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Monday June 24th, 2024

Nick Leeson-style losses at Sri Lanka’s CPC raise big questions: Bellwether

ECONOMYNEXT – Finance Minister Mangala Samaraweera started a price formula in 2018 May just as fuel price started to spike, but the Ceylon Petroleum Corporation (CPC) made a colossal loss Rs104 billion, and the rupee collapsed anyway.

According to finance ministry data, fully Rs82.5 billion of the enormous loss came from forex losses.

Is there a Nick Leeson at CPC or was it moral suasion by an outsider in the Central Bank or Treasury that led to the debacle?

Graph: Bell logo

And in the process, did he/they sabotage Mangala Samaraweera’s price formula, knowingly or unknowingly?

These are essential questions to answer since it will help avert future balance of payments crises and losses at state enterprises.


There is a trail of circumstantial evidence about the debacle.

According to the Finance Ministry, CPC product sales by volume was virtually flat, growing just 0.6 percent to 5,624 million litres in 2018 from 5,591 million litres in 2017.

But, helped by the price formula, revenues jumped by Rs76.9 billion rupees to Rs535.2 billion rupees in 2018 from Rs458.2 billion rupees a year earlier.

Cost of sales grew by Rs105 billion from Rs418.9 billion to Rs523.9 billion rupees.

Graph: Unhedged-od

Note very carefully, CPC recorded a gross profit. This may have been helped by tax offsets also, but that is not an issue.

The entire deterioration in the gross profits was only Rs28 billion.

Other costs, including depreciation, was only Rs32.5 billion. Amazingly sales and distribution costs were down to Rs14.4 billion from Rs15.4 billion, despite all the supposed inefficiencies and overstaffing of CPC.

Profit before forex losses, including depreciation according to these numbers, reversed from Rs8.2 billion in 2017 to Rs21.3 billion loss in 2018.

This is a reversal of 29 billion rupees or only a little over the 28 billion rupee reversal seen at the gross margin level.

The finance ministry report said the operational loss was Rs22.1 billion in 2018, reversing from a profit of Rs7.7 billion in 2017.

This, in fact, is what one would expect, given the price formula.

While oil prices had gone up, according to the Treasury’s own data, they had not gone up so far to generate such colossal losses, over and above the price formula.

Graph:Oil Price

Yet there was an Rs82.7 billion loss from currency depreciation coming from dollar borrowings.

If the above gross margins are accurate, only the cash losses before depreciation, which is about 22 billion rupees should have been covered by bank borrowings. Yet the debt to banks rose from Rs338.2 billion to Rs562.4 billion, which is an enormous Rs224.2 billion rupee increase.

Cover Up

There are other clues. The government’s contingent liabilities from government guarantees rose from Rs652.2 billion to Rs828 billion.

Notes elsewhere show that that there are massive ‘Cover Up’  (whatever that means) loans to the CPC from state banks.

In 2018, a ‘Cover Up’ loan from People’s Bank jumped to US $900 million. There was also a US $700 million loan from Bank of Ceylon. There was also a $200 million balance already drawn by 2017 as well as an Rs67 billion drawdown from People’s Bank shown in 2017.

What precisely a ‘Cover Up’ loan is, will be interesting to find out.

Where did the money go?

It does not seem to have gone to the Ceylon Electricity Board as is the usual case in the previous balance of payments crises. According to CEB accounts in the finance ministry report, total outstanding to the CPC and Independent Power Producers were down to Rs71.6 billion by end 2018 from Rs72 billion in 2017.

The CEB’s own borrowings from banks had gone up from Rs24 billion to Rs67 billion with an operating loss of Rs30 billion. This type of increase in credit would usually be expected when a company runs losses.

CPC Mystery

So then why did borrowings at CPC go up by Rs224 billion? Was it SriLankan Airlines?  According to earlier reports, SriLankan is charged penalty interest; therefore, CPC can well borrow in rupees with the penalty interest.

There is no requirement to borrow dollars and run an unhedged forex loss.

One reason could be that the CPC, in fact, had rupee cashflows, and rupee deposits in banks, which it was not using to buy dollars and settle import bills. Another reason could be that it was funding other government customers, like the military or government departments.

If the second is true, then the budget deficit is understated. If the first is true, it is a significant governance failure both at the CPC and in macro-economic management.

Was the CPC being forced to borrow dollars by the Central Bank or Treasury due to some false Mercantilist belief that if the SOE borrowed dollars, it would help the exchange rate?

In March 2019, accounts of state banks like People’s Bank and Bank of Ceylon dollar loans have fallen. Borrowings from customers have also fallen. But wherever the cash went, it effectively sabotaged the price formula.

Why a price formula?

The reason analysts, including this columnist, has pushed for a price formula is not to raise the price and discourage consumption and ‘save foreign exchange’. While market pricing fuel and electricity definitely make users energy efficient, it is a gradual process, since energy demand is generally inelastic.

The reason market pricing is needed is to balance the external and domestic demand through a process similar to Ricardian equivalence.

When a user buys oil at market prices, he has to curtail the purchase of another good, which will reduce imports. When energy is market priced, there may not be much reduction in oil imports, but non-oil imports have to fall when customers choose oil over other types of consumption.

Individuals are well-qualified to decide what is ‘essential and non-essential’. There is no need for bureaucrats in the Treasury or central bank to decided what is ‘non-essential’.

This is why in 2015, despite the fall in oil prices, imports did not come down and help the ‘balance of payments’ as Mercantilist, including the International Monetary Fund said. When retail oil prices are cut, people will consume more non-oil imports.

That itself should not cause the rupee to fall since the increase in non-oil imports would be balanced by the fall in the oil bill.

The reason the rupee fell was that new money was printed by the central bank by releasing liquidity tied up in term repo deals and giving resources to give unsustainable credit, which was not backed up by deposits.

Extending the argument further, anyone can see that a person faced with rising oil prices, to keep up his previous level of consumption has to cut is savings or dip into his earlier bank deposits.

Either way, the total resources available in the banking sector for new credit would reduce. To keep the same level of credit as before, banks have to raise new deposits – or discourage our man from withdrawing his deposit – for which a rise in interest rates is required.

Therefore it can be seen that even if CPC did not have a price formula, and it ran a loss and funded that from bank credit, as long as the central bank did not control rates and discouraged banks from raising additional deposits the rupee will not fall and the external current account would not shoot up suddenly.

Sabotaging the Price Formula

On the other hand, if the CPC borrowed dollars to pay import bills and deposited the cash inflows from customers in state banks in repos or other deposits, the entire benefit of a price formula would be lost, and it would be effectively sabotaged.

The banks would lend the money in repos or deposits to other customers instead, who will pay their import bills before the CPC. Non-oil imports will not fall despite the price formula. The external current account deficit will shoot up by the amount of new dollar credit the CPC took to delay the payment of import bills.

If the currency is under pressure and the central bank continues to print money after selling dollars, the rupee will fall. CPC or any other importer for that matter will then pay the import bill, after the rupee had fallen, realizing a massive loss.

In the meantime, any remaining dollar debt will be an unrealized loss in the books of the importer. It will be translated into a cash loss when it tries to repay the loan. If there is no cash, the importer or CPC will then be forced to convert the import bill loan to a term loan, because there is no cash to cover the forex loss.

In any case, the external current account of the country will shoot up by the amount of the dollar borrowings of the importer.

In a past balance of payments crisis, the CPC ran its working capital with a loan from Iran. The external current account would then shoot up by that amount.

Central bankers and other bureaucrats then blame the current account for macro-economic instability, when in fact it is the dollar inflow from credit that made the external current account expand.

This is the problem with Mercantilism. Classical economists from Ricardo to Hayek to Mises understood both credit and trade.

Adam Smith also tilted towards the anti-bullionists and the ‘banking school’ type of debate. Mainly he argued that bills discounting did not lead to a permanent expansion of reserve money, which was more nuanced. This is a bit like the central bank saying term reverse repo injections are better than direct interventions in the Treasuries market. But that is a separate story.

But modern-day Neo-Mercantilists cannot make the connection between credit and international trade at all.

This may be because their understanding of credit and monetary systems is weak and modern universities see no reason to teach monetary economics. It is a well-known fact that Keynes did not get the connection between money, credit and trade either (The Keynes–Ohlin controversy).

If the government runs a budget deficit financed by foreign borrowings, there will also be a trade deficit. If private firms borrow abroad or get foreign direct investment, there will be a trade deficit and current account deficit. If the CPC borrows 900 million dollars, also there will be an expansion in the external current account by that amount.

Questions to Answer

There are important questions to answer.

CPC only has little dollar revenues from aviation fuel sales and the like, which far outstrips in rupee sales and dollar imports. Why is the CPC which has rupee revenues allowed to have such colossal unhedged dollar borrowings?

There was a time when even private firms which did not have dollar revenues were not given clearance to borrow dollars. Not that it is the business of government to tell what risks private firms should assume, but CPC is definitely a government business.

Any errors fall on the heads of the ordinary people who have to bear the losses.

Why does the CPC Board of Directors allow it?

Is it because of some Mercantilist pressure from Central Bank or Treasury bureaucrats who mistakenly believe that the ‘Oil Bill’ is the reason for the rupee to fall?

Or did someone in the CPC itself borrow dollars hoping that the rupee will fall later? But can a CPC official run an open position of that nature?

It is relevant to ask the pithy Sinhala question. ‘Kawda mewwater waga kiyanne?’ (Who is accountable for this?).

But it is even more critical to make sure that such debacles do not happen in the future.

Either CPC needs better risk management or people in decision-making positions should learn economics instead of making decisions based on Mercantilist false doctrine.

It is well known that Sri Lanka’s bureaucrats have peculiar Mercantilist fears about the ‘oil bill’.

They undoubtedly think in some voodoo Mercantilist way that oil is different from some other imports. Many believe inflation is caused by diesel; therefore, money is printed to keep diesel prices down.

In the times of classical economists, gold was a hot button. In the early 19th century in the time of Ricardo, it was corn imports.

Today it is oil and cars. Gold remains a hot button as import taxes by both the Central Bank of Sri Lanka and Reserve Bank of India show.

Gold taxes are an overt sign of a Mercantilist fog enveloping the macro-economic policy framework.

Mercantilism may be fine for debating at the coffee table or economic forums. But ignoring economics and acting on Mercantilist doctrine has disastrous consequences for the people.

Private companies can make any number of mistakes.

It is not like Nick Leeson at Bearings where some wealthy shareholders sell the company for one dollar.

Errors of the state and officials are paid for by ordinary people, who will have to pocket it out in taxes.

This column is based on ‘The Price Signal by Bellwetherpublished in the July 2019 issue of the Echelon Magazine. To read Bellwether columns as soon as they are published, subscribe to Echelon Magazine at this link. The i-tunes app can be downloaded from here.

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Sri Lanka central bank appoints two Deputy Governors

ECONOMYNEXT – Sri Lanka’s central bank said Assistant Governors A A M Thassim and J P R Karunaratne were promoted to the post of Deputy Governor.

The full statement is reproduced below:


In terms of the provisions in the Central Bank of Sri Lanka Act, No. 16 of 2023, Hon. Minister of Finance, as recommended by the Governing Board, has appointed Mr. A A M Thassim, Assistant Governor and Secretary to the Governing Board, and Mr. J P R Karunaratne, Assistant Governor, as Deputy Governors of the Central Bank of Sri Lanka with effect from 20.06.2024 and 24.06.2024, respectively.

Mr. A A M Thassim

Mr. A.A.M. Thassim has over 31 years of service at Central Bank of Sri Lanka (CBSL) in different capacities in the areas of Supervision and Regulation of Banking Institutions, International Operations, Communication, Payments and Settlements, Employees Provident Fund, Finance, Risk Management, Deposit Insurance, Security Services and Information Technology.

He has served as the Director of Bank Supervision (DBS), Director of International Operation (DIO) and Director of Communications (DCM) and has contributed towards strengthening the legal framework, governance, implementation the Basel 3 international guidelines for capital and liquidity and adoption of International Financial Reporting Standards (IFRS) 9 to the banking sector, thereby strengthening the resilience of the Financial Sector.

Further, as the DIO, Mr. Thassim was responsible for the investments and management of foreign reserves of the country and exchange rate management. Mr. Thassim has also gained experience and knowledge in the field of payment systems and was involved in the implementation of the Cheque Imaging and Truncation System. In addition, he has also served on several high-level internal committees including in the areas of monetary policy, financial system stability and international reserves.

Prior to the appointment as the Deputy Governor, Mr. Thassim held the position of Assistant Governor and was in charge of several key departments including the Bank Supervision Department. He also served as the Secretary to the Governing Board, Monetary Policy Board, Audit Committee, Board Risk Oversight Committee, Ethics Committee and Financial Sector Crisis Management Committee.

At present, Mr. Thassim is a board member of the Sri Lanka Export Credit Insurance Corporation and the Vice Chairman of the Institute of Bankers of Sri Lanka (IBSL). Further, he has also served as a board member of the Credit Information Bureau of Sri Lanka and LankaClear (Pvt) Ltd.,

Mr. Thassim is an Associate member of the Chartered Institute of Management Accountants (ACMA) United Kingdom and possesses a Masters in Business Administration (MBA) from the Postgraduate Institute of Management (PIM), University of Sri Jayewardenepura (USJ). He has also completed a programme on Gold Reserves Management from Hass School of Business, University of California, Berkeley, USA.

He is also an Alumni of Harvard University, USA having successfully completed the executive programme on Leaders in Development conducted by the John F. Kennedy School of Government.

Mr. J P R Karunaratne

Mr. J P R Karunaratne has over 33 years of service at the Central Bank of Sri Lanka in different capacities in the areas of supervision and regulation of Banks and Non-Bank financial institutions, Currency management, public debt, Secretariat, Finance, policy review and monitoring. He has served as the Director of Supervision of Non-Bank Financial Institutions (DSNBFI) and the Superintendent of Currency (SC) and has contributed towards strengthening the legal and regulatory framework in the Non-Bank Financial Institutions sector and has played a prominent role in the consolidation of the Non-Bank Financial Institutions sector. Prior to the appointment as a Deputy Governor, Mr. J P R Karunaratne held the position of Assistant Governor and was in-charge of the Department of Supervision of Non-Bank Financial Institutions, Finance Department and the Facilities Management Department.

As an Assistant Governor Mr. Karunaratne has previously overseen several other departments namely, Macroprudential Surveillance, Resolution and Enforcement, Foreign Exchange, Currency, Regional Development, Legal and Compliance, Risk Management, Center for Banking Studies, Security Services and Staff Services Management.

He has also served as the Secretary to the Monetary Board, Secretary to the Board Risk Oversight Committee, Monetary Board Advisory Audit Committee and the Ethics Committee. Further, He was on release to the Ministry of Defence, where he served as a Financial Advisor. He was also appointed as the Chief Operating Officer for the Secretariat of Committee of Chartered Accountants appointed by the Supreme Court in 2009.

He has served as the Chairman of the Sri Lanka Accounting and Auditing Standards Monitoring Board and has been a Council Member of the Certified Management Accountants (CMA) of Sri Lanka. Mr. Karunaratne was awarded the CMA Sri Lanka Business Excellence Award at the CMA Sri Lanka National Management Accounting Conference 2023 in recognition of his service to the profession. He has also received “Long Service Award” of the IBSL in 2019 in recognition of his long career and contribution as a resource person at IBSL.

He was the Project Team Leader of the South East Asian Central Banks (SEACEN) Malaysia, research project on “Implementation of Basel III Challenges and Opportunities in SEACEN Countries” and SEACEN published the research in 2013. He serves as a member of several internal and external committees at present.

Mr. Karunaratne holds a Master of Commerce Degree in Finance from the University of New South Wales, Australia and a Postgraduate Diploma in Applied Statistics and a Bachelor of Science (Physical Science) Degree with a First class from the University of Colombo. He is a Fellow Member of the Chartered Institute of Management Accountants (CIMA), UK and a Chartered Global Management Accountant (CGMA). Further, he is an Associate Member of the CMA Sri Lanka.

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Sri Lanka opposition questions claims that IMF housing tax is only for kulaks

ECONOMYNEXT – Sri Lanka’s opposition has questioned claims made by government spokesmen that a tax on housing proposed in an International Monetary Fund deal is only limited to rich people but if as promised by President one house is exempt, it is welcome, legislator Harsha de Silva said.

Sri Lanka President Ranil Wickremesinghe made a promise in parliament that the first house of a citizen will be excluded from the property tax.

Related Sri Lanka to exempt one house from imputed rent wealth tax: President

But opposition legislator Harsha de Silva pointed out that the IMF program documents clearly says taxes will be levied on owner occupied houses on ‘imputed taxes’, not second houses.

Under current inland revenue laws, actual rent income from a second house is already captured as part of taxable income.

The IMF document mentions a threshold value from which taxes will be exempt but not that a whole owner-occupied primary residence will be exempt.

“The tax is imposed on the income of individuals (rather than real property itself) and thus raises central government revenue in accordance with the constitution,” IMF staff said in their report.

“A similar tax was previously included in the Inland Revenue Act. No. 10 of 2006.

“Under this regime, primary residences were exempt and the assessed values for rating purposes were used to determine the base.

“Given the broad exemption and the use of outdated and downward biased annual values, the tax generated hardly any revenue.”

Meanwhile Sri Lanka has promised to impose the housing tax from April 01, 2025.

“…[W]e will introduce an imputed rental income tax on owner-occupied and vacant residential properties before the beginning of the tax year on April 1st, 2025,” the memorandum of economic policies agreed with the IMF said.

“An exemption threshold and a graduated tax rate schedule would make this tax highly progressive.

“The full revenue yield from this tax is estimated at 0.4 percent and would materialize in 2026 (with a partial yield of 0.15 percent in 2025).

“This yield would still fall short by 1 percent of GDP relative to the expected yield of 1.2 percent of GDP from the property tax envisaged for 2025 onwards.”

Presidential Undertaking

“Whatever the President said the IMF agreement says owner occupied house,” De Silva told in parliament.

“It is not the second house that is mentioned in the agreement.

“But there is one thing. I am happy as Samagi Jana Balawegaya, that we have been able to save the middle class in society from a massive tax that was to be imposed.”

In Sri Lanka there is a belief that the most productive citizens are fair game for excessive or expropriationary taxation, just like kulaks were targeted in the Soviet Union for actual expropriation, critics say.

Wealth taxes have had disastrous effects on some US cities like Baltimore, leading to falling populations and dilapidated houses.

Sri Lanka is currently facing a brain drain due to high income tax after on top of depreciation from severe monetary debasement from a flexible exchange rate, which is neither a hard peg nor a clean float.

Sri Lanka has imposed a wide range of taxes on the people to maintain a bloated state, after inflationists engaged in extreme macro-economic policy (tax and rate cuts) glorified in Saltwater-Cambridge doctrine to boost growth, throwing classical economic principles and monetary stability to the winds and driving the country into external default.

The IMF itself gave technical assistance the central bank to calculate potential output inviting the agency to cut rates to close the perceived econometric ‘output gap’.

In the run up to the default, rate cuts triggered multiple external crises, leading to output shocks as stabilization programs were implemented.

Macro-economic Policy

Macro-economic policy as known now was devised by Cambridge academic J M Keynes in the wake of the Great Depression triggered by the Federal Reserve after it invented open market operations and policy rates in the 1920s and also popularized by Harvard academic Alvin Hansen among others.

Macro-economic policy started to de-stabilize countries in peacetime in the interwar years and after World War II it led to the collapse of the Bretton Woods system.

The Great Depression was also a peacetime collapse of what was later known as the roaring 20s’ monetary bubble.

“They have blithely ignored the warnings of economists,” classical economist Ludwig von Mises wrote of European nations which got into trouble from rate cuts and Keynesian stimulus, which brought currency depreciation and protectionism in its wake from the 1930s.

“They have erected trade barriers, they have fostered credit expansion and an easy money policy, they have taken recourse to price control, to minimum wage rates, and to subsidies.

“They have transformed taxation into confiscation and expropriation; they have proclaimed heedless spending as the best method to increase wealth and welfare.

“But when the inevitable consequences of such policies, long before predicted by the economists, became more and more obvious, public opinion did not place the blame on these cherished policies…”


In Sri Lanka however there is some understanding of the role played by macro-economists in the most recent crisis.

There are rumblings of unhappiness about ‘central bank independence’ given to an agency to create 5 to 7 percent inflation and currency debasement under a flexible exchange rate and its constitutional status relating to parliamentary control of public finances.

Sri Lanka’s central bank’s current flexible inflation targeting (inflation targeting without a floating rate) regime as well as its 1980s money supply targeting without floating rate has busted the national currency for decades and made it impossible to run budgets, made it difficult for people build houses which are now to be taxed, and also for millions to live and work in the country of their birth.

Fiscal metrics deteriorate each time rate cuts drive the country into currency crises and new taxes are brought in stabilization programs, ousting reformist governments and leading to policy reversals.

Sri Lanka’s citizens have suffered for decades from the privilege given to a few macroeconomists to print money to cut rates with inflationary open market operations and trigger forex shortages.

Related How Sri Lanka’s elections are decided by macro-economists and the IMF: Bellwether

Critics have pointed out that since 1954 in particular, central bank rates cuts which drive the country into external crises and the stabilization programs that follow, have been the main determinant of elections in the country and election of fringe political parties. (Colombo/June13/2024)

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India supports Sri Lanka Coast Guard to boost maritime security

ECONOMYNEXT – India has given 1.2 million US dollars’ worth spare parts to Sri Lanka’s Coast Guard to be used in a vessel also gifted to the Indian Ocean Island on an earlier occasion, the Indian High Commission in Colombo said.

“Handing over of the large consignment of spares symbolizes India’s commitment to support capability building towards addressing the shared challenges of Maritime Security in the region,” the Indian High Commission said

The spare parts were brought to Sri Lanka on the Indian Coast Guard Ship Sachet, an offshore patrol vessel that was on a two-day visit to the island.

The spares were formally handed over to the Sri Lanka Coast Guard Ship Suraksha which was gifted to Sri Lanka in October 2017 by India.

India has gifted spare parts for the ship in June 2021 and April 2022 and also provided assistance in refilling of Halon cylinders in January 2024. (Colombo/June23/2024)

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