Sri Lanka’s stock market presents a promising investment opportunity due to a sensible central bank, low inflation, and policy stability, according to Django Davidson, an international portfolio manager who applies the capital cycle theory in his investment strategies. Prior to the economic crisis, Hosking Partners held a few positions in Sri Lanka, eventually becoming the largest foreign investor in the stock market.
Sri Lanka defaulted on its foreign debt in 2022, following aggressive macroeconomic policies that cut rates and taxes, leading to a financial crisis. Davidson, speaking at a forum organized by CT Smith Securities, explained, “There was a significant and traumatic withdrawal of capital in the bond and equity markets, setting up investments valued below their replacement cost, which is rare in a low-interest-rate environment with booming stock markets.”
Davidson highlighted that while the Federal Reserve’s extended credit cycle contributed to inflation and market booms, the European Central Bank (ECB) is attempting to phase out such policies. A return to a scarce reserve regime, which historically brought prosperity and stability, is still uncertain. Despite recovering from its currency crisis and debt default, Sri Lanka faces concerns over recent currency depreciation and central bank policies that could trigger another default, despite recent tax hikes aimed at stabilizing budgets.
Davidson believes Sri Lanka still offers investment potential. “Look for companies trading below replacement costs where new capacity is irrational, and management is disciplined with assets,” he advised. The country’s stock market and economy are well-structured, with limited examples of irrational competition. “If disciplined fiscal and monetary policies are maintained, the outlook is very exciting,” he added.
In Sri Lanka, private credit has diminished, with mortgage lending only 2.7% of GDP in 2024, similar to India’s situation in 2010, which eventually led to a long-run mortgage cycle. “Policy stability, low inflation, and a sensible central bank could unlock fantastic opportunities here,” Davidson noted.
Foreign investors anticipate that central bank independence will create a more stable system, although recent rate cuts and monetary debasement have sparked concerns. Davidson emphasized that global capital cycles often lead to irrational investments, particularly in emerging technologies. The current artificial intelligence boom exemplifies this, with declining returns despite massive investments in data centers by new companies and major tech giants.
“What if AI represents an incredible leap forward?” Davidson asked, drawing parallels to the British railways in the 1840s and 1850s, a revolutionary technology that transformed the economy yet proved a poor investment during the bubble. The British Railway bubble ended with the Panic of 1847, a Europe-wide credit crisis that prompted early lender of last resort operations by the Bank of England and the Bank of France.
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