A reply to Central Bank’s response

We appreciate the response of the Central Bank to our article titled ‘Why amendment to Monetary Law Act may be flawed’. It is encouraging to note that the Central Bank is aware of the different views being expressed on its actions and comes forward to defend its actions.

The writer also notes that the functioning of the Central Bank improved vastly after the disastrous 2015-2016 episodes, which almost destroyed the credibility of the Central Bank. The writer also believes that the intention of the Central Bank on this particular issue of independence of Central Bank is bona-fide. 

What we have been saying in our column

However, we wish to reiterate what we’ve been pointing out in our column over the last several months. Sri Lanka’s most concerning issue is the lack of growth and to rectify that the Government needs to take a decisive role. While on one hand the geo political advantages should be exploited, a focused investment drive should be started. 

The writer is not referring to basic infrastructure. To give a single example (which we have mentioned in our column before), SLASSCOM has pointed out the need to increase the annual IT graduate output to 18,000 from the current level of 6,000. That is the type of infrastructure the Government should initiate and provide which is a crucial factor to unleash technological industries and achieve a high economic growth rate. 

While many measures could be used to finance such an investment drive, the support of the Central Bank could be just one such measure. 

Central Bank’s role in the big picture

The writer was referring to a master plan where the Government, Central Bank and other stakeholders function in-sync. 

In contrast, when each entity has its own independent road map, the overall economy would not function smoothly and invariably the desired results would not be achieved. Hence, the ideal objective of the Central Bank is not to be a “perfect central bank”, but instead to facilitate the master plan of the country.

Finally, just because a tool has been misused in the past it doesn’t mean that it is logical to get rid of it altogether. That would mean a very useful tool being eliminated for someone who is capable of using it wisely.

Reply to Central Bank’s responses

The writer wishes to clarify his rationale further by way of replying to the specific response given by the Central Bank:

1. The writer’s assumption that a central bank exists merely to fund a government’s desire to put in place basic infrastructure in a country is erroneous.

Nowhere in the article was it mentioned that funding basic infrastructure is the sole purpose of the Central Bank. 

Also as we have pointed out in our column repeatedly, we are not referring to basic infrastructure. We are referring to very specific infrastructure which is necessary for selected industries to grow and as a result, put the country on a sustainable high growth path. Central Bank would be just one of many sources that could be used to finance that initiative.

2. Central Bank printing money for a Government investment drive is catastrophic as seen in hyperinflation episodes in interwar Germany, Zimbabwe and Venezuela.

Did any of these countries print money for the purpose clearly mentioned in the article? In case of Zimbabwe, it was mainly to finance military activities including the involvement in Congo. In the case of Venezuela, it was to finance an unwinnable war against the geopolitical reality. In the case of Germany it was once again to finance the world war. So it is completely misleading to compare with these examples.

3. The change was needed as per the recommendation of Presidential commission of inquiry appointed to investigate the issuance of treasury bonds. Advanced economies did not use QE to finance budget deficits through Central Bank financing, but resorted to liquefy markets through secondary market transactions. The Central Bank will continue to maintain its ability to intervene in the secondary market.

What happened during the infamous bond scams in 2015 and 2016 were the issuance of treasury bonds at much higher interest rates at the auction (primary market) than the market rates (secondary market) that prevailed at that time. The party which snapped up the vast majority of that auction, sold it to Government institutions in the secondary market at much lower interest rates, resulting in a phenomenal capital gain for that party. 

If the Central Bank says that intervening in the secondary market is better than taking part in the primary market, the writer wishes to state that intervention in the secondary market is more likely to repeat situations such as what occurred in 2015 and 2016. On the contrary, investing in the primary market and holding till maturity would not result in such suspicious transactions.

4. Central Bank has been able to anchor inflation in single digit levels over the last 10 years as it has remained increasingly vigilant of monetary financing of fiscal deficits.

If the Central Bank has managed to be vigilant of monetary financing of fiscal deficits and maintain inflation in single digits over the last 10 years with the existing regulations, the question arises why it needs to change it drastically.

5. In the absence of strong macroeconomic fundamentals, there is not even hope for high economic growth.

This is a typical banker’s mindset and not that of an entrepreneur. The question arises why investors rush to Vietnam despite the existence of high budget deficits. The simple answer is the high growth rates maintained by Vietnam. 

Even in the corporate sector, most successful companies incur losses in initial years, but the focus is on growth and capturing of market share. The monetisation happens at a much later stage once the company reaches a sizeable size. The investors do not worry about losses or balance sheet weakness during early years as long as the business is focused and growth is sound. 

It’s the lenders who look for clean balance sheets as they are just interested in recovering the funds that were lent.

6. The 70-year-old law has to be amended. Central Bank cannot provide a guarantee of the use of money printing by the government for right purposes.  Allocation of public expenditure is a responsibility of the Parliament. 

In the article it was clearly mentioned that changes could be made appropriately. Clearly if it’s 70 years old, it would have to be modernised. 

But the claim that Parliament cannot be guided as to how the public expenditure could be utilised is not acceptable. There are ways and means of doing things, if one is innovative. 

(The writers can be contacted via [email protected].)