BOOMING SRI LANKAN STOCK MARKET SHOWS ECONOMIC

UNCLAS SECTION 01 OF 02 COLOMBO 000944

SIPDIS

DEPARTMENT PASS TO USTR FOR VICTORIA KADER

E.O. 12958: N/A
TAGS: CE ECON EFIN KMCA EINV
SUBJECT: BOOMING SRI LANKAN STOCK MARKET SHOWS ECONOMIC
CONFIDENCE


1. Summary. The Colombo Stock Exchange (CSE) surged to a
record high in early October, making it the world,s second
best performing stock market in 2009. According to analysts,
the CSE is rising due to the end of the Sri Lankan civil war
(thereby lowering the risk premium for the country),lower
interest rates, expectations of post war economic growth, and
increased investor confidence after the IMF loan. Local
investors have led the boom, although foreign investors are
starting to invest as well. End Summary.

A Booming Stock Market


2. The Colombo Stock Exchange,s All Share Price Index
(ASPI) closed at 3,098 points on October 5, the highest level
ever. The ASPI measures the price of shares of all of the
listed companies. The ASPI has recorded a remarkable growth
of 106.8 percent for this year, making the CE the second best
performing stock market in the world after Lima,s stock
market. The market has risen over 60 percent since May.
According to Nihal Fonseka, president of the CSE, there have
been two bursts of investing, immediately after the end of
the war in May and in the last two months.


3. The end of the war, combined with future expectations
of economic growth, are the biggest reasons for the rise of
the stock market. Chinthaka Ranasinghe, head of research at
John Keells Holdings Stock Brokers (JHK-SB),observed that
the long brutal civil war has been the largest obstacle for
the local economy, so the end of the war has boosted investor
confidence. Simultaneously, the war risk premium has been
removed from the CSE. Other factors helping the market
include declining interest rates, low inflation, stability of
the rupee, improved foreign exchange reserves and post war
economic growth potential.


4. The highest levels of growth have been in companies
associated with post war construction and tourism. All
sub-sectors in the CSE have performed well in 2009, with
construction (up 286 percent) investment trusts (208
percent),hotels and tourism (123 percent),local
conglomerates (157 percent) and banks (123 percent)
outperforming the market. Ranasinghe asserted that the
earning potential for the entire market is high. While some
equities have been pushed by speculators and may not match
their fundamentals, the improved economic outlook has made
investors optimistic. JHK-SB analysts expect a moderate
improvement in corporate earnings in FY 2010 (ending March
2010) and that a significant peace dividend will be seen in
company earnings in FY 2011 (April 2010-March 2011). Their
analysis is based on reconstruction programs and renewed
economic activities in the North and East, infrastructure
projects in the South, a strong rebound in tourism and
increased capital inflows and investment.

CSE Demonstrates Local Condience in the Economy


5. The CSE lists 230 companies; most are large local
companies, but there are also a few multinational firms.
Important sectors like garments and infrastructure are not
listed in the CSE and therefore not included in the ASPI.
The investors include not only the wealthy, but also upper
middle class and retired Sri Lankans.


6. The growth in the CSE is primarily driven by local
investors. According to analysts, local investors are
shifting their money from fixed rate instruments to equities
due to lower interest rates and expectations of low
inflation. Benchmark three month Treasury bill yields have
declined 774 basis points from a year ago to a five year low
of 9.48 percent. Inflation is at a record low of 0.7
percent. Total CSE volume in the first nine months of 2009
was Rs 87 billion $756 million),with foreign investors
contributing about 30 percent of that volume. According to
market analysts, foreign investors have been slow to enter
the market. In fact, right after the war ended, CSE
President Fonseka thought that there had been a net outflow
of foreign investment, as the market became more liquid and
some foreign investors were able to sell and get out. Now
foreign investment appears to be coming back into Sri Lanka.

COLOMBO 00000944 002 OF 002


Other new investors have not yet entered the market and seem
to be reviewing the situation. Econoff recently spoke to a
large U.S. hedge fund that was considering coming into Sri
Lanka, but they were worried that they could have missed the
boat and were too late.


7. The CSE with a market capitalization of Rs 1 trillion
($8.6 billion) represents between a fourth and a fifth of the
Sri Lankan economy. Channa De Silva, Director General of the
Securities Exchange Commission, considers the optimism of the
stakeholders of the CSE a reflection of the buoyancy of the
economy. According to De Silva the ASPI is a leading
indicator of the mainstream economy. It reflects economic
prospects about 6 months ahead. However, factors
constraining CSE growth could be the upcoming elections and
market liquidity.


8. Comment. Although the Sri Lankan economy is starting
to rebound (growth estimates are up to 4 percent for 2009),
the enormous growth in the stock market appears to reflect a
mix of improving economic prospects and speculation. There
are a number of factors that could cloud the economic future,
including uncontrolled government spending in advance of the
presidential and parliamentary elections and the European
Union pulling its GSP trade preferences. Nevertheless, the
fact that local investors are leading the growth in stock
prices demonstrates real confidence in the economic potential
of Sri Lanka. End Comment.
BUTENIS