combank_economic_capsule_july

Economic Capsule July 2011

C o n t e n t s

Financial Sector N e w s Commercial Bank Posts Rs 4 bn 1H Net Profit

Commercial Bank, ‘Best Bank in Sri Lanka’ – Euromoney

Commercial Bank No 02 in LMD’s ‘Most Respected 2011’

Commercial Bank’s Bangladesh Operations Upgraded to AAA by CRISL

Service Points Openings

Economic & Business N e w s Fitch Upgrades Sri Lanka’s Rating to 'BB-‘

Sri Lanka’s Credit Outlook Raised by Moody's & S&P to 'Positive'

Sri Lankan USD 1 Bn Bond Issue Oversubscribed

US Credit Rating Downgraded by S&P

The Emerging World Begins to Seize the Lion's Share of Global Markets

Provincial Gross Domestic Product - 2010

First Half Tourism Revenues up 50 %

ADB: Inflation Threatens East Asian Growth

Analysis & Forecast

Research & Development Unit

Financial Sector N e w s


Commercial Bank Posts Rs 4 bn 1H Net Profit

The Bank reported profit before tax and financial VAT of Rs. 6.528 bn for the half year ending 30 June 2011, a growth of 24% over the first half of 2010.

The bank’s profit before tax (after financial VAT) was up 42.9% to Rs. 5.75 bn over the first half of 2010, with the financial VAT component shrinking by Rs. 458.7 mn to Rs. 778.7 mn consequent to the reduction of the rate from 20% in 2010 to 12% in 2011.

Profit after tax grew by a remarkable 74.4% to cross Rs. 4 bn for the first time in a six-month period, as both the loan book and business volumes witnessed strong growth and the bank benefitted from a reduction in the effective tax rate.

The Total Loans and Advances portfolio of the bank increased by Rs. 15.8 bn in the half year reviewed, from Rs. 228.4 bn as at 31 December 2010 to Rs. 244.1 bn at the end of the first half of 2011. The increase over the 12-month period from end June 2010 to end June 2011 was Rs. 57.5 bn, reflecting an impressive growth of 30.8% YoY.

Total Deposits grew by Rs. 28.1 bn or 10.8% over the six months to Rs. 287.8 bn as at 30 June 2011. This figure represents a commendable growth of Rs. 45.5 billion or 18.7% YoY since 30 June 2010.


Commercial Bank, ‘Best Bank in Sri Lanka’ - Euromoney

Commercial Bank was adjudged ‘Best Bank in Sri Lanka’ by the world’s leading financial markets magazine Euromoney.

Adding another award to the list of global awards won during the past few months by Commercial Bank, Euromoney has recognised the Bank for its strong strategy of attracting and serving customers, its innovative product development, asset growth and strategic relationships.

As Euromoney’s choice for Best Bank in Sri Lanka, Commercial Bank is ranked alongside other renowned global banks. The awards ceremony took place in Hong Kong in July 2011.

Commercial Bank is the most internationally lauded financial institution in the country. In 2011, the Bank was adjudged ‘Best Bank in Sri Lanka’ for the 13th consecutive year by ‘Global Finance’ magazine and was also adjudged the ‘Best Sri Lankan Trade Bank’ by the ‘Trade Finance’ magazine for the second time.


Commercial Bank No 02 in LMD’s ‘Most Respected 2011’

Commercial Bank has been ranked at No 2 in the LMD's ‘Most Respected 2011’ list amongst all corporates in Sri Lanka. The bank was also ranked top amongst all financial institutions.

‘Most Respected’ survey for LMD covered a sample of 800 businesspeople attached to organisations operating within the limits of Greater Colombo, as was the case last year. A random sample was drawn from and weighted on the basis of population proportions of organisations, so as to best represent the mix of entities operating in Sri Lanka.


Commercial Bank’s Bangladesh Operations Upgraded to AAA by CRISL

The Bangladesh operations of Commercial Bank PLC have been upgraded to AAA (triple A) for long-term credit and reaffirmed as ST-1 for short- term credit by Credit Rating Information and Services Ltd (CRISL).

This upgrade follows the AA + ratings received by the Bank’s Bangladesh operations for the past three consecutive years from CRISL.

Banks in the triple A category are adjudged to be of best quality, offer highest safety and have highest credit quality. Risk factors are negligible and risk free, nearest to risk-free Government bonds and securities. Changing economic circumstances are unlikely to have any serious impact on this category of banks.

The ratings are based on financial performance of Commercial Bank up to December 31, 2010 and other qualitative and quantitative information relevant to the date of rating, June 28, 2011. This includes the bank’s continuous maintenance of strong fundamentals in the area of capital adequacy, asset quality, financial and operating efficiency and risk management.

CRISL has stated that it has viewed the bank with ‘Stable Outlook,’ believes that bank will be able to maintain its strong fundamentals in future, and does not foresee any volatility in the operation of the bank within the validity period of rating.


Service Points Openings

199 Kuruwita

Kataragama Opening

Economic & Business N e w s

Fitch Upgrades Sri Lanka’s Rating to 'BB-‘Sri Lanka’s Credit Outlook Raised by Moody's & S&P to 'Positive'

Fitch & S&P GradingAAA+AAAAAA-AA+ AAAA-A+ AA-BBB+ BBBBBB-BB+ BBBB- (Fitch)B+ (S&P)BB-CCC+ CCCCCC-CC+CCCC-C+ CC-D+D

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Moody’s GradingAaa1Aaa2 Aaa3Aa1Aa2 Aa3 A1A2 A3 Baa1 Baa2 Baa3Ba1Ba2 Ba3B1B2 B3Caa1 Caa2 Caa3Ca1Ca2 Ca3C1C2 C3

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Fitch rating: 3 levels below the investment gradeS&P & Moody’s rating: 4 levels below the investment grade

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


Reasons for the upgrade Facts that would affect the rating

Stabilization and recovery of the economy under the

country's IMF programme

Increased efforts to address the chronic budget deficit position

– Fitch views the authorities' ability to continue consolidating the budget deficit, by both enhancing the tax revenue base and rationalising expenditures, and in tandem lowering the level of public debt as supportive for Sri Lanka's ratings.

– A sustained period of strong economic growth, particularly if accompanied by an improvement in the investment climate and private sector capital spending, would also be supportive for the ratings.

– In contrast, continued double-digit inflation or deterioration in political stability would put downward pressure on Sri Lanka's ratings.

Improving external liquidity

Progress in addressing structural fiscal weaknesses

The government's effort to keep inflation near that of trading partners

– The ratings are likely to stabilize, or S&P may lower them, if there is a substantial deviation from the IMF program, or if Sri Lanka's growth and revenue prospects begin to end.

An increasingly evident peace dividend reflected in greater macroeconomic and financial stability;

A policy orientation of fiscal reform and economic growth, supported by a successful IMF program;

An improving external payments position; and

A reduction in political event risk following the end of the civil war in 2009.

– Continued deficit reduction as targeted by the government coupled with the containment of inflation amidst sustained high rates of growth would be credit positive developments over the 12-18 month rating horizon.

– Such developments would lead to a steady reduction in the government's debt burden and would enlarge the government's fiscal space to cope with future contingencies or shocks.

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


Sri Lankan USD 1 Bn Bond Issue Oversubscribed

Year Amount(USD mn) Period Interest

Rate Oversubscribed by

More Than

Distribution

USA Europe Asia

2007 500 5 years 8.25 % 3 times 40.0 % 30.0 % 30.0 %

2009 500 5 years 7.40 % 13 times 45.0 % 31.0 % 24.0 %

2010 1,000 10 years 6.25 % 6 times 52.5 % 25.0 % 22.5 %

2011 1,000 10 years 6.25 % 7.5 times 43.0 % 30.0 % 27.0 %

Sri Lanka’s international sovereign bond for USD 1 billion at an interest rate of 6.25% was oversubscribed by more than 7.5 times.



US Credit Rating Downgraded by S&P

The United States lost its top notch AAA credit rating from Standard & Poor‘s, in a dramatic reversal of fortune for the world's largest economy.

S&P cut the long-term U.S. credit rating by one notch to AA + on concerns about growing budget deficits.

U.S. Treasuries, once undisputedly seen as the safest investment in the world, are now rated lower than bonds issued by countries such as the UK, Germany, France or Canada.

According to S&P “the downgrade reflects the opinion that the fiscal consolidation plan that congress and the administration recently agreed to falls short of what would be necessary to stabilize the government's medium-term debt dynamics".

The move reflects the deterioration in the global economic standing of the United States, which has had a AAA credit rating from S&P since 1941, and it could have implications for the U.S. dollar's reserve currency status.

The outlook on the new U.S. credit rating is negative, a sign that another downgrade is possible in the next 12 to 18 months.

Source: Reuters

AAA

AA +



The Emerging World Begins to Seize the Lion's Share of Global Markets

REAL GDP in most rich economies is

still below its level at the end of 2007.

In contrast, emerging economies’

output has jumped by almost 20%

over the same period. The rich

world’s woes have clearly hastened

the shift in global economic power

towards the emerging markets. But

exactly how big are emerging

economies compared with the old

developed world? This chart looks at

a wide range of indicators: Cont…Source: www.economist.com



The Emerging World Begins to Seize the Lion's Share of Global Markets (cont…)

The chart below shows more detail of how the economic clout of emerging economies has risen over time:

Source: www.economist.com The views expressed in Economic Capsule are not necessarily those of the Management of Commercial Bank of Ceylon PLC


Provincial Gross Domestic Product - 2010

The Western province, made the highest contribution of Rs. 2,525 Bn to GDP in 2010.

However its share in GDP reduced to 45.1 % from 45.8 % in 2009.

Reflecting the rapid expansion in income generating activities in the Northern province, GDP growth rate was highest in the province at 22.9 %.



First Half Tourism Revenue up 50 %

381,538 36.9%

USD 370.1 Mn 50.9%

Jan – June Arrivals

Jan – June Earnings

Sri Lanka's tourism industry has earned USD 370.1 mn in the first half of 2011, up 50.9 % from a year earlier, amid a strong increase in arrivals.

In the six months to June arrivals had grown to 381,538, up 36.9 % from a year earlier.

Arrivals from Pakistan and China had considerably grown over 80 %, compared to the 1H, 2010.

Accordingly, from January to June total arrivals from Pakistan had shot up by 84.8 % to 7,364 compared 3,985 in 2010. The number of Chinese people visiting the island during January to June has also increased by 83.8 % from 4,686 in 2010 to 8,613.



ADB: Inflation Threatens East Asian Growth

The region faces risks that also include more volatile financial markets and destabilizing inflows of short term capital, also known as "hot money.“

In the first half of 2011, economic growth across East Asia eased from a blistering pace as inflation surged across much of the region, driven by higher commodity prices and strong economic recovery.

Other sources of rising prices in the East Asian economies are climbing property prices and the devastating tsunami and nuclear disaster in Japan in March (which spurred a debate over the use of nuclear power), which could drive up energy prices by boosting demand for other energy sources such as oil and gas.

The threat of inflation has been a major worry in Asia this year. The ADB has warned that surging food prices of 10 % on average in many Asian economies could drive 64 mn more people into poverty.

According to ADB, surging inflation, a weak post-tsunami economic recovery in Japan and debt woes in the U.S. and Europe threaten East Asia's economic outlook.

Headline Inflation (y-o-y, %)

Cont…



ADB: Inflation Threatens East Asian Growth (cont…)

ADB expects governments to use a mix of different methods to fight inflation, including allowing their currencies to strengthen. That would make imported goods including food cheaper.

The ADB's economists also fretted about the dismal prospects for the U.S. and Europe, which are plagued by high unemployment and debt problems. Both are major customers for East Asia's exports.

The region could also be hurt if the U.S. government's top-notch credit rating is downgraded amid fears that U.S. lawmakers may fail to come up with a way to prevent a debt default in the world's biggest economy.

That could depress the dollar against other currencies, hurting Asian governments that hold large amounts of U.S. government debt in their foreign reserves.

China is the biggest holder of U.S. government debt, with USD 1.15 trillion in Treasury debt by the end of April,2011.

Meanwhile, the Japanese economy which is already struggling with recession following production disruptions caused by the tsunami, must also cope with a strengthening yen, which will hurt its exports by making them more expensive.


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The Government revenue and grants grew by 17.6 % in the first four months of 2011 with tax revenue recording an increase of 22.4 % compared to the corresponding period of 2010 due to improved performance in the overall economy and an increase in imports.

Total government expenditure increased by a lesser 11.6 % aided by slower growth in recurrent expenditure.

As a result, the overall budget deficit declined to 2.7 % of GDP, compared to 3.0 % of GDP recorded for the corresponding period in 2010.

In financing the deficit, the dependence on domestic financing had increased during Jan-Apr 2011. Within domestic financing, the dependence on banking sources had also increased while the dependence on non bank sources had decreased. This greater dependence on banking sources will have inflationary consequences for the economy.

Fiscal Sector

Summary of the Budget (Jan Apr)‐ 2010 2011

Revenue / GDP (%) 4.3 4.4

Recurrent Expenditure / GDP (%) 5.8 5.6

Public Investment/ GDP (%) 1.6 1.6

Revenue Deficit / GDP (%) (1.5) (1.2)

Overall Budget Deficit / GDP (%) (3.0) (2.7)

Financing the Budget Deficit (Jan –Apr)

As a % of the deficit 2010 2011

Foreign Financing 25.27 9.95

Domestic Financing 74.73 90.05

Non Bank 65.10 52.52

Bank 9.63 37.53


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The largest contribution to the growth in export earnings (Jan-May 2011) came from the industrial exports, mainly due to higher exports of textile and garments. Export earnings from rubber products continued to reflect higher levels of domestic value addition, particularly in the form of solid tyres and rubber gloves.

Gross Official Reserves continued to remain above the targeted level and stood at USD 7.5 bn by end June 2011. Based on the previous 12-month average expenditure on imports of USD 1,372 mn per month, GORs were equivalent to 5.4 months of imports.

Worker remittances during the period Jan – May 2011 were enough to offset 60.7 % of the trade balance.

The country should focus on increasing its export income while reducing the expenditure on imports with a view to reducing the trade deficit. Since the primary commodity exports are still in excess of USD 1200 mn, the country should focus more on increasing value added exports.

Other potential areas for greater foreign exchange earnings include tourism and ICT/BPO.

External Sector

Category (in USD Mn) 2010 2011 % Growth

Exports 2,926.43 4,298.82 46.90

Agricultural 754.70 938.57 24.36

Industrial 2,132.22 3,307.90 55.14

Textiles and garments 1,193.70 1,849.14 54.91

Rubber products 175.73 336.98 91.75

Imports 5,240.08 7,761.92 48.13

Consumer Goods 1,127.09 1,687.17 49.69

Non-food consumer goods 361.06 782.90 116.84

Intermediate Goods 2,902.80 4,264.92 46.92

Textile and clothing 601.96 977.01 62.31

Investment Goods 1,089.40 1,783.31 63.70

Machinery and equipment 440.94 737.89 67.34

Transport equipment 210.77 499.82 137.14

Balance of Trade -2,313.65 -3,463.10 -49.68

Workers’ Remittances 1,639.22 2,103.03 28.29

External Sector (Jan – May)


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Despite pressure on LKR/USD to appreciate due to the increase of foreign fund inflows with the end of the war, inflows from IMF- SBA facility, and relaxation of foreign exchange controls etc., the rate of appreciation has been kept under control due to interventions by the Central Bank of Sri Lanka (CBSL).Sri Lanka’s reserve position remains strong and the Balance of Payment (BOP) is expected to record a surplus in 2011. However, rapid import growth due to ongoing development activities and high oil and commodity prices in global markets might apply pressure on the BOP

In the event of such developments, the CBSL will have to allow greater flexibility in relation to the exchange rate, so that it will reflect market forces, and avoid sales of foreign exchange reserves to defend the rupee. This will help to maintain a healthy level of gross official reserves while retaining the competitiveness of exports.

With the government receiving the proceeds of the USD 1 bn bond issue (2011), the rupee is expected to slightly appreciate during the remaining period of 2011.

Exchange Rate


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The high oil prices and global commodity prices will be key areas to watch in relation to the rate of inflation.

Inflation

However, improvements in domestic supply side factors have helped to stem inflationary pressures arising from high oil and global commodity prices.

Headline inflation is expected ease in the second half of 2011 due to further improvements in domestic supply-side and stability in global commodity prices.

However, the prospect of higher core inflation is a concern as the economy strengthens and domestic demand pressures begin to be felt. The core inflation rate (yoy) recorded 8.9% in July, 2011. However, core inflation is not expected to be a key risk in the short term.

Private sector credit growth has been rapid, but from a low base, and there are not yet signs of demand-driven inflationary pressures.

The Central Bank is expected to use the SRR rather than policy rates to contain demand driven inflationary pressures which are expected to set in as the economy strengthens. The Central Bank should, however, be on the lookout for signs of overheating, and be prepared to adjust policy rates if required.

Cont…


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Interest Rates

The interest rates have remained rather subdued due to an excess liquidity position in the market. However, excess liquidity in the banking system fell from Rs. 63 bn recorded as at 01 July, 2011 to Rs.23 bn as at 27 July, 2011. This shows the impact of steep net sales of dollar reserves, in non-sterilized transactions.

The rate of inflation too has been kept under control despite a rise in commodity and food prices in international markets.

Improvements in domestic supply side factors such as enhanced food supplies coming in from the northern and eastern provinces and other areas have helped to keep the rate of inflation under control. This too has helped to keep interest rates in check.

Average broad money growth during the first five months of 2011, at 17.9 %, has been higher than expected mainly due to the rapid growth of credit obtained by the private sector.

However, a deceleration in the expansion of credit obtained by the private sector is expected during the remainder of 2011, due to some saturation, helping subdue monetary expansion in the ensuing period, which in turn will help to keep interest rates under control.

The government has shown some improvement in its fiscal management, and the budget deficit is likely to record 6.8 % of GDP in 2011, further reducing the pressure on interest rates.

In view of the above, policy rates (Repo and Reverse Repo) are not expected to be increased in the second half of 2011. Therefore, the interest rates are expected to remain stable in the second half of 2011.


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Interest Rates (cont…)



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.

“People have asked me why Sri Lanka should bother to increase its ease of doing business rankings when India has managed to attract high FDI with the same rankings.

But the reality is that Sri Lanka can never offer the same economy of scale as India can.

Therefore, Sri Lanka must be better than India to attract FDI”

Dr. Koshi Mathai - IMF Resident Representative , Sri Lanka


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