The losses of the Central Bank

The performance of the Central Bank cannot be judged in terms of its profits or losses as it is not a commercial enterprise

By Parakrama Jayasuriya

A prominent economist in Sri Lanka contends in a series of articles published recently that the continuously loss-making Central Bank is no better than SriLankan Airlines. In his essay he pointed out that the Central Bank made losses for the third year in succession in 2015, resulting in a depletion of its capital base. It appears that his motive in raising this argument is to impress upon the public that the present administration of the Central Bank is lacking the required competencies to manage the bank.

It is true that the Central Bank is presently making losses on its operations, but it should be understood that this loss-making position commenced from 2013, prior to the assumption of duties by the present Governor in 2015. The Central Bank generated profits of Rs.66.2 billion in 2012, but this was converted to a loss of Rs. 24.3 billion in 2013. Although these losses have increased to Rs. 32.3 billion in 2014, the present Governor was able to reduce the losses to Rs. 19.6 billion in 2015. Therefore, the conversion of the profit-making Central Bank to a loss-making entity began under the dispensation of the previous Governor.

The aforesaid economist, by developing his argument further, says that if the Central Bank continues to incur losses, the capital funds of the bank may get depleted to the extent of becoming bankrupt. In this regard he further stated that the Central Bank’s transfer of funds to the Government out of its reserves to the tune of Rs. 28 billion in 2013 and Rs. 8.5 billion in 2014 when the bank was making losses, is tantamount to a loss making company paying dividends to shareholders.

In addition this economist has further drawn attention to another expenditure component incurred by the bank to fill up the shortfall of Rs.7.3 billion in the pension funds of the bank in 2015. (The actual cost for the year was only Rs. 1.3 billion) as indicated in the statement of other comprehensive income.

According to this writer all those transfers could also cause bankruptcy in addition to the losses of the bank. It should, however, be mentioned here that even after taking into account the above mentioned fund transfers, the Central Bank would never go bankrupt as its original capital of Rs. 15 million has now been increased to the maximum amount of Rs. 50 billion as required in the Monetary Law Act and if the Central Bank needs any more funds, it is in a position to issue currency notes and coins as long as it is acceptable to the public as legal tender without creating any undue impact on the country’s inflation. 

The ‘seigniorage’ earned on the issuing of currency notes and coins have the capacity to enhance Central Bank profits. Therefore the writer’s fear of the Central Bank going bankrupt due to the continuous losses of the bank is totally unfounded.

In any case, the performance of the Central Bank cannot be judged in terms of its profits or losses as it is not a commercial enterprise. In terms of the Monetary Law Act, the Central Bank of Sri Lanka was established as the authority responsible for the administration, supervision and regulation of the monetary, financial and payment systems of Sri Lanka to meet the objectives of (a) economic and price stability and (b) financial system stability with a view to encouraging and promoting the development of the productive resources of Sri Lanka.

Due recognition should be given to the monetary policy operations of the Central Bank going beyond its profits and losses in the accounting sense. 

As pointed out by Prof. S. Colambage, another eminent economist, a profit-making Central Bank is not necessarily better than a loss-making one, as the success of this institution depends on the way in which monetary policy is conducted and not by their profits or losses per se. On this basis the writer was of the view that the monetary policy adopted by the Central Bank since 2012 until the assumption of duties by the present Governor in 2015, had some adverse impact on the Sri Lankan economy. 

Prior to the assumption of office by the present Governor, the Central Bank reduced its policy interest rates continuously while defending the rupee at an overvalued exchange rate with the intention of reducing borrowing costs.

Such a policy had led to excess liquidity in the market, the overheating of the economy with resultant demand pressures as reflected in the continuous rise in import demand and core inflation even now. It is only during the last few months that the Central Bank has allowed greater flexibility in the exchange rate and interest rates so as to respond to market realities. Accordingly, the depreciation of the exchange rate and the rise in the market interest rate would help rectify macroeconomic fundamentals which had been in disarray for a long time. 

The increase in the interest rate of Government rupee bonds in the recent past should not be cited as an allegation against the present Governor as the cost of money would reduce aggregate public expenditure thereby reducing dependency on borrowings.

The Central Bank being the monetary authority of the country has broader obligations to be fulfilled in the interests of the national economy. When conducting its monetary policy operations focusing on national goals, it may incur unavoidable losses at times.

(The writer is a retired Senior Central Bank Officer.)