Another T bill issuance irregularity on the table?

 

In my article released to this blog on 7 June revealed a significant loss to the public caused by the issuance of Treasury bills at the auction held on 31 May 2023. The loss occurred as the Central Bank (CB) did not reduce the auction yield rates in line with the 2.5% reduction in policy interest rates determined by the CB in the same day afternoon although the Governor and Tender Board members had the prior knowledge.

This article reveals an early warning on a similar policy irregularity that can happen at the next T bill auction due on 5 July (tomorrow), the day before the next monetary policy meeting.

Background Inputs

• On 27 June, the CB announced the advancement of the next monetary policy review to 6 July at 7.30 am from the normal scheduled date of 13 July. At this advanced, breakfast meeting, the Monetary Board will decide on the overnight policy interest rates of the CB, i.e., standing deposit facility rate and standing lending facility rate on overnight money printing transactions with banks and primary dealers.

• On same day, the CB conducted a Treasury bill auction for Rs. 130 bn. Accordingly, bids worth Rs. 55.434 bn were accepted and the private placement window was open for raising the balance funding. However, only Rs. 22.768 bn was raised through placements despite the long settlement date.

• The normal 2-working day settlement time given for auctions falls on 30 June. However, the settlement date was announced as 4 July as relevant senior officials had the prior knowledge on the banking holiday of 5 days announced by the Governor in the late evening of same day (27 June) from 29 June to 3 July. Accordingly, the next working day after the banking holiday, i.e., 4 July, became the settlement date.

• Next day, on 28 July, the CB announced the next Treasury bill auction for Rs. 140 bn to be held on 5 July, i.e., one day before the advanced monetary policy meeting, with a settlement date as 7 July.

Concerns over last T bill auction held on 27 June

• Bids for all three maturities were accepted at the weighted average yields of the previous week's auction, i.e., 23% for 91 days, 19.46% for 182 days and 16.99% for 182 days.

• A long settlement time of 7 days was given despite the severe funding difficulties confronted by the government. As Primary Dealers and Primary Dealer Units of banks were working on 30 June, the unjustified special bank holiday for the public, the normal two working days' settlement could have been followed, given the government funding difficulties. When concerns were raised over why the T bill auction held on 31 May was not delayed by one day till next day (1st June) to know the policy rate decision (2.5% cut) announced by the CB on 1st June, the CB's media responded that it could not hold even one day because of the government funding urgency.

• As the auction was subscribed only 42.6%, a huge opportunity in terms of bidding and long settlement date has been open for private placements.

Expectations over policy interest rates decision on the advanced meeting on 6 July

The purpose of the abrupt advancement of the Monetary Board meeting to 7.30 am of 6 July, i.e., the day after the next T bill auction, is very clear that the CB intends to announce another policy interest rate cut of a significant amount. The reasons are very clear.

• The monetary policy decision on 31 May was based on the actual inflation of 35.5% in April and significantly faster disinflation path projected, among other macroeconomic factors. As the month of May was over and the release of inflation figures by the Census and Statistics Department was due on same day, the Governor and relevant senior officials had the prior knowledge on further reduction of inflation to 25.2% in May.

• Further, when Monetary Board meeting was advanced on 27 June, the Governor had the prior knowledge of further reduction of inflation to 12% in June as price data collection had been over by 27 June.

• According to the CB's inflation press release on 30 June, inflation fell to 12% in June and the projected disinflation path has become steeper.

• Accordingly, if the current market conditions and consumer price trends prevail, inflation will fall to around 5% in August and around 2% in next 4 months purely due to the base effect.

• In fact, there is a high probability that the country will face a significant deflation risk in next year.

• If the inflation-based monetary theory and monetary policy approach are believed, the cumulative lagged effects of significant monetary tightening by way of 10.5% hike in policy interest rates will be a major force causing the deflation risk. A policy rate hike of 9% was implemented by the present CB Governor during the period of April 2022 to April 2023. However, as a 2.5% policy rate cut was effected at the last monetary policy meeting held on 31 May, a 8% cumulative policy rate hike remains to be reversed if the deflation risk is to be controlled early. This is to induce a significant stimulation of the aggregate demand in the economy without delay in order to keep the inflation in the CB's target zone of 4%-6%.

• Further, according to the CB Governor's PowerPoint presentation made to the Cabinet of Ministers on 28 June on domestic debt optimization concept, the proposed exchange of Sri Lanka Development Bonds and FCBU debt for local currency debt is to take place at a floating interest rate of the CB's standing lending facility rate plus 1%. This also requires an urgent policy rate cut to reduce the cost of the government on the proposed domestic debt optimization.

• In terms of IMF programme conditions, the monetary policy is required to maintain a real policy interest rate 2.5% as its natural level.

In view of the above reasoning, a policy rates cut at least 5% could be justified and expected at the next Monetary Board meeting on 6 July. Accordingly, policy interest rate should fall below 8%-9% from the present level of 13%-14%.

Justifiable decision at the next T bill auction on 5 July

• Four members of the T bill Tender Board will know by the time of the Tender Board meeting in the afternoon of 5 July the proposed new policy rates as they would have attended the monetary policy committee meeting at least two days prior to the Monetary Board meeting. 

• Two members, i.e., Director of Economic Research and Assistant Governor supervising the monetary policy subject, should have singed the Monetary Board paper on the monetary policy review submitted to the Monetary Board at least two days prior to the Monetary Board meeting as per the procedure. This is the paper that forwards the recommendation of the Monetary Policy Committee on the policy interest rates and other policy instruments to the Monetary Board. The recommendation is submitted with the concurrence of the Governor because it is the Governor who officially recommends policies to the Monetary Board for approval in terms of the Monetary Law Act.

• Given the current trend of inflation, steeper disinflation path projected by the CB and foreign exchange and balance of payment front, Tender Board members should not have any ambiguity over the next policy interest rates decision of the Monetary Board.

• Therefore, a reduction of T bill yield rates comparable to the proposed policy interest rates cut should be effected at the forthcoming T bill auction if Tender Board members are professional economists and financial professionals who behave in the public interest as required. This is especially required since T bill yield rates are used by the CB as de facto policy interest rates to transmit the monetary policy stance to term credit markets.

• As the private placement window is amply available now, there is no difficulty to determine a significant reduction in yields rates to be consistent with new policy interest rates, given the ample liquidity injected by the CB last week (around Rs. 800 bn) in response to banking holiday panic and high yield rates kept at the last T bill auction.

• If the Tender Board is not capable of cutting the yield rates as proposed, the auction can be postponed to the next day afternoon pending the Monetary Board's policy interest rates decision in the early morning. This could be easily done as 7 days were given for settlement of the last T bill auction. If the government needs funds urgently, the CB can make a special T bill issuance to itself and advance funds as this method of monetary financing has been normal after the present CB Governor assumed duties.

Overall Public Concerns

• Even though Tender Board members knew present macroeconomic trends favourable for lower interest rates as highlighted above, yield rates at the last T bill auction were kept unchanged at the levels of the previous auction and a 7-day settlement period was offered. Therefore, once yield rates fall in response to significant disinflation and policy interest rates cut expected at the next Monetary Board meeting due on 6 July, dealers will realize an immediate capital gain just after two days from the settlement on T bills they purchased from the last auction and private placements.

• If the Tender Board effects a reduction in yield rates at the next T bill auction due on 5 July pending a significant policy interest rates cut next day, dealers who purchased T bills at the last auction will receive another capital gain just after one day from the settlement.

• If the Tender Board at the next T bill auction due on 5 July does not cut the yield rates by considering prevailing trends and circumstances highlighted above, dealers will immediately realize a significant capital gain in response to the policy rates cut pending next day, 6 July, at a loss to public funds.

• The loss to the public funds by way of increased interest payments on debt raised through T bills and bonds in 2022 and 2023 so far due to exorbitant yield rates decided by the Tender Board is unbearable. The yield rates were more than twice or thrice the prevailing policy interest rates. Total issuance in 2022 and 2023 so far has been around Rs. 2,745 bn on T bonds and Rs. 13,420 bn on T bills. Therefore, the interest cost at yield rates generally ranging from 25%-32% has effectively made the domestic debt unsustainable at present. Therefore, the Tender Board is directly responsible for the loss to public funds and unsustainability of domestic debt due to its failure to adopt effective strategies for raising funds at justifiable yield rates, given their professional qualifications, public authority and confidential information set. The mandate of the public debt management as set out by the CB is to manage the debt at lowest cost and risk.

In view of facts, concerns and views presented as above, it is the public duty of the audit and fiscal authorities to conduct an independent, in-depth inquiry on the loss to the public caused by the CB including the Tender Board on issuance of T bills and bonds from January 2022 if the government is to look for a fairer domestic debt optimization process. The general public is unable to provide any observations on this subject as the dealer-wise information on bids and secondary market transactions is not transparent.

(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 10 Economics and Banking Books and a large number of articles published. 

The author holds BA Hons in Economics from University of Colombo, MA in Economics from University of Kansas, USA, and international training exposures in economic management and financial system regulation)