that these two groups cannot claim tax credits for the GST that they have paid.

Potential of GST

The estimate of consumer spending that would have been subject to GST was around Rs. 288,869 million or 32% of the GDP in 1997. If it is assumed that the same percentage of the GDP is subject to GST in 1998, the GST base for 1998 works out to Rs. 300,000 million providing the government with about Rs. 40 billion revenue for 1998.

Since the tax was introduced after the first quarter of 1998, the revenue collection during the balance nine months could be around Rs. 30 billion.

According to official sources, the gross revenue from GST during the first quarter of 1998 was Rs. 11.7 billion and, when refunds are taken into account, the net revenue from GST during the same period comes down to about Rs. 9.6 billion. This works out to Rs. 38 billion for the entire year or Rs. 29 billion during the last nine months of 1998, the period since the introduction of GST. The amount of tax that would have been generated if TT had been continued would be around Rs. 48.7 billion for 1998.

The 1999 budget, which has been prepared by assuming that the 1999 GDP would be around Rs. 1150 billion in current market prices, estimates Rs. 58.111 billion from GST. This suggests that the GST base of 1999 is expected to be around Rs. 465 billion (which can be derived by dividing the estimated tax of Rs 58.111 billion by the standard rate of 12.5%). As a share of the 1999 estimated GDP, the GST base is around 40%, compared with its estimated share of 32% in 1998.

If the government can raise the target revenue of Rs. 58.1 billion in 1999, then the GST will certainly have an advantage over TT as a source of revenue since the latter was expected to generate only Rs 52 billion in 1999.

However, based on the revenue data during the second quarter of 1998, it appears that the projected revenue from GST is at least Rs 10 billion greater than that can be expected given the existing GST framework.

Rs. 16b boost for BA Economy Class

British Airways is spending £150 million (more than Rs.16 billion) on their new World Traveller programme. The programme launched on November 3, will offer long haul economy passengers a host of new services and benefits; greater comfort in new ergonomically designed seats which are already receiving rave reviews, better inflight entertainment and new menus created with BBC celebrity chef Brian Turner, a company release said.

Less than a month after winning the industry 'Oscar' for their inflight entertainment, British Airways unveiled plans for sweeping improvements. Every longhaul economy seat will have its own personal video screen with 12 new video channels, 12 audio channels and a special flight information channel.

The new World Traveller Taste Of The World Menus tempt passengers with dishes from every corner of the globe; stir fried chicken with chilli plum sauce from China, smoked Nile Perch, Thai Salmon with Singapore noodles and Italian foccacia bread layered with cream cheese and roasted vegetables.

The first ever economy cabin inflight snack bars give passengers the opportunity to literally help themselves to a variety of savoury nibbles, chocolates, fresh and dried fruits as well as soft drinks.

The shift to more international cuisine was broadly welcomed during test flights during the summer as passengers enjoyed the chance to try new dishes which they would not normally cook themselves.

Passengers also gave an enthusiastic thumbs-up to the new range of cool frosted blue and brightly-coloured equipment and the revolutionary double tray which is exclusive to British Airways.

HSBC Group senior appointments

John Strickland, Chairman of The Hongkong and Shanghai Banking Corporation (HongkongBank) and of Hongkong Bank Malaysia Berhad, will retire at the end of December, 1998, after 30 years service with the HSBC Group.

Mr. Strickland will be succeeded as HongkongBank's Chairman by David Eldon who joined the HSBC Group in 1968 and who has been the Bank's Chief Executive Officer since January, 1996. Mr. Eldon has also been appointed a director of HSBC Holdings plc with effect from January 1,1999.

Aman Mehta will succeed David Eldon as HongkongBank's Chief Executive Officer and John Strikland as Chairman of HonkongBank Malaysia Berhad. Mr. Mehta joined the HSBC Group in 1968. He was appointed a Group General Manager in 1991 and HongkongBank's Executive Director International in 1998.

HSBC Group Chairman John Bond said "John Strickland has made an outstanding contribution to our organisation, above all as one of the principal architects of the Group's information technology. Throughout a long and distinguished career he has combined exceptional professional skills with a strong sense of civic duty. We shall miss John as a colleague but we wish him well in what will no doubt be an extremely active retirement in Hong Kong.

At the same time, continuity in management is one of HSBC's great strengths. David Eldon and Aman Mehta are long-serving executives with wide international banking experience. I have complete confidence in their ability to lead HongkongBank through a challenging period for Asia and to take advantage of the opportunities which lie ahead."

HonkongBank and Hongkong Bank Malaysia Berhad are indirectly held, wholly-owned subsidiaries of HSBC Holdings plc which, with some 5,500 offices in 79 countries and territories and assets of USD464 billion at 30 June 1998, is one of the world's largest banking and financial services organisations.

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