ECONOMYNEXT – Deciding prices by an omniscient bureaucratic committee is a ‘fatal conceit’ that has taken countries away from markets in Sri Lanka and elsewhere, a top economist said as country was sliding rapidly down a slippery slope of price controls in credit markets.

Pendulous swing from markets to the state accompanied by short term bias and more discretion where rules that are flouted or weakened has happened several times in the past around the world, Razeen Sally, a visiting professor at the National University of Singapore said.

Western nations were hit by state interventions especially in the wake of the ‘Keynesian revolution’ of the 1930s after the US Fed triggered the ‘Roaring 20s’ bubble in the first decade of its creation, which ended in the Great Depression.

Following inflation and economic stagnation in the 1970s, after the collapse of the Bretton Woods soft-peg system, both the US and UK and swung back to markets in the early 1980s under President Reagan and Margaret Thatcher.

Several East Asian nations used the window of Western opening up to become export oriented and draw foreign investments.

Vietnam started to return to markets in 1984 under Đổi Mới.

Vietnam started reforming the central bank from 1989 as the currency collapsed rapidly. The Dong plunged from 20 in 1986 to 4,500 in 1989 and per capita GDP collapsed from about 500 dollars soon after opening to 98 dollars by 1989.

In 2005 Sri Lanka had started a process of de-liberalization, involving import protection, cronyism, nationalism and state interventions.

The swings away from markets are driven by a misguided world view, which got inspiration from Keynesian interventions, Sally said.

Misguided View

“Underlying all this is a misguided world view,” Sally said. “It is a world view Lord (John Maynard) Keynes and his Bloomsbury circle had shared. And (Friedrich) Hayek accused Keynes and his ilk of suffering from a fatal conceit, for that very reason,” Sally said delivering a lecture marking 69 years of Sri Lanka’s central bank.

“Why is the world view misguided?

“It is as if you could get a committee of really good super qualified, intelligent people, together. Who are platonic guardians as it were, who only have the public interest in mind. They are the best committee to sort out the complex problems of the world because they know best.

“They also assume they have the requisite knowledge to intervene here, there and everywhere as superior to the market, in particular situations.”

“Let me choose a generic example. And this happens around the world, sometimes also here in Sri Lanka.

“The generic example is, say, the monetary board of a central bank that actually tells market actors beginning with commercial banks what interest rates they should charge, to whom they should lend and under what conditions.

“And when these market actors don’t behave accordingly, they are ticked off like naughty school children and sometimes threatened with punitive action.”

“In a market economy that is not appropriate and I think it is a fundamental mis-understanding of what a market economy is about.

“Not least because it assumes that a certain committee of good men, have better interests and knowledge,” he said.

Involuntary Sales

Even as Sally was speaking a committee had decided that what the market bid for a 115 billion rupee bond auction was ‘wrong’.

Over 2.9 billion rupees of bonds were were forced on buyers under so-called ‘phase 3’ involuntary sales apparently because the rate was ‘wrong’ at the margin of a multiple price auction where 112 billion rupees of bids were ‘correct’.

Administratively decided rates of rupee securities and voluntary pricing of a ‘tap system’ was replaced by multiple price auctions in the 1990s, by then central bank Governor A S Jayewardene.

He also appointed US style primary dealers.

A variation of a voluntary tap system later returned raising concerns of corruption. Many Jayewardene reforms have been unraveled, critics say, leading to currency crises coming in rapid succession.

Involuntary bond sales began under the current administration, which had at one time gained praise liberalization and market based reforms in 1978 and 2001 which led to economic growth.

The Soviet Union was the prime example of going away from markets.

India had also tried it until 1993, and come back. China started to return to markets from the late 1970s, and big reforms were made in the early 1990s, including in monetary policy some of which have since been reversed analysts say.

Sri Lanka’s central bank has also announced price controls on bank deposits on a formula based on gilt rates as the country recovered from a currency collapse.

In addition to involuntary bond sales, of late the central bank had also dumped on itself at above market prices (low yields) using printed money, treasuries in excess of three hundred days in a bid to suppress rates across the yield curve, data shows.

Constitutionally Ignorant

“But in a market economy when it comes to how price are formed, and even interest rates are formed, all of us are constitutionally ignorant, as Hayek said. And we form common knowledge through the interaction of the market, spontaneously through decentralized transactions,” Sally said.

“As a classical liberal I would much rather have institutions – as David Hume once put it – under which bad men to least harm, institutions with checks and balances.

“Rather than institutions that rely on good men who are supposed to be completely public spirited. That is a better understanding of human nature.”

Though the central bank is no longer buying Treasury bills at the auction, different methods have been found to print money and generate instability critics have said.

In April 2018, through a so-called buffer strategy bonds were rolled over apparently with money printed into state banks through liquidity windows.

Analysts have suggested that the central bank be prevented from printing money along the yield curve at below the Sri Lanka Interbank Offered Rate to prevent currency collapse somewhat in line with practices of the GCC monetary authorities or ban interventions beyond the overnight market altogether to reduce risks of sovereign default on dollar loans in the future.

Controls are now planned on individual lending rates of banks.

After unsterilized excess liquidity and injections of cash triggered monetary instability in 2018, import controls were brought by the central bank.

The current slippery slope of interest rates controls started with controls on penalty rates of credit cards. Banks countered by raising fees. The controls were later lifted but the fees remain.

Fiscal authorities also placed controls on micro-credit. Involuntary sales of bonds to dealers participating in multiple price auctions also began under the current administration.

Sally said he welcomed moves to reform the central bank law, which will hopefully bring more rule based monetary policy and reduce discretion.

However analysts have raised concerns that the reforms that are known do not go even as far as the reforms of the People’s Bank of China in 1995, including prohibitions on swaps (forward guarantees) that laid the foundations for monetary stability and growth in China, and insulated the PBoC from the Asian Financial Crisis.

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The reforms led to a collapsed of nominal interest rates in China as monetary stability was restored ending chaotic currency collapses until 1993. (Colombo/Sept13/2019 – corrected bond auction of Rs115bn)