economic capsule february 2012

< Research & Development Unit >

ECONOMIC CAPSULEFebruary 2012

C o n t e n t s

COMMERCIAL BANK NEWS Group Results for the 12 Months ended 31.12.2011

Commercial Bank Launches Web Services for Instant Remittance Solutions with ‘Xpress Money’

Commercial Bank Debenture Issue

Analysis & Forecast Exchange Rate


S&P Revise Sri Lanka’s Outlook

Tourist Arrivals up by 27% in February

Fuel & Electricity Price Hike

ECONOMIC NEWS

COMMERCIAL BANK NEWS

Commercial Bank of Ceylon PLC - Group Results for the 12 Months ended 31.12.2011

< Research & Development Unit > Cont…

− Loan Book by: Rs 59.6 bn.

− Deposits by: Rs 58.6 bn.

− Revenue: Rs 45.4 bn.

− Assets: Rs 441 bn.

− Total dividend of Rs 6 per share

Commercial Bank Breaks Rs. 10 bn Barrier in Profit Before Corporate Tax

The Commercial Bank of Ceylon PLC has achieved outstanding growth in 2011.

For the 12 months ending 31st December 2011, Commercial Bank exceeded Rs. 10 bn in Profit Before Corporate Tax reaching a new milestone by growing PBT by 17.9% to Rs. 10.987 bn in the review period.

Profit After Tax grew by a robust 45.7% to reach Rs. 8 bn (Rs 8.047 bn) from Rs. 5.523 bn for the previous year.

Commercial Bank - Group Results for the 12 Months ended 31.12.2011 (Cont…)


Commercial Bank News


CBC launched a new web service in association with ‘Xpress Money’ to offer a faster and more efficient process of receiving remittances from overseas.

Commercial Bank has integrated its systems with those of ‘Xpress Money’ - a global money transfer brand - to introduce a new dimension in speed, reliability and convenience to recipients of remittances in Sri Lanka.

Remittances made via ‘Xpress Money’ can now be received instantly by beneficiaries, without incurring deductions of commissions or charges.

Commercial Bank will open its Rs. 1 bn debenture issue on 27 March, 2012. CBC will offer 500,000 unsecured, subordinated, redeemable debentures of Rs. 1,000 each with the option to issue another 500,000 if the issue is oversubscribed.

The Colombo Stock Exchange has approved an application for the listing of the debenture on the main board.

Interest Rate for the above debenture is 12.75% per annum, while Fitch Ratings Lanka Ltd., has affirmed the national long-term Rating of AA- (lka) for the subordinated debt issue.

Commercial Bank Launches Web Services for Instant Remittance Solutions with ‘Xpress Money’

Commercial Bank Debenture Issue

CBC Service Point Openings Marawila 214

ECONOMIC NEWS


Source: CBSL e-estimate, f-forecast

Economic News

Standard & Poor's (S&P) Ratings Services revised its outlook on the long-term foreign currency sovereign credit rating on Sri Lanka to stable from positive. At the same time, S&P affirmed its 'B+' foreign currency sovereign credit ratings on Sri Lanka.

▬ Reasons for the outlook revision: the ratings are constrained by weak external liquidity, moderately high and increasing external debt, fundamental fiscal weaknesses, the attendant high public debt and interest burden, and political institutions that, in some cases, lack transparency and independence.

▬ S&P may raise the rating if there is evidence of: progress in addressing the external weaknesses and domestic problems, such as fiscal or structural economic reforms that reduce the vulnerabilities from high debt and interest burdens and the still-narrow economic profile.

▬ Conversely, S&P may lower the rating if: there is substantial further deterioration of the country's external liquidity, or if Sri Lanka's growth and revenue prospects fall below S&P’s current expectations.

S&P Revise Sri Lanka’s Outlook

CBSL projections now indicate that Sri Lanka's GDP is likely to record a growth of 7.2% in 2012, compared to the earlier projection of 8%, made in CBSL’s monetary policy statement.

Sri Lanka 2012 Economic Growth Revised Downward to 7.2%

Slower credit growth, higher energy prices and lower imports are expected to reduce economic activity this year.

GDP Growth (%)

The views expressed in Economic Capsule are not necessarily those of the Management of Commercial Bank of Ceylon PLC

Tourist Arrivals up by 27% in February

Sri Lanka’s tourist arrivals rose by 27% to 83,549 in February, 2012 compared to the corresponding month in 2011, continuing the growth momentum established in 2010.

Data released by the Sri Lanka Tourism Development Authority indicate arrivals topping 169,423 during the first two months of 2012, a 21% increase compared to the corresponding period in 2011.

The largest arrivals from a single country came from neighbouring India, which recorded an arrival figure of 11,342 in February, 2012, a 12.6% increase from February 2011.

Source: CBSL/ Sri Lanka Tourism Development Authority

According to United Nations World Tourism Organization (UNWTO) predictions, by end 2012 more than one billion people, almost 14% of the world population, is expected to cross international borders as tourists.

In 2011, more than 980 mn tourist arrivals were recorded across the world and 12 mn of them came to the South Asian region, contributing to 6% of the region’s GDP.

UNWTO predicts that South Asia will attract 18.8 million tourists by 2020, of which Sri Lanka will get a share of 03 million.

< Research & Development Unit > The views expressed in Economic Capsule are not necessarily those of the Management of Commercial Bank of Ceylon PLC


Economic News

Fuel & Electricity Price Hike

Fuel (w.e.f. - 12.02.2012) Previous Price Rs./Ltr. Present Price Rs./Ltr.

Petrol—90 137.00 149.00

Petrol—95 155.00 167.00

Diesel—LAD 84.00 115.00

Diesel—Super 106.30 142.00

Kerosene—Domestic 71.00 106.00

Kerosene—industrial 76.00 111.00

Electricity (w.e.f. - 16.02.2012) Fuel Adjustment Charge %Domestic—0-30 (units/month) 25%

Domestic—31-60 (units/month) 35%

Domestic—above 60 (units/month) 40%

Industrial & Hotel 15%

General Purpose & Gov. 25%

ANALYSIS & FORECAST

Exchange Rate


A combination of an overvalued exchange rate (the Real Effective Exchange Rate overvalued by 25% in 2011) which makes imports cheaper and a low interest rate regime which led to a sharp rise in credit, which in turn, fuelled demand for imports, led to an unsustainable increase in the trade deficit.

The deterioration in the trade and current account balances was not compensated for adequately by the increase in remittances, tourism earnings and FDI.

Further, access to borrowed and non-borrowed capital flows have also become more constrained due to increased risk aversion in global markets.

These factors exerted pressure on the Rupee to depreciate and the Central Bank of Sri Lanka (CBSL) tried to prop up the rupee by selling foreign exchange in the market. The outcomes have been:

1) A loss of a quarter of the country’s gross official reserves (reserves declined from around USD 8.2 bn in August, 2011 to USD 5.9 bn by the end of 2011); and

2) The Government’s obligations in relation to Eurobonds, foreign holdings of Treasury Bills and the IMF stand-by loan now exceeding its reserves.

These trends have resulted in a liquidity crunch that has resulted in the Government:

1) Seeking to borrow abroad to meet the oil bills; and

2) Encouraging commercial banks to raise tier-two capital through foreign borrowing.

Reserves Under Pressure

Cont…The views expressed in Economic Capsule are not necessarily those of the Management of Commercial Bank of Ceylon PLC

Recent Policy MeasuresThe recent policy measures introduced by the Treasury and CBSL have hopefully prevented an external payments crisis. These policy measures are summarized below


Further, the losses of some state-owned enterprises, particularly those of the Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB), accumulated due to the non-passing through, until very recently, of the increase in international oil prices and also due to other operational inefficiencies.

It remains to be seen how much more has to be done by way of exchange rate depreciation, interest rate increases, and fiscal measures.

Cont…

Measures taken by the Treasury/CBSL Expected Implications

The CBSL increased the policy interest rates by 50 basis points with effect from 3rd February 2012.

The increase in borrowing cost would restrain credit growth leading to a reduction of demand for imports.

The CBSL direction to commercial banks to limit their credit expansion in 2012 to 18 % [23 % if additional funds above 18% growth could be raised from abroad] of the outstanding credit balance at the end of 2011.

To reduce the quantity of credit granted by commercial banks.

The CBSL decided to limit its intervention in the forex market with effect from 10th February 2012.

The CBSL has decided to limit the supply of foreign exchange to the extent needed to settle the bulk of petroleum import bills, and to absorb surplus forex liquidity that would flow into the market from various sources thereby allowing a more market determined exchange rate.

The CPC Increased the domestic prices of petroleum products with effect from 12th February 2012.

To encourage energy conservation and help reduce the use of petroleum products, thereby aiding to keep import expenditure under control.

The CBSL imposed a 90 day cap on forward foreign exchange deals with effect from 01st March,2012

To reduce the volatility in the forex market.

The CBSL direction to reduce overnight foreign exchange positions held by commercial banks for trading to 1/3 of such amounts held by each bank on 01.03.2012.

To reduce the volatility in the forex market.

Exchange Rate (Cont…)



The impact of the correction began to be felt with the CBSL deciding to limit its intervention in the forex market with effect from 10 February 2012 and resultant rapid depreciation of the LKR vis-à-vis the USD thereafter.

Bus fares have increased and the prices of bakery products including bread have also increased. Other such price increases could unfold in the near future.

However, the medium-term prospects of the country remain favourable, provided there are no policy reversals, effective action is taken to stabilize the economy and structural reforms are introduced to increase the competitiveness of the economy, particularly in relation to exports.

Impact and Implications The exchange rate depreciation will have a negative impact on

investment, growth and employment in the short-term mainly due to a, initial decline in output as a result of a reduction in economic activity due to a rise in the rupee costs of imports.



The exchange rate depreciation will have a negative impact on investment, growth and employment in the short-term mainly due to a, initial decline in output as a result of a reduction in economic activity due to a rise in the rupee costs of imports.

Sri Lanka will not be able to sustain a higher growth trajectory, without fundamentally altering the anti-export bias it has usually had in its policy-mix over several decades. With the increase of policy interest rates by 50 basis points, market related interest rates i.e. T-bill yields, deposit rates, and lending rates have all increased much more than the increase in the policy rates.

The higher interest rates will increase the cost of funds and will thereby dampen growth and employment in the short term through its impact on investment.

Oil price increases will also apply downward pressure on growth through an increase in the cost of production. However, the increase in the price of fuel and electricity will reduce the losses of CEB and CPC thereby helping to reduce the pressure on the government budget deficit and the balance sheets of state banks i.e. BOC and PB.

According to finance ministry data, the CPC had incurred a loss of Rs. 90 bn in 2011 and if the fuel prices had not been increased, the loss by the end of 2012 could exceed Rs. 200 bn.




In 2011 around 82% of the increase in imports was driven by imports of intermediate and investment-related goods compared to 71 % in 2010. The demand for these goods are largely inelastic in nature. Therefore, the importation of those items is not expected to reduce much as a result of the depreciation in LKR. However, the importation of consumer items is likely to experience a greater reduction due to the increase of LKR price of those items and resultant decrease in demand for those items.

In due course, a more competitive exchange rate will provide a boost to export growth, provided macroeconomic stabilization is achieved and a conducive investment climate is maintained.

The higher finance costs and the rise in import prices will exert considerable pressure on the operations of some businesses. Therefore, the private sector will have to meet the short-term challenges through efficiency/productivity improvements and position itself to take advantage of the more propitious medium-term prospects.

The increase in the Rupee value of remittances, as a result of the depreciation of the LKR, will serve to boost the domestic demand generated by the beneficiaries of such remittances.

The 90 day cap on forward foreign exchange deals and the CBSL’s direction to reduce overnight foreign exchange positions held by commercial banks for trading to 1/3 of such amounts held by each bank on 01.03.2012, will help to settle the market in the short term. However, the exporters may not want to convert their USD to LKR and this could cause a shortage of dollars. The foreign exchange market could also be volatile since everyone will be focusing on the short term as a result of the cap.






THE WAY FORWARD

The aggregate demand in the economy has to be necessarily reduced; this means that policies have to be introduced to ensure the country lives within its means.The increase in prices will inevitably lead to wage and income pressures. However, any wage/income increases should not undermine the intended gains from the corrective measures taken, thereby derailing the overall stabilization programme.The country should strive to have a healthy trade/current account balance to attract more foreign investments, since investors mostly prefer to invest in countries which have lower current account deficits due to resultant lesser fluctuation in exchange rates of such countries.The country should also focus on reducing the budget deficit to sustainable levels to reduce the pressure on interest rates. The Budget deficit for 2011 is likely to record around 7.8 %.Since the price of oil has become a major issue both in relation to the trade deficit and the budget deficit, the manufacturing sectors should focus more on energy efficient production processes with a view to reducing fuel consumption (thereby reducing the cost of production).

Sources:−Commendable Start: Now for the Finish, Pathfinder (This is the 25th in the series of Economic Alert articles published by the Pathfinder Foundation.)

−Way out to fix the sick external sector: Getting back to IMF’s fold a must now, Island (5th March 2012)

−CBSL Press Releases

−The seminar organized by the Exporters Association of Sri Lanka on “Flexible Exchange Rate: Capitalizing on Opportunities and Managing Challenges”, 28 February, 2012

−www.treasury.gov.lk



The information contained in this presentation has been drawn from sources that we believe to be reliable. However, while we have taken reasonable care to maintain accuracy/completeness of the information, it should be noted that Commercial Bank of Ceylon PLC and/or its employees should not be held responsible, for providing the information or for losses or damages, financial or otherwise, suffered in consequence of using such information for whatever purpose.

Research & Development Unit

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economic capsule february 2012

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