Sri Lanka’s stocks sizzle, but why so few foreign investors?

By Shihar Aneez

(Reuters) - Sri Lanka’s shares <.CSE> are trading at record highs and returns so far this year top 100 percent, making the market Asia’s top performer and the second-best in the world.
But foreign investment is noticeable by its relative absence. Here are some questions and answers about why foreigners have stayed away and what that may mean for the bourse’s future:
Q:What is the foreign investment trend?
A: Despite predictions foreign investment would flow into the market after the end of the civil war, foreign investors have been selling their holdings. Net foreign investment inflow was 1.4 billion rupees between Jan. 1 and the end of a 25-year war on May 18. Foreign investors turned net sellers in June and that picked up slightly by the middle of September.
As of Tuesday, net purchases this year totalled 613.2 million rupees. But that was still a fraction of last year’s record 14.1 billion rupees ($122.8 million).
Q: Why are foreign investors staying away?
A: There are constraints. The stock market is small, lacks liquidity and the proportion of freely floating shares is relatively small.
Market capitalisation is about $8.7 billion now and daily turnover this year has averaged about 499 million Sri Lankan rupees ($4.35 million).
Foreign investors have also complained in the past that regulations to stop insider trading are not tough enough.
Just as elsewhere, the global financial crisis has cooled appetite for riskier investments. Many foreign investors find government securities more attractive because they carry less risk and pay interest of more than 10 percent a year. However, that window is closing because foreign investment in government securities is already close to its 10 percent limit.
Q: Will foreign funds enter sri lanka in future?
A: Possibly, since market players say foreign investors have shown a lot of interest even if they are not buying yet. Analysts say foreigners will wait for the rally to cool off, and look for companies to show stronger earnings and concrete evidence of recovery from the war and the financial crisis. To spur corporate credit growth and help investment, the central bank has brought inflation down to a record low and is pushing banks to lower interest rates.
Since the end of the war, the central bank has kept the rupee steady at near 115 per dollar, which analysts say has helped soothe investor fears the currency could drop sharply.
Q: Are there any political concerns?
A: Yes. Sri Lanka is expected to hold parliamentary and presidential elections early next year. Sri Lankan policymakers in the past have always given priority to populist measures to woo voters, instead of maintaining consistent policies to boost investor confidence. The present government’s populist policies in the past have hurt corporate profits due to high taxes, soaring inflation and interest rates, high government borrowing, a bloated, inefficient public sector, and poor regulations.
Analysts say foreigners are also monitoring the government’s steps to bring down 2009 budget deficit to 7 percent, as agreed with the IMF for a $2.6 billion loan approved in July.