27th February 2000

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CSE to trade government debt

In a groundbreaking manoeuvre, the Central Bank has agreed to permit government debt to be traded on the Colombo Stock Exchange's Central Depository System.

"There was a meeting of minds from both sides, to work together and make it possible," CSE Director General, Hiran Mendis told The Sunday Times Business.

The CSE's Central Depository System (CDS) will be linked to the Central Bank's CDS, to permit the flow of securities. The CSE's CDS will act as a depository to hold government debt in trust for investors, pending transactions on the automated trading system and will act as a safe keeper of the securities.

Clients who wish to trade government debt, could do so by going through the ten primary dealers appointed by the Central Bank, 15 stockbrokers and 15 commercial banks providing custodial services.

Primary dealers would have two sets of accounts with the CSE - their own account to trade securities and multiple accounts for their clients. The dealers would also maintain separate CDS accounts with the Central Bank.

Primary dealers will be restricted to deal only with government debt, as per Central Bank guidelines, whereas others can trade all debt.

The trading rules applicable to corporate debt will apply to government securities as well. Each unit of government debt would remain at Rs. 10,000, while there will be six decimal places for rate and price, and trades cannot be cancelled.

The transaction fees will be flexible, Mendis said. The brokerage will be negotiable and the CSE and SEC charges will be computed based on transaction value.

Clearing of the securities will take place at the end of the day and settlement will remain at T+1 (trading plus one market day).

With regard to entitlements, secondary market trading and CDS activity will be suspended one market day prior to the date of maturity. The entitlement will be generated and forwarded to the settlement bank. The settlement bank will collect proceeds from the Central Bank and credit the appropriate primary dealer/broker account. In turn, the primary dealers/brokers will issue individual cheques to beneficiaries.

The CSE recently called for bids for a new debt trading system, which will facilitate the trading of government and corporate debt.

A separate trading system for debt became necessary, as the CSE's present front-end system favours equity transactions. Like the equities, the new front-end system will be order driven. Trading facilities will be enhanced to enable brokers to have better information before trading. For instance, the system will display yield, maturity dates and a risk profile needed for corporate debt. The system will provide a trading mechanism an improvement from the present system where one dealer calls up the other for quotes.

Initially, trading of all government debt in the secondary market will not necessarily go through the CSE's CDS, Mendis said. He is optimistic that the trading facilities will pave the way for investors to opt to buy government debt from the CSE, rather than shop around ten primary dealers to get the best yield.

There are lots of benefits when securities are traded on our CDS, Mendis said. The present system is not readily accessible to everybody. "What our system does is that makes it more readily accessible to clients. We are adding more value and adding value to the industry."

Government debt would also be far more accessible, which means that the distribution of securities will improve and have repercussions on the interest rate structure. It will in turn, have a knock on effect on the corporate debt market, which is priced a few basis points higher than the 12 month Treasury Bill.

Feature of the trading system

* Order driven trading system with price and time pri- ority
* Facilities for negotiated trades
* Supports delivery versus payments (DVP)
* Accrued interest and yield computation
* Search criteria based on investment needs
* Market watch with best five bids
* Order entry based on prices or yield
* REPOs and Reverse REPO's between participants and clients
* Online updating of CDS
* Real time trade reporting
* Facilities to extend trading via internet

Mind your Business

By Business Bug
A separate body needed

One row between an Internet service provider and a telecommunication network is already before courts and more such battles are on the cards.

All this has only underscored the importance of a separate regulatory authority to govern the information technology industry.

The earlier proposal was for the watchdog monitoring telecommunications to oversee this sector as well but now pressure is growing to set up a separate body. Indeed, that may be a reality soon.

Cancellations call for complaints

Having one airline company manage two airlines has its own peculiar advantages- the inconvenience to passengers notwithstanding.

It appears that when one carrier doesn't have enough of a load, the flight is cancelled and the passengers are offered alternative flights on the other carrier.

The official explanation for the cancellation though is that aircraft are not available because of other reasons- being sent for refurbishing, for example! Now however, this is happening ever too often and passengers have begun to complain.

Cricket loverly cricket

The presidency of the board that runs the gentleman's game must be the most prestigious job in the country next to the presidency of the country itself.

Now business magnates have entered the fray, lending their support to one candidate or the other. The game after all is now played for high financial stakes and in return for this support, favours in the form of sponsorship contracts are expected. So, it appears that all is fair in love, war and cricket!

Electronic trading laws this year?

New laws to govern financial transactions carried out via the Internet and electronic commerce are expected to be out this year, Central Bank Governor, A S Jayawardena said.

Presently, the banking laws recognise transactions carried out with the backing of hard copy contracts and do not recognise electronic signatures. "There is an urgent need to have these laws enacted before the end of the year, to enable Sri Lankans to take advantage of e-commerce," the Governor said addressing the media last week.

Meanwhile, the Central Bank has also compiled a consolidated set of laws relating to banking and finance in seven volumes.

Volume 1 contains the Monetary law Act establishing the Central Bank and specifying its powers and functions, the John Exter report proposing the establishment of the Central Bank and the relevant articles of the Sri Lankan constitution relating to the control of public finances. Volume 2 includes the Banking Act regulating commercial banks and specialised banks, the Bills of Exchange Ordinance.

Volume 3 includes the Exchange Control Act, the Finance companies Act, the consumer credit Act, and the EPF Act.

Volume 4 contains the Registered Stock and Securities Ordinance, the Foreign Loans Act, the Treasury Certificate Deposit Act, Tax Reserves Certificate Act, and the SEC Act.

Volume 5 contains the Trust Receipt Ordinance, the Inland Trust Receipts Act, the Mortgage Act, the Registration of Documents Ordinance, the Debt Recovery (Special provision) Act and the Recovery of loans by banks (special provisions) Act.

Volume 6 contains the establishment of the Bank of Ceylon, People's Bank, National Savings Bank, DFCC Bank, State Mortgage and Investment Bank and the National Development Bank.

Volume 7 includes the Mediation Boards Act, the Evidence (special provisions) Act, the Imports and Exports (Control) Act, the Prevention of Frauds Ordinance, the PERC Act, the Credit Information Bureau Act, the Sri Lanka Accounting and Auditing Standards Act.

The present edition contains the laws in force up to December 31, 1998 and incorporates amendments made to them up to that date. The editions will be revised annually either by incorporating any amendments made to the existing laws or inserting new laws enacted or deleting the laws repealed during the year.

The set of seven volumes are priced at Rs. 5,000 or Rs. 1,000 for individual volumes. The Central Bank hopes to have an on-line edition, but accessible at a fee.

NSL is burdening us, say unit trusts

The fund management industry is objecting to the recent budget decision to slap a 5.5 percent National Security Levy (NSL) on the industry, industry sources said. The industry has been exempted from NSL in the past, because it came under the service sector.

Presently, Unit Trusts charge a management fee for the services rendered to unit holders. The fee covers the heavy marketing expenditure and the salaries of the professional staff for their day to day operations. At present, the expenditure exceeds the management fee derived from unit trusts and nearly all fund management companies are incurring losses, President Unit Trust Association of Sri Lanka, Dhirendra Abeyratne said.

"This security levy would invariably lead to either cutting down of expenditure relating to promotion of unit trusts in rural areas or alternatively pass on the funds to unit holders, thereby further depressing investor returns," he said.

From the government's point of view, this would not be a desirable situation since the industry is in the process of being liberalised.

With the announcement of the industry opening to non residents, all management companies are drawing up high promotional and advertising budgets to attract Sri Lankans living abroad.

The recently introduced NSL will be a major blow to the promotional strategies already planned and invariably it will lead to the scaling down of activities in overseas markets.

"We are however, confident that there was no intention on the part of the government to place such a burden on the unit trust industry, which has a strategically important role to play," he said.

In the interests of the industry and the capital markets, the association has highlighted their plight to the President in her capacity as the Finance Minister and to the Treasury Secretary, for an exemption.

While commending the government's initiative to attract non-residents, the Association believes this step will enable the industry to attract a significant inflow of funds particularly from overseas Sri Lankan residents. Non-residents could then participate in the market with the flexibility to realise investment proceeds in their own currency through the Share Investment External Rupee Account (SIERA).

Similar measures in India, have helped in attracting overseas Indian citizens to remit a considerable amount of funds for national development through unit trusts.

The Association has also agreed to take several measures to ensure that any speculating movement of funds from foreign sources would not affect the unit trust industry and the equity market.

Fiscal discipline needed to improve budgetary situation

Last week we commented on sev- eral weaknesses of the Budget pre- sented on February 14th. Today we carry a more detailed analysis of our fiscal situation in this month's Focus on the Economy. The fiscal situation discussed in this feature points to several fundamental weaknesses of our public finances. The fiscal situation is indeed dismal. It is dismal because few options are available to our policy makers to make the budget an instrument for economic development. It is dismal because no realistic options are available to get out of the fiscal mire we have got ourselves into. It is dismal because we lack the political courage to take much needed measures in financial discipline.

It must be recognised that this situation did not arise suddenly. It is partly a legacy inherited by this government. It arose initially by a lack of fiscal discipline and large budget deficits incurred in the 1980s, some of it no doubt for large developmental expenditures. The escalating war expenditures were part of the reasons for the large deficits later on. These converted into a large public debt and a burdensome debt servicing cost.

Today debt servicing alone absorbs about one quarter of our revenues. Nearly 70 per cent of the budget deficit is on account of debt servicing costs.

Given this parlous fiscal situation what are the options available. First of all peace is essential. Even if the initial savings on war expenditures are likely to be minimal, over time the costs of defence are likely to be more manageable. We will not arrive at the pre-1971 defence expenditure levels of less than 1 per cent of our GDP, but we can perhaps contain it to around 4 to 5 per cent of GDP in due course.

The second option has been discussed ad- infinitum and in fact accepted in the government's policy statement in 1994. The option of cutting down wasteful expenditures and improving the targeting of welfare measures. Cutting welfare measures appear to be an illusive objective in our competitive politics and political culture. Each party bids with the other to give more and more welfare benefits. In the earlier days it was the rice ration, whose curtailment once brought down a popular Prime Minister. Today it is the transfer payments, begun under the previous government's Janasaviya programme and reincarnated as the Samurdhi programme. The present government which began by vowing to improve the targeting of welfare programmes has ended up by giving benefits to nearly one half of the households in the country. It costs the government about Rs 10 billion or around 4 per cent of GDP. Apart from the cost of the programme and its financial implications for the budget deficit and fiscal policy, which is discussed in the Focus on the Economy, we wish to raise a different issue. Even if we are to spend such a large amount on a welfare measure, is it the best type of expenditure to incur. Aren't there better ways by which the poor could be benefited? For instance would this expenditure on improving rural schools have a more lasting impact on the poor?

An additional expenditure of this magnitude in improving rural health facilities could have an important impact on the health of the poor and that in turn could improve their productivity and income generating capacities.

It is high time to look at these expenditures in a realistic and non-political manner and make bold decisions. The government is fully aware that financial discipline does not consist of merely arriving at a low figure for the budget deficit, but also of spending public money in the most productive and least wasteful manner. Will the government please look into this possibility at least after the general elections to Parliament? Although the defence expenditures are blamed for our weak fiscal situation, it must be recognised that there are other options available. We cannot wait for the peace dividend to solve all the problems of our public finances. There are other options too to improve them. Without such an effort our budgets cannot be expected to play a lead role in economic growth and development.

More power to Sri Lanka

About 45% of Sri Lankan households have no access to electricity. A substantial number of households in the areas served by the network, cannot receive the electricity supply for various other reasons.

Sri Lanka's per-capita electricity consump tion is about 300 kilowatt-hours (kWh). Developing countries in the region have higher consumption rates: India 500 kWh, Malaysia 2000 kWh. Developed countries have much higher rates; Norway 25,000 kWh, USA 9,000 kWh.

While per capita consumption of electricity is not the best indicator of the level of development in a country, there is no doubt that Sri Lanka needs more electricity. Up to what level? It is certainly a difficult decision, and one can only build scenarios. The graphs show one possible scenario, based on an econometric judgmental forecast.

In this scenario, the demand for electricity grows at or around 8% per year over the next decade, and continues to grow thereafter, but at lower rates.

This forecast for growth in electricity demand is indeed modest. If one needs a simple interpretation, the forecast implies that our demand for electricity, and thereby the size of the electricity network, will be equivalent to what it is in Malaysia today.

When will that happen? In year 2040. Electricity sales, presently at 5000 million units will reach 45000 in year 2040. This represents a compound growth rate of 5.6% per year. Electricity sales doubled over the past ten years, and they will double over the next ten years as well, before annual growth rates decline when we move into the second and third decade of the new millennium.

What has been discussed above is the sales forecast: in other words, the energy requirement, measured in units of electricity, technically known as kilowatt-hours (kWh). To provide the required energy, the electricity supply system needs capacity at generation level, measured in Megawatts (MW). A one MW generator working for one hour will deliver one Megawatt hour of energy. Generators based on renewable energy, including hydroelectrics, can be operated only when their "fuel" is available. Generators operating on fossil fuel (oil, coal or gas) or nuclear can operate throughout the year, except during maintenance.

Hydroelectrics are usually sized to operate 50% of the time in a year, whereas fossil-fuel based generation can operate up to 85% of the time.

The generated power has to be transmitted to load centres, and distributed from there onwards.

The country needs large investments in new generating plants, transmission lines and distribution lines, to serve the inevitable growth in demand. Moreover, the aging generators in the hydroelectric system would require to be rehabilitated. Old thermal plants need replacements. Old transmission lines need to be rehabilitated. All these require investments.

Sri Lanka would require to conduct centralised planning of the electricity sector investments for some time to come, until the system can be fully liberalised.

Unlike any other industry, technical details of future system needs are extremely complex. Projects require long periods for detailed planning approvals, financing and construction. Once built, the projects should operate in unison with the rest of the system, in real time, balancing the supply with demand from moment to moment.

Electricity cannot be stored in substantial quantities. It has to be produced right at the moment the customer needs it, and transmitted and distributed. The customer needs it whenever he decides to switch-on. He needs it to be continuously available. He will not tolerate blackouts or brownouts. Above all, the customer needs it at a lower cost.

Our electricity generating system is in transition from a predominantly hydroelectric system to a mixed hydro-thermal system. The next generation of thermal power plants have to be larger than the ones we presently have and those which are now being built. The customer should reap the benefits of the economy of scale in electricity generation. The need is to go in for fuel diversification, for both reliability and economy. The transmission network requires strengthening, and distribution networks require expansion.

All these transitions call for a certain amount of centralised planning, to ensure that the customer demand is met in time, there will be no more blackouts, and the price of electricity will be lower and more affordable. With most large hydroelectric projects now developed, the share of hydroelectricity will decline in the future.

Utility scale electric power generating plants are expensive to build. At the lower end of the scale, it costs at least US $300 to build one kilowatt of power plant. However, such a cheap power plant will have lower efficiency and therefore will be expensive to operate. In the medium range, it costs about US $500 - 700 per kilowatt, and the operating costs are moderate. The lowest operating costs will be achieved in power plants that are the most expensive to build. They will cost about US $800 - 1000 per kilowatt.

In simpler terms, the country needs at least 125 Megawatts of new generating capacity to be added every year, and this will gradually rise to 200 Megawatts over the next fifteen years. Sri Lanka's electricity supply system is energy-deficient (as opposed to being capacity deficient). This does not mean that we have enough capacity, but it means that we are constrained by energy, owing to the large hydroelectric share in the generating system. It also means that new generating capacity to be built should provide energy at a lower cost. We should not go for cheap investments, which are expensive to operate. This implies our investment should be on more efficient electric power plants, which can give cheap energy. And they will cost US $800 - 1000 per kilowatt to install.

A detailed network expansion plan is too complex to list and explain here, but in general, the country needs an average of about US $120 million to be investedd every year, on the generating system alone. There has to be matching investments on the transmission and distribution network, as well.

The investment need in small, non-utility generating systems is also substantial, mostly in small hydroelectric power plants. Ever since the private developers of renewable energy power plants were allowed to connect to the network, there have been substantial investments made in several Megawatt-scale small hydroelectric power plants. Perhaps Sri Lanka has yet another 100 Megawatts of small hydroelectric capacity to be developed. Furthermore, rehabilitation of smaller hydroelectric plants in the 100 kilowatt range (there are an estimated 200 of them yet to be revitalised), would also require investments.

Sooner or later, our electricity industry would require to be restructured to ensure a greater degree of accountability to the customer (and the investor), and to improve operational efficiency. The limits of state-owned, vertically integrated electric utility organisations have been well realised in Sri Lanka. Customers call for more accountability. They need higher reliability, and lower prices. A new structure should evolve, where state control of the electricity industry is minimised. The sooner we do it, the better it would be for the electricity consumer and the economy.

The potential to provide electric energy services is also substantial. Investments are needed to improve the technical efficiency of the power transmission and distribution system.

The electric utilities have not been able to cope with the large investments needed to achieve network loss reduction. Such investments and projects are best handled by one or many Energy Services Companies, who will have a clear focus on the energy service they provide, with accompanying guarantees and penalties. The economic potential for network loss reduction in Sri Lanka now is 350 million units of electricity per year, which has a market value of Rs. 1500 million. Thus, there is a large "income" to be recovered by a proper system of network loss reduction. And there are many other similar opportunities for non-utility investors to play a role in the electricity sector.

For whose benefit? Certainly, for the customer's benefit, who for years, has been crying for a more reliable, higher quality and more affordable electricity service for his industry, business and household.

Dr. Thilak Siyambalapitiya, former Chief Engineer (Generation Planning), Ceylon Electricity Board and a Consultant to the Saudi Arabian Electric Utility, is presently Partner, Resource Management Associates (Pvt) Ltd., Colombo.

Courtesy Achievers NDB Journal.

Free capital flows provide long-term benefits

Capital controls can be useful in dealing with volatile movements of capital, but they are difficult to administer and must be used in conjunction with proper macroeconomics policies, according to a new IMF staff report. At a press briefing held on January 11 to announce the release of the report, Stefan Inges, Director of the IMF's Monetary and Exchange Affairs Department, emphasized that this conclusion in no way negates the IMF's position that "free capital flows are good for everyone in the long run."

Akira Ariyoshi, Assistant Director in the department's Exchange Regime and Market Operations Division, described the objectives of the report, Country Experiences with the Use and Liberalization of Capital Controls. These, he said, include examining why some countries have imposed capital controls and why others have liberalized, the form the controls have taken, the effectiveness of controls, and the costs of adopting them. The 14 countries covered in the report are grouped by similarity of purpose to permit the authors to draw more generally applicable conclusions. In addition, Ariyoshi noted, the report studies the link between prudential policies and capital controls to show how better prudential policies and accelerated financial sector reforms could address the risks in cross-border capital flows.

Discussing motivations for adopting capital controls, the report explains that countries have imposed such restrictions for a variety of reasons: to improve economic welfare by compensating for financial market imperfections; to allow monetary policy to pursue domestic objectives; to reduce pressures on the exchange rate; to protect monetary and financial stability in the face of persistent capital flows; and to support policies of financial repression to provide cheap financing for government budgets and priority sectors. The design of controls has varied among the countries. Some have taken the form of administrative controls, which usually prohibit cross-border capital transactions outright or stipulate an approval procedure for such transactions. Others have been market-based or indirect controls, which attempt to discourage particular capital movements through taxes or taxlike measures. These affect the price or volume of a given transaction, or both. Although the effectiveness of controls has been mixed, according to the report, the country experiences invariably showed that capital controls provided no benefits when underlying policies especially macroeconomic policies, were inconsistent or ill conceived.

Countries that used controls effectively on outflows, Ariyoshi said at the press briefing gained "some temporary breathing space in which to adopt and implement sound economic policies and reforms." Even when controls seem to be effective, he cautioned, it is difficult to disentangle their contribution from those of the other policies a country is implementing.

When countries adopt capital controls or reimpose controls after having liberalized transactions, the report states, they can incur a number of costs whether or not the controls are effective. First, restrictions on capital flows may interfere with desirable capital and current transactions along with the undesirable ones. Implementing controls may also involve administrative costs, particularly when the measures must be broadened to prevent market participants from finding ways to circumvent the controls. A third cost is that imposing controls may delay a country's implementation of necessary reforms. Finally, controls may cause market participants to view the country in a negative light, making it more difficult and expensive for the country to access foreign funds.

The report draws a number of tentative conclusions from the 14 case studies that the authors believe may prove useful in formulating policy:

No single capital control measure is effective across all countries at all times.

Controls on specific transactions may effectively limit those transactions, but market participants will find ways, especially in sophisticated markets, of circumventing the controls through unrestricted channels. Thus, to be effective in the longer run, controls generally need to be comprehensive and strictly enforced.

The need for controls to be comprehensive implies that more effective controls are also more distortionary and hence more costly.

Administrative capacity to implement the controls and the level of financial market development will influence the choice of controls and their effectiveness.

The evidence is mixed on whether capital controls can correct financial market imperfections and serve a prudential purpose.

Strong prudential policies were found to play an important role in orderly and successful capital account liberalization and in reducing a country's vulnerability to external shocks.

Here are some of the punters

H W P Atapattu a former Colonisation officer has been playing the market since 1987, when he bought Asian Cotton Mills for Rs. 6. In his spare time he used to go through the daily papers and write to John Keells Stockbrokers giving instructions or buy/sell shares.

Transactions took around two weeks to complete, but he felt that since prices fluctuated very little at that time, it didn't matter so much.

With the proliferation of telephones, he began to trade via the phone until MMBL opened a branch in Matara.

His present portfolio has a mix of blue chip and mid cap stocks. On Monday he told his broker to buy Blue Diamonds for Rs. 2.50 and was hopeful to dispose them at Rs. 2.75.

His says that Blue Diamonds is a high risk high profit stock and he is fully aware of the recent events that happened in the company.

"I would like to know more details about the irregular dealings for my knowledge," he says. But Blue Diamonds is a favourite stock of his because it represents his lucky number 6.

He maintains a file for each share and number the files as and when he buys a new stock. Whatever file bears the number six, he trades on that stock often. For instance, file number 42 is Blue Diamonds.

Four and two add up to six, so he consider it a lucky share. "Sometimes I lose most times I win. Nestle has also been a lucky stock for me."

Kapila Mendis Railway employee and present secretary of the Investors Association began trading in 1992 by purchasing NDB for Rs. 50. He later sold it off for Rs. 250 in 1994.

Mendis was one of the few investors we came across who traded on fundamentals. Being a former maths student, he is able to understand financial statements and spends about two hours a day studying daily trading reports. He also maintains historical data, and keeps tabs on his portfolio by reading newspapers, research reports and gossip columns.

Mendis was an unusual person, who remembers names of research analysts, brokers and financial reporters. He says he takes serious note of reports written by certain people as they were easy to understand and nearly always accurate on market information. He too, doesn't keep stocks for long, except for John Keells, Hayleys, Aitken Spence, Singer and Central Finance.

He was full of praise for these companies as he felt the directors were committed towards the welfare of the company and its shareholders.

He also has a few plantations, hotels stocks. He is eagerly waiting to snap up SLT stocks when it comes out this year. He says despite SLTs poor service, the international monopoly and the guaranteed price increases makes it a good buy. He suggests that perhaps the authorities should have a fund to help investors who lose out when companies are de-listed or they go bankrupt.


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