“Greek Bond” issue is being cunningly used as a red herring – Ajith Nivard Cabraal

3 January 2017 12:02 am - 0     - {{hitsCtrl.values.hits}}

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One time Central Bank Governor Ajith Nivard Cabraal, in an interview with the Daily Mirror speaks about the last budget and the current status of the economy. He shared the following: 

 

In the recent budget, there is a proposal to remove some Central Bank functions such as Public Debt Management, to be vested with another Ministry. As a former CB governor, how do you see it?  

The Central Bank carries out the Public Debt Management Function on behalf of the government. Therefore, as the Principal, the government can entrust that function to another body after amending the necessary laws. However, it must be noted that, until February 27, 2015, the public debt had been managed in an exemplary manner by the Central Bank whereby the funds required by the government were raised at the appropriate time at the least possible cost. To do so, the Bank had followed the time-tested policy of “auction cum direct placement”, which had ensured that the interests of the public and the government were safeguarded.  
It is only after January 2015 that controversies have arisen in relation to debt management, the root of which has already been identified as the arbitrary and sudden system change on February 27, 2015 as revealed by Central Bank internal examinations, Auditor General’s investigations, and two COPE probes. Hence, it would now be possible to deal with this situation in an appropriate manner by immediately discontinuing the present “auction only” system, and reverting back to the “auction cum direct placement” system, instead of indulging in further exercises to cover up the escalating debt management crisis.  
When I became Governor in 2006, Sri Lanka’s Debt to GDP ratio was 91%, and the Average Time to Maturity (ATM) of the Debt stock was 2.4 years. When I left in January 2015, the Debt to GDP had reduced to 71%, and the ATM had increased to 5.8 years. Further, by end 2014, Treasury interest rates ranged from about 5.6% for 3 months to about 9.5% for 30 years. This shows that the PDD and the CB are quite capable of carrying out the debt management function satisfactorily. Therefore, I hope the government would have the wisdom not to make ad hoc changes in order to cover up the present scams.   


How do you analyse the overall fiscal and economic situation of the country in the light of the current budget?  

From 2010 onwards, Sri Lanka’s fiscal deficit has been on a downward trend from 7.0% in 2010 to 5.7% in 2014. This favourable trend has been helpful in moving the other key macro-fundamentals towards favourable levels. By end 2014, the average growth was 6.8% for the preceding 5 years, and the average inflation was mid-single digits. Foreign reserves were USD 8,208 million, and Foreign Direct Investment (FDI) had risen to USD 1,616 million from just USD 287 million in 2005.  
Unfortunately, these trends were reversed in 2015 with the uncontrolled spending causing the deficit to rise to 7.4%. Not only was this deficit detrimental to government finances, the reversal conveyed the message that the government was on a splurge of indisciplined spending, which frightened investors and disturbed the macro-fundamentals.  
Even as we speak, growth has fallen below 3%; foreign reserves have plummeted by about 25%; interest rates have doubled; inflation expectations have risen; FDIs have fallen to war-time levels; the stock market has lost significant value; exports have shrunk; the Rupee has depreciated significantly and the Balance of Payments (BOP) has turned from a surplus of USD 1.4 billion in 2014 to a deficit of USD 1.5 billion in 2015, with a likelihood that it would record a deficit this year as well; the Public Debt which was Rs. 7,391 billion by end December 2014, had shot up to Rs. 9,382 billion by end July 2016, thereby recording an increase of Rs. 1,991 billion in just 19 months; the massive depreciation of the Rupee has resulted in the public debt shooting up by Rs. 285 billion in 2015, and by another Rs. 141 billion up to July 2016, totalling Rs. 426 billion. That sum would have been sufficient to construct another Nurichcholai Power Plant, Colombo-Matara Expressway, Colombo-Katunayake Expressway, Mattala Airport and a Hambantota Port! Today, there is no asset to show for that increase of Rs. 426 billion of the liabilities in the country’s balance sheet. In the meantime, the unwarranted increase in interest rates due to the bond scams have added Rs. 66 billion to government expenditure in 2015, and another Rs.71 billion in 2016.  

 

"When I became Governor in 2006, Sri Lanka’s Debt to GDP ratio was 91%,  and the Average Time to Maturity (ATM) of the Debt stock was 2.4 years.  When I left in January 2015, the Debt to GDP had reduced to 71%, and the  ATM had increased to 
5.8 years"

 


In addition, the compensation liabilities that the government has recently incurred have been monumental. The arbitrary stoppage of the Port City Project led to a reported damages claim of USD 143 million (Rs.21 billion), and it is now well known that the government had to provide additional land to the Chinese company in consideration of dropping this claim. The unilateral cancellation of the Sri Lankan Airlines’ aircraft purchase resulted in another damages claim of USD 125 million (Rs. 19 billion), according to media reports. Another alarming feature has been that foreign investors in government securities who held nearly USD 4 billion in 2014 have now reduced their holdings to below USD 2 billion, and there is a real possibility that they would flee when the Fed raises the US policy rates in the next few weeks, putting even greater pressure on our Rupee and reserves.   
Unfortunately, all these critical factors have not been given sufficient attention in the budget debate, but have obviously been recognized by the International Rating Agencies who have recently downgraded the country’s credit rating and placed the economy on a “negative” watch.  


When you served in office, there was an allegation that you were responsible for causing a huge loss to the government by investing in Greek Bonds. How legitimate was 
that allegation?  

That allegation is completely untrue and unsubstantiated. The CB’s decision to invest in Greek Bonds was a part of its reserve management strategy that was implemented in 2011. That strategy yielded the highest ever return of USD 430 million, or 6.6% on the reserves, in 2011. In contrast, with a reserve of a similar magnitude, the return that was generated by the CB in 2015 was only USD 111 million, or 1.8 %.  
Nevertheless, as you said, there was a FR Petition 457/2012 alleging that the Monetary Board and the CB were responsible for causing a huge loss by investing in Greek Bonds, filed by a Minister of the present government, when he was in the opposition. However, “Leave to Proceed” for such petition was refused by a Supreme Court bench comprising Justice Sripavan, (present Chief Justice), Justice Marasinghe and Justice De Abrew with the order that, “Considering the totality of the circumstances, it is neither possible nor desirable to hold that the Members of the Monetary Board in taking a decision to invest in Greek Bonds, have acted arbitrarily, unreasonably and in a fraudulent manner.” (See judgement dated September 18, 2014 in the website of the Supreme Court). The following extracts from the judgement would also be helpful to understand the true context re. this investment.  

 

"At present growth has fallen below 3%; foreign reserves have plummeted  by about 25%; interest rates have doubled; inflation expectations have  risen; FDIs have fallen to 
war-time levels"

 


“The investment in Greek Bonds and its trade forms part of the risk management strategy. If all investments are maintained as risk-free investments the return would be negligible. The CB therefore has to select a mix of low risk and risk-bearing investments expecting a reasonably high return…”  
“The decision to invest in such Bonds was based on the trade-off between different risks faced and the CB’s tolerance for higher risk on a very small part of its portfolio (only 0.6% of its portfolio was invested in Greece Bonds). Investing in high-yielding sovereign paper is an integral part of management of many funds in the world and the CB too had followed a similar practice…”  
It must also be stated that the Auditor General too, had confirmed that no irregularity had occurred, via his report dated October 11, 2012 to the Chairman of COPE. After such report, COPE had also accepted that although a loss had occurred, no wrong or illegal activity had taken place.  
In the face of the above judgement and other authoritative determinations, it would be seen that there is no basis for the sweeping allegations that are being made, and that the “Greek Bond” issue is being cunningly used as a red herring to divert attention from the “Treasury Bond” issue, which is causing acute embarrassment to the government.   


A minister of the previous regime once alleged that you had taken the decision to go for the controversial Hedging deal. It caused enormous loss to the government by way of payment of compensations to some foreign banks. How responsible were you for it?  

When oil prices were rising rapidly in the second half of 2006, the Economic Research Department of the CB rightfully recommended that Sri Lanka should practise “Hedging” in order to meet the challenge to the economy arising from the rising oil prices. As per such recommendation, a presentation was made to the Cabinet by the CB, after which a detailed study was commissioned by the Cabinet. Based on that study, the Cabinet decided that the Ceylon Petroleum Corporation (CPC) should undertake “Hedging”. Hedging is not an unknown or strange concept, but is a common practice that is used extensively in order to deal with risky economic situations.  
In that background, there is absolutely no nexus whereby the CB or the Monetary Board or the Governor could be held responsible for any loss from “hedging”, because what the CB did was merely its duty of managing economic risk by making a prudent recommendation to the Government, while the diligent implementation was a function of other organisations 
and institutions.  

 

"The massive depreciation of the Rupee has resulted in the public debt  shooting up by Rs. 285 billion in 2015, and by another Rs. 141 billion  up to July 2016, totalling Rs. 426 billion "

 


In relation to the “loss” and payment of compensation, the basic facts, as per my understanding and recollection, are as follows: When the unexpected happened and global oil prices suddenly declined, the CPC was exposed to damages claims from three banks that held hedging contracts with the CPC. Of the three claims which initially amounted to around USD 500 million, the Attorney General and Sri Lankan authorities were able to successfully repudiate one claim fully. However, the CPC was found liable in one court action, while one arbitration went against the Government. Nevertheless, the Sri Lankan authorities were able to successfully reduce the final payments through negotiations, and the final payment that was made to the two banks was a total of around USD 90 million, and that too, paid after many years. In the meantime, the CPC was able to import oil at the prevailing lower prices without any hindrance or interruption.  

 

  • It is only after January 2015 that controversies had arisen in relation to debt management 

  • Foreign Direct Investment (FDI) had risen to USD 1,616 million from just USD 287 million in 2005

  • Growth has fallen below 3%; foreign reserves have plummeted by about 25%; interest rates have doubled


In contrast, when the present government unilaterally cancelled the Port City project in January 2015, the government faced a damages claim of USD 143 million, which, according to reports, has been “settled” in an indirect manner by granting ownership rights to an additional 5 acres of prime property to be reclaimed, to the aggrieved developer. In that situation, it would be readily seen that the persons who took the decision to arbitrarily cancel this project could someday be held “responsible” for the “compensation” payment in kind, made to the developer by the government.  


In the meantime, the government has decided to take over some properties purchased by the CB in the United States and Brazil during your time. Could you share your views on it?

The CB’s decisions to purchase properties in USA and Brazil had been made after careful consideration, and diligently implemented in compliance with the prevailing rules, regulations and Laws. In addition, the necessary approvals, including those from the Cabinet, Monetary Board and Attorney General, had been obtained. It was not a sudden decision of one person. Notwithstanding such compliance and diligence, the present government has publicly stated that it wishes to “take over” these properties belonging to the Bank. In fact, I believe they may do so soon, because in a newspaper interview recently, a learned Minister gave the reason for the massive depreciation of the rupee as being due to the fact that the previous CB Governor had bought properties in the USA and Brazil! Following that logic therefore, by taking over the properties, the accomplished Minister would soon be able to appreciate the Sri Lankan Rupee back to Rs.131 against the US Dollar, from the current depreciated level of Rs.150, and thereby prove all traditional Central Bankers wrong in their theories of exchange rate management.   
According to the Daily Mirror of November 17, 2016, the properties in USA and Brazil are today valued at Rs.1,245.6 million, while the cost was Rs.734.3 million; an increase in value of Rs. 511.3 million (or 69.6%). This simple report itself confirms that the CB had made a prudent and practical investment.

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