Sri Lanka’s reluctant saviour

Indrajit Coomaraswamy was all but retired when the call came to run Sri Lanka’s Central Bank. He can’t remember saying yes to the job, but in 18 months, the self-effacing civil servant has given a government on the edge of bankruptcy a new lease of life.

They don’t make them like Indrajit Coomaraswamy any more. The calm and self-effacing governor of the Central Bank of Sri Lanka spent most of his career behind the scenes, working diligently to give strength and structure to a fragile frontier market. An economist by training, he spent more than 40 years bouncing around the upper echelons of Sri Lanka’s civil service, advising a finance minister here and a prime minister there, and enjoying 16 years with the central bank.

He occasionally veered into the private sector, with directorships at Hatton National Bank and conglomerate John Keells. But by 2016, Coomaraswamy’s working life seemed to be winding down. Yes, his advice was still sought by ministers and chief executives. But he was 66 and counting, and happy, after a lifetime of civic duty, to hang up his suit and spend more time with family and friends. Then all that changed. In July of that year, President Maithripala Sirisena, bowed to intense pressure and fired the then-Central Bank Chief, Arjuna Mahendran. A Singaporean national, Mahendran was never a popular choice: some saw him as a financial puppet of the ruling United National Party. But the governor’s fate was sealed with the discovery that more than two thirds of the securities issued in a SLRs10 billion ($65 million) bond auction in 2015 had been sold to a primary debt trader owned by his own son-in-law. The scandal could not have come at a worse time and it nearly crippled a government that was already struggling to stay afloat.

When Sri Lanka finally emerged from a long and bloody civil war in 2009, it borrowed heavily to pay for an ambitious infrastructure spree, putting enormous stress on state finances. It took a $1.5 billion IMF-led bailout, agreed in early 2016, to stave off insolvency. The presidential commission’s report published in January this year found Mahendran guilty of leaking sensitive information to Arjun Aloysius, his son-in-law, and of manipulating rates to allow him to profit directly from the auction in February 2015. That sale had started out small, with the central bank announcing plans to raise SLRs1 billion from selling 30-year government notes with a 9.5% coupon. It then suddenly hiked the target to SLRs10 billion and the coupon to 12.5%.

Aloysius snapped up SLRs 7 billion of the debt securities, pocketing $11 million, according to the report – money that the state is still trying to claw back. The report also accuses Perpetual Treasuries, a primary debt trader owned by Aloysius, of profiting from the sale of treasuries by buying them cheap and then selling at a generous mark-up to the Employees Provident Fund, the largest social security programme in the country. Aloysius was detained in Sri Lanka in February and has been refused bail, while the Attorney General has asked Interpol to help track down and arrest Mahendran so that he can be brought back to Sri Lanka. The former central bank chief is believed to be in Singapore. Mahendran, Aloysius and Perpetual have all denied any wrongdoing.

The repercussions have been serious. Sri Lanka dropped 12 rungs to 95th place out of 176 countries in Transparency International’s Corruption Perceptions Index for 2016, placing it alongside El Salvador and nearby Maldives. Global investors were understandably wary of doing business in a corrupt, low-growth jurisdiction, especially given the involvement of a central bank governor in such a scandal. It did little to allay fears that Sri Lanka, for all of its manifest attributes, was an economy on the way out rather than up.

Dumbfounded

With Mahendran gone and the government in turmoil, the country needed a new candidate to run the central bank, preferably one with an impeccable reputation. To the surprise of everyone – including Coomaraswamy himself – the president plumped for the dutiful and stoic servant. When Asiamoney meets Coomaraswamy in his wood-panelled offices over a cup of tea on a brilliant, hot February morning, he still seems a little dumbfounded at his elevation to one of the top jobs in the country. His dark eyes, peering out from beneath a thick mop of silver hair, crinkle in amusement as he remembers being told the role was his.

“I was completely retired,” he laughs. “And I don’t recall being asked to do the job, or saying yes. I heard about the appointment from a journalist who rang up to congratulate me. I had some reticence, as there were a lot of challenges in the economy and the non-bank financial area. But by that point, I clearly didn’t have a lot of choice in the matter.” Yet Coomaraswamy turned out to be a wise choice. Few can claim to have his institutional knowledge of the central bank: his ability to make sense of its rhythms and nuances, and to temper and channel its power. He began his career there, and while he dipped in and out of the grand old building on Janadhipathi Mawatha over the years, spending most of the 1980s on secondment to the finance ministry, he always returned.

Any concerns that a career civil servant used to receiving orders would wilt when presented with the chance to lead were quickly dispelled. The immediate task he faced was to instil belief and motivation in insiders wearied by years of sovereign financial mismanagement and internal scandal. “Morale was the big problem,” he admits. “This is an iconic institution, long known for its professionalism and technical excellence. But over a period of about 10 years, a number of issues emerged where its credibility was questioned. All the vast majority of staff wanted was to be able to do their jobs in a professional way. It was my challenge to create an environment that let them do that.”

Transparent mechanism

Coomaraswamy is wary about commenting publicly on his predecessor, noting that Mahendran was and remains a good friend. But his actions since assuming the governorship point to a deep-seated belief on his part that the bank was in need, not just of a new change of leader, but of a totally new way of thinking. The old bond allocation system, deemed too opaque and open to exploitation, has been replaced by a three-stage hybrid structure. Primary dealers bid at auction for government debt securities, and if an issue is undersubscribed, the process moves onto steps two, with primary bond dealers and larger funds offered additional bonds at the same weighted average yield, and three, where the central bank can force dealers to buy any unsold bonds. That final stage has yet to be enacted, in part due to doubts held by traders and, insiders say, the central bank itself, as to its legitimacy.

More transparency has also come in the form of an annual central bank auction calendar, released each November. Do these steps – the new hybrid structure and the government bond auction calendar – mark an improvement that provides more transparency and makes the system less vulnerable to manipulation? “For sure, these are both steps in the right direction,” says one investment banker working in Sri Lanka. “In an ideal world, the most transparent mechanism is the complete market-driven single-price auction system. But certainly, this is a step in the right direction.” So far, the new approach seems to have worked. Sri Lanka raised $500 million from the sale of development bonds in January. More will come. Colombo aims to sell $5 billion-worth of debt securities this year, a mix of $3 billion of development bonds and $2 billion of sovereign bonds.

As of early March, a $2 billion sovereign print was “very much on the cards”, according to a leading debt banker. “The government is in the process of pre-bookbuilding for it. Proceeds will go towards settling maturing debt.” This investment banker also says a renminbi-denominated panda bond, equivalent to $500 million, is being “considered and which may take place late in the first half of the year, subject to conditions”.

Coomaraswamy confirms that the central bank is considering the sale of debt priced in yen and renminbi on top of the dollar-denominated issues this year. “We could go with either samurai bonds or panda bonds, or both,” he says. “Basically, we are agnostic – we will see where the market takes us, and go by cost.” That additional money is sorely needed. Sirisena’s government faces record debt repayments of $12.7 billion in 2018, including $5.36 billion in interest and $2.9 billion in foreign loans, much of it owed to Chinese state lenders. Another $5 billion in maturing foreign loans and interest is due in 2019. Coomaraswamy is also taking steps to tackle the country’s troubling debt-to-GDP ratio, which jumped from 68.7% in 2012 to 79.3% in 2016.

A new Liability Management Act, tabled in parliament in late February, aims to cut that ratio to 70% by 2020, by allowing the central bank to exceed borrowing requirements set out in the December budget, so long as it can prove capable of paying off new and existing debt. “Existing rules forbid us from exceeding borrowing requirements, meaning we cannot build up buffer stocks to manage our future obligations,” the governor says. “The new laws have real teeth. So long as we can specify why we are breaching the budget limits, and how we are planning to get our finances back on track, it gives us the headroom we need, letting us do more switching and refinancing to extend the tenor of our external debt and bring down overall debt. It would be great if we can retire some of the expensive stuff.” It sounds daunting, but 18 months on from his appointment there are signs of genuine progress. Tax revenues are growing as more people are brought into the system and after last year’s increase in value-added tax to 15% from 11%. The Inland Revenue Act, scheduled for approval by parliament on April 1, will lift the top rate of income tax to 24% from 16%. Another new levy tipped to arrive in the second half of 2018 will impose a 0.2% tax on every financial transaction. It’s handy money for the state, though bankers aren’t happy: they put the likely annual cost to the sector at around SLRs150 billion. Foreign reserves meanwhile continue to rise, hitting $8 billion at the end of 2017, against $5.5 billion a year ago. Exports hit an all-time high of $11.4 billion in 2017, up 10% year on year, according to the international trade ministry.

Even foreign investment is slowly returning. Chinese cash is helping to finance a vast new financial hub, Colombo International Financial City, which is taking shape on reclaimed land off the capital’s shoreline, while in December, state-run China Merchants Port paid $810 million for a 70% stake in Hambantota Port, a harbour and investment zone on the south coast. That deal has spurred on India and Japan, with companies from both nations investing in Trincomalee, a deep-water port on the northeast coast. State-owned Indian Oil Corporation is in talks to fund a new, $350 million refinery adjacent to the port. Western companies are also returning, albeit tentatively.

Good decisions at the right time

In February, Germany’s Allianz bought Sri Lanka’s Janashakthi General Insurance for $107 million, marking the largest-ever foreign acquisition of a local firm. That deal will “give a big boost to investor confidence,” says Deshan Pushparajah, managing director at investment bank Capital Alliance Partners, which advised the Sri Lankan insurer. Rising investment may actually help the government balance its books for the first time in living memory. “For years, our biggest source of instability has been the budget,” Coomaraswamy says. “But we are on track this year to post our first primary surplus since 1953, and our first current account surplus since 1987. So, these deeply entrenched structural imbalances seem to be getting addressed, and that’s a major advance.” What strikes business travellers to Colombo is the respect, bordering on affection, that mention of the governor’s name inspires. Analysts and bank chief executives alike, even off duty, have nothing but praise for his ability to bring equilibrium to the central bank and sanity to the nation’s finances, without seeming to break a sweat. He is “the man who returned integrity to the central bank and to the government,” the chief executive of a local lender tells Asiamoney. “He isn’t a rock star who loves the spotlight, as is the case with some central bankers, and he doesn’t have agendas. What he does is to make good decisions at the right time.”

Another banker says the governor “didn’t need to do this job, but he answered the call out of duty. He came in with a fresh approach and said and did all the right things in a tough political environment. Hats off to him – he saved this government from itself.” For his part, Coomaraswamy gently scotches the notion of a knight riding to the aid of an imperilled nation. “If that is what I really am, then we are in a lot of trouble,” he smiles.

Parlous state

But then, perhaps the central bank chief, for all of his innate humility and impeccable manners, knows it makes good sense to keep his feet firmly planted on the ground. For the truth is that despite an upswell in business confidence – which is explained away by some as sheer relief that things are not a whole lot worse – Sri Lanka’s finances remain in a parlous state. Take the basic matter of growth. By all rights this safe and open frontier market, blessed with a good education system, a benevolent climate and a handful of standout industries (tourism and apparel, among others), should be powering ahead. Yet it isn’t. In India, the economic motor of south Asia, output grew 7.2% year on year in the final quarter of 2017.

By contrast, Sri Lanka’s economy is on track to expand by between 5% and 5.5% in the year to the end of March 2018, Coomaraswamy reckons, up from 4.7% in 2017 and 4.4% in 2016. He describes the current growth rate as muted and a far cry from his target of between 6% and 8% over a sustained period. In its October 2017 World Economic Outlook, the IMF expects output to expand by 4.8% in the 12 months to the end of March 2018. Deshal de Mel, economic adviser to the finance ministry, says the “problematic” economy was performing “well below potential”.

What holds Sri Lanka’s growth rate in check is a mix of shallow capital markets, the small pool of investible assets, a lack of interaction with the wider region, poor infrastructure and corruption.

- Asia Money