Why a Hutch; when no rabbits inside!

I was interested in anarticle that discussed about an acquisition in the Sri Lankan Telco Industry. The story was interesting to me in several ways. Firstly, I have a small holding of Sri Lanka Telecom PLC (SLTL.N000) shares and hence this is of importance to me as a shareholder. Secondly, the story talks about an acquisition and some valuation numbers for the target company (Hutchison TelecommunicationsLanka (Private) Limited) and thirdly there is underlying politics to all this.

Rotten story

In fact, this acquisition story is not a new thing to the market. It has been floating around for quite some time. This story suggests that Hutch was on the lookout for a sale in Sri Lanka. This article gives more color to the industry’s rumors to the possible consolidations. As per this article it looked like the acquisition of Hutch by SLT was imminent. Likewise, I can give many examples of this nature and the fact is none of these contemplated acquisitions have taken place as of my writing.

Presidential attention

Interestingly, this is not the first time that country’s presidential attention, albeit in different presage, was driven to this story as per the above article. In 2014, the then president also interfered in this matter as this article suggests. Further, this latter story from 2014 points out to the fact that there were disagreements on the value of the acquisition target. At the time, SLT has offered to buy Hutch USD132 million (c. LKR17.1 billion at LKR/USD of 130) whereas Dialog had offered USD78 million (c. LKR10.14 billion) as per the article.

The Telco Industry in Sri Lanka

Well, let’s quickly look at the Sri Lankan Telco Industry. Telco industry in Sri Lanka is regulated by the Telecommunications Regulatory Commission of Sri Lanka (TRC) and there are currently 6 operators offering Landline, Mobile, Data, Enterprise, TV, etc services. See the below table for a brief analysis:

Clearly, these things suggest that the Lankan Telco Industry is now in a saturated situation and I attribute to it an Oligopolistic market structure (well, except that fact that they can’t set prices and earn abnormal profits as a result of regulation). The 3 firm concentration ratio as per my calculations (based on subscriber base) is about 82%. To give it a different flavor I looked at the Herfindahl-Hirschman Index – HHI value for the Lankan Telco Industry and based on my calculations I arrived at an index value of 2,588 which suggests that it is a highly concentrated industry.

Refer below chart from Central Bank of Sri Lanka annual report.

Value vs Price

With that brief discussion I move on to value the target. No, I can’t do it. Why? I don’t have any revenue or cash flow figure to do a valuation model. Hutch is not a listed entity in Sri Lanka and hence no information is publicly available except what I gathered so far. I can only make some approximations by looking at the other players and their performance.

Also based on the available information, I think I should be able to do some sort of pricing of the target. That should be better than nothing, I suppose!

The new deal value is mentioned in that above article as being USD130 – 135 million (c. LKR19.17 billion using LKR/USD 142). Which is equivalent to a Price to Subscriber ratio of c.LKR9,585. More than Dialog’s Price to Subscriber ratio and a 33.75% discount to that of SLT itself.

As with my approximations please look at the above table. Accordingly, based on mobile revenue and mobile subscriber base, I arrive at LKR6,020.49 and LKR6,120.00 of Revenue per Subscriber for Dialog and SLTL respectively. Quite contrast to that, the same figure for Airtel is LKR4,939.09. I think this is explained by Dialog’s and SLTL’s market leading positions, product offerings, etc. If I try to approximate the revenue figure for Airtel using an average of Dialog and SLTL Revenue per Subscriber figure, I arrive at a LKR10.926 billion whereas it’s actual is LKR8.89 billion. Hence, I reject leaders’ ratio as an approximation figure for Hutch and Etisalat. (May be for Etisalat it may be ok to use and average of all three: Dialog, SLTL and Airtel. However, Etisalat is not the focus in this post, hence I don’t bother too much about it). I, therefore, utilize Airtel’s ratio to approximate the sales figure for Hutch and arrive at a LKR9.878 billion as their topline. (I’m sure Hutch must also be operating at a loss like Airtel and Lanka Bell). The proposed payment consideration is at an implied Price to Sales multiple of 1.94x which compares with the same of 1.33x for both Dialog and SLTL. (Actually a premium of 45%). Or to look at it from another angle. Hutch should be at least making LKR14.4 billion or more to justify paying that much to acquire it by SLTL.

Figures in LKR '000s except ratios which are times.

As per the blow chart, as per my approximations (I accept that my approximations may be wrong!) I derive a Price/Sales based price of LKR13.15 billion for Hutch. Similarly, applying the SLTL and Dialog Price/Subscriber ratios I derive a pricing range of LKR28.94 billion to LKR18.86 billion.

Bottomline

Given that it is a horizontal integration strategy, my doubt is why should anyone (especially one of the dominant players already) pay Hutch market leading multiples? In fact, in this case all what SLTL would be acquiring is Hutch’s subscriber base and I don’t see any other synergies to them in this deal. Specially, given that no one is competitively bidding and the only bidder came at very low level, I think they should let Hutch voluntarily exit the market (let them bleed and die and then later lure its subscriber base at a cheaper price, simply) or offer at a cheap price now that would be worthwhile. Or else numbers should speak for themselves.      

TPP, the never seen formula for success

Recently, I came across thistweet by a well-known Professor, who, as usual, tries to argue that the recently signed Trans-Pacific Partnership (TPP) was a once in life time opportunity Sri Lanka missed. It was not the first time he voiced his dissatisfaction over this, as this earlier tweet of him says, with a link to the New York Times article. 

Well the learned Professor must be praising the TPP for its merits to countries like us in the APAC, I thought! Is that true? If yes, what is in it for us? How does it help countries like us? And how are we disadvantaged due to not being a signee to the Pact, as he claims in his tweet?

With these questions in mind, I tried to find anything in the public domain that would help answer these questions. But, it was very difficult to even find a draft of an agreement signed by any nation. But, as the New York Times article which the Professor shared says, “The pact, part of Mr. Obama’s strategy to balance China’s economic ascent, would knit together a largest-of-its-kind trading system in the Pacific”. Further, as the Office of the United States Trade Representative puts it in its website, it is another Made in America product which is aimed at “Leveling the playing field for American workers & American businesses”. As thisarticle by Koichi Hamada highlights “with the TPP, the US is catching a big fish with small bait. But the increased trade and investment flows brought about by the TPP’s ratification and implementation will benefit even the countries that must make larger sacrifices”. So, it is evident from these that this is not a Pact deliberated for the bilateral benefit of signees, rather to largely fulfill unitary requirements of one signee. (also not forgetting the fact that USA is heading to an election and that they need to give the US citizens something if they were to be in power. Further, their efforts to come out of the GFC and the subsequent recession via Fed lead measures have not really worked out and the Europe is also in really bad shape). 

The non-existent Free World

If I go to mainstream media, capital market or listen to any politician, I’m made to understand that we live in a globalized Free World where there are no barriers to trade. (or for years, from the Imperial times, they are boasting of Free Trade). Further, to facilitate such free trade or the free world, they invented apparatus like World Trade Organization, etc. If this is the case, why on earth do we need these other Trade Agreements, which I don’t even know whether override the already existing WTO or other stipulations, to benefit countries? May be this so-called Free World is non-existent and it only exist in documents. Still they are talking about Trade Liberalization and also at the same time some form of protectionism. (I know it is easier said than done!).   

Different views

I think it is worthwhile looking at different views so that we can form some sort of understanding that is not partial or biased. As I mentioned above that this agreement is not something drafted transparently, as the US Senator Bernie Sanders points out in thisarticle. Further, I also think that we should look at merits and demerits of previous Trade Pacts that countries and regions have signed before. Just because it is a very new pact and that the world is in a shaky situation, we should not just opt to this. (I don’t think that it is easy to reverse it once we penned it!). At least, if the Professor points out the great benefits that we derived from any such agreement with other nations (like SL and India Free Trade Agreement, etc), that would be greatly appreciable. I know of this article by economistMartin Feldstein, wherein he argues that trade agreements by Chile with USA have benefitted both.     

Bottomline

As I conclude the post, I have to mention that I do not personally know the Professor nor have I met him. Hence, I do not have anything personal rather than my own reactions to his thoughts. Honestly, I accept some of his thoughts on some other topics like the Appointments to Government positions which appeared in ft.lk as an article, etc. But, on the TPP I have my doubts and it may be true that I’m also one of the Sri Lankans swimming in the Pond called Sri Lanka listening to only our Mass Media such that I’m amazed why countries should go for these types of pacts, as the Professor mentioned in his Ravaya article. I hope that he may also write about the great aspects of the TPP and how it benefits us in an already (non)existent so-called Free World (which is assumed to be facilitated by apparatus like WTO, etc) where there are tariffs to protect their interest, in country, and pacts to protect their interests elsewhere. 

Thought to share this and wrap up. 

Follow the herd! Win or lose?

It’s been a while since I last posted on My Views. I was attracted to a very interesting stock this time, Hayleys Fibre PLC (HEXP). HEXP is a subsidiary of diversified holdings, HayleysPLC. HEXP is an exporter of coir fibre. However, they generate approx. 15% - 20% of its revenue from the local market. They manufacture a variety of products which fall under five main categories, Erosion control, growing media, horticulture, bedding and upholstery and industrial fibre. In terms of revenue Asia (I assume Russia is also categorized under this by the company) and Europe account for about 75% of their export revenue while the balance is split between Japan and USA. (refer below Sale by region graph, Sourced from Company’s latest published Annual Report).

Company going forward

As per the latest annual report, the management intend to focus on the following in order to grow revenue and increase profitability from the business:

• -       More focus on erosion control, specifically to focus and rationalize the product portfolio and consolidate business with more emphasis on value added products (I hope it the most profitable product category and they will stop producing loss making products);
• -       Invest in new technologies (hope they will increase efficiency and also reduce operating costs);
• -       A backward integration project (this should help reduce raw material costs);
• -       Energy saving initiatives; and
• -       Aggressive marketing at the Joint Venture company level.

With this in mind it is good to look at historical performance to get an idea about how they have performed. (refer below for profitability ratios of HEXP). The performance numbers says the story that HEXP is operating in a very competitive market (globally competing) and are a price taker when it comes to sourcing raw materials.

As a result, returns on capital has been shockingly low. (refer the ROIC chart below). 

Recent explosive growth

At the beginning of this month, REXP was at LKR44.90 (6 October 2015) and as of my writing the stock appreciated rapidly to reach LKR88.40 as 97% return in less than a month. (refer the graph below).

As far as I know, there was no any significant news about the company which should trigger this type of appreciation. (as usual, may be market possesses some information which I’m not privy to).

However, I was interested to find out a reason for this. From what I understand, one reason may be the recent drastic depreciation in the Sri Lankan Rupee. Hence, technically, HEXP being an export company become price competitive in the market and their foreign currency earnings are now converted to higher LKR value. To see how this plays, I ran a correlation analysis in to HEXP’s revenue and LKR/USD to see if they are correlated. However, I was surprised to see that they show a negative .0.8240 correlation.

Alternatively, it is merely due to excessive retail participation due to some market rumour and subsequent herd behavior where everyone else jumped in to enjoy the rally.   

HEXP valuation

In order to value the shares of HEXP, I conducted a discounted cash flow valuation, as I usually do. As always, the valuation is based on assumptions made by me and I certainly do not possess expert knowledge as to how this business operate (but I think my assumption here are more generous than in any other case). However, I have used assumptions that I believe are reasonable and I would be glad to change them and see the impact on valuation if you can come up with more robust assumptions.

My cost of capital calculation is based on few parameters like beta of 1.17 (against All Share Index) for the stock which was taken from Colombo Stock Exchange, risk free rate of 9.85% (current 10 year Sri Lanka treasury bond rate in the market), Equity Risk Premium of 8.00% (my subjective judgment as I currently don’t have a scientific method to calculate, I will soon rectify this), pre-tax cost of debt of 9.50% and a tax rate of 15.31%.

On the tax rate I want to specifically mention that the company’s export earnings are only taxed at 12% concessionary rate while other earnings are taxed at normal 28% rate. Hence, I used a weighted average tax rate for cash flow calculations. Equity and debt weights of 79.59% and 20.41% were used respectively. Using these assumptions I derived a cost of capital for the firm of 16.93%.

The other assumptions are as per the below calculations.

Based on all these, I derived an equity value of c. LKR367.67 of which about 88% is coming from non-operating assets. These non-operating assets consist of Investment Property (property in Ekala that is rented), investment in joint venture company (carrying value of 50% ownership in Bonterra Lanka Ltd, which is equivalent to 50% of the net assets value of the entity) and other financial assets (investment in unquoted shares of Toyo Cushion Lanka Pvt Ltd and Rileys Pvt Ltd which are valued by them based on DCF method).

The derived value gives a per share value of LKR45.96 per share of REXP. The market price as of my writing of the share was LKR88.40 which is 92% higher than my valuation.

Bottomline

As I always say, I’m a very bad trader and every time I try to profit from this type of stock rallies, I end up buying in at the peak. So, now I tend not to join the bandwagon. But, if you are good at trading please go ahead and do it. But, if you are not, please be careful as the stock is currently heavily overvalued as per my valuation (you are welcome to argue with me on my valuation). If you are a believer in technicals, then be mindful as it is now in the overbought territory and a similar fashion drop is also all possible. 

Would you buy a Fortress or a Lighthouse!

Thought to do a comparative analysis of two companies as the topic hints. Of course it is a strange question to ask. In fact, I had this question in mind as I was looking to buy one of the Southern Coast based hotel operators. In this regard, my focus was on two companies, i.e., The FortressResorts PLC (RHTL.N0000) and The Lighthouse Hotel PLC (LHL.N0000). Well, going by the analysis that follows, I’d rather opt to buy the Fortress instead of the Lighthouse.

The two hotels

The Fortress is a luxurious hotel located in Koggala and the Lighthouse is located near Galle. In terms of the offering, the Fortress serves a high-end clientele while Lighthouse serves a different segment that is more price conscious. The below comparison of room rates from Tripadvisor (accessed on 2 June 2015) suggests the difference. (On the left side are the quotes for the Lighthouse and on the right side are the Fortress quotes, higher than the Lighthouse as you can see)

The Fortress operates with 53 rooms and the Lighthouse with 86 currently. In my opinion, I don’t expect that the Fortress will increase its key capacity any time sooner (but there may be a requirement for a major renovation in the near future as they have not done it for some time now) although the Lighthouse keeps adding keys slowly (with added properties like Kurulubedda and extensions to the existing main property). Close to a 50% of revenue of the Lighthouse came from Western European market and the Fortress’s revenues are also skewed towards European market. Both, players are now focusing on diversifying in to other emerging market segments like China, USA, Middle East, etc. As per the Fortress FYE2014 Annual Report “Compared to its major competitors in the area the Fortress is maintaining a higher market share in terms of boutique hotels category. In total there are approximately 43,665 room nights available in the area, concentrated amongst three main competitors, of which the Fortress accounted for approximately 13,974 room nights during the year. This secures an approximate 31% of the area market share, based on available room nights”.

Revenue wise, both companies managed to achieve 19% CAGR over the last five years.(the below table shows the revenue patterns of the both Hotels).

Premium offering with premium margins

As mentioned, the Fortress focuses on tapping the high-end clientele who are willing to pay a premium price for a premium offering. It is believed that as a model they have rightly chosen to address a gap in the market with this offering in down south. I believe that the profitability analysis given below evidently shows that. In terms of most of the margins (except the GP margin) the Fortress lead the game with some healthy margins in comparison to the Lighthouse. Even with some significant tax effect, the Fortress’s NP margins are very attractive.

Moreover, the Fortress is ahead of the game in terms of operating cash flow generation. If you look at the Operating Cash Flow to Sales ratio, the Fortress has been able to achieve a very high level of OCF to Sales compared to the Lighthouse. 

Higher administration costs at the Lighthouse have caused this, I believe. Sometimes, there may be management fees paid to the Jetwing Group which is the ultimate holding company of the Lighthouse (however, they have not disclosed anything in to this effect in their Annual Reports).

Shifting debt metrics

The gearing levels of the two entities have moved in opposite directions. Accordingly, the net debt position of the Fortress has gone from positive to negative and their balance sheet is nearing zero debt levels, hence they have enough financial flexibility to go for a debt funded renovation once the decision is made. (in fact I assume that they will go for a complete renovation in FY2017.) Also there is enough evidence to believe that there may be a dividend announcement from the Fortress but subject to how they finance a potential renovation) However, the Lighthouse’s debt free situation has taken a u-turn and net debt is currently at c. LKR137.3 million.

Distinct returns

The two companies show significant differences in Return on Invested Capital (ROIC) as seen in the chart below. 

Over the last five years, the Fortress recorded average ROIC of 14.77% while the Lighthouse only managed to average 4.40% over the corresponding period.

Pricing analytics, can they be justified!

With all the above performance indicators in mind, I’m going to have a look at the pricing of the two hotels in the Colombo Stock Exchange. As of my writing, the LHL and RHTL closing prices were LKR63.50 and LKR17.60 respectively. On trailing 2015 numbers and at those current prices, LHL and RHTL are trading at PER of 22.57x and 10.28x respectively. Similarly on a book value basis LHL is trading at 1.18x PBV and RHTL is at 1.39x PBV. Currently, the Hotel  and Travel Sector trades at PER of 53.2x and PBV of 3.6x, well this is a very broader measure and includes some of the best managed properties to worst managed properties, startups and mature companies, etc and hence the multiples are not without noises. Similarly, for the historical patterns have a look at the below chart.

On what basis can anyone justify the lower Price to OCF paid for the Fortress. (either the Fortress is fairly priced and the Lighthouse is overpriced or vice versa).

Also on a per room basis, RHTL’s revenue per room has always been above that of LHL. More interestingly, the per room EBITDA generation by RHTL is pretty impressive compared to LHL. At current market prices, LHL is priced at c. LKR34.4 million per key whereas RHTL is priced at c. LKR36.8 million. The question is; why are the both properties priced at almost similar level when their earnings are significantly different.

I also looked at enterprise value multiples (just to make sure that I’m not missing something important!). At the prevailing market price of LKR17.60, RHTL is priced at EV/EBITDA of 4.82x and LHL at 13.51x.

Valuation

At the next level, I tried my favorite method. Hence, on both stock I ran DCF’s to see what the numbers say. They are reproduced below.

Assuming my cash flows and other input assumptions, I derived an equity valuation of LKR19.89 for LHL. 

I also used a model to value the company assuming it is in mature growth stage and based on that my value per share of LHL is LKR21.28. 

My valuation and the market prices are ludicrously different. May be one can argue that the land itself is valued at c.LKR459 million as per the financials which is about c.LKR9.97 per share. Even if you add this component as a non-operating asset, the valuation would still be way more lower than the current market price. Someone would also argue that the property was a design of Geoffrey Bawa and hence should attract a premium price. However, none of these premium qualities are reflected in the cash flows. From a valuation perspective, I think anything should be echoed in the earnings capabilities and the quality of the company. 

   

Similarly, I calculated share values for RHTL using the same methods as per LHL. The charts below highlights the values.

So, based on an extended DCF subject to my assumption, I value a share of RHTL ar c.LKR17.56 which is about the current market price. 

Based on the other model, I derive a value of c.LKR19.38, slightly higher than the current market price.

Bottomline

From a market pricing perspective, I can’t seem to find any justification as to why RHTL should be trading at a huge discount when it’s achieving some quality earnings. Moreover, the valuations that I have done subject to my own assumptions do not justify such a higher price for LHL. But, as usual I have to caveat my opinions here saying that I might be missing something!

Also I have to mention here that I currently own shares in RHTL. (Well not on the top 20 shareholders list, yet!! May be one day!) 

Everything is politics but ….

Even though I hate to write things about Sri Lankan politics, it has come to a point where I can’t just ignore and stay back. (well, no one can just ignore politics as it affects everyone’s’ day to day life as well as their decisions in life). This reminds me of the book of which the topic was “Everything is politics but politics is noteverything: A theological perspective on faith and politics” from which I actually borrowed part of my topic today. But, don’t worry that I’m not going to write good things about any political party or anything bad about another party. (that is done big time currently in all types of media!). But, if anything that I write here looks as if I’m partial please bear with me. (Because I know that in Sri Lanka if you say something political, there is a culture that you will be labeled. You will agree with me, don’t you!).

Anyway, I just wanted to shed some light on some of the news that comes up in a very urgent fashion in the run up to the elections. As an investor and a blogger who cares about the markets and the equity valuations, I do need to look at those news from that angle. How does these news affect the markets and in turn me. After all, businesses and investors do conduct this analysis called “PEST Analysis” of which the letter “P” stands for political analysis.

Media behavior

An important aspect of these news items is that they have found their way in to the mainstream media and it seems like that they have not done any sanity check on these items. That makes me be skeptical about the accuracy, relevance and importance of these items. But what can I do there are inherent problems in the way the media is handled as this book by Robert W.McChesney argues. (I think these arguments are more or less valid in Sri Lankan context as well).

One recent news item that was very interesting was about introducing Google Loon in Sri Lanka. In fact, one of the Sinhala medium websites mentioned it as the first time something like this was ever done in the world and the witty fact was that they did not seem to have logged on to Google Loon’s website to simply check the truth. On the other hand some web sites depicted it as free wifi internet connections for everyone in Sri Lanka. (if that was the case it will be really good and I also hope and pray that it would happen one day). This was shared on social media by many and none of them seem to have given a thought to some questions like:

• why Sri Lanka at this particular time (when there is an election forthcoming);

• if this is free, why would Google want to do this (they are a for-profit listed company in the USA);

• if not for free who is going to bear the costs (as a balloon is said to have a 100 day life span and then need replacement, i.e., three times a year);

• some articles say that it will be in collaboration with local internet providers (if that is the case it would not be free or may be the government will have to subsidize in order for it to be affordable to poor. In that case, government subsidies will have to be borne by someone, tax payers or everyone);

• if this was available free what will happen to listed companies like Dialog, SLT (if you are investors in these companies) and other commercial operators like Airtel, Etisalat and Hutch;

• Google Loon is still in test stage and why wasn’t it rolled over in most of the poorer nations.

I believe, like anything else there are pros and cons to anything so try to think of any sectors in the market that will be benefitted directly out of this, if this happens. Also note that there will be a lot of ground work to be done in order for the benefits to spill over to the corporate sector. For instance, the English knowledge of the rural populations are very low hence even if they had affordable internet connections most of them would possibly not use these services. For instance, Banking, Finance and Insurance sector can significantly reduce costs if they resort to online solutions. A study conducted by one of the friends found that the usage of online banking services even in Colombo is very low. (I can put you in touch with her if you wanted to!). I also believe most companies will be able to reduce their marketing spend if they use more online services.  

In other instances, it was mentioned that the Board of Investment of Sri Lanka signed agreements to revive a Sugar factory and to build the tallest tower in the country. The sugar factory investment is a USD110 million project, supposedly. But, the names appearing on the article do not seem to even have a proper website for those companies (I know that you can set up a company in Singapore in like hours!). I believe an investor who is bringing in USD110 million to the country should be a reputed company with a track record. Besides, from my encounters with the investor community I do not believe that any investor would look at investing in a country when there is political uncertainty and especially an election at the door. Will this be history after the election! Wouldn’t they conduct a PEST analysis before entering! Or they must be having some deep pockets to take this level of risk.

Sri Lanka currently consumes about 572,300 MT of sugar per year. Of this about 91% is imported with an approximate cost of USD255 million. This is c. LKR64,142.28 per MT. If the Kantale Factory was opened and start producing the quantum of 72,000 MT per year as the BOI mentioned, we should be able to reduce imports by about 13% and increase the local production to c.22% of the market demand. Also thereby save c.USD32 million in forex. What remains in dark still, is the fact whether we will be able to achieve a lower retail price per Kilo of sugar if we increased production locally as compared to imports. Also will this be another political thing as it has always been. (because consecutive governments have promised this as per this article). Further, the Central Bank of Sri Lanka Annual Report 2014 mentions (page no.38) that “while the Kantale factory, which was not in operation in 2014, continued with sugar cane cultivation with an intention to recommence operations in the near future”. (so what was the arrangement there!). I hope something good for the country and economy will happen, at least this time.  

The other company (the real estate one) has one of the candidates in the election as the chairman so I have lots of doubt there as well. (politicians are politicians!). Weren’t we against this type of involvement by politicians!

Another news item read that Volkswagen was considering setting up a plant in Sri Lanka.  The interesting thing was no official from the company itself was involved in any of these discussions and the company is 50.73% owned by Prosche not the Government of Germany. (Only about 20% voting rights are with a State). Refer their Annual Report in page 92. So, I was wondering how the government officials can sign agreements on behalf of a company which is owned by someone else. As far as I know the company has not confirmed this venture. For me, I need more concrete evidence to believe that this deal is done. As the Chrysler CEO puts it, the Auto industry is struggling with some fundamental issues, have a look at this preso.    

Similar items appeared on oil exploration in Sri Lanka’s east coast by French company Total, re-entry by Shell in the LPG market. Shell’s exit was explained in this by the Company.  

   

Bottomline

Don’t fuel a culture of blindly following news, especially the ones published with a view to gain political advantage. Just double check the accuracy and always try to evaluate the importance of these to the economy and thereby our decisions. (on the investments if you are an investor, cost of living and the real earnings for a person in the general public, etc). Because everything is politics…. I think thereby we can also work toward disciplining politicians and making them more accountable to what they do and say. (Broadly, in nurturing a conducive political culture and media  that is responsible).

Borrowed reserves: Politics or Economics?

This post was necessitated by two things. Firstly, the recent Currency Swap Agreements between the Central Bank of Sri Lanka (CBSL) and the Reserve Bank of India (RBI). Secondly, the recent upheavals in the political environment and the lack of clarity on how such swaps help the economy plus the mechanics. In fact, it is my understanding that the current political developments pushed the existing government to show that their economic management is better than the previous regime and hence there is no pressure on the LKR or the reserve position (as the opposition alleged).  

Some background

Central Bank currency/liquidityswaps are not new to the financial world. They are mostly used during crises. As per this Zerohedge article, China has become a prominent player in the currency swap market since of late.

In the South Asian region, India was utilizing the Swap arrangements with Bank of Japan (BoJ). Further, in May 2012 at the SAARCFINANCE governors’ meeting it was announced that RBI has offered a swap arrangement of up to USD2 billion both in foreign currency (USD and EUR) and Indian Rupees (INR) with a view to strengthening regional financial and economic cooperation. This facility is intended to be used to meet any balance of payments and liquidity crises till longer term arrangements are made or if there is need for short-term liquidity due to market turbulence. The very first swap under this agreement was signed in March 2013 between the RoyalMonetary Authority of Bhutan and RBI for a value of USD100 million.

Mechanics of the RBI arrangement

Under this agreement, RBI will offer USD, EURO or INR against the requesting country’s domestic currency or domestic currency denominated government securities. India is contributing USD 2 billion towards this. Any country (specified SAARC countries only) can draw subject to a minimum of USD 100 million and a maximum of USD400 million. Drawals can be made in multiple tranches. Each such drawal will be of 3 month tenor (with possibility to extend on maturity with the second rollover at a higher interest rate, i.e., 50 bps more than the normal rate). The normal interest here is 3m LIBOR+200 bps or RBI Repo Rate-200 bps on INR drawal. (Currently RBI Repo Rate is at 7.25%). From this it is obvious that this is no different to borrowing offshore. Only difference is that you don’t call it a borrowing rather a currency swap (which is difficult to understand!)    

   

CBSL’s signing of the bilateral swap agreements with RBI

In March this year, CBSL signed the Currency Swap Agreement with the RBI and the agreement is valid for a period of three years. (Expires on March 2018). Within this period, CBSL can draw up to USD400 million (or equivalent) in multiple tranches. (under above mentioned terms, of course) This I believe is an indication that there is a balance of payment or liquidity crises. (or is expected). This belief is further reinforced as the CBSL signed a Special Currency Swap Agreement in July 2015 for a value of up to USD1.1 billion for a period of 6 months. This special facility proposal of USD1.1 billion was approved by the Union Government of India. (So we can’t say it is not political). Plus during that period, the government of Sri Lanka was on the verge of announcing a general election. Hence, the ruling government would not want to let a currency related matter to disadvantage them in the forthcoming elections. (I assume and this is again politics!) I believe that they can show a higher reserve amount (taking in to account the drawing rights) and show that they were not borrowing (at least to the general person, as they were vehement against foreign borrowing by the previous regime) as the name hides the fact this itself is borrowed reserves.

As far as information is concerned, CBSL has not done any drawals so far. (My understanding). If CBSL did not make a drawing, it won’t affect unless there is some fees involved on undrawn amounts. (There is no such fees). 

  

Bottomline

Currency Swaps are good instruments to deal with short term currency crises and hence it is perfectly normal to tap that source. However, it is not a long term mechanism to cover up bad policy. Hence, these measures should be followed by more permanent long-term measures to deal with reserve management of the country. Or else the country will be deep in a vicious cycle.  

End of the day politics and economics go hand in hand.