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19th September 1999

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ACL takeover triggers monopoly issues here

By Dinali Goonewardene

ACL Cables buy out of Kelani Cables has created a cable giant that has left small players in the market reeling and triggered speculation of anti monopoly legislation.

The two companies together are estimated to control 70 per cent of the market. "If they flood the market we will not be able to sell," Ruhunu Cables Ltd, Managing Director, H.N Jayasinghe told the Sunday Times Business. Ruhnu Cables together with Alucop Cables and Kamal Cables are the other players in the market.

"Their plant is computerised while ours is not and we may be forced to close and go home.

There will be job losses and disastrous consequences," Ruhunu Cables, Chairman W D Sirisena said. Employees of Kelani Cables said that ACL Cables and Kelani Cables were the main tenderers for Ceylon Electricity Board contracts.

The buy out has prompted speculation of anti monopoly legislation. However the Fair Trading Commission under whose jurisdiction this arises will not interfere. "Cables have to be gazetted as an item which cannot be monopolised and a percentage which construes a monopoly must be indicated. There is no such gazette,"Secretery General, of the Fair Trading Commission, D B R Muhandiramge said. However only 46 items have been gazetted.

These include milk powder and electricity but not cables! "A monopoly exists in relation to supply and usually if 50 per cent of supply is controlled, it is considered a monopoly,"Mr Muhandiramge said. Anti monopoly legislation in Sri Lanka is contained in the Fair Trading Act and is identical to legislation in the UK. A monopoly by its mere existence does not contravene the law and must abuse its power to the detriment of public interest in order to be frowned upon by the Fair Trading Commission.

The ACL-Kelani cable monopoly will not be affected by anti monopoly legislation unless its trade practices are detrimental to public interest.

"A price war situation existed between cable companies now they will dictate prices," Kamal Cables, Accountant, Felix Cooray told The Sunday Times Business. However employees of Kelani Cables said they had been informed by the management of ACL cables that they would be operated as a separate entity.

"The Fair Trading Commission should have been approached before the buy out, however the industry will be exposed to imports from abroad," Mr Muhandiramge said, explaining the stance of the Fair Trading Commission.

Kelani Cables came up for sale earlier this month after the DFCC Bank bought an 85 per cent stake in Lanka Olex Cables which had a 75 per cent share of Kelani Cables. DFCC held the balance 15 per cent of Lanka Olex. Bidders for the company included Ruhunu Cables and employees of Kelani Cables in partnership with Sierra Construction.

ACL Cables bid of Rs. 285 mn was accepted despite higher bids. DFCC said the decision to sell to ACL Cables was based on the interest of Kelani Cables and was intended to strengthen the cable industry. Shares of ACL Cables have been suspended for the last week, pending a mandatory offer to minority shareholders of Kelani Cables.

The Sunday Times Business learns that the delay in making a mandatory offer is due to negotiations between ACL Cables and the Securities and Exchange Commission regarding a offer price for the mandatory offer. The share was last traded at Rs. 67.

Quotas to be auctioned?

Textile quotas may be auctioned in the future to prevent fraudulent transfers, top apparel exporters said.

The government may auction part of it on a proportionate basis, giving priority to hot categories, exporters said.

The proposal to auction quotas was put forward by the Free Trade Zone Apparel Manufacturers as an alternative method to prevent quota frauds.

Though the proposal for quota auctioning was shot down by the Textile Quota Board officials and numerous apparel associations, apparel exporters say top government officials have been taken up with the idea as it would then provide a secure source of revenue to the government.

If the proposal goes through the small and medium term exporters will be the hardest hit.

They allege that the Free Trade Zone apparel manufacturers consist of mostly foreign investors who have inside information to the up coming hot categories, new styles in the west.

They would also have the clout and the financial backing to bid higher for these hot categories. "We may be forced to close down," the small and medium apparel exporters say.

Some apparel manufacturers are questioning the government decision to auction quotas saying the US government gives quotas to the apparel industry and not to the Sri Lankan government. However quotas are auctioned in Pakistan at present.

Apparel manufacturers say the success of the new system will depend on how the government allocates quotas.

Customs, port burning midnight oil

Sri Lanka Customs is now burning midnight oil or at least working until 8 p.m. following hard lobbying from the export trade.

A Treasury directive last week to extend working hours until for Customs and 24 hours for Sri Lanka Port will improve turnaround times tremendously, exporters said. While a round the clock Port service means faster clearing, the pressure on the roads will also ease, they added. But the more significant development that will make the export trade significantly snip off lead times is the introduction of the ASYCUDA ++ software for Customs clearance. The system should be operational by January 1st 2000, where all exporters will be online with Customs and can process documents from their offices, Lyn Fernando, of the Exporters Association of Sri Lanka and Chairman Creations (Pvt.) Ltd. told the Sunday Times Business. A pilot study will be run with the Hayley's Group, Fernando added. Mid year 2000 will see more computerisation of the export trade when EDI network service is installed for on line customs, bank, ports documentation.

A joint seminar by the Exporters' Association and the Sri Lanka Shippers Council will be held in November, to familiarise the trade with the forthcoming computerisation, he said. Mr. Fernando said that the export industry needs to aggressively market our port, which has actually been losing business to rivals. We need more ships coming to the Colombo port so that if we happen to miss a shipment today, we can still get it on board tomorrow and not affect lead times too badly, Fernando explained.

He added that our overall export performance has not been too healthy.

Although volume has picked up, values have dropped. "Speaking for myself, I have plenty of inquiries coming in at prices that are lower than my cost of fabric! That's the competition we are talking about," he added.

Newcomers shake housing loans sector's foundation

By Mel Gunasekera

Yearly disbursement of housing loans by banks (Rs. bn)

1994    1995    1996    1997    1998     1999 (est.)

2.6         4.2      5. 1     6.0        10.0    14

(Source: Central Bank)

The demand for housing loans has taken off at a rapid pace over the recent past thanks to the commercial banks issuing a number of debentures last year, partly aimed at long term lending for the housing sector.

But the downside is that a good number of the small and medium income earners who have taken housing loans are finding it difficult to pay their monthly instalments.

According to the 1998 Central Bank annual report, the housing and property development sector was the second largest absorber of total credit, taking a 13% slice, while credit granted to this sector increased by 20%. As the table shows, the demand for loans has been on the rise, but the appetite was whetted when the debentures came onto the scene, which opened the flood gates of applicants for housing loans.

The State Mortgage and Investment Bank (SMIB) a pioneer in the housing lending market, saw a sudden shift when the commercial banks stepped into their arena in 1996. "There was a shift in demand, where medium and high networth individuals preferred a 'hassle free' service and went to commercial banks for their housing needs," SMIB Finance Manager, W P P Perera said. With lending rates hovering between 14% - 15%, SMIB continues to cater to the lower income borrowers. Industry analysts say the commercial banks are targeting middle income and high networth individuals whose monthly salary is from Rs. 15,000 and upwards a fact most commercial banks we spoke to did not deny.

Hatton National Bank was the first out of the private commercial banks to enter the housing market in 1996. Since then Rs. 950 mn was disbursed up to end 1997, while Rs. 800 mn was disbursed as at end 1998.

The bank expects the growth to sustain around 20% - 25%, HNB DGM, Nihal Kekulawala said.

HNB's rival Commercial Bank too has reported similar success. Since 1996, the Bank has disbursed Rs. 600 mn worth of housing loans with an annual 30% growth rate Around 8 per cent of our total loan exposure last year was for the housing and property industry, Seylan Bank economist Saliya Kumara said.

Seylan anticipates a 15% average growth over the next few years. In the absence of medium and long term funds, all commercial banks dip into their savings deposits to fund their housing loan portfolio.

As one banker said, nearly 50% of savings are usually locked in for 18 years, making it an easy source of access for long term lending requirements.

The local floor tile market is projecting a 15% growth, while several cement packing plants have also sprung up

However, all's not too well. A senior research analyst said most small and medium income earners are finding it difficult to cough up the minimum 25% down payment, due to the prevailing economic downturn. SMIB's official confirmed this saying, "the quantum of loans have increased but the value of the loans have not increased accordingly." This could result in asset price bubbles, and a possible maturity mismatch on the part of institutions whose liabilities are essentially short term", an official said. However, banks have thrown caution to the wind. While the National Development Bank is setting up a separate institution to deal with housing loans, commercial banks are coming out with innovative housing loan products to sustain their market share. An analyst quipped, there is little signs the ride will slow down in the next few years.

Basis of prosperity is science education

Economic growth is dependent on many factors. Modern economic growth is virtually dependent on science and technology. The underdeveloped countries of the world are those with low levels of science and technology among their people.

A country's research may produce the nuclear bomb, but if its people are illiterate and science and technology out of the reach of its people then development will remain an illusion.

In a recent article in the London Economist Jeffrey Sachs of Harvard University has made this point very strongly. "Modern society and prosperity rest on the foundation of modern science. Global capitalism is, of course, a set of social institutions but the prosperity that results from these institutions has its roots in the development and application of their science based technologies".

He goes on to point out that economic prosperity in the second half of this century was based on the achievements of "solid state physics which gave rise to the information revolution, and on genetics, which have fostered breakthroughs in health and agricultural productivity". These scientific developments ushered in the material progress of nations.

Sachs' point is that the poorest countries will remain poor unless this technology is made available to them. The state of their health, labour producivity and the productivity of their land will remain low unless the marvels of modern science is utilised in these countries.

A telling point is that "Many of the scientific and technological breakthroughs are made by poor country scientists working in rich country laboratories".

There are many reasons for this and it is impractical to expect we could correct all the factors which constrain scientific development. At least there are a few factors which we could begin to correct. First is the very low expenditure on scientific education and research. This must be changed if we are to get anywhere.

Given a tight fiscal constraint, the government's capacity to spend more on science education and research is limited. So how do we fund it significantly? One quick answer is that the private sector should take some responsibility for funding science.

But persuasion has failed. Only driblets find their way to science institutions or research outfits. Private firms find it more profitable to support cricket than science. It is a classic case of immediate commercial gains to the firm outweighing national long term gains. It is another case of market failure which requires redress through government intervention.

One possible means is to impose a cess on either exports or imports or both and establish a National Science Fund. Another would be to impose an additional tax on corporate profits beyond a certain level of profit or tax certain corporate expenditures such as advertising and entertainment expenditures of firms. These are some of the broad suggestions we could make, the specifics and details must be worked out by the experts in public finance.

The other consideration is that our educational expenditures should have a scientific bias. Today the government spends most money for expenditure on university education in the liberal arts. In 1997 thirty seven per cent of university graduates were in the arts. This is a serious distortion in national priorities. Public expenditure on liberal arts education must be curtailed and channelled to science education.

This may seem a bias against rural areas and an impractical solution as most liberal arts students come from the hinterland. Yet why rural areas have fewer students in the sciences is due to the lack of science teaching facilities. These too must be improved.

The National Science Fund could supplement education department expenditures to establish and run science laboratories in schools. The science community through the Sri Lanka Association for the Advancement of Science (SLAAS) and other professional science associations and universities could be brought into a program of expanded science education, if the funds are available.

Scientists and economists alike are agreed that science education is the basis for economic growth in the long run. An eminent economist concluding his address on Globalisation at the annual sessions of the Organisation of Professional Associations said that globalisation meant intensive international competition and that the most efficient producers alone would survive. The competitive capacity of Sri Lanka, he said, was very much dependent on the improvement of our scientific skills and technological abilities. Improve and expand scientific education or perish appears to be the writing on the wall.

The rising Asian Market star

Continued from last week

After a strong run up this year, which saw stock market price indices double in some cases, Asian stock markets have fallen back in recent weeks. The rise was prompted by the beginnings of economic recovery combined with lower domestic and international interest rates. The key question for investors is whether or not this rise is justified and whether to regard the current correction as a buying opportunity. The charts show the IFC Investible indices in dollars rebased to January 1992=100.

A long term perspective

Contrary to the enthusiastic view of emerging markets prevalent before the Asian crisis, investors overall have earned very poor returns from Asian stock markets. One reason is that Asian markets performed best in the late 1970's and first half of the 1980's. After the mid-1980's Latin America was the emerging market star, with some eastern European markets shining in the 1990's. Generally the lesson has been that the best returns from emerging markets come when they first emerge as dynamic economies, in Latin America's case, the late 1980s/early 1990's when free market reforms were introduced, or in East Europe's case, following the collapse of communism.

Another reason for poor performance is the catastrophic market falls caused by the Asian crisis. Even after the pick up in equities this year, several stock markets are still well below their peaks. Thailand for example is currently only at 20% of its 1995 peak in dollar terms, while Indonesia in only slightly better at 25% of its 1997 peak.

The upside potential

If Asia is now in a turnaround situation, like Latin America ten years ago, this could be a good time for a long-term strategic investment. The table obove makes some heroic assumptions to give some idea of the upside. Using the IFC Global Index it takes the average level of corporate earnings in these markets during the good years of 1992-6 and applies a price earnings ratio of 20, to arrive at a "normalised" level for the index. The potential upside ranges from 367% in Thailand, through 165% in Indonesia, and down to 19% in Korea. If these rises were to happen in (say) the next three years, the annualised returns would be impressive in some cases.

However in Hong Kong, Singapore and Taiwan the current levels of these markets are already above the levels implied by this calculation. The reason is that profits are nowhere near so badly affected as was the case in some of the developing countries like Thailand. In addition, PE ratios are already higher than 20, anticipating the profit recovery. In Thailand and Indonesia, by contrast, profit levels are still very depressed.

In many respects the calculation is conservative. First, it is done simply in nominal terms and yet the world price level in dollars in (say) 2001 will be some 15% higher than the average of 1992-6, so earnings perhaps could also be 15% higher. Secondly, as the table shows, PE ratios were often much higher than 20 during those years. Thirdly, improvements in corporate governance, increased openness and greater emphasis on profitability should improve earnings in the future. Finally, real GDP in most of these countries is likely to return to its previous peak by next year, itself higher than the 1992-96 average by 20% or so.

The risks

However there are risks with this optimistic view. The expectation that countries can quickly return to healthy economic growth and buoyant profits may not be realised. The overhang of bad debt in the banking system in many countries, the high levels of government deficits now, which will need to be unwound and the general weakness of confidence still, suggests that GDP growth may be subdued for some time. After the current bounce in economic activity, GDP growth could fall back to modest levels of perhaps only 3-5%pa, well below the 7-8% routinely seen in the past.

It can also be argued that profits in the 1992-6 period were exceptional and are not rasily achieved again. In some cases they reflected boom-time conditions and in many countries the property boom was a key factor, boosting the profits not just of developers, construction companies and banks but of many other companies too through capital gains. This is a particularly important factor in Thailand since so much of the market is property related. What is the bottom line? The economic performance of these countries in the 1980's and 1990's was based on a high savings rate, an encouraging government with sound fiscal and monetary policies and reasonably liberalised markets. It will be surprising if this picture is not restored at some point, certainly in most countries, and the only question is how long it takes. An overweight position seems appropriate. Nevertheless the risks are there and investments in these countries should only be a small part of most investor's portfolios.

Current IFCG

IFCG level as % PE Ratio Potential

level 1992-6 1992-6 market

average gain*,%

IFCG Asia 300 76 24.5 10
Korea 381 79 22.5 19
Taiwan 932.1 117 27.5 -37
Malaysia 136.7 45 29.3 53
Thailand 196.1 22 19.5 367
Indonesia 37.2 37 20.5 165
Philippines 1697 53 24.5 62
Hong Kong 1 13403 167 15.4 -23
Singapore 2 159 121 23.3 -25

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