Financial Times

Sri Lanka: A market reborn
By William Spain
COLOMBO, Sri Lanka, Sept 11 - (CBS.MW) -- Finally, they are getting the right kind of boom. With at least a temporary end to years of bombings in the cities and ethnic slaughter in the countryside, Sri Lanka is back to business with a vengeance. The stock market is soaring, corporate profits are way up, interest rates are plunging, visitors are pouring in and foreign investors may be ready to take another look.

"Business is getting better by the day," said Naren Godamunne, a vice president at DFCC Stockbrokers. "Companies are posting strong earnings growth, exports are increasing, the cost of imports is down and there is an improvement in the trade deficit." In addition, "the government's need to borrow has been reduced," which has brought down interest rates from the high double-digits to a more manageable 7 percent range.

The All Shares Index, comprising the 250 or so equities on the Colombo Stock Exchange, is up over 30 percent year-to-date to decade-long highs, on top of an equally impressive gain in 2002. Volumes have doubled and doubled again, from a daily average of 50 million rupees (about $500,000) in late 2001 to more like 200 million to 300 million ($2 million to $3 million). It recently had a billion-rupee ($10 million) day.

Sri Lanka's gross domestic product grew 4 percent last year and is expected to add 5.5 percent for 2003. Corporate profits, up an average of 68 percent in fiscal 2003, should get a still-large bump of about 35 percent. Following years of devaluation, the rupee has been holding steady at about 96 to the dollar for most of 2003. Two major factors combined to set the stage for more positive investor sentiment: The election of a new government in late 2001 and a ceasefire early the next year that put the country's brutal 20-year civil war on hiatus.

The worst point: July 2001
This tropical island nation hit bottom spiritually, politically and economically in July 2001 when guerillas from the Liberation Tigers of Tamil Eelam attacked the international airport, turning much of Sri Lanka's aviation sector into smoldering junk. Tourism, already suffering from the effects of the war, fell off a cliff. Insurance surcharges on planes, trains, automobiles and ships went through the roof, weighing on exports. GDP growth fell into the negative range for the first time ever, and the flight of capital, human and otherwise, intensified.

Topping it off, a severe drought shrivelled crops and led to wide scale power outages in a hydro-dependent industry. And then came Sept. 11. While Washington's subsequent "war on terror" has had mixed results worldwide, the fallout from those attacks has been mostly positive here. The spectre of a vengeful international community ready for the first time to support the Sri Lankan government, along with growing war fatigue, was enough to bring the ferocious "Tigers" to the negotiating table for the first time in years.

They have stayed there for about 18 months. If huge differences over the future shape of Sri Lanka remain, the mere fact that the violence stopped was enough for investors to perk up. There are also indications that the government of Prime Minister Ranil Wickremesinghe, who came to power in December 2001, will finally follow through on promised reforms in tax and investment policies. While corruption and red tape are still too common, a tax amnesty was modestly successful. It apparently brought a lot of "black" money into the open, making it available for investment in stocks.

But it is the ceasefire that counts. "This is the longest period where we have had a situation of no fighting," said Ajit Gunewardene, joint managing director of John Keells Holdings, one of the Colombo Stock Exchange's blue chip companies. Further, "there appears to be a feeling of genuineness from both sides. We may not have peace but there is no war. This has resulted in a upsurge of business activity that hasn't been seen in years.”

Local investors lead the rebound
Profits at his company, which has interests in everything from tourist hotels to tea plantations to the local franchise for Pizza Hut, were up almost 144 percent for the fiscal year ended March 31. Its share price better than tripled over the same period, to just under 71 rupees.

It's now trading around 117 rupees. The market rise is mostly fuelled by local investors, because it requires intimate knowledge of the terrain and a willingness to take big risks. Among the biggest local players is Dhammika Perera, whose Vallibel Holdings has used the market to gain controlling interests in four separate companies over the last year while reaping rich rewards from short-term buys. One of Vallibel's first big investments was in a publicly-traded bank.

It bought 12 percent of the company at 28 rupees when, remembered Vallibel manager Nimal Perera (no relation), "everyone recommended not to buy. "Selling at 90 rupees only six months later, "it was a killing. Nowhere in the world can you make a return like that," he said. When it comes to getting control of a company, though, "the problem is liquidity." So much of the stock is often held by principals or their friends and relatives, "there is often no stock to buy and even when there is, you have to give a very big premium -- as much as 50 percent or more," he said.

Of course, that could still be considered cheap, at least for now. With an average price-to-earnings ratio of about 10, "the market is being re-rated upwards, said Dushyanth Wijayasingha, research director of Asia Securities. "Earnings growth has far outstripped the performance of the market, so this can probably continue for some time.”

Foreigners in the market
So far, most of the benefits have accrued to Sri Lankans. But a few foreigners -- notably the Galleon Fund, a U.S. hedge fund run by a Sri Lankan emigrant - have also taken positions. One foreign investor who stayed through thick and thin is David Perry, an American who has lived on and invested in the island for more than a decade.

While he has turned a respectable profit over the years, an "American going into this market would probably be better off finding some kind of Asia fund, one that isn't too greedy." Apart from that, "as with any peace dividend, you buy on hope and sell on reality." William Spain, son of former US ambassador James W. Spain who resides in Sri Lanka and a reporter for cbs.marketwatch.com in Chicago, recently visited Colombo.

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