The independence of the Central Bank is for building the trust of the people in its actions. As long as the Bank is subject to political manipulation, the people will not trust the monies it issues for use by them
A debate without substance
I spent two afternoons last week in watching the live debate on the forensic audit reports by Sri Lanka’s Parliamentarians. Sadly, there were only two Parliamentarians who made constructive suggestions that should merit attention of the people. One was Parliamentarian Patali Champika Ranawaka. The other was Parliamentarian Rauf Hakeem. All others looked at the forensic audit reports through the political colour of the party to which they have pledged their allegiance.
Ranawaka’s admission of the conflicting role being played by the Monetary Board
Ranawaka, though he was not completely free from party lines in his analysis, used the latter part of his speech to draw attention of Parliament to a structural problem faced by the Monetary Board when performing its duties by the nation. It is the issue of conflicting objectives which previous Parliaments had given to it. The foremost function of the Monetary Board was to deliver an inflation free world to Sri Lankans together with a stable financial system. They have been enshrined in the Monetary Law Act under which the Monetary Board has been incorporated and the institution called the central bank has been established as ‘economic and price stability’ and ‘financial system stability’.
Two other functions which Parliament has assigned to the Board are directly in conflict with these two stability objectives. One was the raising of loans for the Government at the cheapest cost possible. The other was to manage the Employees Provident Fund or EPF and give its members the highest benefit possible. Ranawaka saw the weakness in this arrangement and suggested that Parliament should consider freeing the Board of these conflicting functions.
Hakeem canvasses for an independent Central Bank
Hakeem did not take a party line when he addressed Parliament. The charges and counter-charges levelled by the Government party and the main opposition against each other was similar, according to him, to the proverbial ‘the pot calling the kettle black’. Refraining himself from talking about the results, he dug deep into the cause of the alleged malpractices that have been the topic of discussion.
His diagnosis zeroed on a single virus that had been inserted to the Central Bank by successive governments. That was to appoint ‘politically exposed persons’ to the highest position of the Bank. It effectively converted the Central Bank to a politicised animal that was ready to be a yielding hand to the wishes of politicians. He, therefore, suggested that both sides of Parliament should get together and make the Bank an independent institution free from political interferences. Going forward, he also suggested that EPF too should be placed under the management of professional fund managers who are able to meet the fiduciary requirements involved in managing monies belonging to other people.
These suggestions are not new
Both these Parliamentarians have made suggestions which I have been arguing for a long time. In fact, when the Central Bank underwent its modernisation program during 2000 to 2004, the suggestion was to take both the public debt and EPF away from the bank and introduce a new central banking law making it independent. Public debt was to be handed to an independent debt authority that functioned under the Ministry of Finance.
The proposal for the reform of EPF was much wider than what both Ranawaka and Hakeem have suggested. It was proposed to set up a Social Security Board of Sri Lanka by amalgamating EPF and Employees Trust Fund or ETF, on one side, and placing all those miscellaneous pension schemes which were dependent on the Treasury for funding under its charge, on the other.
In today’s context where the world is moving toward the Fourth Industrial Revolution or 4IR, it is not just hard work but ‘smart work’ that would bring prosperity to a country. Central banks can only facilitate this process by keeping price changes in check or keeping inflation within limits. The real contribution should come from the Government which is in a position to influence the real production of goods and services
By early 2004, several teams of experts within the Central Bank had finalised the draft legislations and the government of Ranil Wickremesinghe that was in power had agreed to go for the proposed changes. However, with the change in the government in April 2004, all these reforms were shelved and it is after 16 years that they have resurfaced, not from anyone from the two main political parties but from two leaders belonging to minor political parties. But they are suggestions worthy of being pursued.
The conflict of interest in performing the three functions
Apparently, not many understand the conflict which the Monetary Board has got from the three functions which have been assigned to it by Parliament. The Monetary Board’s prime responsibility has been to keep inflation close to a zero level. When inflation rises, the people who hold the money issued by the Bank will find that they could now buy a smaller basket of goods for a unit of money. It would make them poorer in terms of the welfare level they are enjoying.
The solution has been to neutralise inflationary pressures by increasing interest rates and cutting down credit levels. But that course of action will go against its responsibility towards the government for raising debt at the lowest possible cost. Thus, faced with a dilemma, the Board will have to push down the interest rates applicable to government securities. But it will go against its responsibility towards the members of EPF. This type of manipulation of interest rates which the Board does for the sake of the government has been the main reason for forensic auditors to charge the Board that it has caused losses to government especially in the pre-2015 period. More about this later.
Parking of EPF in the wrong place
As I have pointed out earlier, EPF was housed in the Central Bank as a temporary measure by the Bandaranaike government in 1958. At least, this was what was told to the late N.U. Jayawardena who was the first Ceylonese Governor of the Bank but in 1958 was a Senator when he protested against the planned move. But this promise of freeing the Monetary Board of the responsibility for running a social security fund was forgotten soon and the temporary assignment became a permanent one over the years.
On many occasions when there were suggestions to take EPF away from the Central Bank, it was the organised trade union sector that made objections to it. This was because, albeit there were some minor hiccups, trade unions had the full trust in the Monetary Board for protecting the monies belonging to the working population of the country. Thus, any move to take EPF out of the Monetary Board should receive the consent of the organised trade unions.
EPF reforms should be a part of a broad reform of the social security system
But the reform should not be just to take EPF away from the Monetary Board and hand over to another body. It should be a broad one like the proposal made during 2000-4 referred to above. In this reform, both EPF and ETF should be amalgamated and numerous miscellaneous pension funds covering fishermen, farmers, etc. should be brought together. In this connection, one should remember that ETF was created in early 1980s not as a social security measure but as a way to allow the working population of the country to own private companies collectively. This was a move to adopt an economy-wide strategy to establish an Employee-Share-Ownership-Plan or ESOP.
Previously, individual companies had ESOPs to permit the workers in their companies to own shares of the company concerned and thereby become employee-cum-owners. ETF sought to establish an economywide ESOP with contributions made by employers on behalf of their employees. The ultimate objective of ETF was to narrow the income gap between the ‘haves’ and ‘have-nots’ and establish a socialist society through democratic means – a strategy known as ‘democratic socialism’. ETF was also expected to provide seed capital to start-up companies and thereby promote entrepreneurship among enterprising young Sri Lankans. But in practice what ETF did was to function as a source of funding for the government at cheap rates.
The multiplication of work by EPF and ETF
But administratively, both ETF and EPF have become a burden to the economy not by duplicating but by ‘multiplicating’ the work. Both have to register employers and employees separately, receive monthly contributions separately, keep account separately, maintain computer systems separately, issue statements separately and pay back benefits separately. This is a waste of resources, on the one hand, and an additional inconvenience to both employers and employees, on the other.
Hence, by amalgamating both institutions into a social security board and running ETF as the share market investment arm of the board, the objective of democratic socialism could still be attained. But as Hakeem has stressed in Parliament, this should be made free from political interferences and allowed to be managed by professional fund managers who have no political affiliations. In other words, the managers should not be ‘politically exposed-persons’. But at the same time, politicians should also be ‘nationally conscious-persons’.
Public debt is also an unwelcome guest at the Central Bank
To free the Monetary Board of its conflicting interest, public debt which was handed to it by Parliament in 1949 should also be divorced from it. As mentioned earlier, raising funds for the government at the cheapest cost interferes with the main objective of the Monetary Board to maintain an inflation free world. This specifically happens when inflation is rising and the Monetary Board, as a remedy, has to jack up interest rates in the economy. The action to be taken by the Monetary Board to accomplish both tasks may not be viewed later by those who would look at it only from one perspective. This happened with respect to the alleged loss calculations made by the forensic auditors during the pre-2015 period.
A childish loss calculation
When the forensic auditors interviewed me, I specifically mentioned to them that in 2007-8, the country was at a war, the government had drained all its resources for the war efforts, there was no prospect of raising funds from foreign bilateral or commercial sources, the domestic funding had dwindled and inflation was rising at about 20% per annum. They were also told that all attempts made by the Monetary Board to raise funds from foreign sources, including the tapping of Sri Lanka’s diaspora, proved ineffective.
The Monetary Board had the difficult task of controlling inflation and raising funds for the government. As a result, the front office of the Public Debt Department had been permitted to raise the needed funds from whatever the source available at prices acceptable to the Department. Hence, the forensic auditors were told that any attempt at calculating losses to government by using an imaginary price would not be appropriate.
Despite this explanation, they have gone ahead of coming up with a loss figure of Rs. 10.4 billion resulting from the genuine efforts of the officers who had worked at the Public Debt Department at that time. They did not stop at that and used the same defective methodology to put the losses to government in the post 2015 period at Rs. 9.6 billion and those to EPF at Rs. 8.7 billion in the entire period. Worse, the Parliamentarians on either side of the isle had used these numbers without bothering to find out how they had been arrived at to blast their political enemies.
In this connection, an observation reported to have been made by an anonymous person may be a learning experience for those Parliamentarians. He is said to have observed that ‘there are two things which people may not consume if they know how they are made. One is sausages and the other is statistics’.
An embarrassment to the Monetary Board
This has been an embarrassment to the Monetary Board and it is now required to explain to the people exactly what its perpetual predecessors had done in good faith. But the damage has already been done and what has been recorded in the minds of the people is inerasable now. This would not have happened had the public debt been handed to an independent debt authority as was suggested during 2000-4.
An independent Central Bank is for the citizens
The independence of the Central Bank, as I have argued repeatedly in this column, is for building the trust of the people in its actions. As long as the Bank is subject to political manipulation, the people will not trust the monies it issues for use by them. Therefore, the Central Bank independence is not for politicians but for people. It is the independence of the citizens from unduly interference from politicians who desire the Bank to print money and help them finance budgets that basically allocate resources for unproductive purposes in the absence of a mechanism for deciding on priorities in the economy. In the long run, the country will be engulfed with inflation where all citizens have to bear the cost.
But there are some who have argued against an independent central bank. They normally present two arguments in support of their view. One is that both monetary policy and fiscal policy should work together to create wealth in a country. The other is that for a developing economy like Sri Lanka, a little bit of inflation is always desirable in the initial stage of economic development.
Money is not a real product but a mental thought
Both these arguments are based on a misidentification of money’s role in an economy. Money as against a real good, say like rice, is only a mental notion without any real existence. It, therefore, assumes only a nominal role. That is the reason for calling everything measured in terms of money ‘nominal’, like nominal prices, nominal income or nominal interest rate and so on. It can facilitate the acquisition of a real good like rice or a house, if people are willing to use it to make payments for same.
Hence, in ushering economic prosperity, money is only a facilitator and not a real contributor. Real contribution, as the first Singaporean Finance Minister Dr. Goh Keng Swee said in 1991, comes from hard work done by people of all walks of life – students at schools, undergraduates at universities and workers at work places – and not from the money printed by the central bank.
In today’s context where the world is moving toward the Fourth Industrial Revolution or 4IR, it is not just hard work but ‘smart work’ that would bring prosperity to a country. Central banks can only facilitate this process by keeping price changes in check or keeping inflation within limits. The real contribution should come from the Government which is in a position to influence the real production of goods and services.
In this connection, both Ranawaka and Hakeem should be congratulated on and credited for making constructive suggestions.
(The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at firstname.lastname@example.org.)