Political uncertainty-driven investor sentiment

When politics takes centre stage, investors and even investment managers get nervous as political events can dominate news headlines and rattle markets. The replacement of the once supreme President Mahinda Rajapaksa with his long-term loyalist and Minister Maithripala Sirisena may be history now. However, the ultimate effect on the economy and the markets will be unknown for some time now. 

The nature of political uncertainty is such that investors must think of a way to adjust their portfolio to the potential downside risk that faces their investment portfolios.  

Political uncertainty is primarily the key reason why our economy cannot get into top gear. The prevailing period of vagueness can be attributable to political uncertainty, due to the lack of political patronage within Parliament and its lawmakers entrusted to govern the country. 

It is the first time since 2006 that the country is witnessing a minority government and it is also the first time since 2004 that the country is witnessing an executive from one party and a Government comprising a majority from another party. In addition, the present Government comprises a coalition of many factions with numerous views and values. Such factors have driven indecision in the minds of many investors which has resulted in low confidence and has tempered their willingness to invest in comparatively risky investments such as stocks.  

This period of indecision has resulted in many investors cashing in their shares and transferring to more stable fixed income instruments. Some have pounced on the opportunity to devote more funds to the stock market and pick up strong fundamental counters dumped at a further discount to their long-term price targets. 

The liquidation of shares can be attributable to fear that drives investor sentiment as investors are unable to decide on the correct investment decision regarding the direction of the market in the wake of the outcome remaining a dilemma. On the contrary, bold investors are likely to rely on long-term potential or they may be simply adhering to buying to take advantage of volatility. In essence, the market will have a low appeal to many investors in periods of decline, nevertheless, the true edge over their rival investors is also formed during such periods. 

Equity market participants expecting a period of strong and long returns with the election of President Sirisena and the formation of a national government headed by a more capitalist  United National Party, has been made to ponder the possible results of the decisions taken by the current administration. 

The future outlook for a strong Government after the general election, due later this year, also remains a quandary with the Sri Lanka Freedom Party (SLFP), led by President Sirisena, showing intentions to form a Government of its own. This notion would mean that the national government concept vociferously proclaimed by Sirisena would also come to an abrupt end. 

Investor uncertainty

In addition, factions loyal to former President Rajapaksa have shown signs of resurgence with a case to declare Rajapaksa as a candidate for Prime Minister within the party. Election outcomes are relevant for investment decisions as they have implications for industry regulation, monetary and trade policy, taxation and, in more extreme cases, possible expropriation or nationalisation of private firms.    

The new administration has also put a halt to the mega infrastructure projects initiated by the previous Government, highlighting large-scale corruption and overvalued cost estimates. Several development agencies have highlighted the ill-effects the cessation of such projects would have on the growth rate of the national economy. Also the present Government has yet failed to completely clear the inefficiencies and accusations of corruption regarding the Treasury Bond issue that occurred under their purview, which left the country’s interest rates soaring upwards unexpectedly. 

In spite of the above, the Government has been able to reduce the cost of living by granting concessions on some key necessities and salary increments to state workers. These concessions have been granted at the expense of more debt and instilling one-time taxes on highly profitable entities. 

In addition to the concessions, the Government has been able to take large steps in the move towards establishing a broader democracy with the passage of the 19th Amendment to the Constitution. This was possible despite them having to compromise on many key elements of the Bill to gain the support of the required number of MPs. Measures are already in place to bring forth sound electoral reforms such as the 20th Amendment. Therefore, with the measures in place during the past 110 days, it can be stated that more democratic, transparent and credible governance is on the verge of being established in an island nation that is poised for a true growth story. 

The ‘Good Governance’ era, as proclaimed by the incumbent President during his election campaigns, can be arguably perceived to be in operation. However, the actual establishment of good governance may in essence be a few years away. 

With the existence of such abundant uncertainty, investors should carefully watch the political climate as talk is cheap but outcomes aren’t. Furthermore, as soon as the election nears we should experience a period of dormancy where more investors will move into a wait-and-see mood and divert more investments into stable return generating fixed income instruments.  Such times will be beneficial for those equity investors with long-term investment horizons. 

It is very likely that we have entered a temporary period of political uncertainty that will subside after the next general election. Economic growth will begin once the political outcomes become clearer. The investment climate will improve greatly if interest rates and inflation remain low with a stable currency. As in the past, with more certainty comes more activity as investors move off the sidelines back into the game while being better positioned for what is to come. 

(The writer is the Assistant Manager – Capital Markets at Candor Equities Limited Sri Lanka. He has a   BEng in Chemical engineering Honours degree from University of Nottingham, United Kingdom and a MBA from University of Colombo. He is also a Chartered Financial Analyst. He can be reached via email on [email protected])