Wednesday August 15, 2018

Sri Lanka better off with currency board: Sally

Dec 28, 2015 12:22 PM GMT+0530 | 3 Comment(s)

ECONOMYNEXT – Sri Lanka would be better off with a currency board instead of a central bank which was politicised under the ousted Rajapaksa regime and needs to operate more independently, says Razeen Sally, a top international economist.

“Clearly, the independence of the central bank was compromised under the last government. The last central bank governor was very political,” he told a forum at Ceylon Chamber of Commerce.

Sally, a former London School of Economics Professor who is chairman of Sri Lanka's Institute of Policy Studies, said he would like to see “de facto and de jure” central bank independence in terms of monetary policy.

Successful example of policy reform from Latin America, Eastern Europe and East Asia often involve central banks with credibility and with increasing independence, he said. 

“It was a big mistake to move from a currency board to a central bank,” Sally said.

“In an ideal world I’d like to see Sri Lanka get back to a currency board, something fixed and rigid with little discretion, at least until policy is put on a sustainable footing for the medium term and credibility restored,” he added.

“But that’s not in the offing at the moment.”

The Sri Lankan rupee has fallen sharply this year and is expected to weaken further next year, possibly to the 148-160 rupee to the US dollar level, according to forecasts by private sector economists.

The rupee has fallen 8.7 percent against the US dollar this year, hitting a record low of 143.80 on December 15 but recovering slightly later.

Sally, who has also been with the National University of Singapore, said the problem with Sri Lanka was that “there aren’t hard rules and external discipline on domestic irresponsibility, not just fiscal but monetary irresponsibility as well.”
 (Colombo/December 28, 2015)


Related Stories


  1. Dinesh January 05, 12:11 PM

    Bellwether, I agree with the advantages you are outlining: a currency board is superior to the current system. My point is that in order to make it work, you need a stable international reserve currency to anchor. However, I do not agree that there is such a stable anchor currency money supply of international reserve currencies have increased sharply. Even if there were one, there is no mechanism that will prevent future inflation of an anchor currency. This will lead to volatile external flows that will exacerbate domestic volatility.This is what is happening to Sri Lanka. Policymaker response in the US and EU to the GFC and European debt crisis was to drive rates down to zero and flood the system with liquidity. Initially, this created large inflows to emerging markets, including Sri Lanka, enabling us to borrow well beyond sustainable levels. That money is gradually moving out and will worsen the coming economic crisis.When external flows in the current environment are volatile, a currency board will increase volatility since it affects the monetary base and has a multiplier effect on broad money. Therefore, I'm not sure if it is a big improvement over the current system.The free market developed a sustainable system: the gold standard with 100 reserves. Personally, I don't think there is a superior system to that.As a footnote, I would like to add that we will see the currency board system's ability to prevent economic volatility. If it works, economies like Singapore and Hong Kong should be stable going forward, without significant financial system and economic volatility. They were stable in the past because the anchor WAS past tense stable. If the ongoing crisis impacts those economies, that would be proof that currency boards have significant flaws in the current global financial environment. I suppose time will tell ...All the best for 2016

  2. Bellwether January 05, 09:53 AM

    Dinesh,A currency board does not work only when an external account is stable. It is the currency board that makes the external account stable. A currency board will not increase economic volatility more than its anchor currency country.

    Assuming Sri Lanka hard pegs to the US our downturns will be limited to that of the US. There will be no BOP crisis in between like now.In addition because banks in currency board countries do not have reverse repo windows at all or true reverse repo windows they usually become very good at liquidity management since the onus is on them.

    In fact banks tend to fare better in the currency board country than in the anchor currency country see Hong Kong.

    But the biggest advantage is not just monetary but fiscal. When there is a currency board a government cannot destroy debt by depreciation. Therefor it becomes fiscally prudent.

    The crises that comes from fiscal shocks like now in Sri Lanka are then completely eliminated.

  3. Dinesh December 31, 11:35 AM

    A Currency Board, though better than a Central Bank, is still a weak system that will not prevent financial instability. First off, there must be a widely accepted currency with a stable supply. None of the major international currencies qualify their quantities issued have skyrocketed over the past decade.Secondly, the idea of a currency board I stand to be corrected on this is to ensure external flows are reflected in changes in domestic broad money supply. A currency peg will maintain a stable relationship between the reserve currency and the monetary base of the domestic currency. It will actually cause higher volatility in broad money aggregates. An example: if the monetary base is 100 and broad money is 500 a 5x multiplier, an outflow of 10 will reduce the monetary base to 90 and thereby the broad money supply to 450. Therefore, broad money contracts by a larger amount 50 than the outflow 10. This process also works in reverse and actually increases volatility.In my view, a currency board will only work when the external account is stable. When external flows are volatile, a currency board will increase domestic volatility and add to financial instability.

Name *
Email *
Telephone Number