The stock market rally can be put into context by analyzing its market capitalizations as percentage and Gross Fixed Capital Formations as a percentage of GDP
The long term Market Capitalization as percentage indicates that that the Global markets as overbought and that a correction is in order.
The previous three occasion were 1997-1999 the Japan Asset bubble in and US banking crisis in trigged the fall. In 2000-2001 it was the US dotcom bubble and finally in 2007-2008 the US mortgage and derivative bubble.
Sri Lanka with its unique blend of diverse culture, bio diversity and friendly people enters the global map as The Best Travel destination and retains its proud identity despite recent setback following 4/21 destruction of life and property. The Lonely Planet – the best-selling magazine featured Sri Lanka in 2019 – 10 years after a sustained upbeat in tourism nearly three decades after ending conflict in 2009.
The country that was torn by war has entertained 2.4 million tourists by the end of 2018 benefiting nearly 300,000 direct and indirect employment and livelihoods,. A large number of them being small and medium entrepreneurs engaged in supply chain activities, investments in the development of leisure facilities, transport and logistics, urban and rural property development. This sector also accounted for USD 4.2 billion in foreign exchange earnings marginally lower than the country’s single largest industrial export income of USD 5.3 billion from textile and garment exports. In 2009, this now buoyant industry accounted for a mere USD 349 million.
The Lonely Planet ranked Sri Lanka as a top country to visit in 2019, stating “Already notable to intrepid travellers for its mix of religions and cultures, its timeless temples, its rich and accessible wildlife, its growing surf scene and its people who defy all odds by their welcome and friendliness after decades of civil conflict, this is a country revived.” The Lonely Planet recognises new highways and railroads help connecting critical areas of the country. It has also recognized that Sri Lanka’s tourism industry is developing properties around the island with more international hospitality brands.
Tourist interest in beaches are expanding to places like Tangalle, and going beyond popular places like Unawatuna and Weligama. Another attraction highlighted in the best-selling Lonely Planet Magazine is the train between Nanuoya and Ella passing through the hill country area beautified with the lavishness of tea plantation and natural environment. The ancient ruins of Anuradhapura with a wider attraction to the sacred Ruwanweliseya Stupa built in 140BC during which time Buddhism had flourished to its peak. The country’s history is enriched with leaders so devoted to empowering the island by Buddhist philosophy and culture with massive stupas and temples.
Economically the culture was supported by agriculture with amazing engineering talents to create its agricultural infrastructure with tanks and canals. The Sacred Temple of the Tooth is the holy place protecting the Tooth Relic of Load Buddha which is another attraction for visiting tourists. Both Anuradhapura and Kandy are two of the most holy places visited by many Sri Lankans as well. Showcasing the cultural extravaganzas every August the Trustees of Tooth of the Temple of the Tooth hold the Kandy Essla Perahera. Peradeniya Botanical Garden – the largest and oldest botanical garden in the country introduces the glamour to make Kandy which has been around for several 100 years as a tourist city.
The Eastern Tourism corridor spanning from Yala to Kuchchaveli through Pasikuda and Arugam bay is well known for the best waves in Sri Lanka. Surfing enthusiasts enjoy this area from April to October.
Moody’s Credit Rating Agency on the 23rd of November 2018 announced that they have downgraded Sri Lanka’s sovereign credit by one notch from B1 to B2. Many political statements have been made of this downgrade.Let us examine what it really means to Sri Lanka.
Table-1-Credit rating range From Aaa to Ca
Source: Econsult & moody’s
Each country is rated based on their governments likelihood to default on their external borrowing obligations. The credit rating therefore looks at the default probability of the state. In doing so Credit rating agencies take into account GDP growth, per capita growth, monetary conditions, fiscal deficits, external debt burden and a host of other quantitative and qualitative data in arriving at the credit rating political risk is also one such variable.
Moody’s have an established rating score which is Aaa which indicated the highest quality of credit with a probability of default of 0.03 percent while speculative grading’s are from Ba1- Ba3 with a probability of default 2.60 percent. The lowest credit score is classified as High risk or Highly Speculative obligations which are rated by Moody’s as B1, B2 and B3 (probability of default 9.58 percent). With the lowest and most riskiest being Carated sovereign credits (two year default probability of 35.9 percent).
Sri Lanka Credit Rating B1 to B2
In this regard Sri Lanka was already rated as a high speculative country B1 (stable) since July 2013 and later the rating outlook downgraded from stable to negative rating reaffirmed in 2016, 2017 and 2018 . Therefore Sri Lanka a B1 credit was below investment grade to begin with the outlook changing from ‘stable’ in 2013 to ‘negative’ from June 2016. (Source: countryeconomy.com). The corrective action plan could have reversed this outcome; however, the trajectory was unadjusted.
Moody’s appears to place a higher weight on GDP growth, inflation, growth in per capita income in order to achieve a higher grade rating, while lower inflation and lower external debt also consistently relate to higher ratings.
Therefore the overall credit rating of Sri Lanka in terms of its high risk rating has become more pronounced as the external debt and external foreign reserves situation has decreased since 2014 with warnings not heeded by persons responsible for managing the external debt. Added to this our external Foreign exchange reserves too has continued to decline and has declined by 30pct from USD 9.9 billion in April 2018 to 7.0 billion as at November 2018
Chart-1-External Debt Maturities
Source: Econsult & moody’s
Putting the Impact into perspective
The credit rating impact thus must be seen as a testimony of the shift in the economic model which has seen a shift to consumption demand which is supplied by external sources, thus this has lead to the trade deficit widen to USD 14 billion. Non-consumer import demand during the past three year have witnessed an increase by 47pct growing from USD 1,700 million to USD 2,500 million over the period 2012-2014, 2015-2017 With the rupee depreciation rapidly to stem the imbalance in the overall current account.
Therefore the reason for the downgrade is three fold a) Sri Lanka’s growing debt to GDP ratio which had increased from 71% of GDP in 2014 to 85% of GDP as at 2018 June and b) its deteriorating external finances and c) the deterioration in GDP growth from 9% in 2012 to 3.1% in 2017 and also a stagnant per capital growth over the past 3 years.
Chart-2-All Share Index and USD/LKR price behavior
In fact the financial markets had already factored the credit downgrade of Sri Lanka since June this year (Chart-3) as depicted in the Colombo Stock Exchange All Share Index breaking the 6000 mark (Yellow line) and the flight of foreign bond holders from the government debt securities market which resulted in the Rupee depreciating by 15% on year to date basis (Purple line) therefore it is not professionally correct to underpin the downgrade to the last two weeks of political swings
Chart-3- Sri Lanka Sovereign Bond secondary market behavior
Source: Econsult & moody’s
The deterioration in the country’s external finances also had a significant bearing the ability raise finance as the 2025 USD Bond with a coupon of 6.875pct witnessed a sell off in the secondary market. The sell off of the Sovereign bond (ISIN 85227SAQ9) was witnessed since January 2018 but exacerbated during the past one month, reaching a yield of 9.04pct
This negative sentiment has thus prevented Sri Lanka tapping the Euro bond markets for refinancing its external maturities. This can pose a short term stress condition.
While it also provides Sri Lankan risk takers with the opportunity to buy the Sri Lanka credit at a discounted value, and factor in high yields as part of their investment portfolios