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Thursday February 9th, 2023

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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Thousands of Sri Lankans protest against tax hike

ECONOMYNEXT – Thousands of Sri Lanka’s highly paid state workers protested against tax hikes, citing it as ‘unfair’ with most of them have been caught into the tax brackets for the first time.

The tax hike protest also saw hundreds of private sector workers also gathered in Colombo Fort, demanding a downward revision of the newly implemented taxes.

The protesters later went to a central Colombo Hyde Park to continue their agitation after a court order issued them to clear the area.

Under a theme of ‘Repeal Oppressive Tax Refers’, workers representing 40 trade unions including all private and public sector banks, university lecturers, Port Authority, Ceylon Electricity Board (CEB), Government Medical Officers of Health participated in the protest.

“We don’t mind paying taxes, we know we have to contribute to government revenue,” K L Chandana, representing CEB Engineer’s Union told EconomyNext.

“Moving from one tax bracket to a higher tax bracket is unrealistic, especially with the inflation and global factors. Earlier we were in the green to pay taxes because the country wasn’t in hyperinflation and we had a better quality of life, but our income don’t match with inflation. So there’s no way we can squeeze another expense.”

The ongoing economic crisis has forced President Ranil Wickremesinghe’s government to impose high PAYE and personal income taxes up to maximum 36 percent depending on their income.

A person who paid a tax of 9,000 rupees on a 400,000-rupee monthly income will now have to pay 70,500 rupees as income tax, the latest data showed.

The government took a step back to exempt some allowances partially including for fuel, driver, and vehicle, a government document showed.

“We don’t mind paying fair taxes, we paid them earlier,” Udaya Ekanayake, an Administrative officer from Anuradhapura told Economynext.

“We are opposed to taxation because it is not in line with the economic crisis, inflation is exceeding 50 percent and we are being taxed by 32 percent.”

Meanwhile, the Government Medical Officers Association Media Spokesman, Chamil Wijesinghe said, the protest was the first warning and that if the government fails to respond, the unions will bring the country to a standstill.

“If the government still can’t understand, we are ready to take further actions and we will make the country come to a standstill,” Wijesinghe said.

A renowned actor and a new member of the Ceylon Mercantile Industrial Union Peter d’ Almeida told EconomyNext that the government should bring in higher corporate taxes and taxes on the super-rich reducing the burden on the general public.

“These people had enough of the burden which has been placed on people, with the so-called tax reforms and increased price in utilities, and the general increase in the cost of living,” Almeida told EconomyNext.

“And the sad part is people who ruined this country are still in power and it is people who have nothing to do with this facing the burden of rebuilding the country.
That is unacceptable.”

“A very high cooperate tax and taxes on super rich including wealth and capital gains should be in order.”  (Colombo/ Feb 08/2023)

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Sri Lanka stocks edge up after President’s policy statement amid protests 

ECONOMYNEXT – Sri Lanka shares edged up on Wednesday on dull sentiments over rising protests against tax hikes, which is also expected to hit corporate earnings in the face of reduced consumption, analysts said.

“The President’s address in Parliament assured that the country would be seeing tough times in the road to recovery and that taxes are here to stay,” an analyst said.

Protests were staged against the tax hikes on Wednesday in capital Colombo citing it is “unfair” and does not comply with cost of living especially since income has not reflected inflationary hikes.

If protests resurface, investors could pull down investor momentum towards shares, the analyst said.

“The investors are looking at a positivity towards the IMF, there is no concrete confirmation on that but they are looking at a positive direction with the IMF,” the analyst said.

All Share Price Index (ASPI) edged up by 0.13% or 11.59 points 8,987.45

“Investors are willing to invest if macroeconomic conditions come into place and there are further developments to an assured IMF deal,” an analyst said.

President Wickremesinghe said that Sri Lanka had reached the final stage of negotiations with the International Monetary Fund and that a basic agreement last September was agreed for and now there is the debt sustainability program.

The Central Bank expects the IMF deal to be finalized by the end of the first quarter or fist month of second quarter.

Sri Lanka got assurances from India, Paris Club and China towards debt restructuring in order to secure 2.9 billion dollars for an IMF loan.

The IMF has so far only accepted the letter of debt re-structuring sent by India.

However, the IMF has still not approved restructuring assurances from Paris Club and China.

China’s Exim Bank has given Sri Lanka a two-year moratorium on its defaulted loans and will discuss additional re-structuring within the ‘window’, the Chinese Foreign Ministry spokesperson Mao Ning said last week,

“The international support demonstrates that we are on the right path,” President Wickremesinghe said.

John Keells Holdings has been receiving high amounts of foreign buying after announcements with regard to the opening of Cinnamon Life in 2025.

The most liquid index S&P SL20 closed down at 0.09 percent or 2.63 points to 2,782.56.

The market saw a turnover of 1.1 billion rupees today, comparatively lower to the year’s daily average of 1.9 billion rupees, and significantly lower than the 2022 average turnover of 2.9 billion rupees.

The bourse saw a net foreign inflow (NFI) of 291 million rupees.

Top losers during the closure was HNB, LOLC, DFCC.

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Sri Lanka opposition mum as monks burn India-backed constitutional amendment

ECONOMYNEXT – As sections of Sri Lanka’s Buddhist clergy took to the streets against a proposed full implementation of an India-backed constitutional amendment to resolve Sri Lanka’s ethnic issue, the country’s opposition parties remained mum on the protests and on their own stance on devolution.

Opposition National People’s Power (NPP) leader Anura Kumara Dissanayake when asked by a journalist about the monks’ protest on Wednesday February 08 claimed that President Ranil Wickremesinghe had set a trap.

“I ask the people of this country to not get caught in this trap. What Wickremesinghe wants is to brush the real problems aside and bring out other problems to create a disturbance in society,” said Dissanayake.

The NPP leader said President Wickremesinghe will not fully implement the 13th amendment to the constitution as repeatedly assured by him.

“He won’t bring it. He plays this game every time. He wants to set fire to this country and protect his power,” he said.

Dissanayake did not elaborate on his party’s position on the 13th amendment.

A group of Buddhist monks staged a protest against the amendment near the parliament complex Wednesday morning as President Wickreemsinghe told MPs that he is committed to devolving power within a unitary state as a permanent solution to the island nation’s decades-long ethnic issue.

Tensions rose at the protest as police tried to block the monks who only dispersed after an official from the presidential secretariat spoke to them and assured a response from the president.

Some of the monks set fire to a copy of the 13th amendment in full view of the media and police personnel in a scene that was eerily reminiscent of Wickremesinghe’s United National Party (UNP) burning a draft bill of a new constitution presented to parliament by former President Chandrika Bandaranaike Kumaratunga’s government in 2000 also a solution to the conflict.

Meanwhile Sri Lanka’s main opposition the Samagi Jana Balawegaya (SJB) has yet to make its views known on the rising opposition to the 13th amendment from nationalist quarters.

A small number of MPs on both sides of the aisle have expressed their opposition, but the president has said he will go ahead with full implementation.

The SJB boycotted a recent all-party conference (APC) on the ethnic issue but said it supports devolution of power, though the party has yet to articulate its position on the amendment’s full implementation.

Wickremesinghe told parliament on Wednesday that there will be no division of the country, contrary to fears expressed by some Buddhist monks.


Sri Lanka president reiterates commitment to devolution within unitary state

The 13th amendment to Sri Lanka’s constitution emerged from the controversial Indo-Lanka Accord of 1987 as a purported solution to the worsening ethnic conflict, four years after war broke out. Provincial councils came in the wake of this amendment, though land and police powers have yet to be devolved to the provinces as originally envisioned. Both Sinhalese and Tamil nationalists have historically opposed the amendment, the former claiming it devolved too much, the latter complaining it didn’t devolve enough.

A full implementation of the amendment would see land and police powers devolved to the provinces, a development that is not likely to garner support from Sri Lanka’s more nationalist-oriented parties including sections of the ruling Sri Lanka Podujana Peramuna (SLPP).

Meanwhile, India has expressed its support for Wickremesinghe’s assurances that the amendment will be fully implemented. India’s support is crucial to the cash-strapped island nation as it struggles to recover from its worst currency crisis in decades. India has officially communicated to the International Monetary Fund (IMF) that it will support Sri Lakna’s debt restructuring process, which is a prerequisite for a desperately needed 2.9 billion dollar IMF bailout.

The leftist Janatha Vimukthi Peramuna (JVP), which controls the NPP, staged a violent insurrection in the late 1980s in opposition to the Indo-Lanka Accord. Former President Ranasinghe Premadasa also opposed the accord signed by his predecessor President J R Jayawardena.

Meanwhile, Jaffna district MP an former Northern Province Chief Minister C V Vigenswaran on Wednesday welcomed the president’s decision, while noting however that the 13th amendment falls short of the aspirations of the Tamil people.


Sri Lanka reconciliation: Vigneswaran backs president, wants monks not to interfere


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