ECONOMYNEXT – Sri Lanka is planning to revamp its Treasuries auctions with room for non-competitive bids, with new rules, which are now being vetted by international experts, a top official said.
Central Bank Governor Indrajith Coomaraswamy said the new rules will also be presented to market participants and other stakeholders including the government to comment.
Unlike the Securities and Exchange Commission and the Sri Lanka Telecom Regulatory Commission, and Public Utilities Commission, Sri Lanka’s central bank does not have a strong record of making rules through public consultation.
Financial Repression
Sri Lanka’s Treasuries sales was for years manipulated with ‘private placements’, selling ‘on tap’ at mandated rates, issuing illiquid rupee securities which could not be traded, and large scale purchases of securities with printed money.
These are among fundamental factors that made Sri Lanka a lagging nation in Asia, allowing rulers and bureaucrats to spend people’s money and secretly expropriate their wealth, critics say.
Even after auctions were started in the mid-1990s, rate were manipulated down with placements among government controlled funds, accepting less bids than offered, which delayed the matching of market credit demand with risk free rates.
The financial repression resulting from manipulating rates downward by accepting less bids than offered and other techniques led to general economic mayhem involving high inflation and currency collapses.
The problem is attributed to well-intentioned bureaucratic thinking who distrust markets (the community and human reactions) and place more faith in the coercive power of the state, even when officials have some economic education.
Sudden Change
In 2015, the central bank went into a fully auction based method, with no prior warning and no public consultation under then Governor Arjuna Mahendran.
The central bank also started to accept vastly more bids that previously announced in some auctions involving long bonds, amid protest by officials involved in the auctions, which analysts said effectively rigged the auctions to push rates up.
Coomaraswamy said closed circuit television cameras have been set up at key locations in the public debt department.
Dealers who were aware through insider sources that higher than announced volumes would be taken up were then able to bid unusually large volumes at high rates, critics said.
But in a clear demonstration of the success of markets and price signals it became increasingly difficult for the auctions to be rigged, with market many participants submitting large bids for long bonds.
With volatile rates, other investors also began to leverage, borrowing from banks and buying long bonds.
As a result larger and larger volumes of extra long bonds had to be sold, raising suspicious and generating a public outcry.
Sri Lanka’s new central bank Governor Indrajit Coomaraswamy, halted the practice of selling more bonds at auctions that originally offered.
Transparency
From July 2016, the Public Debt Department, which sells bonds on behalf of the Treasury had started pre-bid meetings where all primary dealers were updated with information of fiscal or other conditions.
"So the same information will be available to all primary dealers as a result of these pre-bid meetings," Coomaraswamy told reporters.
"From June onwards a decision has been taken not to accept anything more than the offered amount.
"Of course sometimes the central bank will accept less if the terms on offer are not attractive for the government but we will not accept anything more than the offered amount."
In the past, by not accepting the offered amount and rejecting bids budget deficits were expanding, the Central Bank allowed money to flow into private credit and sometimes paid much higher rates than at the rejected auction, analysts who closely follow the auctions say.
It is not clear whether a study has been done to find out the success or otherwise of rejecting bids.
A US Treasury expert, who had ‘considerable experience in helping developing markets’ is also in the country looking at, debt, cash flow, management and bond markets, Coomaraswamy said.
A bond clearing house, electronic trading platform and central counterparty is also being set up.
Non-competitive bids
Rules for a new auction process has also been devised with the participation only of bureaucrats up to now.
"The central bank’s public debt department, had consulted all the officials who worked in the public debt area in developing a new set of auction rules," Coomaraswamy said.
"The outcome of the process has been shared with experts from the World Bank, the IMF who are looking at it. We want to get validation of this system before we go live with it. We hope to do so in the first quarter of 2017."
Coomaraswamy said there were plans to consult market participants and other stake holders including the government.
"It is apparent that the level of market development is not sufficient to sustain a pure auction system so we are looking at a hybrid system of competitive and non-competitive bidding," he said.
"Once the system has been validated by international experts we will then consult all the stakeholders and go live with it."
Allowing non-competitive bids is does not necessarily have anything to do with the level of market development, analysts say.
In some markets non-competitive bids are used to allow smaller investors to participate directly in auctions.
Even in the US, where single price auctions are used, arguably the most advanced and liquid Treasuries market, non-competitive bids are used.
In the US, competitive bidding by a single investor is limited to 35 percent of the total offering.
In Sri Lanka non-competitive bids had been suggested as a way to stop the Employees Provident Fund, a pensioned fund of private sector workers, from being pressured to bid low, a long-term problem associated with so-called ‘captive funds’ where ordinary people’s wealth is expropriated by the state.
Central Bank officials said investors who submit non-competitive bids will be allocated at the ‘weighted average’ yield, seemingly indicating that the new auctions also involve multiple price auctions. (Colombo/Nov30/2016)