10th October 1999
Are political changes important for business? The question has arisen once again owing to next year being an election year. Many attribute the lack of an aggressive business thrust to the impending elections. Is this a reasonable explanation?
There was a time when elections mattered much as the two main political parties subscribed to very different political views and pursued widely different economic policies.
One party was basically for private enterprise, foreign investment and fairly free trade policies. The other party and its coalition partners were for state ownership of the commanding heights of the economy, state enterprise and administrative controls.
It was a choice between either largely capitalist policies or mostly socialist policies. In such a political context changes in government meant fundamental changes in economic policies.
Private investment could be adversely affected with a change of government. Fiscal policies, among others, could change business opportunities and profits. A business enterprise could even be expropriated by the government.
Fortunately, this situation changed in 1994, when the People's Alliance government decided to continue with the economic policies of the previous government. For the first time since independence a continuity in economic policies was assured.
Consequently, there are only two outcomes possible. The present government comes back into office and pursues the same policies or the UNP comes back into power and pursues almost the same economic policies.
So why should there be any anxiety among the business community? What is the rationale for a wait and see stance by the business community?
One possible reason is that they expect next year to be one when the government puts the economy on the back burner. Needed actions on economic matters may go unattended. The pre-occupation with the election might mean that they would postpone any actions which may be necessary.
It may be also difficult to get the bureaucracy to take decisions. Delays in decision making or indecision and slow implementation of policies imply difficulties for private industry. What this means is that next year would be a slow sort of year in government and the business community could be adversely affected by this situation.
It is possible that some business enterprises feel that a change of government might be beneficial for business. Maybe the business community has greater confidence in a UNP government.
They may be expecting a new government to pursue a more pro-active economic policy which would benefit business enterprises. This could make them want to wait for the change and a more favourable economic environment.
Such postponement of business activity and investment is detrimental to the economy. A year lost is a loss in the momentum of economic growth. Even though the economic impact of such a postponement of business activity is not as injurious to the economy as a drastic change in economic policies, such interruptions are not ones which an economy which is seeking to grow at a higher rate than its historical record could afford. It could aggravate the country's problems and affect international competitivenes.
The other reason why the business community may be averse to making investments is not because they are so much concerned with a change of government but a fear that there may be post-election political instability.
This could arise out of no party having a majority of seats in parliament. It could also arise if the President is elected from one party while the majority in parliament is opposed to the newly elected President.
This type of situation could lead to a lot of difficulties especially as we do not have a tradition for bi-partisan agreements and actions.
The situation in Sri Lanka is further aggravated owing to a weak bureaucracy. India has faced considerable instability in recent years but the impact has been minimal owing to the bureaucracy performing its functions even in the face of unstable political conditions and weak political leadership. We cannot expect the same in Sri Lanka as the capacity of the administration has been weakened over the last few decades.
These may be some of the reasons for the diminished business enthusiasm. It may also be due to hard economic facts such as the drop in our exports. Even the reduction in the statutory reserve requirement does not appear to have stimulated the economy.
In such a context the business community itself must take a lead role and cajole the government into pro-active policies. It must organise itself to have a momentum of its own, irrespective of who comes in and who goes out of parliament and the presidency . If the business community does not play such a leading role, we may continue to lose our momentum every now and then as the nature of our electoral politics is hardly likely to change.
By Dulindra Fernando
"The World is moving very fast. We were the object of ridicule till June 1997. They were called Asian Tigers. We were called the slow moving elephants. Here in India today the argument is over 5% or 6% growth. Our industry thinks there is a great recession. They don't understand what a recession is, negative growth for 2 consecutive quarters. We have never had it for the last 20 years" says G.V. Ramakrishna. Head of the Indian Disinvestment Commission in the December 1998 edition of Euromoney. "..India now finds its moderate approach held up as a model for the opinion-formers in Washington as they scratch around for a new economic paradigm to replace the now discredited pseudo-capitalism of the Asian economies".
On July 15, 1999, on news breaking of the Pakistani backed Muslim rebels pulling out of Kargil, the Bombay Stock Exchange 30-share Index, the BSE Sensex rebounded past its previous record high of 4630 points on September 12, 1994 to close at 4710.25.
The market capitalisation rose by 1.87% to Rs. 5,99,385 crore (SL Rs. 9,855 billion or $ 138 billion). On September 22, 1999, the two leading bourses, the BSE and the new electronic National Stock Exchange (NSE) registered a record aggregate turnover, of $1.5 billion in one day.
Some of us have lofty ambitions of Sri Lanka becoming a financial centre for South Asia. While we have done little towards making it a reality, India is striding towards its destined role as the economic centre of South Asia. In the context of financial markets, the NSE of India is scheduled to introduce futures and options exchanges. In the meantime, our stock market capitalisation has declined in dollar terms, from $3.2 billion in March 1994 to almost $1.5 billion today.
The operational quality standards and the expertise we require to become a financial centre has not developed here. The level of financial expertise in India is much higher due to the size and diversity of deals available, as well as the presence of many International Investment houses that have commenced operations in India. Therefore, sadly, our ambition of becoming a regional financial centre appears to be a mere fantasy. In fact what is more likely to happen is that Indian and Hong Kong investment bankers will arrive here for the few big deals that do exist and take them away from our hands as it did with the Sri Lanka Telecom privatisation.
To quote Mr. Justin Meegoda, CEO and President of Vanik Incorporation Ltd, "Sri Lanka should adopt a policy of making it mandatory for all privatisation bids to be made through Sri Lankan Financial Institutions, so that foreign Investment Banks will have to work with Sri Lankan institutions so that expertise would naturally develop in Sri Lanka while a share of fees will also remain in the country".
The Colombo Stock Exchange
"Foreign investors have been net sellers since the nuclear tests in May last year and the Colombo Stock Exchange (CSE) is fairly sensitive to foreign investors" according to Mr. Hiran Mendis, Director General of the CSE in the Sunday, Island of July 11, 1999. Strangely enough, India and Pakistan, the countries that precipitated the crisis have seen their markets tearing back up at 35% and 12% respectively during the first half of 1999. The benchmark IFC emerging markets composite Index has climbed 35.1% during the same period.
The CSE that fell 24.4% from May to December in 1998 following the nuclear tests fell a further 13.3% during the first half of 1999. It appears that foreign investors have found better investment prospects in the recovering Tiger economies, in India and even Pakistan despite its political instability. So it is time we took a step back to see where we are heading.
The most convenient explanation would be to blame the government. However, for a country that has allowed itself to slide into such deep trouble we cannot afford to be so casual.
It would also be an insult to an institution as important as the stock market that has the potential to become the engine of capital growth in our economy. The stock market is a potentially vast source of financing for risk capital and foreign capital while offering the investor public an opportunity to share the profits earned by successful companies.
It is important to note that our economy too has weathered the South Asian economic storm relatively well with stable growth and a gradual depreciation of the exchange rate.
The privatisation process has continued attracting partners of international repute such as NTT, Shell, Emirates and P&O while the privatisation and stock market quotation of the plantation industry has also been carried out successfully. It is even more commendable that the security forces have successfully gained an upper hand in the war to provide a handle on the problem.
Our Stock Market has undergone dramatic development in recent years. The most significant developments have been:
• Introduction of an automated, electronic Exchange and CDS settlements system to become one of the most technologically advanced exchanges internationally.
• Introduction of the new Milanka Price Index, designed on liquidity and market capitalisation criteria.
• Issue of quoted debt securities by private financial institutions and corporations.
• Tax concessions and Stamp Duty waivers for listed companies and securities.
• An active SEC presence and the introduction of a Settlement Guarantee Fund to increase investor confidence.
• Setting up of a Debt Rating Agency and listing of Debentures of Unquoted companies.
• Proposed introduction of Short Selling, Stock Lending and foreign investment into the Unit Trust industry
• Proposed introduction of on-line Trading on the CSE.
Factors Inhibiting Stock Market Development
• The small market size and poor liquidity increases volatility and precludes serious consideration by international fund managers.
• Underdeveloped Pension and Fund management industries deny our market the minimum support it needs to evolve.
• The market interpretation of economic risk projected by the war.
• Lack of representation of the Utilities sector and other institutions of large economic activity on the stock market. Despite the garment industry being our largest foreign exchange earner there is not a single such company represented on the CSE. Therefore, our economy is poorly represented on the CSE.
• Absence of a conviction or strategy to develop equity markets.
India offers nearly a sixth of the world's population and the worlds largest middle class market, healthy economic growth rates, and is in the process of opening its economy.
It will experience a flurry of economic activity over the next two decades. As a regional superpower, India will also command political power. With President Clinton scheduled to visit India and other South Asian countries early next year, the Indian market should receive another vote of confidence by foreign institutional investors.
With developments in information technology, Sri Lanka may have the opportunity right now to tap onto something much bigger if we act fast enough.
That opportunity is to become a Stock Market that represents the South Asian region. That is not to say that we can ever become as large as India, but the quotation of securities that derive value from South Asian markets, offers the potential to substantially improve demand and the market capitalisation of the CSE with the sheer size and weight derived from Indian, Pakistani and Bangladesh stock markets.
The task is by no means easy but we do have enough models and the technological means to get there. Hong Kong has provided investors convenient mechanisms to access the large market of China with many securities that derive value from the best of Chinese stocks.
Singapore financial markets reached its present heights by trading NIKKEI Index futures. Rapid development of Internet technology also provides an immensely powerful tool to develop the infrastructure necessary to access the information superhighway as well as marketing channels to any investor anywhere in the world at his or her personal computer.
If our regulators facilitate the mechanisms necessary i.e. permitting approved Fund Managers and Investment companies to invest in South Asian Stock Markets, Sri Lanka's economic importance in the region will transform dramatically from being a tiny market to being the only economy in the region, that provides off shore access to other South Asian markets. Foreign
Fund Managers and Securities firms will seek to tie up with Sri Lankan Investment companies to create Investment Funds and securities for quotation on our Stock Market as has happened in Hong Kong.
Such products can range from Depository Receipts on selected stocks to Sector Indices or even outright listing of Indian companies on the CSE once our market is sufficiently developed.
If the regulators are concerned about the risk of local capital flowing out to the region, they could limit investment in such securities to foreign investors only, during a transitionary period. While maintaining our policy of a restricted capital account, we can permit SEC and Central Bank approved Investment Funds and companies to perform the services discussed.
There will be many other spill over benefits to Sri Lanka such as the natural development as an offshore banking centre if the necessary legal and tax framework is in place. It will change our Stock Market risk from high local risk to a diversified regional risk.
The securities industry will take a regional focus while our fund managers, brokers, sales and research departments would have a broad regional product range with size to sell to a much larger client base that includes foreign institutional investors. The CSE could provide a mechanism for South Asian expatriate and domestic investors to participate in their markets without running the risk of capital and tax restrictions of investing directly in their markets.
One may wonder about the availability of infrastructure necessary to accommodate such transactions. As a beginning we already have Banks that offer such comprehensive custodial services to foreign fund managers and this service can easily be extended to local companies through their South Asian networks. There will also be benefits to our economy from foreign currency account reserves that will develop here.
Some of the strategic advantages Sri Lanka has are as follows:
• Sri Lanka has the political neutrality to play an important role in South Asia
• Sri Lanka Telecom has a parallel vision of making Sri Lanka the telecommunication hub of South Asia while India's state run Department of telecommunication has problems
• High-tech Stock Exchange and settlement system
• The technology advantage of being a late starter
• Progressive minded regulators
• The availability of Internet technology provides an immensely powerful tool in creating financial and marketing infrastructure. One day, all retail investment and banking will be done through a PC.
• Double Taxation treaties with countries in the region to avoid double taxation on dividends received.
The South Asian countries posses the same basic legal and administrative systems left behind by the British. Although most are badly in need of reform, such systems have nevertheless been functioning for over 50 years, unlike in the ex-communist block countries where such systems were introduced only recently. Sri Lanka too, has inherited from the British a legal framework and commercial culture for the effective working of financial institutions that has stood it good stead since independence. Hence, Sri Lanka has a good financial institutional set-up that can be developed into a sophisticated financial centre provided a good legal and regulatory framework is put into place together with incentives to attract expertise".
"When you look at the great financial centres of the world...we see a complex web of skills, institutions and infrastructure coming together to generate a hotbed of innovation and market liquidity. This attracts investors and companies from all parts of the world" to quote Dr. Ajay Shah a securities and derivatives expert and a director of the NSE in India. According to him the four kinds of human skills required for Capital Market development are traders, administrators, thinkers and engineers. Besides developing the infrastructure necessary to support such a role a vital pre-requisite to becoming a securities market financial centre is to develop the pension fund and fund management industries.
Some of the benefits accruing from such capital market development in Sri Lanka are as follows:
• Large revenues in the form of fees for listing, brokerage transactions, fund management, advisory, research and legal-tax-accounting services.
• Develop a confluence of expertise and innovation in Sri Lanka at international standards
• Generate foreign investment capital inflows into Sri Lanka and boost economic growth
• Generate a flow of regional investment banking activities through Sri Lanka
• Mobilise financing for a spectrum of risk varied projects
• Improved efficiency, transparency and stability of our Capital Market.
With the economic integration of South Asia, Sri Lanka's manufacturing sector will be under severe economic pressure from India and many industries will gradually disappear.
Therefore, it is imperative that Sri Lanka enter into the service industries now to exploit opportunities where it does have a strategic advantage. Sri Lanka also has the advantage of being a small economy that can be turned around quickly. Therefore, it is important that we reach internationally competitive standards now to be able to exploit opportunities that will come our way in years to come.
• Involve the CSE in the privatisation process
• Plan a development strategy for the Pension fund industry
• Make the most of the high-tech advantage of the CSE and integrate with South Asia to reflect the economic value of the entire region
• Promote the Fund management, Stock Brokering and Investment Banking industries to adopt a regional strategy
• Permit the Stock Brokering industry the flexibility to negotiate brokerage fees and achieve regionally competitive rates while facilitating discount brokerage to promote On Line trading that has taken the world by storm..
• With a global trend in individuals taking charge of their own investments through the web, the CSE could cater to the potentially vast untapped market of South Asians living. As the attractiveness of the highly valued US, Japanese and European markets diminish, retail investors the world over will soon be in search of new growth markets to exploit.
• Encourage the SEC to introduce surveillance and reforms at international standards to improve confidence in the market.
• Reform our legal-tax framework to promote Sri Lanka as a regional off shore banking centre.
Involving the CSE in the privatisation process means to list privatised institutions such as Sri Lanka Telecom and Air Lanka. Even a 10% listing of the State Banks and other utilities as a compromise alternative to the sale of privatisation sensitive institutions would introduce efficiency and a profit making culture into such organisations that are badly in need of reform. It would also provide an exit mechanism for an employee share ownership scheme. The presence of such large institutions would boost market capitalisation and enhance the attractiveness of the CSE to foreign investors.
The opportunity afforded to Sri Lanka today is immense. We can either take command of our destiny, or we can continue with reforms at our own self contented pace, follow India and be satisfied with the small mercies that come our way.
The path is by no means easy, yet the choice is clear. Unless we integrate ourselves into the regional market of South Asia, Sri Lanka will miss out on the opportunity to develop as a regional financial centre in the dawning of a new millennium which holds so much promise for South Asia. At the end of the day, it really boils down to a question of, have we got what it takes ?
The writerr is Assistant Vice President Vanik Incorporation Ltd.
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