I will touch on some of the more macro issues pertaining to these.
Capital Needs
In the case of the first, the need (or demand) for debt capital again has, broadly, two branches. Short term and long term capital, and it is important to recognize this as the nuances of prognosis for the two are quite different.
The primary use and need for short term debt has been for working capital, and the logical providers of this have been the commercial banks.
However, given the wide margins within the banking sector, driven by structural factors such as high operating costs, credit costs and taxation, there seems to be a very strong case for disintermediation of the banks.
So why hasn’t this happened? (let's hold that question in abeyance for the moment)
The primary use of long term capital is project financing (in theory at least).
And by ‘project’ I mean not necessarily Greenfield/Standalone projects, but even incremental fixed asset formation in a company.
And needless to say, a 30-year risk overhang brought about by the conflict, resulting in limited growth, nominally high interest rates, a policy environment that has kept, and continues to keep, private sector participation in a number of sectors muted, have minimized the demand for such capital.Not least of these has been risk. Not only commercial risks but market (or interest rate) risks have compelled corporates to, wittingly or unwittingly, finance such investments with equity. And kudos to those that did, for debt financing of long term assets given the historical volatility of interest rates, and brakes on demand growth trajectories, could have been near suicidal.
There’s also been another, slightly more perverse factor. A BOI regime (and even going back to the GCEC era) that offered tax havens to a number of large and medium scale businesses meant that the tax advantage of leverage was also lost amongst what would have otherwise been significant users of debt.
Moving on to the second factor, ie: the sources and supply of debt capital, and we come across this time to a structural impediment that arguably goes back to the dawn of independence. And that is a politico-economic, and resulting social structure that effectively discourages savings and the build up of capital, for any form of investment, be it debt or equity.
Flippant State Spending
Political aversion to taxation and short sighted and flippant spending meant large deficits without any corresponding build up of assets, physical, human or financial, that in turn could have increased revenues, and created a virtuous cycle.
Large and endemic primary account deficits meant inflation, which in turn discouraged savings to begin with. Vacillating primary account deficits meant volatile interest rates, further hampering any viable termed out structure of savings, of whatever savings were generated.
Hence the two savings regimes that were being built over this period, ie: the statutory savings regime of EPF, ETF and the likes, and the market driven savings regime of personal and corporate savings, behaved like two very different animals.
The first almost solely and exclusively toward deficit financing, both primary account as well as overall deficit, and the latter toward a short term structure, that sought “liquidity” and “re-priceability”. Outside these two, the insurance sectors’ investments were also governed by regulatory restrictions, again directed toward deficit financing.
Therefore, while demand for long term investments was hampered, clearly so was, or more so was, the supply of funds.
Similarly, any attempt to disintermediate the banks as far as short term capital was concerned (ie: the answer to the question raised earlier), was also hamstrung as savers (both corporate and individual) sought the “service benefits” of banks. Mutual funds, which could potentially fill this void, are still a relatively embryonic or an unheard of savings instrument.
So now that I’ve spent time (too much time) articulating the problem, it won’t do justice to this forum unless I at least attempt to articulate a probable solution or way out.
Clearly the problem of fiscal crowding out and high inflation are so structural, so embedded in the political and social fabric of this country that it will be naïve, to say the least, to expect any short term reversal or redirection of such.
Demographic Dividend
This is certainly not to say that we shouldn’t start the process, we should, but that the benefits of it, even if we start now, would take a long time to realize. It’s like the proverbial big ship, slow to change course and requires a lot of tinkering from bridge to deck to hold and back up again.
And time, quite frankly, is something we don’t have.
Sri Lanka is on the verge of missing the bus on the famous demographic dividend. Our demographic profile is at its optimum now. We have the highest proportion of working age population that we will ever likely to have.
If we don’t take advantage of it now, and make our investments, we won’t have the savings to service the aged population in the future.
Hence, when I refer to the development of the corporate debt market, I’m not merely referring to the attempt to re-direct part of the existing savings base into corporate debt, or even infusing a culture (and practice) of increased savings by government as well as society, but more so toward attempting to by-pass these structural impediments.
So how do we do this?
Quite simply, we get others’ savings to invest in us.
Dr Mahathir fast tracked this by force feeding his ample savings base into infrastructure. Intermediated through debt and equity capital markets.
He had the savings because even the public sector paid taxes and to the provident funds, AND he was more disciplined on how he spent it.
He then brought stability, economic and political, and the external savings flowed in. Even through the blip of '97 and the more recent crisis.
We, on the other hand, don’t have the savings to create the instruments and follow this fast track approach. We need to fast track the fast track.
Foreign Savings
And the solution to this lies in creating the necessary conducive environment toward attracting foreigners’ savings, at the lowest cost possible.
And very, very importantly, we need to recognize that the degree of this conduciveness is what will determine both the quantity and pricing of this funding, and thereby the success of this strategy.
Now this conduciveness has many aspects to it. Not least the more obvious of fiscal discipline that will lead to greater visibility and stability of macro fundamentals such as interest rates, inflation and the exchange rate, and a credible and transparent accompanying monetary policy.
But there are a number of other 'softer' more intangible requirements as well.
A better streamlined bureaucracy to reduce the cost of the intermediary challenge of 'red tape', greater transparency and accountability to reduce the intermediary cost of corruption, a more rational and simplified tax structure, quicker legal redress, are all equally important.
And lastly, let me state that achieving some of these goals lie in fundamental changes to our constitution. But I won’t delve into that now. That’s something to talk about at the next forum!
Chanaka Wickramasuriya is head of Fitch Ratings in Sri Lanka. This article is based on a speech made at the 5th LBR-LBO Chief Financial Officer Forum in Colombo
