Corrupt privatization doesn’t deter IMF lending to Sri Lanka

The Government Accountability Project (GAP) based in Washington D.C. this week released a report on how corrupt privatizations in Sri Lanka did not deter the International Monetary Fund (IMF) from approving a 20-month standby arrangement worth US$2.6 billion for the government of Sri Lanka.

The first tranche of the loan – US$ 322 million – was made available on the same day the Board approved the arrangement. According to the IMF’s mission chief for Sri Lanka, the lending will help the government to reverse the decline in tax revenue over the past few years. The IMF is on the record, however, identifying the causes behind a decline in Sri Lanka’s tax revenues: Budget deficits and the lack of reserves are not the result of a scarcity of available revenue, but rather a reluctance on the part of successive governments to implement the measures necessary to collect it.

GAP reports that two Supreme Court decisions handed down since June 2008 show specifically that corruption and fraud favouring private interests in the sale of state-owned enterprises, a policy promoted by the Fund itself, together with the World Bank and the Asian Development Bank (ADB), are partially to blame. Ironically, the report states that six months after the Supreme Court reversed a fraudulent privatization that benefited John Keells Holdings Ltd, the company’s CEO, Susantha Ratnayake, enjoyed a dinner meeting with the IMF team visiting Sri Lanka to negotiate the standby arrangement just approved. In 2004, the IMF published ‘Sri Lanka: Selected Issues and Statistical Appendix’ identifying deficient tax and revenue policies that allowed foreign exchange ‘leakage.’

The lenient policies considered – including a tax amnesty in 2003 – are symptomatic of corrupt relationships between corporate and political elites, as policy makers at the IMF are well aware.
At the same time, the World Bank has been aware of pervasive fraud in Sri Lankan privatisations since the early 2000’s, at the very least. More recently in 2007, Nihal Sri Ameresekere, the former Chairman of the Public Enterprise Reform Commission (PERC) and one of the complainants in both Supreme Court cases, wrote to Praful Patel, the vice president for the Southeast Asia region at the Bank.

In part, Ameresekere’s letter said: “In view of the gravity and seriousness of mismanagement of public finance and malpractices, the Auditor General deemed it necessary to forward an extensive Special Report to Parliament in July 2006, which was a severe castigation of the systems and an indictment of those responsible. The parliamentary Committee on Public Enterprises in December 2006 presented a Special Report to Parliament highlighting widespread fraud and corruption, including revelations of collusion by large corporations and questionable professional conduct by well-known accountants and auditors.”

Within three weeks, Mr. Ameresekere received a platitudinous note from Elaine Tinsley, then the Bank’s Country Officer for Sri Lanka, which said: “We have noted the contents of the series of letters you have sent to the World Bank in past years concerning governance. As we have mentioned, the World Bank recognizes the importance of governance in the development of countries like Sri Lanka and in their efforts towards poverty reduction. Our programme of assistance to Sri Lanka includes a strong commitment to helping improve the governance of public sector institutions.”

The GAP report states that Mr. Ameresekere and others had in fact furnished World Bank and IMF management with numerous documented disclosures of corruption at the highest levels of government over the years, including the fraudulent tax amnesty, malfeasance on the part of the government’s auditors and the corrupt privatization process. The responses were always the same: a vague reference to ‘good governance’ and a reassurance that the corruption issue was taken ‘very seriously.’

Nonetheless, neither institution allowed these disclosures to constrain their lending programs to Sri Lanka. The judiciary took steps at the national level to reverse the tax amnesty and the most larcenous privatizations, but the work of the Supreme Court has gone unsupported by management at the IFI’s.
In light of the most recent Supreme Court decisions, GAP states that the US$2.6 billion vote of confidence in Sri Lanka’s governance practices by the IMF could not be more poorly timed.

The Court reversed two major privatization transactions, effected six and seven years ago as part of the Public Enterprise Reform Program under the direction of Milinda Moragoda, former Minister of Economic Reform, Science and Technology. In both cases, the Court determined that the public interest had been subverted and, although the Court’s jurisdiction did not extend to charging the Minister and PERC Chairman P.B. Jayasundera, the findings of the justices demonstrated illegality. In response to the Court’s decisions, the public began to demand Moragoda’s resignation from office, and requests for investigation were formally submitted by the complainants in the lawsuits to the Inspector General of Police and the Criminal Investigation Department (CID). CID investigations do not generally proceed, however, without the direction of the Attorney General.

The report further states that in the wake of the second Supreme Court ruling reversing the privatization processes, the public anticipated actions leading to the prosecution of Moragoda and other high-level officials responsible for fraudulently divesting the state of its revenue producing assets. Instead, however, the government named a new Minister of Justice and Judicial Reforms over the Attorney General: Milinda Moragoda.

Background
The report states that in August 2002, the government, through the Ministry of the Treasury and PERC under Moragoda, sold a majority stake in Lanka Marine Services (LMS). The following year, the same executive agencies sold a controlling interest in the Sri Lanka Insurance Company (SLIC). Over the course of 2008 and 2009, however, the Supreme Court of Sri Lanka reversed both share sales and denounced the corruption associated with them in the strongest terms.

escribing the LMS transaction, the justices wrote that it “was done without lawful authority” for the benefit of a private holding company. With respect to the transfer of the SLIC to private control the Court determined: “The execution of the Share Sale and Purchase Agreement with parties not known and not approved by Cabinet was a wrongful executive act done without jurisdiction and as such was illegal and null and void ab initio.” The report further states that the two privatizations concluded by the UNP government conformed to the conditions attached to fiscal support from the IMF, the World Bank and the ADB.

In fact, the primary respondent in both cases was K.N. Choksy, the President’s Counsel and former Minister of Finance. In that capacity, Choksy had also served in 2003 as the Governor of the World Bank and the IMF for Sri Lanka. Another respondent in the privatization of the SLIC was Faiz Mohideen, former Deputy Secretary to the Treasury. Mohideen had been the Alternate Governor of the IMF and the World Bank for Sri Lanka in 2000, and was also the counterpart for Sri Lanka on the World Bank’s Economic Reform and Technical Assistance Project (ERTA), which set out privatization goals in 2002. GAP states that both transactions incorporated all the elements of corruption long identified and denounced by critics of the process around the world since the 1980s. The public assets were under-valued, the government lost a tax-paying revenue stream without just compensation, and private interests well-connected to high-level government officials effected a transfer of public wealth to private hands. As in many other cases, these transactions were justified by claims from the IFI’s that they would promote efficiency and economic growth.

The judgments handed down by the Court, however, show that the real motivation at work was an illegal intention to appropriate a substantial and reliable flow of revenues that had, until privatization, helped to support a struggling public sector, financially drained by civil war. The report states that on July 21, 2008, the Supreme Court of Sri Lanka reversed the privatization of LMS which before its sale in August 2002, had been a wholly-owned subsidiary of the Ceylon Petroleum Corporation (CPC). In their decision, the justices found that P.B. Jayasundera, then Chairman of PERC reporting to Moragoda, worked in collusion with the buyer, John Keells Holdings, Ltd. (JKH) to secure illegal advantages for JKH. JKH is ironically a UN Global Compact Company, publicly and rhetorically committed to combating corruption.

In analyzing the presentations to the Court, the GAP report states that the Justices ruled that the value of LMS had been artificially lowered for sale to JKH: a clause granting JKH a monopoly on the services it was to provide – which dramatically increased the profitability of LMS – was inserted into the transaction after the valuation was completed. Further, the then President of Sri Lanka awarded LMS, after its sale, substantial property in land for which the government was never compensated by the now private company and LMS was assigned tax-free status for which it was ineligible. In addition, a subsequent assessment of the sale concluded that: “[T]he privatisation of LMS had not yielded the expected low prices and competition, requiring further reforms in the sector.” The transaction, in short, converted a profitable, tax-paying public enterprise into a tax-free private enterprise that operated a monopoly in a service of fundamental importance to the Sri Lankan economy.

The Supreme Court Judgment: In its judgment, the Court referenced the original mandate of the PERC, established in 1996 to promote a reform agenda in the public sector: The function of the Commission shall be to advise and assist the Government on the reform of public enterprises with the following objects in view:

a) fostering and accelerating the economic development of the country;
b)improving the efficiency and competitiveness of the economy;
c)upgrading production and services with access to international
markets on a competitive basis by the acquisition of new technology and expertise;
d) developing and broadbasing the capital market and mobilizing long term private savings;
e)motivating the private sector;
f)augmenting the revenues of the government so as to enable it to better address the social agenda.

In writing its opinion, the court emphasized that the objectives of PERC are to benefit the people of Sri Lanka and provide financial support to the country’s public sector in order to better fund social services for a population ravaged by war. The report states that as a public enterprise, LMS provided marine fuel to ships at anchor in the port of Colombo or offshore, an operation known as “bunkering” that has the capacity to generate substantial foreign exchange revenue. To provide this service, LMS operated 12 tanks and a network of interconnecting pipes linked to shipping berths and a jetty in the port.

This network is known as the Common User Facility (CUF). When an executive committee considered liberalization of bunkering in 2000, its recommendations were cautious. It advocated maintaining the public operation of bunkering in the port and the grantng of three licenses for the supply of new bunkers beyond the confines of the port facilities.

Subsequently, the Minister of Shipping agreed with the committee, but recommended that LMS be privatized through a phased approach within the following year as competitive bunkering services beyond the port expanded. When the Cabinet of Sri Lanka approved the proposal it articulated the purpose of the sale: “The benefits to the GOSL are expected from the increase in tax revenue through higher income tax from local companies as well as opportunities for employment generation.”

Despite directions to proceed deliberately, the GAP report state that PERC, under Jayasundera, proceeded to solicit Expressions of Interest from prospective buyers without broadening the licensing process and without establishing the necessary legal framework for competitive privatization.
The actions taken by Jayasundera, in fact, had the effect of granting a private majority shareholder in LMS a continuing monopoly on limited bunkering services through the existing CUF.

Jayasundera himself agreed to amend the draft CUF Agreement, at the behest of JKH and insert this provision, after the valuation of the company had been prepared. In effect, Moragoda and Jayasundera allowed JHK to monopolize the supply of bunkers post-privatization, in direct opposition to the stated intentions of the Cabinet of Ministers.

The value of LMS was additionally understated because Jayasundera had obtained an estimate of the company’s assets through a private bank that he alone selected, rather than using the good offices of the government’s Chief Valuer. The private bank in question did not ask for and was not given a true account of LMS’s monopoly privileges. A subsequent valuation prepared by the private bank, when its auditors were informed that LMS held a monopoly on the provision of bunkering services, virtually doubled the worth of the company when compared to the figure the bank had previously submitted.

In a subsequent step, Jayasundera had the then Secretary to the Treasury appoint a Technical Evaluation Committee (TEC) that would assess the viability of the incoming bids. In apparent collusion with Jayasundera, the TEC accepted a bid from JHK in association with an enterprise that presented credible credentials in port operations, and chose JKH as the winning bidder despite the subsequent withdrawal from the proposal of the qualified enterprise.

The newly privatized company, LMS, then fraudulently applied to the Sri Lankan Board of Investment for tax-exempt status, which was granted. The Supreme Court Justices described this decision as a ‘tailor made’ special gazette notification by Minister G.L. Peiris, Professor of Law, and a former Minister of Justice for Constitutional Affairs.

Whereas the object of the process of liberalization, according to the Cabinet Memorandum that approved it, was to increase the volume of bunkering and thereby increase the foreign exchange revenue yield to the State, the end result was the transformation of a public monopoly into a private one and the complete loss of tax revenue because of a fraudulent exemption.

(Second installment next week)