New CB up on DDO conversion deal. 7 traces of misconduct punishable for criminal breach of trust.

 

The press notice issued by the new CB (NCB) on 21 September 2023 (last Thursday) shows a list of new Treasury bonds and Treasury bills issued by the Public Debt Department for the conversion of provisional advances and Treasury bills held by the CB under the Domestic Debt Optimization policy (DDO). See link: https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/press/pr/press_20230921_conversion_of_outstanding_credits_of_cbsl_to_government_into_negotiable_debt_instruments_under_ddo_e.pdf

• Accordingly, 10 new Treasury bonds and 12 existing Treasury bills have been issued to the NCB on 21 September 2023 as indicated below.

• Accordingly, total debt so converted amounted to Rs. 2,713,144,352,006 consisting of Rs. 2,492,347,352,006 into Treasury bonds and Rs. 220,797,000,000 into Treasury bills. Treasury bonds are issuances of new series while Treasury bills are reissuances to existing series.

• The maturity of 10 new Treasury bonds is annualized for 10 years ranging from 15 March 2029 to 15 June 2038. The maturity of 12 Treasury bills ranges from 5 months to 12 months in 2024 .

• Therefore, it appears that the NCB has restructured nearly 94% of total outstanding credit granted (of around Rs. 2,900 bn, i.e., Rs. 344 bn of provisional advances and Rs. 2,556 bn of Treasury bills) to the government through provisional advances and direct purchase of Treasury bills.

However, 7 areas of misconduct can be traced on the conversion deal as revealed from the limited information disclosed in the NCB press notice. These could be seen as insider acts pursued to raise financial benefits unduly to the NCB at a disadvantage to the government against the very objective of DDO strategy approved by the Parliament. 

The purpose of this short article is to highlight those 7 traces as given below. The target audience of the article is the group of professionals interested in the insight into the true outcome of the DDO process and relevant policy-makers.

1. Additional cost burden to debt service

Although the interest was not charged on provisional advances around Rs. 345 bn, the government now has to pay interest on converted bonds and bills. For example, converted bonds receive half-yearly coupons at 12.4%, 7.5% and 5% over the maturity. However, the additional interest cost to the government cannot be estimated as details of the conversion (i.e., underlying debt, interest rate and converted securities) are not disclosed.

2. Maturity restructuring not easing the debt unsustainability

Provisional advances did not practically have maturity dates where the total amount got accumulated with new advances granted each year consequent to new national budget (10% of the budgeted revenue). However, all converted bonds and bills now have maturity dates within next 10 years. New Treasury bills have maturity dates within next year. Therefore, the conversion has raised the burden of the debt unsustainability.

3. New bunching problem

The bunching is the problem of accumulating debt too much for repayment around a date or a week or a month or a year whare the government will find very difficult to raise funds of huge sums for repayment due to market limitations. The debt unsustainability is primarily connected with the bunching.

12 Treasury bills will add to the bunching problem already confronted as Treasury bills issued in the recent past also become due for repayment in almost every week, given the weekly routine of Treasury bill issuance.

Further, the maturity dates of all new Treasury bonds fall due in 2-4 months period from the maturity dates of new Treasury bonds (each face value of Rs. 267 bn) issued to the EPF on 14 September 2023 under the same DDO process. Meanwhile, there can be several other Treasury bonds and bills maturing around these months. 

Therefore, raising such huge sums of funds to repay all those bonds and bill will be a daunting task to the government. In that context, the only option would be to rollover them at the maturity at contemporary market interest rates as the government will not have such amounts of budgetary surpluses to redeem debt.

4. Conversion into 12 existing Treasury bills not justified

Issuance of Treasury bills is only a delay of repayment of debt by few more months, i.e., 5-12 months in this case. Therefore, restructuring of any Treasury bills held by the NCB into these 12 Treasury bills is meaningless. If any amount of provisional advances is converted into these Treasury bills, the government will confront a new debt service problem in 2024. 

Further, weighted average yield rates of these 12 Treasury bills have not been disclosed to assess whether these bills are financially favourable to the government on DDO. It appears that these are the Treasury bills recently issued at high weighted average yield rates around 28% to 15% which are costly to debt service.

5. Violation of the law

The conversion violates the DDO law and rules authorized by the Minister of Finance under sections 34 and 35 of the Registered Stocks and Securities Ordinance (RSSO) and several other legal provisions governing the government debt.

• First, Minister's DDO authorization does not cover the conversion of provisional advances into Treasury bonds issued under the RSSO. Accordingly, only debt that has been raised through securities (bonds, bills and other negotiable instruments) under any law can be converted into Treasury bonds. However, provisional advances are not securities or negotiable instruments.

• Second, the conversion of debt into Treasury bills is not covered in the DDO authorization. 

• Third, the issuance of Treasury bills is governed by the Local Treasury Bill Ordinance (LTBO) whereas the conversion as provided for in the RSSO is not authorized in the LTBO. The present procedure is to issue Treasury bills with maturities of 91 days, 182 days and 364 days as approved by the Minister of Finance where there is no procedure for part-issuances to the remaining maturities of the existing Treasury bills in the market.

• The Central Bank of Sri Lanka Act certified on 14 September 2023 does not carry any provisions for the issuance of government securities outside government debt laws although it provides for the conversion of exiting provisional advances and Treasury bills held by the NCB into negotiable debt instruments of the government. Therefore, these debt instruments should be issued in compliance with government debt laws.

Therefore, the NCB has violated the DDO authorization by the Minister and provisions of RSSO and LTBO. Policy actions taken in violation of relevant legislation and authorizations become subject to the review by the Auditor General and law enforcement authorities as such violations accrue undue benefits to those who acted in violation. Therefor, violation of laws and public procedures is a publicly punishable offence.

6. Incorrect clarification given in the press notice regarding the benefits of the conversion

It states as "This conversion contributes to alleviating the Government's short-term liquidity pressure whilst preserving CBSL financial soundness and ensuring compliance with the reduction in Net Credit to the Government committed to in the context of the Government's IMF-supported program." Contents are grossly incorrect and deceptive as highlighted below.

• First, the preservation of the NCB's financial soundness by the conversion is baseless because financial soundness of central banks are not questioned or assessed, given their non-profit seeking based money printing business not being subject to bank runs as in the case of other banks and financials intermediaries.
• Second, the alleviation of the government's short-term liquidity pressure is a baseless claim. The government never confronted any liquidity problems to repay dues to the central bank as they have been rolled over without requiring new funds. In fact, converted bonds and bills are likely to cause short-term liquidity problems to the government to service them due to the aggravated bunching problem.
• Third, the compliance with the reduction in net credit to the government under the IMF programme conditionalities is baseless as the total outstanding credit to the government by the NCB does not fall or change because the conversion ends up in the same outstanding amount of credit to different debt instruments. Further, as highlighted above, the conversion does not ease the debt unsustainability problem first raised and publicized by the IMF itself whereas the net credit subject of the IMF is not a part of the debt law relevant to the DDO in the country.

7. Undercover legalization of violations committed on making loans to the government amounting to Rs. 2,713 bn.

The DDO conversion deal has been implemented as unique opportunity for an undercover rectification of violations willfully committed by CB officials in lending to the government for their own interests. Both types of lending have been in violation of relevant provisions and principles of the Monetary Law Act (MLA) up to 14 September 2023 as follows.

• The rule of recovery of each provisional advance within a period of 6 months violated. Instead, advances have been accumulated for outstanding up to 10% of the budgeted revenue annually.

• Direct purchases of Treasury bills were routinely carried out to control or stabilize the yield curve/government securities yields on Treasury bills and bonds at auctions in order to drive market interest rates in line with the requirements of the monetary policy. The relevant practice was to cutoff auction bids at yield rates preferred for the monetary policy targets and to provide the balance funding through the CB's direct purchase of Treasury bills at the auction weighted average yield rates. In some occasions, outstanding amount of provisional advances at the beginning of the year was converted to Treasury bills through a direct issuance by the CB to the CB in order for the government to receive a fresh provisional advance to fund the new budget deficit. This direct purchase practice has been violating the MLA rule that prohibited the CB from underwriting the issuances of government securities whereas the CB was permitted only to submit bids directly to auctions of Treasury bills.

Therefore, relevant senior management of the CB has quietly framed a specific provision in the new CB legislation to convert all such outstanding credit of the CB to the government into negotiable debt instruments over a period of one year from the appointed date. 

The undercover objective was the rectification of the above stated MLA violations. Meanwhile, the DDO was found as the opportune conduit for the rectification job advocated for government debt sustainability.

Accordingly, total such violated credit accumulated as on 21 September 2023 was around Rs. 2,900 bn. i.e., Rs. 344 bn of provisional advances and Rs. 2,556 bn of Treasury bills and securities. This has been continuously criticized by economic and political activists as undue money printing to fund the government. Data show that the present CB Governor's regime is responsible for the most share of such unlawful money printing.

Therefore, the DDO strategy aided the NCB to convert nearly 94% or Rs. 2,713 bn out of the outstanding into negotiable debt instruments. Accordingly, nearly Rs. 187 bn of credit granted through the purchase of government securities still remains as outstanding credit in the NCB books. This amount probably could be government securities purchased in the secondary market under monetary policy operations.

Accordingly, the DDO and new CB legislation have helped the NCB management to launder the CB's unlawful money printing habitually carried throughout the past.

Concluding Remarks

• The NCB management has willfully acted to accrue undue financial benefits to the NCB despite the fact that the NCB should have acted for the benefit of the government in order to improve the public finance from the present status of unsustainability and near-term default of domestic debt as alerted by both old CB and NCB being the official public debt manager and fiscal agent for the past 73 years.

• The violation of the law of land as well as the sprit of the DDO process (envisaged to ease the financial bankruptcy of the government through domestic debt restructuring) is a punishable offence.

• The very objective of a debt restructuring strategy is to ease the borrower's immediate liquidity and financial condition in order to regain the borrower's solvency at a fair cost to creditors. However, this DDO conversion brings undue benefits only to the creditor against the objective of the DDO.

• Given the acute condition of public finance and its adversity on the socio-economic stability of the country and the central bank's utter failure in debt management and fiscal agent for the past 73 years, the best strategy would have been the conversion of central bank credit to a long-term bond with a maturity at least 60 years at a nominal annual interest rate around 1% if the conversion had been designed for the country's macroeconomic benefit and stabilization. This is the continuation of credit as a new book entry. Whatever said and done, the government will never be able to redeem this debt and, if redeemed, the monetary system/the NCB will be risker due to the conversion it to the private credit-based money printing. Therefore, this would be a fair option as even the present conversion doesn't have criteria to justify the particular segmentation of bonds and bills, maturities and interest rates as the conversion is a pure private placement decided by the Superintendent of Public Debt outside his public duties to the proprietary trade account of his employer the NCB. Therefore, the conflict of interest is a serious issue in the governance behind this conversion deal. Further, ample evidence is available on significant irregularities involved in private bond placement system followed by the CB in debt management.

• Overall, it is strange that the relevant Treasury authorities have blindly endorsed the said conversion deal for the NCB irrespective of fundamental concerns discernible over the deal's impropriety as highlighted above.

(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)