An Echelon Media Company
Friday May 7th, 2021
Economy and Markets

Sri Lanka central bank independence; time for Treasury representation to end

ECONOMYNEXT – Sri Lanka’s central bank should be reformed to insulate it from political meddling and the time has come to end finance ministry representation in its governing board, a top economist has said amid concerns over threats to its independence.

Sri Lanka’s central bank was perceived as having been ‘politicized’ over the last decade, though there has been concerns over ‘fiscal dominance of monetary policy’ where it is pressured to print money to finance the deficit by purchasing Treasury bills for even longer.

In recent months, recent statements by Sri Lanka’s Finance Minister has generated concern over the independence of the agency. The budget for 2017 also proposed several measures over banking and credit which was in the purview of the central bank.

"When a central bank is independent, it can discipline itself by avoiding overprinting of money, the main causal factor for self-feeding high inflation," W A Wijewardene, a former Deputy Governor of the Central Bank said in his column in Sri Lanka’s Daily FT newspaper.

"It could also take timely action to tighten monetary policy by way of increases in interest rates if the money and credit situation is far above what is desired by a well-balanced economy.

"When people realise that the central bank would take necessary action to curtail inflation without being influenced by those in power, it builds confidence among people in central banks’ action which in turn contribute to lower inflation expectations…"

Sri Lanka’s central bank had drawn fire from critics for firing unsustainable credit bubbles which spur imports, generating currency collapses, and generally de-stabilizing the economy since its creation soon after independence.

It also engages in several quasi-fiscal activities which are better done by other government agencies or independent statutory bodies like managing a pension fund of private sector workers, selling debt or pushing rural credit.

The central bank is currently emerging from a scandal over bond sales an agency function it performs for the Treasury.

The Central Bank is now headed by Indrajit Coomaraswamy, a highly respected economist and former public servant whose integrity is unquestioned. He had already started to restore public trust in the institution.

Under Sri Lanka’s existing monetary law, the Secretary of the finance ministry is automatically a member of the monetary board.

In the past secretaries have been blamed for effectively ‘vetoing’ potential rate hikes and forcing the Central Bank to buy up Treasury bills with printed money to keep interest rates down.

Wijewardene said John Exter, a US born economist who helped found the central bank allowed a finance ministry representative to serve as a conduit to the finance ministry and political authorities.

Exter had also noted that the effectiveness of the measure "depended on the maturity and experience of the people occupying the high positions in government."

"But over the years, Exter was defeated by some of the officials who had occupied the topmost position in the Ministry paving the way for critics to justify their charge of having a subservient Central Bank," Wijewardene said.

"Hence, any move to make the Central Bank independent should re-examine whether the Secretary to the Ministry of Finance should continue to be a vote-carrying member of the governing board of the Bank…"

In 1950 when the Central Bank was set up, abolishing a British era currency board that has kept the exchange rate fixed, inflation low and the rupee convertible to sterling for more than half a century, Sri Lanka had permanent secretaries.

Permanent secretaries of ministries acted in the best interest of the people, and could resist political pressure like a Supreme Court judge because he had security of tenure.

But with two constitutions in 1972 and 1979 broke the back of the civil service and ministry secretaries are now mere political appointees.

The Reserve Bank of India also reduce the role of the Finance Ministry representatives on its rate setting committee as part of reforms in 1991 following a severe balance of payments crisis.

But RBI’s independence has also come under threat from India’s current administration.

Questions have also been raised about the role played by RBI in the latest demonetization fiasco when large denomination notes were cancelled suddenly throwing the economy into chaos.

Wijewardene noted that conflicts between politicians and central bank happened elsewhere as well but countries remained stable when central banks were allowed to do their jobs freely.

Prime Minister Ranil Wickremesinghe had pledged to reform the central bank in a policy statement in 2015, he said.

During a previous administration headed by Wickremesinghe in 2001-2004 a new central bank law and banking law had already been drafted, Wijewardene said.
The laws could be updated to reform the central bank, he said. (Colombo/Dec22/2016)

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