Stock market shutdown will leave a bitter taste but others have been forgiven
The shutdown of the equity market in Sri Lanka likely leaves a long-lasting bitter taste for foreign institutional investors. Many will be put off by the ad hoc closure of the market for such a long period – Bangladesh, Jordan, and Sri Lanka are the only equity markets to shut for this length of time.
For most foreign institutional investors, when a market is shut for so long they cannot fairly attribute a value to their positions in that market or liquidate them. This has the knock-on effect that performance fees on this portion of their fund are put at risk and, worse, if their fund suffers a redemption, during the time this market is closed, they may have to sell disproportionately out of positions in other countries.
Of course, nothing is unforgivable and foreign institutions have returned with considerable vigour to markets which have endured long, unplanned effective shutdowns before, eg Egypt and Pakistan, albeit years later.
A relatively orderly re-opening...
If there was no further global change then there is unlikely to be a rush to sell when the Sri Lanka market re-opens. Regional peer equity markets (Pakistan, Philippines, Vietnam) are up 14%, on average, since the Sri Lanka market shut. Global benchmarks (DM, EM, FM, FEM) are up 15%, on average. Furthermore, on a year to date basis, the performance of Sri Lanka prior to its closure (down 27% for the local CSE All Share index and down 34% for the large cap-biased MSCI country index) is much worse than the average c20% decline of regional peers and global benchmarks.
...But quite an anaemic investment case ahead
Sri Lanka equities are cheap relative to history, but this is not a distinguishing feature among its regional or global frontier peers.
There is tension in the top-down investment case between hopes of more decisive, pro-growth and pro-foreign investment policy implementation under the Rajapaksas (President Gotabaya and his brother, Prime Minister Mahinda) and concerns over fiscal sustainability, FX rate vulnerability, and political cohesion (not so much within the ruling coalition that might emerge from the 20 June parliamentary election but the potential authoritarian exclusion of those outside it).
Obviously in the short-term, the combination of Covid-19 and lower oil price hurt growth (the IMF forecast for 2020 and 2021 growth was cut from 3.5%/ 4.3% to (0.5%)/ 4.2% in its April update). The current account also suffers in 2020: the benefit of lower-priced oil imports (equivalent to c2% of GDP if oil price remains around US$30), is likely more than offset by lower remittances from the GCC (a 20% cut would equate to 0.8% of GDP) and lower overall tourist receipts (a 30% cut would equate to about 1.8% of GDP).
Twin deficits, high external debt (almost 70% of GDP), and short-term external debt higher than FX reserves, implies that much is riding on credibility of policy. This, in turn, almost certainly requires a follow-on IMF deal (the current Extended Fund Facility expires in June 2020). The catch-22 is that the fiscal conditions attached to that IMF deal may undermine some of the hopes pinned on the Rajapaksas to revive the economy.
Sri Lanka: Govt seeks IMF assistance; focus on economic revival emerges, 30 April 2020 (Lakshini Fernando, Asia Securities)
Sri Lanka: Now for the hard part, 19 November 2019