The ‘Bond Scams’ Were Caused By A Broken Bond Market – Part II

By Arjuna Mahendran –JUNE 19, 2020

Arjuna Mahendran

On Thursday 26 February 2015, I had been at the central bank for a month and was still familiarising myself with the bank’s operations. That morning the former ministers of finance and highways and an advisor to the prime minister dropped by my office. They were accompanied by the finance secretary and senior management of the road development authority (RDA). I invited the 3 deputy governors of the central bank to attend the meeting. The meeting was to ascertain how much extra funding was needed by the RDA to revive highway construction that had stalled due to non-payment to contractors. Before the meeting, I requested that economic research staff of the central bank contact the RDA to verify the funding needs of the organisation.

At the meeting I recall that the Chairman RDA requested Rs 15 billion immediately and another Rs. 75 billion in a month’s time. The central bank research staff confirmed that these figures tallied with their estimate of arrears of payments by the RDA. Soon thereafter, I attended a larger conclave called by the minister of finance with over 50 groups of private road construction contractors who were awaiting the payment of their fees to resume the stalled construction of roads and highways. The minister persuaded most contractors to take a substantial haircut on their contract fees in exchange for receiving their delayed payments. It was evident to me that the contractors were in urgent need of the funding.

Prior to the meeting with the ministers at the central bank, the board of the central bank met for its regular fortnightly meeting. The finance secretary, who was an ex-officio member of the board explained how the finance ministry was in urgent need of additional funding as he was receiving several claims of unpaid bills from the previous financial year. A deputy governor told the meeting that an auction to raise funds through the issue of a 30-year bond had been planned early in the year. He also stated that the Employees Provident Fund (EPF) had Rs. 2 billion surplus cash available to invest in this bond. The board agreed to proceed.

Upon further inquiry I found that the finance ministry had already formally asked the central bank to borrow a total of Rs.172 billion in the month of March 2015. Of this large amount, Rs. 13.6 billion had to be raised by Monday 2 March 2015. This implied that the extra funds requested by the Chairman RDA had not been included in the finance ministry’s estimate. Moreover, there was a large repayment of Rs 128 billion worth of bonds which were maturing in mid-march 2015. I discussed this with the senior managers of the department issuing government debt and asked them how they proposed to raise these large sums which far exceeded the sums already borrowed in January and February 2015. They responded that they would hold an auction of 30-year bonds that week for a sum of Rs.1 billion and raise a much larger amount through accepting any extra auction bids in excess of Rs. 1 billion plus a sizeable private placement of bonds with bond dealers. When I suggested that it was absurd to advertise a Rs 1 billion auction when we were expected to borrow an average of over Rs 40 billion a week, they replied that advertising a larger amount would signal the market that the government was in desperate need of funding.

When I looked at the weekly ‘run-rate’ at which the central bank was borrowing money for the finance ministry through private placements over the preceding 6 months, it was evident that borrowing amounts over Rs 5 billion a week would be impossible using private placements as the main funding method. The deputy governor overseeing the debt department reviewed the proposed strategy of the department officials to borrow the large amounts of money required by the finance minister. He agreed that their strategy simply didn’t make sense. 

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