Why Stock Markets Aren't Paying Attention to Sri Lanka's Bankruptcy but You Should

The Lehman Brothers' bankruptcy seems like yesterday.

There were also Reliance Communications, Bhushan Power, Essar Steel, Lanco Infra, DHFL...

There is a long history of large corporates going bankrupt.

The mix of labour crisis, credit crisis, high operating expenses, poor cash flows, forex losses is the perfect storm for any business.

No one should be surprised if such a crisis befalls any major corporate...and over time it goes bankrupt. After all, it's nearly impossible to recover from such a vicious cycle without a big bailout.

Not every company has the kind of luck that Goldman Sachs had at the peak of 2008 crisis. Most other companies go down the Lehman Brothers way.

But when countries face such a crisis, governments, banks, and regulators do pay attention. Both, to restrict the contagion and to learn from it.

India itself faced such a crisis three decades back.

India's fiscal policy was already loose in the summer of 1979. Then the country simultaneously suffered the worst drought since independence and a global oil shock. This period saw a rise in food grain prices. Fertiliser subsidies increased tenfold.

By 1991, India's fiscal deficit widened. A greater interest payment burden due to higher cost of borrowing, rise in wages, bailout of loss-making public sector firms, and slower growth in taxes, made the situation worse.

A sharp depletion in India's forex reserves brought it to less than US$ 6 bn. This was just enough to meet around two weeks of the country's imports.

The government's and the RBI's measures to bailout the economy from the crisis were not without painful haircuts.

Opening up the economy to competition, devaluing the currency, pledging our gold holdings were few of the steps taken in 1991.

Fast forward to 2022. Our neighbour Sri Lanka now faces a similar crisis along with the prospect of bankruptcy.

As the country's inflation rises to record levels (11% in November 2021), food prices rocket, and forex reserves run dry, it's ill equipped to raise taxes, repay vast amounts of debt to China, and replenish its foreign exchange reserves.

What kind of painful measures Sri Lanka takes to recover from this crisis remains to be seen.

Stock markets may not pay heed to the crisis in countries like Sri Lanka unless the debt problem blows up into a global credit contagion. The falling Sr Lankan rupee may be the only sign of the country's lost fortune.

But as an investor, you must not forget that such crisis can impact any and every company that fails to recognise liquidity risks.

Like the poor exchange rates suffered by bankrupt countries, companies with low PE ratios initially draw attention. It turns out that PE is one of the most exploited indicators to lure unsuspecting first-time investors in every bull market.

A statically cheap stock can never be a good investment. But the so called 'market experts' and talking heads find the PE multiple to be the most convenient and compelling number to endorse.

The PE ratio neither captures real risks in a businesses nor the possibility of it going bankrupt.

Thus, it becomes the easiest tool for mis-selling. This is undoubtedly one of the worst indicators to buy or sell stocks in the current bull market.

In fact, some of the so-called value stocks today are among the top stocks to sell in this rising market.

Not because of their valuations but because of the poor quality of balance sheet, cash flows, and management quality.

So, the next time you are tempted to buy a 'cheap' stock, be aware that you're probably a target of mis-selling.

Warm regards,


Tanushree Banerjee
Editor, StockSelect
Equitymaster Agora Research Private Limited (Research Analyst)