EXTRAORDINARY GAINS A THING OF THE PAST    

Hasitha Premaratne states that the stock market is feeling the effects of speculative
trading and with over-valuation sans foreign participation extraordinary returns
are now a thing of the past

October recorded the lowest monthly turnover in 2011, as activity levels dropped to Rs. 25 billion. This saw average daily turnover slipping to 1.3 billion rupees. The All Share Price Index (ASPI) fell 464 points (6.8%) during October. Year-to-date, the index was down 4.7 per cent at end October, the longest period that the ASPI had stayed below last year’s close of 6,636 points. In fact, the ASPI briefly fell below 6,636 points in July, but recovered amid speculative trading. The wave of speculative trading that had driven prices of selected illiquid stocks still continues, though the quantum of such trades are on a declining trend.

STRONG FUNDAMENTALS Despite volatility in capital markets over the last few months, economic fundamentals still remain strong, though there are a few external pressures impacting the real economy.

MODEST INFLATION Over the last few years, inflation has been in single digits, a marked contrast to the inflationary environment that prevailed from 2006 to 2009, where the index remained in excess of 20 per cent for a long period.

While inflation may increase marginally in the next few years due to excessive demand, it is likely that the single-digit inflationary environment will continue to exist in the medium term.

INTEREST RATES With inflation moderating, interest rates have dropped drastically and Treasury Bill rates have hovered at around 7-8 per cent during the last two years. Meanwhile, the Prime Lending Rate (PLR) has remained in single digits during 2011, indicating a borrowing environment that is conducive to both businesses and individuals. A low interest rate regime is expected to continue in the medium term, though interest rates in general are expected to increase by 1-2 per cent over the next two years.     

RUPEE SLIDE During 2011, the exchange rate fluctuated in a narrow band of Rs. 109-111, which is less than two per centin in terms of volatility. The relatively stable exchange-rate environment provided stability to businesses, and it appeared that the Central Bank was trying to maintain a stable Sri Lankan Rupee, at times going against the free market principles. While a stable rupee will encourage importers and businesses in general, exporters may not be happy about it. That said, the budget proposals point to a rupee depreciation of three per cent going forward. 

Up to last year, the trade deficit was financed by worker remittances; but over the last few months, the deficit has expanded at a rapid pace, and the 25 per cent worker-remittances growth has become inadequate to cover it. Right now, the trade deficit is partly financed by external commercial borrowings and this is not a sustainable way to manage the Balance Of Payments (BOP).

Given that there is no serious strategy to boost export income nor to curb import expenditure, the BOP is likely to come under threat in the short term. Hence, it was clear that defending the rupee would be a challenging task. In summary, exchange rates will now depreciate, unless the US Dollar falls substantially in global markets.  

GDP GROWTH Post war, the country’s economic growth has stabilised around eight per cent, after going through a passage of volatility over the last 20 years, during the war. While most infrastructure-development projects are still in progress, it is likely that the services-sector-driven economy will continue to post growth in the range of eight per cent in the medium term.

With stable GDP growth, a modest inflationary environment, single-digit interest rates and a relatively stable rupee, the economic fundamentals remain positive for corporates to capitalise on and boost profitability in the next few years.

But all is not positive, as the widening trade and fiscal deficits, mixed policy signals (such as the expropriation bill), a powerful government and a volatile global economy may stop macroeconomic fundamentals from performing to their true potential.

CAPITAL MARKETS With a relatively stable macroeconomic environment ahead of us, the Colombo bourse has been going through a bad patch over the last few months. The problems in the market are more to do with micro than macro issues; thus, it is vital that stakeholders such as regulators, stockbrokers, investors and so on work together in order to promote stability in the market.

Over the last 12 months, market growth was primarily driven by excessive credit (with not much hard cash), an overly dominant retail investor base, and speculative and manipulative trading, which has led to the downfall of the market and the present scenario.

During early 2011, we had an overvalued market with little or no foreign participation that was widely dominated by speculative and manipulative trading. By end October, the index fell nearly 19 per cent, and the market lost Rs. 326 billion in value and many investors lost out.

Most investors did achieve remarkable gains at the time the market grew 125 per cent and 96 per cent, in 2009 and 2010. However, these extraordinary returns will not be repeated in the next few years and investors should adjust their mindsets and look for annual returns of 20-30 per cent, which is much higher than bank deposit rates. Accordingly, investors should revisit their portfolios by gradually accumulating fundamentally sound stocks with growth potential which currently trades at low valuations.

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