Capital market: Significant progress, yet long journey ahead
Monday, 3 March 2014 02:04
Following is the address by SEC Chairman Dr. Nalaka Godahewa at the Capital Market Conference 2014, held on 26 February at the Galadari Hotel
I would like to thank the organisers for inviting me to address this Capital Market Conference 2014. Conferences of this nature are always good opportunities to reflect upon what’s happening in the industry and understand where our economy is heading. They help us better focus our knowledge and prepare ourselves for tomorrow’s challenges more effectively.
As you are all aware, in most of the countries the capital market is a vital contributor to the economy. It is the main channel through which the savings and funds available with retail and institutional investors are mobilised for long-term capital formation. Usually it’s done using instruments such as equities, bonds and other hybrid instruments. The capital so raised is then used for further wealth creation and redistribution, infrastructure development and employment generation.
The capital market also provides an opportunity for savers to manage their finances better in the short and medium term through diversification of risks. There are two main components in any capital market; the primary market for issuing new securities and the secondary market for trading existing securities.
Colombo stock market
There are four pillars essential for the successful development of a capital market: 1) macroeconomic stability, 2) A sound and efficient banking system, 3) solid institutional frameworks, and 4) adequate regulation and supervision. Even though the capital market of Sri Lanka is still not in the big league, we can proudly say that we already have these fundamentals in place.
Though small in size, the Colombo stock market has a long and an eventful history of over 115 years that dates back to the era when the island was still a British Crown Colony. By the early ’90s the CSE was one of the most technologically-advanced modern stock exchanges in the region. In fact the CSE was the first South Asian exchange to introduce a scrip-less trading system in 1991. However, due to reasons that we all know, the market didn’t reach its full potential during the next 20 years while the rest of region moved forward.
It has been four years since our country ended the war on separatism in 2009. We have achieved lasting peace and political stability. Today the country has an undivided focus on economic development. With the war coming to an end, more funds are available for economic development. There are business opportunities everywhere. The initial few years has been spent laying the foundation and getting the policy framework geared to support the ambitious economic growth plans of the country.
When Sri Lanka’s GDP reaches US$ 100 b within the next few years, the stock market is also expected to follow suit. In most of the regional countries, the market capitalisation is as high as 70% of GDP. Using conservative estimates we can expect the market value to reach at least US$ 50 b within about four years from now.
The macroeconomic outlook of Sri Lanka today is more promising than most of the other emerging markets. The GDP has been growing at an average of 7.5 % per year since 2010 despite the global headwinds. In the next four years, Sri Lanka’s economy is expected to grow at about 8% rate, which will put us in the domain of an upper echelon middle income country with a GDP value of over US$ 100 b.
Our capital market with market capitalisation of approximately US$ 20 b belongs to a particular subset of the emerging markets called the frontier markets. The investment case in Sri Lanka’s equities market is a compelling one. For the period 2008 to 2013 the Colombo Bourse returned figures of an average of 32% year-on-year. When compared to the overall Emerging Market Index which returned 12% and the Frontier Market Index which returned only 4% for the corresponding period, this is not only attractive but admirable.
Today our bank interests are at the lowest levels for decades. Inflation is in mid-single digits. Forward PE valuation of the market is around times 11.7. Most industries are doing well and showing high potential for growth, so it’s time for us to look at fundamentals and facts rather than mere trends.
Towards the latter part of 2013, you would have noticed a number of regulatory measures announced by the SEC. That’s because in 2013 we took steps to bridge certain regulatory gaps that were in existence for several years. We wanted to make sure that when we step into 2014 we are ready with a sound regulatory framework; a strong foundation to build on. I believe that to a large extent, we have now achieved that objective.
As the market regulator, the primary task of the SEC to protect the interests of the investors and creating a transparent and fair market. Contrary to what some people think, the mandate of the SEC is not promoting day-to-day trading and driving the market indices up. Whether the market goes up or down on a particular day is a reflection of the investor sentiments on that particular day. It’s the same for any market in the world.
Unfortunately we have one peculiar problem of the overall market being small. Fluctuations in the prices of the stocks of one or two blue-chip companies can easily affect the market index, giving a wrong picture of overall market conditions. Whenever some large foreign players are booking profits and it results in a drop of market index, this is misunderstood as the beginning of a market downturn and people hit the panic button. Their negative market behaviour then results in a negative trend.
"When Sri Lanka’s GDP reaches US$ 100 b within the next few years, the stock market is also expected to follow suit. In most of the regional countries, the market capitalisation is as high as 70% of GDP. Using conservative estimates we can expect the market value to reach at least US$ 50 b within about four years from nowThe macroeconomic outlook of Sri Lanka today is more promising than most of the other emerging markets. The GDP has been growing at an average of 7.5 % per year since 2010 despite the global headwinds. In the next four years, Sri Lanka’s economy is expected to grow at about 8% rate, which will put us in the domain of an upper echelon middle income country with a GDP value of over US$ 100 bOur capital market with market capitalisation of approximately US$ 20 b belongs to a particular subset of the emerging markets called the frontier markets. Towards the latter part of 2013, you would have noticed a number of regulatory measures announced by the SEC. That’s because in 2013 we took steps to bridge certain regulatory gaps that were in existence for several years. We wanted to make sure that when we step into 2014 we are ready with a sound regulatory framework; a strong foundation to build on. I believe that to a large extent, we have now achieved that objectiveWith bank interest rates at unprecedented low levels, the Sri Lankan public and the business community should realise sooner than later that their savings in the banking system are not growing against the inflation. Under the current circumstances the capital market invariably becomes an attractive alternative for diversification of investmentsWe have been making significant progress, yet it’s a long journey ahead before our capital market becomes a significant contributor to the national economy. Our next target should be reaching market capitalisation of 50% of GDP. I sincerely hope that all stakeholders will continue to work together to reach that goal sooner than later"
The problem with retail investors anywhere in the world is that they are mere followers of market trends. They buy when the indices show positive signs and sell when indices show negative signs. This has always been a fact in our market. You can’t blame them. The problem is when our institutional investors also behave the same way. Some of them repeatedly miss opportunities in the market as a result.
Development of the SME sector
In November 2012, we launched a 10-point three-year action plan for the development of the capital market. Our initial focus was to bring stability to the market and lay a strong foundation for future developments. The progress of each project is continuously reported and updated on our websites. The proof of the pudding is in the numbers and facts speak louder than words. Information is available in the public domain for anyone to analyse. With most projects progressing well, we are also looking at a few other areas where we can contribute to the development of capital market. One area is how we can help the development of the SME sector.
As per the Government estimates, around 80% of businesses in Sri Lanka are SMEs. They contribute over 50% of the Gross Domestic Production (GDP) of the country. They provide 35% of all employment in the country.
Since independence, successive Governments in Sri Lanka have taken various steps towards developing the SME sector. The ‘Mahinda Chinthana – Vision for the Future’ policy document also has clearly highlighted the need to develop the SME sector. The last few Budget proposals contained a number of initiatives in this regard. Yet, one of the main challenges that SME owners still face is access to financing and working capital to grow their businesses.
The absence of good credit appraisal, the absence of collateral arrangements and lack of reliable credit information on the risk management of SME have made it difficult for lenders to be able to assess risk premiums properly, creating differences in the perceived versus real risk profiles of SME. It is time we paid more attention to these needs and accordingly this year we will be evaluating various options to support the SME sector through capital market development initiatives.
Treasury Secretary Dr. P.B. Jayasundera has also advised the SEC to study how Sri Lanka’s capital market can enhance our role in supporting the SME sector. Is the current Diri Savi Board geared to meet the requirements of the segment we are talking about? Is there a need for a third board specifically catering to the needs of SMEs? Do they prefer medium and long term debt instruments over equity? Can the Government help the SMEs who need to raise capital with some form of a guarantee, insurance or collateral? These are the questions we need to answer. We are currently studying models adopted by several other countries while seeking indigenous solutions for our requirements. We are also open for your ideas and thoughts.
We currently have 289 listed companies at the Colombo Stock Exchange. There are a number of new IPOs in the pipeline. We see a lot of interest amongst companies now to consider listing as a way forward. We are also anticipating some potential de-listings. Some companies with very small market capitalisation may find it difficult to continue with the mandatory minimum public float rule introduced recently.
With the proposed financial sector consolidation there is a likelihood that number of finance companies in the country may shrink. Since some of these companies are already listed that too will have an impact on the number of listed companies. But such mergers will not significantly affect the market capitalisation in the short run. However in the long run it should work positively for the market as the merged companies are expected to be stronger and more stable.
Attractive investment alternative
With bank interest rates at unprecedented low levels, the Sri Lankan public and the business community should realise sooner than later that their savings in the banking system are not growing against the inflation. Under the current circumstances the capital market invariably becomes an attractive alternative for diversification of investments.
However, the lack of financial literacy and fear of mistakes will discourage most of the potential new investors. Of course if you identify a good investment advisor, our broker community is quite well-equipped to guide you.
Another route that the new investors could consider is investing in unit trusts. During 2014 we will be making an extra effort to create greater awareness of the unit trust market. Even during 2012 when the stock market didn’t do well the statistics show that the unit trust companies on average did better than fixed deposits and Treasury bill returns. Investing in a unit trust fund is an ideal launching pad for a new investor. However, the current levels of awareness of unit trust products and the distribution networks of existing unit trust companies are not yet at a satisfactory level. So we are planning to start a project to publicise the performance of all unit trusts funds available in the country on SEC and CSE websites. Within the next two to three months this information will be freely available to the public so just like you check equity market information online, you will also be able to check the performance of mutual funds.
During the recent past there was quite a bit of media publicity about the failures of a few listed companies, raising investor concerns. As a capital market regulator we have little control over the management of a listed company as it’s not our purview. The Companies Act 2007 on the other hand provides sufficient provisions for the shareholders to take action against errant company directors.
We on our part insist that all listed companies make adequate disclosure to the shareholders and the public. We closely monitor the companies under our preview whether they comply with these listing requirements and we have no hesitation in taking action wherever violations are observed. Wherever we observe some errant behaviour not necessarily covered under the provisions of the SEC Act, we make it a point to refer such findings to the relevant authorities for further action. We have even intervened in the court proceedings of one such company to safeguard the interests of the investors.
We too will be taking legal action against some decision makers who have violated the regulations. But as a policy we don’t give publicity to individual cases until all investigations are completed and findings are verified. Otherwise it’s not fair by those companies and individuals who are investigated.
We have been making significant progress, yet it’s a long journey ahead before our capital market becomes a significant contributor to the national economy. Our next target should be reaching market capitalisation of 50% of GDP. I sincerely hope that all stakeholders will continue to work together to reach that goal sooner than later. As Aristotle once said, the whole is greater than the sum of all parts. That’s why all intellectual resources available to us should be harnessed and we should all work together towards a common objective of brining economic prosperity to this country.