Treasury's inability to manage debt. Is the COPF an outlier? Who should be responsible for next default?

The COPF's (Committee on Public Finance of the Parliament) recent discussions and investigations on the new Public Debt Management Office (PDMO) reveal that both the COPF and the government have no knowledge on economic and financial fundamentals of the debt and the likely role of the PDMO. Therefore, the COPF seems to be criticizing the PDMO almost on daily basis for its incapacity to manage the mountain of debt inherited from the Central Bank at the end of 2025. 

This debt stock which is claimed to be unsustainable is a cumulative result of the Central Bank managing the debt as part of its monetary policy since 1950. Therefore, the COPF has forgotten that the Central Bank defaulted debt in April 2022 resulting the then politics to decide to transfer of the mismanaged debt stock to the PDMO for better management despite its mismanaged legacy of risks and issues where the COPF expects the PDMO to do all wonders to make the debt stock sustainable.

The COPF's investigations so far have been focussed primarily on five allegations and deficiencies relating to the PDMO. Those are repayment of several foreign debt instalments worth US$ 2.5 mn to hackers, inability to prepare for controlling of the considerable rise of yield rates at auctions of government securities immediately after a sudden and significant hike of policy interest rate by 1% by the Central Bank announced on 26th May 2026, non-availability of foreign currency to service foreign debt in the event the Central Bank does not supply required foreign currency in timely manner, incapacity to commence active liability management operations to reduce risks and costs of the debt stock and inadequate training and general deficiency of the PDMO.

However, the COPF fails to recognize that the PDMO is another newly established state bureaucratic office that lacks resources and freedom to operate an active debt dealing room. Operations of the PDMO are restricted and coordinated by several Treasury Departments whereas banking, settlements and securities accounting are handled by the external Central Bank. Allegation that sufficient training has not been arranged for the PDMO staff from the Central Bank is unwarranted as the Central Bank being the failed debt manger is not fit and proper to train the new debt management staff.

Further, when criticizing the PDMO, the COPF or debt economists fail to understand the nexus between the public debt and money in modern state currency-based monetary systems. Therefore, they believe debt as an fiscal activity separate from the money printing and monetary control of the independent Central Bank. The adherence to this neoliberal myth will no doubt sooner or later kill the PDMO bureaucracy at its infancy.

The present debt market and dealer system is a part of the monetary cartel linked to the Central Bank in several ways. 

• First, dealers are licensed and regulated the Central Bank. 

• Second, the liquidity they require for settlement of trades is provided largely on overnight basis by the Central Bank within its policy rates-based open market operations (OMO) mechanism. 

• Third, the money market liquidity is daily manipulated or regulated by the Central Bank OMO arbitrarily to target overnight interbank lending rates as the single conduit for the monetary policy transmission. In the present context, foreign currency operations of the Central Bank are the major source of changes in the market liquidity on a daily basis as the Central Bank does not fund the government directly. 

• Fourth, bid prices at auctions are highly linked to speculations of primary dealers on the Central Bank OMO and policy rates outlook where such dealers being OMO participants have a close rapport with the Central Bank to serve the Central Bank policy agenda and not the debt sustainability agenda. Therefore, dealers operate as an integral part of the Central Bank monetary policy mechanism whereas debt is only a day-to-day profiteering business to them.

Therefore, both General Treasury and PDMO cannot fight the Central Bank as long as they adhere to the neoliberal monetary ideology which treats the government as a user of money/currency like the private sector. However, in reality, the government is the monopoly printer or supplier of the local currency (legal tender) to the economy where the Central Bank is only the agent of the government to manage its monetary operations on fiscal spending and debt in line with macroeconomic objectives such as growth, employment, price levels, interest rates and exchange rates in a balancing manner.

This framework underlying debt can be clearly understood from the Monetary Law Act (MLA) and Exter Report on the establishment of the monetary system and Central Bank for Sri Lanka in 1950.

Until 1950, the country followed the Currency Board System that issued local currency on its foreign reserve stock of Indian Rupees received on surplus in the balance of payments. Local currency was indirectly convertible into Sterling Pounds through Indian Rupees where banks created money on the reserve of local currency. Therefore, the government like the private sector who did not have the discretionary power to issue local currency for its fiscal needs had to borrow from both banks and public to finance fiscal deficits. Local Treasury Bills Ordinance of 1923 and and Registered Stock and Securities Ordinance of 1937 provided the legal framework for such government borrowings. These legislations with subsequent amendments still govern the government's domestic market borrowings.

In 1950, the MLA abolished the Currency Board and established the state currency monopoly where the government debt and foreign currency reserve of the Central Bank were the prime sources of the currency supply to drive the monetary system. The same still prevails although the MLA was abolished on 14th September 2023. The Monetary Board/Central Bank were established to administer and regulate the state currency-based monetary system for macroeconomic objectives. Therefore, the duties of the Central Bank as the fiscal agent, banker, depository, debt manager and financial adviser of the government were crucial duties in the regulation of the monetary system. 

It is in this context that the Central Bank was entrusted with the immense public powers to decide and implement the national monetary policy comprising both domestic and international  for economic growth, employment and stabilization objectives. Accordingly, the national monetary policy was built and operated on the two pillars, i.e., the management of government debt and management of foreign reserves, where the Central bank was charged with the duty of regulating the supply, availability, cost and international exchange of money created on such management to achieve specified macroeconomic objectives. In that regard, the Central Bank was further empowered to control credit operations of banks and to provide special liquidity lines (refinance) to banks to ensure that money and credit were distributed at favourable rates for development of productive sectors of the economy.

Therefore, the MLA empowered the Central Bank with enormous powers for management of both debt and foreign reserves as specifically provided for in the MLA to enable it to carry out the national monetary policy for specified macroeconomic objectives set out in the MLA. How the Central Bank implemented those powers and its macroeconomic outcomes after 73 years is a different matter.

Some of debt management powers were as follows.

• Grant of provisional advances to the government up to 15% of the estimated revenue of the government for the current fiscal year, subject to every such advance is repaid within a period not exceeding six months.

• Agent of the government for management of the public debt. This led to the famous Public Debt Management Department.

• Agent of the issuance of debt securities of the government and its agencies for their accounts. The Central Bank was permitted to make direct tenders only to issuances of Treasury bills and not permitted to underwrite any issuance of such securities.

• OMO (trade) only in government securities (denominated in both local currency and foreign currency) for purposes of changing the supply, availability and cost of money under the national monetary policy and of changing the liquidity of stabilization of the values of government securities to promote private investments and to prevent or moderate sharp fluctuations in quotations of such securities without altering the fundamental movements in the market resulting from changes in the pattern or level of interest rates. In addition, issuance and trade of own securities were permitted as contingency arrangement for OMO.

• Central Bank to maintain an adequate holding of short-term government securities to enable it to contract its credit (through selling of securities in OMO) in the event such contraction is necessary.

• No government or agency to issue any stock or debentures to raise new loans unless the prior advice of the Monetary Board is obtained upon the monetary implications of such loans or issuances.

• The Monetary Board to make recommendations to the Minister of Finance or to any government agency as to the measures and policies that should be adopted by such agency for the purpose of coordinating its policy with the policies of the Monetary Board. This is mainly for coordination between the fiscal policy and the monetary policy.

Some of foreign reserve management powers were as follows.

• Maintaining an international reserve to protect the exchange rate for the free use of the Rupee for current international transactions and to meet foreseeable deficits in the balance of payments.

• Trade of foreign currencies with commercial banks and determination of exchange rates for such trades and for bank trades with public customers.

• Regulation of foreign currency operations of commercial banks.

• Adopting policies to prevent foreseeable balance of payment deficits and serious decline in the international reserve.

Therefore, the Central Bank managed debt in its capacity as the monetary authority of the country and used its public powers to manage the debt. However, despite all such monetary powers and debt management expertise since 1950, the Central Bank defaulted not only foreign debt but also some of domestic debt raised on Sri Lanka Development Bonds and Treasury bonds.

The major factor that led to the default of debt was the mismanagement of debt for the monetary policy in violation of the relevant MLA provisions listed above. In fact, the Central Bank used the debt as the key instrument to conduct the monetary policy disregarding the specific monetary policy instruments empowered in the MLA. A few such instances are highlighted below.

• The heavy use of private placements of securities to control the yield curve within the monetary policy targets instead of auction-based yield curves discovered from the market. In this regard, the Central Bank had the blessings of state controlled banks and EPF controlled by the Central Bank itself to drive the debt at what ever interest rates it wished. Therefore, the Central Bank did not use OMO to regulate yields as lawfully provided for in the MLA. Instead, the Central Bank used the OMO trades of government securities only to control overnight inter-bank interest rates within the artificial policy interest rates corridor funded by overnight money printing. 

• Underwriting of securities issuances through post issuances of Treasury bills to the Central Bank in violation of the MLA. This was an unlawful contingency to control yield rates in line with the monetary policy. It is unthinkable that the Treasury bills holding of the Central Bank which was reduced to Rs. 6 bn in early June of 2015 from Rs. 190 bn in the middle of January 2015 rose to Rs.2,839 bn at the end of September 2023.

• The heavy use of foreign borrowings to fund the foreign reserve and stabilize the exchange rate and interest rates at level preferred for the monetary policy. A former Central Bank Governor has bravely stated that his regime raised foreign borrowing through Sovereign Bonds alone amounting to US$ 9.9 bn in 2026-2019 just to delay the default of debt. It is this kind of debt management strategy that led to the foreign currency crisis and default of debt in 2022.

It is this catastrophe of the Central Bank debt management that caused the birth of the PDMO. By looking at the monetary powers that the Central Bank had for the debt management, the PDMO is only a debt management clerk operating on some office files copied from the Central Bank without any of monetary or market powers.

Why the PDMO is unable to drive auctions of government securities on most favourable terms to the government is not the inefficiency of the PDMO per se but the nature of the present monetary policy mechanism and money markets controlled by the Central Bank that cannot be challenged by the PDMO or the General Treasury at present.

That is why the PDMO could not control yield rates of auctions held just after the policy rate hike of 1% announced in the early morning of 26th May that disrupted both Treasury bill auction due on the same day and Treasury bond auction due on 27th. 

Yield rates at Treasury bill auctions rose sharply by 1.18% to 1.43% which is more than the policy rate hike on the same day. Yield rates at 6 successive auctions held until 1st July in total have risen by 1.17%-2.05% before slowing down them thereafter to a level of 1.68%-to 1.96% by 28th July.

Meanwhile, yield rates at Treasury bond auction held on 27th for medium-term bonds maturing in 2030, 2033 and 2035 rose to 11.86%-12.93%. The increase in the yield rate on the bond maturing in 2033 is 1.70% from the previous auction held on 12th May. Yield rates of Treasury bond auctions held after three auctions on 30th July for four medium-term bonds maturing in 2031, 2034, 2036 and 2037 stood still at high11.90%-13.01%.

Given the achievement of so-called IMF- defined fiscal discipline and Treasury surpluses, yield rates rising so high beyond 1% policy rate hike is not justified if the treasury market is functioning orderly. The money market in the past two months has largely been in surplus of Rs. 100 bn - 185 bn with overnight call money rates prevailing closer to the upper band 9.25% of the policy rates corridor as pushed up by the Central Bank repo auctions daily offering around Rs. 30 bn - 80 bn. 

If not for such repo auctions, call money rates would have come down around the Central Bank overnight policy rate target of 8.75%. Therefore, overnight call money rates being artificially pushed closer to the upper band is a gross violation of the overnight policy rate based monetary policy announced by the Central Bank on 27 November 2024 (see the press release here ). Therefore, this causes an undue loss to the government on debt.

Therefore, the only reason for such a high rise in yield rates of government securities and cost to the government is the Central Bank monetary policy cartel that the PDMO or General Treasury has no control in the current context of neoliberal economic ideology. However, the Central Bank had perfect control over yield rates under the MLA-based monetary policy prior to the transfer of debt management to the PDMO. Therefore, it is futile to blame the staff of the PDMO for not being able to control the yield rates and reduce the cost on debt stock.

The PDMO or the Treasury also does not have the financial market knowledge and demeanour to drive the money market to its favour. Therefore, the PDMO/Treasury has no option but to wait and see until the money market cartel slows down the yield rates in line with the guidance of the Central Bank. Therefore, only service that the PDMO can offer at this stage is to carry on the clerical work letting the yield rates prevail high through market forces to attract any foreign investments into government securities market as preferred by the Central Bank for its foreign reserve number.

Any cut in the overnight policy rate would not happen soon as the Central Bank is in the deaf-dream of higher interest rates under the cover of 5% inflation target where the inflation in July has further accelerated to 7.3%. Therefore, it is highly likely that the current level of yield rates and cost will not come down materially until global inflation concerns are eased after the US war in the Middle East ends and the US interest rates start come down. However, no economist is able to set any timeframe for this.

(This article is released in the interest of participating in the professional dialogue to find solutions to present economic crisis confronted by the general public. All contents in the article are based on the author's research and views on the subject which have no intension to personally discredit characters or ideologies of any individuals.)

P Samarasiri

(BA Hons Economics, University of Colombo, MA Economics, University of Kansas)

Former Deputy Governor, First Central Bank of Sri Lanka

(35 years of experience in staff class in the Central Bank, inclusive of Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 13 Economics and Banking Books and a large number of articles published.)