By W.A Wijewardena –
To Regain Lost Credibility, Central Bank Should Act As ‘Impartial Spectator’ And Not As ‘Policy Owner’
The loss of credibility
The conduct of Sri Lanka’s Central Bank in the recent few years has drawn a lot of criticism from the concerned public. One such criticism has been that it has functioned as a branch office of the ruling party defending insanely every policy action taken by the Government.
The bank’s failure to appraise properly the policy actions of the Government has caused it to lose its credibility in the eyes of the public.
Praise of Mattala Airport
For instance, the Central Bank in its Annual Report 2011 expected the Mattala Airport to serve “several leading airlines which have expressed interest to operate” (p 70) there. But the actual outcome was that only Sri Lanka’s national carrier, SriLankan Airlines, had made an uneconomical stopover there when it flew from and to different international destinations.
The bank, while hiding this fact, had praised the Mattala Airport as one having “3,500 metre long and 75 metre runway” that is “capable of accommodating even the largest aircrafts (sic) in the world including the airbus A 380” in its Annual Report 2013 (p 88). Yet, there was no disclosure by the Central Bank how many such aircraft had landed at Mattala and how much had been earned by Mattala from such airlines.
*Ravi Karunanayke – The new Finance Minister
SriLankan Airlines, which would have been compelled by political authorities to make its uneconomical stopover, has now decided to suspend its operations at Mattala Airport in order to cut losses amounting to $ 18 million or Rs 2.3 billion per annum. With the withdrawal of the SriLankan Airlines, it is expected that even the small airlines which had used Mattala are to suspend their operations (available here).
Defending Expropriation Act that violated property rights
When legislation to expropriate private businesses was introduced by the Government in November 2011 under the catchy title of ‘Revival of Underperforming Enterprises and Underutilised Assets Act,’ there was criticism in the market that it was a violation of property rights, the protection of which was necessary for private entrepreneurs to engage in businesses.
The Central Bank, instead of taking an independent view, immediately issued a press release defending the Government’s action. However, contrary to the Central Bank’s expectations pronounced in the press release in question that it was a wonderful legislation, the performance of the businesses taken over under the new expropriation legislation has not been impressive since then. Yet, the Central Bank had been silent on its failure in its subsequent publications.
Central banks are created to serve the people and not politicians
A central bank is created by society not to function as an arm of the party in power. Its job has been to analyse economic policies without taking a political side and inform the public accordingly.
Its annual report, presented to the Minister of Finance and through the Minister of Finance to the public, is an apolitical report. It should analyse both the pluses and minuses of the policies adopted by the government and present its independent view to the public. If the bank fails to do so, it loses its credibility.
Hence, it is the duty of all those in the Central Bank to work individually and collectively to preserve its reputation and credibility in the eyes of its masters, namely, the public. It, however, calls on those working in a central bank to make very hard decisions which may not be viewed by those in power with favour.
Past Governors had acted judiciously to preserve bank’s credibility
There have been instances in the past where the Governors of the Bank had acted judiciously to preserve its credibility. This writer wishes to mention only two of such instances, one that happened in 1994 and the other in 2004.
In the first instance, there was a request for the release of a lady officer attached to the bank to serve the election campaign of the Government headed by the current Prime Minister Ranil Wickremesinghe. The Governor of the Bank, H.B. Dissanayake, after consulting senior officers, informed the Prime Minister that the bank could not make available the services of the Central Bank officers to serve an election campaign. This position was accepted by Ranil Wickremesinghe.
The instance in 2004 took place when the Ranil Wickremasinghe Government had to fight a snap Parliamentary election for reappointment. The Opposition People’s Alliance had presented an election manifesto full of popular promises which could not be delivered without getting into serious budgetary problems. Some analysts had even termed the manifesto in question a recipe for total economic disaster.
The Cabinet, out of desperation, had decided without consulting the Central Bank that the manifesto would be thoroughly studied by the bank and an announcement would be made with respect to the implementability of the promises.
The incumbent Governor, A.S. Jayawardena, had an urgent telephonic discussion with the two Deputy Governors and informed the Government that it was not the job of the Central Bank to review the manifestos presented by different political parties at elections. This was despite the fact that a Cabinet decision had been taken that the Central Bank should do the job.
The Government accepted the point made by the Governor and left the matter at that.
Had the Governors on these occasions yielded to the pressure of the government in power, the bank would have been labelled as a political arm of the government and its credibility would have been lost irrecoverably.
Central Bank can take ownership of only what is in its domain
There are two legally-mandated goals which the Central Bank should seek to achieve. One is to maintain an inflation free world which is known as maintaining price stability. The other is to keep the financial system of the country in good health known as maintaining the financial system stability.
Policies relating to these two goals are taken by the Central Bank and therefore it has the policy ownership for those policies. All other economic policies are taken by the Government and the Central Bank’s job in relation to them is to review policies independently and apprise the Government of the suitability of those policies.
The bank has to communicate its views on these policies with the members of the public as well. But if the Central Bank takes ownership of these policies, then, it cannot make an independent review of the same.
Central Bank’s role as advisor to the government
How should the Central Bank form its views on a policy? This was discussed by this writer in a previous article in this series titled ‘Central Bank as advisor to the government: How and what it should advice?’
The Monetary Law Act under which the Central Bank of Sri Lanka has been set up does not clearly spell it out. However, the architect of the Sri Lanka’s Central Bank, John Exter, has shed some light on the Central Bank’s role as advisor to the government in his report on the establishment of a central bank in the country, known as the Exter Report.
John Exter: Central Bank should present an apolitical view
Exter had expected the Central Bank to give advice and “hold views which are more detached and objective than those of a government department” according to 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 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: Central Bank reports should be dispassionate and objective
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 in Ceylon Daily News and reproduced by the Central Bank in its 60th Anniversary Volume 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’.
Politicians should learn to honour central bank independence
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 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.
Credibility once lost cannot be regained
At the heart of the credibility of a central bank lies its independence. 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. Hence, it is the uprightness of the central bankers that will preserve the credibility of a central bank.
A subservient central bank will be cause of a government’s electoral defeat
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, it is the government which is voted out of power by the electorate. If a central bank just praises a bad economic policy implemented by a government, then, the government loses the opportunity for correcting itself in the very first instance and thereby avoiding the chance of committing a series of mistakes later.
Governor should be accepted as an independent professional by the market
The mistake made by the Central Bank in the recent past has been to assume ownership of the policies of the Government. This was because the Head of the Central Bank considered himself as a part of the Government and not as a part of an independent central bank. This was demonstrated by his resigning from the post of the Governor when the Government lost at the recent elections.
This was not what was expected by John Exter when he designed the blueprint of the Central Bank in 1949. The term of the Governor was fixed at six years in the Monetary Law Act drafted by Exter when the term of the Parliament was for five years at that time. That was to enable the Governor of the Central Bank to serve a part of the new government that would be elected to power after its five-year term. Thus, the continuity of the Central Bank was assured by having a Governor whose term had been delinked with that of the government in power.
Central Bank should be an impartial spectator
Central banks are therefore required to function as impartial spectators, a term coined by Adam Smith in his 1757 book titled ‘The Theory of the Moral Sentiments’. Smith found that when people act in their self-interest, the conflicting interest will drive societies to disorder and chaos. Thus, Smith pronounced that man should be guided by an imagined man called the impartial spectator living within his ‘breast’.
It is nothing but the man’s conscience which will tell him what is right and what is wrong in his action. Similarly, a central bank should also be guided by the individual and collective conscience of people who work within it by guiding them to judge what is right and what is wrong.
If this impartial spectator is killed, as it has happened in the case of the Central Bank in the recent past, the bank’s action cannot be expected to lead to the good of the people who have brought the bank into existence.
Central Bank’s full independence can be a goal under 100-day program
In the present 100-day program of the Government, the job of the Central Bank should be to take ownership of only the two mandates it has been given, namely, the maintenance of economic and price stability and financial system stability. It should not take ownership of the 100-day program which seeks to establish democracy, rule of law, and good governance by abolishing the authoritarian executive presidency and re-establishing parliamentary powers. However, the Central Bank can keep educating the public of the value of democracy, good governance and rule of law for long-term sustainable economic growth and improving the quality of life of people. Above all, the Central Bank can use this opportunity to win full independence from the Government since it goes well with the good governance principles being propagated by the Government in its 100-day program.
Let conscience and not political will guide central bankers
Hence, the Central Bank should desist from becoming an owner of Government policy. Instead, it should be an impartial spectator who will work according to his own conscience and not according to the whims and fancies of those in power.
*W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at firstname.lastname@example.org