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Friday Nov 15, 2024
Monday, 26 January 2015 00:00 - - {{hitsCtrl.values.hits}}
Confused markets speculate on the reasons
The market has not been able to comprehend the reason behind this unprecedented move. Some websites had attributed it to a conflict of interest which the current Minister of Finance, Ravi Karunanayake, is alleged to have with the Central Bank.
It would appear that the logic behind this move has been much more than a simple conflict of interest since the Government could have avoided it by appointing someone else to the post. On examination of the detailed facts, it appears that the objective of the Government has been to make the Central Bank an independent institution in the long run.
A new role for Ministry of Policy Planning and Economic Affairs
The Ministry of Policy Planning and Economic Affairs, according to the gazette notification, has been assigned the functions of “formulation of monetary policies and macroeconomic management in coordination with the Central Bank of Sri Lanka” and “liaising with donor agencies and international financial institutions”, among others. 
Thus, the monetary policy is no longer an exclusive preserve of the Central Bank and liaising with international financial institutions, namely, IMF, World Bank and ADB, is not a function of the Minister of Finance though he is the Governor of Sri Lanka in all these three institutions. In the new arrangement, the Governor of the Central Bank is supposed to report to the Prime Minister as the Minister of Policy Planning and Economic Affairs and receive instructions from him with respect to major administrative decisions concerning the bank.
To facilitate this new arrangement, the Ministry has been given responsibility for implementing some of the legislations, but not all, pertaining to the functioning of the Central Bank. They are the Monetary Law Act, Exchange Control Act, Banking Act and the Loans Recovery Act. However, no mention has been made in the gazette notification about the other important legislations that come within the purview of the Central Bank such as those relating to finance business and anti-money laundering.
A central bank subservient to the Ministry of Finance
A criticism levelled in the past against the arrangement in which the Central Bank functioned under the Ministry of Finance, despite its statutory semi-autonomy, has been that it has become subservient to the Ministry. As such, though it had independence in deciding on monetary policy, critics had charged that its policies had in reality been dictated by top officials in the Ministry of Finance. This has been made possible by the presence of the Secretary to the Ministry of Finance on the Monetary Board, the policy deciding body of the Central Bank, with voting powers. John Exter, the architect of the present Central Bank, had clarified in the report he submitted to the government on the establishment of a central bank in Ceylon, known as the Exter Report, why this arrangement had been made in the structure of the Central Bank. According to him, it will allow a better coordination between the government and the Central Bank with respect to policy by permitting the Minister to make his views known to the Board through the Secretary to the Ministry of Finance (p 13).
However, he made a qualification that its effectiveness depended on the maturity and experience of the people occupying the high positions in government and in the Central Bank. Thus, the Secretary to the Ministry of Finance was expected to function as a conduit between the Minister and the Monetary Board and not as a super-official steamrolling over its decisions. But over the years, Exter was defeated by some of the officials who had occupied the topmost position in the Ministry paving the way for critics to justify their charge of having a subservient Central Bank.
A previous attempt at making the Central Bank independent
Thus, a strong call was made in late 1990s for freeing the Central Bank from the crutches of the officials of the Ministry of Finance. It required a complete overhaul of the legal structure of the Central Bank by bringing in a new legislation to make it independent from the Ministry of Finance but still accountable to Parliament.
The Cabinet Sub-Committee on Economic and Monetary Affairs headed by Prime Minister Ranil Wickremesinghe during 2002-4 had accepted in principle that a new central banking legislation should be introduced making the Central Bank independent in line with emerging global trends. Accordingly, under the guidance of the then Governor A.S Jayawardena, a new central banking legislation was drafted by a Committee headed by this writer with technical assistance from IMF.
The new legislation proposed, among others, to make the Central Bank and not the Monetary Board the legal body, expand the size of the Monetary Board by making the Deputy Governors vote carrying members and permit the Secretary to the Ministry of Finance to attend the Board meetings without power to vote. But before the new legislation could be discussed with the government, Ranil Wickremesinghe administration was voted out of power. The new administration that came to power, especially the top officials at the Treasury, did not like the idea of a diminished role for the government and decided to shelve the draft legislation. As such, it may still be dusting in the archives of the Central Bank.
Goal is laudable but the legal structure and hardcore economics are unsupportive
Given this background, the new arrangement made by the present Ranil Wickremesinghe administration may be viewed as a step taken toward making the Central Bank independent from the undue pressures of Treasury officials.
However, since the laws have not been amended suitably, it will lead to several practical complications in terms of macroeconomic management and prevailing legal provisions.
Macroeconomic management requires close coordination among key policies
Macroeconomic management involves the management of three key policies, namely, the monetary policy, fiscal policy and exchange rate policy, in order to facilitate the optimum economic growth for a country. Of these policies, monetary policy is a prerogative of the Central Bank, fiscal policy of the Ministry of Finance and exchange rate policy of both the Central Bank and the Ministry of Finance. These three policies are interrelated and interdependent. As a result, the Central Bank cannot attain the objectives of its monetary policy if the fiscal policy pursued by the Ministry of Finance does not fall in line.
For instance, assume that the Central Bank seeks to attain an inflation free world by tightening its monetary policy. The bank is required to increase interest rates and cut money supply by restricting credit levels. The objective is to maintain the total demand in the economy, also known as aggregate demand, at a level equal to total supply known as aggregate supply. But if the Ministry of Finance follows an expansionary fiscal policy, then, the aggregate demand will increase defeating the objective of the tight monetary policy pursued by the Central Bank.
With increased aggregate demand over aggregate supply, the economy will get overheated making price stability a difficult goal and causing a consequential fall in the exchange rate. Hence, both the Ministry of Finance and the Central Bank will have to work very closely if they want to do proper macroeconomic management.
To facilitate this close working arrangement, the Monetary Law Act has provided for the Secretary of the Ministry of Finance to sit on the Monetary Board functioning as a conduit for such cooperation. Hence, the umbilical cord connecting the Central Bank with the Ministry of Finance cannot be severed by a mere delisting of the Bank from the Ministry.
Minister of Finance, a protective barrier
From a legal standpoint, it is the Minister of Finance who has been mentioned by name in all the legislations relevant to the Central Bank. Thus, the Central Bank’s relationship with the Government is through the Minister of Finance though it has not been explicitly spelt out in the Monetary law Act. But, in many recent central banking legislations such as those found in Bhutan or Nepal it has been explicitly provided for that the Government should communicate with the Central Bank only through the Minister of Finance. In the inverse, the central bank too cannot directly communicate with the government and it has to do so through the Minister of Finance. Hence, the Minister of Finance is the protective barrier between the government and a central bank that assures its independence and thereby helps it to attain its goals.
The Monetary Law Act which is the legislation governing the Central Bank has stipulated the role of the Minister of Finance in relation to the Bank.
Minister’s role in key appointments to the Central Bank
Section 12 stipulates that the Governor is appointed by the President on the recommendation of the Minister of Finance. The three private members are appointed to the Monetary Board by the President again on the recommendation of the Minister of Finance in terms of Section 8(2)(c). The salary of the Governor is also fixed by the President on the Finance Minister’s recommendation as per Sections 12(3). Under Section 14(2), the allowances payable to the other Board members are directly fixed by the Minister in consultation with the President. The concurrence of the Minister is needed for the Monetary Board to appoint Deputy Governors to the Bank, as per Section 22. Minister’s concurrence is also needed for the Monetary Board to release a Deputy Governor to serve in the government or as a director of a bank according to Section 23(3). The Minister also has powers to recommend the removal of the Governor or private Monetary Board members (Section 16) to the President under circumstances stipulated in the section under reference. Similarly, the concurrence of the Minister is needed for the Monetary Board to remove a Deputy Governor under Section 23(2).
CB’s reports to the Minister
There are a number of reports which the Central Bank has to submit to the Minister of Finance in terms of the Monetary Law Act: Annual Report of the Bank (Section 35(1)); a special confidential report whenever there are abnormal changes in the money supply or price level or economic disturbances threatening the monetary stability (Section 64(1)); continuation of the submission of those reports until the country is free from such threats (Section 64(3)); a special confidential report whenever there is a serious decline in international reserves (Section 68(1); a special confidential report before the 15th of September of every year to enable the Minister to prepare the annual budget (Section 116).
Currencies are Finance Minister’s prerogatives
The currency issue is a joint exercise done by both the Minister of Finance and the Central Bank under the Monetary Law Act. Every currency note issued by the Central Bank shall have the signature of the Minister of Finance in facsimile (Section 53(2)). The Minister’s approval is needed for the Central Bank to prescribe the denominations, dimensions, designs, inscriptions, and other characteristics of currency notes (Section 53(1)). A similar approval of the Minister is needed for the coins to be issued by the Central Bank in respect of metals, fineness, weight, size, designs, denominations and other characteristics (Section 53(3)).
A new Section 52A has been introduced to the Monetary Law Act in 1998 requiring the Minister to approve of the issue of commemorative notes and coins. Section 39(c) stipulates that if the Monetary Board decides to transfer a part of its profits to the government, the manner in which it should be done should be decided in consultation with the Minister.
The Minister of Finance cannot issue directives to the Central Bank as in the case of other public sector institutions. Yet, in terms of Section 116(2), if there is a difference of opinion between the Minister and the Monetary Board about the appropriate policy to be taken, the Minister can direct the Board to adopt the policy he prescribes by taking responsibility for the consequences of such direction.
Finance Minister’s powers are inalienable
This list is not exhaustive and does not cover the powers, duties and obligations of the Minister of Finance under other legislations such as the Exchange Control Act or the Banking
Act. However, they are all inalienable and therefore, the Minister is responsible to Parliament and to the nation for them. It may be an awkward position for the Minister of Finance to be responsible for work for which he has no role to play. Hence, though the objective of listing the Central Bank under PM is laudable, it is not workable under the prevailing legal structure. It will get into serious trouble in the event of a recalcitrant person occupying the portfolio of finance.
A Governor walking on a tightrope
Human nature is such that when people are forced to have divided loyalty, they cannot serve either party well. This may be the biggest challenge to be faced by the Governor of the Central Bank in the period to come. His role will be similar to that of an acrobat walking on a tightrope balancing carefully every step he makes forward. Any imbalance will mean that he will fall off the rope thereby having to deviate from the goals which he is pursuing to attain in the Central Bank.
However, it may not be an issue if, as Exter expected, people in high places are with maturity, experience and wisdom. But, if these qualities are not present in them, it will invariably lead to conflicts and most of their professional time will have to be spent for resolving them. To avoid such a situation, it is necessary that all those in high places should work in appreciation of each other toward the final goal of making the Central Bank a more responsible institution forgetting their personal differences.
Have a Cabinet subcommittee to ensure coordination
The solution to this conflict can be found in the Exter Report. It says: “One further point is well worth making. There is a clear need in Ceylon for some sort of economic council at Cabinet level to achieve improved coordination of Government economic policies. If in future such a council is set up, it is suggested that the Governor of the Central Bank should have a place upon it” (p 13). Needless to say that in the present arrangement the Minister of Finance should also have a place upon it.
Arjuna Mahendran receives the letter of appointment as the Governor of the Central Bank from President Maithripala Sirisena on Friday
Amend the central banking laws as a part of the 100-day program
With an unsupportive legal structure, the present arrangement, though laudable, is unlikely to work properly. Hence, within the 100 day constitutional reform programme, it is advisable to introduce appropriate legal reforms to the Central Bank as well.
For that, the wheel need not be reinvented. It is just a matter of retrieving the dusting draft central banking legislation from the archives of the Central Bank and introducing it with suitable amendments after an economy-wide consultation with all the stakeholders. Unless this is done as a matter of urgency, the current arrangement is fraught with failure.
(W.A Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected] )
