ECONOMYNEXT – Sri Lanka’s stocks would be a good investment opportunity with a sensible central bank, low inflation and policy stability, Django Davidson, an international portfolio manager who uses the capital cycle theory to invest, said.

Hosking Partners had a ‘few positions’ in Sri Lanka, before the crisis and had then become is believed to have  become the largest foreign investor in the stock market, he said.

Blood on the Streets

Sri Lanka defaulted on its foreign debt in 2022 after macro-economists cut both rates and taxes in what analysts say is the most aggressive full-employment policy (potential output targeting) exercise ever seen since setting up the central bank.

“So why did we invest in Sri Lanka?,” Davidson told a forum organized by CT Smith Securities.

“Well, firstly, there was just this huge and very traumatic destruction and withdrawal of capital, whether you looked at the bond market, whether you looked at the equity market, whether you looked at fixed capital formation.

“It was a brutal period. You guys lived through it. What that did was set up a lot of investments that were basically valued at below their replacement cost.

“And that’s kind of unusual in a world with low interest rates, with booming stock markets. You know, most of the world trades at very significant multiples of replacement cost.”

Since the end of the Housing Bubble, which was fired in an eight-year credit cycle by the Federal Reserve (its usual cycle is 4 years), amid a push to re-flate prices after what US macro-economists and inflationist academics in particular claimed was deflation around the turn of the millennium.

In 2001, Joseph Stiglitz suggested that the IMF print Special Drawing rights.

In 2002 Ben Bernanke who was not yet Fed Chief, also fired the false deflation scare, in a speech before the National Economists club. (Deflation: Making Sure “It” Doesn’t Happen Here : Remarks before the National Economists Club

In the same speech Bernanke also outlined the use of quantity easing and zero interest rate, floor systems with excess cash. Gold was 300 dollars an ounce, ‘more or less’ he said.

The Fed now operates what is called an ample reserves regime with excess money market liquidity with gold now over 4,00 dollars. After repeated stimulus and rising costs, government fiscal metrics are devastated.

The floor system also spread to the European Central Bank, triggering inflation, strikes and an expansion of nationalist parties, while stock markets boomed.

The ECB is now trying to phase it out.

However, a return to a scarce reserve regime, which brought unprecedented prosperity to the world under the so-called Great Moderation period, stopped inflation, sharply reduced the risk of asset price bubbles and social unrest especially in Germany before the Euro, is still not on the cards.

READ MORE : Towards a new Eurosystem balance sheet

Sri Lanka is now recovering from its last currency crisis and default, though concerns have been raised about recent currency depreciation and flaws in the operating framework of the central bank which can trigger another default, despite tax hikes fixing budgets.

Choosing Stocks

Meanwhile Davidson said Sri Lanka still had investment opportunities.

“If you were to say to me, Django, how do you use this capital cycle framework to make money in the stock market?,” he asked.

“I would say look for companies that are trading below replacement costs, where it would be irrational for new capacity to come in, and where the management team is cognizant of that idea and is being disciplined with the assets that it has.

“I think Sri Lanka is really interesting in that regard. The stock market and the economy is well structured.

“I haven’t seen too many examples of irrational competition. They’ll come as things get better, but at the minute it’s a disciplined corporate sector. If a discipline can be met with a disciplined fiscal, monetary policy framework, the outlook is very exciting.

In Sri Lanka private credit has shrunk over the years and mortgage lending was only 2.7 percent of gross domestic product in 2024 according to the central bank, Davidson said.

There was a similar situation in India in 2010 where a ‘long run mortgage cycle’ was unleashed in India, Davidson said, though some other India watchers are now raising concerns.

READ MORE : Is India’s Housing Boom a Bubble or a Scam—or Just a Structural Squeeze?

“If that can be unlocked here through policy stability, low inflation, sensible Central Bank, the evolution of the bond market, there’s an absolutely fantastic opportunity here,” Davidson said.

Foreign investors believe that ‘central bank independence’ will lead to a sounder system, though the central bank has cut rates and debased money disregarding calls for sounder money and market based interest rates including governments which will prevent mal-investments.

Meanwhile Davidson said the world goes through capital cycles where people invest irrationally in assets, usually in some emerging technology, he said.

The artificial intelligence boom and the heavy investments in data is a case in point.

Massive amounts of money was being invested in data centres by new companies and also the Magnificent 7 tech giants who do not want to be left out, but returns were declining, he said.

AI was becoming commoditized, with multiple competitors offering the same product at low prices.

From Railway Bubble to AI

“But what if AI is this incredible civilizational leap forward?,” Davidson asked.

“What if it changes the way we work, we interact? What if it dramatically increases productivity? Fair questions. I would submit to the jury the example of the British railways in the 1840s and 1850s.”

“This was a truly revolutionary technology that changed the way we lived, that changed our productivity. You could suddenly get coal from Newcastle down to London. It used to take a week.”

Coal could be brought from Newcastle to the coast in two hours and exported.

“It completely changed the nature of the U.K. economy,” Davidson said.  “In real terms, this was an absolutely disastrous investment.

“If you invested at the top of the bubble, you didn’t get anywhere near getting your money back. This was an incredibly successful technology, but it was a very poor investment.”

“There are lots of reasons to think that AI will be different. But the basic insight here – and this is why the capital cycle is so useful when you’re looking at bubbles – is that successful technology doesn’t mean good investment.”

The British Railway bubble ended in the Panic of 1847 also called the Commercial Crisis of 1847. It was a Europe-wide credit bubble which broadly collapsed at the same time.

The collapse of the credit bubble led to the Revolutions of 1848 also known as the Springtime of the People triggering the collapse of monarchies and more liberal rule.

In Sri Lanka (then Ceylon), as commodity prices collapsed ending a so-called Coffee Rush leading to lower tax revenues. Taxes were hiked by Governor Torrington, on top of falling incomes, helped fire a rebellion in 1848, which was put down.

After the collapse of the currency in 2022 after aggressive macro-economic policy in the form of rate and tax cuts (potential output targeting) people also came to the street, analysts have pointed out.

The current trouble in Europe and the US however is leading to a rise in nationalism and the destruction of liberalism, observers say.

Mining

While tech and data centres are eating up capital, traditional areas line mining have seen little investments, Davidson said.

At the moment, renewable energy and electric vehicles were driving up the need for metals like copper.

Davidson believed that opportunities “in industries like metals and mining, which have seen basically 10 years of no investment, is massive.”

“..[M]y biggest investments are in mining companies. Copper has been under-invested in for about 20 years,” Django said.

“We have not found a large new copper discovery in about 20 years. It takes about 15 years for a new copper mine to come on by.

“So the cycle, one question, a good question often gets asked is how do you know how long these cycles are? The answer is you do not. But a good anchor is the asset life of the company or industry you are looking at.”

“How does it apply to Sri Lanka?

“Well, the kind of thought here is that the capital cycle is a useful framework for industries and companies, but it also has relevance for countries, particularly emerging market countries where these boom-bust cycles repeat.”

In the US, another big credit bubble, also characterized by a railway bubble, collapsed in 1873, leading to what is called the Long Depression.

The bubble was worsened by the printing of ‘Greenbacks’ by the government, which were later deflated.

Iron and steel and mining companies collapsed.

The long depression lasted at least until 1879 and a recovery then led to the Panic of 1884.

In the US so-called national banks were at the time monetizing government debt with official sanction following Banking Acts of 1863 and 1864.

The US national banks were also given the priviledge of ‘Government Acceptance’ in a bid to create a uniform dollar note, which analysts have pointed out is a priviledge given to Sri Lanka’s note issue bank, the nation into a foreign debt trap by choking the Treasury of dollar tax revenues to service debt.

RELATED : Sri Lanka need not be a forex beggar nation, Treasury should charge dollar taxes

The 1884 bubble was characterized by a divergence between gold and silver price ratio, which had for many decades (or centuries) been around 15 to 1.

In Sri Lanka the Eastern and Oriental Bank Corporation, which was the main bank of issue, and had borrowed in gold and lent it silver, was hit as coffee prices collapsed, hitting plantations.

Analysts had drawn the comparison between the Oriental Bank Corporation and the swap losses of the central bank (borrowing in dollars and lending in rupees) in the 2022 collapse.

The failure of the Oriental Bank Corporation led to British authorities setting up a currency board, which kept the country stable during two World Wars and a Great Depression until the central bank was set up in 1950. External troubles started from February 1952.

By 1884, the gold to silver ratio had increased to 18.4 to 1.

In January, 2026 the gold to silver ratio is 56 to 1, with silver prices catching up.

(Colombo/Jan16/2026)