ECONOMYNEXT – Sri Lanka’s central bank has used an imputed valuation of its re-structured government securities, to get over lack of a market price, which may have allowed it to avoid negative net assets and even bigger losses in 2023.
The central bank reported losses 114.3 billion rupees in 2023, solely due to a 766 billion rupee ‘one day loss’ from restructuring its Treasury bill portfolio into long term bonds with ‘step down’ coupons.
The Tool
The Treasuries portfolio, acquired to drive monetary instability from 2020, initially gave it high profits as rates went up to correct balance of payment deficits.
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Unlike in 2022, when a currency collapse led to losses on its foreign assets portfolio, which was negative due to swaps not being outlawed by the legislature, foreign currency income was a positive 83 billion rupees, compared to a loss of 778 billion in 2022.
The one-day loss, outstripped domestic assets income of 595 billion rupees, helped by high yielding securities held before September 2023.
The central bank then ended up with Treasury bond with maturities of 6 to 15 years. They have a coupon interest of 12.4 percent which will reduce (step down) to 7.5 percent from 2026 and 5 percent from 2027.
The restructure of the bonds, represents an effective transfer of profits from the central bank to the government, without creating any inflationary liquidity injections, analysts say. Direct profit transfers were not permitted under an earlier monetary law.
By end December 2023, the government securities portfolio was carried in the balance sheet at 2,044.3 billion rupees.
But the book value discounted to market rates was reported at 1,622 billion rupees in daily reports of the central bank on the last trading day of the year.
It represents a gap of 422 billion rupees.
The Gap
The central bank reported 11.1 billion rupees of equity at the end of the year, escaping negative equity by the skin of its teeth.
However, the gap of 422 billion rupees, between the carrying value and reported daily book value represents a negative value of 411 billion rupees.
The gap comes from an imputed valuation method used.
The balance sheet carrying value was arrived at by using an imputed price, using proxy two-way quotes.
Though government securities are expected to be a marked-to-market, there was no actual price for the step-down securities as they were not traded, Central Bank’s Chief Accountant D S L Sirimanne said.
“There is no actual price in the market for the bonds with the step-down coupons,” she explained at a recent central bank forum.
“Based on a method which was also put forward by our auditors, there is as certain discount applied to available two-way quotes to reflect the nature of the step down coupons.”
“That is how it is valued.”
Governor Nandalal Weerasinghe said the value was also revised every month based on the indicative prices under IFRS accounting standards.
The Question
Though the International Monetary Fund has raised concerns about having positive equity at the central bank, it is not clear whether it is an actual problem, as long monetary stability is maintained.
Extending the maturities of central bank held securities and forcing a hit on its balance sheet was a key strategy by Sri Lanka to insulate the broader government securities market from an induced default to meet IMF’s statistics which they believe will help with debt sustainability.
Government securities yields collapsed by around 1000 basis points on the day the strategy was announced.
Rates have continued to ease as monetary stability was maintained. Rates may continue to ease over time as real savings build up, as long as monetary stability is maintained by avoiding liquidity injection backed rate cuts, when rates come under upward pressure when private credit picks up, analysts say.
Falling rates could also improve the market value of the bonds over time.
However, the central bank may face practical difficulties in sterilizing foreign reserves if it runs out of marketable domestic instruments. To the extent that it has to mop up reserves and also repay debt to India and the IMF, the market value of the securities matters, analysts say. (Colombo/June08/2024)