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Interest Rate Anomaly and Large Treasury Bills/Bonds Holdings of Commercial Banks – Is there a fundamental Conflict of Interest in Commercial Banks being Primary Dealers?

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By Chandu Epitawala

A fundamental principle in finance and economics of risk-return trade-off dictates that Government Issued Debt Instruments should yield the lowest interest rate for the (lender/investor) and the government should be able to borrow at the lowest cost since the government paper is supposed to have no default risk (Giltedged).

However, in Sri Lanka, this principle does not seem to hold. This has been the case for as long as I can remember (even in the 1990s) and needs to be corrected. Discussions of the current hot topic in the country on Domestic Debt Restructuring (DDR) glaringly highlighted this. Most commercial banks in Sri Lanka hold massive amounts (up to 39% according to one research report) of Government Paper in their Asset or Loan Portfolio, going well beyond the inclusion of T Bills/Bonds under Tier 2 Capital requirements.

Term Structure of Interest Rates

How are the interest rates constructed or formed? The largest portion (perhaps up to 80%) of a given Interest Rate is the expected inflation (not past reported inflation) for the period/tenure (3 Months to 30 Years) of the debt instrument or the deposit. Then the next most important factor (perhaps 15%) is the default risk premium attached to the institution which issues the debt instrument (the institution that borrows). Then comes all the other risk premia, which are supposed to cover such risks as reinvestment rate risk, liquidity risk, risk associated with tenure etc. As a result, any country’s Government Issued Debt Instruments carry the lowest (close to zero or zero) premia for Default Risk and Liquidity Risk, as Government Paper is the most liquid. Default Risk is zero since the government has extraordinary/unique authority/powers to Impose Taxes and to Print Money.

The function of Commercial banks

The primary function of commercial banks in an economy (Capitalist economy) is to function as an intermediary between the ultimate saver and borrower (usually a business, government or individual). It’s called intermediation. The commercial banks (which are specifically authorised/licensed by the Central Bank to collect/accept deposits from the savers) will gather dispersed savings from individuals (small or retail savings) by offering an attractive or appropriate (market-driven) interest rate and lend or loan them to businesses/corporates (usually large amounts) to do their productive activities (capital investments, operational activities etc.) in all sectors of the economy keeping a reasonable margin (spread) for their expertise in risk assessment/intermediation. This is the critical function/process of capital formation in a Capitalist economic system. By and Large traditional commercial banks do not directly get involved in the equity sphere of financing/raising capital or in the disintermediation process. However, these conventional boundaries have now largely disappeared.

Therefore is it correct for commercial banks to hold such large amounts of T Bills/Bonds without channeling them to productive economic activities of Corporates/Businesses through their traditional lending activities? This is only possible because there is an anomaly in the interest rates in Sri Lanka.

The Function of Primary Dealers

The Central Bank appoints Primary Dealers who must be well-capitalized and of good repute. They perform a critical function in financial markets and the economy. They are expected to bid at the weekly Primary auctions for Government Securities and create a secondary marketplace (liquidity providers) for T-Bills/Bonds. The term Dealer means an entity that quotes both ways (buy and sell) which requires them to maintain some inventory of T-Bills/Bonds (to sell) as well as cash (to buy). They are expected to create an active secondary market for T-Bills and Bonds. This process should produce a market-driven interest rate/yield for Government Securities, which reflects expected inflation and other risks. These rates (one year, five years and 10 years) should be the benchmark (lowest) rates for a particular tenure upon which all other rates are formulated.

Disintermediation using Capital Markets

Capital Markets (Primary) are used by seekers of Capital (Borrowers and Recipients of Equity Capital) to bypass the commercial banks (Deposit-taking Institutions) and directly go to the saver and raise funds/capital. This bypassing the Banks (via Capital Markets) is called disintermediation. The Stock Market is the best example of this process and is mainly used for raising equity capital. Treasury Bill/Bond Markets can be considered the largest and most liquid market where the government goes directly to the market/savers to borrow debt capital. Then there are other markets (centrally organized, exchange-traded, or over-the-counter-OTC) for Corporate Bonds/Commercial Paper, etc. Commercial banks are not prohibited from participating in any of these markets, but it is not their primary economic function.

The primary market is where the borrower/seeker of equity or debt capital initially sells/markets their Security (share, promissory note, commercial paper, T-Bill/Bond etc.). Initial Price Offering (IPO) of shares (Equity) and T-Bill/Bond (Debt) auctions are the best examples of Primary Markets. Only authorized Primary Dealers can participate in weekly T-Bill/Bond auctions. Most Commercial banks are also Primary Dealers. And the Primary Dealers have a responsibility and obligation to create a secondary market in T-Bills/Bonds so that retail investors have an opportunity to participate/invest/lend directly to the government and create liquidity for the T-Bills/Bonds, thereby creating an efficient market-driven price/yield discovery mechanism. Since this market is less transparent and inactive in Sri Lanka than it ought to be, it would be correct to say the interest rate/yield is not 100% market-driven and reflect the correct risk premia for expected inflation and other risks.

Another fundamental principle of Finance/Economics states; the higher the risk, the higher the return. The lender/investor of equity will expect a higher return (usually annualized returns for ease of comparison with other investment options) for their funds as the borrower/recipient of equity capital riskiness is higher and vice versa.

Interest Rate Anomaly

As explained earlier, once the risk premia are added up, in any developed and efficient capital market, the government-issued debt instruments should yield or return the lowest for a lender/investor as the government has the lowest default risk and liquidity (trading in the secondary market) of government-issued debt instruments ought to be the highest. Therefore (correspondingly), the Yield/Return of T-Bills/Bonds should be the lowest for a given tenure (three Months to 30 years). However, this fundamental principle in Sri Lanka does not hold as T-Bill/Bond rates often exceed (higher) than the Commercial Bank deposit Rates for similar tenures. This is the anomaly.

This anomaly allows Commercial banks to mobilize deposits from mainly unsophisticated (uninformed or uninitiated) retail and corporate savers and turn around and park those funds in higher yielding T-Bills/Bonds and make an easy/effortless profit (including tax-free capital gains). This doesn’t seem right or inappropriate on two levels;

This (lending to the government) is not commercial banks’ core function or responsibility.

As Primary Dealers of T-Bills/Bonds, commercial banks appear not to be meeting their obligation to actively create a secondary market for T-Bills/Bonds, as this directly goes against their deposit mobilization objectives.

What is the reason for this persistent and abnormal disparity in interest rates?

I believe this anomaly exists in Sri Lanka due to two main reasons;

The lack of financial literacy or understanding of retail lenders/depositors/savers of the above explained principles and obvious/myriad of advantages of investing in a tradable debt (in the Secondary Market) instrument like T-Bills/Bonds. It even allows the investor/lender/saver an opportunity to make a Capital Gain which is tax-free (Ex. Those who invested in T-Bills/Bonds at high rates seen in the past six months to a year can now exit with up to 100% capital gains!!!).

Most primary dealers (ones with deep pockets) are commercial banks and lack interest in creating a secondary market, which requires them to actively market the T-Bills/Bonds to the retail investors/lenders/savers. I believe this is why commercial banks carry significant T-Bill/Bond investments in their Asset/Loan Portfolios, as pointed out in the research report mentioned at the beginning.

Why should commercial banks lend their funds to riskier customers when they can lend to the government if the depositor is ignorant or ill-informed enough to deposit their savings in commercial banks at lower rates (sometimes this gap can go up to 4-5%), than what T-Bills/Bonds (safest investment/debt instrument) pay/yield them?

Some suggestions to correct the persistent interest rate anomaly It is in the interest of the Government/CBSL to ensure that the government can borrow at the lowest cost in any market. My suggestions to correct the anomaly are;

Mandate all Primary Dealers (including commercial banks) to actively create a secondary market and market and trade a minimum amount obtained at the Primary Auction to retailers and corporate or institutional investors. Ideally, they should be required to advertise the T-Bill/Bond rates and deposit rates at all their Branches. A dealer should be obligated to carry inventory, quote both ways (buy and sell) and have a good track record of active trading and market making.

The government/CBSL should educate the public/ retail savers through ongoing marketing campaigns. Ideally, this should be in the school curriculum along with other elements of financial literacy) about all the advantages of investing in T-Bills/Bonds – the risk-return principle, and how easy to access (online etc.) T-Bills/Bonds, the high liquidity in the secondary market (just like cash), and, very importantly, the potential for capital gains (which is tax-free).

These two measures, in my humble opinion, should correct the interest rate anomaly and bring the T-Bill rates down (and conversely deposit rates up), allowing the government to borrow at the lowest cost like in any other country in addition to giving the general public access to a low risk, liquid Security (Debt Instrument) that can be easily accessed, traded, mortgaged and liquidated (turned into cash).



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More state support needed for marginalised communities

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A landslide in the Central Province

Message from Malaiyaha Tamil community to govt:

Insights from SSA Cyclone Ditwah Survey

When climate disasters strike, they don’t affect everyone equally. Marginalised communities typically face worse outcomes, and Cyclone Ditwah is no exception. Especially in a context where normalcy is far from “normal”, the idea of returning to normalcy or restoring a life of normalcy makes very little sense.

The island-wide survey (https://ssalanka.org/reports/) conducted by the Social Scientists’ Association (SSA), between early to mid-January on Cyclone Ditwah shows stark regional disparities in how satisfied or dissatisfied people were with the government’s response. While national satisfaction levels were relatively high in most provinces, the Central Province tells a different story.

Only 35.2% of Central Province residents reported that they were satisfied with early warning and evacuation measures, compared to 52.2% nationally. The gap continues across every measure: just 52.9% were satisfied with immediate rescue and emergency response, compared with the national figure of 74.6%. Satisfaction with relief distribution in the Central Province is 51.9% while the national figure stands at 73.1%. The figures for restoration of water, electricity, and roads are at a low 45.9% in the central province compared to the 70.9% in national figures. Similarly, the satisfaction level for recovery and rebuilding support is 48.7% in the Central Province, while the national figure is 67.0%.

A deeper analysis of the SSA data on public perceptions reveals something important: these lower satisfaction rates came primarily from the Malaiyaha Tamil population. Their experience differed not just from other provinces, but also from other ethnic groups living in the Central Province itself.

The Malaiyaha Tamil community’s vulnerability didn’t start with the cyclone. Their vulnerability is a historically and structurally pre-determined process of exclusion and marginalisation. Brought to Sri Lanka during British rule to work for the empire’s plantation economies, they have faced long-term economic exploitation and have repeatedly been denied access to state support and social welfare systems. Most estate residents still live in ‘line rooms’ and have no rights to the land they cultivate and live on. The community continues to be governed by an outdated estate management system that acts as a barrier to accessing public and municipal services such as road repair, water, electricity and other basic infrastructures available to other citizens.

As far as access to improved water sources is concerned, the Sri Lanka Demographic Health Survey (2016) shows that 57% of estate sector households don’t have access to improved water sources, while more than 90% of households in urban and rural areas do. With regard to the level of poverty, as the Department of Census and Statistics (2019) data reveals, the estate sector where most Malaiyaha Tamils live had a poverty headcount index of 33.8%; more than double the national rate of 14.3%. These statistics highlight key indicators of the systemic discrimination faced by the Malaiyaha Tamil community.

Some crucial observations from the SSA data collectors who enumerated responses from estate residents in the survey reveal the specific challenges faced by the Malaiyaha Tamils, particularly in their efforts to seek state support for compensation and reconstruction.

First, the Central Province experienced not just flooding but also the highest number of landslides in the island. As a result, some residents in the region lost entire homes, access roadways, and other basic infrastructures. The loss of lives, livelihoods and land was at a higher intensity compared to the provinces not located in the hills. Most importantly, the Malaiyaha Tamil community’s pre-existing grievances made them even more vulnerable and the government’s job of reparation and restitution more complex.

Early warnings hadn’t reached many areas. Some data collectors said they themselves never heard any warnings in estate areas, while others mentioned that early warnings were issued but didn’t reach some segments of the community. According to the resident data collectors, the police announcements reached only as far as the sections where they were able to drive their vehicles to, and there were many estate roads that were not motorable. When warnings did filter through to remote locations, they often came by word of mouth and information was distorted along the way. Once the disaster hit, things got worse: roads were blocked, electricity went out, mobile networks failed and people were cut off completely.

Emergency response was slow. Blocked roads meant people could not get to hospitals when they needed urgent care, including pregnant mothers. The difficult terrain and poor road conditions meant rescue teams took much longer to reach affected areas than in other regions.

Relief supplies didn’t reach everyone. The Grama Niladhari divisions in these areas are huge and hard to navigate, making it difficult for Grama Niladharis to reach all places as urgently as needed. Relief workers distributed supplies where vehicles could go, which meant accessible areas got help while remote communities were left out.

Some people didn’t even try to go to safety centres or evacuation shelters set up in local schools because the facilities there were already so poor. The perceptions of people who did go to safety centres, as shown in the provincial data, reveal that satisfaction was low compared to other affected regions of the country. Less than half were satisfied with space and facilities (42.1%) or security and protection (45.0%). Satisfaction was even lower for assistance with lost or damaged documentation (17.9%) and information and support for compensation applications (28.2%). Only 22.5% were satisfied with medical care and health services below most other affected regions.

Restoring services proved nearly impossible in some areas. Road access was the biggest problem. The condition of the roads was already poor even before the cyclone, and some still haven’t been cleared. Recovery is especially difficult because there’s no decent baseline infrastructure to restore, hence you can’t bring roads and other public facilities back to a “good” condition when they were never good, even before the disaster.

Water systems faced their own complications. Many households get water from natural sources or small community projects, and not the centralised state system. These sources are often in the middle of the disaster zone and therefore got contaminated during the floods and landslides.

Long-term recovery remains stalled. Without basic infrastructure, areas that are still hard to reach keep struggling to get the support they need for rebuilding.

Taken together, what do these testaments mean? Disaster response can’t be the same for everyone. The Malaiyaha Tamil community has been double marginalised because they were already living with structural inequalities such as poor infrastructure, geographic isolation, and inadequate services which have been exacerbated by Cyclone Ditwah. An effective and fair disaster response needs to account for these underlying vulnerabilities. It requires interventions tailored to the historical, economic, and infrastructural realities that marginalized communities face every day. On top of that, it highlights the importance of dealing with climate disasters, given the fact that vulnerable communities could face more devastating impacts compared to others.

(Shashik Silva is a researcher with the Social Scientists’ Association of Sri Lanka)

by Shashik Silva ✍️

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Crucial test for religious and ethnic harmony in Bangladesh

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A political protest that led to governmental change in Bangladesh mid last year. (photograph: imago)

Will the Bangladesh parliamentary election bring into being a government that will ensure ethnic and religious harmony in the country? This is the poser on the lips of peace-loving sections in Bangladesh and a principal concern of those outside who mean the country well.

The apprehensions are mainly on the part of religious and ethnic minorities. The parliamentary poll of February 12th is expected to bring into existence a government headed by the Bangladesh Nationalist Party (BNP) and the Islamist oriented Jamaat-e-Islami party and this is where the rub is. If these parties win, will it be a case of Bangladesh sliding in the direction of a theocracy or a state where majoritarian chauvinism thrives?

Chief of the Jamaat, Shafiqur Rahman, who was interviewed by sections of the international media recently said that there is no need for minority groups in Bangladesh to have the above fears. He assured, essentially, that the state that will come into being will be equable and inclusive. May it be so, is likely to be the wish of those who cherish a tension-free Bangladesh.

The party that could have posed a challenge to the above parties, the Awami League Party of former Prime Minister Hasina Wased, is out of the running on account of a suspension that was imposed on it by the authorities and the mentioned majoritarian-oriented parties are expected to have it easy at the polls.

A positive that has emerged against the backdrop of the poll is that most ordinary people in Bangladesh, be they Muslim or Hindu, are for communal and religious harmony and it is hoped that this sentiment will strongly prevail, going ahead. Interestingly, most of them were of the view, when interviewed, that it was the politicians who sowed the seeds of discord in the country and this viewpoint is widely shared by publics all over the region in respect of the politicians of their countries.

Some sections of the Jamaat party were of the view that matters with regard to the orientation of governance are best left to the incoming parliament to decide on but such opinions will be cold comfort for minority groups. If the parliamentary majority comes to consist of hard line Islamists, for instance, there is nothing to prevent the country from going in for theocratic governance. Consequently, minority group fears over their safety and protection cannot be prevented from spreading.

Therefore, we come back to the question of just and fair governance and whether Bangladesh’s future rulers could ensure these essential conditions of democratic rule. The latter, it is hoped, will be sufficiently perceptive to ascertain that a Bangladesh rife with religious and ethnic tensions, and therefore unstable, would not be in the interests of Bangladesh and those of the region’s countries.

Unfortunately, politicians region-wide fall for the lure of ethnic, religious and linguistic chauvinism. This happens even in the case of politicians who claim to be democratic in orientation. This fate even befell Bangladesh’s Awami League Party, which claims to be democratic and socialist in general outlook.

We have it on the authority of Taslima Nasrin in her ground-breaking novel, ‘Lajja’, that the Awami Party was not of any substantial help to Bangladesh’s Hindus, for example, when violence was unleashed on them by sections of the majority community. In fact some elements in the Awami Party were found to be siding with the Hindus’ murderous persecutors. Such are the temptations of hard line majoritarianism.

In Sri Lanka’s past numerous have been the occasions when even self-professed Leftists and their parties have conveniently fallen in line with Southern nationalist groups with self-interest in mind. The present NPP government in Sri Lanka has been waxing lyrical about fostering national reconciliation and harmony but it is yet to prove its worthiness on this score in practice. The NPP government remains untested material.

As a first step towards national reconciliation it is hoped that Sri Lanka’s present rulers would learn the Tamil language and address the people of the North and East of the country in Tamil and not Sinhala, which most Tamil-speaking people do not understand. We earnestly await official language reforms which afford to Tamil the dignity it deserves.

An acid test awaits Bangladesh as well on the nation-building front. Not only must all forms of chauvinism be shunned by the incoming rulers but a secular, truly democratic Bangladesh awaits being licked into shape. All identity barriers among people need to be abolished and it is this process that is referred to as nation-building.

On the foreign policy frontier, a task of foremost importance for Bangladesh is the need to build bridges of amity with India. If pragmatism is to rule the roost in foreign policy formulation, Bangladesh would place priority to the overcoming of this challenge. The repatriation to Bangladesh of ex-Prime Minister Hasina could emerge as a steep hurdle to bilateral accord but sagacious diplomacy must be used by Bangladesh to get over the problem.

A reply to N.A. de S. Amaratunga

A response has been penned by N.A. de S. Amaratunga (please see p5 of ‘The Island’ of February 6th) to a previous column by me on ‘ India shaping-up as a Swing State’, published in this newspaper on January 29th , but I remain firmly convinced that India remains a foremost democracy and a Swing State in the making.

If the countries of South Asia are to effectively manage ‘murderous terrorism’, particularly of the separatist kind, then they would do well to adopt to the best of their ability a system of government that provides for power decentralization from the centre to the provinces or periphery, as the case may be. This system has stood India in good stead and ought to prove effective in all other states that have fears of disintegration.

Moreover, power decentralization ensures that all communities within a country enjoy some self-governing rights within an overall unitary governance framework. Such power-sharing is a hallmark of democratic governance.

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Celebrating Valentine’s Day …

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Valentine’s Day is all about celebrating love, romance, and affection, and this is how some of our well-known personalities plan to celebrate Valentine’s Day – 14th February:

Merlina Fernando (Singer)

Yes, it’s a special day for lovers all over the world and it’s even more special to me because 14th February is the birthday of my husband Suresh, who’s the lead guitarist of my band Mission.

We have planned to celebrate Valentine’s Day and his Birthday together and it will be a wonderful night as always.

We will be having our fans and close friends, on that night, with their loved ones at Highso – City Max hotel Dubai, from 9.00 pm onwards.

Lorensz Francke (Elvis Tribute Artiste)

On Valentine’s Day I will be performing a live concert at a Wealthy Senior Home for Men and Women, and their families will be attending, as well.

I will be performing live with romantic, iconic love songs and my song list would include ‘Can’t Help falling in Love’, ‘Love Me Tender’, ‘Burning Love’, ‘Are You Lonesome Tonight’, ‘The Wonder of You’ and ‘’It’s Now or Never’ to name a few.

To make Valentine’s Day extra special I will give the Home folks red satin scarfs.

Emma Shanaya (Singer)

I plan on spending the day of love with my girls, especially my best friend. I don’t have a romantic Valentine this year but I am thrilled to spend it with the girl that loves me through and through. I’ll be in Colombo and look forward to go to a cute cafe and spend some quality time with my childhood best friend Zulha.

JAYASRI

Emma-and-Maneeka

This Valentine’s Day the band JAYASRI we will be really busy; in the morning we will be landing in Sri Lanka, after our Oman Tour; then in the afternoon we are invited as Chief Guests at our Maris Stella College Sports Meet, Negombo, and late night we will be with LineOne band live in Karandeniya Open Air Down South. Everywhere we will be sharing LOVE with the mass crowds.

Kay Jay (Singer)

I will stay at home and cook a lovely meal for lunch, watch some movies, together with Sanjaya, and, maybe we go out for dinner and have a lovely time. Come to think of it, every day is Valentine’s Day for me with Sanjaya Alles.

Maneka Liyanage (Beauty Tips)

On this special day, I celebrate love by spending meaningful time with the people I cherish. I prepare food with love and share meals together, because food made with love brings hearts closer. I enjoy my leisure time with them — talking, laughing, sharing stories, understanding each other, and creating beautiful memories. My wish for this Valentine’s Day is a world without fighting — a world where we love one another like our own beloved, where we do not hurt others, even through a single word or action. Let us choose kindness, patience, and understanding in everything we do.

Janaka Palapathwala (Singer)

Janaka

Valentine’s Day should not be the only day we speak about love.

From the moment we are born into this world, we seek love, first through the very drop of our mother’s milk, then through the boundless care of our Mother and Father, and the embrace of family.

Love is everywhere. All living beings, even plants, respond in affection when they are loved.

As we grow, we learn to love, and to be loved. One day, that love inspires us to build a new family of our own.

Love has no beginning and no end. It flows through every stage of life, timeless, endless, and eternal.

Natasha Rathnayake (Singer)

We don’t have any special plans for Valentine’s Day. When you’ve been in love with the same person for over 25 years, you realise that love isn’t a performance reserved for one calendar date. My husband and I have never been big on public displays, or grand gestures, on 14th February. Our love is expressed quietly and consistently, in ordinary, uncelebrated moments.

With time, you learn that love isn’t about proving anything to the world or buying into a commercialised idea of romance—flowers that wilt, sweets that spike blood sugar, and gifts that impress briefly but add little real value. In today’s society, marketing often pushes the idea that love is proven by how much money you spend, and that buying things is treated as a sign of commitment.

Real love doesn’t need reminders or price tags. It lives in showing up every day, choosing each other on unromantic days, and nurturing the relationship intentionally and without an audience.

This isn’t a judgment on those who enjoy celebrating Valentine’s Day. It’s simply a personal choice.

Melloney Dassanayake (Miss Universe Sri Lanka 2024)

I truly believe it’s beautiful to have a day specially dedicated to love. But, for me, Valentine’s Day goes far beyond romantic love alone. It celebrates every form of love we hold close to our hearts: the love for family, friends, and that one special person who makes life brighter. While 14th February gives us a moment to pause and celebrate, I always remind myself that love should never be limited to just one day. Every single day should feel like Valentine’s Day – constant reminder to the people we love that they are never alone, that they are valued, and that they matter.

I’m incredibly blessed because, for me, every day feels like Valentine’s Day. My special person makes sure of that through the smallest gestures, the quiet moments, and the simple reminders that love lives in the details. He shows me that it’s the little things that count, and that love doesn’t need grand stages to feel extraordinary. This Valentine’s Day, perfection would be something intimate and meaningful: a cozy picnic in our home garden, surrounded by nature, laughter, and warmth, followed by an abstract drawing session where we let our creativity flow freely. To me, that’s what love is – simple, soulful, expressive, and deeply personal. When love is real, every ordinary moment becomes magical.

Noshin De Silva (Actress)

Valentine’s Day is one of my favourite holidays! I love the décor, the hearts everywhere, the pinks and reds, heart-shaped chocolates, and roses all around. But honestly, I believe every day can be Valentine’s Day.

It doesn’t have to be just about romantic love. It’s a chance to celebrate love in all its forms with friends, family, or even by taking a little time for yourself.

Whether you’re spending the day with someone special or enjoying your own company, it’s a reminder to appreciate meaningful connections, show kindness, and lead with love every day.

And yes, I’m fully on theme this year with heart nail art and heart mehendi design!

Wishing everyone a very happy Valentine’s Day, but, remember, love yourself first, and don’t forget to treat yourself.

Sending my love to all of you.

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