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On my Sri Lanka Investing Blog which will be the hub of all my work about Sri Lanka, one of my readers wrote:

It looks to me in a preliminary way that Sri Lanka is in that select category of frontier markets which have a decent chance to evolve and progress into becoming emerging markets. There was a time not that many decades ago when countries we now think as emerging markets, Indonesia, South Africa, India for example, were in the nascent frontier stages of economic development. I believe that is a worthwhile long-term investment theme to consider.

- Valley Boy on Seeking Alpha, December 27, 2012

Sri Lanka has everything necessary to emerge into a higher level middle income country. It is a question of if the right policies are implemented and if businesses are ready to take the next steps.

Why Sri Lanka? Why Now?

I visited Sri Lanka for two weeks in October of 2012 and plan to make a return trip in July 2013. In my opinion, this is an exciting market set up for steady growth for years to come. And then, the contrarian in me really likes Sri Lanka because I do not think the investment opportunity is getting the attention it merits.

There are things one looks for when investing in a frontier market (NYSEARCA:FM) such as solid GDP growth, improving corporate governance and improving infrastructure. Frontier markets (NYSEARCA:FRN) offer the potential for high returns in countries developing from low per capita income toward, and beyond, global average per capita GDP and income. Sri Lanka checks all these boxes.

Sri Lanka's GDP growth on a linear chart looks like a J-curve where as the logarithmic chart shows that GDP has grown steadily for decade.

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Sri Lanka's GDP Growth, Linear Chart. Source: World Bank, Google Finance.

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Sri Lanka's GDP Growth, Logarithmic Chart. Source: World Bank, Google Finance.

Sri Lanka is a country going through many transitions. As Valley Boy said, Sri Lanka's business people tell me it is more of an emerging market than a frontier market. It is challenging to define when a country crosses the line from frontier market to emerging markets as discussed in a prior article on that topic. As a country that had a 26 year civil war until 2009, Sri Lanka has different connotations to people of different beliefs about the civil war.

Objectively, regardless of moral connotations, countries emerging from war-time and civil wars, are often ready for an economic boom. In the case of Sri Lanka, during the two years that followed the civil war, returns on the All Shares Index of the Colombo Stock Exchange averaged a little over 100% per year.

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Source: Bloomberg, CSE All Shares Index 5-year chart as of December 25, 2012.

To provide some context, one should understand going back into 2009 the stock exchange had lost about 50% of its value in the year prior to the post-civil war rally. Thus, if you invested one year too early, you lost half your money, then got back to break even, then doubled your money, in 3 years.

This is in the past now. The market has corrected. The Central Bank of Sri Lanka intervened to pull the economy back to stable growth rates, as Deputy Governor of the Central Bank Dr. Weerasinghe discussed in an interview recently published on Seeking Alpha.

What Morgan Stanley thinks in less than 200 words

Mr. Ruchir Sharma is a Managing Director, Head of global emerging markets equity team, Portfolio Manager, and Member of global tactical asset allocation investment committee at Morgan Stanley Investment Management Inc.

In May 2012, he penned an article for the Economic Times of India on Sri Lanka's peace dividend. His book, Breakout Nations, from which the article was excerpted was voted one of Foreign Policy's "21 books to read in 2012."

When I returned in 2011, the civil war had ended with surprising finality [in 2009]...

During the war years Sri Lanka grew half as fast as Korea and Taiwan and became another country in the long line of emerging-market disappointments. In the 1960s Singapore's Lee Kuan Yew had visited Sri Lanka to study it as a leading model of development...

Today it seems that Sri Lanka's time has come...

The civil war is over, the process of healing is under way, and there is every chance that Sri Lanka will again become a breakout nation. Despite slowing sharply during the war years, the economy continued to grow at an average pace of nearly 5 percent.

Why contrarian?

I mentioned in the first paragraph that I like Sri Lanka in part as a contrarian play. In this interview from February 2010, Leopard Capital announced they were raising money for a fund to invest in Sri Lanka. If you look at Leopard's team and their consulting partners, there's a who's who of frontier market investing starting with chairman Marc Faber. Yet, in 2010, with the stock exchange skyrocketing, Leopard Capital was not able to raise sufficient funds to start the fund. This is per recent conversations with two people who work with Leopard in Sri Lanka and with Leopard Capital at a conference in December 2012.

Source: CNBC Doug Clayton interview on YouTube about the opportunity to invest in Sri Lanka in 2010.

Frontier and emerging markets trends are currently focused on the letter M: Mongolia, Myanmar, Mozambique, and MISTs (Mexico, Indonesia, South Korea, Turkey; also known as "the next BRICs"). Frontier and emerging market people are focused on leveraging China's growth story. Meanwhile, the Indian sub-continent is a massively populous region that has its own particular economic factors which provide diversification from other markets. Sri Lanka has more particular qualities which I will discuss more in future articles.

Source: CNBC Alisher Ali interview about M3 (Mongolia, Myanmar, and Mozambique).

Conclusion and select news clips from Sri Lanka in December 2012

I have set up an instablog that links to select news clips from December that will focus mainly on central bank news, economic news and some corporate governance steps that continue to move Sri Lanka in a very positive direction. There is a little bit of tourism news as well, though infrastructure and tourism will be discussed more in future articles.

Important to all this news that generally points in a positive direction is that Sri Lanka's ruling party has the majority of seats in parliament, and there are no parliamentary or presidential elections that need to be scheduled until 2015 in all likelihood.

This means the below policies and developments from the news have stability for 2013 and 2014. That's a good bit of time to invest.

Regarding the Colombo Stock Exchange and business practices: What Sri Lanka needs is moves to improve structure, corporate governance, market breadth, market float, and hedging mechanisms. Based on meetings I had in October with Sri Lanka's SEC and business leaders, all these changes are in the works and being discussed.

Below is local monthly magazine Business Today's corporate governance ranking for 2011 (yellow) and 2012 (blue) of Sri Lanka's Top 25 companies. Two things that were important to me with this: (1) public business news agencies are paying attention to corporate governance and rewarding companies with improving practices; (2) when I met with the CEO of a company that scored low and asked him about it, he took immediate note of it as something to rectify.

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Source: Accompanying Business Today article from October 2012, link to chart at bottom.

Overall, the government and Central Bank's policies should be conducive to growth with lowering interest rates and inflation going forward. Additionally, a stabilizing exchange rate after a difficult 2012 may result in increasing foreign inflows.

With that, here is a link to news from December 2012. I took a one-month snapshot to see if readers see the same trends I do, or not, without my comments getting in the way.

How you can invest in Sri Lanka

Currently iShares Frontier Markets ETF (FM) has two Sri Lankan holdings.

Outside of Sri Lanka, there are two publicly-traded companies.

  • John Keells, the largest single conglomerate in Sri Lanka, trades in Luxembourg as well as in Sri Lanka.
  • Virtusa (NASDAQ:VRTU) is a Sri Lankan based information technology firm that trades on the NASDAQ.

Interested investors can also refer to my instablogs linked from my Sri Lanka Investing Blog home page:

There are notes on currency risk as well as other things to consider in each of these blogs.

Source: Sri Lanka's Investment Story Now

Additional disclosure: I have a bank account and brokerage account in Sri Lanka.