Market cycles are indelible features of any modern economy. An upturn promises short-term gain, while a downturn presents lucrative long-term opportunities for savvy investors. No one can escape economic cycles, but a fair and robust market can give investors significant returns in the long term, help enterprises raise capital for growth and elevate the rest of the economy.
Dilshan Wirasekara assumed office as new CSE Chairman in June 2022 as the economy continued to sink deeper into crisis. However, Wirasekara and his team are determined to continue developing the exchange into a modern capital market and unlock opportunities for investors and companies despite the economic downturn. Wirasekara has served on the Board of the CSE since 21 November 2017 and is the Director/Chief Executive Officer of one of the leading investment banking firms, First Capital Holdings Plc.
In this interview, he shares insights on the economic challenges and their implications for investors and companies looking to raise capital and how the CSE can fulfil its role as a growth facilitator, now more than ever.
What is your outlook for the economy and the equities market?
The economic and even the equity market outlook is quite daunting and challenging. If you look at how the equities market has behaved over the last couple of months, after reaching a high at the end of 2021, we had close to Rs5.5 trillion market cap and the All Share Price Index peaking at around 13,000 points in January 2022. The market has fallen 40% since, with the ASPI down to 7,500 points in mid-June and market cap declining to Rs3.2 trillion on the looming default, steep currency depreciation and steep 700bps policy rate hike in March. The depletion in forex reserves has precipitated an acute shortage of essentials and energy, dragging the economy deeper into crisis. Even listed companies are struggling to cope with the fuel and gas shortages and the power cuts.
The economy is heading for a sharp contraction, with the GDP forecast to decline by 5-7% in 2022. In this context, a challenging environment for equities is expected in the short term. The equity market reflects the broader economy, and the health of companies listed on the CSE will get challenged by rising interest rates, record high inflation, depreciation in the currency and shortages.
Anticipating a staff-level agreement with the IMF, we have pre-emptively rolled out a series of corrections by increasing fuel prices, removing subsidies, introducing formula-based pricing, tightening policy rates, reversing tax cuts, and allowing the currency to depreciate.
There may be a few things left. One is pricing utilities fairly, especially electricity. A tariff hike is currently on the cards, and with that, we could meet a good 75-80% of what would have been IMF conditions before we even reach an official bailout agreement. Other reforms will follow, including restructuring loss-making state-owned enterprises that continue to drain the public coffers, further fiscal consolidation and making debt sustainable via debt restructuring.
So immediately, the outlook is a bit negative, and we expect things to remain challenging in the next three to four months. However, towards the end of this year, the economic challenges will begin to ease and therein lies the equities opportunity. Once we reach a deal with the IMF, hopefully before the end of this year, that will be the catalyst for other bilateral lenders and friendly nations to come on board and offer to help us out, so we are moving in the right direction.
In the March 2022 quarter, total corporate earnings reached an all-time high of Rs286 billion, up 134% from a year earlier. Naturally, company earnings could decline as the economic crisis deepens and the tax reversals take effect.
Nevertheless, if you look at valuations, they are at historic lows. If you look at multiples for the entire market, we are trading below book value at an affordable 0.8x price-to-book multiple, and on trailing earnings, we are something like less than 5x the PE ratio. Investors will not find more attractive valuations.
Developed and more liquid markets are in the region of 15-20x price-earnings and 1.5-2x price-to-book multiples. The CSE has some brilliant companies that would remain profitable during these challenging times. There are also defensive counters like export-oriented and dollar-earning companies that can still do well in this environment. Therefore, I believe the longer-term prospects for the CSE are still exciting.
A question often asked is – with the interest rates at 20%+ would investors not shift from equities to fixed-income assets? That would be natural, but with inflation at 40%, the negative real returns from fixed-income investments are substantial. Equities could be one hedge against inflation, provided you take a three to five-year view on your investment portfolio. Investors need to focus on what those companies are. If you pick sectors like banking, most large-cap banks are trading at less than half their net asset value, some as low as 0.3-0.4x, and 2-3x PE, so those are real bargains in the long run.
Where do you see inflation, interest rates, and the currency heading?
Inflation would remain elevated around the 30-40% mark for at least another three to four months, especially with the electricity tariff revision on the cards. However, these are all one-off adjustments we made starting from the currency depreciation when everything imported went up in price: we also had issues with food production because of the fertilizer fiasco. Therefore, towards the end of the year, inflation should come down but will still average around 15-20% into 2023.
Interest rates have eased to 21-23% since peaking at 25% in April-May 2022, and we expect rates will hold out at those levels for the rest of the year. Currently, elevated interest rates, even in the ballpark of 22-23%, are significantly high, so I do not think raising rates any higher would address inflation. Especially, as it’s seen as supply-side-led inflation as opposed to demand-driven.
Towards the end of the year, when we have the IMF programme, we expect foreign inflows to improve with investors and bilateral lenders taking a more positive view of Sri Lanka. The currency has depreciated more than it should have. If you take the real effective exchange rate, I think the rupee should be trading somewhere between Rs300-320 against the US dollar, whereas now the currency is trading between Rs360-370. So, a slight appreciation is possible by the end of the year.
You are taking over the reins as Chairman of the CSE during a daunting period for the economy. What are your plans for the exchange?
The primary role of the CSE is to conduct a free and fair market to facilitate capital formation effectively. Despite Covid-19, 2021 was a record year in the number of listings and value of the capital raised. However, a slowdown is inevitable under the present economic conditions. Over the last 20 years, we have had multiple challenges, from civil conflict to political unrest, natural disasters like the tsunami, the Easter bombings, and the pandemic. We have always been resilient and bounced back stronger. The current market downturn will be no different, harder to negotiate than before, but possible to overcome. We will continue to focus on our strategic objectives because we are not looking at it from a year’s perspective.
We have a long-term view of where the capital market should be and will build towards that. A big issue we have had is that our market has been a dual product market, we have equity which is a cash market, and we have listed debt or the debenture market. So, one area of focus is product diversification, and about two years ago, we put this strategic plan in place to introduce new products to broaden the investor base. We introduced REITs, brought in the SME board, and got approval to have a US dollar-denominated board where companies can list and raise foreign currency in the country. We are looking at commodity-backed products, stock borrowing and lending and regulated short selling. There are a whole lot of new products that we are currently working on that will be introduced in due course. The stock market is not just about buying and selling equities; you will soon have different asset classes that you can invest in through the Colombo Stock Exchange.
Another focus for us is to look at our infrastructure, primarily IT. We want to build a world-class exchange. The CSE has been far more advanced than our regional peers in embracing technology, even though we are a much smaller market. We were one of the first to move into CDS and scripless securities, and after the Covid-19 outbreak, we digitalized the entire exchange to enable remote operations. Another initiative on the infrastructure side was to move to DVP (delivery versus payment), as opposed to the previous T+3 basis. Also on the cards is the CCP (central counterparty settlement) system, elevating the bourse to the level of sophistication of most global exchanges and boosting investor confidence further.
Thirdly we are looking at how we can broaden our investor base by creating awareness, even working with the Ministry of Education to build capital markets into the national curriculum. Financial literacy is a problem. Many Sri Lankans are unfamiliar with the equities market, and digital technology can improve access and financial inclusion. Investing in technology is another prong in our growth strategy by elevating investor convenience and experiences. Out of the 650,000 CDS account holders (from an eligible population of 15 million), only 65,000 trade at least once a year. We will endeavour to grow the number of CDS accounts to a million over the next few years and increase active trading by introducing new products, enhancing efficiency, and creating more awareness.
These are the fundamentals of our strategic plan to help the exchange ride these challenging times and unlock opportunities for investors and enterprises. The CSE was fortunate to have had two good years of robust earnings that helped us build enough reserves to take care of rising costs and ensure we execute our market development strategies unabated.
What can the CSE offer investors and companies struggling to survive this crisis?
Companies may be reluctant to raise capital via listing because valuations are pretty low, but that has been a challenge for us in this market for a long time. For companies needing to raise capital, the CSE is the best option because debt financing is much more expensive now. With the current elevated interest rates, debt financing will be a daunting exercise if not an unviable option. Banks will not lend below the risk-free rate, so you are looking at 25%-plus borrowing costs. Our SME or Diri Savi board can enable smaller companies to raise capital on more favourable terms. That is also true for companies wanting to list on the main board.
Even from an investor perspective, you need to ride these phases out. A mistake many people make is selling out in a depressed market, but if you look at successful investors who made money, they bought in a depressed market and booked profits when markets recovered. Now is a good time for accumulating portfolios for people who have that risk appetite, who can ride this crisis out because these shares are ludicrously cheap and could lead to windfall returns three to five years down the line. It is hard not to lose confidence and avoid feeling depressed. But getting through this crisis and emerging stronger requires us to focus on the good things as individuals, companies, and a country.
We are grateful we have functioning capital markets where valuations offer attractive long-term potential. While it looks bleak now, I think the economy will begin to see some improvement before the year ends.
My message to investors and the entire market is to remain positive. If you keep that positive mindset, keep going, trying to achieve something more than what you had yesterday, I think we will move forward as a country.
Whether it is a company getting listed to raise capital or an investor coming in, my advice is to take a medium to long-term view, talk to us and see how the CSE can help you in that journey. We have an Investor Relations and Marketing Acquisition team continuously looking at potential companies for listing. Our teams would go and encourage these companies, talk about the benefits of listing, and sometimes, even jointly with other investment banking firms in the country, promote equity listing. We also have a team that can assist companies with the corporate governance standards, helping them understand the listing rules and the various compliances and regulations governing listed companies.
I remain optimistic about Sri Lanka and the Colombo Stock Exchange. We have seen the worst of times before, and although the next few months will be challenging, we believe that things will start getting better, and we will be on a path to recovery.