Friday Apr 19, 2024
Friday Apr 19, 2024
Friday, 31 March 2023 00:05 - - {{hitsCtrl.values.hits}}
The eminent academic panel consisted of three experts in the field, Dr. Indrajit Coomaraswamy – former Governor of the Central Bank of Sri Lanka, Dr. Howard Nicholas – Senior Lecturer in Economics at the Institute of Social Studies, The Hague, Netherlands, Professor Sirimevan Colombage – Emeritus Professor in Economics at the Open University of Sri Lanka and the event was moderated by Professor Sirimal Abeyratne – Senior Professor in Economics at the University of Colombo. Many distinguished guests graced the event, including two former Vice Chancellors of the University of Colombo, Prof. G.L. Peiris and Prof. W.D. Lakshman (former Governor of CBSL), as well as the current Vice Chancellor, Senior Professor H.D. Karunaratne. This comprehensive discussion to exchange insights of professionals from diverse perspectives with rich substance over policy, predictions and theory is imperative to enlighten decisive actions, to minimise the cascading effects of the ongoing crisis.
Administered vs. regulated laws
The Central Bank of Sri Lanka being the apex institution in the financial sector of the country, has been increasingly challenged in the recent past in the wake of the crisis. Sri Lanka is in the process of enacting a new Central Bank Act, which has sparked controversy and has become the focal point of debate.
Though the independence of the Central Bank was long focused by governments, it has emerged as a major concern recently in the backdrop of macroeconomic issues in the country. The history of the present Monetary Law Act of the Central Bank, drafted by the first governor, John Exter, dates back to 1949. The enactment of the act was consequential to Exter’s report. It brought out a clear mandate of an autonomous and nonpolitical body to deal with problems of long-term nature to prevent the infusion of narrow short-term political thinking. Exter also emphasised the importance of economic policy coherence between the Central Bank and the government of the day, emphasising effective fiscal and monetary coordination. The model of Exter ceased to exist, leading to a fiscal dominance of the monetary policy which resulted in the Central Bank lending to the government in excessive amounts. The act was refined in 2002 since the laws that are administered by the Central Bank were overridden by the laws that regulated it.
Looking back at our 75-year post-independence history, Sri Lanka has been running large fiscal deficits. Having less capacity for fiscal stimulus successive governments had difficulty in running fiscal policy in a sustainable way and relied on Central Bank to bail them out either through direct deficit financing or financial repression which dislocated the economy. What the Monetary Law Act envisaged was not fulfilled. The need for a new Central Bank act would not have arisen if it had strictly acted on the current Monetary Law Act which already provides sufficient independence and scope.
Divided perceptions
An independent Central Bank which is included in the new Central Bank Act is a key criterion, being one of the pre-conditions of the proposed bail-out package stipulated by the IMF. It emphasises on Central Bank setting its own policy, free from political considerations. The bill aimed to provide a stronger autonomy entails the primary objective of the Central Bank in pursuing a flexible inflation targeting regime. The new legislation includes clauses on accountability and transparency with effective monetary and fiscal policy while suggesting that the government can work on revenue based fiscal consolidation.
In the context of the amendment of the Monetary Law Act in 2023, divided perceptions were created among many. Amidst the unprecedented problem of running large external deficits, the renewed interest of Central Bank independence due to the request from IMF, poses a question whether the Central Bank should be given independence in order to protect the monetary system or to adhere to the compliance of outside pressure.
The Central Bank operated between the extreme paradigms of goal independence which is left to the elected government and instrument independence which the Central Bank holds. The Central Bank uses instrument autonomy where it is given a target through the government gazette to set the exchange rates and interest rates periodically. It is evident that the Central Bank supersedes the political authority of the country.
Central Bank independence
There are supporting and opposing views regarding the independence of Central Bank. The consensus of the forum is that political interference is not needed in bureaucratic decision making. When the government spends on short-term benefits it depends on the banking system to cover the expenditure which leads to long-term issues, increasing overall liquidity of the system, termed as time inconsistency policy. The economic mismanagement in the past with the lagged effect of the rapid monetary expansion further impeded the economy. In that context it is argued that it is necessary to let the Central Bank act independently without undue influence from the government. Central Bank independence is a necessary but not a sufficient condition. The independence of the Central Bank depends on the credibility and strength of the administration to resist political interferences and increasingly controlling financial and foreign influences. This does not mean that the Central Bank should be isolated but it should work in close harmony with the fiscal policy of the government to lead the economy in a steady growth path.
There is a trajectory towards independent Central Banks in many countries where financial sectors control Central Banks. Some countries experience the erosion of Central Bank independence. It is required to guard against Central Bank lobbying with the private sector elites, financial sector infringing and dominating for their benefits.
Stability and growth objectives
One of the most important arguments was argument that inflation targeting is the heart of monetary policy only in Sri Lanka, whereas most of the other countries logically emphasise mainly on growth and employment objectives in the context of stabilising prices. Deviating from traditional theories, discrediting the Quantity Theory of Money there were contrasting views on the relationship between the money supply and inflationary pressure. Drawing valid conclusions from global literature, the argument theoretically carried that a large part of inflation is not due to the monetary expansion and deficit financing in the economy. It was viewed that supply side factors as well such as escalating oil prices also have pushed inflation worldwide including Sri Lanka. Opposing ideas stated money supply is the main reason not the only reason for inflation. It was also opined that commercial banks disperse money through credit creation with a multiplier effect larger than the currency issued by the Central Bank.
Since Sri Lanka’s economic policy encompasses many areas that need both fiscal and financial discipline to move forward, Central Bank cannot function as a separate entity in a sovereign state without being subserviently independent. It is viewed that fiscal and monetary policy should go hand in hand without a fully regulated or a fully independent monetary policy. The objective of the Central Bank should be to control inflation without having damaging effects on economic growth. Inflation is a monetary phenomenon, but it should not be separated from real phenomenon.
How can the Central Bank be optimised to cater to the financial system today? The subject matters dealt by the Central Bank need long-term perspectives with the political cycle of a country. It needs to create space to restore and safeguard financial stability and to ensure an adequately capitalised banking system. The political authority might set the policy, but once it is set the Central Bank should be given a full reign to anchor stronger fiscal and financial discipline with targeted intervention using its technical expertise and instruments.
(The writer is a Visiting Lecturer at the Department of Economics, University of Colombo and a Council Member of the Sri Lanka Economic Association.)
