Is ‘form over substance’ the guiding principle within the Central Bank?

‘Substance over form’ is a vital principle of good governance that the leaders at the helm of affairs at the Central Bank must commit to and always strictly conform to in their regulatory and governance roles.

Governor of the Central Bank Ajith Nivard Cabraal presenting the ‘Road Map; Monetary and Financial Policies for 2011 and Beyond’

Substance over form is an accounting concept where the entity is accounting for items according to their substance and economic reality and not merely their legal form. This concept is one of the key determinants of reliable information. For most transactions there will be no difference, so no issue arises.

In some cases, however, the two diverge and the choice of how to present the transactions can give very different results. This difference occurs when an asset or liability is not recognised in the accounts even though benefits or obligations may result from the transaction, or oppositely.

Early this year the Governor of the Central Bank, presenting the ‘Road Map; Monetary and Financial Policies for 2011 and Beyond,’ forecast that economic growth would be 8.5% in 2011 and be broad based across the agricultural, services and manufacturing sectors and would accelerate to 9% and 9.5% in 2012 and 2013.

He predicted that the GDP Deflator would be 6% in 2011,credit to private sector would expand by 16%, broad money grow by 14.5%, with a balance of payment surplus of US$ 350 m and FDI flows of 2% of GDP.

He went on to estimate that credit to the Government would be Rs. 42 billion and World Bank Ease of Doing Business ranking would improve to 30 by 2016 from current 102 and 2011. He predicted that the Rupee, which appreciated 3.1% against the dollar in 2010, would appreciate further in 2011. These predictions came in the wake of repeated promises to deliver a per capita GDP of US$ 4,000 by 2016 and US$ 6,000 by 2020.

“The effect of floods on prices is not permanent and does not need a monetary response...” “Domestic food prices can be controlled by utilising buffer stocks and importing food items...” “The Central Bank commits to maintain inflation at around 4-6 per cent and we do not see structural and demand driven pressure on inflation. The challenge is to keep food prices down. And this is something that can be done...” “These price increases in the domestic economy are expected to have only a transient effect on domestic inflation...” These are statements attributed to the Governor and high officials of the Central Bank.

State-associated media, however, carried headlines at around the same time recording the following: “Economic damage estimated at US $ 500 million.” “Rice shortage, food prices rises likely in the wake of rain havoc.” “The Government to subsidise essential food items.” “The Army to distribute vegetables.” “Vegetable prices keep on increasing.”

Media also refers to the President chairing a special committee charged with ensuring food security and efficient distribution of food at affordable prices, as food shortages and price increases are predicted later in the year.

At the same time international analysts predict that that rising food prices and inflation will plague developing economies. Local experts also state that as global food prices inflate to record levels, local food prices are set to rise.

The events that have unfolded in the recent weeks will bear testimony to the intellectual integrity of the positions and predictions as pronounced by the leaders of the Central Bank.

To establish their credibility and prove that that their statements are not based on the principle ‘form over substance,’ it is necessary that the Governor and the top team at the Central Bank engage in an intellectual public debate and respond to the following 12 questions:

1. Are best practices of risk management in place?

Have necessary risk assessments been carried out and risk weights embedded as a part of the processes leading to the announcement of Central Bank estimates? For instance, are the estimates of petroleum and other key import commodities consistent with the present predictions of the future price scenario? Have potential global warming and weather related negative impacts been factored in? Have at least the possibility of national calamities like the recent floods, 2004 tsunami and even earthquakes been considered, even if not factored in?

Has the likelihood of the payment by the state of damages to the Banks under the aborted hedging deal been taken cognisance of? Will the credibility of the state improve so dramatically in the short term, bureaucracy eliminate political interference and transparency indices improve beyond expectation in the short term to attract the predicted FDIs and improve ease of doing business ranking?

2. Does the Central Bank discount possible serious economic implications arising consequent to the recent floods?

“The shortfall in the paddy crop has serious economic consequences,” says respected Economist Nimal Sanderatne. “Even a 30 per cent crop loss implies the need to import a fair quantity of rice and wheat. This would involve quite a drain in foreign exchange as rice prices, as well as wheat prices, have risen sharply. This is due to the declining trend in production coupled with the increasing demand for grains, as well as the devastation of crops in several grain producing countries.”

3. In the context of the positive commitment of the Central Bank on restraining price increases and assuring guaranteed food supply security, why is it now proposed to:

a. Have high level Cabinet committees examining strategies for food security, emergency/State-managed food distribution schemes and control cost of living mechanisms in place.

b. Reduce in import taxes of petroleum, gas, milk powder, onions, potatoes and possibly even wheat flour, all with negative monetary impacts on Government revenue and budget deficit.

c. Imposition of price controls.

Why are the Governor and the Central Bank:

•    Comparing Sri Lankan prices of food and other household expenses linked items of goods and services consumed with the prices prevailing in the developed West, without any comparative reference to the relative household incomes?

•    Comparing the inflation rate of 2010 with the inflation in other neighbouring countries of Asia, in isolation, ignoring the cumulative effect of inflation in the period 2005-2010?

•    Changing yet again the market basket for compilation of the cost of living indices, without a professional market survey being carried out, by merely announcing that services take a larger share of household income than food? This assumption may apply to the households of the Governor, the Monetary Board Members and top management of the Central Bank. But this presumption will certainly not be reflective of the household spends of a majority of Sri Lankan homes. How can they then justify to increase services spend share and reduce food spend by 15-20% to less than 50% of family spends? This is surely representative of ‘form over substance’!

4. Are Central Bank responses ideological and political, rather than pragmatic economic responses?

Dr. Sandaratne in his Sunday column writes: “The Sri Lankan economy as a trade dependent small economy has always been vulnerable to external shocks. When the external shock coincides with an internal disruption, it is of serious concern. In such a situation the countervailing policy measures to cope with the situation must be based on sound economic principles that cope with the immediate problem without jeopardising the long term economic interests of the country. Far too often the responses have been ideological and political rather than pragmatic economic responses. Policy responses should be in the long term interests of the country.”

5. Explain how the promised per capita GDP increases will impact on the lives of the poor?

How much of this promised delivery, in the land deemed to be the ‘Miracle of Asia,’ will trickle down to the poorest households in the country (i.e. the poorest Pradeshiya Sabah area of Siyabalanduwa, Harispattuwa, Cheddikulam, Mussali, Tissamaharama, conflict-impacted villages of Kilinochchi, Veddha families of Mahiyangana, estate areas of Nuwara Eliya and tenements of Colombo)?

6. Are average families poorer in the period since 2005?

Highly-recognised young Economist Harsha de Silva states that according to the Household Income and Expenditure Survey of the Department of Census and Statistics, “the real mean household income, that is the value of household income after adjusting for inflation, has actually declined from Rs. 17,465 in 2006/07 to Rs. 17,203 in 2009/10. Consequent to this, it has been found that food consumption including rice, wheat flour, bread, dhal and sugar has also fallen.”

(The writer is a former Chairman of the Ceylon Chamber of Commerce.)

Contd. on p 12

Is ‘form over...

What will be the impact on national nutrition levels of the common citizens in the wake of price increases? Will the younger generations growing in this scenario develop cognitive power to form an intellectual hub?

7.    Is the appreciating rupee the key strategy to deliver promised per capita GDP?

Is the Central Bank relying on appreciating the rupee annually by 3 to 3.5% in a bid to achieve the per capita GDP of US$ 4,000 by 2016 and US$ 6,000 by 2020? Analysts believe this factor is entirely relied upon to spur growth rates of 8-10 % annually in the context of a population growth of 1% per annum to reach the targets promised to be delivered!

8.    Is it correct to compare the growth in per capita GDP from 2005 with the previous periods, without reference to applicable inflation rates during the same periods and also the applicable exchange rates?

9.    Can the value added export sector survive the future challenges within a potential regime where a 3- 3.5% annual appreciation of currency is the reality with relatively high inflation rates, merely relaying on productivity gains, supply chain efficiencies, lower interest costs and lower taxation?

10.    Has the Central Bank validated present fiscal gap of Sri Lanka ( the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue (including pensions) in all future years and what are the estimates for 2016 and 2020?

11.    Can the Central Bank justify that all key capital infrastructure projects spends since 2005 and key proposed spends of the Government and State agencies in the future will add long term socio economic value to Sri Lanka and its people and generate positive rates of return with resultant long term positive cash flows, yielding consistently free cash flows?

12.    Whilst the leaders in governance emphasise the importance of domestic savings, is the Central Bank aware that its present policy regime impacting on the deposit interest rates and its lax control regime are driving citizens to invest in unregulated deposit institutions and also provide a free reign for pyramid schemes and pseudo marketing schemes that drain out funds illegally from depositors and even out of the country?

The Central Bank must pay strict attention to the substance and content of any public statement, published information, data, estimates, forecasts and commentaries they issue. These must always conform to the principle ‘substance over form’. They must never commit a cardinal sin and attempt to develop and design these publications as ribbon wrapped packaging fit as a birthday present to the ‘King and the Court’.

If these statements and the associated regulatory action lack integrity, transparency, professionalism, conformance with global best practices and are doubtful in long term delivery, they will merely be read and seen as a very nice and attractive to see packages that lacks integrity, credibility and substance and its contents empty and/or rotten.

It is best that the leaders of the Central Bank settle in to bed after the independence day celebrations with Hans Christian Andersen’s ‘The Emperor’s New Clothes’!