ECONOMYNEXT – Sri Lanka’s Central Bank Governor Arjuna Mahendran said he did ask a tender board to accept bids of 10 billion rupees or an ‘even larger quantity", at a controversial auction in February but he was in the corridor and not inside the room where bids were assessed.
"I was not in the dealing room, Madam," Mahendran responded to a reporter at a media briefing Friday on whether he had gone into the room where a tender for Treasury bills was in progress.
"I was in the corridor just outside the Public Debt Department approaching the Superintendent’s (of Public Deb) room to ask her precisely this question.
"’We have to raise a large amount of money for the government this afternoon’, and I wanted to ask how she was proposing to do that.
"I was nowhere, anywhere near this electronic trading system or any of the paraphernalia that goes into the whole bidding process."
A 30-year bond auction on February 27, a Friday, where 10 billion rupees of bids were accepted from the market sending the average yield soaring to 11.73 percent from recent market rates of around 9.00 to 9.50 percent.
After the auction Sri Lanka’s bond markets came to a standstill for almost two days as shell-shocked dealers were unable to price and quote bonds of any maturity after the 30-year yield rocketed over 250 basis points in a single day.
Mahendran and the current administration is in hot water for allegedly pressuring the tender board to sell large volumes of long bonds at sharply higher rates in February after initially calling bids for only a billion rupees of bonds.
Five billion rupees of the bonds were sold to Perpetual Treasuries a company connected to Mahendran’s son-in-law. Out of the 5.0 billion, 3.0 billion rupees of bonds were sold to yield 12.50 percent, for a bid that came via the Bank of Ceylon.
Mahendran insisted that his involvement in the auction was not "beyond established procedure."
A decision had been made to sell all bonds through auctions but it was not communicated to the market properly, he said.
He said he asked the Superintendent of Public Debt and senior officials how to find 10 billion rupees by the following Monday. The tender board had recommended that only 2.6 billion rupees be accepted from the market at the auction.
"This was Friday afternoon remember," Mahendran said. "Up to that Friday afternoon for most of the week they had only been able to raise a maximum of 3.5 billion rupees. So it seemed inconceivable that in the remainder of the Friday afternoon we could raise 10 billion.
"And that was my suggestion to the tender board. They then had every possibility of rejecting my advice. In fact initially when they said there was 20 billion available I said, ‘Shall we take even a larger quantity?
"Then they said that was not feasible because some of those bids were dummy bids etc. And when I said 10 billion then they said that is more feasible."
Reporters repeatedly questioned Mahendran whether he had asked the tender board to accept up to 20 billion rupees of bids.
"I suggested that they borrow 10 billion yes, because there was no other way we could raise it," he said.
"Can we move away from this topic please, I want to discuss something more positive about Sri Lanka than an auction that is long over," Mahendran said after the same question was asked for the third time.
The balance 10 billion rupees of bids for the auction had also came from Perpetual Treasuries with one 5.0 billion rupee bid coming at 12.75 percent and another at 12.99 percent also via Bank of Ceylon, according to information that was uncovered later.
Mahendran insisted that there were no alternative ways to borrow the money.
He said Treasury bills, which were short term securities, could not be sold to raise the money.
"Treasury bills are obviously issued at a lower rate of interest. But remember that there is a limit on how much the government…the Central Bank can issue Treasury Bills, particularly to itself to fund the government. And that limit was close to being reached.
"And there again we always try and keep a buffer on the amount of Treasury bills that are bought by the Central Bank at any point of time and there again I do not think that it was a feasible avenue to raise money.
"That is why we thought the Treasury Bond market was still the best way to raise this money."
However the 30-year bond is the most expensive bond to sell, as it has a limited set of buyers. Analysts say medium term bonds ranging from 2 to 7 year bonds could have been sold.
Analysts say if the government believed its own forecasts that budgets would improve over the next few years, it should have sold medium term bonds and sharply cut sales of long bonds.
The strategy should have been to at least flatten the yield curve as much as possible, even if it was not possible to actually invert it.
It was also not clear what limit on Treasury bills Governor Mahendran was referring to or whether he was confused about provisional advances from the Central Bank to the Treasury or the total T-bills outstanding issued by the state, on which there is also a limit.
In fact analysts have suggested that the lack of limit on Central Bank Treasury Bill holdings is the key source of instability to the economy.
If a limit is placed on Central Bank holdings of Treasury bills the agency will no longer be able to generate forex shortages, balance of payments crises, or high levels of inflation and de-stabilizing the economy.
Analysts say both provisional advances and purchase of T-bills by the Central Bank which is monetizing debt, are the most dangerous ways of raising money, though data shows that both methods were used this year.
Mahendran said he also did not want to advocate the use of a bank overdraft because it ‘crowded out’ private borrowers.
"When we looked at the overdraft position it was already much over 100 million (sic) rupees, I think from both the Peoples Bank and Bank of Ceylon the government had already borrowed 120 or 130 billion," he said.
"I did not think it was a good measure to borrow some more. Remember when the government borrows on such a large scale that it means that business, particularly small businesses get crowded out.
"They do not have access to finance because large amounts of money are going to the government. That is not desirable.
Reporters pointed out that Perpetual Treasuries by its actions had in fact ‘overdrawn’ the Bank of Ceylon through a swap deal. But unlike a direct overdraft at a lower rate, the Treasury had to pay 30-year bond yield, the most expensive gilt yield in the economy.
"If it was not the bank of Ceylon it may have been someone else," Mahendran replied. "The bank of Ceylon had sufficient surplus liquidity to give it out. But remember these bond don’t stay in one entity’s hands.
"So if the Bank of Ceylon bought it they would have off loaded it within a short time to somebody else whether it was to that company to anybody else is the question. So Bank of Ceylon would have got that liquidity back.
"Whereas if the government went for an overdraft then definitely it would have crowded out because there the government would not have been able to re-finance the overdraft in such a short period of time."
But analysts say an ‘overdraft’ is not a term loan, and are also supposed to be repaid like the Perpetual Treasuries swap by a later bond sale.
Data already made public shows that the Treasury was expecting to run an overdraft of up to 226 billion rupees by April 2015. But the overdraft was sharply under budget at 168 billion rupees, and was in fact below the January figure of 180.7 billion rupees.
Mahendran said a decision was made to auction all bonds and discontinue private placements but admitted it was not communicated to the market. He insisted that the full-auction process was a success.
He said the supply response to higher auction rates "was tremendous," as large volumes of bonds were sold in March.
"I think the supply response was what overwhelmed everybody."
Though there are also questions on how a large bond maturity on March 16 was managed, analysts say Mahendran is right about the supply response at least.
The Central Bank had in the past engaged in private placements which blunted price signals and therefore the supply response. Some analysts blame this on a bureaucratic distrust of markets that exists among many state officials.