Late Investors May Miss the Boat on Sri Lanka's Postwar Economic Boom - The Wall Street Journal

31st December 2010, online.wsj.comBy Mohammed Hadi And Bijou George

Sri Lanka's postwar economic boom is only just beginning. Have investors already missed the boat?

In the 19 months since the nation's civil war ended, stock prices are up nearly 250% and the rupee is up 6%. Government debt also is in high demand. The difference between yields on a Sri Lankan dollar-denominated bond due in 2012 and similar Treasurys is just 3.5 percentage points, data from Barclays Capital show. A year ago, that spread was closer to six percentage points.

The potential goes well beyond a boost in tourism. Sri Lanka's location within east-to-west shipping lanes is promising, and large areas of farmland and coastline in the northeast can be developed now that fighting has ended. The government, meanwhile, recently implemented tax cuts and other changes aimed at boosting foreign investment. Adjusted for inflation, economic growth could be close to 8% this year, up from an average of 5% in the prior decade.

Bond-market strategists are expecting Sri Lanka's credit rating to be revised upward next year. Investors, though, already have taken things a step further: Moody's says the market-implied rating on Sri Lanka's sovereign debt is Ba1, three notches above where the agency rates the country and only one level below investment grade.

But Sri Lanka still is far from investment grade, in large part because of government debt racked up over three decades of fighting. This debt stood at a whopping 86% of gross domestic product last year. On "debt affordability," Moody's rates Sri Lanka above only Lebanon and Jamaica. Rising commodity and food prices could make efforts to cut this debt tougher if domestic investors demand the government pay higher yields to compensate for inflation. About 40% of spending in next year's budget is allocated for interest payments.

Stocks face a possible headwind, too. As many as 60 companies could conduct initial public offerings next year, says Yolan Seimon, head of research at John Keells Stock Brokers in Colombo. Many of these deals will be small, but the rush still is substantial, given that there are only 240 companies listed. Anyway, Mr. Seimon says, with stocks now trading at 14.9 times expected earnings, price gains likely will average 20% to 25% a year, tracking profit growth.

Investors turning up now, seeking the triple-digit-percentage returns of recent years, will find that ship has sailed.