Financial Times

Cosy budget as losses mount at CPC

Two days after a historic presidential election in the US, President Mahinda Rajapaksa as the country’s finance minister presented what at a glance was seen as a populist budget -- reducing fuel prices and promoting local industry.

But a closer look signifies that it is a short-term strategy and, where we are heading on the long-term is anybody’s guess with defence spending also expected to rise above budget levels. Furthermore the fuel price reduction was anyway happening with the Ceylon Petroleum Corporation (CPC) under severe pressure to do so.

The main issue is that while cuts have been made across the board to benefit low income groups and industry, the government has also raised its revenue expectations. It is pertinent to note also that this is perhaps the first time in many years that former Treasury Secretary Dr. P.B. Jayasundera was not involved in the budget (at least in the latter stages and on budget day).

Tax consultant N.R. Gajendran told this newspaper that trying to achieve the Rs 32 billion revenue surplus projected in the budget is a tough call., adding that this is similar to last year’s situation. On the other hand, the government is reducing dependence on bank borrowings and foreign loans and relying on non-bank sources like EPF or ETF for example.

The real story as one economist says is in analysing the figures and the annexures which were not read out by the President in his relatively short 90-minute speech – a departure from the Finance Ministers of the past, particularly Ronnie de Mel whose long- winded speeches apart from the key proposals were a boring resume of the economy of the past.

The budget aside which will be analysed by many people in the next week few days, there is bigger issue that has cropped up this week and is the focus of The Sunday Times FT lead story on Page 1.
It appears that due to a badly-structured, essentially one-sided hedging contract between the Standard Chartered Bank and the CPC, the state petroleum distributor has to now cough out millions of dollars a month, ending up in possibly paying off a cool $200 million in the next six to eight months!

That’s why the CPC has been unable to bring down prices. Industry analysts say the CPC didn’t have the expertise to understand the risks in such a deal and is now realising the folly of getting into one that has gone very, very sour.

The hedging contract was signed in January 2007 at a time when fuel prices was at around $56 per barrel. But after rising to a high of $134 per barrel in July 2008, the price crashed subsequently to a low of $58 last week and is now trading at the $60 level.

Accusing fingers are pointing at the Standard Chartered Bank for offering a product to an agency that didn’t have the expertise to analyse the risks. On the other hand, the CPC must share most of the blame for stepping into hitherto unknown territory without seeking independent advice. Ironically hedging as an option for petroleum futures was first suggested in around 2002 by Upul Arunajith, a Sri Lankan expert working in Canada.

In a May 13, 2007 article in The Sunday Times FT, Arunajith alerted Sri Lankans over the dangers of the hedging deal that CPC had got into. “Effectively, the Zero Cost Collar (the current deal) will pay off once the spot market price exceeds the Call Option strike price (call capped price). The Put Option will expire worthless. However if the spot market price drops below the Put Option Strike price (put capped price) the Zero Cost Collar Strategy will not allow any participation in the down side,” wrote this experienced hedge trader. The full article headlined “The zero cost collar hedging strategy” is available on The Sunday Times web: It’s a must read for our planners to see where the CPC went wrong. On the other hand, if only this advice was taken …..

Struggling to pay back this money, the CPC is considering defaulting on the payment on the grounds that it was not properly informed by Standard Chartered ahead of the transaction. Central Bank guidelines on financial derivative products clearly say that the offer firm (Standard Chartered) must adequately inform the receiver (CPC) of the risks.

Ironically the CPC, it is understood, has sought Central Bank permission to open an account with Standard Chartered Bank in Singapore to borrow funds to settle its dues at the Bank’s Colombo branch!
Someone, clearly has to pay for this downright fraud where millions of public rupees is being spent to correct a mistake!

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