Financial Times

Development bonds issue sign of ad hoc crisis management-economist

CB issues development bonds
The Central Bank (CB) said this week that it received offers totalling US$75 million from an offer to issue Sri Lanka Development Bonds (SLDBs) to eligible investor categories for subscription at a rate of US dollar 6 month LIBOR plus a margin to b determined through competitive bidding. The bonds on offer amounted to US$ 70 million for a 2 year maturity period.

The CB said the offer was opened on September 8 and closed on September 15 and was subscribed by both foreign and local commercial banks, with the total bids received amounting to US$75 million. Of such bids, the government has decided to accept US$ 60 million of 2 year SLDBs at the market determined rate of US dollar 6 month LIBOR + 2.895 per cent (weighted average margin). Today, the US dollar 6 month LIBOR rate is 3.0894 per cent.

Further, the CB stated that this SLDB issue is within the annual borrowing limit approved by Parliament for 2008 and the funds mobilized through the new bond issuance are to be used to settle the major part of SLDBs of US$ 70 million that are maturing this year.

The latest issue of Sri Lanka Development Bonds (SLDB) is yet another sign of ad hoc crisis management of the critical public debt problem faced by the present government, according to a Sri Lankan economist. Principal researcher at the Point Pedro Institute of Development Dr. Muttukrishna Sarvananthan said the Mid-Year Fiscal Position Report released by the Ministry of Finance in July 2008 that revealed government revenue and expenditure during the first four months of this year show several indicators of acute fiscal vulnerability in the economy.

In a paper titled 'Fiscal Conundrum', Dr. Sarvananthan said the budget deficit increased by almost 26% during the first four months of 2008 (Rs. 93,420 million) compared to the first four months of last year (Rs. 74,264 million). Hence, it is clear that the rise in government expenditure thus far this year has been higher than the rise in government revenue, which is a matter of concern. He added that an even more ominous indication is the changing composition of deficit financing during this year vis-à-vis last year.

uring the first four months of 2007, 49.42% of the budget deficit was financed through external borrowings (foreign loans accounting for 34.78% and foreign grants accounting for 14.65%) and 50.58% was financed through domestic borrowings. On the contrary, during the same period this year almost 80% of the budget deficit was financed through domestic borrowings and only 20% was financed through external borrowings (foreign loans accounting for 16.24% and foreign grants accounting for just 3.84%).
In spite of strenuous efforts by the government to mobilize external resources through the sale of foreign currency denominated treasury bonds, Dr. Sarvananthan wrote that syndicated loans and sale of SLDB's to Sri Lankans working and living abroad, the amount of external resources (including official development assistance from bilateral and multilateral donors by way of grants and loans) received this year have been significantly lower than last year.

This reality check is in contrast to the government propaganda of undiminished aid flows, especially from emerging economies and non-traditional sources such as China and Iran. Lending by these new sources are on commercial terms and not on concessionary terms as in the case of traditional sources such as the ADB, Japan and the World Bank.

He added that despite deceleration of economic growth in Sri Lanka during this year, the CB seems to be propping up the rupee in order to minimize the external debt burden to the government. In the past couple of years, the present government has resorted to short-term (less than five years) borrowings from international capital markets at high interest rates (up to 8.25% per annum). Repayments of these short-term external debts have become a drain on the foreign exchange reserves. One of the ways in which this burden is mitigated is through CB's intervention in the foreign currency market to prevent depreciation of the rupee and thereby reduce the cost of external debt repayments (both interest and capital), which the CB Governor spoke of at the annual Economic Summit organized by the Ceylon Chamber of Commerce couple of months ago, where he referred to this as a "balancing act" performed by the apex bank of the country.

Dr. Sarvananthan explained that the reality of this "balancing act" is somewhat different. By artificially propping up the rupee through interventions in the foreign exchange market the CB is making Sri Lanka's exports less competitive in international markets notwithstanding the fact that total export value in real terms (i.e. in terms of USD value) has increased by almost 10% during the first half of this year vis-à-vis the first half of last year. Logically, because of the stability of the rupee against USD and appreciation against GBP and EUR, import values should have decreased.

On the contrary, he writes that total import value in real terms (i.e. in terms of USD value) has increased by almost 36% during the first six months of this year in comparison to the same period last year, which was primarily due to higher import cost of petroleum products. Staggering increase in the total import value at least partly offsets the benefit accruing from lower external debt repayment burden to the government. Furthermore, stable or higher value of the rupee should have contributed to decreased cost of living by reducing the cost of imports, which does not seem to take place.

Dr. Sarvananthan added that myopic fiscal policies of the present government appear to be caught up in a vicious cycle of debt trap and exchange rate manipulation. Crisis management appears to be the order of the day. There is no vision of a sustainable fiscal strategy that would promote sustained growth of the economy.

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