Sri Lanka Needs to Develop Corporate Bond Market as Investors Eye Asian Instruments due to US Quantitative Easing

29th March 2011, www.island.lk

Sri Lanka needs to develop its corporate debt securities market in order to attract investments as the banking sector is not in a position to finance long term projects that are required for the post-conflict economy to realise its growth potential. John Keells Holdings President, Head of Corporate Finance and Strategy, Krishan Balendra said foreign investor appetite for rupee denominated bonds was healthy with the conglomerate receiving many inquiries.

"There is strong investor appetite for long term rupee securities and it is an excellent opportunity to develop the corporate bond market in Sri Lanka," Balendra said addressing the CMA Business Forum in Colombo yesterday (29). The forum was organised by the Institute of Certified Management of Sri Lanka together with RAM Ratings Lanka Private Ltd and its global partner Standard and Poor’s.

Sri Lanka has an active government bond market and the government in its recent budget paved the way for Sri Lanka’s corporate sector to issue bonds to foreign investors by relaxing exchange controls in this regard.

"Hopefully, the private sector can follow the government’s success," Balendra said adding that it would be a good thing for the government to issue a sovereign bond denominated in rupees.

For the corporate bond market to be a success, the government would have to issue bonds on longer tenures ranging from 10 to 15 years which are actively traded on the secondary market.

So far, the government has had three sovereign bond issues denominated in dollars totalling US$ 2 billion, most of which were snapped up by US based investment houses.

Foreign investors eye local currency bonds

Managing Director Standard and Poor’s Singapore Surinder D. Kathpalia said quantitative easing in the US (printing money to stimulate its struggling economy) resulted in investors looking at emerging economies where returns were relatively better.

He said foreign investors were interested in investing in local denominated bonds, resulting in the ‘internationalisation’ of local currency markets, particularly in Malaysia, Thailand, Japan and Hong Kong.

"Investors are primarily attracted by the liquidity levels in these markets, their attractive pricing and funding needs of the countries themselves. Global investors are increasingly holding local currency bonds (as against dollar denominated), driven by higher bond yields, potential currency appreciation and strong growth prospects.

In these Asian economies, banks financed around 1/3 of total investments along with equity which was also around 1/3 while bonds financed half of all investments in these economies.

"Perhaps the lesson for Sri Lanka is that it could try to deepen its bond market and allow cross-border bond issues," Kathpalia said adding that in Sri Lanka, banks financed a little more than half the investments while the equities market financed the balance, eluding to the fact that Sri Lanka had potential to develop the corporate bonds market as a cheaper sourced of financing compared to bank borrowings.

However, he cautioned that Sri Lanka would not be able to develop a vibrant bond corporate bonds market overnight.

The Securities and Exchange Commission has been trying to develop the corporate bonds market for some time, but absence of longer tenures in government bonds made it difficult to develop a yield curve that would make it possible to price private sector bonds.

Banks cannot do the job

Chairman Chemanex PLC Preethi Jayawardena, a member of the Central Bank Monetary Board Consultative Committee, said raising finances through a corporate bond issue would be cheaper than borrowing from the banking system.

"There is also a mismatch because banks prefer lending on the short to medium term, but large development projects require long term loans. Corporate bonds do not have this problem as the tenure would match the project."

Jayawardena criticised the banking sector saying that if policy rates were increased by half a percent banks would increase lending rates by 2 percent, a problem eliminated by sourcing funds through a corporate bond issue.

The corporate bond market must be developed immediately if the private sector is to find the finances to invest in the economy on a long term capacity, and fulfil its role as drivers of the economy, he pointed out.

In order to maintain economic growth at 8 percent in the medium to long term, a gross investment rate of nearly 34 percent of GDP would be required. In the past five years the gross rate of investment has been only 27 percent of GDP, with the government accounting around 6 percent of this.

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