By Hema Senanayake –
A new Governor to the central bank would be appointed soon. I am not sure who he or she is going to be. But what I am sure is that if the new governor thinks that this is a job he can do fairly easily with currently serving members of the Monetary Board and top bureaucrats of the institution and with the help of IMF economists then he or she is mistaken. Many economists and interested intellectuals including many lay readers on the subject have awakened to this truth now.
One of the readers of Colombo Telegraph, commenting on one of my recent articles had observed that given the mess … now entrenched in the Central Bank, it would need someone with extra-ordinary ability to be appointed as the governor. The extra ordinary ability which he was referring must be about the theoretical and practical know-how in regard to managing the country’s monetary infrastructure with a view to achieve the best possible economic growth for the wellbeing of our people.
Assuming that a new governor would be appointed to the central bank, in my view for the most responsible job in our governmental system, I invite him to think outside the box through which he may be able to develop the expected extra-ordinary ability. In order to think wisely and outside the box he may need to listen to some near extra-ordinary intellectuals who have submitted their analyses relentlessly in the recent past in order to put the central bank on correct path. Those people think outside the box and work outside the establishment.
As such I would propose that the government must immediately appoint a pro bono advisory council to the Monetary Board under which the Central Bank functions as its operational arm. This kind of advisory council exists even in the United States. It advises the Federal Reserve Board which is equivalent to our Monetary Board. The said advisory council is named as The Federal Advisory Council (FAC). Its function is defined as follows: “FAC, which is composed of twelve representatives of the banking industry, consults with and advises the Board on all matters within the Board’s jurisdiction.” (Official website, Federal Reserve)
Such a council, possibly with a fewer number of members, is badly needed for Sri Lanka. Yet, this must be a pro bono council and this is important due to two reasons. First, some serious economists with integrity do not want to get remunerated by political masters. Secondly, when the council is on pro bono basis there won’t be any unqualified friends of politicians who would be interested to get appointed. I believe, there are qualified Sri Lankan economists with intellectual integrity who could be appointed for the council.
I am serious on this suggestion. Why? Forget about bond scams, yet the central bank has been at low ebb professionally in managing monetary infrastructure and advising on fiscal policy to the government. Let me justify my argument with citing just two real examples. One example is to prove the weaknesses of existing system or the establishment which weakness we want to eradicate by appointing a pro bono advisory council to the Monetary Board. The other is to prove the lack of economic wisdom on the part of IMF economists so that if anybody thinks that IMF economists can advise us accurately then he or she might understand that such thinking is not close to reality.
The new government wanted to increase salaries by Rs. 10,000/=. The IMF did not support it and warned that such an increase of salaries would not be a prudent idea as it could badly affect to the foreign exchange reserve levels. IMF’s view in a way was very accurate but not all-out true. But anyway the government did increase salaries. I supported the government’s move but opined that the central bank must suitably contain the growth of a certain parameter known as “credit money” in the monetary system. If the central bank did it, then there would not have had severe bad repercussion on the nation’s current account and as a result on foreign exchange reserve levels too. Readers might well observe that the above were two competing propositions. As far as I know, the Central Bank has had no specific idea rather than meekly supported for the salary increase. The crisis hit immediately. Within a few months after increasing salaries, this crisis situation was documented by IMF in September 2015, as follows:
“The increase in consumer spending created by the sharp rise in public wages and salaries has also contributed to a sizeable increase in imports of consumption and other goods—more than offsetting savings from lower oil prices. The resulting deterioration in the nonoil trade balance has contributed to persistent downward pressure on central bank foreign exchange reserves…” (IMF Press Release No. 15/427, September 18, 2015.)
In simple language IMF says that salary increases contributed the reduction of foreign exchange reserves. Concerned Sri Lankan economists foresaw this, as was done by IMF, but urged the central bank to contain the growth of “credit money” in the monetary system in order to prevent sharp depletion of foreign exchange reserves after salary increases. The Central Bank must have acted proactively but did not.
However, depletion of foreign exchange reserves created more crises for the entire monetary system and for the new government. Rajapakse’s borrowing was not good. But even if Rajapaksa had not gone on borrowing spree, this new weakness arose from the action of the new government as was documented by IMF. But it was a crisis only the central bank could have prevented happening, if it worked outside the box but under a prudent theory.
As was pointed out above, when the current account deficit increased, foreign exchange reserves depleted heavily and as a result the government has to borrow extensively in foreign currencies, mainly U.S. dollars. This was quite evident when the government borrowed dollars from India over the currency SWAP agreement signed by and between Sri Lanka and India. Currency SWAP agreements are signed to promote bilateral trade through the use of domestic currencies of partnering countries without using U.S. dollars. It was not a mechanism to borrow money in dollars. But Sri Lanka did it. Still this was not sufficient.
The central bank’s next solution was to float the rupee and Arjuna Mahendran hailed the decision declaring that the market forces would decide the value of rupee hence forth. This was a very unprofessional statement from the Governor. Please read the next point carefully. If the rupee’s value which is being determined by market forces, could have solved the current account problem then the same result could have obtained by containing the domestic credit growth without floating the rupee.
Yet, I know even Arjuna might agree with my point but he would argue that the central bank has no enough policy tools to do it other than increasing what is known as Reserve Ratio if you do not want to increase the rate of interest. The Monetary Board kept the rates steady for a while but increased the Reserve Ratio by a fraction. I continued to argue that the central bank’s approach was very traditional and the measures taken would not bring the necessary stability to rupee. I pointed out that new theory and new approach are what we need in this period of time.
However, IMF agreed with the decision to float the rupee or the Central Bank did it on the advice of the IMF. In either case, since IMF backed its decision, the central bank got a new strength to convince the President and the Cabinet about their decision and they did it. Even middle level political leaders like Sujeewa Senasinghe supported for a “floating rupee” which is terribly bad in attracting foreign investors. But I will show you that we cannot count on IMF economists for prudent monetary theory and its application. Please, read the following carefully.
In December 2001, Argentinian economy plunged into a devastating crisis. IMF economists had no clue about it until it happened. Country’s output reduced drastically and unemployment hit more than 20%. In a subsequent report IMF admitted it and says that, “These events have raised questions regarding the country’s relationship with the IMF because they happened while its economic policies were under the close scrutiny of an IMF-supported program.” (The Role of the IMF in Argentina, 1991-2002, Issues Paper/Terms of Reference for an Evaluation by the (IEO). Interesting! Isn’t it?
This is why, I mentioned at the beginning that if any new governor appointed to the central bank thinks that he can do the job easily with IMF economists it is not a realistic idea. From the previous example you may easily understand that as to how the official economists within the establishment have blundered. Simply they do not expand their horizons.
In view of above I earnestly suggest that a pro bono advisory council to the monetary board must be appointed as early as possible. It will surely strengthen good-governance (Yahapalana) government with no extra cost. However, if the Monetary Law Act does not provide for the setting up of such council, then the President must constitute the said advisory council under him.