Treasury Bond fiasco and the borrowing cost

Tuesday, 5 May 2015 01:52 -     - {{hitsCtrl.values.hits}}

The article in the Daily FT of 28 April titled ‘A Clarification on the Bond Scandal’ by Dr. Udara Peiris has attempted to establish two positions. First: that the cost of the now notorious Bond to the tax payers of the country so far, is not Rs. 42.5 billion, but only Rs. 25.9 billion, when considering the Treasury Bonds and Bills issued during the post-scandal period from 27 February to 8 April 2015. Second: that although interest rates did rise in the market after the controversial bond issue, the causal claim has not been explained or justified. Let us consider the first contention. As we know, if a 30-year Treasury Bond of Rs. 10 billion is issued at an annual interest rate which is 3% higher than the market interest rate, the Government (or the tax payers) will have to cough out an additional interest cost of Rs. 300 million annually: i.e., 3% of Rs. 10 billion. Accordingly, the total additional interest cost to be paid by the Government over the 30 year period will amount to Rs. 9 billion: i.e., 30 years at Rs. 300 million per year. In a similar manner, when the interest rate increase of all Treasury bonds and bills issued from 27 February to 8 April 2015 is considered, as a consequence of the artificially created 30 year Bond interest rate, the estimated additional interest cost that the Government will have to incur will amount to Rs. 42.5 billion. Although Dr. Pieris seems to be in agreement with this computation, he has proceeded to calculate the “present value” of this additional interest cost of Rs. 42.5 billion over the period of the Bills and Bonds, and has shown that the cost to the taxpayer at today’s rupees is only Rs.25.9 billion, when the total expected interest payments are discounted to the present value. While such a calculation would serve to support an accounting concept, it must be acknowledged that, in the final analysis, the Sri Lankan taxpayers will have to fork out this additional massive sum of Rs.42.5 billion over the next 30 year period due to the reckless adventure of the Governor and some others who must have been involved in this scandal. Dr. Peiris’ second contention is a clear contradiction since he suggests that the current high interest rates prevailing in the market is not due to the controversial bond issue of 27 February 2015, and that, while “it is true that interest rates did rise, there is no basis to assert that it was caused by the Bond scandal”. Dr. Pieris does not however venture to explain as to what then caused the interest rates to rise, when inflation was on a sharp downward trend, and Governor Mahendran himself is on record in early February 2015, that interest rates are expected to moderate. As we all know, our Government securities market is now fairly well developed and investors, primary dealers and other financial institutions are quite savvy about policy interest rates, market developments and macro fundamentals. Hence, all these factors are taken into account by them in the determination of interest rates for government securities, and that has helped to build a reasonably well-developed yield curve in the market. None can also deny that all those macro-economic factors which contribute towards the determination of the interest rates, were in a favorable balance by the end of February 2015. As a consequence, the yield curve of the Government securities market was on a downward trend, and indeed, had been so throughout the period from 2014 until the controversial Bond issue on 27 February 2015. On that basis, the yield curve on 26 February 2015 recorded the two ends of the yield curve, namely the three months Treasury Bill rate at just below 6% and the 30 year Treasury Bond rate at just below 9.5%, and as customary, the interest rates for all other Treasury Bills and Bonds were between the above mentioned two rates. In that context, it has to be readily acknowledged that the issuance of a 30 year Bond at an increased rate of 12.5% (about 3% above the market rate!), was clearly unacceptable and unwarranted, and that such action had distorted the entire yield curve. Even worse, that inexplicable aberration contributed to the unnecessary upward movement of the entire yield curve from 27 February 2015 onwards, causing the Government to borrow from the local market at considerably higher rates when compared to the pre-27 February 2015 rates.   Rex Fernando Retired Banker