HSBC is turning positive on Sri Lanka as a frontier market pick, but it's lowering exposure to Vietnam after the recent rally.
HSBC's upgrade of Sri Lanka's upgrade to "positive" from "negative" may surprise some. The country only reached an agreement with the International Monetary Fund for a $1.5 billion bailout last month after foreign exchange reserves dwindled amid a slump in exports.
While HSBC acknowledges Sri Lanka's rising fiscal and external vulnerabilities, it believes all the negative news is now priced in.
"The deal is a good opportunity for the government to replenish its forex reserves, ease the debt burden and pursue long-term fiscal and macro reforms," HSBC said.
And for stock investors, HSBC noted that the last time Sri Lanka received a tranche of a loan from the IMF, in 2012, the local stock market rose 42 percent over the next six months.
HSBC also expects company earnings have bottomed and will see some improvement, while the market's high dividend yield of over 3 percent should attract yield-seeking investors.
Among market sectors, it expects Sri Lanka's construction and building materials industries will benefit from the restarting of several stalled infrastructure projects. Tourism is also a focus, it said.