By Hema Senanayake –
I would say “Yes” to the above question. But it needs a paradigm shift. The word paradigm is simply defined as the “existing world view.” Since, if we want to do better in central banking, in fact we need to make a paradigm shift. This new paradigm must originate from a new understanding of macroeconomic fundamentals and monetary economics. But for a moment I invite you to forget all macroeconomics and monetary economics, but try to visualize what you want from the Central Bank doing.
In our economic system we exchange goods and services. We cannot have an efficient exchange economy if we cannot have a common unit of measure of value to express the value of each and every produce. This should be an extremely flexible measure of value that freely penetrates into each and every productive resource so as to have a value for the output. Sri Lanka too, has such a common unit of the measure of value known as the rupee. But this rupee has no true value in its own form like gold or silver as it can be produced without any significant effort. But, read the next point carefully: Any unit of the measure of value that has no value in its own form and which can be produced without any significant effort will lose its character as a good unit of measure of value, if the production of such unit is not restricted or regulated.
Therefore, preserving rupee as a good unit of measure of value should be the primary role of the Central Bank of Sri Lanka (CBSL). Has the CBSL done its job properly? Can the rupee be depreciated to unplanned or unexpected levels, if the CBSL has done its job? Just think of these questions and if the answer is “NO” then it intimates that the job of central bank can be and must be done better.
So far, we have discussed only the basics but can we discuss more about specifics? Perhaps we can. Our broader goal is to preserve the rupee as a good unit of the measure of value. If we achieve this goal then we will achieve at least five important objectives. Those are (1) having low and steady rates of interest, (2) having stable exchange rate, (3) having optimum private sector credit growth without being too cautious, (4) having managed excessive liquidity effectively, and (5) preventing the need of buildup of excessive “cushion” of foreign reserves from borrowed funds.
Let us discuss a few points in regard to above objectives. As at now the country’s current account is negative and the gap (deficit) is widening even though the import bill of fuel has reduced and widening current account deficit has put negative pressure on the balance of payment situation. Visiting IMF team has explained this situation 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.” (IMF press release, Sept. 18th 2015)
Widening gap in the current account means that Sri Lanka is building up liabilities to foreign countries. This cannot continue. The apparent solution is to make imports expensive so that imports will be reduced. CBSL did it by devaluing the rupee. IMF has praised CBSL for doing it. But its choice of words is different. IMF says that, “The mission welcomes the CBSL’s recent decision to cease setting daily spot prices for the rupee and let market forces play a greater role in determining the exchange rate.” (IMF press release, Sept. 18th, 2015)
Accordingly it seems that whenever, there is an increase in imports, widening the current account deficit, the solution is to devalue the rupee. Will this action preserve the rupee as a good measure of value? I do not think so. But if we can maintain the stable exchange rate for the rupee then only it become a good unit of measure of value. Therefore, now we need a new solution to discourage imports without devaluing the rupee in order to preserve the rupee as a good unit of measure of value. Is there any such solution? Let us discuss.
In finding a true solution first you have to understand as to why imports are picking up. As you may see from IMF’s above quote IMF identifies that the reason for the increase in imports is “the sharp rise in public wages and salaries.” Yet, our business leaders identify that the reason is something else. They cite the sharp increase in private credit issuance as the cause for the increase in imports. Especially they say that, “A rash of credit-fueled vehicle imports is affecting Sri Lanka’s balance of payments at the moment.” I go with our business leaders on this point; because they are right.
If the cause for the problem is the increase of wages and salaries, then there can be no solution without cutting back the salaries increased or at least by not adding the increased allowances to the basic salary from the next budget as promised by the UNFGG manifesto. But if the real problem is the sharp increase in private credit growth then we can find a different solution.
CBSL on or about 15th of this month, “decided to impose a maximum Loan to Value (LTV) ratio of 70 per cent in respect of loans and advances granted for the purpose of purchase or utilisation of motor vehicles…” As a result of this decision, now buyers will not get 100% credit to buy a car instead they will get only 70% of credit from the value of the vehicle. This action of CBSL will reduce the amount of credit issuance and as a result imports will be reduced. What does this mean?
It means that if the CBSL has a policy tool or tools to contain or regulate the domestic credit issuance effectively, it can possibly maintain a stable exchange rate without devaluing the currency. In fact CBSL has a policy tool on the money-supply side to limit the issuance of credit. It is known as “reserve ratio.” I argue that this tool is not enough. Please note that interest rate is a policy tool on the money demand side but not on the supply side. Since, one of the five objectives I mentioned above is to maintain low and steady rates of interest, I am not in favor to increase interest for the sake of discouraging imports when inflation is low. So, how do we regulate the quantum of loanable funds in the system?
Loanable funds relates to the amount of money created in the system. As many of us believe, most of the money (rupee) is not produced by CBSL; instead most of money is created by the banks known as “designated commercial banks” during the process of lending and hence, such money is known as “credit money.” I remember, once Rajendra Theagarajah said when he was the CEO of HNB that they could give loans amounting to Rs. 10 from an incoming deposit of one rupee. He was right and the modern banking system is such a system.
Therefore, I strongly argue that it would be more appropriate if CBSL can acquire a new policy tool on the money supply-side that could be used to regulate the production of loanable funds in the system – And, it should not affect the banks’ ability to lend money which comes as deposits. Even though this has not been the objective, India is using a supply-side monetary tool known as Statutory Liquidity Ratio (SLR). It seems SLR is flexible and responds quickly.
If we have such a tool, then CBSL does not have to increase the rate of interest for the sake of discouraging imports; also CBSL would not have to devalue rupee to reduce the current account deficit; also CBSL would not have to be too cautious in regard to private credit growth; also it can effectively manage the excessive liquidity if exists; also CBSL does not have to build up excessive foreign exchange reserves for the sake of stabilizing the rupee. Finally, rupee will be a good unit of the measure of value on which a dynamic economy can be built upon.
Hence, I would suggest to explore the possibility of introducing a new suitable monetary supply-side policy tool for CBSL and to amend the Monetary Law Act if necessary to facilitate the use of such a policy tool by the Monetary Board.