17th October 1999

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Economy on a recovery track

Excerpts from Jardine Fleming HNB Securities Pvt. Ltd, on the Economic and Strategic outlook by Amal Sandaratne, Strategist and Economist Jardine Fleming HNB Securities Ltd.

Slowdown in 1998 and 1h cy99

GDP growth slowed to 4.7% YoY in 1998 from 6.4% YoY in 1997, with exports coming under pressure due to currency depreciation in a bid to compete with other Asian countries.

Though 1998 growth was resilient by regional standards, business confidence deteriorated in 2h cy98 as higher GDP growth had been the norm before.

1h cy99 growth was also weak at 3% YoY; therefore, full-year 1999 growth is forecast to decelerate further to 4% YoY.

Improvement in 2q cy99

For 2q cy99, GDP growth came in at 3.3% YoY, higher than the 2.7% YoY recorded in 1q cy99, which had fed much pessimism in the market.

Overall growth was less than the 3.8% YoY we had expected for the quarter.

However, an analysis of the sectoral figures gives no reason to revise our 4% YoY forecast for the year downwards.

Manufacturing and agriculture did significantly better than in 1q99, even surpassing our expectations.

The construction sector, too, did somewhat better than in 1q99 and JF expectations.

In services and mining, growth came in below our expectations.

The shortfall in services was due mainly to a 5.3% YoY decline in value-added in the trade sub-sector.

Though export trade grew 5% YoY and domestic trade 2.9% YoY, value-added in import trade fell by almost 16% YoY.

With import trade making up almost 10% of GDP, the fall in the sector came to as much as 1.6% of GDP.

In other words, if we had just flat growth for import trade instead of the 16% fall, GDP growth in 2q99 would have been about 4.9% YoY.

With the pick-up in manufacturing and agriculture, we should see a recovery in domestic demand, which should boost import trade and thus, overall GDP growth.

Trade figures lend support

Recent trade figures also indicate that import trade is improving, as YoY import comparisons do show an improvement.

Consumer food imports rose 9.3% YoY in July, against a cumulative fall of 16.8% YoY for the first seven months of the year.

Consumer durables rose 14.2% YoY (7m99: 3.9% YoY).

Intermediate goods imports fell only 6.2% YoY (7m99: -10.6% YoY).

Textiles, which tend to be a leading indicator of garment exports, recorded a 0.6% fall (7m99: -15.3% YoY).

Total imports fell 6.3% YoY (7m99: -10.5% YoY).

The three-month moving average monthly trade charts also show a definite pattern of improvement

Exports disappoint in July after a strong June

Total exports, however, disappointed in July, falling by 19.5% YoY.

Key exports such as garments fell by 20.3% YoY, while tea exports fell by 28.1% YoY.

However, coconut exports grew by 46.3% YoY and mineral exports by 5.9% YoY.

The decline in tea exports should reverse soon, given the increase in tea prices.

The drop in garment exports was partially due to pricing reductions for both inputs and outputs.

Indications have been that volumes and value-addition in the sector have been increasing.

The improvement in textile imports-the key input in the garment industry, accounting for 57% of garment exports-seems to be a leading indicator of better garment exports coming up.

Economic outlook - Signs of a pick-up

Trade numbers for June had shown positive growth, the first in many months.

Export growth (2.9% YoY) was positive for the first time since January 1999, while import growth (1.7% YoY) was positive for the first time since September 1998.

Rebound expected from August

Going forward from August, we expect to see positive YoY growth in trade numbers like in June, instead of the negative numbers generally seen.

The fact that quota problems have been eased should boost garment exports (52% of total exports).

The rupee has continued its steady depreciation despite the appreciation of other Asian currencies since 2h98; this should help to boost the competitiveness of industrial exports.

Agricultural exports should turn positive, with tea prices recovering.

Tea prices reached record levels in early 1998 and then collapsed.

As they remained low in 1h99, agricultural exports performed badly for the same period (down 21% YoY).

However, tea prices have begun to pick up strongly since July, due to crop shortfalls in Kenya and India.

These factors, along with a lower base of comparison in 2h98, should lead to much better YoY export growth in 2h99.

Steady rupee depreciation to continue

The rupee has depreciated by 4.9% year-to-date, after a 9.6% depreciation in 1998.

Our target exchange rates are Rs 73.5/US$ (down 7.8%) for end-1999 and Rs 79/US$ (down 7.0%) for end-2000.

As national elections are due in 2000, the government will aim to contain inflation and hence, limit depreciation.

This implies that depreciation could come in below our expectations.

Currency risk from a balance-of-payments (BoP) crisis and a forced devaluation is minimal because the current account deficit has fallen from 7.4% of GDP in 1994 to 1.9% in 1998, and will be less than 1% in 1999

Forex reserves are also at a safe level-about six months of imports.

Furthermore, Sri Lanka's policy of gradual depreciation over the years and its closed capital account have made it immune to attacks on the rupee.

The rupee has depreciated at about 7% pa in the past 10 years.

Inflation fall prompts easing of monetary policy

Since peaking at 15.9% in 1996, inflation has fallen quite significantly, averaging 9.4% in 1998. Our current forecast for 1999 inflation is 6%, due to the expected strong agricultural performance.

The risk to this forecast comes from a possible sharp increase in commodity prices. With inflation falling, the central bank eased monetary policy in August and shifted the interest-rate outlook from a stable one to a falling rate.

The relaxation occurred in mid-August, when the statutory reserve requirement (SRR) was cut from 12% to 11%.

More significantly, the central bank said that it plans to reduce the SRR further.

The move is expected to release about Rs 3bn into the banking system.

As expected, interest rates have fallen since the easing of the monetary policy: The 12-month T-bill rate is down to 12.31% from 12.71% (Figure 2).

Corporate out look

Wide impact of plantations sector

The spectacular rise in the plantations index has been fuelled by the rise in tea prices in 2h99.

In the past two years, tea prices have had a disproportionate impact on the earnings of many companies outside the plantations sector.

The four conglomerates -John Keells, Aitken Spence, Hayleys and Richard Pieris-are not the only listed companies whose earnings are exposed to the sector: During privatisation of the plantation companies, even ceramics firms bought stakes.

The tea market affects investor sentiment as well: Many retail investors have made bigger profits in the tea sector than in any other, and have been badly burnt as well.

Commercial and development banks' exposure to the plantations sector has been on the rise and increasing prices would reduce the risk of bad loans.

Company earnings growth slows from a high base

The 23.2% decline in company earnings in 1h99 seems to mirror the slowdown in the economy.

But low tea prices have been an even more important factor since it would take more than a strong economy to achieve growth from the very high base in 1h98.

In that period, earnings grew over 50% YoY, driven largely by record tea prices.

The decline since then also reflects the impact of provisions by financial institutions for losses on their equity portfolios, and of course, the overall sluggishness of the economy.

Underlying favourable trend of IFC-5 earnings

Going forward, though 2q cy99 earnings for big caps were weak, a closer look supports our view that their earnings should move strongly into positive territory the next quarter.

We say this confidently given that the results of the June quarter were hit by two easily monitored factors, which rebounded after the end of June.

The first is tea prices, which had crashed in the quarter and dampened the earnings of the plantations sector, one in which all three conglomerates have exposure.

With the hit the plantations sector took, the conglomerates should e a much greater hit to their profits than that reflected in the interim accounts.

However, their earnings showed resilience as profit growth in other sectors, such as tourism and transportation, was strong.

With rising tea prices conglomerate earnings should rebound

The upturn in tea prices in July continued strongly into August and September.

Consolidated numbers should be strong as a return to profitability should add to the already strong growth of other sectors.

John Keells and Aitken Spence did worse than in the previous quarter, but that was because the relative importance of tourism is much greater in the January-March quarter (due to the tourist season).

Thus, in that quarter, the tourism counter to the negative impact from the plantations sector was greater.

Rebound in the market will help DFI earnings

The other factor is the fall in equity prices.

This has hurt the Development Finance Institutions (DFIs), which had then to make provisions.The market has recovered by over 9% since June, and the write-back and capital gains should result in more normalised earrings growth in this quarter.

Even with the provisions, the DFIs recorded better numbers than 1q99.

The underlying trend showed a turnaround from the even weaker numbers of 1q99. Of course, this bullish argument is somewhat circular and contrary to our expectations and the market could always fall again.

Investors own preference to dictate choice of big or mid caps

In terms of market segments, JF Sri Lanka retains a soft spot for its mid-cap favourites.

This segment offers a unique selection of companies that are monopolies or market leaders, with strong cash positions, high RoEs, proactive management, excellent dividend payouts and valuations at a significant discount to the market.

However, over the next quarters, it will be the big caps which will see the greatest earnings turnaround, moving from negative growth to a strongly positive outlook.

With their superior liquidity, they would again outperform given a return of FII interest in Sri Lanka.

Moreover, with the economy recovering, these conglomerates and DFIs are often seen as the first plays on such a recovery.

Thus, we believe that the underperformance of the big caps is set to end soon and this time around, we take no bets on the relative performance prospects between the two segments.

How clients will choose between the two segments would depend on their risk preferences, liquidity requirements and willingness to play on a return of FIIs.

If there were a return of FIIs, selling mid caps with their strong dividend yields would prove to be the safer strategy.

US expert at Chamber

The Ceylon Chamber of Commerce has hired Mr. James Nethercott, a volunteer expert with experience in corporate governance, to assist in their programme on good corporate governance.

We will focus on the board of directors and the role they play in corporate governance, Mr Nethercott told The Sunday Times Business.. He said the board of directors was representative of investors and also evaluated the management of the company.. I will be addressing the composition of the board of directors, namely executive directors and non executive directors, Mr Nethercott said.

The role of the board of directors in the USA and western Europe has changed considerably and consists largely of non executive directors. This contrasts with the situation in developed countries such as Sri Lanka.

Nethercott said corporate governance was beneficial to capital markets as it would result in better information to investors, better resource allocation and improved investment decisions. It would also provide individual firms with a more accountable system as the board of directors would monitor management.

Millennium on Nasdaq?

The same people who put the Colombo Stock Exchange (CSE) 'on line' are looking at overseas stock markets for a listing.

Millennium Information Technologies (MIT), the three year old IT experts told a press briefing recently that they were considering getting a listing on the Nasdaq or closer to home, in India or Singapore. Company officials said the decision to list on a overseas stock exchange was made because the price earnings ratio (PER) in the local bourse was very low compared to the PE of IT stocks in India. Head of MIT, Tony Weerasinghe said they hoped to raise something between US$ 25 million to US$ 50 million on the listing.

As the first step towards achieving this goal the company made a successful private placement overseas last week, in which the company raised US$ 10 million for its proposed software development camp in Kotte. Weerasinghe said that the camp would concentrate on developing new applications and research and development projects. Work on the IT camp is expected to commence shortly. MIT placed its shares at US$ 3 each, 24 times its PE, with Citibank, HSBC, GMO a US based investment company, and Ayojana Investments who invested initially and the only local company to increase its stake. People's Venture Investment Company (PVIC) also has a stake in the company from initial investments while the management and staff of the company owns 41 percent. Weerasinghe said that based on the year 2000 profits, if targets are achieved that is if they achieve targets, investors had the option of converting their preference shares into ordinary shares at US$ 4.50 each.

Weerasinghe said that the placement pushed the companies market capitalisation from Rs. 30 million to a whopping US$ 30 million approximately.

MIT after its initial project with the CSE has concluded many other projects and is looking at more projects in the Asian region and the African continent.

Gaining on branded and herbal teas.

Shafraz Farook

The market that picket up in leaps and bounds recently after a long dry spell is slowing down. Officials say the market is actually stabilising after the mid September rally which saw prices from all three elevations recorded significant price gains.

Last week's auctions witnessed price gains for high and midium growns, but low grown prices, inspite of some demand, declined Rs. 10 to Rs. 15 for a second consecutive week.

Low grown prices which picked up on account of additional pre-winter buying by Russia is stabilising, brokers said.

In overseas markets, Egyptian customs authorities informed the Sri Lanka Tea Board that they had cut import duties on Kenyan teas from six percent to three percent with mimmediate effect. In effect duties to other COMESA members is below 12 percent. A Forbes and Walker Tea Report which gave the extracts from the Planters Chronicle said that the Russian Rouble crisis had led to the increased import deliveries from such countries as India, Georgia, China and Bangaladesh at the expense of Sri Lanka.

Some suggestions for alternatives of the Russia tea market development made by the Chronicle included strengthening market positions of branded teas and development of herb tea and therapeutic herb tea segment. Officials said this was a good opportunity for Sri Lanka to regain her lost market share. It would be easy for Sri Lankan companies to build on this since some of them are keen on development of the segment.

18% of Lanka Ceramics changes hands

Indices on the Colombo bourse slid further as the government of Pakistan was taken over in a coup. The bloodless coup was led by army chief of general staff Pervez Musharraff.

The All Share Price Index fell 3.01 per cent to close at 544.9 while the Milanka Price Index dropped 3.86 per cent to register 874.5. The MBSL Midcap index fell 2.48 per cent to close at 975.23.

Net foreign outflows for the week were Rs 71.3 mn. Eighteen per cent of the shares of Lanka Ceramics changed hands on Wednesday.

The largest tranche of 4.8 mn of the shares were sold to the Readywear Group by the Merchant Bank of Sri Lanka and DFCC Bank. Average turnover during the week was Rs 80.94 mn.

Top gainers for the week included Hotel Reefcomber 66.67%, Lanka Ceramics 24.64% and Ceylon Investment Company 23.05%. Watawala Plantations lost 21.74, Madulsima 19.48 and Udapussellawa 17.07 per cent.

The plantation sector index was the hardest hit on the sliding bourse. The indices dipped 13.56 per cent but was spurred on by weak prices for low growns at the tea auction and negotiations for labour wages in the sector.

"There is great optimism in the market but at present there is consolidation," Head of Research, MMBL Phillip Securities, Nouzab Fareed said.

"There is political and economic volatility throughout South East Asia and this presents a grey picture of the Colombo Stock Exchange to foreign investors," he said. "There will be a narrow fluctuation in the market next week but there is no reason for significant changes,' he added.

"The market should stabilise next week," head of Research CDIC Sassoon Cumberbatch, Diluk Desinghe said.

"It is doubtful whether the Pakistan military government will antagonise India." He concluded. "If the uncertainty in Pakistan is reduced it will be beneficial to the Colombo bourse,' Strategist, Jardine Fleming HNB Securities, Amal Sanderatne said.

Readers not yet sold on electronic books

FRANKFURT,(Reuters) - Readers still have no real appetite for electronic books and it could take up to three years before computerised titles have a major impact on the publishing industry, an analyst's report forecast on Friday."Manufacturers try to make e-books as much like conventional printed titles as possible but the fact remains that the old-fashioned book still does its job very efficiently," said Bob Broadwater, managing director of the U.S. investment banking firm Veronis, Suhler and Associates.

Their report was released in Frankfurt at the world's largest book fair which this year has attracted 6,600 publishers from a record 115 countries.

About 80 percent of all global rights deals are concluded at Frankfurt where one in four exhibitors comes from the electronic media, who are greeted with open arms by the organisers.The report concluded that the printed word was far from being run off the information superhighway by computerised books."For any technology to capture the public imagination, it has to be a quantum leap on what went before," said Broadwater.

Microsoft is trying to overcome consumer reluctance with its new Microsoft Reader, software that allows files formatted for print to be displayed or downloaded on a printer. The pages are sharp, clear and easy to read. But the report estimated that electronic books "will not have much of an effect on the book industry before 2003.

NGOs slam globalisation

SEOUL, (Reuters) - A focus on economic growth through unfettered free markets was hurting the well-being of people around the world, a conference of non-governmental organisations in Seoul said on Friday.This drive towards globalisation was creating disparities between rich and poor, a declaration from more than 1,000non-governmental organisations (NGOs) from 107 nations said at the end of a five-day conference.

"Despite its promise of progress, globalisation is undermining local traditions and cultures," said the statement of the 1999 Seoul International Conference of NGOs."A single-minded focus on economic growth through unfettered free markets... are crippling many national economies, exacerbating poverty, eroding human values and destroying the natural environment," said the statement. Still, the NGOs said there were "many reasons for hope"due to the phenomenal growth of people's movements, civil society organisations and NGOs committed to addressing the seills.

Insurers unfavourably taxed, says Rehmanjee

By Mel Gunasekara

The present tax structure is unfavourable to insurance companies, Union Assurance CEO, H Rehmanjee said recently.

He says insurance companies are taxed like any other company except on the profits from their life insurance business.

The life insurance business is taxed on the basis of investment income less expenses.

"This usually results in a composite insurer with a growing life portfolio being in a tax loss position even though the general insurance business may be profitable," he said addressing a recent fund managers' conference.

For an insurance company, one of the disadvantages of being in a tax loss position is the unrecoupability of advance corporate tax (ACT) paid on dividends.

A company distributing dividends has to ensure that it has the cash for the dividends as well as the advance corporate tax payment to Inland Revenue which is as high as 54% for a listed company.

This ACT tends to accumulate in the balance sheet in view of the fact that ACT in only available for set off against corporate tax liability and is not refundable.

On the other hand, the advantage of the high rate of ACT is that the shareholders receive a dividend virtually tax free because of the imputation credit allowed.

However, for the individual taxpayer in Sri Lanka the deduction of insurance premium from the assessable income has been progressively reduced, he said. At present, no deduction for insurance premium is allowed.

The last time when such deduction was permitted was for the 1991/92 tax year, when an individual was entitled to a Rs. 25,000 or 1/3 deduction of the assessable income whichever was less.

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