Alignment of fiscal and monetary policies critical for stability: CB Chief

• Warns an imbalance between the two policies will cause fiscal dominance
• Opines no consistent work has been done in the past to achieve macro-fiscal policy framework objectives
• Speaking at FITIS organised Sri Lanka Internet Day 2022, says no digital currencies soon in SL but closely monitoring the progress of India’s CBDC project

By Hiyal Biyagamage

Central Bank Governor Dr. Nandalal Weerasinghe stressed the importance of creating harmony between Sri Lanka’s fiscal and monetary policies, ensuring that both are aligned perfectly to regain macroeconomic stability.

Attending the Sri Lanka Internet Day 2022 by the Federation of Information Technology Industry Sri Lanka (FITIS), the Governor said that one of the major imbalances of Sri Lanka is not having proper complementary or coordination between the two policy entities, resulting in fiscal dominance. 

“The perfect alignment between fiscal and monetary policies is critical for Sri Lanka to regain stability from a macroeconomic standpoint. In any country, the authority for fiscal policy is the government, the Ministry of Finance, the cabinet and the parliament. It is called public finance. For monetary policy, it is the Central Bank.

“We must understand the roles of both policies and who is responsible for them. However, these two policies cannot go in different directions. These two policies should complement each other and be an overarching theme to facilitate macroeconomic stability. Furthermore, fiscal policy should not interfere with monetary policy and vice versa.”

“But if you look at the Sri Lankan situation, one of the major imbalances is that there is no complementary coordination between the fiscal policy and monetary policy. This results in fiscal dominance, where fiscal policy leaves less space for the monetary policy to play its role effectively. Thus, it redirects the monetary policy to control inflationary pressures by increasing interest rates.

“For example, when the government runs a fiscal deficit for a certain period and builds up debts to unsustainable levels, it will impact the monetary policy’s implementation. The Central Bank, although independent, cannot just ignore what is happening with fiscal policy.”

He also said that since May 2022, the Central Bank has communicated the economic challenges and how to mitigate them through CB’s macro-fiscal policy framework. However, Dr. Weerasinghe opined that as a country, Sri Lanka has not been doing consistent work to achieve macro-fiscal policy framework objectives with rigour. 

“This is what the IMF expects from us. There needs to be proper coordination of what we do regarding fiscal and monetary policy changes, and you need to conduct them accordingly. This is where the understanding of fiscal authority is important. Irrespective of administration changes and shifting positions in the political system, fiscal and monetary policies should be driven in one direction. With the crisis, there is a great understanding among many government and opposition parliamentarians. I see this as a positive development,” said Weerasinghe.

When asked about the delays of technology implementations in the banking and financial sector, Dr. Weerasinghe agreed that the Central Bank, in some cases, has taken significant time, resulting in some projects being completely halted. He also spoke about delaying Digital KYC solutions but believes it would be a game changer for the local sector. 

“I certainly recognise that implementing technologies to elevate the financial sector has taken time. Some of these implementations have not been successful at all. As the regulator, the Central Bank is receiving many complaints from banks and Fintech players. While critical infrastructures and systems were in place, we lacked technology adaptation. One clear area in this regard is the delay of digital KYC. However, we are moving towards that, and many organisations are actively implementing digital KYC solutions for their customers. This will be a game changer for us.”

“As a country, we need first to address several bottlenecks in technology adoption and remove those barriers first to use technologies so that we can transform our banking and financial sector. Before issuing digital banking licenses or payment licenses, I would first like the banking and finance sector to prioritise KYC technologies and other digital elements to strengthen its digital capabilities. When we do that, new opportunities will open up,” said Dr. Weerasinghe. 

Answering to a question about Central Bank Digital Currencies (CBDCs), Dr. Weerasinghe said that Central Bank has no plans to introduce them soon but is closely monitoring the progress of India, where the Reserve Bank of India (RBI) rolled out a pilot of its proposed digital rupee, enlisting nine private and state-owned banks to conduct interbank transactions with this form of currency. The digital rupee bears the same value and legitimacy as a banknote or a coin, except that it takes no physical form, making transfers and settlements easier and more efficient.

“We cannot jump into these things suddenly. As a country, we need a suitable sequence. First, we need to enable technology adoption and then look into other opportunities. We have done some initial research on CBDCs and looking at what other markets are doing. We are especially looking at what India is doing. For a country like ours, there is a huge cost involved to introduce these technologies.

“However, CDBCs bring many advantages, including cost reduction in printing currency notes. CBDCs differ fundamentally from other digital coins in that central bank deposits or a government pledge directly back them. Therefore, they offer stable value and can aim to combine benefits in the areas of trust, regulatory stability, and audit transparency.”

“As the Central Bank, we are carefully looking at how CBDCs are performing and how RBI’s project is progressing. As a country, we have no immediate plans to introduce CBDCs to the market soon,” stressed Weerasinghe.