ECONOMYNEXT – Sri Lanka’s new monetary law will continue to have the Treasury secretary in its governing board in but monetary policy decisions will be made by a separate body, a draft law to replace the island’s existing monetary law shows.
There have been calls to remove the Treasury Secretary from the agency’s governing board as in the past, he has used his de fact veto to stop the central bank from raising interest rates and forced it to print money pushing inflation up and busting the currency, in so-called fiscal dominance of monetary policy.
However in recent years, money has been printed and the rupee depreciated without any pressure from the Treasury.
Monetary policy however will be conducted by a separate body, called the Monetary Policy Board, under the draft law.
The central bank has a monopoly in the issue of currency and is solely responsible generating inflation and currency depreciation (the domestic and external value of the paper it produces).
The “Monetary Policy Board shall regulate the supply, availability, and cost of money, taking into account the macroeconomic and financial condition of Sri Lanka,” the draft law says.
12. (1) The Monetary Policy Board will be made up of , the Governor of the Central Bank who shall be the Chairperson of the Monetary Policy Board, Deputy Governors of the Central Bank and ” four experts in economics or finance.”
The draft law says Any member of the Governing Board (which includes the Treasury Secretary) may be appointed as an expert under paragraph (c) of subsection (1).
Sri Lanka’ central bank was set up under US advice when so-called ‘New Dealers’ a group heavily interventionist Keynesian ideologues dominated policy in America.
They set up central banks and pushed policy in several countries which brought sweeping monetary destruction and political instability, after World War II including in the Philippines, where an authoritative dictatorship was also established, critics say.
Sri Lanka has had balance of payments troubles, foreign exchange shortages and currency depreciation from shortly after the central bank was set up due to conflicting money and exchange policy (targeting both interest rates and exchange rate).
Currency instability has worsened in recent year under a so-called ‘flexible exchange rate’, a highly instable soft-peg where call money rates are targeted with tens of billions of rupees of excess liquidity.
Currency defence from the liquidity shock is delayed until a ‘disorderly fall’ severely undermining the credibility and generating jitters, even when private credit is weak.
The call money rate is targeted under bureaucratic discretion at rates lower than the policy rate set by the monetary board with unlimited amounts of excess liquidity.
Under the ‘flexible exchange rate’ Sri Lanka has earned two credit downgrades since 2015.
The new law however places inflation and not economic growth as a primary goal, though the flexible exchange rate, implies that there will be no genuine floating exchange.
The monetary policy board will continue to target the exchange rate through the ‘flexible exchange rate’ (external anchor) while also targeting an inflation index (domestic anchor) raising fears that existing policy conflicts that leads to currency collapses and IMF bailouts may continue.
“There shall be a Monetary Policy Board of the Central Bank (in this Act referred to as the “Monetary Policy
Board”), which is charged with the formulation of monetary policy of the Central Bank and implementation of flexible exchange rate regime in line with the flexible inflation targeting framework in order to achieve and maintain
domestic price stability,” the draft law says.
There is no legal requirement to target an output gap. In recent years in the transition to ‘flexible’ inflation targeting rates have been cut, despite elevated interest rates to target a potential output gap with printed money.
Real effective exchange rates have also been targeted.
It is not clear whether under ‘flexible inflation targeting’ bureaucratic discretion will remain to chase after multiple objectives.
Among South Asian central banks, monetary indiscipline as shown by currency depreciation has been worst in Sri Lanka.
Sri Lanka’s rupee has fallen from around 4.70 to the US dollar to 180 to the US dollar since the creation of the central bank. Under a ‘flexible exchange rate’ the rupee has fallen from 131 to 182 to the US dollar.
India’s rupee has fallen from 4.76 to 70 to the US dollar and Pakistan which also runs frequently to the IMF to 155 to the US dollar in the latest crisis. Pakistan also has a tendency towards authoritative dictatorships.
Bangladesh currency has fallen to 84 to the US dollar and has remained generally stable for almost a decade helping lay the foundation for a strong growth phase.
Maldives Monetary Authority has a lower level of monetary indiscipline with very long periods of monetary stability, as shown by the exchange rate is around 15.4 to the US dollar. (Colombo/November 05/2019)