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Sri Lanka stocks hurt by Coronavirus, underlying economic issues

ECONOMYNEXT – Sri Lanka stocks may fall 10 to 15 percent amid a Coronavirus crisis before recovering in line with regional peers though underlying pre-crisis economic problems will continue to weigh on stocks where profits have been depressed for some time, analysts said.

“If we look at our regional peers, the net impact year to date would be about minus 20 percent,” Nikita Tissera, Head of Research, Bartleet Religare Securities said in an online forum by Sri Lanka’s Echelon Magazine.

“We have actually fallen a lot far before the markets closed compared to the net amount.

“There are two ways of looking at it. Either we have o think that we have fallen too far before, or we could use our emerging peers as a guide to what the post Covid-19 equilibrium could really be.”

Index Movement

Some global markets had fallen steeply before starting to recover. Sri Lanka had lost 27 percent before markets closed on in March.

The Colombo All Share Index ended at 4,571 before the market was closed.

Sri Lanka’s stocks may fall at least another 10 percent before recovering, Chethana Ellepola, Director Research, Acuity Stockbrokers said.

“The reason I say a minimum 10 percent is because, the worst fall of the index was 41 percent for a full year back in 2008 after the Global Financial Crisis. I think most agree that this is far worse than the Global Financial Crisis.

Sri Lanka’s stock market was closed for seven weeks making foreign investors unhappy.

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“I don’t think there is going to be a lot of buyers in the market,” Dimantha Mathew, Head of Research, First Capital Research said.

“There is going to be a lot of panic selling- from locals as well as foreigners. Because we have closed the stock market, one of the most liquid asset classes of Sri Lanka has now become illiquid.”

First capital forecasts the market to fall 25-30 percent before recovering towards the end of the year.

“At the moment we are looking 3,750 along with a rebound to 4,750 towards the end of the year,” Mathew said.

“However it could fall even lower if it goes into the worst case scenario. Even after that we are not expecting huge market gains because of the macro situation.”

“The deteriorating foreign reserves and the debt position towards the end of the year will make things worse in the following year 2021.”

Stimulus Issues

Sri Lanka’s economy is expected to contract 1 -3 percent in 2020 amid a Coronavirus lockdown and external issues stemming from ‘stimulus’.

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Sri Lanka however has been contact tracing aggressively and is ahead of many countries in the world in the fight against Coronavirus.

Sri Lanka may be behind a few countries like Vietnam, which is the global leader in contact tracing and perhaps its neighbhours Cambodia, which is also tracing, though accurate information is scarce observers say.

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Vietnam had already re-opened the economy, which was never fully closed, its stock markets are rising and sovereign bonds are trading at a premium to issue price.

The State Bank of Vietnam avoided any monetary stimulus that would have broken the Dongs mildly crawling peg with the US dollar up to now. In 2009 however a ‘stimulus’ led to a currency collapse and a prolonged slowdown.

Sri Lanka has closed several testing gaps in contact tracing over the last three weeks, with tests outside clusters located by symptomatic index cases, raising the chances of discovering cases missed by contact tracers.

But Sri Lanka is facing tighter external conditions after weak growth in 2019 coming from a currency collapse in 2018. Sri Lanka cut rates and injected liquidity in April and July 2018, triggering a currency pressure, which was worsened by a political crisis in October, economic analysts have said.

In January 2020, another ‘fiscal stimulus’ was engineered in the form of tax cuts without waiting for the cyclical recovery to happen from around mid 2020, spooking rating agencies and bond holders.

Rates were cut on January 30 and liquidity injections were made from the last week of February.

Injections were ratcheted up in March as the crisis hit, and jittery foreign investors sold down, International Sovereign bonds, pushing the yield of a bond maturing in October 2020 towards 100 percent as the rupee came under pressure and reserves started to fall.

The rating as later downgraded. But if the bond is repaid, confidence among foreign investors could rise.

The worst case scenario for the stock market could be a 15 to 20 percent decline, Danushka Samarasinghe, Chief Executive, Softlogic Capital Markets said.

“But there is a flip side, foreigners might return after we repay our international sovereign bond.

“The biggest concern of the foreigners is Sri Lanka going into debt defaults. What happened was, we closed our markets at the worst possible time. From the 20th of March onwards all the emerging markets and frontier markets have gained.

“And because we were closed we haven’t seen that gain. Therefore, there is a pent up force of selling pressure from the foreigners which could not be materialized due to the market closure.”

Foreign Reaction

Foreigners have always been a big part of Sri Lanka’s stocks markets. The closure of the market, where they were locked out may make them would add another negative for Sri Lanka.

Tissera said he did not expect foreigners to be “very thrilled” about the closure, as it nullified the idea of a market, though they could return if Sri Lanka got its act together.

In Egypt where the market was closed for several months of the Arab spring uprising, foreigners had returned.

Unlike bond markets where banks could buy bond with printed money from the central bank (from reverse repo auctions or the liquidity window) triggering currency collapses, stock investors cannot get credit from the banking when the market is falling.

Stock investors on credit face margin calls. As a result foreigners find it difficult to exit, due to lack of liquidity.

“The worst recorded outflow the Sri Lankan stock market has had was about 38 billion back in 2012/2013,” Ellepola said.

“That was when the economy was overheating and foreigners started to exit. We have to remember that they have been selling out for the past two years since the beginning of 2017.”

Foreigners have been net sellers in stocks and bonds for some time.

Bond investors have sold down their holdings from 450 billion rupees to around 20 billion over 5-year as the credibility of the Sri Lanka soft-peg dwindled and the currency fell steeply.

Sri Lanka had 267 billion rupees of foreign holding excluding the strategic holdings which 12 times greater than what remains in bond markets.

“Total foreign holding amounts to around 450 billion rupees along with the strategic holdings of Nestle, Ceylon Tobacco etc.,” Udeeshan Jonas, Senior Vice President, CAL said.

“We don’t see huge selling coming in but in terms of emerging and frontier market funds we see the fund sizes had shrunk significantly during the last 6-12 months.

“That is also because of the shift from emerging, frontier markets to developed markets not only in the context of Sri Lanka but also other frontier markets as well,” Jonas said.

But, given that foreigners are a little bit more worried on the fiscal conditions and on the market closure,”

“Normally you will witness the shift in terms of foreigners’ coming back into emerging and frontier market funds when you see the recovery cycle starting to happen. However, we will not see that happening in the next six months,’ Jonas said.

Bottom Fishing

Investors were also put off as profits of listed companies continued to falls steadily amid currency collapses, weak growth and rising bad loans.

“Profits from around close to 300 billion are likely to drop to 166 billion rupees this year,” Mathew said.

In 2020 Sri Lanka witnessed a 26 percent reduction in earnings making it the first instance in almost two decades where earnings declined for three consecutive years.

This year with banks expected to take a hit, profits would fall further.

“Banking sector will need t least 9-12 months to bottom-out and recover in terms of earnings. This year is going to be a pool of blood in terms of earnings,” Mathew said.

Debt moratoriums offered will slow the decent but banks would face higher levels of bad loans. Fitch Ratings had said that bad loans could rise to as much as 13 percent after regulatory forbearance is normalized.

Banks are going to have narrower margins and lower profits but they are trading at 0.4 to book value giving strong value, Jonas said.

The sectors to bounce back quicker will be food and beverages, telcos and the healthcare sectors.

“Dialog would be the stock which is closest to what we could call a ‘stay at home’ stock like Netflix,” said Tissera. Any currency fall however would hit Dialog.

“Others would be modern trade companies with last mile delivery like Ceylon Cold Stores and Cargills.

Lubricants could also do well with base oil set to fall.

Companies exposed to tourism along with companies with high debt levels will also suffer more.
(Colombo/May11/2020)

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