MEMO FROM THE FUTURE: Sri Lanka Investment Thesis Review

Sovereign Risk, Sectoral Performance, and Valuation Implications — June 2030

Prepared by The 2030 Report Confidential: For Investment Committee, Asset Allocation, Fixed Income, and Equity Research

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

SUMMARY: THE BEAR CASE vs. THE BULL CASE

BEAR CASE: Passive Portfolio Positioning (2025-2030 Outcome)

The bear case assumes a passive, reactive approach to AI disruption—minimal proactive adaptation, waiting for solutions, accepting structural decline.

In this scenario: - You maintain broad diversification but avoid concentrated bets on AI transformation plays - You stay underweight on domestic-facing businesses; overweight international exposure - You assume further compression of valuations in employment-intensive sectors - You accept 4-6% annual returns from defensive, dividend-yielding positions - You avoid speculative entry points, waiting for further market dislocation - By 2030, your portfolio has preserved capital but underperformed growth indices by 300-500 basis points - Key holdings: utilities, healthcare, financials; minimal exposure to tech disruption winners - Exit point for growth positions: at 20-25% appreciation (take gains early)

BULL CASE: Proactive Disruption Positioning (2025-2030 Outcome)

The bull case assumes proactive, strategic adaptation throughout 2025-2030—early positioning, deliberate capability building, and capturing disruption as opportunity.

In this scenario (initiated with decisive moves in 2025): - You identify and overweight sectors benefiting from AI adoption in Sri Lanka - You build concentrated positions in transformation winners: software, advanced manufacturing, AI-adjacent services - You enter growth positions early (2025-2026) before market repricing; you're willing to tolerate volatility - You accept underperformance during 2025-2026 downdrafts as temporary positioning cost - By 2028-2030, your thesis compounds: concentrated bets deliver 15-25%+ annual returns as winners emerge - You've also built optionality: small positions in transformational adjacencies (biotech, climate, fintech) - By 2030, your portfolio has outperformed indices by 400-600+ basis points - Key holdings: AI software, AI infrastructure, automation enablers, Sri Lanka-specific growth plays - You've harvested early gains from 2025 positions; you rotate into next wave of disruption - Exit points: taken profits at 50-100%+ appreciation; redeploy into next opportunities

EXECUTIVE SUMMARY FOR INVESTORS

Sri Lanka represents a high-risk, potentially high-return investment environment as of June 2030. The sovereign risk landscape has shifted materially since the 2023-2027 recovery period, and valuations across both fixed income and equity have adjusted accordingly.

Key Investment Metrics (June 2030):

Investment Thesis: - Near-term (6-12 months): Tactical downside risks, potential for further FX distress or IMF program stress. Hold/reduce positions. - Medium-term (12-24 months): Structural adjustment underway; potential for tactical opportunities if market has overcorrected. Selective positioning possible. - Long-term (3+ years): Recovery trajectory dependent on execution of structural reforms and global growth normalization. Thesis highly dependent on path taken.

SECTION 1: SOVEREIGN CREDIT ASSESSMENT

Debt Sustainability Analysis

Debt Stock Position (June 2030): - Total government debt: LKR 24.8 trillion (~USD 51.1 billion at 485/USD) - Debt-to-GDP ratio: 112-115% (elevated) - Foreign currency debt: ~USD 18-20 billion (40% of stock) - Local currency debt: ~LKR 16-18 trillion (60% of stock)

Debt Trajectory Scenarios:

Assessment: Base case debt trajectory is technically sustainable but requires: (a) consistent primary surpluses of 2.3%+ of GDP for 10+ years, (b) nominal growth of 4%+ annually, and (c) no external shocks. Risk of deterioration scenario is material (25-30% subjective probability).

Debt Maturity Profile and Refinancing Risk

Maturity profile is reasonably well-distributed with no major refinancing wall in next 3 years:

• 2030-2031: USD 1.8 billion maturities (manageable)
• 2032-2033: USD 2.1 billion maturities
• 2034-2035: USD 1.4 billion maturities

Refinancing Risk Assessment: Moderate. Government has market access at elevated spreads (8.0-8.5% for USD bonds as of June 2030). Spreads are high relative to peer sovereigns but not in "fallen angel" territory. Probability of forced debt restructuring in next 24 months is low (15-20%), but increases to 35-40% if external conditions deteriorate materially.

Creditor Structure Post-Restructuring

Post-2029 restructuring, creditor composition has normalized: - Official creditors (Paris Club): 38% of stock - Bilateral creditors (China, Japan, etc.): 24% of stock - Market creditors (bonds): 23% of stock - Multilateral (IMF, World Bank, ADB): 15% of stock

Assessment: Creditor diversity is actually positive for stability. Concentration in official/bilateral creditors reduces risk of opportunistic holdout behavior but increases political/strategic creditor influence.

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

SECTION 2: FIXED INCOME ANALYSIS

Bond Yields and Spread Dynamics

Current Yield Environment (June 2030):

• USD-denominated government bonds (2027 maturities): 8.1-8.3% yield
• USD-denominated government bonds (2032 maturities): 8.5-8.7% yield
• 5-year CDS spread: 380 bps
• Implied probability of default (CDS-based): 4-5% annual

Comparative Spreads: - Argentina (June 2030): 2,200 bps (in default) - Egypt (June 2030): 480 bps - Vietnam (June 2030): 140 bps - Sri Lanka (June 2030): 380 bps

Assessment: Sri Lanka's spreads are elevated relative to peers (except Argentina) but not in distressed territory. Yields of 8.1-8.5% represent fair compensation for sovereign risk in context of elevated probability of extended stagnation.

Fixed Income Recommendation

Near-term (6 months): AVOID new purchases. Spreads may widen further to 400-420 bps if current account pressure persists. Wait for capitulation signals (spreads >450 bps, CDS approaching 500 bps).

Tactical Opportunity (6-12 months): IF spreads reach 450-500 bps, then SELECTIVE BUY (3-5% allocation). Upside potential is significant (100-200 bps compression) if government stabilizes situation.

Credit Watch: Monitor monthly: - Forex reserves (if below USD 4.5 billion, risk increases sharply) - Current account deficit (if exceeds 7% of GDP, risk increases) - CDS spreads (movement of >50 bps month-on-month indicates market stress) - IMF engagement (any signals of program review delays or augmentation needs should trigger raise in risk assessment)

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

SECTION 3: EQUITY MARKET ANALYSIS

Colombo Stock Exchange Performance

Index Performance:

Valuation Metrics (June 2030): - P/E ratio (CSE Index): 8.2x (down from 14.5x in June 2027) - Price-to-Book: 0.78x - Dividend yield: 4.2% - Implied earnings growth (3-year forward): 2-3% annually

Assessment: Valuations are cheap on historical basis, but earnings estimates are being revised downward continuously. Current valuations reflect depression baseline assumptions (low growth, steady deterioration).

Sectoral Composition and Outlook

Composition of CSE Index:

Banking Sector Deep Dive

Banks are the largest sector weighting and are under significant stress:

Key Metrics (June 2030): - Sector aggregate NPA ratio: 5.2% (elevated, up from 3.1% in June 2027) - Sector aggregate capital ratio: 12.8% (above regulatory minimum of 10.5%, but tight) - Sector profitability: ROA -0.2% (negative), ROE 4.1% (depressed) - Loan-deposit ratio: 92% (tight, reduced lending capacity)

Stress Factors: 1. Currency exposure: Many banks have significant USD-denominated assets but LKR-denominated liabilities. Rupee depreciation creates losses. 2. Interest rate sensitivity: High policy rates (14.0%) have reduced lending demand and increased borrowing costs for banks. 3. Real estate exposure: Colombo real estate slump has negatively affected both bank assets and borrower ability to service loans. 4. Emigration impact: High-earning depositors are moving abroad, reducing deposit base.

Equity Sector Recommendation: AVOID banking stocks. Sector faces 12-24 months of earnings pressure before stabilization. Some banks may require recapitalization; others may be forced into mergers. Equity upside limited; downside risks are material (35-50% further decline possible in worst case).

Non-Bank Equity Opportunities

Some non-bank sectors offer potential value:

POSITIVE: - Telecom: Etisalat Sri Lanka, Dialog Axiata. These are monopolistic franchises with stable cash flows. Trading at depressed multiples (6-7x P/E) while dividend yields are 5-6%. Suitable for defensive investors seeking income. - Utilities: Ceylon Electricity Board equivalent (partially privatized). Monopoly returns + dividend policy means some downside protection. - Selected Manufacturing: Companies with export diversification (not dependent on IT/BPO; not exposed to garment sector collapse). Limited opportunity set.

NEGATIVE: - Retail: Consumer discretionary weakness will persist through 2031. Avoid. - Real Estate Developers: Colombo property market is under pressure. Developers have limited financing and face demand collapse. Avoid. - Construction: Infrastructure demand is weak due to fiscal constraints. Avoid.

Equity Recommendation (June 2030): HOLD defensive positions (telecom, utilities) if already owned. Avoid new purchases in cyclical sectors. Domestic equity valuations do not offer sufficient margin of safety given macro stress.

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

SECTION 4: CORPORATE CREDIT MARKET

IT/BPO Sector Distress

The major IT/BPO companies (Virtusa, WSO2, 99X, IFS, etc.) are under significant distress:

Key Metrics (June 2030):

Debt Situation: - Most major firms have moderate leverage (1.5-2.5x EBITDA) but EBITDA is declining rapidly. - Several companies have increased debt to fund redundancy payments and maintain operations. - Default probability is rising but still low for major firms (5-8% for Virtusa, 15-20% for smaller firms like 99X).

Corporate Bond Implications: - Spreads on IT/BPO corporate debt have widened to 500-700 bps over government yields (vs. 150-250 bps in June 2027). - Covenant compliance is becoming an issue (some firms are in technical default on leverage covenants). - Recovery in event of default would be low (30-40%) due to lack of hard assets.

Corporate Credit Recommendation: AVOID IT/BPO corporate bonds. Risk-reward is unfavorable. If already held, reduce to 2-3% of fixed income allocation maximum.

Banks as Corporate Credit Exposure

Secondary concern for corporate credit investors is the banking sector (discussed above). Bank senior debt is trading 200-250 bps over government, which might seem attractive, but subordinated debt is trading 400-500 bps, reflecting market concern about viability.

Bank Credit Recommendation: AVOID subordinated debt entirely. Senior debt only for investors comfortable with elevated sovereign risk (on thesis that government will support systemic banks if needed).

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

SECTION 5: CURRENCY AND MACRO STRATEGY

Rupee Outlook and Hedging

The Sri Lankan rupee has depreciated from 330/USD (June 2027) to 485/USD (June 2030). Further depreciation is likely in our base case, with target of 500-510/USD by end-2030.

Longer-term Rupee Trajectory (2031-2035):

Assessment: Rupee is likely to find a floor around 480-510/USD by end-2030. Further depreciation beyond this level would require either significant external shock or major policy deterioration. However, path back to 330/USD is implausible in any scenario; structural depreciation has occurred.

Hedging Recommendation: - For LKR asset exposure: Consider 50-75% USD hedge if risk tolerance is low. - For LKR liability exposure: Consider 25-50% hedge if cost of hedging is acceptable. - For new portfolio construction: Assume 480-510/USD range for modeling; do not assume mean reversion to 330.

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

SECTION 6: REAL ESTATE AND PHYSICAL ASSET VALUATIONS

Colombo Real Estate Market

Colombo commercial and residential real estate peaked in 2026-2027 with speculative inflows from diaspora and foreign investors. By June 2030, market has contracted significantly:

Price Movements: - Prime office (CBD) space: Down 28-35% from 2027 peak - Luxury residential (Colombo 5-6): Down 22-30% from 2027 peak - Suburban residential: Down 12-18% from 2027 peak - Retail commercial: Down 35-40% from 2027 peak

Yield Dynamics: - Prime office yields: 5.5-6.5% (up from 4.0-4.5% in 2027) - Luxury residential yields: 2.5-3.5% (up from 1.5-2.0% in 2027)

Assessment: Real estate market is in correction phase. Supply is still being completed (projects initiated in 2024-2025 are coming to market in 2029-2030), which is creating price pressure. Absorption is weak due to: (a) reduced purchasing power from employment losses, (b) emigration reducing local demand, (c) currency weakness increasing local currency cost for USD-denominated purchases.

Real Estate Recommendation: AVOID. Market has not yet found a floor. Further 15-20% downside is possible if macro deteriorates further. If forced to own, hold for long-term (5+ years).

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

SECTION 7: TOURISM SECTOR VALUATION

Hotel and Tourism Asset Values

Tourism was on recovery trajectory through 2027 but has reversed sharply since 2028:

Key Metrics:

Impact on Hotel Values: - Hotel valuations are typically based on 8-10x EBITDA multiples during stable periods - Current valuations are compressed to 4-5x EBITDA - Some hotels are trading below construction cost (distressed sales) - Several hotel projects initiated in 2024-2025 have been suspended or abandoned

Ownership Structure: - Major international chains (Hilton, Marriott, ITC) maintain limited presence but operate on management contracts (lower capital risk) - Local operators own majority of stock; many are facing difficulty servicing debt - New development pipeline has slowed significantly

Tourism Sector Recommendation:

Short-term (6-12 months): AVOID. Sector is in downturn and no near-term catalysts for recovery. Distressed asset sales may create opportunities, but timing is risky.

Medium-term (12-24 months): SELECTIVE BUY if valuations reach 3-4x EBITDA and global recovery signals are visible. Thesis depends on tourism arrivals recovering to 1.6+ million by 2032. This is plausible but not certain.

Long-term: Tourism is a secular growth industry globally. Sri Lanka will benefit from that growth eventually, but recovery may take 3-5 years.

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

SECTION 8: SECTORAL OPPORTUNITIES IN STRESS

Renewable Energy / Power Sector

One potential growth area is renewable energy exports. Sri Lanka has solar and wind resources and could potentially export power to India via interconnection. However, project development is capital-intensive and requires: - Infrastructure development (transmission lines) - Regulatory agreements - Generation asset construction - Grid integration

Current Status: Several projects are in planning stage but none have reached FID (final investment decision) as of June 2030. Government is interested but capital constraints are limiting.

Investment Thesis: High-risk, long-dated opportunity. Payoffs would occur in 2033+. Suitable only for patient capital and investors with India exposure mandate.

Agriculture Value-Added Processing

Sri Lanka's tea, rubber, cinnamon, and other agricultural products have strong brand recognition. Current exports are primarily commodities. Opportunity exists to move up value chain through processing, branding, specialty products.

Current Status: Some operators are pursuing this (specialty tea blends, organic certification, direct-to-consumer channels), but capital and scale are limited. Industry is fragmented.

Investment Thesis: Medium-risk, medium-term opportunity. Returns would materialize over 3-5 years. Requires expertise in agricultural supply chains and consumer branding. Opportunity is real but not transformative at scale needed for economy-wide impact.

Domestic Business Services / Fintech

As foreign-facing BPO contracts collapse, opportunity exists to repurpose IT talent and infrastructure toward domestic market needs. Fintech, healthcare tech, e-commerce platforms serving Sri Lankan market could absorb some displaced talent.

Current Status: Some activity occurring but limited venture capital, limited consumer demand (due to economic stress), limited payment infrastructure. Growth rate is slow.

Investment Thesis: Medium-risk, medium-term. Could provide 10,000-15,000 jobs over next 5 years, but will not solve employment crisis. Requires patient capital and strong management teams.

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

SECTION 9: PORTFOLIO CONSTRUCTION FRAMEWORK (JUNE 2030)

Investor Profile-Based Recommendations

Conservative Investor (Risk Tolerance: Low)

Recommended allocation: - Sri Lanka sovereign bonds: 0% (wait for spreads >450 bps) - Sri Lanka corporate credit: 0% - Sri Lanka equities: 0% - Alternative: Maintain regional exposure to India, Singapore (better credit profiles)

Rationale: Risk-reward is unfavorable. Better opportunities available in lower-risk geographies.

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

Moderate Investor (Risk Tolerance: Medium)

Recommended allocation: - Sri Lanka sovereign bonds: 2-3% (enter on dips to 400-420 bps spreads; hold to maturity) - Sri Lanka corporate credit: 0-1% (only if secured/senior debt) - Sri Lanka equities: 1-2% (defensive only: telecom, utilities) - Alternative positioning: 20-30% regional exposure (India, Asia ex-China), 40-50% developed markets

Rationale: Limited allocation to Sri Lanka for tactical value, but core portfolio should be diversified away from high-risk sovereign.

Opportunistic Investor (Risk Tolerance: High)

Recommended allocation: - Sri Lanka sovereign bonds: 8-10% (entry on spreads 400+ bps; accumulate on weakness to 450+ bps) - Sri Lanka corporate credit: 1-2% (selective, senior debt only) - Sri Lanka equities: 3-5% (defensive sectors only) - Real estate: 0-1% (distressed opportunities if identified) - Thesis: Recovery play; requires patience and ability to weather volatility

Rationale: For investors comfortable with 3-5 year holding period and volatility, Sri Lanka offers compelling risk-adjusted returns if base case scenario (managed adjustment) plays out.

SECTION 10: KEY RISK FACTORS AND TRIGGERS

Downside Triggers (Shift to Deterioration Scenario)

Monitor these indicators for evidence of shift toward deterioration scenario:

1. Forex reserves fall below USD 4.5 billion (2.0 months of import coverage) → Triggers capital control risk, "hard landing" risk
2. CDS spreads exceed 500 bps → Market pricing in material default risk
3. Rupee weakness exceeds 520/USD → Suggests loss of policy control
4. Current account deficit exceeds 7% of GDP → Unsustainable trajectory
5. IMF program review (scheduled Q3 2030) signals major issues → Creditor confidence collapse risk
6. Tourism arrivals fall below 1.0 million in 2030 → Further downward revision of sector outlook

Action triggers: If 2+ of above occur, reduce Sri Lanka exposure to 1-2% of portfolio maximum.

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

Upside Triggers (Shift to Reform Scenario)

Monitor these indicators for evidence of structural improvement:

1. Government announces credible SOE privatization/reform program → Fiscal sustainability improves
2. Renewable energy project achieves FID → Growth diversification evident
3. Tourism arrivals stabilize and begin recovery (reaching 1.5M+ in 2031) → Sector stabilization signal
4. Emigration flows stabilize or decline → Human capital stabilization signal
5. CSE Index shows sustained 15%+ rally on improved sentiment → Equity market capitulation bottom reached

Action triggers: If 3+ of above occur, increase Sri Lanka exposure to 4-6% of portfolio on thesis of recovery inflection.

CONCLUSION: INVESTMENT STANCE (JUNE 2030)

Sri Lanka represents a high-risk, moderate-reward opportunity for investors comfortable with uncertainty and volatility.

Sovereign bond valuations (8.0-8.5%) are fair compensation for risk but do not offer the margin of safety that would justify major portfolio commitment at current spread levels. HOLD from earlier positions, AVOID new entry until spreads widen to 400+ bps.

Equity valuations look attractive on P/E basis but are justified by depressed earnings outlook. AVOID exposure beyond defensive 1-2% tactical position.

Real estate is in middle of correction; AVOID until floor is identified.

Medium-term thesis (12-36 months) depends on base case scenario (managed adjustment) playing out. If this occurs, sovereign spreads should compress to 250-300 bps by end-2032, providing 300-500 bps capital gains for investors who accumulate at current levels.

Risk-weighted expected return for sovereign bonds at current (8.0-8.5%) yields and elevated spread is attractive for patient capital with 3-5 year horizon. Not suitable for investors with shorter time horizons or lower risk tolerance.

Bull Case Alternative

[Context-specific bull case for this section would emphasize proactive, strategic positioning vs. passive approach described in main section.]

Prepared by The 2030 Report June 2030 Investment analysis subject to all applicable disclaimers and disclosures

COMPARISON TABLE: BEAR vs. BULL CASE OUTCOMES (2030)

REFERENCES & DATA SOURCES

The following sources informed this June 2030 macro intelligence assessment:

1. Central Bank of Sri Lanka. (2030). Economic Report: Growth Recovery and Monetary Policy Framework.
2. Department of Census and Statistics Sri Lanka. (2030). Economic Indicators: Trade, Manufacturing, and Service Performance.
3. Board of Investment Sri Lanka. (2029). Foreign Direct Investment Report: Manufacturing and Strategic Sector Growth.
4. World Bank Sri Lanka. (2030). Development Indicators: Income Growth and Infrastructure Development.
5. Asian Development Bank. (2030). South Asian Economic Outlook: Sri Lanka's Regional Integration Progress.
6. IMF Sri Lanka Article IV Consultation. (2030). Economic Assessment: Macroeconomic Stability and Reform Progress.
7. PwC Sri Lanka. (2030). South Asian Business Environment: Market Opportunities and Investment Framework.
8. McKinsey South Asia. (2029). Sri Lanka's Economic Transformation: Technology Adoption and Trade Sector Growth.
9. Colombo Stock Exchange. (2030). Market Report: Corporate Performance and Capital Markets Development.
10. Sri Lanka Chamber of Commerce. (2030). Economic Report: Business Conditions and Strategic Outlook.
11. Bloomberg Terminal. (2030). Capital Markets Data: Sector Valuations and Investment Performance Metrics.