By W.A Wijewardena –
The Central Bank’s clarification on the external debt numbers
The Central Bank in a right move has clarified the debt sustainability issues raised by this writer in a previous My View (available here ) by means of a Press Release (available here under Press Releases and Speeches dated 13.06.2014).
The My View under reference was a critique of a previous press release issued by the bank on 13 May 2014 informing the public of the improvement of the country’s external debt sustainability numbers. The My View brought to focus the discrepancy in the debt sustainability numbers in the press release and the bank’s Annual Report for 2013.
The Central Bank’s present response is a welcome development since it creates an environment for the public to weigh the evidence for and against the issues raised by this writer and come to their own conclusions through an open dialogue.
The bank has a communication policy to manage market expectations
The bank on its part had earlier recognised the importance of regular public communications when announcing its communication policy in the Road Map 2014 in order to ‘manage the public’s expectations properly and thereby enhance the credibility of Bank’s policy measures’ (slide 122 of the Road Map presentation available at: www.cbsl.gov.lk ).
It had also highlighted that it will use its communication policy to the maximum ‘considering the importance of market expectations for the success of macroeconomic policies’ Thus, managing the market expectations is one of the objectives of the bank’s communication policy.
Central Bank communications should have a Balance of Risks analysis
While emphasising on the need for speaking the whole truth by central banks in their communications to manage market expectations, this writer highlighted an important global best practice that should be present in such communications in a previous My View in this series. That is to present a statement of how the central bank proposes to manage the risks arising from its actions, known as the Balance of Risks or BOR in every public communication it makes (available here ). Such a BOR will enable the public to make an informed opinion on the pluses and minuses of central bank actions.
A presentation of a BOR is mandatory for the institutions which are regulated by financial regulators including central banks when such institutions seek new funds from the markets. This requires a central bank to present both pluses and minuses of actions which it desires to communicate to the public.
The importance of learning from criticisms
In the above mentioned article, this writer further emphasised on the need for a central bank to learn from outside criticisms since it is only such criticisms that will help a central bank to change its course if it is not desirable.
This writer said: ‘A good quality which a central bank should cultivate to play this role properly is to be receptive to outside criticisms. Such criticisms not only help a central bank to identify its own weaknesses but also to steer its future policy actions. Those in central banks may be overjoyed when they kill outside criticisms by making blunt attacks on the critics’. But, as is appreciated by civilised society, such blunt attacks on critics will not serve any purpose.
The clarification demonstrates a crack in the bank’s internal communication system
The clarifying press release of the bank, hence the clarification, is short of these good practices. Instead of clarifying the issues which this writer had raised in his previous article, the bank has simply defended its calculation of the country’s external debt by the Public Debt Department or PDD which is contrary to its own Annual Report, while taking a personal punch at this writer as well.
The clarification said that its external debt compilation had first been introduced in 2008 ‘under the supervision and guidance of the then Deputy Governor of the Central Bank of Sri Lanka (CBSL) Mr. W.A. Wijewardena’. Thus, the clarification claims, this writer does not have right to say that it is faulty now. Claiming that the bank has recently started compiling external debt numbers according to the 6th Edition of IMF’s Balance of Payments Manual, known as BPM6, the clarification has advised that this writer and his ‘associated analysts’ to expand their understanding of the developments and methods of UN ESCAP and those contained in BPM6.
This advice, it appears, has been offered without reading the My View under reference and that is a dangerous trend. The main argument of the said My View was that PDD has not even followed the UN ESCAP Manual or the treatment of external debt by the Bank’s Annual Report for 2013 which had been expanded in terms of BPM6. Hence, it is PDD which has to follow the golden advice in the clarification in the first place.
In this backdrop, it is advisable that the bank should revisit its first press release, its Annual Report for 2013 and My View under reference and identify the contradiction between its First Press Release and the Annual Report and the confusion it has made in the clarification by presenting entirely irrelevant arguments. It is not good for a dynamic bank to continue to defend an action which it had started in 2008 and continued till now without change when its own Economic Research Department has moved into BPM6 a year ago.
Clearly, there is a flaw in the bank’s internal communication system: What one unit does is not known to another unit, leading to contradiction and confusion in their approaches to economic issues. When this writer was serving the bank, this was done at the Deputy Governor level by freely exchanging views and methods between different units and thereby harmonising the systems across the bank. It is important that the Central Bank revisit its internal communication system and find remedies for the cracks that have emerged instead of counter-charging its critics which does not serve any purpose. It will not hurt the bank’s sense of pride but provide it with a valuable learning opportunity.
A quick run-through over issues not clarified by the bank
To facilitate that learning opportunity, the issues raised in this writer’s article that questioned the debt numbers of the bank’s first press release but not answered in the clarification are presented below:
The Central Bank’s first press release as well as the clarification talks about an improvement of the ‘country’s external debt’ though PDD had used not the country’s debt numbers but the narrowly defined central government ‘s debt numbers to come up with its conclusions. There is a vast difference between these two numbers and it is misleading to talk about an improvement in the country’s external debt sustainability just by considering only the central government’s debt.
PDD had claimed in the First Press Release that its debt sustainability calculations had been based on UN ESCAP Manual on Effective Debt Management. This writer’s argument was that PDD’s debt numbers were pretty much narrower than even the recommendation in the UN ESCAP Manual which is compatible with BPM6. The clarification has been silent on this issue.
The Central Bank Annual Report for 2013 has very correctly expanded the coverage of Sri Lanka’s external debt in terms of BPM6. If PDD wanted to talk about Sri Lanka’s debt sustainability, it should have used the numbers reported in the Annual Report. This writer raised this issue in his article but the clarification has not clarified it.
The UN ESCAP Manual recommends, as highlighted by this writer in his article, even for the government, a wider definition of external debt comprising those contracted by the central government and other government agencies, namely, the Central Bank, Government-owned commercial banks, Government-owned deposit taking institutions like NSB and Government-owned corporations plus the debt raised by private entities on government guarantees. This wider definition is important in terms of BOR to be prepared by the Central Bank because if any of these latter institutions default their external debt, it is the taxpayers who have to bear the full burden. Hence, PDD’s argument based on only one part of the country’s external debt is misleading.
The debt service ratios presented in the first press release were questioned by this writer because they did not tally with the numbers reported in the CB Annual Report for 2013 on page 154. Now the clarification has revealed for the first time that PDD has added the remittances too to the earnings from export of goods and services to calculate its debt service ratios. The implication of adding remittances is that it augments the foreign exchange flows and thereby reduces the ratio giving a better picture. The clarification has charged this writer and other critics for not recognising remittances in their analyses. This charge made against this writer should be correctly levelled against the bank’s own Annual Report for 2013 which has overlooked the remittances by using only the earnings from export of goods and services to calculate its ratios thereby, as the clarification has alleged, misleading the public. However, the inclusion of remittances in the foreign exchange flows as has been done by PDD in calculating the debt service ratios is not something recommended by UN ESCAP (p 78 of the Manual). That is because it has correctly termed the flow of foreign exchange under reference as ‘earnings’ meaning that they have been earned by providing a service. Remittances are not classified as earnings because they are just one way transfers – free gifts – known as ‘unrequited transfers’. It is quite misleading to secretively include remittances and claim that PDD has made its calculations in terms of UN ESCAP Manual which has not made that recommendation. When the discrepancy between the Annual Report and the press release is pointed out, the Central Bank simply finds fault with the messenger rather than the message.
This writer has drawn attention to the ominously rising external debt service payments as reported by the bank’s Annual Report for 2013 on page 155. Accordingly, the debt service payments as a ratio of earnings from export of goods and services have increased from 19.3% in 2012 to 25.2% in 2013. This is a critical situation and the clarification has been silent on this emerging risk.
This writer has also argued in his article that the total external debt, not merely the narrow debt of the central government, as a ratio of the Gross National Income or GNI is also not something to be happy about. This is what he said in his article: ‘For instance, the press release says that the disbursed external debt outstanding to gross national income has amounted to 37.2% in 2012 and 35.1% in 2013. Thus, the country is ranked as moderately indebted. Since the country’s Gross National Income or GNI in 2013 was $ 65 billion, the disbursed external debt outstanding used for this calculation would have been $ 23.5 billion which is close to the central government’s external debt reported in the Central Bank Annual Report 2013 in Table 6.6 on page 177. That number is Rs. 2,960 billion or $ 22.9 billion. However, the calculation of this ratio by using the outstanding external debt reported in Table 5.12 on page 154 of the Annual Report 2013 which is the correct figure for analysing the country’s debt sustainability reveals that it has been 64% in 2012 and 61% in 2013. In terms of these numbers the country is ranked as highly indebted’. The clarification is silent on this issue as well.
Another adverse development is the high total external debt ratio as a percent of the earnings from export of goods and services reported in the CB Annual Report for 2013 (p155).
This writer raised the following issue regarding this aspect of debt development: ‘The press release has reported that the ratio of disbursed external debt outstanding to export of goods and services at 111.1% in 2012 and 106.6% in 2013 ranking the country in the less-indebted category. Here-again, there is a discrepancy in the disbursed external debt outstanding used for this calculation. Since the export of goods and services in 2013 (Table 5.13 on page 155) has been $ 15.1 billion in 2013, to arrive at the above ratio for that year, the disbursed external debt outstanding should be $ 15.9 billion, a number significantly different from the one used in the previous calculation.
But according to the numbers reported in Table 5.13, the total external debt outstanding is 275% and 265% higher than the export of goods and services in the two respective years. Though they are within the range of moderately indebted category, they are on the threshold of moving into the highly indebted category – an ominous red light which should not be ignored in any meaningful debt sustainability analysis.’ The clarification is silent on this issue as well. It now appears that PDD has brought the ratios to its desired level by augmenting the foreign exchange flows by adding the remittances as well.
Another grave omission in the clarification is the silence over the discount rate used to compute the present value of the external debt of the country. This writer has raised this issue in his article but the clarification has chosen to ignore it.
This writer argued in his article that a proper external debt vulnerability assessment should use an indicator like the External Debt Vulnerability Yardstick suggested by UN ESCAP in its Economic and Social Survey for 2013.
This Yardstick is a better indicator of external debt vulnerability than the traditional debt service ratios.
This is what this writer said in his article about the yardstick under reference: ‘In this Yardstick, the sum of short term external debt, quarterly imports based on four quarter moving average and estimated international portfolio investment is expressed as a percentage of the external reserves of a country. It thus measures the number of times a country’s short term obligations are bigger than its available foreign reserves. By using the numbers reported in the Central Bank Annual Report for 2013, this yardstick was calculated in respect of 2012 and 2013. It amounted to 197% and 188% in the respective two years placing Sri Lanka in the category of most vulnerable countries’.
It would have been better if the Central Bank had been more transparent by making a comment on this revelation which puts the country into a very high debt vulnerability state.
The Central Bank’s clarification is therefore not complete and has covered only some selected issues. Even with respect to the issues it has covered, the clarification is defective. When one removes the personal attacks on the critics from the clarification, what is left is only a serious indictment against its own Annual Report by disputing the numbers reported therein.
Now the ball is not in this writer’s court but the court of the Monetary Board
A Sunday newspaper, having been rejoiced by the Central Bank’s personal attacks on its critics, had referred to the clarification ‘as passing the ball to the court’ of this writer. However, now it seems that PDD through its clarification has unknowingly passed the ball onto the court of the Monetary Board of the Central Bank which has submitted its Annual Report 2013 to the Minister of Finance with a different set of numbers.
The overjoyed journalist had implied that this writer should pick the ball and play it now like a good player. Thus, it is the Monetary Board which has to pick the ball and play it as implied. However, the ball that has been passed onto this writer’s court is just a ‘soap bubble’ which will burst naturally before anyone could pick it up and play.
The bank has issued a clarification, but it begs more questions than the ones answered.
*W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at email@example.com