Wednesday, June 27, 2012

Why does S&P classify the Sri Lankan banking sector as 'high risk'

The ratings agency Standard & Poor's has issued a report that says the Sri Lankan banking sector faces high economic, credit and regulatory risks. The Central Bank was quick to issue a rebuttal but what is the report all about and should it concern the public?

The report details the risks the SL banking industry faces in comparison with that of the banking sector in other countries. It is important to note that the major  issues stem from the institutional framework and regulatory conflicts. It does not look at individual institutions but looks at risks the sector as whole faces.

The problems identified have to do with bank regulators (Central Bank) , the system of justice and broad macro economic policy. These will impact on the sector as a whole, although some banks will be more affected than others, depending on specific circumstances, such as the quality of their loans and internal control systems.

The issues highlighted will have long term detrimental impact, my guess is probably over a 2-5 year horizon. This gives time for corrective action, if regulators are interested. There has been no sudden deterioration in the banking system, the issues highlighted have been building up over the past 5 years.  

The report, is in my opinion,  of relevance for long term investors, particularly foreign investors. For local investors/companies, in my opinion,  there is not much that can be done except that investment horizons should be shortened (look for 2-3 year paybacks) and minimise dealings with more vulnerable entities. 

Pertinent comments in the report are:

"Nevertheless, in our view, Sri Lanka's economic imbalances could increase if credit growth continues at the current pace."

Banking sector credit is still growing quite fast, the main drivers being construction projects by the Government as well as private sector projects. This will keep the rupee under pressure and may push inflation and the budget deficit.

"relaxed lending practices and underwriting standards, as well as a weak payment culture and rule of law."

The relaxed lending practices is a relative term, it is not clear if this relates more to state banks or private sector banks. Credit evaluation is not standardised and the level of credit information is low, so evaluation, especially of personal loans cannot be as sophisticated as that in developed markets. 

The rule of law is a concern due to the inefficiency of the court system and the increased susceptibility to corruption and influence which means enforcing contracts, mortgages etc is difficult, time consuming and expensive. The GoSL repudiation on the oil hedging contract is an example of an issue that has raised this red flag amongst rating firms, banks and investors.

"We view the banking regulations in Sri Lanka as somewhat weaker than international standards. Governance and transparency of banks are weak by global standards."

"The key regulations for banks seem sufficient. However, finance companies are less regulated, in our view. This is despite the December 2008 collapse of a finance company triggering a run on a bank in that group."

"Moreover, we see a potential conflict of interest in the central bank's role. In addition to policy formulation and supervision of banks, the monetary board of the central bank also oversees Employees' Provident Fund investments. The fund is a large investor in Sri Lankan banking stocks."

Largely self explanatory, comments refer mostly to certain state banks and the recent interference in private banks, eg through the removal and appointment of directors, the EPF/ETF/SLIC using their shareholdings to remove experienced bankers and nominate unqualified state nominees. 

Finance companies are vulnerable due to high concentration of loans to certain asset classes (eg pawning, land and vehicles) and rapid growth in credit  in an environment of rising interest rates. Exposure to share market is also problematic since share prices have been falling.

How is this relevant to the public?

It is a broad macro level report. For the public in general the main issue is where they should invest their money. Remember Ceylinco? Could it happen again?

In my opinion there are several finance companies that look distinctly shaky, so be careful where you invest your money. Only invest in the ones that are listed by the Central Bank. Even amongst the regulated ones, some are better than others, so read the rating report (all are supposed to be rated) and go for the ones that have higher (A or BB) ratings. There is no point trying to get higher interest rates if one risks losing the capital invested.

For investors and businessmen it is a message that governance matters. Many have been pooh poohing the impact of corruption and have not noticed a deterioration in the rule of law. If the systems don't work, one cannot rely on the law to protect ones investment.  If you get into difficulties there is little hope unless one has influential friends. Some have discovered this the hard way.

Liberal economics and governance tend to go hand in hand with liberal politics. When one is lacking, it tends to show up in one of the others.

For those interested, the methodology behind the S&P assessment is detailed here.


Saturday, June 16, 2012

The Show Must Go On

Thus sang Freddy Mercury, seriously ill and close to the end of his life, in 1990.

On the sunny island it seems that it is the Games that must go on. Sri Lanka may have lost the bid to host the Commonwealth Games, but they will host the Asian Youth Games in 2017 at a cost of US$300m.

The leadership cannot be faulted for lack of tenacity. Never mind that this admirable trait should probably be directed towards the many pressing problems that plague the country instead of sports. This is the familiar cry of the critics but what harm in one event, just one, that will put us on the map?

In July last year, Sri Lanka was supposed to host an IPL style Premier League but that flopped, ostensibly due to the lack of participation by Indian cricketers, but more probably because it was being organised without consultation with the relevant cricket boards. Cricket is a well organised sport and it is necessary to work through the proper channels and protocols if something is to happen. One cannot dream up something and then expect the rest of the world to go through various contortions to conform to our pressing needs. We expect it, but it does not always happen.

Happily, the team names were transferred to rugby and this year we witnessed the Carlton Super 7's, complete with Bollywood stars, just like the IPL. No sense in wasting a good idea, eh?

Rugby however, is small beer compared to cricket, so the putative Premier League is back, for a second innings, so to speak.

Like the Premier League, it seems that the Olympic dream still burns bright and true, hence the Youth Games; surely only a stepping stone to greater things.

In between the various bids for sporting attractions, Colombo also played host to a night race tied to a music festival.

The only thing unusual about the night race was the host city: the capital Colombo. Most of the others are either centred on, or feature Hambantota. This will shortly be rectified however, for a race track is planned for Hambantota.

All in all, it seems that we need not one, but many events, all of which will put us on the map. It's a new trend in marketing, putting cities on the world map but what is the underlying driver of it all? It is surely the one thing that makes the world go round: Love.

The ruler's love for their hometown and country is undisputed and second to none. Pure and unconditional, it determines all policy. Who can fault love? Actions in its name must surely be good and as Freddy said, don't stop me now.

Queen has such great music. Artistry of a high order and so profound. Perhaps we should also remember that he warned that, too much love can kill, just as none at all. Perhaps we should make it our anthem.

 ...Too much love will kill you
If you can't make up your mind
Torn between the lover
And the love you leave behind
You're headed for disaster
'cos you never read the signs
Too much love will kill you
Every time...
                        -Queen-

Wednesday, June 13, 2012

School children attacked by university students-for speaking English

The Daily News carried a story that a group of 'international '(ie English language) school students from Panadura were attacked by a group of university students. The reason for the attack was apparently that the 'international' school students spoke English. The students had entered the university to participate in a tree planting campaign.
 
English is seen by some sections of society as a barrier, it is colloquially referred to as 'Kaduwa' or 'kadda' for short. Kaduwa is the Sinhalese term for sword and it is used in the sense that it is the instrument that cuts people off from advancing. It suggests that there is, rightly or wrongly, resentment against the English language.

Perhaps it is the lack of opportunities and the perception that English helps people to get jobs. Its probably correct, this is what is driving the demand for English language education. The lack of opportunities is what is also driving people into jobs overseas. 

The university students probably thought the school children were being uppity and decided to teach them a lesson, but their action shows just how debased and perverted a nation that we live in.

There is never a shortage of people who jump up to claim that we are heirs to an ancient civilisation, that we are, oh so much superior to the hypocritical and materialistic West, but does this act of violence spark even a murmur of dissent? It barely made the news. Is this what we have descended to, to accept as normal behaviour?

   

Sunday, June 10, 2012

People tighten their belts but pressure on rupee continues

There is a report in today's Sunday Times that local bakery owners have noticed a decline in sales following increases in the price of bread.

I happened to have a chat with a banker on Friday and he said much the same thing. Based on volumes of imports channelled through this particular bank he said that they had noticed about a 15% decline in wheat imports, a 20%-25% decline in milk powder imports and perhaps a further 10%-15% in other supermarket food and FMCG items.

People are indeed tightening their belts therefore the pressure on the currency should ease. This has not because of Government expenditure and construction projects.

The US$500m raised by the Bank of Ceylon was borrowed by the Government and used to settle creditors, possibly including some petroleum bills. No one has a clear idea of what it was used for but bankers seem to think that the money was spent within a couple of weeks.

The infrastructure projects including the Mattala Airport and Hambantota port as well as private sector construction projects contribute to the growth in imports which rose 17% in the quarter to March 2012.

The problem with construction projects is that once started they are difficult to stop.

Infrastructure and construction are not bad things in themselves. They contribute positively to the calculation of the GDP number, which is, in simple terms, a measure of output. They can also create a lot of genuine activity in the local economy, depending on the amount of local content in the project.

The problem is that with the Chinese projects, local content is small, so the process of construction provides minimal boost to the local economy, despite the fact that they do in fact flatter the GDP calculation. Materials, equipment and even labour comes from China.

This is partly why the country reports high GDP growth number while many people fail to see an improvement in their standard of living. Money comes in and goes out, barely touching the local economy. If local labour, local contractors or local suppliers were used, jobs would be created and local businesses would benefit.

The bigger issue is the viability of the projects themselves. A Chinese funded and built project is still good, provided it serves the purpose and most importantly generates an adequate return that covers the cost of finance. The project needs to be able to service the debt used to build it at a minimum. If it fails to do so, then there is a big problem, as the Spanish are now slowly waking up to.

The morning after a particularly hard party can be painful.
  


A little more on the positive side of labour in  Chinese projects is here. There is a good debate in the comments section.

 

Monday, June 04, 2012

Colombo to Haputale by Rail


There is something special about train travel. Perhaps it is the fact that the passengers are seated high above other traffic, perhaps because trains have priority over road users, possibly the immense power of the engine itself or the graceful shape of the train as it wends its way across the horizon. It is hard to pin down but when riding the train many will feel it.

I had read about the train journey in the observation carriage from Colombo to Badulla, all the travel guides advise visitors to do it. I finally got around to it a couple of months ago and it was well worth the effort.

Prospective travelers have three options; first-class observation car (Rs.750, one way), the air-conditioned Expo carriage (Rs.3,950, return) or the ordinary second-class compartment.

The observation carriage needs to be booked 14 days (not 10 days as advised by some websites) in advance of the journey. Tickets sell out fast so one needs to be there at opening time on the prescribed day. When I tried to book it 10 days ahead it was sold out so we had to take the Expo carriage. Booking the Expo carriage is convenient, it can be booked online or at a travel agent and at anytime. Second class travel is an option for the adventurous and should be fine, provided the journey is kept short, of which, more details below.

I think I was fourteen when I last went on a train, which was a long time ago. Walking into the Fort Railway station, things seem to be worse than I remember: overcrowded trains and a dirty, smelly station. I had opted to go from Colombo to Haputale, a journey of eight hours according to the time-table, looking at the crowded second-class carriages I was glad that we had decided to take the Expo carriage.

The Expo carriage is painted nicely but looks a lot better on the website than in real life. It has clean, airline type seats and is staffed by two helpful stewards who will offer breakfast, lunch, and tea. There is free bottled water, a decent lavatory and air-conditioning. The air-conditioning is not really necessary when travelling in the hills but it is welcome when on the plains. Unfortunately the windows are sealed shut, so it’s not possible to open them to feel the cool upcountry breezes. The windows were not very clean, there were black streaks that seemed to be some kind of waste from the engine but luckily they were not dirty enough to spoil the view.

Although clean, the seats are not very roomy and the overhead compartment is not very big so it is best to travel light. Some of the lids on the overhead lockers don’t have good springs so they have a tendency to close while one is taking things out or putting things in.

The food is like airline food, nothing great but edible. For me food is an important component of any trip and having read reviews which said the food was bad, I took my own sandwiches. The Keells at Crescat has some good whole wheat bread and some nice hams, cheese and other meats that can make a good sandwich. The bread had just come out of the oven when I went at 11am. Being particular about my tea I took a flask of strong home-brewed tea with me, the Expo staff were happy to supply me with cups, milk and sugar.

The train set off on time from the Fort station at 5.55am. The lights in the carriage were a little bright so it was difficult to see out of the windows at first, but as soon as it became light we could see the suburbs slowly waking up beneath us.

Life in rural areas tends to cluster around the road. Shops, houses and businesses congregate thickly near the road and thin out as one moves inwards on the lanes and by lanes that spread out from the main road. When one is on the road, one is a part of the activity on the road. The railway however, is away from the road. It travels on a higher elevation, parallel to or across the road. With its increased elevation, passengers on the train find themselves looking down, like distant observers, while daily life unfolds below them. It’s fascinating, almost voyeuristic at times. Children going to school, people walking to the shops, talking in the street, sweeping their doorsteps, watering their plants, digging their gardens, the suburban townscape can be very interesting.

(Click on the pictures for the high resolution image)








As the train starts move away from the suburbs the scenery changes. My childhood memories of the first part of the journey to Kandy were of paddy fields with farmers working the fields with buffaloes. There were far fewer fields and no buffaloes but the scenery was still pleasant and once the train starts to climb there are good views of the hills, especially past Kadugannawa.

From Peradeniya onwards the climb gets steeper and the views, progressively better. Once past Hatton the views are superb and past Nanu Oya, especially when approaching Ohiya, quite spectacular.

The approach to Ohiya skirts the Horton Plains reserve and the colours of the natural forest and vegetation are stunning: trees in deep greens, reds and orange, the grass in light green and yellow. Bella Sidney Woolf, in her book How to see Ceylon bemoaned the encroachment of tea estates on the natural vegetation. I never understood what she meant, until now. The tea estates have a beautiful green that looks very pretty but the glory and variety of the forest puts the cultivated estates in the shade.





The only problem with doing the whole journey is the time taken. Moreover the train tends to run late so the journey gets even longer: Colombo to Haputale was scheduled to be eight hours but we were an hour and a half late when we arrived at Haputale. On the way back we were 45 minutes late. According to people in Haputale the train is usually an hour or two late.


Haputale Station

Haputale Station, with the mist rolling down at about 10.45am




The beauty of the scenery means that the journey is a must-do, but for best effect I would suggest that it be done in stages. Since the best of the scenery is towards the end, travelers could do Hatton-Haputale or Nanu Oya-Badulla. For someone with a large budget it is possible to take the seaplane to the Castlereagh reservoir, which is a couple of kilometres from the Hatton town and then take the train from Hatton. Someone intending to do the journey from Nanu Oya could take the seaplane to Nuwara Eliya and then take a taxi to Nanu Oya. Alternatively, people can drive to either Hatton or Nanu Oya and take the train from there. On a shorter journey (three to four hours) a less comfortable carriage would not matter so much, so either the Observation carriage for even second-class should be fine with the added advantage that the windows can be opened, so it is possible to enjoy the fresh, clean air.

The Colombo-Peredeniya leg, not to be sneered at, could be done separately. The next time you need to go to Kandy, just take the train and enjoy the scenery.








Tips on the Expo Carriage

Not all seats on the Expo carriage have equally good views. Fortunately, provided the train is not crowded the stewards do allow one to switch seats. The best views are mostly on the right hand side of the carriage, so pick a seat on the right but keep a sharp lookout for good scenery on the left.

Rows 4,6,and 9 are good.
Row 7 is about medium.
Row 1 has smaller window, a messy tray table and limited legroom.

The worst seats are rows 3 and 5, only half a window to look through.

Exporail Website


General Tips

Take some sandwiches and water, especially if travelling on the observation carriage or 2nd class.

Do the journey in short legs.
Take a book to read while waiting for the train, it may be late
Journey’s of three to four hours are:

Peredeniya Junction to Hatton
Hatton to Nanu Oya
Nanu – Oya to Haputale or Ella.
Haputale to Badulla

For timetables and further info, have a look here.

Sunday, June 03, 2012

Why is Colpetty crawling with security?

Residents of Colpetty have noticed a sudden increase in the security presence in the area. There are sentries and checkpoints everywhere and frequent patrols. There are even a few mobile units on motorcycles cruising around.

Security is especially tight in the areas behind Temple Trees, in the lanes adjoining St Michael's church. Driving back tonight I noticed it myself.

Observant residents claim that the increased security presence coincided with the release of Sarath Fonseka. Hmm... Wonder what it means?

Political dynasties: a response

Changing Perspectives has written something on political dynasties.

This is my response:

There was a 'ruling class' that used to dominate parliament, the judiciary, the civil service, the church, industry and other institutions in the UK. This was not a family but a section of society- a class. In Britain, the influence of that class has declined steadily since 1945 and for the most part has broken down completely.   Jeremy Paxman documents their involvement in his book published in 1991, but it has declined significantly even since then.

In Sri Lanka there existed something roughly akin to that at the end of British rule in 1948. These were people who had been to St Thomas', Royal, Trinity and the other 'big' schools, or been to Oxbridge. It persisted in some way until the 1970's but although Bandaranaike and Jayewardene were from that class, much of the rest of the government, the public service and others were not.

With the advent of the change in language in 1956, the riots of 1958, and the abolishing of the Civil Service in the 1960's, many Civil Servants, judges and police officers simply migrated, retired or resigned, therefore the governments of the day was not dominated by that class. The sudden departure of vast numbers of educated people wrought havoc and traditions of independence and integrity were lost. New entrants to the services could not absorb all of the practices and knowledge of the departing seniors within a short period of time. In any case many of of the new comers were political appointees and as such were interested more in serving their political masters rather than the public at large.

The dynasties of old no longer exist. In fact, in a proper functioning democracy the dynasty or even the person in a position has little relevance. It is the institution that matters.

A quick primer on the UK and the importance of institutions. The Royal family in England is a constitutional monarchy and only have only a symbolic role to play. Originally the monarchy was very powerful, and its subjects treated badly.

Over the course of an 800 year struggle, starting with the Magna Carta the people rebelled and seized power from the monarchy,  ultimately reducing them to mere symbols. Initially it was the barons who rebelled and imposed the Magna Carta on the king. After many battles with the crown over several centuries came  The Bill of Rights of 1689. This was the foundation of the modern parliament

All of these were aimed at only one thing: limiting the power of the king. 

Having won their freedom, they guard it jealously. Freedom is guaranteed by institutions: an independent judiciary, an independent civil service and police, parliament and a free press which keeps people informed of what is going on. If the judiciary is independent, they can strike down unjust laws, if parliament happens to pass any such laws. The Civil Service and police will not enforce such laws, this is how the power of the rulers is checked.

The Civil Service runs the actual administration of the country. They must be impartial and serve everyone equally. Their independence is guaranteed by Permanent Secretaries (senior civil servants who cannot be removed), the Public Services Commission, which alone can determine the promotion, transfer and salaries of Civil Servants. Politicians should not  interfere in this process.

It is important that the civil service and police be independent of the rulers so that they do not become tools to distribute political largesse or of repression. 

Similar structures ensure the independence of the judiciary and the police. 

England has no written constitution but in most modern democracies the power of the rulers is limited by the constitution as well as the institutions listed above. The idea of the institution is important because no one wants to be ruled by the whims and fancies of an individual. People must be ruled by laws, not by men.

These checks and balances existed at one time in Sri Lanka but in the years since independence have been removed through constitutional change, abolishing the independent civil service and through corruption. The result is that the rulers are now all-powerful, which is detrimental to the rights and liberty of its citizens.

There are vast celebrations held at public expense to celebrate independence from Britain but the rights of Sri Lanka's citizens have been eroded greatly since 1948.


Friday, June 01, 2012

Is it all Greek to you? A simplified guide to the state of public finances


This is something that I wrote in May 2010 for an internal newsletter. There was an election coming around the corner and I felt that people should understand some of the fundamental problems that a Government should address. It is now more relevant than ever, especially since the problems are now apparent. I have been meaning to update the figures but have been too busy at work.

The Government continues to spend merrily, but the budget deficit is a lot better than it was in 2009, the reason being that taxation has increased, so that Government revenue has increased. Are citizens getting good value, in terms of services, for the vast sums expended? It is up to each individual to decide this question, but ask yourself if:

a) Would you send your children to free state schools and universities, if you had the means to send them to private universities here and abroad?
b)  When was the last time you used the free health services provided in state hospitals? How satisfied were you? 
c) Would you turn to the courts and law enforcement authorities, confident that you would receive justice if you had a dispute with the CEB, the CPC, a bank, your landlord or a debtor? Where do you turn to, if you have a dispute with a minister, over a simple matter of property?  
   

The press has highlighted a financial crisis that is taking place in Greece. In a nutshell, what happened was that the Greek government had borrowed too much money and seemed unable to repay. Investors who had lent money to Greece (by buying Greek treasury bills, bonds etc) panicked and it seemed that the Greek government would have difficulty in raising money. This would have meant that Greece, which needed to borrow money to pay expenses would not have been able to pay its workers or run its public services.

It has not yet come to this because the European Central Bank and other European Governments look likely to work out a package to save Greece.

The Government of Sri Lanka has published a pre-election budgetary position report on the 2nd of March 2010, which shows a weakening position.

The figures for Sri Lanka (in summary) are as follows



(The figures published are provisional. Chart from LBO).

Government revenue in 2009 is Rs.702bn (please refer column 4 headed “2009prov”) but expenditure is 884bn. The Government is spending Rs.182bn more than it earns – something that should be impossible, but happens anyway.

Anyone earning a fixed salary will wonder how it is possible to spend more than one earns. The answer is simple: by borrowing money. Of course, this means that while we can spend and enjoy today, we must repay tomorrow – with interest added to the bill.

As everyone knows, the Government’s revenue is made up mostly of taxes; VAT, income tax, Nation Building Tax, import duties etc but what does the Government do with all this money that we end up with a deficit?

The main items of expenditure in 2009 (in order of importance) are:

Interest                                     Rs.308bn
Salaries & pensions     Rs.268bn
Subsidies                                  Rs.194bn
Other goods/services            Rs.113bn.

Note that the single largest item of expense is interest. That is because the Government has for many years been running a deficit and borrowing to meet the difference so the interest cost has risen every year, until it is now the largest single item of expense. Given that the revenue deficit is RS.182bn and interest payments are Rs.308bn, the country is, in effect, taking new loans in order to pay the interest on the old loans.

Why is it that we have a deficit when taxes go up every year?  (Government tax revenue rose from Rs.509bn in 2007 to Rs.585bn in 2008 to Rs.619bn in 2009). The problem is the expenses have been rising faster than taxes. The increases in expenses between 2008 and 2009 are shown below:

Interest costs rose by                          Rs.95.8bn
Salaries/pensions rose by                 Rs.29bn
Subsidies rose by                                 Rs.24bn
Other goods/services declined by   (Rs.7bn)

The fastest increase in spending is on interest. There are two reasons for this. One is that the amount of debt has increased. The other is that the rate of interest paid on the loans has also gone up, partly because of tighter monetary control and partly because the country is now borrowing mostly in the open market rather than obtaining concessionary loans from donor agencies like the World Bank.

There is obviously a limit to which anyone can borrow and spend, so either income (in the form of taxes) needs to rise or expenditure needs to be cut for finances to reach a sustainable state.

Controlling the deficit early is essential: every time the government borrows to spend, the deficit has the potential to expand because of the added interest cost. If the cycle of ‘borrow and spend’ is continued things can go out of control very quickly.

This is why the deficit is important and why the IMF has set certain targets for the deficit. This is what got Greece into trouble.

Sri Lanka’s overall budget deficit is 10.3% of GDP. Last year Greece’s budget deficit reached 12.7% of GDP. Greece’s total debt as a % of GDP reached 94.6% of GDP. Sri Lanka’s total debt was around 82.9% of GDP. Things are a little too close for comfort when compared to Greece.

In the middle of last year the IMF warned that Sri Lanka’s debt, which has almost doubled from the year 2000, was in a very unhealthy state. Not only has the debt grown, its composition has changed. There has been a shift from lower cost external concessional borrowing to higher cost domestic and nonconcessional external borrowing. In addition to increasing the cost of the portfolio, the non-concessional borrowings have been of shorter maturities than concessional funds.

The country has been borrowing more, borrowing at higher interest rates and borrowing for shorter term periods, meaning that loans become repayable more quickly and can thus cause cashflow problems.

Clearly there is a serious problem. What can be done? It is not easy, but for the deficit to fall either Government revenue must increase (higher taxes) or expenditure must fall.

No one would like to pay higher import duties, VAT or other taxes but if waste were eliminated, expenditure would fall, even if nothing else changes. This alone may not be enough, but it would be a start and then other means for reducing expenses can be found.

It is better to face the problem early rather than let it go on until it blows out of control, like in Greece.