Hoping for light at the end of the tunnel for Colombo Stock Exchange

By C. Samaranayake
Investors of the Colombo Stock Exchange are now going through a lean period of time in terms of return and capital appreciation. The situation has arisen due to a combination of factors mainly from the slowing down of Chinese and regional markets and the downgrading of Sri Lanka by Fitch ratings of late. Most countries in the world are plagued with ballooning debt problems, currency devaluations and political instabilities and predominantly by the world economic downturn. This scenario has resulted in lower gross domestic product (GDP) growth in most countries of the world. The policy rate stability has also been not satisfactory in some countries due to internal fiscal problems.

In general, the following factors directly affect the stock markets worldwide, namely, tax policies, budget deficits, trade union action, security concerns, public savings, state and private sector good governance policies, regional cooperation and synergy effects, transaction costs, local legislation governing the security market, etc.

There are periodic ups and downs in any stock market and also different types of investors for equity markets, namely, institutional investors, retailers, high-net-worth individuals, strategic stake seekers, corporate entities, etc. The success of any stock market depends on the active participation of all above investors.
A drawback to the development of a healthy market is the malpractices such as ‘front running’, ‘insider dealings’ and ‘pre-planned manipulations’. However, the imposition of higher penalties is not pursued regularly as it would act as a deterrent to market growth. Higher fines and legal action are prevalent in most stock markets of developed countries. In other countries, the accused are severely warned with a compounded fine. In developed countries even the external/internal auditors, reporting consultants, brokers, management and directors of listed companies fall into the errant categories.  Stock exchange regulatory authorities in countries should endeavour to minimize the occurrences of irregularities and frauds as far as possible as prevention is safer than cure.

Policy interest rates are directly linked to the rise and fall of stock markets. Even a quarter percent rate change may affect the market capitalization by a substantial amount. Foreign equity investors need be provided with all regulatory facilities such as ease of entry and exit through the banking system, lower dividend tax rates, ease of repatriation of dividends and net sales proceeds, etc. Dividend tax, depreciation of local currency vis-a-vis US dollar and foreign exchange reserves of the country are some of the main factors the foreign investors are looking at before the investments are made in overseas equity markets. It is the foreign investor who usually wins at stock market transactions as they are well conversant with all relevant guiding factors. The local investors are required to follow in the footsteps of foreign investors and learn the trigger points of the market based on local and international developments. Foreign investors are adopting wait and see approaches in stock picking and disposal unlike the local investors who need to show patience and detailed analysis on their favourite shares.
 

Types of return
The investors are mainly looking for two types of return, namely the holding gain and the operational gain. The holding gain arises from capital appreciation while the operational gain arises from the returns. The foreign investors are carrying out fundamental analysis on all stocks they buy and the decision is made on fundamentals whereas the local investors especially the retailers drive the market by buying on speculation. The price earnings ratio of a share is a good yardstick for an investment decision.

Market capitalization of the Colombo Stock Exchange is around 30 percent of gross domestic product of the country. This should ideally go up to at least 50 percent in the next three to five years to reduce unemployment and levels of poverty and also to raise the per capita income of the country.

I have witnessed the market movements during the last three decades of the Colombo bourse. There were times where the ASPI (All Share Price Index) fell by nearly 30 percent from that of the previous day in the absence of support from investors. This was mainly due to the security situation in the country. Stock brokering firms were finding it difficult to carry on their business due to losses incurred by them. Against such a backdrop, the Sri Lankan market showed continuous forward march for the last three decades despite many obstacles. There was another major problem in selling shares due to the delay in issuing the share certificate to the buyer by the company secretaries.

As a result, the buyers were unable to sell their shares when prices move up rapidly in the absence of share certificates. This even led to malpractices where certain individuals sold shares with fraudulent share certificates which were detected after the seller received the proceeds from the transactions. With the establishment of the central depository system in early nineties this problem came to an end.  Even the brokers had to call loud in bidding and getting the shares for their clients. With online trading, even this problem was sorted out. The share prices even shot up by over 50 percent in one trading day those days. The Central Depository System now issues a monthly statement for every investor showing the details of transactions and the stock unit balances for every month. Adequate measures are also in place for prevention of money laundering, defaults on payments and other malpractices.   

Margin trading activities also gathered momentum over the years. In the early nineties, the brokers were even willing to permit trading up to 200 percent of the value of the portfolio   to acquire further shares in liaison with affiliated financial institutions. However, in times of market falls, the shareholders were subjected to forced selling by the lenders and many investors suffered heavily, especially in 1995 and up to 2001 end. Unlike the nineties, the market has stabilized and the investors possess holding power.
 

Risks at Colombo bourse
In consideration of the specific risks associated with the Colombo bourse, some of the trigger points are enumerated below.
1. Weather patterns--- This factor mainly affects the plantation and the agricultural sector
2. Labour union action--- Here again the plantation stocks are affected to a great extent.
3. Political environment--- Sri Lanka held elections in most years during the last two decades.
4. Interest rates of the Central Bank
5. Security situation and terror attacks
6. Rumours and speculation  
7. Taxation policy of the government
8. Net foreign selling and buying
9. Quarterly and annual results of quoted companies
10. Initial public offerings
11. Delistings 
It could be seen that Sri Lankan bourse is subject to many factors for both upward and downward movements.
The level of compliance by listed companies as to statutory obligations and matters of routine requirements is at a very high level. Only a handful of listed companies have failed to comply at different times. The stock exchange should endeavour to increase the number of listed companies to at least 400 within the next three years if we are to achieve the expected market capitalization levels to attract substantial flows of foreign capital. Continuous value addition measures had been carried out in the past and also taking place at regular intervals.
Promotional activities such as road shows and fund manager conferences overseas also boosted the foreign investor flows to the country. However, timing of these events is of great importance to obtain the maximum results from such activities. 

The future of our stock exchange very much depend on the government policy, rigid corporate governance measures in listed companies, accounting and auditing standards authorities, political stability, domestic savings levels and our ability to attract foreign capital for the listed companies. All connected parties should map out strategies to augment the market capitalization to at least 50 percent of the GDP   in the near future.
(The writer is a market analyst and a researcher in both Sri Lankan and foreign stock exchanges and could be reached via 
[email protected])