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Wednesday February 28th, 2024

Sri Lanka’s central bank crisis and John Exter’s about face on hard pegs: Bellwether

ECONOMYNEXT – Sri Lanka is suffering the worst currency crisis in the history of its central bank, with the rupee halved in value, children suffering malnutrition, high interest rates, sovereign default and the banking system also taking a beating.

In an island where rule based monetary policy is viewed with disdain by policy makers and flexible or discretionary policy depreciation and mis-targeting of interest rates is revered, it is opportune to consider what the creator of the central bank said in hindsight.

John Exter created the central bank abolishing a Singapore and Hong Kong style hard peg in Ceylon at the request of the then Ceylon government giving a long list of reasons why a central bank was more appropriate than a currency board.

Exter in 1949

The supposed drawbacks of currency boards now claimed even by some present day economists – despite the malnutrition of little kids and out-migration from flexible central banking – was also detailed in Exter report.

The Report contained the standard US post-World WarII propaganda used to break the Sterling Area.

“The decision of the Governor of Ceylon to establish a central bank was a decision with far reaching implications for the people of Ceylon,” the report began.

“One implication already stands out very clearly; in taking steps to establish an independent monetary system to be administered by a central bank the government has demonstrated unmistakably its intention to achieve genuine economic freedom as a corollary of the political freedom achieved a year and half ago.”

“This type of system, therefor is a mark of colonialism,” he added for good measure, which may have been lapped up gleefully by the newly independent nation, little knowing that the public would soon be enslaved by draconian exchange controls, import controls and the import substituting robber barons.

The lofty ideal of ‘economic freedom’ however did not last long. A brand new exchange control law came in 1952 and in 1969 an import control law to deny economic freedoms to citizens.

“For a developing economy it has a number of serious disadvantages,” the report continued.

“The role of the Currency Board must remain purely passive; it cannot influence the money supply in any way and thus relieve the pressure to which rapid swings in the balance of payments may at times subject the economy.”

This claim is oft repeated.

“A 100 percent system is this a ‘fair weather system”,” he also claimed falsely.

A currency board’s value comes not in a fair weather system but protection from the worst type of economic storms possible.

By that time the currency board had already protected Sri Lanka during the Great Depression and two World Wars, from which both Singapore and Thailand suffered as central bank money was circulated by the Japanese.

“Under such a system banks are vulnerable, for without a Central Bank, they have nowhere to turn for help in case of need,” he added.

This criticism is only partially true, as Hong Kong and Singapore had easily solved the problem with overnight liquidity without a fixed policy rate. Also it is quite easy to set up a separate bailout fund with currency board profits if need be.

In practice however banks in currency board territories tend to be more prudent and manage with deposits largely avoid failure due to the inability to overtrade with CB window money.

The large liquidity shorts now found banks in Sri Lanka in 2022 due to giving loans with window money after reserves are sold for imports, are not found in currency boards.

To be fair in 1949 that was the prevailing Keynesian, Latin American dogma. Sri Lanka’s central bank was built on a blueprint devised for Latin America by Robert Triffin, the head of Fed’s Latin America division before World War II.

The US was intent after World War II on getting as many countries as possible to join its dollar pegged Bretton Woods system.

Exter in 1968

However a few years later Bretton Woods itself was under pressure from US monetary activism. In 1968 – a year before Sri Lanka enacted the Import and Export Control Law and around the time that official parallel exchange rates were – Exter had visited Sri Lanka.

In the publication Central Bank of Sri Lanka in Retrospect, a lecture he delivered at the Institute of Chartered Accountants is detailed.

In the Ceylon leture he was quoted as saying that creating excess credit by the central bank was “bound to cause inflation, balance of payments difficulties and generally unstable conditions.”

“Mr Exter said Ceylon could benefit greatly from the example set by several small countries in the area such as Malaysia, Singapore and Thailand,” the news report said.

“Hong Kong was the most remarkable economic in the world – its population had risen from 800,000 to four million in the past 20 years or so and yet there was no unemployment, wages had risen in the sixties by 75 percent while prices were kept at a low level.

“There were no exchange or trade controls of any significance in this small ‘city states’ exported almost as much by value than India, a nation of over 500 million.

“The thing about Hong Kong and Singapore was there were no Central Bank like institution and monetary policy was determined by what he called ‘market conditions’.

“There were no organization which could disturb the stable dynamism of the economy by introducing control by resorting to deficit financing.”

He had also criticized the monetary policies of the US, the report said.

By this time Exter had predicted the collapse of tthe US dollar and had in fact started collecting gold eagle coins according to an interview given to Franklin Sanders, the founder of the Liberty Dollar.

“I should not say that I rejected Keynesianism right away,” Exter told The-Money Changer many years later, a publication linked to Franklin Sanders, who founded the Liberty Dollar.

“I had it pumped into me in those early years and actually taught it in the entry level economics course at Harvard. As the years wore on I became more and more sceptical.”

Barely three years later the Bretton Woods soft-pegs lay in ruins.

Fear of floating and currency board phobia

While Exter had changed his views, it was too late for Sri Lanka.

“…[I]n May 1968, Ceylon implemented a dual exchange rate (FEECS) that was commonly used in Latin America with tacit acceptance of the IMF,” top economist Saman Kelegama wrote in a summary of memoirs of Gamani Corea, a Sri Lanka planner and central banker.

“The Fund was not entirely happy but approved it by saying it was ‘a wrong step in the right direction’.”

In 1969 an import and export control law was enacted, the Dudley Senanayake administration’s attempts to open the economy was at an end.

Sri Lanka’s open economy was closed and the roots of two uprisings in the North and the South was to be laid shortly after.

Neither Washington based policy-makers nor Sri Lanka’s have changed their views even now.

Consistent single anchor regimes are viewed with fear and macro-economists cling to unstable intermdiate regimes which are prone to collapse and external default. There is both ‘fear of floating’ and ‘currency board phobia’.

Deep in the grip of Latin America disease, the country has defaulted, poor children are starving and another ‘flexible’ and ‘discretionary’ monetary law in line with ‘fear of floating’ and ‘currency board phobia’ is planned under an IMF program.

This column is based on ‘The Price Signal by Bellwether‘ published in the November 2022 issue of the Echelon Magazine. It is updated with recent data and the impact of the relief package. To read Bellwether columns as soon as they are published, subscribe to Echelon Magazine at this link.

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To read recent Bellwether columns click here

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(Colombo/Dec14/2022 – Update II)

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  1. Diogenes Fernando says:

    Another great piece with a prime example of IMF weasel words: ‘A wrong step in the right direction.’ (Whatever that’s supposed to mean!).

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  1. Diogenes Fernando says:

    Another great piece with a prime example of IMF weasel words: ‘A wrong step in the right direction.’ (Whatever that’s supposed to mean!).

Sri Lanka confident of “smoother” IMF second review: State Minister

ECONOMYNEXT – Sri Lanka’s second review for the International Monetary Fund (IMF) loan would be smoother than the first as the government has implemented many reforms required for the economic recovery, State Finance Minister Shehan Semasinghe said.

An IMF mission will visit Sri Lanka on March 7 and will engage in the review of second tranche of the $3 billion IMF loan for two weeks, he said.

“The second review will commence on the 7th of March, and we are very confident that will be a smoother review than the first review,” Semasinghe told reporters at a media briefing in Colombo on Wednesday (28).

He said the the first review was difficult because of hard policy decisions taken by the government in the initial stages.

The global lender completed the first review of the 48-month Extended Fund Facility (EFF) on December 12 before disbursing $337 million to support the island nation’s economic policies and reforms.

The IMF after the first review said Sri Lanka’s performance under the program was satisfactory while “all but one performance criteria and all but one indicative targets were met at end-June”.

Sri Lanka implemented most structural benchmarks due by end-October 2023, though some with delay. (Colombo/Feb 28/2024)

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Sri Lanka’s religious leaders need to cultivate harmony: Prez

ECONOMYNEXT – The responsibility of cultivating harmony rests significantly on the shoulders of religious leaders, Sri Lanka’s President Ranil Wickremesinghe has said.

“While politicians often pursue power, religious leaders strive to maintain their positions, frequently resorting to the perilous avenues of racism and bigotry. This unfortunate trend has plagued our country since the 1930s, yielding disastrous outcomes,” Wickremesinghe was quoted by his media division as saying at the ‘Religions to Reconcile’ national inter-religious symposium, organized by the National Peace Council of Sri Lanka, held today (28) at the Bandaranaike International Conference Hall (BMICH).

“Our nation has endured the bitter consequences of racism and religious extremism, culminating in a devastating conflict.

“With the military conflict resolved, Sri Lanka’s political challenges are now receiving attention, necessitating a renewed focus on coexistence,” Wickremesinghe said, adding that steps are being taken to resolve land disputes, address the issue of missing persons, release certain individuals, and initiate a delimitation of powers.

The President’s speech:

Having acknowledged the intrinsic connection between religion and reconciliation, our nation has endured the bitter consequences of racism and religious extremism, culminating in a devastating conflict. Following the cessation of hostilities, our main objective has been to foster coexistence among all communities.

The responsibility of cultivating harmony rests significantly on the shoulders of religious leaders. It is imperative that we remain mindful of our intentions. While politicians often pursue power, religious leaders strive to maintain their positions, frequently resorting to the perilous avenues of racism and bigotry. This unfortunate trend has plagued our country since the 1930s, yielding disastrous outcomes that require no further explanation.

Take Singapore, for example, where the absence of racism and bigotry has contributed to its rapid development despite its diverse linguistic landscape. With the military conflict resolved, Sri Lanka’s political challenges are now receiving attention, necessitating a renewed focus on coexistence, a topic also being deliberated in Parliament.

Mr. Karu Jayasuriya, served as the Chairman of the Sectoral Oversight Committee on Religious Affairs and Co-Existence when he was serving as the Speaker. This committee was established in response to conflicts involving Muslims in March 2018, as well as incidents in Galle in 2017 and Beruwela in 2014. Various proposals were put forth by these committees to address these issues, and consensus was reached on their implementation. It’s crucial that we uphold this agreement and continue working collaboratively to resolve these challenges.

Towards the close of last year, numerous Buddhist monks and Tamil leaders presented the Himalaya Declaration, a document we are currently adhering to. As we move forward, the final phase entails fostering synergy, particularly through discussions with Tamil political parties and MPs, aimed at addressing lingering issues. Steps have been initiated to resolve the matter of missing persons, with further updates forthcoming in the near future. Additionally, arrangements have been made for the release of certain individuals held in connection with these matters.

The primary concern at present revolves around the fate of the missing persons. To address this issue, we’ve presented and successfully passed a bill in Parliament to establish the Truth and Reconciliation Commission (TRC). Numerous reports from Disappearance Commissions have been reviewed, and one report authored by Judge A.H.M.D.Nawaz was selected.

Following the approval of the draft for the Truth and Reconciliation Commission, South African President Cyril Ramaphosa pledged his support for these initiatives. Similar assistance is being extended by other nations as well, enabling us to advance these critical endeavours.

Addressing the on-going political challenges, our attention is directed towards resolving land disputes, particularly in regions like Jaffna where tensions persist between villagers and the Wildlife Department. Similar conflicts also arise in areas such as Vavuniya, Trincomalee, Polonnaruwa, and Mahianganaya. We aim to address these issues through inclusive dialogue, involving all concerned parties. Furthermore, I have instructed to proceed in accordance with the 1985 map. Additionally, I anticipate meeting with Tamil MPs in Parliament next week to discuss these matters further. Following consultations with the security forces, agreements have been reached to release more land, providing a pathway forward in our efforts.

Another pressing issue is the delimitation of powers. A key demand is the empowerment of the 3rd list of devolution, with an emphasis on not interfering with police powers at present, leaving them open for future consideration. The Land Act is slated for presentation, and there are no objections to the delegation of other subjects in the 3rd list. However, securing the necessary consensus with other parties in Parliament to achieve a two-thirds majority remains crucial.

Simultaneously, discussions are underway regarding the implementation of the Provincial Board of Education. Proposals have been made to establish provincial professional training institutes in each province. Additionally, plans are underway to appoint provincial-level committees to lead the modernization of agriculture, establish a tourism board, and undertake related initiatives.

Additionally, the work of five provincial ministries is expected to be distributed among twenty ministries. This restructuring cannot simply resemble a general ministry, so officials are currently deliberating on adjusting their structure accordingly.

I eagerly anticipate addressing the final aspect of this matter, the decentralized budget, once all parties have convened. There’s also a call for a secondary board, akin to a Senate, which the government does not oppose. However, such an initiative would need to coincide with the framing of a constitution, potentially requiring a referendum. I also intend to engage in discussions on this topic with other party leaders.

These measures aim to lay the groundwork for a new era in our country. Religious leaders have been entrusted with significant responsibilities in this endeavour. I am confident that further discussions on these matters will yield fruitful outcomes.

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Sri Lanka rupee closes at 310.00/15 to the US dollar

ECONOMYNEXT – Sri Lanka’s rupee closed at 310.00/15 to the US dollar Wednesday, from 310.25/50 on Tuesday, dealers said.

Bond yields were broadly steady.

A bond maturing on 01.02.2026 closed at 10.60/80 percent from 10.60/75 percent.

A bond maturing on 15.09.2027 closed at 11.90/12.00 percent up from 11.80/95 percent.

A bond maturing on 15.03.2028 closed stable at 12.00/15 percent.

A bond maturing on 15.07.2029 closed at 12.20/50 percent from 12.25/50 percent.

A bond maturing on 15.05.2030 closed stable at 12.25/40 percent.

A bond maturing on 15.05.2031 closed at 12.55/75 percent down from 12.60/80 percent.

A bond maturing on 01.07.2032 closed at 12.50/90 percent down from 12.55/13.00 percent. (Colombo/Feb28/2024)

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