By Dr. G. Usvatte-aratchi, Economist Courtesy The Island

Now that the committee he appointed to report on the events identified as the bond scams has been given to President Maithripala Srisiena, and in the reasonable belief that it will suffer the same fate as the report on the egregious Welikade Jail Murders, I venture to comment on the series of events collectively called the bond scams. (As I have not read the Report, the reader more familiar with events will pardon me if I get something more wrong than the authors of the Report.) The promises that the President made on New Year’s day are as good as the breath he wasted when making promises to the nation at the funeral of bhikkhu Maduluvave Sobhita.

Corrupt Deals Ltd. (CDL) was a primary dealer in the market for government debt instruments. As a primary dealer, it had the legitimate privilege of bidding for government paper that was issued by the Department of Public Debt. At the auction held in February 27, 2017 CDL tendered to buy a huge cachet of 30-year bonds. He bought them very cheap, enforcing capital losses and high rates of interest on the government and markets. As any bond dealer would, he sold these bonds he bought very cheap, very dear and inevitably made huge profits exceeding 11 billion rupees within the ensuing five- months. This is very simple and seemingly entirely legitimate. It is a run of the mill transaction in the bond market, provided there was no market manipulation.

There were market manipulations. There are distinctive features that mark out these transactions. The value of debt instruments that was on offer that morning was far in excess of what had been announced and from what the market had expected. No Primary Dealer except CDL was ready with funds to bid for that volume of debt. In the absence of competitive bids, CDL went laughing all the way to the bank. How was CDL able to be ready with funds to bid so huge a volume of debt? Why did not EPF, flush with cash, bid in competition and waited to buy the same bonds at higher prices?

Anyone familiar with capital markets would suspect insider trading, not very different from what Raj Rajaratnam, fittingly a man of Sri Lanka origin, perpetrated in the NewYork Stock Exchange. Insider trading (a case of asymmetric information)occurs when one party to a transaction in assets possesses information acquired by illegal or improper methods to bid for or offer to sell at prices and in volumes, which information others could not have obtained in fair manner. And under the laws of the United States and the State of New York, insider trading is a punishable offence.

Rajaratnam was tried in Federal Courts and was sentenced to 11-years in jail and fined some $60 million. On the face of it, there was the high probability of insider trading in Colombo and law enforcement officers only had to trace the trail of the flow of information. Things were made very easy for sleuths because there was a high official of the debt issuing office who happened to be close kin of a person who stood to benefit from the fortunes of the afore mentioned CDL. The slogging was in taking down depositions from witnesses, who themselves had transgressed the law, examining incriminating documents and reading transcripts of conversations over telephones on the deals. To an outsider, the lawyers and policemen had done a brilliant job (as reported in the media) collecting and presenting the evidence before the Committee. The other matters raised in the proceedings before the Committee and played upon by the media are matters related but different from the main consideration which I have shown in outline. (Ravi Karunanayake saga is one of them.)

Under clause 12(1) of the Monetary Law Act, ‘the Governor of the Central Bank shall be a person appointed…. by the Governor General (President),on the recommendation of the Prime Minister.’ Was the Prime Minister wise in selecting Mr. Jagmohan to the post of Chairman of the Monetary Board and Governor of the Central Bank? We can all be very clever after the event, but was there enough evidence to say that the appointee was unsuited for the job because of his competence and unquestioned integrity? What is the responsibility of the President who actually appointed Mr. Jagmohan to the office according to law? Why has he been held above criticism, when the Prime Minister has been roasted over coals? In my understanding of the law, the President is more culpable than the Prime Minister. (X can recommend Z to Y but Y must exercise due diligence in appointing Z to post P.) We need constantly to remind ourselves of Dr. Thomas Fuller’s dictum, ‘Be you never so high, the law is above you’. That Mr. Jagmohan was a national of another country cannot be a bar to his appointment. After all, the first governor of the Bank was an American and there was a Director of Economic Research in the 1960s who was a citizen of Canada. Recently, the Governor of the Central Bank in New Zealand and in England were not nationals of those two countries. I am not sure whether Rahguram Rajan, until recently Governor of the Reserve Bank of India, was a citizen of India or of US or both. Anand Panagariya, who was Economic Adviser to Prime Minister Modi for two years, is regularly a Professor of Economics at Columbia University. Several bright officers of the Central Bank of Ceylon (Sri Lanka) have been on invitation, de facto, governors of Central Banks in several other counties.

The Prime Minister was ill advised to appoint three lawyers to advise him on the financial irregularities that were then suspected. The Committee did a commendable job within their competence. But their competence was wholly inadequate to the task at hand. There should have been someone who understood financial markets and someone who was not allergic to numbers. Had he done so he would have come to possess information adequate to trigger him to act under clause 16 (e) of MLA: ‘The Governor-General may, on the recommendation of the Prime Minister, remove the Governor….from office- if he has done any act or thing, which in the opinion of the Prime Minister, is of a fraudulent or illegal character or is manifestly opposed to the objects and interests of the Central Bank’. Although again we are speaking with information that came out much later, someone with a sharp mind and knowledge of capital markets would have been offended by a smelly rat. The Prime Minister’s judgment is severely in question and his advisers seem to have been dumb.

Astonishingly, the Monetary Board similarly seems to have been absolved of blame in flagrant disregard for the law. Clause 8 of MLA reads: ‘The Monetary Board of the Central Bank, in addition to determining the policies or measures authorized to be adopted or taken under this Act, be vested with the powers, duties, and functions of the Central Bank under this Act, and be generally responsible for the management, operations and administration of the bank.’ If there were improprieties, and worse, committed by the Central Bank including its Governor, the members of the Monetary Board are responsible for them in every way. Ignorant TV journalists have left them off the hook. I hope the Committee has not done the same mistake.

Who stole money from the Central Bank? The Editor of this newspaper on 6th January, wrote of ‘… those who robbed the Central Bank not once but twice….’. I can find no robbery at the Bank and obviously no robbers. There is no entry for such losses in the accounts of the Central Bank for 2015 and for 2016, Audited by AG H.M. Gamini Wijesinghe. The Central Bank was not a party to the transactions and it could not have either gained or lost money. These losses are figments of fevered imaginations. The Central Bank, though, lost all its capital of a name for eminent competence and high integrity, accumulated over a long years before 2005.

The Public Debt Department, as agent of government acting under the supervision of the Monetary Board, sold government bonds at ruinously low prices, which were well below the par value of the bonds. That was the first mighty loss. Thirty years later, tax payers will pay to bond holders the par value of each bond (say, rupees 10,000). DCL paid (say) Rs. 9,400 because it was the sole bidder at the auction. Then government sold Rs. 10 billion worth of bonds to receive Rs. 9.4 billion as sales proceeds. Tax payers (aka government) lost 600 million in that sale. Tax payers of this country may during the 30-year tenure of the bond annually transfer a part of their income to owners of these bonds. When bonds mature tax payers (aka government) will pay the par value of bonds to bond holders. Had the bonds been sold at prices closer to par value,the loss to tax payers over that long periodwould have been far less. (Cannot the government save the public from this fate by retiring this debt with a fresh issue to pay for it,committing the government to much lower rates of interest?). This fiasco creates a good opportunity for the Public Debt Department to return to its legitimate home, the Ministry of Finance. Its management by the Monetary Board often compels the Board to act ‘in manifest opposition to the objects and interests of the Central Bank’, the common cliché, conflict of interests.

The Employees’ Provident Fund (EPF) receives money which is expected to stay with it for long periods of time, on average, perhaps,20-years. As such it is eager to buy long term government paper, in a capital market which has few long term assets worth buying. It was, at least, strange that EPF did not bid for a 30-year government bond to raise 10 billion rupees with a reasonable rate of interest. Now it is evident that they were kept blind to the auction with machinations to limit the supply to one primary dealer. As could have been predicted easily, EPF later came to the market to buy these bonds at prices higher than they may have paid had they been able to bid at first issue. The loss that EPF is purported to have suffered probably rises from the difference between the price of the bond that EPF actually paid to DCL and what EPFMAY HAVE PAID had they and other primary dealers had the opportunity to bid competitively at the primary auction. (Many bidders for the same quantity must cause the prices to rise and in this instance for interest rates to fall.) This process was not allowed to take place because of theillegal supply of information only to one primary dealer and to none other. These remarks apply, mutatis mutandis, to purported losses of the Mahapola Scholarship Fund and others.

The Employees’ Provident Fund Act (15 of1958), in clause 5, stipulated that the Monetary Board shall manage the Fund under terms elaborated in that clause. Neither in the main body of the Act nor in clause 47 on interpretation do the words ‘central bank’ appear ever. It seems reasonable to assume that Parliament did not want to mess up the activities of the Monetary Board in managing EPF with its other activities in managing the Central Bank. Parliament probably was well aware of the dangers of such messing up. But that is what the Monetary Board precisely did when they established a Department in the Central Bank to manage EPF. We do not have audits of the management of the Fund for the last fifty yearsbut this one casual test makes one suspect that EPF may not have been well managed by the Monetary Board. One must commend EPF bureaucrats though, for keeping costs of managing no higher than one percent of funds managed in contrast to ratios as high as 6 percent in some privately managed funds in other countries. Managing a large fund requires attitudes and skills very different from those of Central Bankers, business school types in contrast to university types. Isn’t it time we separated the two and allowed members of the Fund to manage its own funds?

To sum up. The losses of the Public Debt Department and EPF Department are not losses of the Central Bank. In making appointments to the post of Governor of the Central Bank the President and the Prime Minister must make thorough background checks and examine candidates for their knowledge of and familiarity with central banking and monetary theory and policy. R.S.Sayers and J.G. Crowther will do no more. (Instead, try reading the Journal of Monetary Economics.) During the forty years or so from 1980, the disciplines have changed sharply. A few years in one’s youth spent at the Central Bank is no recommendation for appointment to that position. The members of the Monetary Board must be held accountable for the management of the Central Bank as laid down in theAct. The Public Debt Department must be relocated to the Ministry of Finance. EPF can be managed by the Monetary Board as in the 1958 Act but not as a department in the Central Bank. The preferred solution is for EPF to cut its links to the Monetary Board to be managed by its own Board.

The case against DCL is essentially one of trading with the wrongful advantage of insider information. As I understand it, all profits so wrongfully earned is forfeit to the State. Besides, DCL must be punished to demonstrate to all that that practice always will be fraught with the high risk of fines, imprisonment and ignominy. If those connected with the scams have broken laws in their functioning in connection with matters that constitute the felony in question, they must be punished according to law.

The courts must punish according to law, all working for the Central Bank or DCL for breach of the relevant laws. All wealth accumulated illegally must forfeit to the State. It is up to the organizations that employ them to punish them separately according to accepted rules and regulations. At the end of it, the courts and the bar must ensure that they deliver a land mark judgement for everyone bent on mischief to see tall and fearsome, as in the Raj Rajaratnam case in US.