By Arjuna Mahendran –
‘We all know what to do, we just don’t know how to get re-elected after we’ve done it” ~ (Jean-Claude Juncker)
In March 2015, the then Minister of Finance presented a bill to parliament for the limit on government Treasury Bill issuance to be raised from Rs. 750 bn. to Rs. 1,150 billion. Treasury bills (as opposed to bonds) are short-term borrowing instruments issued by the government with maturities of less than 12 months. They are critical because the central bank, in terms of its statute, can only buy short-term bills and is prohibited from buying longer-term bonds. Thus, when financial markets are short of fresh funding, threatening potential spikes in short-term rates of interest, the central bank prints new money and alleviates such funding shortages by buying these bills. By February 2015, the total issuance of treasury bills had exhausted the Rs 750 bn. limit.
The parliamentary bill was to be taken up for debate in parliament on the 8th of April 2015, due to its urgency. In the short-lived spirit of cooperation between the two major political parties in parliament, the UNP and SLFP, helmed by the former Prime minister and the former President respectively, it was expected that the increase in the limit on Treasury bill issuance would proceed smoothly. After all, the interim budget of the new administration had just been approved by an overwhelming majority of parliamentarians in February 2015.
However, when the time for voting on the bill came up, a junior member of the parliamentary opposition benches observed that the bulk of the government benches were empty and he called for a vote. The Speaker of Parliament allowed the vote to proceed. The motion to increase the limit on issuance of Treasury bills by the government was defeated on the 8th of April in Parliament by 21 votes. Later that day, senior members of parliament from the opposition held a press conference to ask the minority government to resign. It gradually became clear that MPs from the SLFP and other opposition parties had persuaded their colleagues to defeat the bill.
The leader of the opposition was contended by the UNP to have undertaken that the bill would obtain support from the SLFP MPs. However he later backtracked and stated that he merely indicated that his party would permit the bill to be debated on its merits. But what was rather remarkable was that the government did not fall on that day. In most parliaments, the defeat of a Finance Bill constitutes sufficient grounds for the dissolution of a government. The Speaker of Parliament usually has the power to interpret whether this should be the case, on the premise that a government which cannot obtain parliamentary approval to fund its spending plans cannot possibly continue in office. In all likelihood, the rump of SLFP MPs, who had masterminded the defeat of the vote that day, considered it too premature to face a snap general election so soon after they had been defeated at the January 2015 Presidential plebiscite. Moreover, Sri Lanka’s constitution stipulates explicitly that a government will only fall if the Appropriation Bill, the annual government budget, is defeated.
The 8th April 2015 defeat of the bill to enhance the Treasury Bill limit marked the first cracks that emerged in the unwieldy alliance of the UNP and SLFP in parliament. It also created a challenge for the Treasury and the Central Bank which thereafter could not raise cheaper short-term funding from the financial markets. It was just as well that the central bank had already reinvigorated the treasury bond auctions by raising the size and frequency of bond auctions to ensure that the government obtained requisite funding over the following six months. Eventually, it was after the general elections of August 2015 that the parliamentary bill to raise the limit for issuance of treasury bills was re-presented for approval and became law in October 2015. The bond markets appeared to have saved the intervening days and months.
In fact the banks’ lending rate of interest to their prime customers momentarily blipped up over 7 percent p.a. in April 2015, before receding back to sub-7 percent levels after it was established that the bond market could effectively take up the slack from the non-issuance of treasury bills. What this demonstrated was that signs of political instability have a direct adverse impact on bank lending rates in Sri Lanka. In the aftermath of the 52-day coup in 2018, the prime lending rate shot up to over 12 percent p.a. There has been a lot of uninformed commentary in various media that the treasury bond auction of 27 Feb 2015 caused bank lending rates to rise. These comments are simply not borne out by the data. Banks’ average lending rates published by the central bank kept falling until February 2016 proving that the issuance of long-dated treasury bonds in 2015 had absolutely no adverse impact on bank lending rates.
But we cannot escape the serious predicament Sri Lanka faces in funding its overhang of government indebtedness, which results in a never-ending search for fresh sources of funding both within the country and abroad. In particular, there appears to be a policy preference for short-term government funding driven by a misplaced belief that this will minimize the cost of borrowing for the government and private borrowers. In my opinion, herein lies the root cause of the broken bond market. The reality is that a build-up of short-term borrowings has resulted in an avoidable short-term concentration in the country’s debt repayment schedule. The danger is that if yet more short-term borrowings are incurred to fund these bunched-up repayments over the next 3 years, it will result in a cascading mountain of short-term debt that will strangle the economy.
There is, however, a silver lining for Sri Lanka to tackle its debt problem. From an international perspective, the absolute magnitude of funding required to service these debts is not that large. The covid pandemic has raised the prospect of eased access to sovereign funding on concessional terms. The IMF has suspended country reviews in the near term. With interest rates at their lowest levels in over a century there is a tremendous opportunity now to lock-in long-term funding for the country at very low rates with bilateral and multilateral lenders. This new borrowing necessarily must be accompanied by a clear articulation of a coherent debt management strategy to earn credibility with global financial markets. Elements of such a debt management strategy should include:
1. avoiding any official announcement of requests for debt forgiveness or debt relief; this will cause irreparable damage to Sri Lanka sovereign debt rating and in any case is unnecessary given the relatively small amounts of funding required of around USD 5 billion
2. a commitment to smoothen out the profile of future debt repayments through a deliberate strategy of extending the maturity structure of rupee government debt; the average term to maturity (ATM) of Sri Lanka government debt which briefly rose to a high of 6.28 in 2015, and then receded thereafter, should be raised much higher by way of issuing long-term bonds and ensuring that they are widely held and traded
3. minimizing the reliance on foreign currency borrowings to a bare minimum and simultaneously extending the maturity profile of foreign debt; Sri Lanka should revisit the opportunity it missed in 2017 to commence issuance of 30-year US Dollar bonds which would have afforded the government the space needed to smooth out its short-term lumpiness in dollar debt repayments
4. immediately commencing the long-delayed bond market automated trading infrastructure modernization program for which a USD 75 mn loan has already been contracted; this should be undertaken by LankaClear or a similar institution which is collectively owned by banks and therefore will not be unduly delayed by government procurement and hiring procedures
5. fast-track the modernization of the laws, regulations and procedures governing trading in financial instruments with special focus on updating bankruptcy/insolvency provisions and procedures for timely, smooth restructuring procedures for debtors facing distress. Larger state-owned enterprises and private companies should be incentivized to borrow to a large extent through the capital markets while direct lending by banks gradually reoriented to service the needs of SMEs.
A lot of work has already been done in this area in India which Sri Lanka can learn from, without having to ‘reinvent the wheel’. Former Governor Raghuram Rajan of the Reserve Bank of India pledged comprehensive technical assistance from the RBI in various fields when he visited the Central Bank of Sri Lanka in 2015 and this commitment should be tapped to expedite reforms related to the financial sector. A summary of India’s progress in modernizing her debt market can be found here.
The urgency of these measures cannot be stressed enough. The mindset that government bonds are bought to be held to maturity has to change in Sri Lanka. Modern capital markets, through their trading infrastructure, afford governments and firms the opportunity to borrow through the issuance of long-term instruments like preference shares, debentures and bonds. Buyers of these instruments are afforded the convenience of trading them ahead of maturity when trading platforms are active with wide participation. Unfortunately, the limited nature of infrastructure for trading bonds in Sri Lanka has inhibited the wider ownership of these instruments. Weekly statistics on secondary market trading volumes of Sri Lanka government bonds have barely changed in the last five years despite the total float of bonds increasing from Rs 3 trillion to over Rs 5 trillion in that period.
Remaining in the current limbo that Sri Lanka’s bond market finds itself in is a bit like a swimmer having to surf a wave without a surfboard. The surfboard in this case is readily available. The surfer has to muster the courage to grab the board, ride the wave and land lightly on the shore. The alternative is to be dashed under the tremendous weight of a crashing debt wave.