Lanka can become financial hub in South Asia

Most middle class Sri Lankans have a bank account overseas so the effect of the liberalisation is to make a de facto situation, de jure. Given the fact that interest rates for the Sri Lanka rupee are higher than for most major tradeable currencies, I do not foresee a massive flight of capital out of the country. But the Central Bank should consider moving aggressively to create even more liberalised conditions which will make Sri Lanka a major financial hub in the South Asian region.

The measure is commendable in that it is the first time that the Central Bank has acknowledged that Sri Lankan residents have a desire to keep funds overseas, whether it is for purposes of diversifying their investment portfolio or simply having convenient access to funds when travelling. It will improve the confidence of Sri Lanka’s large expatriate community overseas and foreigners that the Central Bank will not stand in their way if they need to repatriate investment funds that they invest in Sri Lanka. This should improve inflows of investment funds over the medium term.

The move should be viewed in the light of recent comments by the IMF that the Sri Lanka Central Bank should not resort to excessive borrowings to maintain an adequate level of foreign reserves. By liberalising exchange controls, enhanced confidence should stimulate inflows of capital and savings which will, it is hoped, eventually enable the Central Bank and the Treasury to reduce the country’s high level of short-term foreign debt.

But more has to be done to further embellish the status of the Sri Lanka rupee as a fully convertible and tradeable currency. The Exchange Control Act has to be revamped and modernised. This is in order to bring it in line with regulations in other countries which protect foreign investors against, say, arbitrary imposition of exchange controls in the future. No mention has been made about the convertibility of foreign currencies into Sri Lanka rupees which is still confined to locally licensed banks and licensed money lenders.

Here are a couple of ideas to speed up the benefits which would accrue from the partial liberalisation of exchange controls:

1. Link investments abroad to certification from the Inland Revenue Department that taxes have been paid on funds to be remitted. This will prevent the outflow of undeclared funds and provide an incentive for enhanced tax compliance by tax payers. This should be linked to measures to bring public officials within the tax net and abolish tax exemptions, including ‘section 17’ BOI agreements. Improving tax compliance is priority number one for Sri Lanka if it is to make economic and currency liberalisation sustainable.

2. Permit the US Dollar to be used within Sri Lanka as legal tender. The dollarization of the Sri Lankan economy will bring huge long-term benefits to all export-led industries and service sectors, including the vital tourism sector. It will provide a magnet for tourists and business persons from neighbouring countries to use Sri Lanka as a base to transact trade and investment activity freely in a variety of foreign currencies.

(The writer is a well-known economist working in the banking sector overseas who wishes to remain anonymous)

Significance of the Central Bank proposition By Kajanga Kulatunga Figure 1: Sample Risk/return profile of some common asset classes. Data has been generated by the author for illustrative purposes only. Investors should gladly welcome the Central Bank proposition announced earlier this week to allow Sri Lankans to invest in overseas shares and bonds. The benefits of investing globally are countless. Chief amongst these is the ability to diversify risks by holding a basket of global assets, across a range of asset classes, industries and countries. Diversification is the cornerstone of any sound investment strategy. Simply put diversification is about not putting all your eggs in one basket. In investment parlance, diversification is build by combining uncorrelated or negatively correlated asset classes. That simply means building a portfolio combining different assets that theoretically and historically move in opposite direction. This helps protect your capital as the fall in value of one asset is offset by the rise or stable returns from another. The classic mix is between bonds and shares. Usually, given the very different characteristics of these two assets, bonds tend to react differently to shares during various economic cycles. Property is also a unique asset that sits between bonds and equities in the risk/return spectrum. So called “alternative” assets are mostly marketing gimmicks with very little benefit to the average investor. However, there are times when diversification seems to come unstuck. The global meltdown after the collapse of Lehman Brothers in 2008 was a classic example. Every asset class was equally battered. A closer inspection reveals that the benefits of diversification remained intact, and it was the individual portfolio mix that actually failed investors. Figure 2: Shows the annual returns from Global Shares and Bonds over the last 108 years. This graph has been created by the author using multiple sources. Offshore exposure helps in overall portfolio diversification as Sri Lanka is a very small part of the global economy and global capital markets. There are entire industries (such as Aerospace and Defence) overseas that are not available in Sri Lanka, which provide great opportunities to investors. Investing offshore however attractive is not without risk. Foreign exchange risk is the most obvious. Your investment return from overseas is partly dictated by the return on currency as well. Fund managers provide various methods of ”hedging” currency in many markets, which helps remove much of the volatility associated with currency risk. Basic risks associated with any investment also do not go away, simply because they are global. Prudence and due diligence should still be an essential component in selecting a good investment strategy. What investors now need are a few good fund managers to establish distribution arms in Sri Lanka to help ease access to global markets. The current local infrastructure for someone who wishes to invest overseas is sparse and expensive. Investors should be well served by the advent of some low cost basic index funds to begin with. The investment prospects for the average Sri Lankan never looked better. (The writer is an Investment Specialist based in Sydney, Australia. He can be contacted via kajangak@gmail.com).