The Central Bank Bond Controversy

Revisited

By Sam Samarasinghe and Dushyantha

Mendis- 04/23/2015
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(PMs 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 Ministers 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 Ministers 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 committees in the first
place: this would happen if the committees 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
Ministers 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 committees 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
6thMarch 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 Governments 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 its latest statement issued on April 19 states that,
The PDD had projected the governments 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
17thMarch 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 committees report
startling revelations of past misconduct.
If we feel a nagging sense of skepticism about the governments 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%.
Presidents 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.
Posted by Thavam