Monetary Board collectively accountable for imprudent policy decisions

 

Tuesday, 31 May 2022 

The ill-conceived monetary policy measures adopted by the Central Bank of Sri Lanka (CBSL) since November 2019, which included excessive currency (notes and coins) issues, interest rate ceilings, fixed exchange rate, direct credit controls, and foreign exchange rules, have caused irreparable damage to the economy. This is reflected presently in the sky-rocketing inflation, rapid rupee depreciation, high interest rate costs, near-zero foreign reserves, consumer goods shortages, depleting pharmaceutical products, and long queues for fuel, cooking gas, and other essentials. 

Eventually, Sri Lanka has become a bankrupt country with the Government’s declaration of its inability to service foreign debt last month consequent to the drying up of foreign reserves.

In this background, the nitty-gritty of the key policy measures taken by the Monetary Board (which is the governing body of CBSL) surfaced at the meeting of the Parliamentary Committee on Public Enterprises (COPE) held last week.

Revelations at COPE meeting

Giving evidence before the COPE, the appointed member of the Monetary Board, Dr. Ranee Jayamaha stated that she and her counterpart Board member, Sanjeeva Jayawardena were vehemently opposed to fixing the exchange rate at Rs. 203 per US dollar and depletion of CBSL’s foreign reserves for the purpose. She mentioned that their objections were minuted at the respective Board meetings. She further noted that the Government was of the firm view that the exchange rate should be fixed to portray favourable debt ratios. 

Dr. Jayamaja stated that despite their objections, the Monetary Board decided to adopt the fixed exchange rate policy stance, as the other three Board members – Prof. W.D. Lakshman (Chairman of the Monetary Board and Governor of the Central Bank), S.R. Attygalle (Secretary to the Treasury and Ministry of Finance), and Samantha Kumarasinghe (appointed member) – voted in favour of that option, Dr. Jayamaha mentioned that this decision was taken on the basis that the concurrence of at least three members out of five is sufficient to adopt Board decisions. 

Playing the blame game

Although Dr. Jayamaha’s revelation is commendable at this critical juncture, the entire Monetary Board should take responsibility for its policy decisions, as very correctly pointed out by MP Dr. Harsha de Silva at the COPE meeting. In this regard, her revelation is tantamount to nonobservance of the collective responsibility of the Monetary Board.

It would have been more appropriate for the two dissenting Board members to distance themselves from the wrong decision of fixing the exchange rate by stepping down from the Monetary Board with dignity rather than immorally blaming others now when the ship is sinking. Both of them are continuing to retain their position on the Monetary Board up to now implying their endorsement of its policy decisions without any reservation. 

In contrast, the former appointed members, Dr. Dushni Weerakoon and Nihal Fonseka were reported to have stepped down from the Monetary Board previously due to differences of opinion.

Public officers unaccountable

At the COPE meeting, MP Patali Champika Ranawaka legitimately questioned who is responsible for adopting an unrealistic fixed exchange rate causing severe damage to the economy including a substantial loss of foreign remittances to the country. He said that unlike the public officers, the politicians are accountable to a greater extent as they can be sent home at periodical elections depending on their performance. In the present circumstances, they could even be assassinated on the road or their houses could be burnt, he said. 

MP Ranawaka rightly stressed that the entire Monetary Board which adopted wrong policies including the fixed exchange rate and money printing that led the country to bankruptcy should be held responsible.

In a recent FT article, I elaborated on how the two former CBSL Governors, former Secretary to the Treasury, and former Presidential Secretary along with the political authorities were instrumental in pushing the economy to the current predicament (https://www.ft.lk/columns/Economic-mess-looms-with-interest-rate-shock-and-debt-default/4-733537).

Accountability of central banks

It is widely recognised that in a democratic system, central bank independence must always be accompanied by adequate mechanisms of accountability. Accountability can be defined as an obligation owed by one person (the accountable) to another (the accountee), according to which the former must give account of, explain and justify his/her actions or decisions against criteria of some kind, and take responsibility for any fault or damage.

While too broad independence may lead to an unacceptable ‘state within the state’, too much accountability threatens the effectiveness of independence. Therefore, central bank independence and accountability need to be blended carefully when designing the relevant legislation.

Bank of England’s accountability and transparency

The Bank of England (BOE) has undergone a series of reforms and structural changes over the last two decades on the premise that “a transparent, accountable and well-governed central bank is essential not only for effective policy, but also for democratic legitimacy”. 

The BOE exercises accountability via several formal and informal mechanisms, including (a) parliamentary scrutiny, with the Governor and other BOE officials being called to testify in front of the Treasury Committee (TC), and (b) reporting requirements, such as the obligation to publish the minutes of the meetings of the Monetary Policy Committee and the publication of the Bank’s Inflation Reports on a quarterly basis (which inform also the questions posed to the Governor by the TC).

Since 1997, the BOE has been publishing the minutes and votes of the Monetary Policy Committee (MPC). In 2014, its transparency, accountability, and governance were further broadened by deciding to publish in part a transcript of the meetings of MPC. It was also decided to publish the minutes of the meetings of the Court of Directors (the governing body of BOE). 

CBSL’s accountability limited

It is evident from the COPE proceedings how individual members of the Monetary Board can conveniently evade accountability for ill-designed monetary policy decisions that plunged the country into bankruptcy and washed their hands of past sins. As rightly pointed out by MP Ranawaka, it is unknown who is responsible for such unwise decisions. 

A Monetary Board member can easily escape from his/her responsibilities in such a manner as the Monetary Law Act (MLA – the law under which the CBSL operates) does not contain any specific clauses concerning the accountability of the Board members.

Money printing to continue

Prime Minister Ranil Wickramasinghe announced a few days ago that the Government will raise the upper limit of Treasury bill issues from Rs. 3,000 billion to Rs. 4,000 billion shortly to mobilise money to pay public servants’ salaries and to meet other urgent needs. He also mentioned, therefore, that printing large quantities of new money is inevitable. It means that the CBSL will have to purchase the bulk of the Treasury bills issued causing further rounds of increase in the money supply and consequently, the general price level.

This is a dangerous move, as the root cause of the present economic ills has been the Government’s excessive use of borrowings from the CBSL to fill up the huge shortfall in its revenue caused by politically-motivated tax cuts enacted immediately after the Presidential election in November 2019. 

Such bank borrowings led to an increase in the money supply by 18% during the last 12 months and escalate the annual inflation to over 30% by now. 

Continuing to accommodate the fiscal deficits by the CBSL through new currency issues as per PM’s announcement will deepen the present economic crisis.

Managed floating unlikely to arrest rupee depreciation

Meanwhile, the CBSL reintroduced managed exchange rate floating with effect from 13 May 2022, after a lapse of two decades. A managed exchange rate float, also known as ‘dirty float’, is an intermediate regime in which the exchange rate is neither entirely fixed nor free-floating. Instead, the value of the local currency is kept within a band against a foreign currency (or a basket of currencies) by central bank intervention. 

As I discussed in a recent FT column, as long as the official exchange rate band is kept below the market-clearing level in the backdrop of near-zero foreign reserves, the black market foreign exchange transactions will continue to thrive despite CBSL’s stern warnings (https://www.ft.lk/columns/Managed-exchange-rate-floating-unlikely-to-rescue-the-falling-rupee/4-734939).

Balancing accountability and CB independence critical

At present, the CBSL seems to operate on a hand-to-mouth basis rather than formulating monetary policy based on a sound macroeconomic framework geared to tackle the current economic crisis. It depends heavily on obsolete direct controls such as foreign exchange restrictions, mandatory export proceeds conversion, banning informal remittance channels, policing forex dealers, and monitoring forex flows. While such controls may help to ease the balance of payments crisis during these difficult times, their adverse effects on the economic recovery process in the medium-term cannot be underestimated. 

For example, the recent suspension of open account transactions for imports by the CBSL is likely to magnify enormous hardships already experienced by consumers and entrepreneurs due to further import shortages. Open account transactions are generally used between an exporter and an importer with a trustworthy trade relationship built over many years, where the exporter allows the importer to make the payment for the imports whenever the importer has money, without stipulating a particular time limit. Thus, banning open accounts further restricts imports. 

The Monetary Board’s strength in reacting to the Prime Minister’s recent demand for increased money printing through exorbitant Treasury bill issues is yet to be tested. 

Meanwhile, in a special televised address, the PM announced last Sunday several proposals to strengthen Parliament which include the setting up of a larger number of new committees as well as an all-party National Council. Thus, political agendas seem to be given priority once again sweeping the urgently-needed economic recovery strategies under the carpet. 

In fulfilling the CBSL’s core objective of maintaining price and economic stability, it is the utmost responsibility of the Monetary Board to keep the right balance between accountability and central bank independence, instead of blindly bending to political masters. 

(The writer, Emeritus Professor of Economics at the Open University of Sri Lanka and a former Central Banker, can be reached at sscol@ou.ac.lk.)