Groundviews

The Central Bank Bond Controversy Revisited

By Sam Samarasinghe and Dushyantha Mendis

The Ministry of Policy Planning and Economic Affairs has on April 19 issued a press release announcing some findings of the three-member committee that Prime Minister Ranil Wickramasinghe appointed

to look into matters related to the 30-year bond issued on February 27” (PM’s special statement to Parliament, 17th March). The “findings,” however, instead of resolving the issues, appear to have raised yet more issues.

The present authors published a review (in English in the ‘Daily Financial Times’ of  March 25 &  ‘Groundviews’ of March 26, and in Sinhala in the ‘Ravaya’ of April 5 & 12) of the Rs 10.0 billion bond issue based on documents that were available from the Central Bank of Sri Lanka and other sources. We were happy to see the Prime Minister’s action of accountability to the public in appointing a committee. However, we noted that the three members appointed, who have legal backgrounds, did not have any known formal technical qualifications, professional experience or competencies in economics, banking, finance or central banking to make the inquiry that was needed. Moreover, we, as well as others, questioned the credibility of a committee that consisted of individuals who at one time or another were closely associated with the ruling United National Party.

Neither in the Prime Minister’s statement to Parliament announcing the appointment of the committee, nor anywhere else as far as we know, have there been clear terms of reference that were publicly announced to guide the work of the committee. That in itself is a deficiency and hints at a lack of seriousness.

Governor Exonerated

Based solely on the Ministry statement, the major finding of the committee is that “Governor Arjuna Mahendran had no direct role in deciding to accept bids over and above the one billion rupees stipulated in the 30-year bond tender and accept up to 10 billion rupees.”

Finding that Governor Mahendran had “no direct role in deciding to accept bids over and above the one billion rupees stipulated in the 30-year bond tender and accept up to 10 billion rupees” directly contradicts a centrally important point made by  Prime Minister Wickramasinghe in his special statement to Parliament on March 17:

When the Governor of the Central Bank was informed that over Rs.20 Billion bids have been received, he instructed the Public Debt Tender Board to select bids up to Rs.10 Billion. He did so in the presence of two Deputy Governors. The claim that the Governor interfered with the work of the Tender Board is not true. Thereafter the Tender Board submitted their recommendations, which were approved by the Governor without any changes.”

Perpetual Securities

Having exonerated Governor Mahendran,

The Committee observed that the bidding pattern of Perpetual Treasuries was unusual and warranted a further investigation.”

One would have thought that the main purpose of the committee was to investigate the allegations regarding bidding by Perpetual Treasuries on the basis of inside knowledge at the controversial bond auction of February.  The whole brouhaha arose precisely due to the fact that a major shareholder of Perpetual Treasuries was also the son-in-law of the Governor of the Central Bank, and that family connection may have led to insider trading.  In his special statement to Parliament, Prime Minister Wickramasinghe observed that,

Subsequent to this bond issue allegation of insider trading were made. The name of the Governor was mentioned in these allegations and aspersions cast.

Therefore, I appointed a Committee of three to look into matters related to the 30-year bond issued on February 27.”  

What could account for the committee appointed by the Prime Minister kicking the can down the road in this bizarre fashion?

One reason could be that the can was never the committee’s in the first place: this would happen if the committee’s terms of reference did not include such an investigation.

Alternatively the committee has studiously avoided a central responsibility and has thus wasted public funds and time.

Either way, one dreads to think of a staging of ‘Hamlet’ by the Prime Minister’s committee: the Prince of Denmark may never make an appearance! More seriously, this calls into question commitments of accountability, transparency, good governance and ‘yahapalanaya’ etc. made ad nauseam by the present administration.

Central Bank Policy Rates

The Ministry statement also makes no reference to another key issue involving the bond scandal. Our original article indicated that there were actually two major issues involved in the bond auction of February 27. First was the auction itself and bidding by Perpetual Treasuries in a manner which led to allegations of insider knowledge and trading.  Second there was the problem of a change in Central Bank policy interest rates announced on February 27.   To restate this latter aspect briefly, the Central Bank Monetary Board at its monthly meeting on February 23 decided to keep Central Bank policy interest rates UNCHANGED.  However, on February 27th it announced an increase in a key interest rate that caused bond prices to FALL and MARKET interest rates to INCREASE. This took the market by surprise. Anybody who had INSIDER INFORMATION of the change had the opportunity to make a killing by first selling bonds (before the change in interest rates) and later buying bonds (after the change in interest rates).  Media reports in fact alleged such a pattern of activity on the part of Perpetual Treasuries.

The manner in which the change in policy rates was carried out is intriguing by itself.  The announcement was made on Friday February 27 to take effect on Monday March 2, and was then officially announced retrospectively by a Central Bank press release of Tuesday March 3.

In passing it is useful to note that the Central Bank Monetary Board have with effect from April 15 again REDUCED the policy interest rates of the Bank.   This brings Sri Lankan monetary policy back to a trend prevalent from late 2013, that of declining or static interest rates in a background of low and declining inflation.  There could be only one reason for raising interest rates in a relatively open economy – rising inflation.  The increase which prevailed from March 2 to April 15 was obviously not to address this problem, for as the Central Bank Press Release of April 15 itself notes,

“Headline inflation, on a year-on-year (y-o-y) basis, declined to 0.1 per cent in March 2015 from 0.6 per cent in February 2015.”

In any event, even the most obtuse undergraduate student of economics would know that, given the long time lags involved in the working of monetary policy, a monetary policy tightening of around six weeks is laughable if the objective is to tame an incipient inflation.

Since that was not the case where the Central Bank of Sri Lanka was concerned, the logical question that arises is, what motivated the change announced on February 27, and who was responsible for it.  We have raised these questions in our earlier article.

Any investigating committee with minimum competence and integrity would have investigated and reported on this matter. The statement by the Ministry does not mention if the committee has any comment on this matter:  we devoutly hope it has.

At any rate, on this issue at least, it would not be possible to hold that the Governor of the Central Bank had no direct involvement in the decision: he is after all the head of the Monetary Board which alone takes these decisions.

From Rs 1.0 billion to 10.0 billion

What else can we look forward to from the committee’s report?  How about an explanation of why the Central Bank decided to accept bids of Rs. 10 billion where the originals soundings were for bids up to Rs. 1 billion?

Here also we find a contradiction in the statements offered by the Ministry of Policy Planning & Economic Affairs, of which, it may be noted, the Prime Minister himself is Minister.   The statement issued by the Ministry on 6th March states that

At a meeting held on 26 February 2015 to ascertain the Government expenditure projections attended by the Minister of Finance, Minister of Highways, Investment Promotion and Higher Education, Secretary to the Treasury and the Governor of the Central Bank of Sri Lanka, it was decided that the Government needs additional funding of approx. Rs. 15 billion on an urgent basis to fund the recommencement of highways and road construction projects.

… The Government’s immediate needs for cash to make payments for the bills in hand and to complete incomplete projects were to be met through the Treasury bond issues in March 2015.”

However the Ministry in it’s latest statement issued on April 19 states that,

“The PDD had projected the government’s funding requirement as at 2nd March 2015 at 13.55 billion rupees.”

Even if we grant that a difference of Rs 1.5 billion is perhaps nothing between friends, we do hope that the committee is able to explain why the better part of Rs. 15 billion, or Rs. 13.55 billion as the case may be, had to be taken up in one fell swoop at increasing rates of interest in thirty year bonds, and not piecemeal over the month of March, as originally envisaged by the Ministry itself, at very likely lower rates of interest payable over a shorter period of time.

Again, the Prime Minister in his special statement to Parliament of 17th March has stated that the

“investigations that are being carried out are not limited to this issue. It goes back to all transactions of public auctions and private placements from 2012 onwards. This committee has the option to call upon and consult other experts as they see fit. I expect startling revelations to surface because of the unhealthy practices that prevailed.”

So here is yet another thing to look forward to the committee’s report – ‘startling revelations’ of past misconduct.

If we feel a nagging sense of skepticism about the government’s handling of this controversy however, it is because of the numerous contradictions and inaccuracies in the statements issued by the authorities themselves.   Some of these have been noted above.  There are yet others.

Not Cheap Credit

Prime Minster Wickramasinghe was not accurate when he made the following claim in his special statement to Parliament:

“But we can compare the latest 30-year bond issued under this government and the ones that were issued under the previous one. The 30-year bond of June 2014 was issued at an average interest rate of 11.75 percent. The latest bond was sold at 11.73, slightly lower than the rate paid last year. This means we were able to raise just over 10 billion rupees at a rate cheaper than what the previous government paid.”

Mr. Wickramasinghe was right to note that the 30 year Rs 10 billion bond issue of February 27 was at an average interest rate of 11.73%, which was slightly lower than the rate of 11.75% paid for the May, (not June as the Prime Minister stated), 27 2014 30 year bond issue. However, he has disregarded two facts that make his claim invalid. First, the May 27 2014 issue was only for Rs 2.0b. Had the Central Bank accepted only Rs 2.0b on February 27 the interest rate would have been less than 11.0%. Second, market interest rates in May 2014 were around 20% to 30% higher than those that prevailed in February 2015. Thus one must expect bond rates to be lower when the Central Bank wanted to raise funds in February this year.

Again the Ministry of Policy Planning and Economic Affairs in its statement of  March 6 states that

The acceptance of Rs. 10 billion worth of bonds has also resulted in raising the interest rate on the 30-year bond to 11.5% which is where it stood in June 2014 before interest rates were reduced.”

However the correct figure, given by the Central Bank itself, is 11.73%.

President’s Responsibility

It would be recalled that President Maithripala Sirisena wanted to appoint a committee to investigate this bond scandal. He made a public announcement to that effect while he was in, or en route to, London on an official visit. Prime Minister Wickramasinghe who was in Colombo at that time appointed his own committee, thus perhaps preempting the President.  It was President Sirisena who was elected, promising the people of Sri Lanka a government that was transparent, accountable and free of corruption. If there are lacunae in the report of the present committee, the President would then owe the public an independent and credible investigation of what actually happened.

However we very much hope that the committee report will be more complete than suggested by the Ministry press release, and that it adequately addresses all the issues we have raised.