Maintaining an impressive reserve management record vital

Since of late, the returns that the Central Bank of Sri Lanka has made from its international reserve management have been the subject matter of some discussion.

The debate in relation to the returns earned, degree of risk assumed, and the allocation of specific portfolio segments towards investments of different risk levels intensified, after it was known that the Central Bank had invested a part of its reserves in Greek Bonds, which led to certain losses.

The Central Bank responded by stating that even after setting off the losses on the Greek bonds, which was only a very small fraction of its portfolio, the Central Bank has made a massive return of $ 430 m, or 6.6 percent on the average portfolio for the year 2011.

Later, independent research showed that the Central Bank of Sri Lanka's return was significantly higher than the returns made by other Central Banks during the same year, which were, in most instances, less than 2 percent.

Independent analysts also pointed out that no portfolio could be managed in the current highly destabilised global economy, without incurring any losses at all.

In fact, the present 'Fiscal Cliff' debate in the USA, which indirectly suggests that there is a risk in investing in US Treasury itself, and the downgrade of the French Government rating, adds frightening dimensions to this debate because investments that were hitherto considered the safest and 100 percent gilt-edged, are displaying signs of some vulnerability. These and other unthinkable events must be sending shivers down the spine of global investors, who are today grappling with the challenge of providing safety to their investments.

To further aggravate the situation, countries like Japan only offer a 0.1 percent interest and US Treasuries yield a measly 0.25 percent, while the Bank of International Settlements, which is the central bank for Central Banks globally, is giving a negative interest rate.

In this background of low interest rates, the Central Bank of Sri Lanka seems to have developed a healthy model of protecting its reserves whilst providing an above-average return on its portfolio.

Such successes could be gauged by the profit transfers made by the Central Bank over the recent past, which have been, by and large, due to its impressive reserve management operations. The computation of the profits of the Central Bank is guided by the Monetary Law Act (MLA), Sri Lanka Accounting Standards, and International Accounting Standards.

The MLA provides for the distribution of profits by the Central Bank on its international operations, whilst stringent conditions are imposed on the distribution of profits out of its local operations. This is to ensure that the Central Bank makes distributions to the Government in a manner so as to not cause inflationary pressures within the economy.

In that context, the profit distribution of the Central Bank provides some useful guidance as to the manner in which the Central Bank has been successful in its international reserve management activities.

During the initial period of 26 years of the Central Bank, 1950-1975, the total profit transfers by the Central Bank to the Government has been about Rs. 30 m. During the next 30 years, 1976-2005, the Central Bank transferred profits amounting to Rs.60 b. However, over the last six years, 2006-2011, a massive sum of Rs.79 b has been transferred, which means that in the last six years, the profits transferred has been significantly higher than what has been transferred in the 56 years, prior to that. The recent financial statements of the Central Bank indicate that it has so far made interim appropriations of Rs. 21 b out of its profits for the year 2012.

In that context, it is seen that a major improvement has taken place in the foreign reserve management of the Central Bank, which has resulted in massive profit transfers being made to the Government. Such transfers have provided a useful cushion in the curtailment of the budget deficit and the management of the public debt. Needless to say therefore, this favourable process must be supported, without undue pressures or distractions being imposed, that could lead to the disruption of this trend. Towards that end, all key economic stakeholders and the general public must be made to understand that reserve management is a highly skilled function and is not a simple operation like certain politicians have attempted to portray.

As is usual, everyone is wiser in hindsight and could offer various analyses.

However, the challenge for those who are involved in real-time decision making is to assess information available at a particular moment, make a reasonable judgement about the future trends, and thereafter take a reasoned investment decision.

The recent results achieved by the Central Bank provide evidence that their international operations team have been able to deliver significantly above-average returns on a consistent basis. In fact, many countries would envy the returns generated by the Central Bank of Sri Lanka, since their own returns have been much lower.

In this regard, it would also be noted that during 2011, the Federal Reserve Bank has made a profit of $401 m, on an average reserve of $42.2 b, whereas the Central Bank of Sri Lanka had generated a profit of $430 m on a much smaller average reserve of $ 6.7 b.

In Sri Lanka, Opposition MPs and some sections of the media quickly to pounce on any instance of loss in a state institution and highlight it.

But, they are reluctant to acknowledge the creditable performances of any state organisation, if they think that the credit for such performance would boost the Government. This attitude is unfortunate, since it discourages many outstanding officers who diligently perform their duties to generate major gains to the economy and the country. It is therefore hoped that the relevant officials of the Central Bank who have contributed to the outstanding performance of the Central Bank reserve management that has been hailed as the best in the world, will not be discouraged by these negative attacks.