ECONOMYNEXT – Sri Lanka stocks rose 49 percent measured by the Colombo All Share Index in 2024 as the economy recovered from a currency crisis, companies posted higher nominal profits and costs and interest rates fell amid deflationary policy.
Stock values rose by 1.4 trillion to 5.6 trillion rupees, inclusive of capital raisings by several companies, exceeding a 5.4 trillion level reached in 2021 as the central bank cut rates and pumped money market full of excess liquidity.
Sri Lanka’s currency collapsed in 2022, from around 184 in 2020 to 360 in 2022 and is now back at around 295 to the US dollar inflating the nominal value of economic activities.
Sri Lanka’s central bank tightened monetary policy in 2022, after the worst currency crisis in its history as macro-economists triggered a textbook ‘barber boom’ involving rate and tax cuts that
Oxford educated Chancellor of the Exchequer Anthony Barber did to the UK in the 1970s.
When rates fall long term assets go up and when rates are cut with inflationary open market operations, there is plenty of credit to buy any asset.
One of the most well-knowns stocks bubbles were fired by the US Fed in the 1920s, after it invented open market operations in 1923 leading to a spectacular collapse in 1929 and the setting up of the Securities and Exchange Commission to stop stock market manipulation.
Margin loans which started late in the 19th century took off during the roaring 20s bubble.
However, in Sri Lanka the rupee has collapsed inflating the value of everything.
The US has also similarly pumped-up prices until mid-2023 with the Fed claiming inflation was supply chain phenomenon.
Sri Lanka’s nominal GDP inflation from which was estimated to be trillion 15.9 trillion in 2019 inflated to 24 trillion in 2022 and recovered to trillion in 2023.
In 2024 amid low inflation GDP is expected to be around 30 trillion.
Stocks represent real economic activity and nominal profits and earnings per share also recover to pre-crisis levels, boosting earnings per share, even before a real expansion takes place.
According to stock exchange data, the (historical) price to earnings multiple was at 8.89 times by end December 2024 from 11.10 at the end of 2023.
In flexible inflation targeting countries, stock markets collapse and bonds soar as stabilization policies are deployed to end the balance of payments crises that comes in the wake of targeting policy rates with inflationary open market operations to boost inflation.
To restore confidence the lost confidence in the currency and prevent dollarization, economic activity has to be shrunk.
In Sri Lanka bank deposits are also taxed, encouraging some money to flow into stocks as part of long standing efforts to create a share owing democracy. In countries with monetary stability, where nominal interest rates are low, stocks and mutual funds can be alternative asset classes. (Colombo/Dec31/2024)
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