Sovereign States do not have to default. Then, who defaulted Sri Lankan debt? What is the punishment?

 

The purpose of this article is to shed light on the daylight public finance impropriety that took place in Sri Lanka on 12 April 2022 by defaulting of foreign currency payment on foreign debt of the government by unauthorized public officials.

The debt both private and public is part and parcel of the country's monetary system which primarily operates on public debt as the core. Modern monetarists prove that the governments with sovereign currency powers do not have to default on their debt unless they purposely do it for unknown or reckless motives. This position has no exception to Sri Lankan too.

Governments' sovereign currency and spending powers - Facts

Except in countries whose legal tender is the foreign currency, monetary and currency systems in all other countries are based on state or fiat currencies where the whole monetary system including the issuance of currencies is regulated by the governments through their agents being central banks/monetary authorities.

Therefore, sovereign governments have imposed various liabilities to the public in sovereign currencies such as payment of taxes, state fees and legal payments and receipt of government payments. This shows that the public is legally binding on the acceptance and use of sovereign currency operating on the fiat currency in all economic transactions in the country.

This has created a commanding position for the governments to spend in the sovereign currency without restrictions. Therefore, the budget is only an internal accounting programme for the fiscal discipline. In Sri Lanka, the budget, i.e., preparation and implementation, is under the control of the Parliament which is called the public finance control.

However, the budget does not imply any fundamental limitation on the ability of governments to spend in respective sovereign currencies outside the budget. The fundamental reasons are as follows.

• The government does not require tax revenue or pre-collected borrowings to spend. It can issue checks and pay orders as it wishes and its banks including the central bank will never default on honoring such payments. Those banks will create credit in bank books to the government and honor the payments. If government banks fail to do it, they will not survive in banking business where some other banks will easily takeover the profitable government's banking business.

• The government can service all debt through the rollover of same as banks and investors are prepared to accept it as part of their risk free asset portfolio. Therefore, domestic debt does not have to be defaulted in any circumstance. Even in financial and economic crisis times, public invests in government debt while reducing private sector investments. The fine example is the investment in Sri Lankan Treasury bills about Rs. 150 bn - 225 bn each weak, despite so called debt optimization risks.

• Banking system lends to the government by creating book entries in modern monetary economies and, therefore, banks do not require external currency funding from the private sector for lending business.

• The government raises debt in the sovereign currency. It does not borrow in foreign currency as it is easy to deal in domestic currency. The sale of government debt to foreigners is a secondary debt market activity created as a part of business by investors, banks and central bank. Most central banks carry on debt trade programmes to foreign investors in order to boost their foreign currency reserves while exposing the economies unduly to foreign currency risks. Therefore, the foreign debt default in Sri Lanka since 12 April 2022 is only a foreign currency default by the central bank and not a default of debt by the government.

• Therefore, government budget, i.e., spending, tax, budget deficit and borrowing/debt, presented by old monetarists as sins of all macroeconomic and sectoral imbalances and instabilities including currency and BOP crises is only a macroeconomically unfounded concept used by them to deceive political leaders and general public. The central banks are in the forefront of this monetary myth to cover-up frequent failures of their public mandates such as the price stability and financial stability.

• In fact, central banks carry out their monetary policies through the trade of government debt. For example, nearly 92% of the US central bank's assets created in the monetary policy is government/state debt. In the case of Sri Lanka, it is nearly 68% and, therefore, the country's monetary system could have collapsed unless the central bank acquired government debt.

• The most part of private businesses prevails on sale of goods and services to the government where only governments are able to implement national projects because of their sovereign spending and currency powers. Therefore, a sizable growth of economic activities and living standards is not possible without the government spending and connected money creation although the present government with the advice of the IMF and central bank believes the opposite that has pushed the economy and living standards into decades of poverty.

Sri Lankan default not by the government but by unauthorized public officials - Facts

As highlighted above, the fact according to modern monetarists against old monetarists (who think they are monetary priests) is that, given the sovereign spending and currency powers in modern monetary economies, governments do not have to default unless they purposely do it. Therefore, a grave public issue arises as to why Sri Lanka defaulted foreign debt on 12 April 2022.

However, a careful review of facts along with the modern monetarists' view shows that it is not a default by the government but by a concerted act of few public officials who had debt management responsibilities without the authority. Further, the default entails a series of conspiracies to enable them to earn and hold their positions unlawfully. Key events are listed below.

• Debt under default was raised in foreign currency to build the foreign currency reserve of the central bank in order to manage the exchange rate and finance the balance of payments in terms of statutory responsibilities under the Monetary Law Act. In fact, the foreign reserve was topped up and refilled by debt sales to foreign investors to the extent that the monetary policy was driven by the foreign reserve operations representing of 70% to 90% of the balance sheet of the central bank.

• The government received only sovereign currency from the banking system for such foreign debt. Therefore, such debt is de-facto debt in sovereign currency and serviceable in same sovereign currency which does not encounter any repayment problem. The national budget for 2022 had been duly approved by the Parliament in terms of the Constitutional provisions and, therefore, its implementation was at the hand of relevant high ranking public officials.

• However, it is the central bank who confronted repayment difficulties as it could not hold a sufficient level of foreign currency reserve required by the Monetary Law Act due to its fundamental failure of the monetary policy.

• The new Treasury Secretary and central bank Governor who assumed duties on 7 April 2022 are long standing central bank officials of the Deputy Governor rank. Therefore, both knew their public responsibilities as they had hands on experience in debt management, foreign reserve management and monetary policy. As such, they assumed new responsibilities with the prior knowledge of the statutory responsibilities of the posts as well as the chronic situation of foreign currency of the central bank awaiting a currency crisis at any movement. It was reported that the liquid foreign reserve of the central bank at that time was below US$ 50 mn. Therefore, their duties were to resolve the situation as they knew very well.

• However, they defaulted on their duties by defaulting the foreign payment of government debt that has been raised by the central bank as the official debt manager. In the evening of 11 April 2022, they held a national press conference to declare the non-payment as a soft default looking for debt restructuring. Further, the Treasury on 9 April 2022 had requested for proposals from international experts to serve as legal and financial advisors in respect of debt management. Immediately after assuming duties, the Governor also unlawfully urged the international humanitarian aid to help the general public suffered from the chronic shortage of foreign currency. The media information shows that the new Governor agreed to assume the post on the condition imposed to the then President that his colleague central bank Deputy Governor being appointed as the Treasury Secretary. At that movement, both posts were vacant as the predecessors had stepped down. Therefore, it was very poor public policy governance that the Treasury, the financial apex of the country, was brought de-facto under the central bank and, therefore, the government lost its financial sovereignty and currency powers to old monetary priests.

• Three members of the expert committee who advised the President on debt management were a part of professional network of the two. One member was the former CB Governor who had close association with the two in the CB. The President's stance on the default was never communicated to the public.

• As such, it is clear that both public officials assumed duties with well-established plans to default foreign payments on government debt collected by the central bank itself in the past for its foreign reserve management. On the macroeconomic management front, the only reason for default was the central bank running out of the mandatory foreign currency reserve. The government did not have any inability to provide the central bank with sovereign currency to the central bank for the underlying foreign currency payment at what ever the exchange rate managed by the central bank. Therefore, both officials by acting in concert defaulted foreign payments so that they can continue in public seats without any difficulty in fulfilling due responsibilities.

• Parliamentary sources reveal that the Treasury/Central Bank had not sought any amendments to the national budget already approved to facilitate the default. Anyhow, the Parliamentary approval is not required as this is not a default in sovereign currency/debt by the government but a foreign currency default (central bank finance and not public finance) by the central bank which does not come under the purview of the Parliament due to its monetary autonomy. Therefore, the approval reported to have been taken from the then Minister of Finance has no force of law to cover up the default.

• The grave public issue here is that they have assumed public duties with the intension of continuing in the posts without fulfilling their responsibilities under the cover of debt restructuring and fiscal reform through the IMF. This position was created by approaching the IMF immediately after the default. They cite the default and the economic crisis as the result of the chronic fiscal problems in the budget (deficits and debt) and political governments whereas the monetary policy has been prudent, the position always taken by old monetarists. In fact, the problem was not connected with the sovereign fiscal spending powers but connected with the fundamentally flawed monetary policy in violation of the relevant provisions of the Monetary Law Act whereas the blame is passed to the fiscal powers under the myth of the old monetarism. If the Treasury Seretary was independent from the central bank for his public duties, he would have easily supplied sovereign currency to the central bank and demanded that the central bank arrange debt service in foreign currency as per its public mandate under the Monetary Law Act. Instead, Treasury Secretary covered up the central bank by announcing an unlawful default of debt in foreign currency that the Treasury never received.

Concluding Remarks

• Overall, the default declared on 12 April 2022 was not a default of debt by the government but a default of foreign currency payment by the central bank.

• The macroeconomic catastrophe that the public confronted immediately after the foreign currency default by the central bank needs no analysis as everybody is well aware of and it will spread across the society for several decades to come.

• Therefore, the state authorities are recommended to make a special investigation into circumstances including undisclosed conspiracies behind and the national impact of the default in foreign currency by the central bank on 12 April 2022 because the deafault is a public crime. So-called debt restructuring and optimizations after default or before default are seen to be another under-cover financial market business on the global front.

• In the context of the default stated above and the default of public duties on a going basis by complaining about ailing debt restructuring and national Treasury management difficulties, they are deemed to be not fit and proper persons to continue in the relevant public posts, given their professional profiles, because any educated persons can simply hold the posts without fulfilling the public duties assigned to the two posts as they do now. They do not seem to pursue any innovative policy actions to resolve the situation, other than resorting to old monetarist actions encrypted in their office files. They must either fulfil their duties or leave the posts without killing the public times of years to give the opportunity to others who can do the job.

• Therefore, the country will not be abele to get out of the macroeconomic and social mess created by the above default by the central bank until the government activates its spending powers in sovereign currency by discarding the old monetarist and IMF psychiatry because it is this spending and not the monetary policies of central banks that has shaped the development and stability of the economies and living standards.

• Political leaders and policy authorities must understand that economics and macroeconomic management are not for them to test and enjoy their ideological worlds but for raising wealth and living standards of the general public on global standards.

• I am surprised how those who alleged that the country's economy would be bankrupt by the acceptance of additiinal Rs. 7 bn of bids from the public auction of bonds on 27 February 2015 actually bankrupted the economy on 12 April 2022 and stay absolutely free with promotions.

(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 12 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)