The Governor of the Central Bank of Sri Lanka, Arjuna Mahendran last week denied any wrongdoing in the controversial Rs. 10 billion Treasury bond auction and asserted that he was ready to face any inquiry to prove his innocence.

In a wide ranging interview with The Nation Gain, the governor who acknowledged he is a Singaporean citizen claimed he had become a victim as a result of attempting to ensure more transparency in the activities of the Central Bank.

However, given the unusual bidding pattern of Perpetual Treasuries Ltd. at the February 27, 2015 auction, where the Primary Dealer’s bids were fairly large amounts and at higher interest rates (comparative to the total of 36 bids), questions still remain whether Perpetual Treasuries Ltd. had exclusive inside information of the government’s exact urgent funding requirement at the time.

It has to be noted that following the auction, the Central Bank’s Tender Committee accepted four bids that were directly placed by Perpetual Treasuries amounting to Rs. 2 billion. These were Rs. 250 m (11.5%), Rs. 250 m (11.75%), Rs. 500 m (11.99%), and Rs. 1,000 m (12.25%). Further, state-owned Bank of Ceylon making bidding on behalf of Perpetual Treasuries amounting to a colossal Rs. 13 billion, of which the Central Bank accepted Rs. 3 billion and at interest rates as high as 12.5%, raises serious suspicion.

Following are excerpts of the interview.

Q Tell us about yourself. A bit of background of where you grew up, studied, career and how you obtained Singaporean citizenship?

I grew up in Sri Lanka. I was at Royal Junior School and then at Royal College. Then from Royal, I directly went to Oxford in UK. I completed my Advanced Level in 1977 and got admission to Oxford in 1978. I did my degree in Philosophy, Politics and Economics and graduated in 1981. Then I came to Sri Lanka, Prof. G.L. Pieris who was like my mentor at Oxford, introduced me to Dr. Neville Karunathilaka who was the Senior Deputy Governor of the Central Bank at that time.

I was quite keen to join the bank. I sat for the entrance exam and on January 1, 1983, I joined the Central Bank of Sri Lanka (CBSL).

In the meantime, I also worked as an Economist at the Mahaweli Authority for about a year. I joined the Central Bank in the Data Processing Department way back in 1983. The CBSL had the best IT platform and still does. I was trained in Data Processing and was involved in the creation of what is known today as Lanka Clear. At that time, it was a straightforward project to automate the clearing of cheques.

That was the first time I connected to Singapore. The CBSL sent me to Singapore for a month to study the country’s Cheque Clearing System. Then I came back and we implemented an automated system in Sri Lanka.

Then I went for my postgraduate studies in 1985 and got my Masters from Oxford. I rejoined the CBSL in the Research Department. Then I took a year off in 1987 to work in the private sector.

I returned in 1988 and was appointed the Head of the Money and Banking Unit. I worked there till about 1993. It was a fascinating period as that was the first time we opened up the Stock Market.

In 1993, since the stock market was booming, I decided to set up a stock brokering company and ran it successfully till 1997.I started looking at markets in Singapore and India. By 1998, we had closed down our firm.

And then in 2001, Hon. Ranil Wickremesinghe formed a Government in December. At that point, he invited me to take over as Chairman of the Board of Investment (BoI). I was the Chairman from December 2001 to May 2004 until the Parliament was dissolved.

At that time, it was difficult to find a job after being the Chairman of the BoI. I was looking around and went to Singapore and since I could not find anything, I joined the Credit Suisse Bank in Singapore from July 2004.

In Singapore, they have a scheme where after working there until a point, they invite you to become their citizen. As part of their national policy, they encourage people to migrate there. I accepted that invitation since it was difficult to say no. That’s why in 2006, I accepted the citizenship.

That was the time when I was also criticized in Parliament and heard that the Former President (Mahinda Rajapaksa) was also upset with me over certain issues. That was the context in which a lot of us left the country during that period. I was accused of helping the LTTE. In 2010, when Sarath Fonseka was standing for election, I was advised by well informed sources not to come into the country.

Q As a Singaporean national, who has taken the oath of renunciation, allegiance and loyalty to that country, how loyal are you to Sri Lanka?

Well, I grew up here and my parents are in Sri Lanka, my father has been a Government servant for 30 years. So I have strong links in the country and I am not a foreigner. If you ask my colleagues in Singapore, China and Dubai, they will all tell you that whenever I spoke about Sri Lanka my face always lit up and I used to bring all my staff to Sri Lanka on off-sites. I would always consider myself as an unofficial Ambassador of Sri Lanka since I love this country.

Q What is your view on the state of the Sri Lankan economy at present? Are you satisfied with its performance in the past few years?

I think the economy has grown by about 7% or thereabout which is a good achievement. I think the economy could have grown about 8% to 9%. There are some issues that we have pointed out in our Annual Report which point out that there is more work to be done. The whole economic model so far has been dedicated on government borrowing. And we have reached the limits of that government borrowing.

As a result, the government has in the last few years resorted to borrowing by stealth. In other words, instead of borrowing on the government’s balance sheet, they borrowed on bank balance sheets. The BoC raised a billion dollars. DFCC raised 200 million dollars and NSB raised a billion dollars. That was effectively money for the government.

That type of model cannot continue. That is why this year we are trying to restrict our foreign borrowings as much as possible.
We have to now look at how we can grow our revenues.

Revenues were 19% of GDP in 2004. Today they are 10.3%. That is a massive collapse and we have to fix that. The good news is, we were there fairly recently, as recent as 2004 and the same people who ran that government from 2001 to 2004 are available to revive that.

We have to re-look at concepts like the Value Added Tax (VAT). Is the VAT appropriate for a service economy like Sri Lanka? The whole concept of value addition is I think inappropriate for an economy like this because value addition in a manufacturing process makes sense but not in a service economy where we mainly look at logistics, tourism and financial services.

QIt’s been nearly five months since you took over as the Governor of the CBSL. How would you describe your new role so far?

Well it’s like coming back home. It was my first formal job, and it was very heartwarming for me to come back. In fact, two of the Deputy Governors, Mr. Ananda Silva and Mr. P. Samarasiri, both joined the CBSL in my batch in 1983. So it was almost like coming a full circle, and they welcomed me very warmly.

I knew the institution, the people and the system. I have been observing them from afar, and coming here was like a plug and play situation. I was able to restart from where I left off.

There were issues that we had to resolve in the last five months. First issue was the previous Governor had planned a bond issue in January 2015 for US$500 million, which was absolutely critical because there was a repayment of a bond that had been issued five years prior, which was coming up for repayment.

Given that the new government had come into office, we couldn’t issue that bond because the investors wanted time to understand what the new policies of the new government would be etc. That took time. Alternatively, we had to draw on our reserves for the repayment which was something that should have been avoided, but we couldn’t. The currency also weakened a bit during that period, but we managed to hold it since our reserves were still strong.

In fact, one of the first things I did, after I was appointed, was to go with the Finance Minister to Washington where we met with the representatives of the IMF and the World Bank counterpart.

They told us that there was nothing wrong with our Foreign Exchange position and that there was no need for additional borrowing. But, we explained that there could be a climate of political uncertainty until the General Election, and we explained our policies regarding greater transparency and commitment to seeing that the economy does not develop on a slightly lopsided basis where there is too much emphasis on government infrastructure. We wanted the private sector also to flourish. We made our presentations to them.

I also took the opportunity of meeting investors who had invested in our previous bonds. As you know, over the years we had two US$ 500 million bonds in 2007 and 2009. Then in 2010,11 and 12, we did one billion each year. In 2013, a lot of banks such as DFCC, BoC and NSB raised about of 2.2 billion dollars of bonds. Last year, we did another US$ 1.5 billion in sovereign bonds.

So I specifically took time off to meet the investors in the East Coast and West Coast of the US and apprised them of the new policies of the government and assured that Sri Lanka would continue to grow and urged them to visit the country.

The other point is that when I looked at the issuance of Public Debt, I found that there was this reliance on private placements in the domestic Treasury Bond market and first of all this was not in accordance with the Public Debt manual which states that whatever that are raised through Bond issues should, as far as possible, be raised through auctions. When you look at major Bond Markets around the world, that is the norm! You go for auctions as far as possible, since that ensures transparency and also remember that the Bond Auction is a mechanism for establishing what the market’s expectations are of the future growth, future trajectory of inflation what that implies for interest rates and etc.

You get a reading from the market on what the interest rate at a particular time should be. That’s the key element of an auction. Whereas, if you do it through private placements, it’s a bilateral deal between the buyer and seller and that rate of interest is not representative of the market.

QIn your estimate, how much of bonds were raised through private placements in the last few years?

Well, as the Prime Minister has said, Rs. 2.7 trillion worth of bonds were placed in several private placements in the three years 2012, 2013 and 2014.

QIs that figure accurate and what was the proportion of it out of the total funds raised?

Yes I think broadly it is correct. And of course in terms of the auction, it was a very small percentage of that. I’m not trying to make a political statement here. But, we could have raised more through the auctions.

QWell, in contrary to your view that raising funds through private placements is not in accordance with the Public Debt manual, the former CBSL Governor Cabraal has described the Direct Placements to Primary Dealers after conducting an auction, as a time-tested practice.  Your comments?

I disagree completely with that. It is not a time tested practice except maybe in Sri Lanka during the last 10 years of the CBSL!

It flies against all the norms that we have seen in all the other countries where the maximum permissible level for this so-called tap issues (they call it tap because you can turn it on and off) after an auction is maximum 10% of the value of the auction.

If you sell 10 billion worth of bonds in an auction, you can sell maximum of one billion through subsequent tap issues until the next auction is held. I disagree with that. I think it’s not a sound practice.

Q So do you mean to say that Direct Placements are a relatively new phenomenon?

You must remember that the whole issue of raising bond securities through auctions started fairly recently. We’ve been having Treasury bill auction for a much longer time. So the extension into the bond market (securities of more than one year), is relatively a new phenomenon.

Second point is the structure of the market has evolved in recent years. One of the key determinants has been the fact that the expatriate population of Sri Lankans has grown in the last decade. There has been a migration of talent from Sri Lanka in the past years during the war and all.

Sri Lanka today is in a small club of countries who has large expatriate populations. Others that come to mind are Philippines and Mexico. This basically means that there is a fair amount of interest in amongst our expatriate population to invest in Sri Lankan Government security.

And that too has grown in recent years, which is the other aspect I was looking at since I had worked overseas, I saw this demand and said why don’t we try and attract them to invest in these securities and there was no better way than having regular auctions. Because that then signals the market rates of interest and you know, shows that out to the rest of our communities overseas.

QYou have been rocked with the Treasury bond scandal within days of assuming office. We would like to hear your version of the whole saga?

We took a decision at the Monetary Board on the 23rd of February to have the first auction under my governorship. Now this was also coinciding with large requests for funds from the Ministry of Finance. You must remember that the Public Debt function of the Central Bank is an agency function, set up under the Monetary Law Act.  We act as agents of the government.

This is not our intrinsic activity. Our intrinsic job is to formulate Monetary Policy to enable adequate liquidity in the market. Public Debt issuance in other countries is handled by the Treasury. But, here it is handled by the Central Bank.

So, as an agent of the government, if the government orders me, that on the 2nd of March 2015, I should deliver Rs. 13.5 billion, into the account of the Secretary to the Treasury, I have to do it. I cannot question that. It’s an order.

QGenerally, when the Treasury requires money, what is the length of notice that Treasury ought to give the Public Debt Department of the Central Bank?

They give us a month’s notice.

QSo you knew the requirement beforehand?

Yes, but what I noticed was in the weeks leading to the auction, is that the amount raised through private placements was diminishing. In January, we raised a considerable amount, but in February it started declining. When I looked at the projections for March, there was a significant bunching up of government repayments due in March. Over Rs. 100 billion had to be paid in March and we managed to raise one or two billion rupees through each of the private placements, which was insufficient when you look at the degrees of magnitude.

I had anyway told my colleagues at the Public Debt Department (PDD) that we should look at the auction way methodology of doing this and the Monetary Board agreed to that and we decided to go for a 30 year bond.

QWhat were the circumstances that led to this sudden increase in the government’s borrowing requirement?

The Government gave a 40% increase to public servants and the expectation was that the government borrowing was going to shoot up. Anybody who read the Budget (presented on January 29) and has the finance knowledge would understand that the borrowing requirement would go up. In order to see that interest rates were well behaved, I said we will go for the longest tenor, the 30 year bond first, so that we anchor the interest rate.

As you know, the yield curve was upward sloping, so the interest rate for the long term tenor has to be higher. If you lock the longest one, then the entire yield curve gets locked. Whereas, if you went for the short term tenor, the danger is that if the interest moves up, the whole curve starts to move up and you wouldn’t want that to happen in a situation where the traders are expecting the government to keep borrowing more and more money.

And also, at the end of the tax year, which ends on the 31st of March, you find that revenues tend to be weak around that period. Generally February and March is a weak period for revenues because 1st of April is when the new tax year starts and when taxes start coming in again. So there is a shortage of government finance in this period and borrowing has to be high on a seasonal basis.

QWhy did the PDD of the CBSL advertise to raise only Rs.1 billion instead of the actual requirement?

I think the PDD, going on their previous practices advertised for Rs. 1 billion worth of bids at the auction. I think their expectation was that they could raise the balance through Private Placements.

But, when we came to that Friday (February 27, 2015), they had not been able to raise more than about Rs. 3.5 billion out of the Rs.13.5 billion requirement!

So, there was a Rs.10 billion gap on Friday afternoon and we had to deliver it on Monday morning to the Treasury. And there was no way I could see where that Rs.10 billion was going to come from. That’s the simple story.

QWhy do you think the PDD couldn’t deliver on the requirement at the time?

They couldn’t find people to give the money. This is why I said, the earlier system was not working.

QWhat involvement did you have in the activities of the Tender Committee?

When the auction was held, we found that there was Rs. 20 billion worth of bids. The Tender Committee sits separately and I wasn’t part of the committee. But I told them the requirement and that it was an order from the government.

QWas there a communication lapse of sorts where the PDD was not aware of the amount that they had to raise?

No. They knew. When it was advertised, they could have legitimately expected that they could raise through private placements. I don’t blame them for that.

QHas this happened before?

Not to this magnitude. There might have been slippages of Rs. 1 or Rs. 2 billion, but not 10 billion.

So when I discussed this with the PDD, we came to an agreement that there was a need for Rs.10 billion to be raised.

  QDid the CBSL at any point indicate an interest rate in the range of 9.75% to 12.5% to the Primary Dealers?

On Wednesday, February 25, we put a notification on our website saying that the interest rate payable on this bond would be 12.5%. That was public knowledge. On Thursday, the same advertisement came in the newspapers. Nobody ever said it was 9.75%. When people say we indicated 9.75% it’s a complete nonsense. It never was the case.

Q Why was the rate decided at 12.5% then?

That was basically on historic levels of interest rates. In May 2014, at the previous 30 year Treasury Bond auction, the advertisement said 13% and the accepted level was 11.75%. We brought it down to 12.5% for this auction and the accepted level was 11.73%. That is set in terms of the expectations of the market and so on.

QWe had a low interest rate environment last year and even the Central Bank’s indication prior to the February 27 auction was that this trend will continue. However, given that the Tender Committee accepted bids even at 12.5%, it seems Central Bank has adopted a sudden change in stance. Why?

In the secondary markets, there may have been an artificial depression in the interest rate between September 2014 and December 2014. That is because the bulk of the tax revenues come to the government at that time. That depresses interest rates and remember last year the credit growth to the private sector collapsed. So there was no demand for funds and that’s why interest rates collapsed.

But, by the end of the year and particularly after the elections, credit growth started growing again and people started borrowing. And so interest rates started moving up.

QThe three-member committee says that the bidding pattern of Perpetual Securities and securing 50% of accepted bids was very unusual. The committee has recommended a full scale investigation by a proper government authority. Has any investigation started to your knowledge?

The Honorable Speaker of Parliament has asked the Committee on Public Enterprise (COPE) to investigate this matter. COPE is currently investigating this. And in the Central Bank, we are now gearing ourselves to examine the findings of the three member committee and of the COPE when it presents its report on June 12. Then we will conduct our own internal investigation on this matter.

At the same time, the Honorable Prime Minister has asked his Ministry, the Ministry of Policy Planning and Economic Affairs, and the relevant investigative agencies are to look into this matter. I think there is a committee headed by Justice Harsha Soza to not only look into this matter, but other issues in the financial sector.

QThe Committee has also asked the Board of Bank of Ceylon to initiate a full-scale Investigation and if necessary, a forensic audit into the activities of the Dealer room of BoC. Given the fact that BoC falls under the supervision of CBSL, what is the progress of the investigation?

From the Central Bank, our Director of Bank Supervision is aware of what the BoC is doing and we are monitoring them. No sooner the findings are released, then we will factor that into our supervisory activity of the BoC.

I have no timeline as yet, but I think the COPE investigations are critical since that is the highest body at the moment looking at this and then the Harsha Soza Committee’s findings will also be looked at. So there are multiple agencies that are looking into this to give us a broader view as possible on anything that went wrong and remedial action that has to be taken.

QWould the Central Bank, as the regulator, investigate the transaction between BoC and Perpetual Securities?

First of all, BoC themselves will have to come up with their findings. We haven’t got involved in any of this so far. It’s been driven by the Ministry of Policy Planning and Economic Affairs and the Ministry of Finance.

QEven when you were appointed the Governor on January 15, there was a barrage of criticism that your appointment could lead to a conflict of interest as your Son-in-Law controlled Perpetual Treasuries, a primary dealer. Given that this was the case, do you think it was ethical (though legal) for the company to have involved in a transaction of this nature?

Well, as I have said this before, my Son-in-Law had resigned from the company. He has other businesses which he is attending to. So there is no conflict of interest in the sense that he did not personally own this primary dealer company.

QBut it is a family-owned business where he may still enjoy influence over the affairs of the company?

Well, it is not my family! It is a family of a person who married my daughter. That doesn’t mean that I have any personal interest in this. And provided the safeguards are there, if there was any issue regarding this company, I recuse myself from being involved in the discussions and I left it entirely to the PDD to handle this matter. So I think from my perspective, that it is adequate safeguard against any influence.

He himself offered to resign from the company and not to get involved in this area of activity. And I can vouch safe for that there is a professional manager, who is running that company, and he has testified before the Committee and before the COPE and people will realize that he is mature and able enough to run that company independent of any pressures from anybody else.

Let’s be clear about this. Why would I do such a silly thing, given that all these allegations have been made from day one?

In addition, I have various relations in the Maharaja organization and other people. So there will always be conflicts of interest for anybody who is sitting on this seat. My point is that when the previous governor took office, there was a question about Gold Quest and his involvement in the company. That was dealt with in one way or another.

QSince the turn of events and now that you have resumed duties as the Governor, after that brief leave you took to facilitate the inquiry, how hard has it been for you to assert your credibility both within and outside the Central Bank?

Well, to the extent that we were able to raise USD 650 million last week from the international markets at a record narrow spread of below 400 basis points over the corresponding US Treasuries is I think testimony to the fact that this has not at all impacted the reputation or the standing of the Central Bank of Sri Lanka in the international markets. Not one adverse comment has been made about me or the CBSL in any international press to date!

All the comments are basically politically motivated by local commentators who have made this a big issue when the Supreme Court of the country has exonerated me and the Central Bank of any wrong doing. The committee appointed by the Prime Minister has exonerated us. Let’s see what the COPE says and I rest it there. I’m not going to make judgments about my own actions.

QDue to this scandal being splashed in the media and tarnishing your reputation to some extent, was there any point of time you considered resignation which could have controlled the extent of damage it caused? Or did you not consider quitting because you thought it will amount to accepting guilt?

Exactly. Resignation would have amounted to accepting guilt! Secondly, I took up this job with a view to performing certain tasks, and for me to abandon ship just on frivolous charges would have been dereliction of duties.

The Annual Report of the Central Bank by statute had to be presented to the Minister of Finance on May 1 every calendar year. We had to work towards that. I took leave, and as soon as I came back, I made sure that we presented the Report on the due date.

We also had to see that the government’s funding was met. We have managed to do that to date, until 650 million issuance last week, we have not raised any funding in the international markets. That’s a significant achievement.

Last year by this time, the government had raised 1.5 billion US dollars through two bond issues. Without doing that, we managed to raise money in the local bond markets!

To me that’s an unsung achievement of the Central Bank and I give full credit to the officials of the PDD that despite all this adverse comments etc, they have continued steadfastly in their work and have managed to raise record amounts of money in the local bond market.

QThe former governor of CBSL in a recent statement said that post-general elections, the new Government must appoint an Independent Special Prosecutor who must be mandated to inquire into all aspects of this scam. He says if such an investigation is done, that investigation will reveal that a topmost person of the current Government is also directly involved, given the intense effort at that level to somehow conceal this “Bondgate”. What is your response?

I don’t want to respond to the previous governor. I have the greatest respect for him and he is facing several investigations currently and I don’t want to comment on this. My point is, let us look into the future of this country.

I have not concealed anything. We are transparent. In fact, I’m a victim of my own transparency. If I had stayed with the private placement methodology, none of this would have happened and nobody would have known. This company which was linked to my son-in-law would have done this same amount of transaction through a private placement and nobody would have known about it. That is all I can say.

Well, like I said, it has become a political issue and it is unfortunate. The foreign media has not taken this issue seriously at all. It’s been a local issue. I think it is partly because, when you implement change, there are always people affected by that change. This government has not been scared to do this. I have experience on this in 1993 when we liberalized the stock market.

At that time, shares could only be owned by Sri Lankans. We opened it up for foreigners and immediately, there were protests particularly from the private sector from Directors who were worried that their shareholdings would be diluted. I’m not a stranger to this type of controversy and I don’t claim credit for this. It is the Prime Minister and the Cabinet who have seen the need for a change.

QOn the financial sector consolidation initiative, what were the findings of the Committee’s Report and why is the report still not made public?

I think it has been circulated for comment from the various Ministries and you will see a final version out fairly soon. There were some preliminary comments that came out suggesting that it should be a more voluntary approach rather than a forced approach. That is the key changes as I understand.

QWhat does it recommend to do with the ailing finance companies?

Traditionally, when you have an ailing financial company, the Central Bank goes in and restructures it and finds new owners or new managers and then revives it. That model will continue.

However, if you are going to force good finance companies to take over bad ones, you are creating a bit of a hazard for the good finance companies. That I think was the view of the committee.

tablePic by Chandana Wijesinghe