By Hema Senanayake –
On Friday, March 08, 2013 Daily Mirror reported that the government plans to make foreign borrowings through banks. This time the choice of bank is the National Savings Bank. The bank is to issue bonds for international buyers amounting to US $ 1 billion. You might be imagining why on earth the National Savings Bank wants to make an international bond sale or in simple language why the NSB wants to borrow in US dollars to issue housing and other rupee loans to Sri Lankan citizens?
A few weeks ago it has been reported that the IMF had rejected the government’s request for a soft loan of US $ 1 billion. Treasury secretary Dr. Jayasundera did the negotiations but failed. The Central Bank Governor Mr. Cabraal commented that IMF rejected the loan request due to the fact that the country’s foreign reserves are in good shape hitting over US $ 6 billion as at now. It seems that Cabraal’s comment is substantiated at least by now from the fact that the rupee is appreciating against US dollar; the value of a US $ has now come down to around Rs. 125 from Rs. 133 in the mid of last year, but the truth is far from his comments. In fact the government badly needs dollars not rupees.
Member of Parliament Dr. Harsha De Silva, the UNP’s spokesman on matters on economics, has denounced this miraculous sale of international bonds. He questioned “For what purpose does the NSB need one billion dollars? It is very clear that it is in order to channel funds back to the government because government borrowings are no longer legitimate.”
He further explained “This is what is known as creative accounting. The government on one hand says that it won’t borrow in the commercial market this year and instead it uses state banks to borrow, therefore in the debt to GDP ratio the Debt wouldn’t increase. This is what is actually happening.”
Though I agree with his question as to why the NSB needs to borrow US $ 1 billion, I am reluctant to agree with his reasoning because there is no way that the NSB can channel part of the borrowed money to the government without increasing government’s debt. This means if the government wants money from the NSB then the government has to borrow it from NSB which will increase the government’s debt to GDP ratio anyway. Hence I do not agree with the “creative accounting” argument of Dr. Harsha; but I guess that the government pushed the NSB to borrow in dollars due to some other reason. I will explain it as simple as possible. Before that let me explain the possible mechanism of channeling part of the dollar funds to the government by NSB.
Legally NSB is required to hold 60% of its assets with the government. In its website it says “National Savings Bank, the Premier Savings Bank in the country, by its statute is required to invest 60% of its assets in gilt-edged Government Securities such as Treasury Bills, Treasury Bonds and other government instruments.”
Now NSB is borrowing US $ 1 billion. This amount is a liability on the part of the bank hence should appear in the liability side of the balance sheet. Simple accounting procedure is that similar amount must appear in the assets side of the bank’s balance sheet. So, US $ 1 billion must first appear as cash asset. So, now it is legally required to hold 60% of its assets in “treasury bills or bonds and other government instruments.” This means out of US $ 1 billion cash asset, 60% or US $ 600 million must invest in government instruments; so, the government gets dollars. Since such transfer of funds is legally required I think that is what is going to happen. However this transfer of funds must increase the government’s debt to GDP ratio since the government is borrowing from NSB.
Now let us get back to the other important point. Why the government pushed the NSB to borrow in dollars?
The government knows that the engine of growth is government spending. It was disheartened to have missed the ambitious growth targets set for the year 2012. The main reason was the instability of the rupee. To stabilize the rupee which was plunging against the US dollar the government needed to contain the private credit growth substantially. At one point towards the end of the last year the government wanted to restrict the credit issued even to the housing sector. A lot of restrictions put on car importers. Finally the government temporarily managed to turn the situation around. As a result the government had to accept the bitter truth of reduced GDP growth for 2012; as I remember the forecasted GDP for 2012 was just over 8% and the realized GDP was around 6.5%.
This year, Ranil is going around saying that the next year (2014) will be an election year. It might be right or wrong. But the government wants to show off the economic boom. The set target growth of GDP for 2013 is 7.5%. One critically important condition to achieve the higher growth in all domestic sectors is to increase the private credit growth. The obvious repercussion of the private credit growth is the increase of imports which might increase the trade deficit which is the main reason to destabilize the rupee. So, if the government wants achieve a GDP growth of 7.5% this year, it cannot achieve it without increasing the private credit growth.
If the government needs to increase the private credit growth such increase must be backed by increasing the inflow of dollars. Given the situation of Foreign Direct Investments (50% reduced), Exports (stagnant), Foreign Purchases of Stocks (HSBC not even listed the Colombo stock market in its recent report on Asia), voluntary foreign borrowing by banks (not promising) and tourism (mildly better), Sri Lanka cannot expect a huge increase of the inflow of dollars; only positive aspect is the remittances of expatriate workers. Therefore the country needs more dollars if the government wants to ensure credit growth while stabilizing the rupee in order to increase the GDP by 7.5%. The government should have understood this situation. On the contrary the government proposed in its budget for 2013, to reduce foreign borrowings dramatically and even said that it will not borrow from international commercial markets. The reduction of foreign borrowing is good but it has to be a gradual reduction.
Writing an article to Colombo Telegraph on January 26, 2013 I said that “…my conclusion is that the country will never achieve a GDP growth of 7.5% for this year under the proposals made in the budget.” The reason I pointed out was that the government needs to bring in a few billion more dollars so as to increase the credit growth without jeopardizing the stability of the rupee to achieve the growth targets. If the government foreseen this requirement it could have find avenues to borrow at concessionary or cheaper rates than the interest rate at which that NSB is going to borrow.
I do not doubt that the ability of the government to borrow. There are capable fund managers to facilitate borrowing. They are capable to facilitate borrowing until a country crash. I remember at one point prior to the Great crash of 2007, Greece borrowed against the future revenue of ground handling charges of the country’s airports and fund managers facilitated it. NSB bond sales will be facilitated by fund managers. It has already been reported that “HSBC, Citibank NA and Barclays will act as the lead managers.” Such bond sales are not always associated without kickbacks. Ultimately the country will pay a higher rate of interest through the NSB in foreign currencies for the simple fact that the formulators of the government budget could not estimate the real requirement of foreign borrowing for 2013. Emergency funding always cost more money. In all counts the government’s handling of monetary and fiscal policy is not that great; NSB’s sale of international bonds amply proves this point.