In a concerning development for Sri Lanka’s financial landscape, foreign holdings in government securities have nosedived below Rs.100 billion, marking the lowest point since April of the preceding year. Central Bank data reveals a significant divestment of Rs.4,442 million in bills and bonds over the week ending February 22, culminating in a total portfolio value of Rs.99,164 million held by foreign investors.
Throughout the year, foreign entities have divested Rs.18,277 million in bills and bonds on a net basis, despite a net addition of Rs.91,869 million worth of treasuries in the previous year. This trend reflects a stark reversal since the latter half of last year when foreign investors transitioned from net buyers to net sellers.
The initial surge in foreign investment stemmed from the period surrounding the Staff level agreement with the International Monetary Fund (IMF) in September 2022. Subsequently, as the Sri Lankan economy exhibited signs of improvement, particularly in foreign currency liquidity and the disbursement of IMF funds in March, foreign investors increased their bond holdings. However, this optimism waned swiftly, with investors initiating sell-offs from July onwards, coinciding with a peak in holdings by the end of June.
The rationale behind this shift in sentiment remains somewhat obscure, especially considering the nation’s economic strides. One potential factor could be the allure of higher yields offered by US treasuries, presenting a more favorable risk-return profile for fixed income allocations.
Despite attractive yields in the secondary market, such as the 10.11 percent return on the benchmark 12-month bill and 12.99 percent on the 10-year bond, the adjusted returns may not outweigh the risks. Adjusted for taxes and inflation, the 12-month bill effectively yields a negative return for investors in the highest income bracket. Moreover, foreign investors must contend with currency exchange risks, despite present exchange rate stability.
The decline in foreign investment echoes a broader trend, as illustrated by the substantial reduction from over Rs.453 billion in December 2014 to a mere Rs.104,678 million by the end of the Sirisena-Wickremesinghe administration in 2019. This downward trajectory underscores the challenges facing Sri Lanka’s financial markets and the imperative for strategic interventions to restore investor confidence and stimulate economic growth.
