Managing Director/CEO of First Capital Dilshan Wirasekara Speaking To Echelon

First Capital Holdings sees a once-in-a-lifetime opportunity for investors in bonds and equities in Sri Lanka, with the potential for a recovery in the economy despite the current challenges. The completion of the debt restructuring process, along with other favourable factors such as normalization of tourism earnings, remittances, easing import restrictions, and support from the IMF and other multinational agencies, could restore investor confidence and contribute to a positive outlook for foreign currency reserves, interest and exchange rates, and inflation, explains Dilshan Wirasekara, Managing Director and Chief Executive Officer of First Capital Holdings PLC, an investment institution.

What is your outlook for the economy at this crucial juncture?

Sri Lanka’s growth trajectory is currently experiencing a flattening trend, with negative growth expected in the first two quarters of the year, signalling a challenging economic environment. However, there is optimism for a recovery in the third and fourth quarters, with a projected turnaround into positive growth towards the 4th quarter. Nevertheless, the overall outlook for the year remains bleak, with a negative growth rate between 4-6%, leaning towards the lower end of the spectrum.

It is worth noting that despite the expected negative growth this year, it represents an improvement from the significant contraction experienced in the previous year. We expect the growth trajectory of the last two quarters of 2023 to continue, leading to a positive annual growth rate of 4.8% in 2024.

The recently approved Extended Fund Facility (EFF) Arrangement through the International Monetary Fund (IMF) has provided some stability and confidence to the markets, but the next hurdle to overcome is the debt restructuring process. The government has expressed intentions to restructure foreign debt, as well as optimize domestic debt through voluntary means, with a specific focus on central bank holdings and treasury bonds, while avoiding treasury bills. However, there is uncertainty surrounding the success of the voluntary approach, and it remains to be seen if additional measures such as optimization or re-profiling of the debt will be required.

Resolution of the domestic debt restructuring issue is crucial for restoring investor confidence and promoting foreign direct investments. Once this hurdle is overcome and a clear treatment plan is announced, it is expected that there will be increased flows of investments, as witnessed in the current trend of foreign investment flows into bonds and equities. However, some larger foreign direct investments are still holding back, awaiting the outcome of the debt restructuring exercise.

Achieving certainty in the treatment of debt restructuring is seen as a significant milestone that would instil confidence in investors and potentially bring Sri Lanka back to a growth trajectory similar to pre-2019 levels. Despite facing challenges such as the April bombings in 2019, the Covid-19 pandemic in 2020 and 2021, and the economic crisis in 2022, Sri Lanka has the potential to rebound and regain its previous growth momentum after a five year cycle.

Is your outlook for GDP growth predicated on finalizing the domestic debt restructuring and the external debt restructuring?

It is, although I do not believe it carries much weight. If your question is whether the domestic debt restructuring not taking place would disrupt our growth forecast, I do not think so, at least not significantly. Thus, while we do anticipate its completion, I do not believe our current growth forecast is dependent on it.

Naturally, if there were a major disagreement and a prolonged delay in the debt restructuring process, including the foreign element, not just the domestic element, it could have an impact. This would result in a delay in the expected inflows that are intended to boost the economy. Therefore, any disruption to the debt restructuring process could upset our forecast, but a mere delay in reaching a compromise would not throw it off.

There are a few additional points to consider in this whole story that many fail to grasp. If we examine why we are in the current position, amidst various explanations, it ultimately boils down to one major issue – dollar inflows. The most significant impact was felt in the tourism sector. The April bombings in a particular year resulted in a loss of earnings amounting to $3-3.5 billion. Before that, we were earning around $4-4.5 billion with over two million tourists arriving in 2018.

Subsequently, the Covid-19 pandemic in 2020 and 2021 brought tourism to a grinding halt. Collectively, over three years, we lost a staggering $12 billion in tourism earnings.

The math is straightforward. Had we retained that $12 billion in reserves, we would have avoided defaulting in the first place? Furthermore, remittances also dwindled after the economic crisis, resulting in a loss of approximately $10 billion in revenue over three to four years, including 2022, due to external factors. Fortunately, these numbers have started to normalize, with tourism showing some signs of recovery, albeit not fully, and remittances gradually picking up to over $500 million per month in March, with April figures yet to be revealed.

When coupled with import restrictions, which have reduced our monthly trade deficit from over a billion dollars to a mere $400 million, these factors are expected to rebuild reserves and contribute positively. The Central Bank’s monthly net purchases of two to three hundred million dollars in the market also add to this trend. Therefore, these three factors normalizing themselves, along with the potential for additional support from the IMF and other sources, would likely address the major issue at hand. If we can reinstate these favourable conditions, I believe we can navigate through this challenge without significant issues.

What is your outlook for reserves, interest and exchange rates, and inflation?

In terms of foreign reserves, the target is to reach $3.5 billion by the end of the year, with the possibility of achieving this target even earlier due to interest earned. The aim is to significantly reduce inflation in the current quarter, with a fall to below 20% in the second quarter, around 16-17% for June, and around 10% towards the end of the year. the other related economic indicators are expected to significantly improve, especially reserves which are expected to jump up. The government security rate is expected to fall below 20%, with the AWPLR following suit.

Regarding exchange rates, the currency has appreciated significantly due to inflows beyond expectations. The Central Bank is continuing with its dollar-buying program, having already bought $900 million over the first three months, with a requirement to buy at least another $500 million to meet this year’s target. This will help offset any appreciation pressure, and as the economy recovers, there may be some depreciation pressure, but inflows will also help to balance this.

The economy is expected to start recovering in the second half of the year, with the fourth quarter anticipated to see a positive GDP turn. Trade restrictions will need to be relaxed, with a three-month grace period to initially do so, ending by June. As the economy recovers, there may be some depreciation pressure, with projections for the currency to be around the 350-360 mark towards the end of the year. Annual depreciation of around 5% is expected from next year onwards.

Regarding projections for 2024, interest rates are expected to be below 15%, with government securities serving as the benchmark. Inflation is projected to have an annual average of around 7.2% for next year, according to the latest CCPI. These numbers may be even more optimistic, with rates potentially dropping to close to 10%.

What does all this mean for investors in terms of opportunities in bonds and equities?

While many investors may be attracted to the growth story, we want to draw attention to the bond opportunity. We expect interest rates to decline significantly from their current levels, with a historical high of 25%. Even though rates have dropped from their peak of 30%, we believe anything above 25% offers a good opportunity for long-term investment in bonds. We anticipate a windfall profit in six to twelve months, making it a once-in-a-lifetime investment opportunity.

The capital market also presents attractive opportunities in equities. The market has experienced multiple years of crisis, resulting in historically low valuations for shares. This makes it an ideal time for investors to enter the market with heavily discounted shares. It’s important to focus on fundamentally strong companies with earnings to support them, as they are likely to see significant upside potential within a three to five-year timeframe. Once the domestic debt restructuring is resolved and the international debt restructuring process gathers pace, we anticipate increased inflows into the market from foreign investors.

So those are the two key opportunities to consider in the capital market. Firstly, long-term interest rates are expected to decrease, presenting a potential interest rate play that could result in capital gains or higher rates compared to future rates. Secondly, there has been a price correction in valuations of listed companies on the Colombo Stock Exchange, with current market multiples at around one-time book and possibly five times earnings. This presents an opportunity for investors to purchase shares at a discount.

Investors can find opportunities in both the fixed-income and equity capital markets. On the fixed-income side, there is a chance to lock in long-term rates at the moment. On the equity capital market side, we expect positive GDP growth next year, leading to strong company earnings. With trade relaxation and improving consumer demand, there is a likelihood of significant growth in corporate earnings. We anticipate the market hitting the 12,000 mark by the end of this year and potentially surpassing it next year, based on next year’s expected positive growth. As rates decrease, investors may consider alternative investment options, potentially leading to a switch of fund flow from fixed income to equity markets in the fourth quarter of the year. This could contribute to the recovery of the capital markets.

As you contemplate the future, what’s your vision for First Capital?

From a country perspective, achieving the parameters we are aiming for would likely result in moving up the ladder from being a lower middle-income country to a high middle-income country. We were previously in middle-income territory, with a GDP per capita of around $4,300 in 2018. However, we have dropped to just below $3,500 now. I anticipate that over the next five years, we will be able to surpass $5,000 per capita GDP if we can maintain the projected growth trajectory and stick to the reform program.

What does this mean for the citizens of Sri Lanka? It would mean increased public investment in areas such as health, education, and infrastructure, resulting in improved individual wealth and higher standards of living compared to what has been experienced before. I believe that this upward trend will benefit everyone and uplift the overall standard of living, bringing us closer in line with countries like Singapore, Malaysia, and Thailand in Asia.

From a First Capital perspective, we are observing a significant shift in the relevance of capital markets to the economy, surpassing the conventional banking system. This trend is evident in countries like India, where capital markets are approximately two and a half times larger than the banking industry in terms of activity and contribution to the economy. I believe that a similar shift will happen in Sri Lanka, and whoever holds a leadership position in this space will be well-positioned to benefit from this trend. At First Capital, we hope to be that preferred partner with a top-of-mind recall, offering a comprehensive product and services suite, including efficient digital platforms for seamless transactions.

To provide some context in terms of data, the government securities market is a significant part of our business, and over the last three years, government securities issuance has tripled. Looking at the financial year from 2021 to 2022-23, the government is issuing three times as much debt as it did previously. First Capital’s contribution to this market has doubled compared to two years ago, and we currently account for approximately 12% of the total issuances of debt. These numbers illustrate the potential for growth in this scenario, and I believe similar growth will follow in equity, unit trusts, corporate finance, M&A advisory, and stockbroking.

As a company, we are prepared to capitalize on this opportunity, with the necessary platforms in place in terms of people, processes, and systems. We are eagerly awaiting this significant change and aim to mirror the growth we expect to see in the country, benefiting from it accordingly.

At First Capital, one of our aims is to open up opportunities for everyone. Many people believe that capital markets are exclusively for a select group of high-net-worth individuals. However, we are challenging that perception and making the emerging capital market opportunities accessible to anyone. Whether it’s investing in government securities or shares in the stock exchange, we are open to anyone with unit trusts and financial products that can help them unlock opportunities to grow their wealth as demonstrated by our corporate tagline ‘Performance First’, which drives us to serve customers better and be the best at what we do.