Direct sale of government securities: Demon or servant? 

  

The demonised direct sales of Treasury bonds

11 July 2016

The Central Bank has been telling the public again and again since March 2015 that the sale of government securities directly to primary dealers is faulty. According to the Bank, the system helps only a select crowd of primary dealers. Since the sales are made through telephone conversations and not through public auctions, the Bank further charges that the system lacks transparency.

If it is not transparent, it further argues, that it is fraught with room for abuse, malpractices and corruption. Since the prices are determined by officials of the Public Debt Department at their discretion, it also impedes, says the Bank, market development.

This is contrary to the primary requirement of market efficiency for which prices should be determined by market forces. Hence, the Bank has labelled the direct sale system a ‘demon’. It is a demon, it has to be annihilated at any cost.

The belated demonstration of wisdom

This is obviously good wisdom on the part of the Bank. Since the Bank has no legal existence and is owned by the Monetary Board, it is demonstrative of the wisdom of the Board as well. However, the Board thought of demonstrating that wisdom only after it was accused of being a party to a massive Treasury bond scam.

The first bond scam

In this bond scam, the Bank had offered Rs. 1 billion worth of 30-year Treasury bonds carrying a fixed interest rate of 12.5% to the market but ended up selling bonds to a value of Rs. 10 billion. This was 10 times the original offer.

Under normal circumstances, the Bank would have accepted up to 2 to 3 times of the original offer and not more than that. Hence, the market was not ready for such a jumbo issue. Then, it was revealed that a half of the jumbo issue amounting to Rs. 5 billion had been issued to a Primary Dealer company belonging to the son-in-law of the incumbent Governor of the Bank.

However, this issue had been done to this primary dealer at a price of around Rs. 91 per Rs. 100 bond whereas the prevailing market price of a bond of those attributes was as high as Rs. 120. The particular primary dealer company had bid Rs. 2 billion on its own and a further Rs. 13 billion through another primary dealer, Bank of Ceylon, at around the same prices.

All these had happened during the last half an hour before the closing of the auction arousing suspicion that this primary dealer company had got some inside information about the possible jumbo issue of Treasury bonds. Thus, had the Bank accepted the entirety of the Rs. 20 billion at the auction as had been instructed by the Governor, this primary dealer company would have ended up with Rs. 15 billion or 75% of the total issue. Since it would have got the bonds at around Rs. 91 per bond, it would have made a market killing out of the bond issue given its existing price of around Rs. 120 per bond.

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