Central Bank’s failure to respond to unfair criticism on money printing is questionable

The Central Bank’s failure to present the correct picture of money printing not only damages its credibility but also disturbs financial market stability, which is already hit by numerous shocks

Print, electronic and social media have been inundated during the last couple of days with reports on exorbitant money printing by the Central Bank of Sri Lanka (CBSL) by a whopping Rs. 208 billion on a single day, i.e. Monday, 28 June, after printing Rs. 23 billion in the previous week. Taking advantage of such reports, the Opposition parliamentarians have publicised these stories, heavily criticising the Government. 

But, to be fair by the CBSL, it has not printed such a large quantity of money in recent weeks, as alleged by the critics. In this context, it is rather puzzling why the CBSL has not come forward to demystify these erroneous reports so as to clear market uncertainties. 

The exaggerated money printing numbers widely circulated on earlier occasions were clarified in my article published in this column in March (https://www.ft.lk/columns/Budgetary-pressures-restrict-monetary-policy-space/4-713978).

CBSL fuels speculation

The CBSL’s failure to present the correct picture of money printing not only damages its credibility but also disturbs financial market stability, which is already hit by numerous shocks such as foreign exchange shortages, import restrictions, exchange controls, rupee depreciation and export proceed conversion regulations. 

The statement on foreign currency liquidity issued by CBSL Governor Prof. W.D. Lakshman last week, requesting the market players to remain calm without resorting to speculative moves, adds further confusion. Instead of admitting the country’s foreign exchange difficulties in a transparent manner, as usual he blames the analysts for making speculative comments based on political motives. Four days later, however, the CBSL had to impose a series of suspensions and restrictions on outward remittances, proving that the country is facing a grave payments crisis. 

Amidst those market uncertainties, the CBSL’s deafening silence on money printing has damaging effects on the country’s international image as well.

In the past, the outstanding CBSL Governors like Dr. Warnasena Rasaputra and Dr. Neville Karunatilake laid much emphasis on effective and accurate communication of monetary policy, and they wasted no time in taking action to rectify any erroneous media reports regarding the Bank’s monetary policy measures and operations. 

Inaccurate money printing numbers

An article appeared in Sunday Times of 4 July states, “On both the domestic and the international front, the rupee has come under siege with no relief in sight. In the domestic sphere, the Government took the extreme step of physically printing an unprecedented Rs. 208 billion on Monday, after having already printed Rs. 23 billion last week. With this input of fresh liquidity, the Central Bank holdings of government securities or the printed money stock reached a record breaking trillion rupees or Rs. 1,127.65 billion to be exact from Rs. 919.22 billion on June 25.” 

Similar adverse reports appeared in several other English and Sinhala newspapers.

Did CBSL print large amounts of money?

Let us check whether the Government or the CBSL physically printed Rs. 208 billion on the particular day, as reported in media. 

The statement that the CBSL holdings of Government securities increased by Rs. 208 billion from Rs. 919.22 billion on 25 June to Rs. 1,127.65 billion on 28 June is absolutely correct, as shown in Table 1. But it is inaccurate to say that the CBSL printed money to the tune of Rs. 208 billion on 28 June. 

The CBSL holdings declined to the previous level of Rs. 919 billion on the following day indicating that the Government settled the borrowings on that day. The sum of Rs. 208 billion seems to be a mid-year temporary advance disbursed by the CBSL to the Treasury. 

It did not have any impact on money printing, and therefore, it is unfair to pass judgement that the CBSL printed an exorbitant amount of money on a single day. 

In the circumstances, I am surprised why the CBSL does not have the courage to say so. 

Official communications guide market participants

As central banks across the world have increasingly moved towards greater transparency since the 1990s, communication has become a key element of monetary policy. This progressive trend has much to do with the growing recognition that monetary policy is all about managing market expectations. 

It is widely recognised that a central bank’s transparency through effective communication not only enhances the effectiveness of monetary policy, but also improves the institution’s accountability in a democratic manner. Effective communication enables a central bank to mitigate speculation, and thereby to build up market confidence, ensuring macroeconomic stability.

Communication under inflation targeting monetary policy

Communication has become much more important in recent times due to the adoption of inflation targeting monetary policy framework by many central banks, deviating from politically dominated monetary policy. Declaration of inflation targets to the public is a main responsibility of central banks under such monetary policy system. 

It was proposed to adopt an inflation targeting monetary policy framework for Sri Lanka under the CBSL Bill of 2019, which was scrapped recently, thus preventing the central bank’s independence, as I elaborated in last week’s column (https://www.ft.lk/opinion/Draft-Central-Bank-Act-scrapped-preventing-independence-of-monetary-authority/14-719755).

Such policy reform would have paved the way to improve CBSL’s transparency and accountability to a great extent, and thereby to win market confidence, contrary to today’s plight of the Bank. 

Computation of new money printed

Given the misconceptions of money printing publicised these days, it would be pertinent to understand how the CBSL determines the amount of new money to be printed periodically. 

In terms of the Monetary Law Act No. 58 of 1949, CBSL has been empowered as the sole authority to print money or what is called currency or cash (notes and coins) on behalf of the Government. This component of money supply is the one that has been subject to much controversy these days. A steady increase in money supply in tandem with economic growth is essential to facilitate market transactions.

In contrast to arbitrary money printing, as alleged by some critics, the CBSL uses changes in its monetary base or reserve money as the foundation for issuing new currency, as shown in Table 2. The monetary base consists of Net Domestic Assets (NDA) plus Net Foreign Assets (NFA). The component NDA includes Net Credit to the Government (NCG) and other domestic assets/liabilities. 

NDA rose by Rs. 508.2 billion during the 12 months preceding May 2021. This means that CBSL bought that amount of Treasury Bills and Bonds during the year. In effect, the CBSL should have issued an equivalent amount of new currency, as widely publicised by critics. But such impact of NDA was offset by a substantial decline in NFA by Rs. 468.7 billion resulting in an increase in the monetary base by only Rs. 39.5 billion during the period.

Hence, the actual amount of currency issued by CBSL or newly printed money was only Rs. 39.5 billion during the 12-month period ending May 2021, in contrast to the exaggerated figures quoted by the commentators. 

Government borrowings from banks rising

While recognising the much lower amount of currency (new money) issued by the CBSL in contrast to widespread criticisms, we should not neglect the fact that increased borrowings by the Government from the banking system led to raise the country’s broad money supply by 21% to Rs. 10,033 billion in May 2021 from Rs. 8,293 billion a year ago; an increase of Rs. 1,740 billion.

The broad money supply, known as M2, consists of currency or cash (notes and coins) and demand, time and fixed deposits held by the public with commercial banks. The broad money supply amounts to 10 times of the monetary base (notes and coins) in Sri Lanka. In other words, commercial banks have created credit by multiple times of cash issued by CBSL, which is their legitimate right in the financial system. 

The increase in the money supply was largely due to credit disbursed by commercial banks to the Government in such manner. The Government has borrowed heavily from the CBSL and commercial banks. Government borrowings from the CBSL rose by as much as 74.1% during the 12-month period ending May 2021. The impact of such increase on the monetary base was offset by a substantial decline in CBSL’s NFA, and therefore, it did not have a significant effect on the currency issue, as explained earlier. 

The other main reason for the expansion of the broad money supply was a 39% increase in commercial bank net lending to the Government. The rise in commercial bank credit to public corporations by 17% during the 12-month period preceding May 2021 too contributed to raise the money supply.

Never explain, never apologise

The recent increase in money supply was largely due to commercial bank lending to the Government, which needs to be arrested by adopting fiscal discipline. Freeing the CBSL from political pressures too is essential to eliminate fiscal dominance over monetary policy. 

It is the prime responsibility of the CBSL to disseminate accurate economic data and information to the public so as to prevent speculation and uncertainty among market participants. It is in this context that the CBSL should have clarified the misconceptions of money printing, as explained in this column. 

The motto of Montagu Norman, a former Governor of the Bank of England (1920-1944) was, “never explain, never apologise”. He once told Henry Clay, the Bank’s first professional economist, “You are not here to tell us what to do, but to explain to us why we have done it.”

(The writer is Emeritus Professor in Economics at the Open University of Sri Lanka and a former Director of Statistics of the Central Bank of Sri Lanka, reachable via [email protected].)