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Monday June 21st, 2021

Sri Lanka central bank needs new monetary law to block money printing: Governor

ECONOMYNEXT – Sri Lanka’s central bank is seeking passage of revamped governing law to block itself from printing money to finance deficits, Central Bank Governor Indrajit Coomaraswamy said, amid reports that President Maithripala Sirisena had questioned the need to end money printing.

The central bank prints money (provides central bank credit to the government) mainly by purchasing Treasury bills into its balance sheet for new notes during Wednesday Treasury bill auctions or outside of it, expanding base money of the country.

Damaging T-bill Purchases

"This is the most damaging thing you can do, and we have done it repeatedly," Governor Coomaraswamy said at a forum organized by the Ceylon Chamber of Commerce.

"If we are able to convince our political masters, then that will be prevented by law. It will be a landmark change in terms of establishing macro-economic stability. I hope we are able to go through with it."

Central bank officials have prepared a new monetary law, which will make provisions for a modified inflation targeting process, though the text of the bill has not yet been released to the public yet.

"And as a part of that, if Parliament approves it, the Central Bank will be prevented from printing money," Governor Coomaraswamy said.

Provisional Advances

The central bank also prints money for deficit financing through so-called provisional advances, where the central bank has been forced to give up to 10 percent of estimated revenue for a given year in interest free printed money for six months.

Since the government has been unable to quickly repay the money, outstanding amounts of provisional advances have been going up every year and only a small incremental increase takes place now.

Except when the a peg with the US dollar is already under pressure, the central bank has been able to mop up the new money to prevent a liquidity shock taking place.

Analysts have suggested that the outstanding provisional advances be converted to Treasury securities with any discount (loss) being set off against profit transfers to the Treasury and be sold down progressively to re-build foreign reserves to boost dollar backing of the monetary base.

Governor Coomaraswamy said Sri Lanka requires central bank independence and autonomy to break the cycle of inflation and balance of payments crises.

"What about the future? What we need to do is to get away from this past cycle of macro-economic stress where we are repeating cycles of high inflation, balance of payments crisis," he said.

"And then we tighten our belts and go back again usually it is the budget."

Presidential Shocker

His comments came amid reports that the President Maithripala Sirisena had suddenly wanted wholesale money printing to continue with Treasury bill purchases by the central bank.

"The proposed MLA (Monetary Law Act) prevents the CBSL from purchasing any Government securities from the primary market," a note sent by the President was reported to have said.

"Given the global economic conditions, coupled with the impending large debt repayment, it could lead the country to defaulting on its debt."

Analysts however have pointed that it is printing of money which generates foreign exchange shortages, which then leads to foreign exchange shortages and to possible dollar sovereign default. (Sri Lanka has to reform soft-peg to avoid default).

President had also called for wider discussion of the monetary law.

Concerns have also been raised that in 2018 in particular, monetary instability came not from any pressure from the Treasury or the deficit (fiscal dominance) but excess money injected through lender of last resort operations of the central bank as well as rupee dollar swap operations to bring down rates.

There have been calls for rules to reduce the discretion the central bank has to inject large volumes of money to artificially bring down the interest rates, as the agency also intervenes in the forex market to target an exchange rate and to collect forex reserves generating conflicts in money and exchange policies.

Concerns have been raised about ‘flexible inflation targeting’ because the central bank has to collect reserves and intervene in the forex markets, essentially targeting two monetary anchors – an inflation index and the exchange rate.

Analysts have pointed out that in 2011, 2015 and 2018, rates were cut saying inflation was low, but the money printed to keep rates low then generated balance of payments trouble.

But before 2018 fiscal dominance was also a factor.

Inflation Agreement

Under the new law the politicians would still be able to set the inflation target, which the central bank would carry out.

"The government and the Central Bank together set an inflation target." Coomaraswamy said.

"And the Central Bank is tasked to meet that target to have an independent, forward-looking and data driven monetary policy unlike the monetary policy of the past which has been essentially driven by fiscal dominance."

There have also been warnings that the current inflation target of 4-6 percent is too wide and it will lead to monetary instability and periods of stagflation where inflation will overtake real economic growth. (Sri Lanka risks instability, stagflation by being in PIIS soft-peg group: Bellwether) (Colombo/July20/2019)


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