Sri Lanka is Bouncing Back – AFC on the Road – Sri Lanka July 2023

Dear Investors and Newsletter Readers,

Ruchir Desai, co-fund manager of the AFC Asia Frontier Fund, travelled to Colombo from 19^th-21^st June 2023 to meet with policymakers and various Sri Lankan companies, some of which the fund is invested in.

On my last visit to Sri Lanka in November 2022, my key takeaway was that the economy and stock market had bottomed out as inflation and interest rates had peaked, and the country was on the verge of gaining approval for an IMF (International Monetary Fund) loan. Fast forward to June 2023: inflation has reduced significantly, benchmark interest rates have been cut by 250 basis points, and the IMF has disbursed the first tranche of its loan to Sri Lanka.

Clearly, things have moved in the right direction for Sri Lanka since my last visit, as the country has taken some tough decisions since the start of 2022, such as increasing fuel and electricity prices, raising taxes, and allowing the currency to depreciate. All these measures to support stability are paying off not only in terms of economic metrics but also by helping to bring in much-needed foreign exchange revenues.

Both macro and social stability have led to a rebound in international tourism and worker remittances. International tourism revenues so far this year up to May 2023 have clocked in at USD 828 million. Also worker remittances have seen a huge jump this year to USD 2.4 billion in the first five months of 2023 as a more realistic exchange rate for the Sri Lankan rupee (LKR) makes remitters use official channels for sending home their funds which were earlier being sent via unofficial channels due to an artificial exchange rate.

At this pace, tourism revenues and worker remittances could reach approximately USD 2 billion and USD 5 billion respectively in 2023, which will go a long way towards helping Sri Lanka manage its current account deficit. Furthermore, if Sri Lanka can maintain this normalisation in tourism and remittance inflows, it will significantly help the country to revert to a more stable macroeconomic environment and also help build up its much-needed foreign exchange reserves. Thus the priority of the government should be in getting back to pre-pandemic levels of tourism and remittance inflows.

Going Back to Pre-pandemic Levels of Tourism and Remittance Receipts Will be Very Positive for Sri Lanka’s Economic Stability (In USD Billion)

The rebound in tourism in Sri Lanka was evident as I could see a lot of foreign visitors at the hotel I was staying at while my flights in and out of Colombo were full. The atmosphere on the ground among the hotel staff also appeared much more optimistic compared to my previous visit last year. Although it was off-season, the hotel I was staying at had full occupancy for the week since many guests were attending a World Health Organisation conference in the city.

The restaurants I visited in the evenings were also quite full with a mix of locals and foreign tourists even though it was a weekday. Being on the ground, I felt that the momentum for tourism-related industries is definitely coming back.

A Buzzing Breakfast Scene at the Galle Face Hotel in Colombo – Tourism Is Making a Strong Comeback to Sri Lanka

During my visit, I met with blue chip companies from various sectors and also met with the Central Bank of Sri Lanka (CBSL). In general, there is a lot more confidence in the tone of the management teams compared to my previous meetings with them last year, as they are seeing some green shoots of growth as both economic and earnings growth are expected to bottom out in the second half of 2023 while the operating environment for most companies has seen a significant improvement due to greater USD availability while power supply issues have been smoothened out. Furthermore, valuations remain very attractive in Sri Lanka, with most companies I met trading at a P/E ratio of less than 10x.

The higher interest rates and a much weaker currency compared to historical standards have also led to inflation falling from the highs seen in the middle of 2022 when the crisis in the country was at its peak with food and fuel shortages. The momentum in disinflation has allowed the CBSL to cut benchmark interest rates by 250 basis points in June 2023. Given the high inflation base from last year and the declining trend in price pressures, it will not be surprising to see inflation go into single digits in the next few monthly readings.

In my view, as lower inflation points come in, it will allow the CBSL to significantly cut interest rates in the next 2-3 quarters, and it will not be surprising to see benchmark interest rates go back to single-digit levels by the first quarter of 2024.

Inflation Is Cooling Down Fast in Sri Lanka, Which Could Lead to Aggressive Interest Rate Cuts in the Next Few Quarters

The stock market and the Sri Lankan rupee (LKR) have been reacting positively to the improving macro environment, as the Colombo All Share Index and the LKR have been among the best performers globally this year. I believe the equity market in Sri Lanka has more room to run as a positive trigger will be interest rates, which I expect will come down significantly in the next few months.

In addition to this, very attractive valuations and an economic and earnings recovery going into 2024 should support an equity rally in Sri Lanka. After my visit, we are looking to increase the fund’s allocation to Sri Lanka.

Sri Lanka has More Room to Rally as Interest Rates Come Down and Earnings Recover in 2024 
(Year-to-date Returns in USD as of 30^th June 2023)

As always, when I am in Colombo, I take a walk along the seafront on Galle Face Green in downtown Colombo. This time it was more crowded compared to my previous visit in November 2022, which also reflects the improving consumer sentiment and macroeconomic situation in Sri Lanka.

A Crowded Galle Face Green on a Sunday Evening

I also visited the Colombo Port City which is being developed on 269 hectares of reclaimed land from the sea just off downtown Colombo. The Colombo Port City is being developed by China Harbour Engineering Company (CHEC), and the project envisages having an international financial centre and other leisure, entertainment, and residential facilities.

If executed in line with its vision, the Colombo Port City is a longer-term theme for Sri Lanka, but in the next few years, I would focus more on Sri Lanka following through on developing its tourism and logistics-related infrastructure, which are the “must do” activities for the government while also maintaining the reform momentum linked to privatising state-owned enterprises, building up tax revenues and not making major policy misjudgements of the past.

The Colombo Port City Can Be a Longer-Term Theme for Sri Lanka

Sri Lanka has faced many challenges since 2019, but I think the worst is now over, having occurred in 2022. The country has achieved stability and is making a turnaround on its road to a recovery. The responsibility now lies with the government and policymakers to use the country's strategic location and implement policies related to the tourism and logistics industry.

A Trip to Sri Lanka Is Incomplete Without a Lion Beer!

The bottom line from my time on the ground in Colombo is that I am much more optimistic on the outlook for Sri Lanka compared to the past few years. Let’s hope policymakers do not disappoint investors again – the ball is in Sri Lanka’s court.

For further information on our AFC Asia Frontier Fund, please find below the links to the latest factsheets, investor presentations and our previous report on Sri Lanka:

   AFC on the Road – Sri Lanka – November 2022

I hope you have enjoyed reading our "AFC on the Road" report. If you would like any further information about the AFC Asia Frontier Fund, please get in touch with me or my colleagues.

With kind regards,

Ruchir Desai
Co-Fund Manager

This email address is being protected from spambots. You need JavaScript enabled to view it.

Disclaimer:

This Newsletter is not intended as an offer or solicitation with respect to the purchase or sale of any security. No such offer or solicitation will be made prior to the delivery of the Offering Documents. Before making an investment decision, potential investors should review the Offering Documents and inform themselves as to the legal requirements and tax consequences within the countries of their citizenship, residence, domicile and place of business with respect to the acquisition, holding or disposal of shares, and any foreign exchange restrictions that may be relevant thereto. This newsletter is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law and regulation, and is intended solely for the use of the person to whom it is intended. The information and opinions contained in this Newsletter have been compiled from or arrived at in good faith from sources deemed reliable. Opinions expressed are current as of the date appearing in this Newsletter only. Neither Asia Frontier Capital Ltd (AFCL), nor any of its subsidiaries or affiliates will make any representation or warranty to the accuracy or completeness of the information contained herein. Certain information contained herein constitutes “forward-looking statements”, which can be identified by the use of forward-looking terminology such as “may”, “will”, “should”, “expect”, “anticipate”, “project”, “estimate”, “intend”, or “believe” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of Funds managed by AFCL or its subsidiaries and affiliates may differ materially from those reflected or contemplated in such forward-looking statements. Past performance is not necessarily indicative of future results.

For Switzerland only: This is an advertising document. The state of the origin of the fund is the Cayman Islands. This document may only be provided to qualified investors within the meaning of art. 10 para. 3 and 3ter CISA. In Switzerland, the representative is Acolin Fund Services AG, Leutschenbachstrasse 50, 8050 Zurich, Switzerland, whilst the paying agent is NPB Neue Privat Bank AG, Limmatquai 1 / am Bellevue, 8024 Zurich, Switzerland. The basic documents of the fund report may be obtained free of charge from the representative. Past performance is no indication of current or future performance. The performance data do not take account of the commissions, if any, and fund transfer costs incurred on the issue and redemption of units.

AFC Asia Frontier Fund is registered for sale to qualified/professional investors in Japan, Singapore, Switzerland, the United Kingdom, and the United States. 

By accessing information contained herein, users are deemed to be representing and warranting that they are either a Hong Kong Professional Investor or are observing the applicable laws and regulations of their relevant jurisdictions.

© Asia Frontier Capital Ltd. All rights reserved