Public Enterprises Making Losses
The five big loss makers which were once categorised as the ‘biggest monsters’ by the Minister of Finance, plus the Sri Lankan Airlines, have made operating losses amounting to whopping Rs. 48.6 billion in 2009. The detailed distribution is alarming: Postal Rs 2.4 billion, CEB Rs 7.4 billion, CPC Rs 12.3 billion, SLTB including the government subsidy, Rs 9.3 billion, Railways Rs 4.8 billion and Sri Lankan Airline Rs 12.2 billion.
In addition, Mihin Air, government’s pet budget airline, has made an operating loss of Rs 930 million on top of its previous losses amounting to Rs 3 billion absorbed by the government earlier. These numbers just present the difference between the current revenue and current expenditure of these enterprises before charging depreciation and writing off the unrecoverable debts. Hence, the net losses made by them must be much more than the amounts reported in the Central Bank Annual Report, but it will take some time for those numbers to surface because of the delay in publishing the audited final accounts.
Losses Have to be Funded by the Public
There is nothing new about public enterprises making losses and getting away with such losses with total impunity.In fact, they have been continuously in losses and those losses have been funded by the public through subsidies: for instance, according to the data provided by the Central Bank Annual Report, the two transport enterprises, Railways and SLTB, have made operating losses year after year since 2000 amassing cumulative losses of Rs 31.3 billion and Rs 30.3 billion, respectively, by end - 2009. If they were two private sector firms, they would have by now been bankrupt and forced to close their business.
However, all these enterprises have been able to continue their business with subsidies given by the government and loans raised from banks, especially from the two state banks, on the strength of government guarantees. Either way, it is the public who have to bear the burden of such losses eventually. Subsidies are directly funded out of the current tax revenue; defaulted loans are settled by the Treasury, again by issuing Treasury bonds making it a liability of future tax payers. Hence, the public enterprises making losses is undoubtedly ‘bad news’.
Central Banks’ making Super - Profits
If making profits by a public enterprise is good news, making super profits must be extra good news. Then, how can one argue that central banks’ making super profits is very bad news?
The answer is given by the Central Bank itself as a Management Statement attached to its final accounts.
It says that the Central Bank’s core objectives are the attainment of economic and price stability and financial system stability and the Bank’s performance should be assessed on the basis of its attainment of these two goals and ‘not necessarily its profitability per se’. The adoption of a profitability related approach by the Central Bank ‘could result in the Bank pursuing profits while compromising its core objectives, since it has the unique ability to create its own profits through its monetary policy activities which could influence interest rates and exchange rates’.
Many who read the Central Bank’s final accounts tend to miss this clarification. What it says is that a central bank is different from other organisations and in a position to create its own profits, but at the expense of the objective of maintaining an inflation free world.
Central Banks can earn domestic incomes only by creating new money
This could be illustrated as follows. The only power which a central bank has got is to print money. It has to print money when it lends to government and commercial banks and when it buys foreign exchange from the market. Lending will enable the central bank to earn interest incomes in rupee terms; investment of foreign exchange will earn it returns in foreign currency terms.
So, both will increase the bank’s profit levels. But when it prints money more than what the public wants, there will be surplus money in their hands and, therefore, in order to reduce such balances to desired optimal levels, they will use that money on goods and services. If the supply of money is faster than the supply of goods and services which is the usual case, the excess demand for goods and services will put pressure on the prices to rise.
When this happens continuously over a period of time, it leads to inflation. By printing money, a central bank can make profits, but such money will invariably bring about inflation too.
Thus, a central bank can make any amount of profits by printing money, but such profits are made by sacrificing its price stability objective.
Bank’s Financial Performance in 2009
Central Bank’s financial statements show that it has made a thumping net profit of Rs 33.7 billion in 2009. In comparison, in 2008, it made a net loss of Rs 5 billion. Hence, one may draw the conclusion that it has converted itself from losses to profits and its financial performance has been superior to any of the other public enterprises. Both conclusions are erroneous.
The principal source of the losses of the Bank in 2008 was the decline in the Rupee value of its foreign exchange reserves, Rs 23 billion in all, due to the appreciation of the Rupee against the Sterling Pound and the Euro. Since the Bank can influence the direction of the exchange rate, it could have avoided these losses by allowing the rate to depreciate adequately. But the Bank’s exchange rate strategy did not allow it to depreciate the currency and therefore, instead of showing profits in its financial statements, it chose to show losses in 2008.
The source of profits of 2009 was completely different. The Bank made a moderate income of Rs 4.6 billion out of its investment of foreign assets. This was enhanced by a book entry of Rs 8.8 billion representing a gain emanating from the revaluation of the foreign assets at the year - end exchange rates. But the super profits of the Bank came from its domestic activities, namely, its lending to the government. The domestic interest income so earned amounted to unprecedented Rs 28.1 billion as against Rs 7 billion earned in 2008.
Since the interest rates on Government Treasury bills declined substantially during the year, from around 19 percent at the beginning to 9 percent at the end, and stood on average at around 13 percent per annum, to earn such an income, the Bank would have lent the Government a total volume of Rs 216 billion during the year. This is purely new money created by the Bank and according to economists’ parlance, high powered money that leads to multiple money creation by the country’s banking system in the years to come.
When one considers the inflationary impact which such high powered money brings on the economy, Central Bank’s making super profits is not good news.
John Exter’s Wisdom
John Exter who drafted the Central Bank’s law wanted to prevent these profits from being used by the Government because it will create a new cycle of monetary expansion. Thus, he made any profit transfer to the government conditional upon the Bank’s first meeting various other priorities such as building up of capital and absorbing previous losses.
If the Bank desires to make any profit transfer, it should do so, according to the law, after meeting these priorities and having properly apprised the Minister of Finance of the consequences of such a profit transfer. In that manner, unlike the other public organisations, the Government does not get the first priority for the profits of the Central Bank.
However, the Government has the right to claim the profits made by the Central Bank on its investment of foreign assets, since the Bank does so on behalf of the Government. The underlying reasoning is that, if the Central Bank does not manage the country’s foreign reserves, the Government will have to do it by itself and it can then appropriate such incomes for its budgetary expenses.
According to Central Bank Annual Report, in 2009, the Government had anticipated a profit transfer of Rs 8 billion from the Central Bank. But the actual amount paid in the year has been Rs 20 billion and this appears to be an advance extended by the Central Bank to the Government to meet its urgent financial commitments pending the finalisation of its final accounts in February 2010. This profit transfer is very much higher than the earning of Rs 4.6 billion which the Bank made out of its foreign investments and which the Government can legitimately claim as its due from the Bank.
A Central Bank should not Make Losses either
Thus, making super profits by a central bank is very bad news. This does not mean that making losses by a central bank is tolerable and acceptable. Such losses eventually have to be funded by the tax payers just like any other public organisation. Hence, making both losses and making super profits by a central bank are not good news at all.
The writer is a retired deputy governor of the Central Bank of Sri Lanka. To read previous columns in the series go to the WatchTower section on the main navigation panel or click on the links below.