By Hema Senanayake –
Dr. W.A. Wijewardena pointed out that the Central Bank of Sri Lanka (CBSL) made losses in the year 2015. In a recent article, former deputy Governor of Central Bank Dr. W.A. Wijewardena insisted that such losses made by the Central Bank are economic landmines that could explode at any time. Should I agree or should I disagree with his assertion?
First, I do not agree with the present wisdom of CBSL including its Board known as Monetary Board. If economy is broken and is not functioning well and the currency is not stable then do not blame P.M or President, instead put the blame on the Central Bank. If it is not sufficient then blame the P.M., President and other elected officials for not running the Central Bank properly. Having said that, I also would say that I do not agree with the said assertion of Dr. Wijewardena.
I always do appreciate Dr. Wijewardena’s writings. Unlike us who happened to be macroeconomic analysts, Dr. Wijewardena being a former Deputy Governor of CBSL knows in and out of central banking. Yet, if he makes an inaccurate analysis the CBSL could take the upper hand in rejecting not only his comments but also others’ views too. This would be a dangerous development. Therefore our criticism must be fair and must guide political authorities to perform their job properly.
The Central Bank is a peculiar organization. It makes operational losses but still transfer profits to the government. Can any business entity do this? Dr. Wijewardena commented on this situation as follows:
“The loss in 2013 was followed by a comprehensive loss of Rs. 22 billion in 2014, but the accounts of the bank for 2014 showed that the Monetary Board had made an interim profit transfer of Rs. 8.5 billion to the Government out of these losses. An institution making losses can pay dividends to shareholders only by running down its capital and that was exactly what the Monetary Board had done in the two years concerned.” (Colombo Telegraph, May 03, 2016)
The Central Bank has responded to Dr. Wijewardena and he wrote about it as follows:
“The Monetary Board apparently did not take this comment kindly and caused its operational arm – the Central Bank – to issue a statement disputing this writer. The Board had argued in its wisdom that there was nothing wrong in the Bank making losses because central banks are not supposed to make profits and it would be imprudent for a financial institution to have a capital base covering 100% of its domestic assets.” (Wijewardena, CT, May 03, 2016)
Dr. Wijewardena questioned about the Central Bank’s capital and its depletion due to losses and the Central Bank responded saying that there was nothing wrong in the Bank making losses because central banks are not supposed to make profits and it would be imprudent for a financial institution to have a capital base covering 100% of its domestic assets.”
The question itself, in fact has opened an escape route for the Central bank. Further interesting point is that the Central Bank transfers profit while making losses. This could have been done only if the Central Bank had “inflated” its Balance Sheet. Dear readers do not be alarmed, I am not venturing into a discussion on accounting even though I mentioned about the Balance Sheet of CBSL.
A Central Bank can never be insolvent and so is our Central Bank as long as people use the currency the Bank issues because the Central Bank can create money. But due to a legal and logical reason rather than practical reason when money is created by the Central Bank it is recorded or posted as a liability of the Central Bank. Let me explain this point a little further.
Let us assume that CBSL created Rs.100 billion in 2015. Is this Rs.100 billion an asset of the CBSL? Any accountant might think that it is. But, interestingly, this Rs.100 billion would be posted as a liability in the Balance Sheet of CBSL. In general, in any other business, liabilities are money borrowed from or invested by others. Yet, in regard to the CBSL, in our example, it did not borrow Rs.100 billion or nobody invested Rs.100 billion, instead CBSL issued new money (say bills and coins) amounting to Rs.100 billion. So, is this a liability? For any practical reason, the answer is NO. But, as mentioned above, this Rs.100 billion issued by CBSL would be posted as a liability in the Balance Sheet of the CBSL. As a result the balance sheet is inflated and this is what is going to affect the country’s economy for good or bad, but not the profit or loss of the CBSL.
This does not mean that CBSL can or should make continuing losses. In the business of finance when somebody makes losses, another person or entity makes profits. This might be equally true when CBSL makes losses. Hence, what the CBSL should have explained in reply to Dr. Wijewardena’s question was, as to why the CBSL had to make losses in previous years because the losses might have caused due to underhand dealings or due to incompetence or due to the unavoidable reasons in executing monetary policy.
In view of above, I have my doubts to support, if somebody takes a position that, “… central banks are not supposed to make profits, (but) they are not supposed to make continuous losses. That was because when a central bank becomes bankrupt with a negative networth – that is, when it does not have assets to cover its liabilities to outsiders – due to continued losses, the public as the owners of the central bank are required to recapitalise the bank at great costs.”
One of the concerned readers of CT had observed that he had been, “reading and listening for the last 40 years that Central Bank is going broke but still survives.” I respect for his feelings.
That is why I earnestly believe that we must submit factually accurate arguments always thinking as to what we would do differently. Therefore, I would suggest all interested readers and writers that we must launch a strong campaign for stable rupee. I assure you that even if Sri Lanka gets an IMF loan amounting to dollars 1.2 billion, the stability of rupee would not last even till the end of this year. How do we do differently to stabilize the rupee? This is a question that we must resolve during the campaign. If the rupee is stable then the above said need of the “recapitalization” does not arise in near future if somebody truly worries about such a possibility.