23 October, 2017

Central Bank As Advisor To the Govt.: How And What It Should Advise?

By W.A Wijewardena –

Dr. W.A. Wijewardena

Dr. W.A. Wijewardena

An important role played by a central bank of a country is to advise its government on economic and financial matters.

The expanded role of the Central Bank as government’s economic advisor

This has not been clearly laid down in the case of the Monetary Law Act or MLA under which the Central Bank of Sri Lanka or CBSL has been set up except some provisions relating to selective areas where CBSL’s advice to the government has been mandated. Under these selective areas, one important requirement is for CBSL to submit a special report to the Government, known as the September 15th Report because it is submitted on or before 15 September of every year, for use in the preparation in the budget by the Minister of Finance.

The statutory requirement is to cover in the report only the current monetary situation and the policy of the bank and how the government’s budgetary policy affect the bank’s ability to attain its monetary policy objectives. However, in practice, the bank has been submitting a very comprehensive report on all aspects of the economy including the international developments and their impact on the country’s economy.  Apart from this, a healthy tradition has been established ever since the Central Bank was set up in 1950 for governments of all hues to consult the Central Bank on important economic and financial issues facing the country.

Consultation of the Central Bank even on hilarious matters

Sometimes these consultations go into hilarious incidents too. This writer recalls that in early 1980s, a civic-minded citizen had written to the President of the day claiming that all economic ills faced by the country was due to the ominous letters in the currency, namely rupee and cent, used by the country. Instead, if the country re-designated its currency as Kahawanu and Masurang, as had been used by ancient kings of Sri Lanka, the alleged omen would be removed and all economic ills of the country, at that time, rising inflation, the need for having to borrow for infrastructure projects and stagnant economy, would be instantly corrected. Even this letter was referred to the Central Bank for a report though the President in his wisdom would have made the judgment that it was a proposal that did not require any further reporting. Yet, since the matter was referred to the bank, the writer recalls that the bank had to spend some time to prepare a report on the proposal.

Recent central banking laws are more explicit

In more recent central banking laws, the right of the central bank to be consulted has been provided for in the laws themselves. For instance, in the case of the Nepal Rastra Bank Act which was enacted in 2002, it has been provided for that the government shall consult the Rastra Bank “on any matter that is within the jurisdiction and the competence of the Bank”. Similar provisions have been made in the Royal Monetary Authority of Bhutan Act which was enacted in 2010.

John Exter: The Central Bank should take an apolitical view

Though not provided for explicitly in MLA, John Exter who was the architect of Sri Lanka’s Central Bank had expected the bank to give advice and “hold views which are more detached and objective than those of a government department” according to the report he submitted to the government known as the Exter Report (p 12). He had further qualified this by saying that “many governments have learned to value and to use the sort of independent and objective advice the monetary and other aspect of economic policy which central banks have been able to give” (p 12).

Thus, a central bank being a body created by society to serve the society and not the politicians holding power in the government is required to make its policy analyses free from political affiliations by taking into account both the short-term and long term impact of any policy which the government is contemplating to take. The bank is not expected to function simply as another organ of the propaganda machinery of the government.

N.M. Perera’s advice to the Central Bank in 1971

This role of the Central Bank was amply illuminated by Dr. N.M. Perera, the left-wing Finance Minister during 1970-’75 when he addressed the Monetary Board members and the senior officers of the Central Bank on the occasion of the retirement of the long-term Private member of the Monetary Board J. Tyagaraja in 1971. It is reported that N.M. Perera had said that the bank ‘should make independent reports on economic subjects to the government and not report merely to suit the political complexion of the government in power’ and that ‘he would value reports (of the bank) made dispassionately and objectively’.

Central Bank’s independence and probity of those who run it are key to its credibility

There are two requirements which should be in place in a country if its central bank is to serve the nation dispassionately and objectively as suggested by N.M. Perera. One is that a central bank should enjoy a degree of independence, accepted as necessary by those in power and honoured by them at all times, not just in law but in practice as well. The other is that those who run central banks should be versed in the fine principles of central banking and be ready to defend those principles even at the cost of perks, promotions or positions. It is therefore an honourable relationship between a central bank and a government.

The government should recognise that the job of the central bank is to protect the country and therefore should not make unreasonable or contrary demands from a central bank. The central bank too should deal with the government recognising its requirements without unduly offending those in power. A central bank being an organ of a sovereign nation cannot continue to fight with all powerful governments without endangering its independence and position in the society. Similarly, the government, especially the politicians in power should recognise that the “dispassionate and objective advice” given by the central bank is for the betterment of the country and therefore for the betterment of those in power as well.

The lost credibility cannot be regained

The independence of a central bank is at the heart of its credibility. If politicians and businessmen connected to them or otherwise realise that those who run central banks can be manipulated to gain undue advantages for them, then, the lost credibility of a central bank in the eyes of those in the market cannot be regained. This cannot be established through legal provisions alone since those who are intent in using central banking powers for the benefit of some may find ingenious ways of circumventing the laws.

As Andrew Huszar, the Wall Street trader enlisted by the Federal Reserve Bank or Fed to implement the first phase of the now infamous quantitative easing or QE has confessed recently in an article to the Wall Street Journal, the mortgage bond buying scheme to support the US Government has eroded Fed’s independence and through it, its credibility as well. The objective of QE has been to boost the US households and businesses; instead, it has boosted the Fund Managers at US Securities market, commonly known as the Wall Street (available at: http://online.wsj.com/news/articles/SB10001424052702303763804579183680751473884).

N.M. Perera: The disciplinarian of the old school respects the bank’s position

This writer recalls several instances where this honourable relationship was maintained by the government as well as violated by the government. In 1971, the Minister of Finance N.M. Perera through his personal secretary had requested the Central Bank to submit all names of officers to be recruited to the bank for his approval. The then Governor of the Bank Herbert Tennakoon politely reminded the Minister that the law did not permit the Minister to call for the lists of recruitment for approval and the Central Bank’s Monetary Board too could not submit the same to him in violation of the law.

Subsequently, this principle was established by the Supreme Court in 2002 in a fundamental rights application filed against the Bank by one of its officers. In this case, the Supreme Court found fault with the Central Bank for blindly following the circulars issued by the Ministry of Finance regarding the retirement age of bank’s officers since the power to do so had been vested with the bank itself. The law-respecting N.M. Perera belonging to the old school of disciplined politicians did not fight with the Central Bank for the position it has taken.

Felix Dias fiasco in 1976

The second instance relates to independent positions taken by the Central Bank economists when it comes to objectively criticising the government projects. This was documented by this writer as follows when he wrote the appreciation of Dr. Neville Karunathilake, a former Governor of the Central Bank, on the sixth month’s commemoration of his death (available at: http://www.lankabusinessonline.com/news/sri-lanka-economist-with-many-faces:-h-n-s-karunathilake/926502739): “He (Neville) was the Director of Economic Research in 1975 when Felix R. Dias Bandaranaike, commonly known as FRD, was the Minister of Finance. FRD desired the Central Bank to paint a rosy picture about the economy in its annual report and Neville resisted it. In fact, he published in the report an account depicting the failure of the nationalisation of the plantation companies by the government, based on the findings of a field study done by some central bank researchers.

Neville Karunathilake acts according to his conscience

To please the Minister, he could have killed the report, but he did not. Like a true professional, he allowed the report to go, but at the cost of his position as the Director of Economic Research. The top management of the Central Bank, having succumbed to the wrathful pressure of the Minister, transferred Neville overnight from Economic Research Department to the Employees’ Provident Fund Department which was considered as the ‘Siberia of the Central Bank’ or a penal colony at that time.”

Nimal Sanderatne’s disclosure of meeting with FRD   

What actually took place between FRD and Neville at a one-on-one meeting at the Ministry of Finance was related to this writer by Dr. Nimal Sanderatne, one of the key economists who penned the report in question.
Nimal explained: “HNS was a man of enormous curiosity and varied interests. He too participated in some of the investigations in the plantations. We had kept detailed notes on every meeting which we had and what we had seen on each estate. It was obvious that there was a decline in the performance of the plantations after they were nationalised. We reported this and HNS too readily agreed to publish it as it is.”

The disappointed FRD loses his control

“This was 1975 and the Government was getting ready to fight the next elections on the much-publicised positive scorecards it had kept during its rule. The plantations were one such positive score on which it was trying to woo the electorate. Hence, when the report was published by the Central Bank, naturally the Government became infuriated and thought that the Central Bank was undermining it,” he continues.

“We were summoned by FRD to the Ministry. I, along with another colleague of mine, accompanied HNS to the meeting. FRD went through our notebooks and couldn’t find any evidence of our inventing a story to sabotage the Government’s move. The poor state of the plantations had all been noted in detail in their notebooks by the researchers who had visited the estates. He was more furious because we had not allowed him to fire us then and there.” (available at: http://print.dailymirror.lk/business/127-local/43303.html)

Karunathilake and Sanderatne were vindicated later

The subsequent developments in the country’s plantation sector driving it to total bankruptcy within a few years fully vindicated Neville and his team of economists who fearlessly performed their duty by the country.

A.S. Jayawardena defends central banking principles even against the Cabinet

A third incident that took place relates to the firm stand taken by A.S. Jayawardena, Governor of the Central Bank during 1995-2004, when the Cabinet of the Government of Ranil Wickremesinghe decided in early 2004 that the Central Bank should investigate the election manifesto of the United People’s Freedom Alliance or UPFA titled ‘Rata Perata’ and submit a report on the economic feasibility of the implementation of the program presented in the manifesto.

Jayawardena once again politely reminded the Prime Minister that that was not the duty of the Central Bank to comment on the rival election manifestoes since the Central Bank would be viewed in the eyes of the people that it was not dispassionate and objective but partisan. This position was accepted by the Prime Minister and no further pressure was mounted on the bank to carry out the wishes of the Government.

If an economy fails, the central bank is answerable to people

Thus a central bank’s advice to the government should be dispassionate, objective and non-partisan. If a central bank follows the political line of a government and seeks to justify everything which a government does, then, a central bank is doing more harm to the government than a service. This is because if a country gets into trouble due to the short-sighted economic policies taken by a government, then, the central bank becomes answerable to a nation. If a central bank upholds a bad economic policy implemented by a government, then, a central bank is viewed as contributing to an economic mistake being made by the government.

Economic history shows that when a government makes one mistake initially, it leads to adverse economic consequences. Even at that time, the government has the ability to correct it and get out of it if the central bank gives sensible advice to the government. But if it does not, the chances are that the government would go on making a series of mistakes, one after the other, entangling the whole country in a vicious network of mistakes. Once this position is reached, there is no way out for a country but to face economic bankruptcy. A government may not be willing to accept its failure even at that stage and therefore may resort to economic and political repression as has been done in many Latin American and African countries in the recent past.

Failed role of the central banks in Zimbabwe and Venezuela

This is exactly what happened in Zimbabwe a few years back and what is happening in Venezuela today. The Zimbabwean Central Bank supported the Government in undertaking wasteful projects by printing new money to finance the same. The result was the now infamous hyperinflation in the country, running at some stages at the rate of one billion percent per annum. In the case of Venezuela, despite its oil-richness, the uncontrolled expansion of the Government and frightening of the foreign investors away from the country by nationalising foreign owned businesses have made that country economically bankrupt today. The Venezuelan Government is now contemplating the introduction of price controls to ease the cost of living of people which will make the living conditions of the poor worse by creating a black market where goods are available at a price but not at the controlled prices. Hence, the poor will experience a substantial reduction in their wellbeing.

Thus, a central bank’s proper advice to a government in time, done dispassionately, objectively and impartially, is what a society expects of a central bank.

*W.A. Wijewardena could be reached at waw1949@gmail.com

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Latest comments

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    An indelible picture in my mind is the present Governor playing follow the leader behind Namal Rajapakse in Barbados in the runup to the selection of venue for the Commonwealth games. That really fixes the role he has played and advice he has given during his tenure. Cooking the books is common in the private sector and thats what this man has done for the country to fool the people.

    http://www.straitstimes.com/breaking-news/asia/story/pm-lee-speaks-sustaining-development-commonwealth-meeting-20131116

    SINGAPORE has sought to pursue sustainable development, and this means avoiding profligate spending and not entrenching state welfare, said Prime Minister Lee Hsien Loong on Saturday.

    Speaking at the Commonwealth Heads of Government Meeting (CHOGM) in Sri Lanka, Mr Lee told his counterparts that it is right for governments to shield their people from the uncertainties and inequalities of the globalised world.

    But such “noble intentions” have, in many countries, translated into state welfare which has failed to solve the problems of unemployment and a lack of competitiveness.

    Rather, the result has been growing debt as governments spend beyond their means, he said.

    What does ‘Ape Minha’ at CBSL say about this.

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    The present governor of the CB is an idiot who is in the wrong place for the wrong reasons.He needs to be kicked out if the economy of the country is to stop its downward trend. He is useless to anybody but himself and the only advise he can give the govt is to organize Ponzi schemes. That too he cannot do without the able support from his equally foxy wife.

  • 0
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    The examples from history given by Mr Wijewardena are not only interesting, they also ring a clear warning bell. I really appreciate the way he writes, clearly and dispassionately, and always comprehensible to the non specialist reader.

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    The Central Bankers including you are all responsible for Sri Lanka which had one of the highest per-capita incomes at the time of independence, remaining as a low-income country after sixty years. If we had the self regulating monetary system as in Singapore, we would have been on par with Malaysia.

    John Exter, the architect of our Central Bank and Ivor Jennings, the architect of the Soulbury Constitution should be blamed for not understanding the mentality of our politicians to give priority to partisan considerations over national interest.

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