CB governor alleges political ulterior motive in

campaign against him

* Slams DEW and Jayaratne

* Defends son-in-law’s primary dealership
* Justifies BoC bankrolling Perpetual Treasuries bids
* Refuses to divulge details of primary dealers’ bids
* Claims economic growth accelerated after change of govt.

By C. A. Chandraprema-May 19, 2016, 12:00 pm

Central Bank Governor Arjuna Mahendran’s term of office ends in June this year.
There have been calls from opposition politicians as well as good governance
activists for the government to investigate alleged malpractices in the issuance
of treasury bonds during his tenure before reappointing him for another term.
One of the bond issues was investigated by the parliamentary Committee on
Public Enterprises (COPE) but parliament was dissolved just before the day on
which the report of the COPE sub-committee headed by D. E. W. Gunasekera
was to be tabled inP. In this exclusive interview with The Island, Governor
Mahendran contests the allegations against him.

Q. If you look at the front page of The Island today (Wednesday), Mr D. E. W.

Gunasekera has called for an investigation into what he refers to as the ‘bond
scams’ before your term is extended in June this year. He calls this the biggest
scam in Sri Lankan history. Aren’t all these problems due to the fact that you
started going in for bond auctions instead of direct placements as was the
earlier practice?

A. All I can say is that the Supreme Court has vindicated me in the fundamental
rights petition that was filed by Mr Chandra Jayaratne and two others on the
same issue. Mr D. E. W. Gunasekera has a very outdated impression of how the
economy works. In the modern economy the government can’t manipulate
market prices.

One of the issues that I took up after I became Governor was that the
determination of interest rates had not been left to market forces. It was being
done administratively by the people in the Central bank. The rate of interest
should be determined at an auction. That is the way it is done everywhere in the
world. The members of the previous regime say that the interest rates under
that previous system were lower than at the auctions. But that is beside the
point.

My critics are accusing me of arbitrarily raising interest rates whereas the whole
purpose of having auctions is to determine at what price the market will provide
those funds to the government. The government had to borrow vast amounts of
money to pay the salary increases that were announced, both by Mahinda
Rajapaksa and subsequently by President Maithripala Sirisena’s government. In
the past they were using the EPF, the Insurance Corporation and the state banks
to fund the government’s borrowing and artificially set interest rates at
whatever level they wanted to. The problem with that system is that firstly, the
EPF contributors were being short-changed. They can get a much better rate of
interest for their investments if there is an auction. Secondly, the banks who
should be lending this money to private borrowers were instead lending that
money to the government. In Mr Gunasekera’s scheme of things the
government as in a communist state would manage the flow of lending
throughout the economy. That system has now been discredited and is only
practiced in North Korea. Even Cuba has given up that system.

Q. You have told COPE that you introduced auctions to attract more money to
the government and that you wanted to avoid going for a Sovereign bond issue
and to generate more money locally so as to reduce our dependence on foreign
borrowing. But when the interest rate goes up that creates a whole raft of
problems. It increases the government’s debt burden and dampens private
borrowing leading to a slowing of the economy.

A. Private borrowing has not gone down so far. At the moment private
borrowing is growing at 25%. Increases in interest rates have done nothing to
reduce private borrowing. On the contrary we are worried that private
borrowing is too high and that is why we are tightening up.

Q. What about the fact that the rising interest rate increases the debt burden on
the government?

A. The point is that if the government is to pay higher salaries it has to get the
money from somewhere. I increased the size of the auctions. Earlier auctions
were for one billion and amounts like that. I made it 10 billion and we
immediately got the money. There is enough money in Sri Lanka. All I did was to
get it from the public, instead of robbing the EPF, the state banks and the
Insurance Corporation.
Q. You have referred to an ‘explosion’ in government spending which made it
necessary to attract more money into the system. You have, in particular,
mentioned the mini-budget in January last year at the COPE inquiry.

A. President Mahinda Rajapaksa also announced an increase in public sector

wages in the 2015 budget.

Q. But not to the same magnitude.

A. You can argue the point. But, Since the announcement of the presidential
election in 2014, there was a ramping up of government spending and there was
a cut in the price of petroleum products. The previous CB Governor had left a
500 million USD bond to be repaid in February 2015. We didn’t have enough
money to pay that and I had to reach out to the Reserve Bank of India and
borrow some money. We were in a parlous situation where the bills were
accumulating. The immediate reason why we went for that big auction at the
end of February 2015 is that the RDA had informed the cabinet sub-committee
that they needed Rs. 75 billion. That is why I went to the Public Debt department
on the day of the auction and asked how much we could raise because the
government needed more money. They said there was 10 billion available even
though we had advertised only for Rs. one billion. So I said take the whole 10
billion. The interest rate we advertised was 12.5%. We didn’t pay anything more
than we had advertised.

Q. This contested bond issue was for 30-year bonds. Bonds with such maturity
period are taken only by long term investors like the EPF, ETF and the Insurance
Corporation ...

A. That is complete nonsense. No primary dealer to date has contested any of

these bond auctions.
Q. I was not referring to primary dealers ...

A. I know. But, people who say that only the EPF, ETF and the Insurance
Corporation invest in 30 year bonds are talking through their hat. Last week we
had a bond for 15 or 20 years which was bought by foreigners and local pension
funds.

Q. In other words, organisations that need long term investments. Why was a
direct placement system not feasible among institutions that need such long
term investments?

A. Because we don’t want to deprive the private pension funds of access to

these bonds. The EPF has to compete with private pension funds and other fund
managers in the market for this money.

Q. Couldn’t these bonds have been placed with the private pension funds as well
the same way they were placed with the EPF and ETF?

A. Then there is no point in having a market. We can’t go back to a Soviet Union

style planned economy. Even the interest rate has to be market determined.
Otherwise, we will have a shortage of money in the country.

Q. What you said before COPE was that in that instance, you needed Rs. 13
billion. You managed to raise 3 billion and needed 10 billion more. Then you
advertised to sell treasury bonds for Rs. one billion at 12.5% but after the bids
came in you accepted 10 billion. Half of it went to Perpetual Treasuries in which
your son-in-law has an interest. The three directors of the holding company that
owns Perpetual Treasuries was your son-in-law, his father and the sister of
previous Governor of the Central Bank. It was in other words a family owned
company. Of the Rs. 20 billion in bids received, 75% or Rs. 15 billion was by just
your son in law’s company bidding on its own and through the Bank of Ceylon.
How would that look like to an outsider?

A. In the Supreme Court we argued that in this auction process which is

conducted electronically, nobody can decide who is going to get a preference.
They all bid on the interest rate that they are prepared to pay the government.
All those who had bid at the rate of 12.5% that we had asked for, got it. Those
who had asked for a higher interest rate did not. So this company in which my
son-in-law has an interest and by the way he had resigned from the board of
directors ...

Q. But he was still in the holding company...

A. In the holding company but the point is he had no day to day dealings with
that company. It was being done by a professional set of managers. He had
recused himself the moment I became governor just to see that there was good
governance. There was no way that anybody could have anticipated that his
company was going to get 50% of the bond issue because it’s all automated and
done electronically. That was the gist of my argument in the Supreme Court. It
was just fortuitous that he managed to get that 50% by borrowing from the
Bank of Ceylon and all that. That is what the primary dealers do every day.

Q. Mr J. D. K. Dharmapala, who was the chief dealer in the Bank of Ceylon, said
that he had taken the risk of putting in this bid on behalf of Perpetual Treasuries
for Rs. 13 billion (bids of 3,5 & 5 billion) because he never expected it to be
accepted. Firstly, only bonds worth Rs. one billion had been advertised and even
though the advertised amount may be exceeded two or threefold, it has never
before gone as high as 10 times the advertised amount. Furthermore, he said
that the bids were for an interest rate of 12.50% when the going rate was
9.50%. So, he never expected any of these bids he put on behalf of Perpetual
Treasuries to be accepted.

A. That again I completely contest. That was the first auction we had. Earlier
private placements were yielding this 9.5%. So, his assertion that the earlier rate
was 9.5% was complete nonsense because we announced that this was going to
be an auction. This is precisely the mentality that we were trying to change. He
was assuming that these private placement rates would continue in the auction.
In an auction you don’t agree on interest rates. Earlier they were using artificial
means to suppress interest rates.

Q. You have also said that you had to go for that particular bond issue because
the government had tried to increase the treasury bill limit from 850 billion to
1,250 billion but that the legislation did not go through parliament. Then you
were compelled to resort to issuing treasury bonds. Were you a victim of
governmental incompetence?

A. Look, the reason why the bill was defeated in parliament was because the
government did not have a majority.

Q. There was also this argument that you could have borrowed at a lower
interest rate. It was pointed out that two year bonds for example carried an
interest rate below 7% and instead of going in for a 30 year bond, there could
have been a combination of maturity periods which would have enabled the
government to borrow at a lower cost.

A. The following week after this bond issue we raised Rs. 100 billion in two or
three auctions and there we had bonds maturing in 2, 5 and 7 years. We have
been issuing bonds with varying maturity periods. It just so happened that on
that particular day it was a 30-year bond. Pension funds need long term bonds.
There are other investors who want short term bonds. So, we have to cater to
diverse needs and we need to push maturities into the future so that we don’t
have the bunching up of repayments. In 2019 we are going to have a massive
bunching up of repayments because several bonds are coming due in that year.
The investors in the market already know that. So as we get into 2018, I am sure
interest rates will go up not because of any economic reasons but due to the
bunching up of maturities in 2019. There is something called liability
management where we try and smooth out the stream of repayments of these
bonds. That is the reason why we issued a 30-year bond.

Q. One of the reasons why this particular bond issue became so controversial is
because it was the first time that one primary dealer had bid on behalf of
another primary dealer...

A. No that’s complete nonsense. There were several instances before that when
primary dealers had bid on behalf of each other.

Q. Then the fact that over ten times the advertised amount was accepted was
unusual.

A. There had been instances in the past where the advertised amount was
increased by over ten times. In March and November 2014 I pointed out two
instances where bids over 10 times the advertised amount was accepted.

Q. As the Governor of the Central bank which oversees the operations of

commercial banks, how would you regard the fact that the Bank of Ceylon put in
a bid for 13 billion on behalf of Perpetual Treasuries and it was reported to COPE
that the BoC made a measly profit of just Rs. 234,000 on that transaction of Rs.
13 billion.
A. Work out the interest rate on Rs. 13 billion for six or nine hours. The moment
they bought the bonds it would have been transferred to the books of the
primary dealer and they would have given that money to the BoC. That short
period where they held it on behalf of Perpetual Treasuries would have been the
period for which interest was charged.

Q. Perpetual Treasuries placed bids for Rs. 2 billion and the remaining Rs. 13
billion in bids was placed on their behalf by the BoC. Isn’t this a case of
Perpetual Treasuries making money off the BoC?

A. That’s the standard practice. The BoC has a treasury which lends money for
short periods of time at high rates of interest. That is one activity of a bank.
They lend surplus funds in the open market at high rates of interest instead of
keeping that money tied up in an investment earning only 6%. If that money had
not been lent to Perpetual Treasuries, it would have been lent to some other
organisation. That happens every day in the money market. To accuse PTL of
malfeasance in that regard is complete nonsense.

Q. There is also this issue of institutions like the EPF, ETF, the Insurance
Corporation and the government banks having to buy these bonds on the
secondary market from private primary dealers. There is the allegation that the
interest rates on long term bonds are being pumped and dumped on these
institutional investors.

A. Any allegation of pumping and dumping has to be proved. There is no

evidence of collusion in the market. As I said the bidding system is purely
electronic. There is no way people can collude and fix this. There are about 15
primary dealers who are bidding every day including the EPF.
The EPF has to see to it that they get what is required. If they can’t do that then
they have to go to the secondary market and buy these bonds. No other country
allows institutions like the EPF to bid in the primary market. Normally, primary
auctions are only open to primary dealers. But, as an exception we have allowed
the EPF to be there. The EPF gets money on a daily basis from their contributors.
If they keep this money in a fixed deposit they will get only 6% whereas if they
buy a bond in the secondary market they will get around 8, 9 or 10%. They buy
bonds in the secondary market because they can’t wait for the next auction
which may be two weeks away.

Q. These auctions were started for the sake of transparency. But now there are
accusations of opaqueness in the auction system. Mr Chandra Jayaratne has
written to the Monetary Board asking for the names of the primary dealers who
bid at the auctions held this year, and the amount of bonds that had been sold
by private primary dealers through the secondary market to institutions like the
EPF, ETF, the Insurance Corporation and the state banks.

A. Nowhere in the world are the details of the primary auctions released to the
public. That will lead to a lack of confidence in the market. These primary
dealers have their own clients who want confidentiality. If I were a billionaire
like George Soros, I wouldn’t want the whole world to know where I am
investing my money. That is why we keep these details confidential. I am
surprised that Mr Chandra Jayaratne with all his experience does not
understand this. This is why I feel that there is a political ulterior motive in all
these comments. I challenge Mr. Jayaratne or anybody else to show me a
market that practices global standards of corporate governance where the
details of dealers or brokers’ customers are revealed to the public. That simply
does not happen. It is the curse of Sri Lanka that intellectuals are trying to get us
to do things which are totally unfamiliar to any organised market in the world.
You will immediately drive away the significant investors in our market by even
suggesting this. So they are doing a national disservice by even making such
suggestions.
Q. When the UNP was in the opposition it alleged that the figures issued by the
Central Bank were cooked and that all these good indices publicised by the
Rajapaksa government were too good to be true. But in the Central Bank report
that you put out you have followed the same trajectory.

A. We have dramatically changed the GDP figures. What we have shown now is
that the economy was growing at half the rate at what was portrayed. Up to
2014, they were saying that the economy was growing at 7 to 7.5% and nobody
believed that. I was living overseas at that time and I was amazed that we could
grow like that because we had a drought in 2012 and 2013.

Secondly, in 2012 the Central Bank savagely cut the growth of bank credit under
the IMF programme. Then they devalued the rupee which also affected
consumers’ incomes. Finally, there was the collapse in the price of gold. So with
all that going on, for the economy to grow at 7.5% was unbelievable. When I
came to the Central Bank we looked at the numbers and we issued the annual
report in any case because that was all we had. It took us about six months to
dig deeper and when the GDP series was rebased we issued the new numbers
which indicated that in 2013 the economy grew at 3% and in 2014 it was 4.3%
and in 2015 it has risen to 4.8%. But we shouldn’t make this a political game.
We accepted the fact that there was a misstatement of the GDP figures. But
then again we don’t want to show the rest of the world that we have been
doctoring our figures. If we do that confidence in our markets will disappear. We
have to be responsible and portray to the rest of the world that there may have
been some bona fide mistakes in calculating these numbers and because of the
rebasing the numbers changed. But we can’t thrash the former government or
indulge in political muckraking to the detriment of the national interest. We
must show that there are a professional set of people who run the government
irrespective of which political party is in power.

Q. Sri Lanka was in an IMF programme from 2009 to 2012. Is it the case that the
former government has been deceiving even the IMF with these bogus figures?
A. All I can say is that we found that there were several borrowings and
contingent liabilities by the government in the form of guarantees given by the
treasury to several institutions like Sri Lankan Airlines etcetera which even the
IMF was not aware of. So much so that the IMF sent in a special forensic
investigation team in February this year to investigate these findings and now
we have got a better picture of all those hidden borrowings which suggest that
the fiscal deficit which was reported at about 5.7% in 2014 was actually much
higher than that. The government had borrowed a lot of money particularly
from the NSB for road development projects. Window dressing practices were
used to try and reduce the fiscal deficit number.

Q. So the former government did mislead the IMF?

A. Well, it appears to be the case. There appears to have been some element of
window dressing. Remember that these are not illegal practices. Within
accounting standards and practices there are ways of trying to massage the
numbers to make them look better than they really are. We have decided to
come clean now. Last year the fiscal deficit shot up to 7.4% because we paid off
a lot of these arrears. We flushed all these problems out of the system, hopefully
to start 2016 on a new footing where we have absolute transparency in our
numbers.
Posted by Thavam