Bond Scam II: Way to get out of the muddle



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By Dr. Janaka Ratnasiri


President Maithripala Sirisena announced recently that he would take over the management of the economy of the country as it has been mismanaged all this time. Generally, one would expect bodies like the Treasury, Ministry of Finance and the Central Bank collectively to be responsible for the management of the economy of the country, guided by the policy directions given by the Cabinet of Ministers.


Present economy of the country


The management of the economy of a country cannot be any different to managing the economy of a household. The basic requirement is that the occupants should learn to live within their means. There is also a saying that one should save for a rainy day, which I believe even the Buddha has preached. A life style imposed on Sri Lanka by the West is to live on credit. If a person has a regular income, he need not wait years saving money to invest on something like a house or a motor vehicle, because there are so many financial institutions willing to offer loans, making a profit in the process. But, the burrower must ensure that he is left with some surplus from his income to pay back the instalment on the capital and the interest on time. Otherwise, he is compelled to take further loans probably at high interest to pay back the first loan. Now, this is what has happened to Sri Lanka.


If one takes a look at the government revenue and expenditure statements for the last 20 years given in the Central Bank Annual Reports (which I believe are authentic), some very interesting facts are revealed. Fig. 1 shows the Annual Revenue, Recurrent Expenditure which includes interest paid on foreign and domestic loans and the Total Expenditure, which includes amortized capital payments on foreign and domestic loans taken. It is seen that the revenue was sufficient to meet even the recurrent expenditure only in 1997. Beyond 1998, the recurrent expenditure has always exceeded the revenue, by more than one hundred billion rupees in the last decade. (See fig.1)


If one considers the capital payments, the total expenditure has been more than twice the revenue for most years as shown in Fig. 1. During 1997 – 1999, the excess has been between 39 and 61%, while for the period beyond 2000, the excess was varying between 111% and 142%, except in years 2001 and 2016. (2016 figures are only provisional). The capital expenditure includes amortized payments of the loans taken from foreign and domestic sources.


Servicing the debt already taken


The interest payable on loans which have been included in the recurrent expenditure and this is added to the capital payments on loans which have been included in the capital expenditure and the sum is shown as the debt service payments. Fig. 2 shows these values for the period 1997 – 2016. The country’s entire revenue is just sufficient to meet the annual debt service payments and in a few years, even falling short of the debt service payments. During 1997 – 2001, the debt service payments were between 43 – 80%, while beyond 2002, it was varying between 94 – 115%. It exceeded 100% in 2003, 2009, 2012 and 2013. (See fig.2)


If this has been the real situation with regard to economy of the country, how did the government meet other mandatory expenses including payment of salaries and wages of public sector employees, health care, agriculture and fuel subsidies, etc.? In addition, the government was committed to undertake infrastructure development activities. The shortfall between the revenue and total expenditure has increased from BLKR 144 in 1998 to BLKR 1,000 in 2009, and beyond 2010 has increased to BLKR 1789 in 2015. The government has somehow or other managed to accomplish the impossible task. The public should be grateful to the officials responsible for this accomplishment and enabling them to enjoy all the luxuries in life without returning to the pre-1977 era.


Position of the Central Bank


What does the Central Bank (CB) say about this situation? Chapter 6 of the CB Annual Report 2016 on Fiscal Policy and Government Finance, says the following:


"Even though Sri Lanka’s per capita income has increased steadily over the last two decades, revenue collection has been well below government expenditure, and has not been adequate even to cover recurrent expenditure of the government. Weak tax revenue collection emanating from complex tax laws, various tax exemptions and tax holidays, narrow tax bases, tax evasion and weaknesses in tax administration has resulted in the government revenue to GDP ratio dropping to a level as low as 11.5 per cent in 2014 from over 20 per cent in the 1990s. The low revenue performance has resulted in the government depending more on borrowings to finance the budget deficit. Debt financing has not only crowded out funds available for private investment, but has also exerted upward pressure on market interest rates. Moreover, heavy pressure on market interest rates. Moreover, heavy reliance on domestic bank financing to fill the resource gap has exerted inflationary pressures in the economy while increased foreign financing has led to higher foreign exchange exposure risks. The government has tended to borrow more, even to service the debt, thereby further contributing to debt accumulation over the years.In 2015, for instance, the government spent 90.6 per cent of its total revenue on servicing debt".


Sometime back, government frowned on establishments such as Golden Key and Sakwithiwho were amassing wealth by taking deposits from the public promising very high interest rates and, instead of investing the money in projects to earn dividends to pay the interest, took more deposits to pay interest to previous depositors. Now, isn’t the government doing the same thing? In the words of the CB, if more loans are taken to pay the interest accrued on previous loans, the question is whether there will be an end to this one day or whether it will continue forever?Since this shortfall continues to grow year by year, it is likely this burrowing will continue forever, unless the government in office take some radicle measures.


Meeting the shortfall


The CB Reports also give information on how the government has been meeting this shortfall between the total expenditure and the revenue. The two main components are the foreign loans and domestic loans. Foreign loans are given mainly for specific projects and the rest as commodity loans under various lines of credit and for unspecified purposes. Fig. 3 shows the country’s debt situation during the last 20 years from 1997 to 2016.


Today, among domestic lenders, treasury bonds are the dominant source of government borrowings amounting to nearly 1/3 the total compring both foreign loans and domestic loans. With the gross debt in 2016 standing at LKR 9,400 Billion, by 2018, the gross debt would have exceeded a staggering sum of one quadrillion rupees. The borrowings from treasury bonds show a steady growth from the time the system was launched in 1997. The balance domestic borrowings come from commercial banks, government financial institutions like the EPF, NSB and insurance funds.


Introduction of Treasury Bonds


Prior to 1997, there were no treasury bonds and the government relied on treasury bills to secure loans from individuals and corporate bodies. Attractive interest rates were provided and in fact treasury bill interest rates were the benchmark for fixing interest rates for fixed deposits in commercial banks. Anyone could purchase treasury bills through a designated commercial bank and it was the popular investment for the common man.


During the tenure of the former Central Bank Governor NivardCabraal, at a time when the treasury bill interest rates were above 15% per annum, he all of a sudden lowered the interest rates to about 5% per annum on the pretext of controlling inflation. This resulted in many depositors withdrawing their money in treasury bills and depositing them elsewhere. This is evident from the fact that in Fig. 3, the treasury bill component remain stagnant while the treasury bond showing a steady growth. In 1997 when the treasury bond system was introduced, it contributed only LKR 10 Billion while the treasury bills contributed LKR 115 Billion to the government to meet its day-to-day expenditure when it did not have sufficient funds generated from its revenues.


Unlike the treasury bills, treasury bonds could be purchased only by a few select companies called primary dealers who have the capacity to offer billions of rupees to the government. It was revealed in the recent investigations on the bond scam that these dealers did not have their own funds but took money from government financial institutions to offer loans back to the government. An ordinary citizen may not be able to get an advance from government financial institutions or state banks running into billions of rupees overnight, but these dealers were in a position to so by offering financial benefits to officials at these institutions as revealed at the recent investigations.


To be continued


 
 
 
 
 
 
 
 
 
 
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