By Hema Senanayake –
I am not a mathematician. But I still admit that mathematics is the apex of all sciences including “economic science.” Without mathematics I cannot imagine what kind of civilization this could be. Perhaps, Prime Minister Ranil Wickeramasinghe could better explain about it.
Now, Mr. Gamini Wijesinghe, the Auditor General submitted a certain calculation based on a certain mathematical principle. He said that if the Central Bank accepts bids to buy government bonds quoted with higher interest rates than prevailing market rates, the government would make a real loss by having to pay higher interest. This is not a nominal loss. This loss can be nominal only if the payment of interest is nominal. But the payment of interest by the government is real. Receiving of interest payments by the bond dealer is real too. There is nothing nominal in this kind of deals.
Subjected to the above mentioned principle, as far as I know, Auditor General calculated the loss to be made by the government by having to incur extra cost on interest as a result of accepting at least Rs. Five billion worth of bonds with higher interest rates maturing at 30 years, offered by Perpetual Treasuries at the bond auction held on February 27, 2015. His calculation of loss amounts Rs.1.6 billion. The loss made by the government by having to pay higher interest rate can be calculated – And nobody can challenge about it. Let me give you a very practical example.
I wanted to buy a car. After making a down payment I needed a loan to buy it. The loan amount needed was $26,000/=. Financial consultant of the car dealers company requested from a few financial institution to submit their quotes to borrow $26,000/= to be paid back in full in 60 monthly installments. One bank quoted to lend the amount at 11% interest per annum and another bank quoted with 4.6% interest rate. If I had borrowed from the first bank I would have ended up paying $ 7,918/= as interest by the time I settle the loan in full. If I had borrowed the same amount at 4.6% rate, my total cost of interest for 60 months would be $3,154/=. Would I have had made a loss of $4,764/= ($7,918-$3154) if I had borrowed at 11%? The answer is yes.
This same calculation is applicable in calculating the loss made by the government in borrowing by having to pay higher interest for Perpetual Treasuries. The only difference is that the calculation is a little bit complex because basically there are two variables involve in the calculation. One variable is the purchase price of a bond of Rs.100 and the other is the quoted interest rate. For an example one Primary Dealer offered to buy 50 million bonds worth of Rs.100 each at a purchase price of Rs.112.01 each. This means that the Central Bank receives Rs. 5,600.01 million and this exceeds Rs.600.01 million than the par value of bonds when the offer is accepted. The yield rate (interest rate) quoted was 9.99%. This has additional benefit because in general the interest rate is paid to the par value of bonds. This simply means that even though the company invested Rs. 5,600.01 million in buying bonds, the company has agreed to receive interest income for Rs.5,000 million only. It means that the effective rate of interest is less than the 9.99% in this example and this is a real example.
The exact opposite happens if a Primary Dealer quotes the purchase price below Rs.100 and quotes higher interest rate. I am going to give you another real example. The Bank of Ceylon on behalf of Perpetual Treasuries offered to buy 3000 million bonds worth Rs.100 each at a purchase price of Rs.90.16 with a yield rate of 12.5% and the bid was accepted. In this case the Central Bank receives Rs.270,480/= million instead of Rs.300,000/= million by issuing 3000 million of bonds. But the interest is paid not on the money received but on the actual or the par value of the bonds. This means even though the company invested Rs.270,480/= million in buying 3000 million bonds, the government pays interest for Rs.300,000 million which is the par value of the bonds issued. As a result the effective rate of interest might be gone up to 13.86% in this case. Both above examples are true cases and data was extracted from the Pitipana Committee Report in regard to the bonds issued on February 27, 2015.
In the first example, the government receives more money than the par value of bonds and the effective rate of interest is less than the quoted yield rate. In the second example, the government receives less money than the par value of bonds issued and the effective rate of interest is higher than the quoted yield rate. So, who can argue that the loss cannot be calculated? There is no argument that the comparative loss can be calculated. If anybody argues that the loss to the government cannot be calculated by having to pay higher interest rate in issuing bonds, he or she is not fit to be a Cabinet Minister who oversees the Central Bank.
I still remember the speech made by the Prime Minister in parliament in March or April of 2015 when MPs demanded an investigation in regard to the bond scam took place on February 27, 2015 when Arjuna Mahendran was the governor of the Bank. He questioned the assembly as to who knows about bonds and further commented that parliamentarians only know about James Bond. This sheer sarcasm should not come from the Prime Minister. However, he would not have uttered those words if he was familiar with a very enlightening quote attributed to Werner S Heisenberg who was the pioneer of modern quantum mechanics. He won the Noble Price in 1933. I quote bellow what he said:
“If a person cannot explain quantum mechanics to a barmaid then that person does not know what quantum mechanics is.” From this what he intimated was that any serious subject can be truly simplified if the person knows it thoroughly. The subject of bonds is nothing in compared to quantum mechanics. If any person suggests that you can’t understand it, then that means he himself knows nothing about it.
(Note: Unfortunately I could not find the exact reference of Heisenberg’s quote. I am sorry about it. Even without a proper reference the message it delivers is truly great.)