Central Bank Governor Arjuna Mahendran

Accepting bids at a yield of 12.5% for 30 year government bonds while the market rate was nearly 300 basis points below the accepted yield caused a far greater destabilizing impact on the economy as a whole which went firmly under the
radar of both economic commentators and politicians who raised the issue at public forums.

It is common knowledge that the artificially higher yield offered to Perpetual Capital (Pvt) Ltd by the Central Bank of Sri Lanka effectively reduced the market value of the paper claims of the already existing bond holders by approximately 25% – 30%, temporarily, until the market readjusted itself to reflect reality which it generally believes in. It was a case where the general interest of the capitalist class was sacrificed to entertain that of a particular by the state.

Nevertheless, this temporary reduction of market value of the entire government bond market in Sri Lanka is causing a far greater destructive effect that’s long lasting on country’s external stability and ultimately its level of foreign indebtedness as a whole. This is so given that the sense of instability triggered within market forces following the fraudulent bond deal caused the foreign holders of Sri Lankan government bonds to withdraw its bond investments out of the country at an alarming rate.

At the start of the year foreign ownership of government bonds was Rs.457 billion amounting to 11.4% of the total stock. The figure remained almost unchanged at Rs.456 billion that was 11.1% of the total till 18th February 2015. However, following the historic bond deal, the figure now stands at Rs.408 billion, indicating a foreign outflow of nearly Rs.50 billion and a reduction of the foreign holdings of government bonds by as much as 11% since March 2015.

The bond deal in its turn triggered a flight of foreign capital from Sri Lanka’s government bond market that is of an economically lethal magnitude. The tormenting effect of a foreign outflow of this scale on external stability of country’s economy is indisputable and furthermore is economically long lasting.

The out flow directly depletes the foreign reserves of the country crippling the already unstable external balance of the economy. It causes the rate of exchange to depreciate and domestic interest rates to rise and as a result, compels monetary authorities to borrow even more from foreign sources to counteract these destructive forces let loose by the bond deal.

The recent currency swaps made with Indian Central Bank and borrowing over USD two billion through international sovereign bonds by Sri Lanka’s Central Bank were partly instigated by the foreign outflow which gathered pace as a result of the historic bond scam. As it is now apparent the process escalates the already humongous foreign indebtedness of Sri Lanka and depletes her foreign reserves throwing the country further down the path of insolvency.

It is absolutely fascinating that such an outcome was brought about together with the involved business interest, by the Central Bank of Sri Lanka at a time where country’s exports receipts are depleting and the deficit in the trade account is growing large enough to swallow up the value of domestic wages to the point of extinction.