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10th January 1999

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SEC looks at futures, options trading here

By Mel Gunasekera

The Securities and Ex change Commission (SEC) is looking at the feasibility of index-based futures and options trading in Colombo. SEC Director General, Kumar Paul told The Sunday Times Business that a committee has been appointed but things are still at a preliminary stage.

Futures are obligations to buy or sell a specific commodity on a specific day for a preset price. Options are the right to buy or sell a specific commodity for a preset price during a specified period of time. Brokers and dealers in Colombo expressed mixed feelings on the first steps towards options and futures trading. "With lot of debt being listed on the CSE on fixed/floating rate basis, futures trading can be used to hedge interest rates on floating instruments, which are linked to government debt instruments, debt market specialist," Mangala Boyagoda said.

"This would, in turn, help develop Sri Lankan capital markets. Without hedging, no market can develop. A development of the equity and debt market would depend on hedging as no investment is called risk free," he added. When Sunday Times Business spoke to a cross section of stock brokers, the reaction was less bullish, more cautious. They felt Colombo was too premature for index-based futures. "A recent study on the Indian futures market has revealed that the market was not big enough for such operations, in that context the Sri Lankan market is quite small," a broker said. He felt that more effort should be put into activating the market and welcomed short selling as it permits more liquidity and transactions.

The road to futures and options trading will definitely be hurdle ridden and will take time. Among concerns are the lack of infrastructure, market size, volume of trading, costs and changes to legal framework. Even the SEC Act may require some modifications, Mr. Paul said. The main stumbling block towards futures trading was the lack of a proper index. The Colombo Stock Exchange last week launched the Milanka Price Index (MPI), which is more suited to be linked to futures trading. When the SEC is ready with the groundwork, futures and options would most likely be introduced first only to stocks. Brokers also have to sit an examination prior to obtaining a licence, a practice followed in other future/options markets.

Unlike the cash market where specifications like coupon rates, maturity, issuer, price, currency, exchange rate, quantum and other information like settlement date must be explicitly stated; futures contracts are standardised with the purchase or sale of a futures contract being limited to only one single variable, price. Trading in futures contracts is conducted in several delivery months concurrently for periods up to one year ahead and in some cases, up to 2 years.

Colombo slow on Euro

By Shafraz Farook

While record highs and lows in global stock markets heralded the launch of the euro last week, a single interbank transaction in euros was recorded in Colombo.

A few accounts were also converted to euro accounts in the same banks. Bank officials said they expected the public to use the euro for transactions in the next few weeks. All banks now provide services in euros including letters of credit (L/C) and travellers cheques.

The introduction of the euro is expected to cut cross currency transaction costs by around $65 billion a year. It is also expected to increase the already high rate of unemployment.

It is estimated that at least one in five workers will be affected by mergers and downsizing and that 5 percent of industrial workers could lose their jobs in a situation where unemployment in continental Europe already stands at more than 11 percent.

While national currencies will remain, the central banks of the member countries will lose their power to set interest rates and currency values, since the Euro-market is under the financial domination of the newly created euro Central Bank (ECB), which took over the control of monetary policy.

WLL operators and SLT at war

The two private telephone operators are complaining that Sri Lanka Telecom (SLT) is using wireless technology to expand their services in the urban areas and thus directly competing with them.

The private operators (Suntel and Lanka Bell) said they were promised the duopoly on wireless technology when they bid for the licence, but SLT was now providing wireless (wireline) services in the urban areas using the 800 MHz band.

However, the dominant carrier SLT said their technology is not limited to copper line services, but include cable, fibre, copper line and even wirelines to expand services.

But a Telecommunications Regulatory Commission (TRC) official said SLT's wireline technology is restricted to the 800 MHz band to provide service to the rural areas not in urban areas.

"SLT's action is a violation of their franchise document, is unfair competitive practice," the official said.

He said SLT was given permission to expand their network on the 800 band in the rural areas like Digana, Kandy, Anuradhapura and Galle as a temporary measure until the cable project was completed.

Now SLT wants to provide additional 30,000 lines using wireline technology on the same 800 band, which would be used to expand their services.

"If it's restricted to the rural areas we have no problem, but they are directly competing with us," Suntel's Technical Director, Mahinda Ramasundara said.

The TRC says some of the temporary frequencies given to SLT is required to expand cellular services, they cannot allocate the frequency without the impeding expansion of the cellular services.

Now SLT says they want to purchase another system, which requires the cellular service band, which is not possible, as the TRC has already reserved them for cellular expansion services, the official said. Meanwhile, WLL operators are facing an uphill task in attracting foreign funding for their expansion programmes.

"The interconnections are not going smoothly as expected, the TRC's recent determination is not favourable, and SLT is offering wireless technology in areas where the private operators are competing," Suntel's Mr. Ramasundara said.

"SLT's unfair competitive practice is hurting our expansion programmes," Lanka Bell CEO, Vijay Watson said.

Telecommunication industry sources say both operators are finding it difficult to keep to targets under present circumstances with SLT adopting various anti competitive practices. WLL operators have a target of 100,000 subscribers each to be served by the end of year 2000. However, if each operator serves less than 40,000 subscribers by the set period,a penal licence fee of Rs. 100 mn will be levied. (MG)

Patrick Amarasinghe to join the UNP

By Feizal Samath

Patrick Amarasi- nghe, one of Sri Lanka's best-known industrialists, is setting his sights on a more turbulent environment - politics.

The businessman, who has fearlessly been critical of both the People's Alliance government and the former United National Party administration and their economic or trade policies, wants to get into politics and is hoping to make an announcement shortly.

"Yes, I am entering politics," he laughed, when asked by The Sunday Times Business. "I am joining the United National Party (UNP)."

Amarasinghe, chairman of the successful Boralesgamuwa-based Woodplex/Furni Fits group, said he would be stepping down from the Presidency of the Federation of Chambers of Commerce and Industry at the end of the month.

Businessman Macky Hassim, the chamber's long-serving vice president, is taking over the reins of the chamber after Amarasinghe's long-time association in this honorary job. Amarasinghe also quit from the businessmen's group, co-ordinated by Ceylinco chief Lalith Kotalawela, spearheading the peace initiative and Kotalawela at a recent meeting of the group thanked the former chambers president for his praiseworthy role in helping to set up the group and its formidable peace agenda.

Why the UNP? "Well,I do agree that I have been critical of the party. But there is a definite need for professionals to get involved in politics and bring in a new political culture in Sri Lanka, a more peaceful environment." He said that unfortunately there wasn't the time or space left for other political parties to enter the fray (many other parties have tried and failed to make a dent) and if professionals needed to get actively involved it had to be through the two main parties - the UNP or the SLFP.

"I see a radical change in the mindset and governance of the UNP. There is new thinking brought in through a set of professionals already guiding the party. I believe the lawlessness and culture of violence associated with the party is something of the past," he said. Amarasinghe and other UNP professionals say that all major parties should strive to attract professionals so that "we could see the emergence of a political culture sans violence and corruption." Some time back the UNP set up its own group of professionals to guide it on economic and trade policy. But UNP professionals were quick to point out that the national interest came before party politics. "We may belong to any party and work for the interests of the party. That is an individual right given to everyone in a democratic country. But if the government of the day invites me to offer solutions to some economic or trade issue or sit on

Tea: harvest still to be plucked

Perhaps the brightest spot in Sri Lan- ka's economy in recent years has been the recovery and growth of the tea industry. Between 1993 and 1998 tea production increased by nearly 25 per cent.

This sharp increase is indeed commendable. The rise in tea production has been one of the important factors for the stability of the Sri Lankan economy in the face of adverse global conditions.

The country has also been fortunate in that the increased production has also been at a time when international prices rose significantly.

The tea industry had a bad run since the 1960s when the threat of nationalisation of the tea plantations hung over the industry and high rates of taxation crippled its growth potential. Then came the land reforms and mismanagement of estates. There was some degree of recovery in the 1980s but owing to low international prices the industry faced a situation where the cost of production was higher than estate level prices.

This was also due to the low productivity of tea lands consequent to the preceding chain of events.

The hand over of management of the estates to private firms and subsequent privatisation of the plantations has added new vigour to the industry.

At the same time good prices have resulted in small holder tea cultivation significantly. All these factors have now led to a significant growth.

While there is little doubt that private ownership of the plantations has been an important factor in the better management of tea plantations and their growth of production, there is another fact which is less appreciated. Unlike at the time of independence when most tea was produced on large plantations and small holdings were an insignificant adjunct to the industry, today small holdings produce the bulk of tea.

Therefore the startling increase in production of tea is not entirely due to an increase in production in the plantations but a response among small holders to price incentives, which have resulted in larger extents of land being brought under small holder cultivation and an improvement in their yields.

There is however a long way to go for the industry to reap its full potential. In fact, the low levels of productivity of Sri Lanka's tea lands compared to East African and Indian producers should now be looked at as a prospect for increased productivity.

Improvements in productivity of tea lands would indeed contribute handsomely to the country's economic growth. We must attempt to re-gain once again our position as the best tea producing country, just as much as we have once again reached the position of the largest exporter of tea.

The tea industry is not without its problems. Labour shortages are emerging and social development on the estates may move many plantation workers to other occupations. There is a need to change the mix of tea production between traditional types to CTC teas. These are in greater demand specially in tea bags.

In the light of the labour shortages, there would be a need to introduce new technologies which are labour saving. A higher proportion of value added tea exports should also be achieved.

A crying need is to improve tea research so as to develop better clones and improve advisory facilities. The privatisation of the Tea Research Institute may be inevitable if we are to achieve this objective.

Small holders have achieved so much with so little support and poor, infrastructure and services.

A more integrated approach to provide facilities to improve the quality of their teas and enhance their productivity is needed.

The growth in tea production in the plantations and small holdings is indeed a fact to celebrate. Yet there is much more to be achieved and it is important to recognise that tea, despite its declining significance in national income owing to the diversification of the economy, is yet a very important source of economic growth and foreign exchange earnings.

There should be a definite target for the country to achieve the world's best tea producing status within the next decade. We must gear ourselves to achieve it.

East Asia

Restructuring corporate debt a formidable task

High levels of corpo- rate debt are inhibit- ing recovery in the East Asian countries that are digging out from the regional crisis.

Onerous debt-servicing costs threaten the solvency of corporations; credit to small enterprises is crowded out as banks feel obliged to roll over loans to large heavily indebted borrowers; and the adverse effect of higher interest rates on highly leveraged corporate balance sheets limits the scope for monetary policy.

Moreover, the debt overhang is self-perpetuating: the recession prevents corporations from deleveraging by retaining earnings or issuing equity, but the high level of debt is prolonging the recession.

Governments in East Asia are taking steps to restructure corporate debt, but the challenges debt restructuring poses are formidable.

A recent study, Coporate Debt Restructuring in East Asia: Some Lessons from International Experience, by Mark Stone of the IMF's Asia and Pacific Department, derives some general principles for debt restructuring from past experience and applies the lessons learned from these experiences to East Asia.

Comprehensive Frameworks

Corporate debt restruc- turing aims at a timely and orderly transformation and reduction of debt. The goal is to enhance profitability, reduce leverage, and restore credit to viable enterprises.

To ensure that creditors and debtors have incentives to restructure debt, the approach must be tailored to individual economic, institutional, and political circumstances.

The approach can range from a case-by-case effort led by banks to a comprehensive framework requiring government involvement.

For the East Asian countries, a case-by-case approach to corporate debt restructuring led by banks is not feasible, because banks have limited experience with loan workouts, low capital adequacy ratios, and a history of government influence and poor supervision.

Further, the legal, tax and regulatory infrastructure needed for debt restructuring was not in place when the crises erupted.

A comprehensive debt restructuring framework involving the active participation of the government is called for when, as in East Asia, corporate debt problems are widespread or have macroeconomic consequences, when market failures inhibit the debt restructuring process, and when banks are short of the capital and expertise needed to work out debt on a large scale.

Extensive financial reform is also needed in these circumstances, because bank and corporate balance sheets are interwined. Further, a workable bankruptcy law is essential to give debtors an incentive to co-operate.

Comprehensive corporate debt restructuring consists of four segments:

establishment of the appropriate macroeconomic, tax and legal environment;

formulation of the debt restructuring framework;

triage, or the separation of the viable corporations for debt restructuring from the nonviable ones that should be shut down; and

financial engineering, involving debt reduction and debt-equity conversions.

Formulation of the appropriate framework is, according to Stone, the most complex part of comprehensive debt restructuring.

Frameworks may be divided into four overlapping categories that may be implemented at the same time.

The categories in ascending order of government involvement are:

Government mediation. Mediation between corporations and banks or between banks is warranted if banks cannot effectively lead bank restructuring, owing to market failures or other factors such as excessive negotiating powers by either debtors or creditors, a lack of co-operation, or a lack of incentives for banks or corporations to work out debt arising from poor supervision and bad governance.

Government schemes. Financial incentives to facilitate debt restructuring through a preset government-financed scheme can be useful if corporate debt problems are pervasive and impose negative externalities on the economy at large such as a credit squeeze or cutoff of external financing.

However, the government must trade off the fiscal costs of the scheme against the benefits of more expedient restructuring for the players involved and the lowering of negative externalities.

Direct bank recapitalization by the government. This aproach is warranted if corporate debt problems are pervasive enough to undermine the health of the banking system and if banks are willing and able to work out debt on their own.

Government asset management corporation. If the number of troubled corporations is large, microeconomic factors severely inhibit debt restructuring, and bank-led debt restructuring is infeasible, a government-financed asset management corporation may be warranted.

Such a corporation can buy bad loans, provide equity to banks and corporations, negotiate with debtors, and take an active financial and operational role in restructuring.

An asset management corporation can also serve as an out-of-court bankruptcy mechanism, if bankruptcy courts are ineffective.

General Lessons

Stone derives several general lessons appli cable to East Asia from a review of corporate debt restructuring undertaken by various countries since the 1980s Mexico in the early 1980s and again in 1995-97, Chile during the early and mid-1980s, the United Kingdom, where the "London Approach" has been in use since 1989, Hungary during 1991-95, and Poland during 1993-96.

A healthy and stable economic and institutional environment is crucial to the success of corporate debt restructuring, according to the author. Preconditions include:

Macroeconomic stability. Debt restructuring makes the need for entrenched macroeconomic stability more urgent, because stable prices, interest rates, and exchange rates are needed to give debtors, creditors, and potential investors enough certainty to value and close transactions.

Macroeconomic stability proved to be a precondition for debt restructuring in Mexico in 1995 and in the transition countries.

Financial reform. Banks should have enough capital to give them the leverage to write off debt without widening spreads and to negotiate with large creditors on equal terms. At the same time, supervision should he improved to ensure that banks have incentives to work out debt.

Limits on banks' exposure to their largest borrowers can help establish an arm's-length relationship. Financial reform accelerated restructuring in Mexico in the 1980s and in Poland.

Removal of tax regulatory disincentives to restructuring. Taxes that penalize debt forgiveness and loan-loss provisioning and restrictions on foreign ownership should be removed, and legislation to remove impediments to debt-equity swaps should he enacted.

New incentives should be temporary to avoid erosion of the tax base and have sufficient safeguards to prevent abuse.

Bankruptcy procedures. Effective procedures are needed to work out debt outside a formal framework and ensure that credit is not absorbed by nonviable firms. The absence of effective bankruptcy procedures slowed restructuring in transition countries and in Mexico in 1995.

Corporate governance must be brought up to inter-national standards. Effective governance is needed to push managers not only to restructure debt but also to operate profitably and thereby avoid future reschedulings. Accurate, timely, and accessible financial information on corporations is essential.

Corporate Debt Restructuring

The systemic crisis of the corporate sector in East Asia originated in the interaction between an aggressive export-oriented growth strategy initiated in the 1970s and the system of corporate governance and financing. Government-controlled banks directed loans to chosen export-oriented industries, while regulatory barriers constrained the issuance of bonds, limiting the role of foreign banks.

Bank borrowing was dominated by a small number of conglomerates, dominated in turn by a handful of owners unconstrained by international standards of corporate governance.

Changes in policy coupled with international capital market integration in the 1980s increased the riskiness of corporate balance sheets. At the same time, high domestic growth and the lifting of restrictions on foreign borrowing triggered a surge of capital inflows that resulted in overleveraging of poorly supervised banks and corporations.

Corporations were lulled into a false sense of security by stable exchange rates pegged to the US dollar and did not hedge their foreign currency exposure.

The regional crisis that began in mid-1997 buffeted corporate balance sheets and cash flow. Domestic banks were no longer willing or able to provide financing. Corporations were further squeezed by the drop-off of capital inflows, which also resulted in large exchange rate depreciations that increased the cost of servicing foreign debt.

At the same time, higher interest rates raised domestic debt-servicing costs, and profits were hit by falling demand. As a result, already high corporate debt-equity ratios in East Asia rose to levels well above the international norm (see chart).

Recognizing that the high level of corporate debt is inhibiting recovery, governments in East Asia are taking the first steps toward debt restructuring.

Reviewing the experiences of Indonesia, Korea, Malaysia and Thailand, Stone finds that these efforts have concentrated on improving the macroeconomic and institutional setting; financial markets have been stabilized in most countries; financial sector reform, including bank recapitalization, is well under way; corporate governance and accounting standards have been enhanced; tax and legal disincentives for debt restructuring are being removed; and bankruptcy procedures have been revised.

Several countries have established government schemes to improve incentives for debt restructuring, and all of them are recapitalizing banks. They have also set up an asset management corporation and created frameworks involving various degrees of government mediation.

The process of debt restructuring itself is now in train in East Asia. It remains to be seen, Stone concludes, whether a more active government role will be needed to enhance restructuring incentives.

(Courtesy THE SURVEY)

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