Sri Lanka opposition renews warning on sovereign bond

Sept 24, 2007 (LBO) – Sri Lanka’s opposition has renewed its warning that a planned sovereign bond has no parliamentary sanction and a future government made up of the current opposition will “cancel” the bond. The opposition United National Party leader Ranil Wickremesinghe had warned HSBC Bank, a joint lead manager of the bond deal, that its banking license in the island will be cancelled if it breaks Sri Lanka’s laws.

In a television interview he said the opposition has also written to the other lead managers. The 500 million dollar bond is jointly managed by HSBC, JPMorgan and Barclays.

Wickremesinghe told the MTV channel Friday that the opposition was also “investigating” JPMorgan for its involvement in a controversial arms deal.

He says Sri Lanka has no capacity to make a ‘bullet repayment’ of the bond — meaning it has be repaid all at once – and it is also falling foul of a law which was enacted to improve state finances and economic stability.

Legal Question

The UNP says it will cancel the bond if the government borrows without parliamentary sanction.

“We will make resolutions in our party,” Wickremesinghe said.

“Thereafter when we come to power we will cancel the bond.”

Wickremesinghe’s stand seems to centre around a fiscal responsibility law which was brought after a government he headed came into power in 2002.

At the time the country was recovering from an economic crisis brought about by money printing and a fiscal deficit in excess of 10 percent of the economy. In 2001 the economy contracted by 1.5 percent for the first time since independence.

Wickremesinghe said the fiscal responsibility law was planned when he was in opposition after watching the developments that led to the 1999/2000 economic crisis.

“We realized how serious the situation was and that we had to have some legal standards by which the performance of a government was judged in relation to fiscal matters and its own bearing on the monetary affairs of the country,” Wickremesinghe said.

“It was one of the first laws enacted by us and it helped us bring the economy under control from negative growth to positive growth. In most countries there are some laws that are similar to this. It is part of the government’s responsibility to Parliament.”

Sri Lanka’s state finances have deteriorated since 2004 with budget deficits rising. The budget deficit impacts the volume of money printing and is the primary determinant behind monetary policy.

Heavy money printing since 2004 prompted by bad budgets has caused inflation to zoom and the rupee to fall.

“One reason [for the law] was to put the government’s finances into shape,” says Wickremesinghe.

“The other was to strengthen the powers of parliament by ensuring that the government was responsible to parliament for fiscal and monetary measures. It is not being observed now.”

The goal posts in the fiscal responsibility law, the budget deficit as well as national debt targets, have been shifted without parliamentary approval.

It is not clear why the government does not seek the parliamentary nod to shift the goal posts in the fiscal responsibility law and clear any legal ambiguity and give comfort to potential investors in the bond.

Meanwhile Wickremesinghe also questioned the selection process of the lead-managers, saying it had to be investigated at some point.

Bullet Repayment

Transparency International also called for details of the bond to be laid before parliament, earlier this month.

The anti-corruption watchdog also asked “why and how three international banks were selected and why others, if any, were rejected” and called for the selection process to be revealed.

The watchdog also asked why the government was raising funds for projects that already had donor financing and asked for mechanisms to prevent the money from being used for other purposes.

It also asked for clarifications whether there would be a ‘bullet repayment’ or it will settled in part as funding for the listed projects come through.

The rating agency Standard and Poor’s which has given Sri Lanka a B+ speculative rating with a stable outlook, has also said the government would not be able to make future repayments on its own resources.

S & P said after the bond is issued it expected Sri Lanka to “maintain adequate external liquidity, supported by limited recourse to short-term borrowing.”

Transparency International has called for “an up front disclosure that adequate cash-flow based returns are available to service the debt in due course.”

“The repayment capacity of the government should be seriously examined. It is commonly believed that the previous borrowings in foreign currency, especially those taken in the last year, have lacked the above risk mitigation action,” the watchdog said.

Sri Lanka has increasingly relied on international commercial borrowings as human rights allegations as well as the current economic framework have made it difficult for the country to qualify for cheap long-term donor funds.

Multilateral agencies give concessionary loans for budgetary finance when policies are directed to lowering poverty.

This is done by creating new opportunities for jobs and economic growth through dismantling restrictions and improving state finances to strengthen economic stability by lowering inflation.

However critics say when policies favour the rich and state money is used to pamper privileged sections of society, such as government servants, electricity users, and fuel users it is almost impossible to get such funds.

Chavez Action

Some independent analysts feel that a volume of foreign financing may help the country side-step some of worst effects of current economic policies and a runaway budget, in the hope that the policy framework could be adjusted in the near future.

Others feel that it may only allow the state to perpetuate excesses and get the country into serious trouble later.

A budget deficit cannot be expanded without financing. Wickremesinghe’s argument on the fiscal responsibility law and making the bond mangers ‘accessory’ to the breach also seems to centre on this principle.

Sri Lanka’s business community had criticized Wickremesinghe for his attacks on HSBC Bank, which has been operating in the country for more than century, and has played a path breaking role in the country’s banking practices.

It is one of the banks that helped revolutionize personnel banking in recent years by starting cash-flow based personal banking instead of the traditional collateralized lending that limited lending to asset-owning classes only.

Wickremesinghe rejected a charge that he was behaving like a “Hugo Chavez” in attacking foreign banks.

“I don’t think you can compare with Hugo Chavez. His [stand] is being anti American. Mine is being pro- Sri Lankan. But it is a good example to give.

“Why does Venezuela have this bent? Because you have to remember that Venezuela is one of the countries that had to go through a debt crisis at the beginning of the 20th century.

“The European powers, their Navies came and shelled Venezuela. They got permission of the US.

“Venezuela was shelled because they could not repay loans. Mexico was occupied because they could not pay the debts.”

Wickremesinghe was referring to events in 1861, when Spain, Britain and France arrived on Mexican shores to force debt repayment. Britain and Spain later recalled their forces but France went onto occupy Mexico City.

In 1902 Britain, Germany, and Italy blockaded Venezuela. In 1903 German ships bombarded Fort San Carlos destroying a nearby village.

Latin American Syndrome

This upset the American people who forced the government to intervene. US President Roosevelt later announced a new policy building on an earlier doctrine which forbade the use of European force to collect debts in the Americas.

However South American countries has continued to print and waste money, run deficits, borrow abroad and get into trouble into modern times despite being enormously rich in natural resources.

Some critics say this was partially helped by the US policy of intervention that not only bailed out profligate governments, but also the banks who lent to spendthrift governments and helped them get into trouble.

Though Latin American nations went bankrupt time and again, international banks made billions in profits by giving loans at high interest rates to encourage wasteful expenditure.

Analysts have drawn parallels with badly managed South and Central American countries and Sri Lanka before.

Venezuela which is an oil exporter had 15.9 percent inflation in August 2007 (17.3 percent in Sri Lanka) and Chavez had announced new measures to control the central bank and take international reserves for his political programs.

Chavez says the country’s inflation index is wrong. Sri Lanka is also trying to change the consumer price index saying that it is wrong.

Fitch had given Venezuela a BB – rating and S&P a B+ rating, the same rating given to Sri Lanka.

Economic analysts have pointed out that Argentina received a BB rating from Fitch in 1997. In March 2001, Argentina’s rating was downgraded to BB-.

Eight days later it got downgraded to B+. In July of the same year it got downgraded to B-, in October to CCC-, in November to CC and C and on December 03, 2001 to DDD, or default, when the country could not repay its borrowers.

Argentina has had 700 percent inflation, tried to abolish its central bank at one time but is still having high inflation.

In February the government sacked the head of the Argentinean statistics office and replaced her with a finance ministry official saying the inflation index was wrong.

.