By W.A Wijewardena –
The Auditor General of the Democratic Socialist Republic of Sri Lanka, a position created by its Constitution, has been of late at the receiving end from political authorities. It is reported that his performance has been subject to severe criticism by Finance Minister Ravi Karunanayake, followed by Prime Minister Ranil Wickremesinghe, in Parliament recently.
Alarmed by these ominous developments, the Editor of Daily FT had written a very strong editorial urging the civil society to protect the Auditor General and warning the public of the possibility of being treated to a toothless National Audit Commission.
Auditor General’s crime
What is the crime committed by the Auditor General? He had submitted a report on the bond transactions conducted by the Central Bank during 2008 to 2016 on the request of the Finance Minister and furnished a copy of the report to the Acting Chairman of the Parliamentary Committee on Public Enterprises or COPE simultaneously. However, the Auditor General has gone even beyond that as it is revealed now.
Acting in the interest of the full public disclosure which is what the present Government had promised to the electorate at the general elections by promising to deliver economic democracy, he has posted his 190-page-long report to the website of the Auditor General’s Department so that it is now a document available in public domain. The beauty of such publicly available documents is that no politician can misquote it to hurl unfounded accusations against their political enemies.
Finance Minister’s request is not according to law
Minister Ravi Karunanayake has requested for the report in question in terms of the powers vested with him by Section 43(2) of the Monetary Law Act or MLA. This section relates to reports which the Minister might request the Auditor General to complete on the accounts of the Central Bank.
However, the report sought by the Minister relates to the bond transactions and therefore, the Auditor General is not under obligation to furnish it to the Minister. Yet, in view of the national interest which the subject in question has evoked, the Auditor General has chosen to oblige the Minister.
A wealth of information previously not in public domain
The report has furnished a wealth of data on the direct placements made by the Central Bank during the period under reference when issuing Treasury bonds on behalf of the Government. Though the Auditor General has not done any conclusive research analysis on the direct placements, because he has looked at them from the point of view of an auditor, such data can now be used by other researchers to do the same.
Further, these data can be used to examine the validity of the charge made by Prime Minister Ranil Wickremesinghe in a statement delivered in Parliament immediately after the first bond scam of 27 February 2015 that the previous Governor Ajith Nivard Cabraal had been guilty of using direct placements which PM had misquoted as private placements to favour his friends and a handful of cronies.
Direct placements as a method of issuing Government bonds
What are direct placements? It is simply a mechanism of issuing Treasury bonds or bills directly to primary dealers at a predetermined interest rate (or equivalently at a predetermined price) instead of issuing them on the basis of competitive bids received from them through an auction. A government which is concerned about the interest cost of its public debt may use either of these methods alternatively or in combination to derive the maximum benefit for itself. It can happen in relation to domestic borrowings as well as to foreign borrowings equally.
Even present Government uses direct placements when making foreign borrowings
For instance, in the case of foreign borrowings, a Government may choose to issue sovereign bonds by calling competitive bids from prospective investors. Such investors are allowed to submit bids within a specified period allowing the Government to build the borrowing book and the Government may choose the appropriate cut-off interest rate at which it would issue bonds at the margin. The competitive atmosphere prevailing in the book building process is expected to give the best rate structure to the Government.
If the prevailing interest rate structure is not favourable to the government, it may, instead, directly place the order with some selected banks or selected investors and ask them to lend money to the government. The Finance Minister Ravi Karunanayake’s much-publicised claim of borrowing $ 2 billion from an unknown Belgian lender was such a direct placement.
The recent decision of the Government to raise a syndicated loan from some selected banks is another such instance. No one can blame the Government for going for such direct placements because the Government as the borrower has the right to choose the best available market or the best available rate structure or the both.
Direct placements in the domestic debt market
This is equally valid for domestic loans too. The Central Bank in this case as the fiscal agent of the government will see to that the government gets the best bargain from the market. If it feels that the auction method is the best, it would go for auctions; at the same time, if it feels that the direct placement is the best method, it would choose that option. Similarly, if it feels that the best is a combination of both, it will go for that too.
The 2001 World Bank-IMF Handbook on Developing Government Securities Market has observed that most countries have preferred to use a combination of these methods as the most practical approach but has warned that it should be practised consistently without shocking the markets (p 165). The consistent policy is the adoption of a preannounced method of placing Government bonds directly with prospective investors with regard to the rate at which they have to invest their moneys in bonds.
Direct placements are not a demon but a servant
As this writer had argued in a previous article in this series, direct sales which were started by the Central Bank in 1997 when it introduced the primary dealer system is not a demon but a servant, well serving the Government to raise money at the lowest costs and maintain interest rates at a stable level. Hence, any finance minister or a government should have welcomed it.
Despite this, apparently being misinformed by some interested parties within the Central Bank, Prime Minister Ranil Wickremasinghe had castigated the direct placement system which he misnamed as ‘private placements’ in the statement he made in Parliament referred to above.
Said the Prime Minister: “Records confirm that private placements had become a norm rather than an exception. In just one instance in 2013, Rs. 16 billion worth of five-year bonds were sold through auction at a yield of 10.9% and thereafter Rs. 76 billion of the same bond were sold through private placements at a HIGHER yield of 11.42%. Who stood to benefit from such acts? The answer is obvious.”
Prime Minister misinformed?
It appears that the Prime Minister has been informed by an interested officer in the Central Bank that it was a crime to issue five-year bonds in 2013 at 11.42% through direct sales. What the Prime minister had not been informed is that the prevailing market rate for an 8.0% – five-year bond was much higher at 11.63% in January 2013 and 11.45% in March 2013.
Hence, if the bonds had been sold at 11.42% under direct sales, it would have been at a beneficial rate for the Government since the bonds in question had been sold above the prevailing market prices. Those who had bought the bonds at those prices could not have made a profit immediately as alleged by the Prime Minister since the bond prices had remained at around the same low level almost throughout the year.
Dealers can make money if bonds have been issued at low prices
Any party subscribing to direct placements could make money only if such direct placements have been made at interest rates pretty much higher than the prevailing market rates or equivalently at pretty much lower prices than the market prices. Thus, if they buy these bonds at bargain prices, they could immediately profit by selling them at higher prices to other parties who are interested in acquiring such bonds. But if the bonds have been issued at around the prevailing market prices, there is no prospect for them to make big money through sales.
Thus, it is the responsibility of the Central Bank, when making such direct placements, to choose interest rates or prices close to the prevailing market rates. But, if they have failed to do so, then, the allegation made by Prime Minister in Parliament is substantiated. However, for lack of detailed information on such bond deals, there was no way to verify the claim made by the Prime Minister that such placements have been shoddy and corrupt.
Findings of the Auditor General: Bonds placed at higher prices
The report submitted by the Auditor General has for the first time brought to public domain the detailed information relating to the direct placements made by the Central Bank during the nine-year period from 2008 to 2016. In conclusion, the Auditor General has remarked that 57% of the direct placements made during this period had been done at yield rates below or around the prevailing market rates and such yield rates had been desired from the objective of bringing the minimal cost to the Government (p6).
What does this mean? It means that a large volume of such bonds have been issued at prices above the prevailing market prices thereby bringing a good debt yield to the Government, on one hand, and preventing the initial buyers from reselling them at higher prices and making huge profits, on the other. Also, according to the Auditor General, the cost to the Government has been lower in the case of the direct placements than under the auction system.
What does this mean? It means that primary dealers have been trying to push the interest rates up under the auction system as foreseen by the former Governor A.S. Jayawardena when he introduced the direct placement system with EPF in 1997 as a check on such activity. The Auditor General has also observed that evidence to suggest that such direct placements have been made without the approval of the Monetary Board had not caught his attention (p 4).
Two matters for the attention of both PM and FM
There are two other observations made by the Auditor General which should receive the attention of the Minister of Finance and the Prime Minister. One is that the former Governor Arjuna Mahendran had scrapped the direct placement system in February 2015 on his own without getting the approval of the Monetary Board. In hindsight, it can, therefore, be concluded that his arbitrary decision against the wise counsel of the officials of the Public Debt Department has helped one of the primary dealers, Perpetual Treasuries, to make huge profits by buying Treasury bonds at ridiculously low prices.
The other is that the Perpetual Treasuries which had been a giant in the Treasury bond market since the first bond scam in February 2015 had in fact been one of the small dealers in the market prior to that. In the period from April to October 2014, it has participated in the Treasury bond issues with small amounts ranging between Rs. 100 million and Rs. 200 million. But since February 2015, its participation in the market has been in billions allowing it to make profits amounting to Rs. 13 billion within a matter of just 18 months. This is not a fact that the Prime Minister as a politician dedicated to establishing a clean government and the Minister of Finance as the keeper of the public purse could ignore.
Evidence does not show that bonds have been sold to cronies
The evidence presented by the Auditor General does not substantiate the allegation made by Prime Minister in Parliament that direct placements made prior to February 2015 have been made to help an exclusive group of cronies. The list provided by the Auditor General for each of the years since 2008 as recipients of bonds under direct placements include all primary dealers without exception.
Further, direct placements have been made at or around the prevailing market interest rates thereby preventing any particular primary dealer from making profits at the expense of other primary dealers. Hence, it appears that the Prime Minister has been misinformed by an interested official of the Central Bank and it is in the interest of the good governance Government to initiate an investigation into such misreporting, leading to an erosion of the reputation of the government.
Government should not blind its third eye
The Auditor General is the third eye of the Government as this writer has argued in a previous article in this series. If the Government deliberately blinds that eye, it would do so to its own peril.