Auditor General’s bombshell on fiscal data raises more questions

The issues raised by the AG haven’t cropped up suddenly. These have persisted for years, and could be just the tip of the iceberg

Sri Lanka’s Auditor General’s bombshell pronouncement over fiscal data has opened a debate on the festering problem in debt numbers and budget deficits that has become increasingly more problematic over the years. The AG disclaiming the accounts of the finance ministry and questioning debt data also cast doubt on deficit data. Sri Lanka’s total public debt – not counting what SOEs have borrowed directly – has been calculated as Rs9,387 billion.

The AG says a number of foreign debt contracts had not been accounted for, and some money invested in SOEs had been understated, while others had been overstated. He also said Rs487 billion in Treasury bond holdings had been undercounted by not recording the face value. All these problems raised the debt-to-gross domestic product ratio to 83.3%, and not 79.3% as reported. The undercounting of foreign loans appears to be sloppy accounting.

Whether there are more benign reasons such as signed agreements that are not fully drawn down is not yet known. The quicker the new minister of finance and his deputy explain the problem, the better.

The issues raised by the AG, however, have not cropped up suddenly. These have persisted for many years. It could also be just the tip of the iceberg.

Treasury Guarantees
The AG has also hinted at another longstanding problem, which became increasingly bigger during the last regime. After showing his calculations, which was total debt at Rs9,864 billion, the AG delivered the following parting shot:
“The above liabilities do not include the value of guarantees valued at Rs563,337 million issued to the Banks for loans obtained by the Public Enterprises on the Treasury Guarantees.”

The treasury guarantees are listed as contingent liabilities. But clearly, many of them are not.

It may be acceptable to give a Treasury-guaranteed loan to Airport and Aviation Services of Sri Lanka, which operates the airports. Airports have revenues to pay back loans. So has the Sri Lanka Ports Authority. The Treasury has to pay them back only if they cannot.

In the case of the Ceylon Electricity Board, the Treasury is already paying back some loans due to problems with pricing. But, it’s not clear how this is accounted for in the budget. In the past, loans to the CEB were on-lent. If it is adjusted through the lending minus repayment heading, the action would get captured.

However, in the case of the Road Development Authority, the agency clearly does not have revenues to repay the massive amount of loans taken from banks. The money from expressways will only cover the loans relating them, if at all. The government will have to pay the loans, unless some expressways are corporatised and sold in the stock market with the debt packaged in them.

Another issue that arises is whether RDA spending has been classified as capital expenditure in the budget in the year they were incurred, or not. If only budget allocations for the RDA are taken as spending on the budget, deficits over the past decades would have been ‘understated’, and deficits in the next 10 years will be ‘overstated’, as the spending will now come to the budget only when the debt is repaid.

SOE Bailouts
Bailouts to SOEs in the recent past have also been fudged. For reasons that no one has explained, tens of billions of rupees of debt taken to bail out entities like the Ceylon Petroleum Corporation have been kept out of national debt, and presumably the budget deficit as well. Central Bank data showed that Rs78.4 billion of bonds issued in 2012 to bail out CPC and Rs13.12 billion in 2013 to bail out SriLankan Airlines are not counted among the Rs9,387 billion in debt. All this would add about another 0.8% of GDP to 84%.

Why this debt is kept out of national debt remains a mystery.

Last year, a Rs4,397 million bond issued to CWE in 2003 was also excluded. The rot appeared to have begun then. It is not clear why the bond was kept out of national debt, but CWE was originally expected to repay the bond with asset sales. This year, there is no mention of the CWE bond. Presumably, the bond matured and was repaid, most probably with proceeds from a new bond. The new bond is seemingly included in the debt stock. This is another question that needs to be answered. Bailout bonds issued to People’s Bank and Bank of Ceylon in the 1990s, however, were included in national debt at the time. The inconsistency needs to be explained.

Undercounting Bonds
● The AG’s report says Treasury bonds should be counted at face value (at par). When the coupon interest rate is lower than the yield at which the bonds are auctioned, the Treasury gets less cash than the face value of the bond (at a discount). The longer the tenure of the bond, the greater the gap.

In the same way, if the coupon rate is higher than the yield, the government gets more cash at maturity (face value of the bond) or a premium. If bonds are recorded at the cash obtained, debt would then be ‘overstated’ compared to the face value. If coupons were set in a random manner, premiums and discounts would more or less cancel each other out.

Presumably, more debt was issued at a discount than at a premium to get the Rs487 billion net understated number that the AG mentions. The AG says, for bonds issued in 2016, debt is carried at face value. Treating bonds in different ways is inconsistent.

Likely, at maturity, any discount that is repaid gets recorded as interest. This is also a question that has to be clarified. This treatment is consistent with recording the debt value as the cash raised from the sale of bonds at a discount, and the discounted amount being counted as interest in the final year. If any premium was recorded in the books, it will have to be written down against any final coupons.

Whether such a method is followed is also not known.

The net effect of selling bonds at a discount (a coupon lower than market yield) will be to report a lower budget deficit in earlier years of a bond and a bigger deficit in the final year. Officials who want to show a lower deficit can effectively push the deficit to later years by selling bonds at lower coupons. There is no suggestion that anything was done deliberately to understate deficits.

How to Increase Transparency?
● This problem can be reduced by issuing bonds with a coupon as close to the market as possible, or through single-price auctions. International sovereign bonds are issued at a single price through a book-building exercise.

Adding fuel to the fire, Central Bank officials were quoted as saying in late June that the department of public debt always counted debt at face value. In that case, the question arises, how any premium or discount is treated in the budget, since accrual accounting is not practised. Are premiums or discounts offset against net interest costs in the year of first issue? Accountants may argue that the problem can be solved through accrual accounting. Indeed, a pilot project on accrual accounting is underway, according to the finance ministry’s annual report.

Accrual accounting will open another can of worms and make it more difficult for users of data to match the deficits with credit markets. When an accrual basis is used, costs (say interest) are taken into the books with the passage of time (say every month), regardless of whether the actual cash payment is made in six months or every 12 months.

Accrual accounting, however, will take away the temptation to run arrears at the end of the year and push the deficit to the beginning of the next year. This technique has been widely used in recent years. But, over the course of two years or more, such tricks will tend to cancel each other out.

Recording the budget on a cash basis is clearly useful for debt market players and those who try to forecast interest rates. A budget on an accrual basis will reduce the usefulness or transparency of the deficit data for such users.

A separate cashflow statement will then also be needed to make fiscal data useful for those funding the deficit. Private companies that prepare profit and loss accounts on an accrual basis also have to prepare a cashflow statement.

Countless examples of P&Ls at private firms prepared on accrual accounting methods on cost apportionment, treatment of depreciation, capitalizing and so on using increasingly complex accounting standards show that it is much easier to fudge numbers on an accrual basis than cash basis.

So, any attempt to show budgets on an accrual basis in a country like ours could make fiscal data even less transparent than they are now.