Rising interest rates, rupee volatility and economic concerns led by a widening budget deficit is likely to cart off the possibility of a stock market recovery in the short term, though some investors and brokers try to blame it on the market regulator, which has become tough in the recent past under a new Chairman and a Director General.

According to the latest available Central Bank data, the Commercial Bank Average Weighted Prime Lending Rate (AWPR) has risen to 13.68 percent week ending July 6, 2012, against 9.41 percent recorded during the corresponding period, last year.

“Interest rates are the catalyst for financial markets. When the interest rates are down, markets become bullish and when the interest rates are up, they remain bearish. When the interest rates are high, the consumers spend less, causing reduced corporate profits. This is compounded by an exodus of money from stock markets as other interest-bearing investments become more attractive,” a market analyst on grounds of anonymity said.

He also said that most of the banks are currently offering very high rates for fixed deposits and noted that it is an indication where the money should flow.

However, according to him, the only silver lining for the Colombo bourse of late has been increased foreign buying. According to the CSE data, foreigners have been net buyers so far in the year 2012, with a net inflow of Rs.23.5 billion. Another stock market analyst, who too preferred anonymity, said that it is quite unlikely for a stock market to thrive when the economy of that country is facing fundamental economic issues such as a widening budget deficit and a currency crisis.

“Last year we were able to witness how the regulators were put under pressure for the market decline, which ultimately ended with the resignation of the Securities and Exchange Commission (SEC) Chairman. However, even after the resignation, the market didn’t go up. The reason was, though the regulator was chased away, the market and economic fundamentals that caused the market to come down remained unchanged, ”he noted.

According to market sources, what happened at the bourse during the latter part of last year seems to be unfolding yet again, as the market regulator is reportedly currently under immense pressure, followed by its decision to re-open some of the high profile investigation cases on market misconduct.

Analysts Mirror Business talked to pointed out that investigations, tightening of rules and closing of regulator loopholes tend to affect market sentiment, but admitted that markets should be well-regulated if they are to grow.“The sentiment should be backed by fundamentals. When the market or economic fundamentals are bad, you can't expect the market sentiment to be positive,” an analyst said.

According to recently released Finance Ministry report, Sri Lanka`s overall budget deficit doubled in the first four months of 2012, with spending growing twice the rate of tax revenues.