Tuesday, April 16, 2024

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DDO – Who misled the President and Parliament?

This short article is to highlight basic legal, conceptual and governance issues relating to Domestic Debt Optimization (DDO) as announced hitherto.

The article highlights few fundamental concerns over the implementability of the DDO and predicts severe repercussions on political and socio-economic fronts. 

Gazette issued under RSSO

On 3rd July, the President in the capacity of the Minister of Finance issued regulations under section 34 and 55 of the Registered Stocks and Securities Ordinance (RSSO) authorizing the Secretary to the Ministry of Finance and Registrar of Public Debt to carry out powers vested with the Minister under section 34 of the RSSO.

  • The gazette is as follows.
  • The section 34 of the RSSO is as follows.

Major legal concerns

  • The exercise of powers and authorities under section 34 of the RSSO does not require an issuance of Regulations. Subjects that require Regulations under section 55 of the RSSO do not cover the subject of “Conversion of Loans” under section 34. 
  • Regulations cover words “convert or exchange”. However, section 34 of the RSSO relates to “conversion” only while nothing is covered on “exchange.”
  • Minister’s powers under the RSSO can be delegated only to the Secretary to the Treasury through a gazette issued under section 56 of the RSSO. There is no any reference to the Secretary to the Ministry of Finance. Therefore, the authorization to the Registrar of Public Debt is unlawful.
  • The Sinhala version of the Regulations refers to “රාජ්‍ය ණය අධිකාරී“. However, RSSO does not refer to such a designation. It refers to the designation of “ලේඛකාධිකාරී” and “Registrar.” Further, there is no designation of Registrar of Public Debt in the RSSO as the duties of the “Registrar” apply only to debt raised through instruments permitted under the RSSO.
  • The conversion of loans requires the section 35 of the RSSO that provides for the arrangement for the conversion. However, it is not covered in the Regulations.
  • If Regulations are lawfully in order as they are, the Minister must declare the specific lists of securities or stocks in the Regulations as implied from the contents of the section 34 of the RSSO. However, the Minister has declared such lists in a separate document “Invitation to Exchange” issued by the Minister on 4 July to superannuation funds and other eligible holders.
  • As the Minister uses provisions in the RSSO to implement DDO, the legality as well as the purpose of a resolution sought from the Parliament for the DDO are not clear.
  • Treasury bonds specified in the “Invitation to Exchange” are not the loans raised in terms of sections 2 and 4 of the RSSO with the authorization by the Minister as required. Therefore, an issue remains as to how loans issued in contravention of the relevant provisions of the RSSO are converted into stocks or securities provided for in the section 34 of the RSSO.
  • If such Treasury bonds are lawful bonds in any case, loans have been raised through such bonds by the Registrar under section 5 of the RSSO. It is the statutory duty of the Registrar under this section to “make all such arrangements as may be necessary to raise loans upon the most favourable terms that can be obtained.” If so, an investigation is necessary as to how such Treasury bonds have become a burden causing public debt unsustainable.
  • The responsibility of domestic debt management with lowest cost and prudent risk has been vested by the Monetary Board with the Domestic Debt Management Committee (DDMC) of the CB. If so, an investigation is necessary as to why the DDMC failed to fulfil its public duties as DDO is now necessary to make domestic debt sustainable.  In fact, the proposed DDO is virtually a default of contracts on promissory notes on Treasury bonds.
  • Passing the burden of domestic debt mismanaged by the Registrar and DDMC to the general public through superannuation funds in a discriminatory manner without any investigations into those who mismanaged debt to the default status is an undemocratic use of the public governance powers by the incumbent government.
  • DDO proposed in Treasury bills held by the CB to convert into Treasury bonds or term loans is not practical as both Local Treasury Bill Ordinance and Monetary Law Act do not have supporting provisions. It is noted that the majority of Treasury bills held by the CB at present is the unlawful increase by the present CB Governor in the conflict of interest. 

DDO conceptual issues

  • Official communications reveal that the proposed DDO is undertaken on the request of external creditors at the discussion between them and the government on foreign debt restructuring consequent to the default announced with effect from 12 April 2022 on the advice of the present CB Governor. He is also responsible for the excessive issuance of International Sovereign Bonds for his foreign reserve management role. In fact, it is the foreign debt that is unsustainable due to the acute shortage of foreign currency reserves with the CB whereas it is the CB that expanded foreign debt aggressively and unlawfully for monetary policy purposes. Foreign lenders who lent excessively by knowing the risks must bear the loss of default and it is undemocratic to share this loss with local currency lenders.
  • Domestic debt raised in domestic currency cannot be unsustainable as debt service can be made through the rollovers at new interest rates as and when the debt matures and the government has money printing and creating power for debt service. The proposed DDO on Treasury bonds is also an early rollover of the existing debt in 63 Treasury bonds with a total face value of Rs. 8,904 bn maturing between September 2023 and March 2045 to 12 new bonds at new interest rates/coupon of 12% and 9% maturing between 2027 and 2038 (see the list below). Therefore, this rollover will not ease the debt stock or debt-GDP ratio. However, it is noted that the policy announcement made by the Ministry of Finance on 4 July covered bonds maturing between 2024 and 2032 for the conversion under the DDO. As such, the Ministry does not know what they are really doing.
  • As present interest rates structure has been elevated at historically high levels by the super tight monetary policy since April 2022, proposed interest rates on new bonds may be costly to debt service on new bonds for the period up to 2038. In contrast, rollovers at maturities would have the benefits of the market interest rates in the future after the economy recovers from the current monetary tightening and CB’s debt management. The rollovers are difficult at present not due to non-availability of liquidity but due to sugar high interest rates on government securities driven by the CB for the monetary policy as the CB serves both functions of debt manager and monetary authority. The CB has been injecting ample liquidity through reverse repo auctions and direct purchases of Treasury bills as it wishes.
  • The criteria used to select bonds for the conversion is highly questionable. 

    *First, there are several bonds with coupon rates below 9% in the declared bond list. The exchange of these bonds at new coupon rates of 12% and 9% as proposed will increase the debt service burden. 

    *Second, 6 bonds maturing from August 2039 to March 2045 are to be exchanged with new bonds maturing up to 2038. As the maturity is shortened here, the debt service burden will increase. What is actually required is to extend the maturity profile of the debt stock in order to ease debt service and bunching.

    *Third, there is no purpose of two bonds with outstanding value of less than 10 bn to be offered in the list as only large value bonds require optimization.

    *Fourth, the coupon rates of Treasury bonds in the list are not representative of the actual cost to the government as the weighted average yield to maturity of those bonds at issuances could be lower than specified coupon rates due to issuance at premium whereas the opposite will apply to discount bonds. As such, discount bonds should be optimized. For this purpose, new coupons can be linked to secondary market yields if the government securities market is developed in terms of the relevant provisions of the RSSO. 

    Overall, it is clear that all existing bonds have been listed for DDO without any assessment of the debt burden of each bond. Therefore, the proposed DDO on Treasury bonds will be another bureaucratic job that will effectively fail as usual.

  • Active Liability Management Act was passed in 2018 to restructure the debt stock as debt unsustainability or default was foreseen in advance. However, the Treasury or the CB never acted accordingly. Instead, they raised more debt by using the additional borrowing powers (i.e., 10% of the existing debt stock) given in the Act. These provisions could have been used for the DDO too as the Act was passed specifically for debt restructuring purpose. An investigation also is required why the provisions of this Act were not implemented despite evolving debt unsustainability.

Public concerns

  • Although authorities talk rosy stories on debt restructuring and DDO, its complexities can have severe effects legally, socially and economically.
  • The popular statement that EPF members will not be affected anyway by the DDO is untrue as any debt restructuring is implemented to gain trough the cost passed to lenders. If there is not cost to the EPF being the single largest lender, the purpose of the proposed DDO is questionable.
  • I recall the political calamity caused by a just attempt to introduce transparency and competition on issuance of government securities in place of the long existed private placements lovingly promoted by the CB. The attempt was to introduce transparency and market discipline to develop the debt market. The present CB Governor was a big advocate for private placements fighting against the market mechanism. As a result, the good governance based government in 2015 was shattered in few months from its beginning.
  • As compared to that event, the proposed DDO is much more controversial and complicated and, therefore, could cause serious legal and socio-economic repercussions due to issues presented above.
  • It appears that the President personally leads the restructuring task without facts known to him. Those who advised the President to follow this path of debt restructuring and DDO seem to have misled the President and Parliament by not revealing facts and consequences behind the DDO concept.
  • Officials who mismanaged debt to be unsustainable are in the forefront of debt restructuring without being subjected to any investigation. This is not acceptable.
  • In this context, if circumstances become unhealthy in future, the President will singularly be responsible for as those who advised the President would have retired and left to their foreign residences and Parliamentarians who voted for the DDO resolution can change their position abruptly overnight for political benefits as usual.

(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 10 Economics and Banking Books and a large number of articles published. 

The author holds BA Hons in Economics from University of Colombo, MA in Economics from University of Kansas, USA, and international training exposures in economic management and financial system regulation)

Source: Economy Forward

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