PowerPoint Presentation - Pravir Goonewardene

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WHAT NEXT? The Path Forward with an IMF Program Presented on 8th April 2022 WHERE DO WE STAND? Meeting our financing needs is not just a problem that is resolved in 2022. We are required to finance between US$4-5bn annually in debt service payments for at least the next 4 years Central Government Debt to GDP Public Guaranteed Debt Total net drains on foreign currency assets (Foreign debt service payments + Project loan + SOE settlements) 119% 110% 94% 107% 6,904 92% 101% 86% 85% 87% 84% 79% 80% 5,075 4,248 4,414 3,734 2016 2017 2018 2019 2020 2021 2022E 2023E 2024E 2025E 2026E Source: CBSL, Ministry of Finance (Data as at end-2020) The budget deficit has ballooned in recent years, with a majority of it needing to be financed through domestic sources. As a result, CBSL asset purchases have increased to record highs The growing budget deficit has been increasingly financed through domestic ….resulting in excessive money printing since the mid-2020s. In 2021, CBSL sources…. holdings increased by Rs. 678bn (c. 1/3rd of the domestic financing of the budget can be assumed to be through money printing) LKR bn 48 (83) 2,000 (429) (382) (465) (543) 1,800 -5.3% -5.5% -5.3% (211) (352) 1,600 (296) 1,400 -896 -1,751 -1874 1,200 -9.6% 1,000 -11.1% -11.1% 800 600 400 2016 2017 2018 2019 2020 2021E 200 0 Domestic Financing of Budget Deficit (Rs. Bn) Jan-21 Mar-21 May-21 Jul-21 Sep-21 Nov-21 Jan-22 Mar-22 Foreign Financing of Budget Deficit (Rs. Bn) CBSL Holdings of G-Secs Budget Deficit as a % of GDP We estimate a shortfall of US$600mn in dollar funding in the next 2 months (April & May), factoring in only the essential imports. Suspension of debt service payments (USD 1.9bn) would significantly ease this pressure. Foreign inflows and outflows until May 2022 (USDmn) USD 600mn USD 4.7bn gap Principal & Interest Payments USD 4.1bn 1,898 400 Net Services Exports 500 Remittances Intermediate Goods Exports of Goods (exc. Fuel) 1,530 2200 F&B 277.7 96 Pharma Indian Credit Line 900 1000 Fuel Outflows Inflows Source: CBSL, CAL Estimates Controlling excess depreciation in the currency post the float will require sharp adjustments on monetary policy 350 18 16 300 35% 14 +730bps depreciation YTD 12 YTD 250 10 8 200 6 150 4 2 100 0 1/3/2022 2/3/2022 3/3/2022 4/3/2022 Oct-21 Nov-21 Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 USD/LKR 12 month T Bill Auction Rate SDF SLF Source: CBSL, Turkey is a prime example of using interest rates to defend currency movements Lending Rate Lending Rate USD/TRY USD/TRY 30 18 Rates increased by 16 TRY 25 1600bps in 3 depreciates months Rates cut by 98% (8% to 24%) 1575bps within Rates 14 14 months increased by 1075ps in 8 20 months 12 10 15 TRY appreciates Rates cut by 8 24% 500bps in 6 months 10 TRY 6 TRY appreciates depreciates 18% TRY 29% 4 depreciates 5 2 0 0 1-Jan-18 1-Jun-18 1-Nov-18 1-Apr-19 1-Sep-19 1-Feb-20 1-Jul-20 1-Dec-20 1-May-21 1-Oct-21 1-Mar-22 Source: Investing.com, Central Bank of the republic of Turkey During the Asian Financial Crisis, S. Korea and Thailand also resorted to hike rates to stabilize the currency USD/THB USD/WON 30 60 30 2,500 25 50 25 2,000 20 20 40 1,500 15 15 30 1,000 10 10 20 500 5 5 10 0 0 0 0 1996/01/03 1997/01/07 1998/01/14 1999/04/01 Jan-96 Aug-96 Mar-97 Oct-97 May-98 Dec-98 Jul-99 Call Rate (Overnight-All Trades) Won per United States Dollar (Close) Interbank overnight lending rates : Average USD/THB Source: Investing.com, Bank of Korea, Bank of Thailand WHAT DOES AN IMF PROGRAM MEAN RIGHT NOW? Time taken to complete debt restructure mainly depends on how long it takes to negotiate – On average completion takes 9-13 months Stylized Timeline of a Sovereign Debt Restructuring Debt Exchange Negotiations Exchange offer (and preparations) (or principal agreement) T+1 T+2 …. …. Result: Default or T+n+1 Participation in % announcement Haircut in % The process is triggered by either • a default (missed payments), or • the announcement of restructuring • Negotiations on restructuring terms (formal or informal) • Creditors accept or reject • Exchange offer prepared by government and its legal debt exchange offer and financial advisors. Sovereign Debt Restructuring process 1. The Players: 5. Creditor objectives: 3. Preparing restructuring proposals 4. Negotiation Process: (i) Sovereign Debtor (i) Accept some degree of debt relief in (Indicative Restructuring Scenarios): The complexity of the debt profile and widely diverse (ii) State owed Entities order to enhance the collectability of Laying out both overall quantum of debt creditors will (iii) The Creditors the balance of exposure. and relief methods of each creditors. Multilateral official (ii) Creditors watch each other warily, No The release of IRS would help to reduce Engagement with creditors: creditors creditors wants to give more debt sticker shock. Bilateral official Creditor Restructuring vehicle relief than the other. Commercial private (iii) Ensuring no backsliding by the Commercial banks London Club sovereign debtor. Bond holders Exchange offers 2. The restructuring Envelope: 6. Methods and Techniques: (i) Hire financial and legal advisors to guide through the process Bilateral (governments) Paris Club (i) Change maturity dates for amounts of (ii) Determine overall quantum debt relief principal or interest due and • Trade creditors are excluded Multilateral (World bank, Preferential treatment; Debt introduce grace periods.. • Any senior or collateralized debt excluded IMF) relief only for poorest (ii) Hair cut: Reduce the principal amount • Excluded Claims of International financing institutions (IFI’s – IMF, World countries of debt bank etc.) Suppliers, Trade creditors Ad hoc (iii) Coupon adjustments: Reduce the interest rate on debt (iv) Mix and match these techniques Source: CAL findings and IMF 10 The standard IMF prescriptions will apply… • Exchange rate – “Recommend a gradual return to a market-determined and flexible exchange rate to facilitate external adjustment and rebuild international reserves” • Import and Capital controls – o Import restrictions and capital flow management measures (CFMs) introduced during the pandemic should be temporary. o The authorities should develop a schedule for the import restrictions to be phased out. o Directors called on the authorities to gradually unwind capital flow management measures as conditions permit. Source: IMF In most cases, interest rates are required to match inflation in order to attain positive real interest rates With inflation expected to rise further due to pass-through impacts of depreciation and impacts of future tax changes on prices of goods & services, interest rates are expected to continue its upward trend % 20 18 16 14 12 10 8 6 4 2 0 Jan-20 Mar-20 May-20 Jul-20 Sep-20 Nov-20 Jan-21 Mar-21 May-21 Jul-21 Sep-21 Nov-21 Jan-22 Mar-22 Headline Inflation (YoY) 12 Month T Bill Auction rate Source: CBSL The IMF has outlined a positive primary balance within a 2 year period following the commencement of the program while debt is expected to gradually reduce Positive primary balance expected within 2 years A graduall reduction in debt is expected within 5 years External debt is a key driver to the gradual reduction • A positive primary balance within a 2 year period has been • A gradual reduction in debt to GDP is to be expected over • The reduction in external debt has been the key driver previously outlined as a debt relief target by the IMF. We the next 5 years. Historically, a 20% reduction is outlined by towards supporting the reduction in total debt. expect Sri Lanka to have similar guidelines on the primary the IMF with extreme cases (eg: Greece) being an balance following an IMF program. exception. Primary Balance (as a % of GDP) Debt to GDP (%) External debt to GDP (%) 250% 5% 180% 4% 160% 200% 3% 140% 2% 120% 150% 1% 100% 0% 80% 100% -1% 60% -2% 40% 50% -3% 20% -4% 0% 0% Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Ecuador Barbados Greece Ukraine Ecuador Barbados Greece Ukraine Ecuador Barbados Greece Ukraine Source: IMF and CAL Research Estimates 13 With the right fiscal measures, the Budget deficit can be reduced to c.4.1% by 2028E A minimum of a reversal of tax measures taken in end-2019 could raise c.Rs. 700bn+ between 2022-24E. In addition, reducing Public investment for the next few years and minimal changes in public sector wages could raise the remaining balances to bring the primary balance to 0.4% by 2024E . We have factored in a 20% haircut on debt restructuring. This means the budget deficit would reduce by Rs. 291bn between 2021 to 2028E. 6,000 How much can we raise between 2022-2024E? 4,000 Possible tax Increases: Rs. Bn 2,000 503 94 Income Taxes (PIT + CIT + PAYE) 100 (538) (771) (533) 0 WHT (10% on Interest Income) 80 -2,000 (1,439) (1,648) (1,364) (1,534) (1,826) VAT reversal 200 -4,000 NBT + SCT+ESC 150 -6,000 -8,000 2019 2021 (Budget 2022E 2024E 2028E Estimate) Revenue Expenditure Primary Deficit Budget Deficit Source: Ministry of Finance, CAL Estimates 14 We can get our debt/GDP to c.80% by 2028 with fiscal deficit of 4-4.5% which is acceptable without a domestic debt restructure We believe a max 20% haircut on foreign denominated securities (principal and coupon payments) with a postponement of payments for 4-5 years is sufficient if the restructuring is combined with a fiscal consolidation plan (LKR 291bn reduction in deficit by 2028E) and monetization of non-strategic SOE (USD 2.5bn) by 2028E to bring down the Public Debt/ GDP to 80.3% by 2028E (vs. 119% at present). If the fiscal consolidation path is put in place, FX debt repayments can be managed via regaining access to bilateral and international funding whilst the current account deficit could be bridged by higher tourism receipts, resumption of worker remittance flows and reduction in imports owing to the LKR depreciation. 20% haircut LKR Bn 140% on foreign debt 119% USD 2.5bn Public debt as at 2022E 24.3 120% SOE 12% 9% monetization Increase in Domestic Debt 7.3 100% 8% 8% 7% 80% Reduction in Foreign Debt (1.2) 39% 44% 6% 80% 33% 6% 5% 25% 23% 22% 21% Monetization of non-strategic SOEs (0.8) 20% 60% Public debt as at 2028E 29.7 40% 65% 60% 62% 60% 59% 58% 56% 55% Public debt to GDP (2028E) 80.3% 20% 0% 2021 2022E 2023E 2024E 2025E 2026E 2027E 2028E Fiscal deficit to GDP 2028E 4.1% Domestic Debt to GDP Foreign Debt to GDP Other debt commitments Source: CBSL, Company Data and CAL Research Estimates 15 We believe an external haircut on external debt (ISBs and SLDBs) will be the most likely scenario… A 20% haircut on external debt (ISBs and SLDBs) will likely erode tier-1 capital for commercial banks. In our analysis, we have taken into account a 20% haircut on foreign denominated securities taking into consideration the impairment provisioning undertaken in 2021 following the reversion to a 30% probability of default and a 20% loss given default under a 12 month ECL model. The reduction in the haircut on foreign denominated securities is then applied on the current tier-1 capital and RWA after factoring in the one-off surcharge tax burden coupled with the cash dividend payout announced in 1Q2022. Our analysis indicates that NDB, BOC and COMB will face immediate capital constraints following the haircut on foreign denominated securities. Adjusted 4Q2021 tier-1 capital buffer following haircut on ISBs and SLDBs, surcharge tax expense and cash dividend payout 8.0% 7.41% 7.0% NDB, BOC & COMB will require a infusion of 6.0% 5.33% capital following an external debt restructure 5.0% 3.82% 4.0% 3.0% 2.57% 2.43% 2.0% 1.62% 1.35% 1.24% 1.0% 0.0% -1.0% -0.23% -2.0% -1.03% -1.10% UBC NTB PB HNB SAMP PABC SEYB DFCC NDB BOC COMB An external debt restructuring, according to our estimates NDB, BOC and COMB will collectively require LKR 27.5bn to revert to the minimum threshold in capital adequacy. COMB will be able to obtain the required infusion in capital via a rights issue or private placement. The extended infusion in capital required by PB and BOC will likely be sourced through printing. Source: Company Data and CAL Research Estimates 16 “Domestic debt is like surgery: You only do it if you must, and you avoid it if you might do more harm than good” : IMF As at 30th June 2021, the banking sector held 30% of total G-Sec A domestic restructure can be considered if the following measures have been undertaken Composition of T-Bills and Bonds Held (%) June 2021 The key is to consider the net benefit of a domestic debt restructuring: To avoid compromising the viability of the domestic financial system, the government may be required to recapitalize some banks or replenish pension savings. Non-Bank The net benefit calculation will determine whether or not the domestic debt should be part of a 12% restructuring, together with external debt, or on a standalone basis. sector The domestic debt restructuring should be designed to anticipate, minimize and manage its impact on the domestic financial system: Commercial 30% The authorities need to put in place measures that mitigate losses for banks, non-bank institutional 58% investors, and households and that minimize spillovers. Banks The impact on banks can be limited by extending the maturities and/or lowering the interest rate rather than reducing the nominal amount of the outstanding claims. CB Losses should be recognized early and may need to be paired with a strategy to restore banks’ capital buffers. System-wide emergency support that allows institutions to convert illiquid assets into cash may be needed to ensure the functioning of the banking system and shore up confidence. In some cases, temporary measures to slow panic-driven deposit withdrawals and capital outflows might have to be considered. The authorities should carefully evaluate the potentially adverse consequences of unilaterally amending domestic law. Source: IMF and CAL Research Estimates 17 The banking sector will come under severe pressure if there is an imposition of an external and domestic restructure A 10% haircut on government securities (T-Bill and T-Bonds) and a 20% haircut on foreign denominated securities will significantly erode tier-1 capital for commercial banks. In our analysis, we have taken into account a 10% haircut on government securities and due to no impairments being undertaken due to the asset being categorized as 0 risk. The reduction in the haircut on government securities is then applied on the current tier-1 capital and RWA after factoring in the one-off surcharge tax burden coupled with the cash dividend payout announced in 1Q2022. The subsequent erosion in capital will cause significant pressure on the banking sector Adjusted 4Q2021 tier-1 capital buffer following haircut on ISBs and SLDBs, G-sec, surcharge tax expense and cash dividend payout 6.0% 4.34% 4.0% 1.96% 2.0% 0.29% 0.0% -2.0% -0.14% -0.33% -0.37% -0.72% -4.0% -2.07% -6.0% -5.82% -8.0% -6.59% -10.0% -12.0% -14.0% -13.16% -16.0% UBC NTB HNB PABC DFCC SEYB SAMP NDB COMB BOC PB An external and domestic debt restructuring, according to our estimates will collectively require an LKR 313bn to revert to the minimum threshold in capital adequacy. Source: Company Data and CAL Research Estimates 18 …However, there have been exclusions on sector exposure even in countries that have undergone a domestic debt restructure Financial institutions hold a significant component of T-bills and T-bonds and a domestic restructure will likely cause undue stress on the financial sector. Barbados (2018) The Financial services Commission (FSC) conducted extensive stress tests over a 3 month period to ensure the proposed debt restructure would not jeopardize financial stability. On the eve of the debt restructure (in December 2017), banks held 53% of total financial sector was highly solvent with capital buffers well over the minimum threshold. However, Commercial banks and insurers were not subject to face-value haircuts, the NPV losses incurred by maturity extensions and interest rate reductions resulted in capital losses, under IFRS-9 applied on financial institutions. However, stress tests ensured that the proposed terms would not result in financial entities did not fall below the minimum capital threshold. Source: IMF and CAL Research Estimates 19 Adjustments in energy prices and pricing mechanisms are expected In order for CEB to breakeven, the tariff rate needs to be c.LKR36/kWh as per our An upward revision in CPC fuel prices may also take place for the entity to estimates. breakeven and match the current LIOC prices. CEB costs and revenue (LKRbn) LKR 36/kWh Current Vs recommended fuel prices for CPC to Recommended breakeven (LKR/liter) 600 tariff rate for CEB to break even 500 LKR 240bn Revenue at an 400 average tariff rate of LKR 16.81/kWh, with 300 total cost per kWh at LKR 21.2 200 322 100 270 254 0 176 2020 2022 IPP cost CEB fuel cost Lanka auto diesel Lanka petrol 92 octane CEB coal cost Other expenditure Current price Recommended price to breakeven Prior to depreciation, the CEB generated electricity sales at an average tariff rate of An upward revision in CPC petrol and diesel prices may be required in order to c.LKR18.57 while incurring a cost of c.LKR 28.91 per unit. As per CEBs initial absorb CPC’s long standing losses. Accordingly, the Lanka auto diesel prices may estimates they may make a loss of c.LKR 145bn due to the higher cost of importing have to be revised upwards to c.LKR 270/liter from the current rate of LKR 214/liter fuel and oil for the year 2021. and Lanka petrol 92 octane to be revised to LKR 322/liter from the current rate of LKR 303/liter. Source: Ministry of Finance, LIOC, CAL estimates IMPACT OF A DEBT RESTRUCTURE ON FINANCIAL MARKETS Currency volatility is a staple with the announcement of a default or restructuring Postponement 40 Request of IMF July 1998 Aug/Sep 2008 90 Default of repayment Programme 60 Devaluation of Pre-emptive currency restructuring 80 35 IMF programme 55 70 30 confirmed 60 50 25 50 20 45 40 15 40 30 10 20 35 5 10 30 0 0 Jan-98 May-98 Sep-98 Jan-99 May-99 Sep-99 Jan-18 Sep-18 May-19 Jan-20 Sep-20 Jan-14 Sep-14 May-15 Jan-16 Sep-16 USD/PKR USD/ARS USD/UKH Lending rate movement; Mozambique & Zambia Mozambique – Lending rate (%) Zambia – Lending rate (%) 30.0 14.0 Jan 2022 12.0 Zambia and 25.0 Official IMF announce commencement a USD 1.4bn of negotiations. 10.0 bailout package 20.0 8.0 A 15.0 restructuring plan was proposed 6.0 for the 10.0 second time for the bondholders 4.0 . 5.0 Default: failure to pay USD 59.8mn in 2.0 Default: failure to pay interest on the USD 42.5mn in sovereign Eurobonds Eurobonds 0.0 0.0 May-19 Sep-19 Sep-20 May-20 May-21 May-17 Mar-19 Mar-20 Mar-21 Jan-19 Nov-19 Jan-20 Nov-20 Jan-21 Jul-19 Jul-20 Sep-15 Sep-20 Mar-18 Dec-16 Dec-21 Apr-15 Aug-18 Apr-20 Jan-14 Jun-14 Nov-14 Jan-19 Jun-19 Nov-19 Oct-17 Feb-16 Jul-16 Feb-21 Jul-21 Lending rate movement; Greece & Argentina Greece – Lending rate (%) Argentina – Lending rate (%) IMF bailout; Argentina Greece warns it might default. receives the biggest loan The EU and the IMF provided package ever dispersed from 12.0 EUR 110bn in emergency 90.0 the IMF of USD 57.1bn. funds in return for austerity measures. 80.0 Finance ministers 10.0 approved a second EU- IMF bailout for Greece, worth EUR 130bn 70.0 8.0 60.0 Feb 2022 Argentina approaches the IMF to restructure the failed 2018 50.0 bail-out program and request for a USD 45bn debt 6.0 Greece and its restructure. Approval pending private creditors 40.0 from the IMF. completed the debt restructuring. 4.0 30.0 20.0 2.0 Economic 10.0 distress indicated default 0.0 0.0 May-18 May-19 May-20 May-21 Aug-18 Aug-19 Aug-20 Aug-21 Nov-17 Nov-18 Nov-19 Nov-20 Nov-21 Feb-18 Feb-19 Feb-20 Feb-21 Feb-22 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Pakistan equity market saw an initial dip with a devaluation taken to control BOP pressures, and strengthened once a restructuring programme was announced Pakistan Stock Exchange 5,000 4,500 Devaluation of Pre-emptive currency restructuring 4,000 3,500 3,000 2,500 -44% in 2 months +70% before in 6 months announcement 2,000 1,500 1,000 500 0 Nov-98 Nov-99 Nov-00 Nov-01 Nov-02 Nov-03 Mar-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Jan-98 May-98 Jan-99 May-99 Jan-00 May-00 Jan-01 May-01 Jan-02 May-02 Jan-03 May-03 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Source: Investing.com Argentina’s stock market saw severe volatility owing to political uncertainty and struggles on debt repayments MERV Postponement of repayment Default 60,000 +182% In 3 months Presidential 50,000 +87% Election In 4 months 40,000 30,000 -48% 20,000 in 1 month -50% in 2 months 10,000 0 Jan-19 Mar-19 May-19 Jul-19 Sep-19 Nov-19 Jan-20 Mar-20 May-20 Jul-20 Sep-20 Nov-20 Source: Investing.com Lebanon’s equity market saw a dip with the default. The recovery has been fueled primarily by the outperformance of Solidere which acted as a hedge against depreciation and inflation BLOM Default 1200 Beirut 1000 explosion 800 600 -21.9% in 2 months -0.4% in 6 months 400 200 0 Aug-19 May-20 Aug-20 May-21 Aug-21 Feb-22 Sep-19 Nov-19 Feb-20 Sep-20 Nov-20 Sep-21 Nov-21 Jun-20 Feb-21 Jun-21 Mar-20 Mar-21 Apr-21 Oct-19 Jan-20 Apr-20 Oct-20 Jan-21 Oct-21 Jan-22 Dec-19 Dec-20 Dec-21 Jul-19 Jul-20 Jul-21 Source: Investing.com 0 500 1,000 1,500 2,000 2,500 3,000 0 400 600 800 200 1,000 1,200 1,400 1,600 1,800 2,000 Jan-02 01/01/2009 Mar-02 01/03/2009 May-02 01/05/2009 Jul-02 01/07/2009 Sep-02 01/09/2009 Nov-02 01/11/2009 Jan-03 01/01/2010 Mar-03 01/03/2010 May-03 01/05/2010 Start Jul-03 01/07/2010 1st Bailout Sep-03 01/09/2010 Negotiations Nov-03 01/11/2010 Jan-04 01/01/2011 Mar-04 01/03/2011 May-04 01/05/2011 Jul-04 Argentina 2002-05 01/07/2011 Sep-04 01/09/2011 Nov-04 01/11/2011 Jan-05 01/01/2012 Athens General Composite – 2009-12 Mar-05 01/03/2012 2nd Bailout May-05 01/05/2012 restructuring Jul-05 01/07/2012 Completed Debt Sep-05 01/09/2012 Bailout Nov-05 01/11/2012 2nd revised 0 100 200 300 400 500 600 100,000 200,000 300,000 400,000 500,000 600,000 0 Jan-14 Jan-16 Mar-14 Mar-16 May-14 May-16 Jul-14 Jul-16 Sep-14 Sep-16 Nov-14 Nov-16 Jan-15 Jan-17 Equity market movements have not been a one-size-fits-all Mar-15 Mar-17 bailout package May-15 May-17 IMF announces the Jul-15 Jul-17 Sep-15 Sep-17 Nov-15 Nov-17 Source: Investing.com Ukraine PFTS 2014-16 Jan-16 Jan-18 Completed restructure Venezuela Bursatil 2016-18 Country the debt Mar-16 Mar-18 announced restructuring May-16 May-18 Jul-16 Jul-18 Sep-16 Sep-18 Nov-16 Nov-18 28 GDP Growth typically declines in the lead up to a default/restructure and recovers thereafter 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 t-2 t-1 t t+1 t+2 t+3 Average Source: Investing.com A default/restructure results in a slowdown in trade, with trade and current account balances improving in the year of default/restructure Current Account Balance (US$) US$ Bn US$ Bn 10 2 5 1 0 0 -5 t-2 t-1 t t+1 t+2 t+3 t-2 t-1 t t+1 t+2 t+3 -1 -10 -15 -2 -20 -3 Ukraine Ecuador US$ Bn 10 US$ Mn 1,000 0 t-2 t-1 t t+1 t+2 t+3 500 -10 0 -20 t-2 t-1 t t+1 t+2 t+3 -30 -500 -40 -1,000 Mexico Uruguay Source: Investing.com Key Takeaways • Political stability to some extent will be required to facilitate discussions with the IMF and negotiations on debt restructuring. • GDP growth will be poor in the near term, but a recovery is expected. Given that pressure on domestic consumption and limited capacity for investment and infrastructure spending will dampen growth prospects, it is necessary to encourage growth from external sources through FDI, Tourism, developments of Port City. • High inflation is not expected to persist - Inflation is expected to rise and remain in 20% levels (headline), with a step up being seen factoring in impacts of depreciation and expected tax and tariff increases, but it could ease thereafter as 1) overall demand contracts 2) global commodity stabilize and 3) agricultural supply normalizes • We do not think that interest rates have peaked – Higher rates are necessary to contain excess volatility on the currency, reduce the burden of Central bank financing the fiscal deficit and curtail CBSL’s asset purchases by improving market subscriptions • Managed exchange rate – While some bouts of volatility may be seen, we believe that further currency depreciation from current levels is likely to be limited. 31 What does it mean for Asset classes and portfolio accounts? The market cap of the CSE has declined 24% YTD (in USD) following a steep depreciation of Go long on bonds when rates peak the currency. The market cap of the CSE has declined to almost pre-pandemic levels Invest in longer tenured bonds (Govt & Pvt) as rates begin go peak. Real rates over the remaining duration should be able to cover up for the depreciation of the currency. CSE Market cap (USD bn) 30 Equity Position to take advantage of the bottom-cycle that could arise as conditions begin to settle. Fundamental counters are currently trading at historical lows. 25 Gold Global gold prices are at a record high. USD gold prices 20 Peak of the pandemic should adjust downwards with the US fed hikes. 15 Real Estate Higher interest rates are negative for real estate. Demand for property will be lower during economic downturns 10 1/2/2017 1/2/2018 1/2/2019 1/2/2020 1/2/2021 1/2/2022 Source: CSE, Investing.com, Company Data and CAL Research estimates 32 Disclaimer This document has been prepared and issued on the basis of publicly available information, internally developed data and other sources, believed to be reliable. Capital Alliance Securities (Private) Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute a judgment as of the date of the material and are subject to change without notice. This report is not intended as a recommendation or as an offer or solicitation for the purchase or sale of any financial instrument. The recipient of this report must make their own independent decision regarding any securities, investments or financial instruments mentioned herein. 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Contacts Trisha Peries Head of Research Tel: +94 11 231 7786 Email: trishap@cal.lk Ishara Nilam Pravir Goonewardene Email: isharan@cal.lk Email: pravirg@cal.lk Nilakshi De Mel Natalie Kulasekere Email: nilakshim@cal.lk Email: nataliek@cal.lk For general queries please email teamresearch@cal.lk or contact +9411 2317777 Address: Level 5 “Millenium House”, No46/58 Nawam Mawatha,Colombo 02, Sri Lanka 33