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CAPITAL ALLIANCE INVESTMENTS LIMITED
PRIVATE AND CONFIDENTIAL FOR THE INTENDED RECIPIENT ONLY
GLOBAL & LOCAL ECONOMIC INSIGHTS
Nov 2015
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL 2
A POSSIBLE FED RATE HIKE IN DECEMBER MAY HINDER GLOBAL ECONOMIC GROWTH
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
US domestic consumption remains robust despite 3Q2015 GDP growth slowing to 1.5%
3
2.5%
0.1%
2.7%
1.8%
4.5%
3.5%
-2.1%
4.6%5.0%
2.2%
-0.7%
3.9%
1.5%
US quarterly GDP growth
Source: US BEA, The Economist & CAL Investments
3Q2015 GDP growth came lower at 1.5% YoY dragged down by companies cutting back on restocking warehouses to compensate for an inventory glut which was accumulated over the last few quarters and spending cuts in the energy sector. The inventory accumulated carved off 1.44% from 3Q2015 economic growth and is likely to fade in 4Q2015.
However, consumer spending which accounts for two-thirds of US GDP grew at 3.2% YoY during 3Q2015 after expanding at a 3.6% YoY growth in 2Q2015 driven by lower energy prices and an improving labour market.
+3.2% Consumer spending
+6.5% Spending on durable goods
+6.1% Housing construction
+1.9% Core Inflation
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
166
188
225
330
236
286
249
213
250
221
423
329
201
266
119
187
260245
223
136 142
271
Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15
The latest job numbers indicate that a US recovery is on the cards and a possible fed rate hike in Dec 2015
4
US Job creations (Thousands)
The job market recovered during October reaching a 10-month high of 271k of jobs created despite going through a sluggish phaseweighted down by the slowdown in the global economy. Unemployment rate fell to 5% in October from 5.1% in September, thelowest level since April 2008. The growing job creations are likely to drive wage inflation in the coming months which maypersuade the Fed to start raising interest rates.
Source: US Data & Statistics
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Global traders believe that there is a 70% chance that the Fed will raise its benchmark rate from near zero in December
5
Source: Bloomberg
Implied percentage probability of a rate hike by end of 2015
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
15.8%
19.2%
17.5%
16.0%16.7% 17.3%
15.9%
9.5%
7.3%
4.7%
2.4%3.1% 2.7%
1.8%2.4%
4.2%
2.4%
4.0% 3.5%
1.3%
-2.7%-3.9%
However, contribution from net exports to GDP may decline as a stronger dollar weighs down manufacturing, trade and exports
6
US quarterly export growth YoY
US exports have declined first time since the economic recession in 2009
The US Dollar has appreciated against all major currencies during the last 12 months, making US products more expensive for foreign buyers. As a result, US exports have already started declining from 1Q2015. In 2013, exports accounted for 14% of US GDP while imports were 17% of GDP. Tightening of the monetary policy may lead to further appreciation of the USD and result in US net exports slowing down and affecting GDP growth
Source: US Data & Statistics
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
EU recovery at snail pace - QE taking effect
7
-0.3%
0.9%
1.6%
1.8%1.9%
2013 2014 2015E 2016E 2017E
European commission annual economic growth forecast
The reduction in oil prices combined with the QE program have boosted private consumption expenditure and has compensated for the lackluster external trade leading to sluggish economic recovery in the EU.
The slowdown in emerging markets, especially China which accounts for c.25% of EU exports may remain as an impediment to economic growth in 2016. However, the EU-19 economic recovery depends on the unprecedented stimulus that may be granted by the ECB
Given the slow economic recovery, the EU is likely to extend the €60bn/month QE program by at least another 6 months from Sep 2016 until ECB reaches its medium term inflation target of 2%.
-1.0%
-1.7%
-0.3%
0.4% 0.5%
1.1%
0.6%0.8%
1.0%
1.3%
1.6% 1.6%
EU-19 Quarterly GDP growth (YoY)
Source: European Commission
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Slowing growth in China raises red flag for global economy
China accounted for c.30% of global growth in 2014. IMFlowered its global growth to 3.1% from its previous 3.3%estimate primarily due to the slowdown in the Chinaeconomy. The slowdown is mainly stemming from theindustrial and manufacturing sectors of China.
The impact is felt by emerging market countries which supplyraw material to China. Commodity producers like Brazil aresuffering as Chinese demand for its materials reduce while itseconomy rebalances itself from investment led growth toconsumption. Developed nations like Germany which exportsmachinery to China are also affected by the slowdown.
Only a significant pick-up in Chinese demand is likely to beadequate to balance metals markets such as copper andaluminum.
Excess capacity in manufacturing, a property marketslowdown and mounting local government debt are a fewfactors that have weighed on growth. Chinas has excesscapacity at present as investments have dropped sharply andglobal trade has stagnated.
8
China quarterly GDP growth
Source: The Economist & CAL Investments
7.7% 7.7%
7.4%7.5%
7.3% 7.3%
7.0% 7.0%6.9%
3Q2013 4Q2013 1Q2014 2Q2014 3Q2014 4Q2014 1Q2015 2Q2015 3Q2015
China industrial production, % MoM annualized
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
However, ‘consumer driven’ economic transition starting to materialize in China
9
Chinese economic growth has slowed down with the shift towards consumption from investments. The slowdown has negatively impacted global suppliers of raw materials and industrial equipment. However, business has picked up for companies that cater to the country’s growing upper-middle class which is evident through the 10.9% YoY retail sales growth witnessed in 3Q2015. Household consumption accounts for 40% of GDP.
Further, travel by Chinese households and golden-week expenditure also affirm that the economic transition is currently underway. Likelihood remains for further declines in exports and manufacturing as the transition intensifies.
YoY change in retail sales & industrial production
Air Traffic Movie box-office revenue
Movie theatres in China generated box-office revenue of ¥33bn for 9M2015, +53% YoY.
Source: The Economist & CAL Investments
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL 10
COMMODITIES MAY SHOW MIXED SIGNALS IN 2016
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
US crude oil production rises 1% YoY despite a 60% YoY reduction in shale oil rigs
11
US Crude Oil Rig Count
US crude oil rig count fell to 572 in Nov 2015 which is the lowest level since June 2015
5000
5500
6000
6500
7000
7500
8000
8500
9000
9500
10000
Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15
Thsd
bar
rels
/day
Weekly US field production of crude oil
Lower oil prices have resulted in US shale oil rigs in operation plummeting 60% YoY as they found it challenging to breakeven at current prices. Oil prices usually reflect the number of oil rigs in operation with a 6 month time lag which means that more rigs could go out of business In the future.
US shale oil drillers are focusing on improving the productivity of their cost-efficient rigs which has resulted in higher crude oil production despite a 60% reduction in operational rigs. Saudi Arabia’s intention to curb US oil production failed due to the improving efficiencies of the oil rigs. Higher US crude oil output has contributed to the glut in global crude oil supply.
Source: EIA, Baker Hughes & CAL Investments
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
-2
-1
0
1
2
3
4
5
75
80
85
90
95
100
Q12010
Q32010
Q12011
Q32011
Q12012
Q32012
Q12013
Q32013
Q12014
Q32014
Q12015
Q32015
Q12016
Q32016
Implied stock change and balance (RHS)World production (LHS)World consumption (LHS)
Projection
Brent crude prices may hover around USD 50-55/barrel
12
Brent crude oil prices
40
60
80
100
120
140
160
Jan
-10
May
-10
Sep
-10
Jan
-11
May
-11
Sep
-11
Jan
-12
May
-12
Sep
-12
Jan
-13
May
-13
Sep
-13
Jan
-14
May
-14
Sep
-14
Jan
-15
May
-15
Sep
-15
USD
/Bar
rel
Global oil production, consumption & Δ in inventory (Mn barrels/day)
2013 2014 2015E 2016E 2020E
108.56 98.89 53.82 56.24 80
EIA forecast
Growth in global demand has risen to a 5-yr high of c.2 mn barrels/day, with India sprinting to its fastest pace of consumption in more than a decade and personal consumption in terms of travel picking up due to lower oil prices. EIA anticipates global crude oil production to continue to outpace consumption in 2016. However, it expects the inventory build up to slowdown on the back of lower US and Canada oil production in 2016. The IEA also predicts that a sluggish recovery in demand and decline in supply would yield a price of $80 /bbl in 2020.
CALI believes that Brent crude may hover around USD 50-55/barrel in 2016 as a result of Iran contributing 500-700kbarrels per day post-sanction removal and due to the expectation that US production is likely to remain flat for 2016.
Source: EIA & CAL Investments
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
China’s transition into a consumer driven economy hurts commodity prices
13
During the peak of its growth phase, China consumed c.50%of the world's copper, 54% of aluminum, 50% of nickel and45% of steel production. Decelerating growth in China andBeijing’s move to build a more consumer focusedeconomy have beaten commodity prices down in 2015.
Given the dull economic outlook for China, it remains unlikelythat metal prices will see a major recovery in 2016. However,a marginal recovery in oil prices may drive production costshigher and moderately increase metal prices in 2016.
The effects of the El-Nino weather phenomenon has starteddamaging food crops via excess rain and limited rainfall acrossthe globe. Excessive downpours in Brazil has led to lowersugar harvest while the drought in Thailand has already hurtrice production. El Nino is likely to lead to an increase in rice,coffee, sugar, maize, cocoa and palm oil prices during end2015 and early 2016.
Since most commodities are USD denominated, a possibleUSD appreciation due to a fed rate hike may makecommodities expensive in local currency terms and reducedemand for the commodity.
The Economist commodity-price index change
-0.4%
0.5%
-1.6% -1.0%-1.9% -2.2%
-17.2%
-12.3%
-23.6%
-15.7%
-26.6%
-3.9%
MoM % YoY % Source: The Economist & CAL Investments
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Gold prices hit a 5-year low on ‘Fed rollercoaster’
14
800
1000
1200
1400
1600
1800
2000
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15
USD
/Oz
Gold prices fell to a 5-year low of USD1074/Oz in November as investors feareda possible US fed rate hike.
The price drop transpired despite a 33%YoY jump in demand for gold in 3Q2015which was led by a 70% YoY growth inChinese investment, the largest consumerof the precious metal. China investorsbought gold as a safe haven investment toprotect them against the stock marketcrash and further Yuan depreciation.
If fed hikes interest rates in December,gold prices may fall further as investorsmove into income-generating assetsrelative to the non-yielding yellow metal.
A possible appreciation of the USD due tothe rate hike may further hurt gold prices.Analysts expect gold prices to crash asmuch as USD 800/Oz if the fed raises ratesin December.
Global gold prices
Source: Bloomberg
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL 15
FISCAL PRESSURE TO BE THE KEY CHALLENGE FOR 2016
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
SL raised USD 3.5bn via Treasury bills, bonds & SLDBs during 11M2015, +64% higher than what was raised in 2014…
16
Total amount of T-bills, T-bonds and SLDB outstanding as at 11Nov2015 was LKR 4.9Tn. The govt raised USD 3.5bn in net borrowingsvia t-bills, t-bonds and SLDBs which was 64% higher than what was raised in 2014.
However, the net borrowings raised via sovereign bonds and SLDBs increased to USD 2.6bn in 11M2015 from USD 1.3bn in 2014.
Net amount raised via T-bills, bonds & SLDBs (USD bn)
2.1
3.5
2014 11M2015
USD
bn
+64%
Net amount raised via USD sovereign & SLDBs (USD bn)
Source: CBSL, Bloomberg & CAL Investments
1.3
2.6
2014 11M2015U
SD b
n
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
…as the budget deficit surpassed the preliminary 2015 target within the first 8 month of 2015
17
Budget deficit
499
540
470
480
490
500
510
520
530
540
550
Initial 2015 target 8M2015 (Actual)
LKR
bn Budget deficit from Jan-Aug 2015 was LKR 41bn
higher than the government’s target of LKR 499bn for 2015
Lower than expected revenue realization and higher than anticipated interest payments were the main reasons for the higher budget deficit.
Govt’s interest payments for 8M2015 was LKR 384bn vs. LKR 425bn estimated for the full year.
Source: SL Treasury
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Likelihood remains for the 2015 budget deficit to close at 6.8%-6.9% vs. 5.7% in 2014
18
Annual budget deficit (LKR mn) based on new GDP methodology
448 489 516
591
750 800
6.2%
5.6%5.4%
5.7%
6.8%
6.5%
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
6.0%
6.5%
7.0%
(100)
100
300
500
700
900
1,100
1,300
1,500
2011 2012 2013 2014 2015E 2016E
LKR
mn
The 6.8% budget deficit for 2015 is on the back of a cut in public infrastructure spending
In Feb 2015, budget allocation for public infrastructure spending was cut from LKR 576bn to LKR 399mn.
Source: CBSL & CAL Investments
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
The govt is facing severe fiscal pressure as 100%+ of its revenue is spent on debt servicing at present
19
87%89%
85%88%
115%
98%
93%
100%
106%
92%
117%
Debt servicing cost (Principal + interest cost) as a percentage of government revenue
Source: CBSL, Treasury & CAL Investments
Sri Lanka’s debt service cost as a percentage of government revenue rose to 117% in 8M2015. Over the last 5 years, debt service cost has remained close to 100%.
The SL govt needs to raise taxes substantially to reduce its budget deficit and decrease dependence on debt financing.
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
SL’s access to multilateral & bilateral loans have reduced over time
20
Loans from multilateral lending agencies (e.g. ADB, IMF) have reduced from 48% of foreign funding in 2005 to 29% in 2014 while bilateral loans with other countries have reduced from 45% in 2005 to 25% in 2014. Japan accounts for 52% of bilateral funding as at 2014 while India accounts for 11%.
If the SL government makes structural reforms to increase tax revenue to acceptable levels, likelihood remains that SL could tap the multilateral lending agencies such as IMF and ADB for low-cost financing
Domestic debt, 60%
Foreign debt, 40%
USD 56bn
Outstanding government debt as at 30 Jun 2015 Foreign debt breakdown 2005 & 2014
48%
29%
45%
25%
7%
46%
2005 2014
Multilateral loans Bilateral loans Financial market lending
Source: CBSL, Treasury & CAL Investments
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
SL corporate taxes are not the lowest in the region (28% vs. avg. 25%)
21
17% 17%
20% 20% 20%
25% 25% 25%
28% 28%30% 30%
35% 35%
Corporate tax rates of regional peers
Avg. 25%
Source: World Bank
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Govt needs to broaden the tax base - Despite higher corporate taxation, contribution from direct taxes are only c.17%
22
Personal income tax, 1%
Corporate Income tax, 8%
PAYE, 2%Economic Service
charge, 1%
Tax on interest income, 6%
Domestic VAT, 23%
Excise Tax , 21%
NBT, 4%Telecommunication
Levy , 3%
Motor Vehicles Taxes & other, 1%
Taxes on External trade, 20%
Non Tax Revenue, 12%
2014 Government
Revenue
Direct Tax Revenue
Indirect Tax Revenue
Non Tax Revenue
71%
12%17%
Direct taxes only account for 17% of the government revenue despite corporate taxes remaining high at 28%. Govt requires to computerize tax filings and track down on tax evaders to broaden its tax base.
However, given that the government has an immediate requirement to increase revenue, it is likely that the govt may resolve to further increase indirect taxes to swiftly materialize the funding requirement
Source: CBSL & Treasury
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
70,993
85,192
94,657
104,123
118,322
132,520 137,253
141,986
30,000
50,000
70,000
90,000
110,000
130,000
150,000
15% 18% 20% 22% 25% 28% 29% 30%
A 1% upward revision in corporate taxes will only contribute LKR 4.7bn in incremental revenue*
23
+4.7bn
*If corporate taxes are increased 1%, the government will only be able to raise LKR 4.7bn in additional revenue assuming that the tax base will not increase due to the tax revision.
Current
LKR
bn
Source: SL Treasury, CBSL & CAL Investments
Corporate tax income at different taxation rates %
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
251,946 279,940
307,934 335,928
363,921 391,915
419,909
503,891
9% 10% 11% 12% 13% 14% 15% 18%
However, a 1% increase in indirect tax such as VAT may have a higher impact with LKR 28bn in incremental government revenue*
24
Value added Tax revenue at different taxation rates %
+28bn
Source: SL Treasury, CBSL & CAL Investments
* Imposing a higher indirect tax will raise 6x of the amount that can be raised via a direct tax increase. The government is more likely to raise VAT or any other indirect tax to generate the funding shortfall within a short span of time.
Current
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
1H2015 GDP growth was primarily driven by private consumption
25
Quarterly volume growth of FMCG categories covered by Nielson's Retail Audit (YoY)
-17%
-2%-1%
2%3% 3%
10% 10%9%
7%
Source: Nielson, CSE & CAL Investments
Real GDP growth (new methodology) during 2Q2015 grew 6.7% YoY on the back of renewed consumer spending driven by lowerinflation and government budget reliefs despite a cut in infrastructure spending.
According to the Nielson survey, quarterly FMCG volume grew 9% YoY in 1Q2015 and 7% YoY in 2Q2015 indicating the extent ofconsumer spending during 1H2015.
3.6%
5.9%
4.0%
0.5% 0.7%
1.9%
4.7%
9.9%
6.0%6.7%
Sri Lanka quarterly GDP growth (Base = 2010)
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Probable indirect tax increases and inflation to hurt private consumption and economic growth during 2016
26
We believe that economic growth is likely to slowdown in 2016 due to possible tax hikes in the budget, an LKR 7% depreciationand higher inflation affecting consumer spending in 2016. However, we anticipate public infrastructure spending to recover to2014 levels and GDP growth to be 6.5% in 2015 and 5.5% in 2016.
SL annual GDP growth forecast
3.6%
5.9%
4.0%
0.5% 0.7%
1.9%
4.7%
9.9%
6.0%6.7%
Sri Lanka quarterly GDP growth (Base = 2010)
8.4%9.1%
3.4%
4.5%
6.5%
5.5%
2011 2012 2013 2014 2015E 2016E
Source: CBSL & CAL Investments
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL 27
INTEREST RATE DIRECTION TO BE DRIVEN BY GOVERNMENT’S FUNDING STRATEGY IN 2016
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
5,843
11,894
-2,418-3,850
17,663
-222 -2,906 -628
-8,040
-31,095
-2,462-2,611 -1,313-2,475
2,9622,568
-9,153
-17,287
-31,342
-25,765
-42,162
-22,076
-7,768
(50,000)
(40,000)
(30,000)
(20,000)
(10,000)
-
10,000
20,000
30,000
LKR
mn
Foreigners exited their bond positions during May-Oct 2015 anticipating an LKR depreciation
28
Foreign holdings in SL government bills and bonds have declined to 7.2% in Nov 2015from 12% in Jan 2015. Foreigners have sold LKR 154bn worth of bills and bonds YTD
Net foreign inflows/ outflows in the government securities market (LKR mn)
Source: CBSL
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Post- LKR depreciation, SL bonds are attractive for foreign investors
29
Comparative 10-yr govt. bond yields
9.6%
8.9% 8.8%
7.6%
7.0%
4.1%3.7%
2.6%
Sri Lanka Pakistan Indonesia India Vietnam Malaysia Philippines Thailand
Source: Trading Economics
With the LKR depreciating 7% YTD and provided no further significant depreciation, the yields offered by SL govt bonds are attractive to foreign investors compared to the yields offered by regional peers
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
SL 5-year bond yield premiums have risen 160bps YoY
30
400
450
500
550
600
650
700
750
800
850
900
Source: Bloomberg
Bond yield premiums above the US 5-year govt bond
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
The CBSL printed upto c.LKR 230bn in currency to pay off its fiscal debt and bond maturities during 10M2015
31
CBSL holding in government securities (LKR bn)
0
50
100
150
200
250
01.0
1.2
015
12.0
1.2
015
22.0
1.2
015
30.0
1.2
015
11.0
2.2
015
20.0
2.2
015
02.0
3.2
015
11.0
3.2
015
19.0
3.2
015
27.0
3.2
015
07.0
4.2
015
17.0
4.2
015
27.0
4.2
015
07.0
5.2
015
15.0
5.2
015
25.0
5.2
015
03.0
6.2
015
11.0
6.2
015
19.0
6.2
015
29.0
6.2
015
08.0
7.2
015
16.0
7.2
015
24.0
7.2
015
04.0
8.2
015
12.0
8.2
015
20.0
8.2
015
28.0
8.2
015
07.0
9.2
015
15.0
9.2
015
23.0
9.2
015
02.1
0.2
015
12.1
0.2
015
20.1
0.2
015
29.1
0.2
015
06.1
1.2
015
17.1
1.2
015
The central bank printed money and purchased government bonds to make settlements for the bond maturities and budget deficit, creating BOP pressure in the process
Consequent to raising the USD sovereign bond, the Central Bank sterilized c.USD 1bn out of the USD 1.5bn proceeds raised due to which the proceeds were not available in the system to drive domestic credit.
Source: CBSL & CAL Investments
CB sterilizes the USD 330mn SLDB taking liquidity out of the system and replacing it with Central Bank ‘s holdings in government bonds
Central Bank printed money to repay rupee bonds
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Market excess liquidity has risen to LKR 140bn as the govtprinted currency and pumped liquidity into the market
32
Market liquidity (LKR bn)
Source: CBSL & CAL Investments
0
20
40
60
80
100
120
140
160
12.1
2.2
014
22.1
2.2
014
31.1
2.2
014
09.0
1.2
015
21.0
1.2
015
29.0
1.2
015
10.0
2.2
015
19.0
2.2
015
27.0
2.2
015
10.0
3.2
015
18.0
3.2
015
26.0
3.2
015
06.0
4.2
015
16.0
4.2
015
24.0
4.2
015
06.0
5.2
015
14.0
5.2
015
22.0
5.2
015
01.0
6.2
015
10.0
6.2
015
18.0
6.2
015
26.0
6.2
015
07.0
7.2
015
15.0
7.2
015
23.0
7.2
015
03.0
8.2
015
11.0
8.2
015
19.0
8.2
015
27.0
8.2
015
04.0
9.2
015
14.0
9.2
015
22.0
9.2
015
01.1
0.2
015
09.1
0.2
015
19.1
0.2
015
28.1
0.2
015
05.1
1.2
015
16.1
1.2
015
LKR
bn
Govt printing money to pay bond maturities & fund budget deficit
Foreigners exiting T-bond positions
A surge in imports & net foreign outflows from the bond market
Central Bank sterilizing c.USD 1bn out of the USD 1.5bn proceeds raised via the sovereign bond
Central Bank sterilizing the USD 650mn sovereign bond proceeds
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
The SL government has LKR 1.2tn (USD 8.3bn) in T-bills, T-bonds and sovereign bond maturities in 2016
33
Cumulative treasury bills, bonds and sovereign bond maturities
Source: CBSL, Bloomberg & CAL Investments
-
50
100
150
200
250
Jan
-16
Mar
-16
May
-16
Jul-
16
Sep
-16
No
v-1
6
Jan
-17
Mar
-17
May
-17
Jul-
17
Sep
-17
No
v-1
7
Jan
-18
Mar
-18
May
-18
Jul-
18
Sep
-18
No
v-1
8
Jan
-19
Mar
-19
May
-19
Jul-
19
Sep
-19
No
v-1
9
Jan
-20
Mar
-20
May
-20
Jul-
20
Sep
-20
No
v-2
0
LKR
bn
LKR
17
8 b
n
LKR
21
8b
n
LKR
44
1 b
n
LKR
34
0 b
n
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
For the rest of 2015, treasury yields are unlikely to move up as the USD bond, SLDB and one-off taxes ease funding pressure
34
New taxes imposed LKR mn
Super gains taxes 50,000
Mansion tax 1,000
Special levy on casino industry 5,000
License fee for vehicle importers 375
Migrant taxes 100
Bars and Taverns Levy 1,000
Mobile Telephone Operator Levy 1,250
Satellite Locations Levy 2,000
Dedicated Sports Channel Levy 1,000
Total 61,725
Funds raised by the government in Oct 2015
Sovereign bond raised - USD 1.5bn
T-bills & T-bonds raised - USD 1.2bn
SLDBs raised - USD 330mn
Proceeds from one-off taxes* - USD 420mn
Total amount raised - USD 3.5bn
One-off taxes* passed in parliament in Oct 2015
The USD 3.5bn will be utilized to make payments for treasury maturities during the Oct-Dec 2015 time period which amounts to USD 2.6bn (LKR 379bn) and fund the budget deficit over the period (USD 1.2bn)* which means the government is unlikely to borrow large amounts until the end of this year.
Source: CBSL, Bloomberg & CAL Investments*USD 1.2bn for Oct-Dec 2015 was derived from the average budget deficit/month (LKR 60bn) for 8M2015
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
However, the USD 8.3bn bond maturities and budget deficit (USD 5.6bn) funding requirement may drive interest rates in 2016
35
Our base case view is that treasury yields will move c.50-150bps upwards during 2016 due to:
• Severe pressure in terms of raising USD 14bn to finance maturities and fiscal deficit• Inflation edging up to 4-5% in 2016• The government finding it challenging to raise USD borrowings from the global market as US
Fed starts increasing rates in Dec 2015
Best case scenario would be treasury yields remaining flat or edging up a maximum of 50bps during 2015 due to:
• The government successfully raising USD sovereign bonds from the global market and reducing dependence on the local market
• Substantial tax increases in the government budget reducing budget deficit burden
Source: CBSL, Bloomberg & CAL Investments
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL 36
Inflation rose to 1.8% in Oct 2015 moving away from the deflationary territory
21%
1.7%
-1%
0%
1%
2%
3%
4%
5%
6%
0%
5%
10%
15%
20%
25%
Mar
-14
Ap
r-1
4
May
-14
Jun
-14
Jul-
14
Au
g-1
4
Sep
-14
Oct
-14
No
v-1
4
Dec
-14
Jan
-15
Feb
-15
Mar
-15
Ap
r-1
5
May
-15
Jun
-15
Jul-
15
Au
g-1
5
Sep
-15
Oct
-15Private Sector Credit growth (LHS) Inflation YoY (RHS)
Source: CBSL & CAL Investments
Inflation rose to 1.8% YoY in October from a 0.3% deflation in September while core inflation* rose to 4.4% YoY from 4.2% in September
Private sector credit growth rose to 21.3% YoY in Aug 2015 on the back of robust consumer spending. vehicles.
With vehicle costs rising and LTV on vehicles being reduced to 70%, vehicle imports are likely to slowdown. Higher inflation and lower consumer spending are likely to keep private sector credit lower in 2015.
Private sector credit growth & CCPI Inflation YoY
*Core inflation excludes certain items that have volatile price movements such as food and energy prices.
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Inflation will kick in from Nov 2015 driven by supply-side dynamics
37
ItemWeek ending
12-Nov-2015A month ago MoM %
LKR/kg LKR/kg
Rice
Samba 98 88.8 10%
Kekulu (Red) 70 69.2 1%
Vegetables
Beans 280 169 66%
Cabbage 200 78 156%
Carrots 230 111 107%
Tomatoes 180 109 65%
Pumpkins 60 64 -6%
Snake Gourd 140 103 36%
Brinjals 140 86 63%
Ash-Plantains 100 92 9%
Other Foods
Red-Onions (Local) 175 142 23%
Big-Onions (Local) 135 136 -1%
Potatoes (N'Eliya) 160 132 21%
Dried Chilies (Imported) 350 344 2%
Dhal (Indian) 190 184 3%
Eggs (Red) 13 14.8 -12%
Coconut (Each) 55 50.2 10%
Fish
Kelawalla 600 536 12%
Balaya 360 298 21%
Salaya 180 150 20%
Paraw (Small) 520 474 10%
Simple average 29%
Average retail food prices – Pettah market
Food & Non alchoholic
beverages, 48%
Clothing and footwear, 4%
Housing, water, electrics, gas &
other fuels, 18%
Furnishing, HH Equipment &
routine maintenance of
house, 3%
Health , 6%
Transport, 12%
Communication, 2%
Recreation and culture, 1% Education, 3%
Miscellaneous Goods and
Services, 2%
CCPI Inflation basket as at Oct 2015
The CCPI avg. household expenditure was LKR 51k as at Oct 2015.Vegetables and seafood account for c.25% of the F&B segment of whichprices have increased on avg. 20% MoM. If we assume that USDdenominated costs such as clothing, household equipment and healthexpenditure increases 6% MoM due the LKR depreciation while otherexpenses remain the same compared to Oct-2015, inflation for Novemberwould come in at 3.1% YoY
Source: CBSL, Census & Statistics & CAL Investments
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
6.5% 6.5%
7.0%
7.3%
7.5%
6.0%
6.2%
6.4%
6.6%
6.8%
7.0%
7.2%
7.4%
7.6%
HNB Sampath Bank CommercialBank
NDB Seylan Bank
Bank deposit rates on avg. have risen 65bps since March 2015 as treasury securities edged up 70bps…
38
1-yr bank deposit rates (gross)
Increase/decrease in deposit rates from March 2015
1-yr treasury bill rates
6.4%
6.3% 6.3%
6.5%
7.0%
7.2%
7.1%
Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15
0.0%
0.5%
0.7%
1.0% 1.0%
HNB NDB Seylan Bank Sampath Bank CommercialBank Source: CBSL & bank websites
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
…and a recovery in private sector credit growth absorbed liquidity
39
Loan growth of listed banks vs. Liquidity ratios Sep 2014 & Sep 2015
55%48%
27% 25% 24% 24%21% 19%
17%
22% 22%23%
22% 22%
27%28%
27%
23%24%25%
27%
25% 25%
34%
30%
34%
27%
0%
5%
10%
15%
20%
25%
30%
35%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
UBC PABC HNB SAMP NTB COMB SEYB DFCC NDB
Loan growth YoY (LHS) Liqudity ratio - Sep 2015 (RHS) Liquidity Ratio - Sep 2014 (RHS)Source: Bank quarterly statements
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Private sector credit growth may start slowing down in 2016 on the back of the recent custom duty revisions and possible taxes in the budget
40
Annual Private sector credit growth
7%
-6%
25%
35%
18%
7%9%
23%
13%
2008 2009 2010 2011 2012 2013 2014 2015E 2016E
CALI expects private sector credit growth to close at 22-23% in 2015E and reduce to 12-13% YoY in 2016E as consumption slows down.
We expect loans given out towards consumer durables, vehicles, credit cards and personal housing to slowdown in 2016.
Source: Bank quarterly statements
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL 41
Currency may hold at LKR 142-145/USD in 2016
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
LKR has depreciated against most currencies in 2015
42
85
90
95
100
105
110
USD/LKR EUR/LKR INR/LKR CNY/LKR GBP/LKR JPY/LKR
Base =Jan 2015
The LKR has depreciated 7% YTD against the USD
Source: Oanda
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Weak Trade balance – Lower oil bill negated by a spree in consumer spending and lower exports
43
Increase/decrease in Jan-Aug imports 2014 to 2015 (USD mn)
-1659.2
125.6 128.8
297.1 317.5
793.8
Higher expenditure on vehicles and consumer goods wasnegated by a 48% reduction in the fuel bill stemming fromlower oil prices and higher coal power generation which ledto the total imports remaining flat for 8M2015
Trade balance Jan – Aug 2014 & 2015
(5,156)
(5,412)
Jan-Aug 2014 Jan-Aug 2015
USD
mn
SL’s exports during 8M2015 fell 3.4% YoY on the back of lower teaand rubber exports resulting in the 8M2015 trade gap widening toUSD 5.4bn from USD 5.2bn in 8M2015.
A delay in depreciating the LKR currency also reduced thecompetitiveness of SL goods in the global market during 8M2015 ascompetitor nations had already depreciated their currencies.
Further, pressure was exerted on the BOP due to outflows in the govtbond and equity market, subdued FDIs and low USD denominatedborrowings obtained by the government during 8M2015
Source: CBSL
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Vehicle imports to decline as new custom valuation, a 70% LTV restriction, a 7% LKR depreciation and possible duty hikes in the budget take effect
44
28k
23k 27k 29k
27k 28k
34k 32k
41k
51k 50k
42k
67k
48k 51k
57k
62k
52k
64k
56k
Jan Feb Mar Apr May Jun Jul Aug Sep Oct
2014 2015
Vehicle registrations per month Vehicle registrations already started to decline from October, contradicting the usual upward trend in vehicle sales before the budget
New vehicle registrations may decline similar to what was witnessed in 2012 where vehicle registrations declined to 397k and 327k in 2013 as a result of the import duty hike in 2013 and a c.13% LKR depreciation
Source: Department of motor vehicles
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
A fall in consumer spending and lower thermal power generation may further reduce import bill in 2016
45
58%
37%
68%
12%
26%
29%
2%2%
2%
28%35%
0%
2013 2014 14-Nov-15
Hydro power Coal NCRE Thermal oil
SL power generation by typeNielson Business Confidence Index
The 7% YTD LKR depreciation has already resulted in imports becoming expensive for SL customers. With inflation starting to kick in from November and possible indirect tax increases in the budget being passed on to the consumer, we expect consumer spending to significantly slowdown during 1H2016 which may drastically reduce the import bill.
At present, 68% of the electricity requirement is generated via hydro power due to the higher rainfall this quarter. With SL securing a contract to procure coal at concessionary rates from South Africa, the energy bill is likely to reduce further in 2016.
Source: LMD, CEB & CAL Investments
120
130
140
150
160
170
180
190
200
210
Jan
-14
Feb
-14
Mar
-14
Ap
r-1
4
May
-14
Jun
-14
Jul-
14
Au
g-1
4
Sep
-14
Oct
-14
No
v-1
4
Dec
-14
Jan
-15
Feb
-15
Mar
-15
Ap
r-1
5
May
-15
Jun
-15
Jul-
15
Au
g-1
5
Sep
-15
Oct
-15
The Nielson BCI fell 46 points MoM in Oct 2015 indicating future slowdown in business activity
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
However, SL needs to diversify its export earnings to sustain long term BOP position and economic growth
46
22.3%22.6%23.6%23.7%29.1%
68.4%75.0%79.6%
86.4%
187.6%
Exports as a percentage of GDP - 2014
39.0
22.3
20
22
24
26
28
30
32
34
36
38
40
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
SL exports as a percentage of GDP (2000-2014)
SL should diversify its export earnings into manufacturing, assembly operations and Knowledge Process Outsourcing (KPO) similar to the transition that the South East Asian countries went through in the 1990s without entirely depending on apparel and commodityexports.
Source: CBSL
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Declining USD reserves indicate that CBSL may be vulnerable in case the LKR is under severe depreciation pressure
47
7.1 7.0
7.5
8.08.3
8.1
8.98.7
9.29.0
9.2
8.8 8.8
8.38.2
7.3 7.2
6.8
7.5
6.8
7.5
6.8
6.5
6.8
6.5
5
6
6
7
7
8
8
9
9
10
Oct
-13
No
v-1
3
Dec
-13
Jan
-14
Feb
-14
Mar
-14
Ap
r-1
4
May
-14
Jun
-14
Jul-
14
Au
g-1
4
Sep
-14
Oct
-14
No
v-1
4
Dec
-14
Jan
-15
Feb
-15
Mar
-15
Ap
r-1
5
May
-15
Jun
-15
Jul-
15
Au
g-1
5
Sep
-15
Oct
-15
USD
bn
CBSL gross official reserves (USD bn)
SL’s USD reserves have declined to USD 6.5bn, one of the lowest reserve positions in the last 2 years
This also includes a USD 1.1bn dollar swap with RBI. Excluding this, the reserve position is at USD 5.4bn
Source: CBSL
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
We believe that LKR may stabilize at LKR 142-145/USD in 2016
A lower import bill due to rising inflation and higher taxation
curbing consumer imports
Improving competitiveness of exports due to the LKR depreciation
An overreaction of the LKR depreciation in 2015
Government tapping global markets to raise USD bonds in 2016 &
FDIs starting to materialize
However, if the Fed continuously raises rates during 2016, possibility remains for the USD to depreciate to c.LKR 148/USD
48
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL 49
PROSPECTS FOR LONG TERM EQUITY MARKET GROWTH REMAINS PROMISING
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL 50
SL equity market has witnessed heavy foreign selling YTD (USD 27mn)Foreign inflows/outflows to equity markets (USD mn)
0.9
10.5 10.5
6.35.3
-20.0
-6.3
-32.4
1.3
-3.7
0.9
Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15
Source: CSE
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
6,700
6,800
6,900
7,000
7,100
7,200
7,300
7,400
7,500
7,600
7,700
Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15
ASPI down 4.3% on the back of fiscal pressure, a depreciating LKR and an uptick in interest rates
51
ASPI
Run up to the presidential election
Imposition of a super gains tax in the interim budget
A recovery in corporate earnings and anticipation of a UNF victory
Rising treasury yields, LKR depreciation and anticipation of a negative budget
Treasury bond scandal
Political uncertainty running up to the general elections
Source: CSE
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
Sri Lanka still a cheaper destination compared to regional peers
52
TTM PER (x)
19.5%
31.0% 33.0%
45.3%
60.0%
75.3%
104.7%
Market cap as a % of GDP
Source: Bloomberg & World Bank
9.8x11.4x 11.7x
17.5x 18.1x19.6x 20.2x
25.3x
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
9M2015 overall market earnings subdued due to forex losses. However, FMCG & manufacturing sectors were driven by consumption and lower commodity prices
53
Source: CSE & CAL Investments
-4%
18%
-16%
4%
15%
4%
21%
44%
21%
3Q2013
4Q2013
1Q2014
2Q2014
3Q2014
4Q2014
1Q2015
2Q2015 3Q2015
Overall market earnings growth YoY
-30%
6%
-2%
22%
51%
9%
17% 11%
-3%3Q2013
4Q2013
1Q2014
2Q2014
3Q2014
4Q2014
1Q2015
2Q2015
3Q2015
Manufacturing sector earnings growth YoY
Banking & Finance earnings growth YoY
-7%
1%7%
32%
56%
35%
42%
31%
6%
3Q 20134Q 20131Q 20142Q 20143Q 20144Q 20141Q 20152Q 20153Q 2015
Food & Beverage sector earnings growth YoY
-4%
18%
-16%
4%
15%
4%
21%
29%34%
3Q2013
4Q2013
1Q2014
2Q2014
3Q2014
4Q2014
1Q2015
2Q2015
3Q2015
3Q2015 market earnings declined 3% YoY primarily due to a 7% LKR depreciation resulting in forex losses
CAPITAL ALLIANCE INVESTMENTS LIMITEDPRIVATE AND CONFIDENTIAL
We expect the long term prospects for the equity market to be promising due to:
Source: CSE & CAL Investments
The SL market being relatively cheaper compared to regional peers
and attracting foreign investors
A growing middle income population driving consumption and
corporate earnings in the medium term
Foreign direct investments flowing into the country post-structural
reforms
However, the market may witness a temporary downturn as corporate earnings slowdown with the possible tax revisions in the budget