Central Bank’s response to ‘Why Amendment to Monetary Law Act may be flawed’

Following is a response to the article titled ‘Why amendment to Monetary Law Act may be flawed,’ issued by the Central Bank’s Communications Director

Sri Lanka is in the process of introducing a new law governing central banking in the country in place of the current Monetary Law Act. Amending this 70-year old law is a long-felt need, in order to update its provisions with regard to monetary policy formulation in line with international best practices, and also to introduce a strong macroprudential policy framework aimed at preserving the stability of the financial system. 

In addition, in line with the recommendations of the Presidential Commission of Inquiry appointed to investigate and inquire into and report on the issuance of Treasury bonds as well as international best practices, the Central Bank’s governance structure is also expected to be strengthened, along with provisions to make the Central Bank an independent institution with public accountability. 

In this consultative process of introducing a new law governing central banking, the Central Bank of Sri Lanka welcomes the opinions expressed by economic and legal experts as well as the general public, and such discussions would enhance clarity and transparency of the law which would govern central banking in Sri Lanka in future.

Nevertheless, it has been observed that some opinions expressed have no theoretical or practical rationale. One such article appeared in the Daily FT newspaper on 23 July 2019 under the title ‘Why amendment to Monetary Law Act may be flawed’. The Central Bank is of the opinion that the arguments made therein warrant a response to prevent the general public being misguided by the author of the said article.

Argument 1: Developed world uses money printing

It is true that Quantitative Easing (QE) programs adopted by advanced economies particularly in the aftermath of the global financial crises in 2009 amount to an expansion of central bank balance sheets. However, these economies did not use QE to finance budget deficits through central bank financing, but resorted to liquefy markets through secondary market transactions involving securities issued by both governments and the private sector. 

In contrast, the proposed amendments in Sri Lanka aim to prevent direct financing of budget deficits through primary market purchases of government securities while limiting provisional advances that can be obtained by the government from the Central Bank. The Central Bank will continue to maintain its ability to intervene in the secondary market to influence monetary conditions whenever the need arises to do so. This is the best practice followed by modern central banks in both advanced and emerging market economies. 

Argument 2: Why money printing could be important for Sri Lanka

The author expects money printing by the Central Bank to help the investment drive by the government and argues that the central bank printing money is not catastrophic by any means. On the contrary, this is a definite recipe for an economic catastrophe as seen in hyperinflation episodes around the world throughout history. The general public are invited to study hyperinflations in interwar Germany, in Zimbabwe or in Venezuela, to realise the dangers stemming from central banks facilitating increased government spending through money printing. 

In addition, money printing to finance fiscal deficits would create excess demand unless monetary policy or operational measures are taken to counter increased demand. Such money printing could increase imports, which in turn would exert pressure on the balance of payments and cause the rupee to depreciate. 

The Central Bank of Sri Lanka has been able to anchor inflation and inflation expectations in single digit levels for a sustained period of over 10 years as it has remained increasingly vigilant of monetary financing of fiscal deficits. The fact that inflation is no longer considered a “serious problem” in this country that had a history of disruptive double digit inflation, merely reflects the results of the Central Bank’s efforts to maintain low and stable inflation, which is a necessary condition for an economy to thrive. The country does not need the problem of inflation to be added to the list of “serious problems” as highlighted by the author. 

Argument 3: Theoretical solutions don’t work for practical problems

The author argues that “theoretical concepts such as independence of Central Bank may not achieve the desired results for the real practical problem of low economic growth faced by Sri Lanka”. It must be understood that strong macroeconomic fundamentals including low inflation, low deficits, low interest rates, and a properly valued currency, are necessary but not sufficient conditions for high economic growth. However, in the absence of strong macroeconomic fundamentals, there is not even hope for high economic growth in this age of highly mobile investment and human capital flows. 

Argument 4: Skilled labour, technology more relevant for investors

According to the author, “the focus should be to achieve sustainable, high economic growth and not to worry too much about near term inflation, budget deficits and other less problematic economic factors”. This simply shows the author’s lack of understanding of the role of central banking in an economy, and his/her erroneous assumption that a central bank exists merely to fund a government’s desire to put in place basic infrastructure in a country. This argument is probably valid for an infrastructure/development bank rather than a central bank. In contrast, a central bank aims to maintain stability, which would facilitate growth in an economy.  

Argument 5: Misuse of money printing

The author acknowledges that “money printing becomes a problem; if it’s not used for the right purpose” and argues that “the answer is to bring in the controls so that it is only used for the right purposes”. The Central Bank emphasises that it cannot provide such a guarantee of the use of money printing by the government for right purposes in line with the author’s thinking that “objective of any amendment to the Monetary Law Act” should be so. Allocation of public expenditure for various purposes is a responsibility of the Parliament.

The Central Bank of Sri Lanka wishes to reiterate its desire to engage the general public and other interested parties in this discussion on proposed amendments to the law governing central banking. As recently stated by the Hon. State Minister of Finance, detailed proposed amendments will be made available to the general public through the Government gazette in the near future.