Ravi K’s critique of Central Bank: An instance

of rendering the blame unto Caesar?

Blaming the Central Bank for

all economic ills

Tuesday, 2 January 2018

Former Finance Minister Ravi Karunanayake in an interview with Daily Mirror is

reported to have pronounced that the Central Bank is absolutely corrupt and
inefficient (available at: http://www.dailymirror.lk/article/Central-Bank-is-
absolutely-corrupt-and-inefficient-Ravi-Karunanayake-142963.html). This is an
important revelation since it has come from a former Finance Minister.

He has also opined that the current economic slump in which the growth rate
for 2017 has fallen even below the historical average of 4% is entirely the
handiwork of the bank. Though the Central Bank’s final accounts have so far not
been released, Karunanayake has revealed that the bank has made a loss of Rs.
2.1 billion in 2017. If true, this is a sequel to the losses made by the Central Bank
since 2013 except in 2016. He has charged that the bank was the biggest
problem he faced with some stooges of the former governor, meaning Governor
Ajith Nivard Cabraal and not Governor Arjuna Mahendran, still running the
bank. Yet, nothing had been done to cleanse the bank of these bad elements, he
laments.

Then, he had elaborated: “You could see it by its performance. You see the
economic growth rate coming down to 3.4%, the inflation rising to 8.4%. These
are what the opposition would like to see. These are the elements that ran the
economy down then. The govt has changed, but not the officials. They are
detrimental to the economy of the country. These Central Bank people live in
cocoons and try to toe the agendas of other people. I say it with absolute
responsibility that crooks are still remaining there.”

He has even confessed to the fact the Prime Minister under whose Ministry of
National Policies and Economic Affairs the bank has been gazetted for
administration purposes has been a victim. According to him, the bank has used
its autonomy to keep the “poor Prime Minister” in the dark. And as a result, the
Prime Minister had to take the blame for the actions of the bank which it had
done without consulting him.

Central Bank is not a sacred cow

The Central Bank is not a sacred cow that is beyond public scrutiny. It is a public
institution and should be subject to public review. Hence, Karunanayake has all
the right to express his critical opinion on the bank. As the Buddha advised in
Brahmajala Sutta to his disciples, the Monetary Board should take these
criticisms positively and tell Karunanayake that in this sense he is correct and in
that sense he is wrong. The country which advocates openness, transparency
and good governance needs such a fruitful dialogue very badly.
But, as mentioned before, the responsibility for managing the bank has been
vested by Parliament with a corporate body known as the Monetary Board
when it enacted the enabling legislation called the Monetary Law Act or MLA in
1949. And, hence, Karunanayake’s criticisms are levelled against the Monetary
Board and not the institution known as the Central Bank or its officers.

It is the Monetary Board which has to take credit for success or blame for
failure. Thus, when Karunanayake says that the Central Bank is inefficient and
corrupt, it is the Monetary Board which is inefficient and corrupt. A farsighted
Monetary Board will always take these criticisms positively.

Master is the Monetary Board

That Monetary Board consists of the Governor of the Bank as Chairman,

Secretary to the Ministry of Finance as an ex-officio member and three other
persons, known as private members, appointed to the Board on their expertise
in economics, banking and finance.

Of them, the Governor is appointed by the President on the recommendation of

the Minister of Finance; the three private members are appointed again by the
President on the recommendation of the Minister of Finance in consultation
with the Constitutional Council set up in Parliament.

The Secretary to the Ministry of Finance is appointed by the President but he

would not have appointed a person to that position unless he has got the
sanction of the Minister concerned.

The holders of positions of the Monetary Board today are all those who had got
those positions during the tenure of Karunanayake as the Minister of Finance.
Hence, it is a little awkward when he says that it is inefficient and corrupt since
he himself had a hand in creating it.

Monetary Board is autonomous

But the Monetary Board, as also has been admitted by Karunanayake, is an

autonomous institution. Except in the case of the Secretary to the Ministry of
Finance who can be removed at any time, once appointed, the Governor or the
three private members cannot be removed even by the President unless a
special procedure laid down in MLA is followed.

In the whole history of the Central Bank, a governor has been removed only
once and that was in 1954 when the late N.U. Jayawardena had occupied that
position. With respect to private members, there has not been any occasion
where a member has been removed by the government. This is the sanctity with
which the successive governments and their political leaders had treated the
Monetary Board as an institution in the past.

Finance Minister or Prime Minister cannot issue directions to Monetary Board

Following the practice relating to all the central banks in the globe, the
Parliament has dictated that the Monetary Board should enjoy independence
with respect to its policy, known as the policy independence, and to its budget,
known as budget independence.

Accordingly, the Minister of Finance or even the Prime Minister or the President
cannot issue any direction to the Monetary Board. This is different from the
provisions relating to other public institutions in which the Minister concerned
can issue general or specific directions to the Boards of Directors of such
institutions and once they are issued, it is the responsibility of the boards
concerned to implement them. If the Boards fail to implement them, the
Minister has powers to remove directors in most cases, without assigning
reasons.

But, there could be instances where there is disagreement between the

Monetary Board and the government with respect to certain policies. For
instance, the Board may be of the view that interest rates should be increased
in order to fight inflation, while the government may feel that they should be
lowered to stimulate economic growth. MLA has provided for in Section 116(2)
how such disagreements should be dealt with. Accordingly, if the government
and the Board cannot reach agreement, the Minister of Finance can direct the
Board in writing that it should carry out the directions of the government but
the Minister has to clearly indicate that the government would take full
responsibility for the consequences that may be brought in the economy as a
result of implementing such directions.

Again, in the whole history of the Central Bank, it was only on one occasion that
the government resorted to this special provision. That was in 1959 when
Wijayananda Dahanayake was the Prime Minister; in this case, the emerging
adverse macroeconomic conditions of the country did not warrant the Board to
reduce interest rates. But the government, thinking of winning the elections to
be held in the following year, directed the Board to reduce interest rates.
However, this strategy did not work and the Dahanayake government could not
win the elections; even the Prime Minister Dahanayake lost his seat in
Parliament.

Budget independence

The Monetary Board enjoys the budget independence because its budget,
unlike other public institutions, need not be approved by Parliament. This
independence is necessary to enable the Monetary Board to take its policy
measures without the fear of losing its budget.
Politicians have always grumbled about this special independence afforded to
the Central Bank by Parliament in 1949. Since they feel that they can do
anything in the country, except perhaps turning a man into a woman or a
woman into a man, they always try to grab powers to intervene in the affairs of
the Monetary Board.

Independence is needed to protect people’s money

However, there was a very good reason for the Parliament in 1949 to keep the
Monetary Board independent from the successive politicians. That is because a
central bank is a unique creature with powers to print money and buy assets.
This power has to be used by the Monetary Board responsibly, since any
excessive printing of money at the bidding of politicians would result in inflation
causing the public to lose the buying power of the moneys they hold.

Though the Board is appointed by the political authority of the country, its
obligation is not to such authority but to the general public. To serve the public
properly, the Monetary Board should be independent from outside parties
including the political authorities.

While the Central Bank of Sri Lanka is a semi-autonomous institution, central

banks in Germany, UK, France, Australia, New Zealand and Canada have been
made fully independent from the government. The present tendency is for the
central banks in other countries too to follow suit.

Politicians are like kids

Politicians have been kept away from central banks because of the tendency on
their part to abuse the money printing powers vested with central banks. This
power is equated to a cookie jar with no lid; the Minister of Finance who is
equated to a kid cannot resist the temptation to eat cookies as much as he
wants.
If the central bank is not independent, the Minister of Finance, like the kid with
limitless desires to eat cookies, will direct the Monetary Board to print money
freely and make it available to him for meeting extravagant expenditure
programmes. This is dangerous and will result in people losing the value of
moneys they hold.

Hence, the Monetary Board have been given power by Parliament to keep the
lid of the cookie jar tight so that the Minister of Finance cannot eat cookies as
much as he wants. This is the autonomy which the Monetary Board enjoys to
serve the public that has been questioned by Karunanayake in the interview
under reference. This is a dangerous trend that should be prevented at any cost.

Karunanayake’s attempt at steamrolling the Monetary Board

During the two-year period he held the Finance portfolio, Karunanayake tried to
steamroll the independence of the Monetary Board on a number of occasions.
This writer in a number of articles published in this series drew the attention of
the public to this ominous development.

In August 2016, an article titled ‘Be warned! Monetary Board is losing its powers
as well as independence’ criticised the Minister’s attempt at grabbing the
powers of the Monetary Board and eroding its independence (available at:
http://www.ft.lk/columns/be-warned-monetary-board-is-losing-its-powers-as-
well-as-its-independence/4-562766). The Finance Minister’s interference with
the Monetary Board in proposals in Budget 2017 was highlighted in an article
published in November 2016 (available at: http://www.ft.lk/columns/budget-
2017-significant-improvement-if-not-marred-by-policy-inconsistencies-and-
interference-with-th/4-580074).

The unsavoury sign of Finance Minister’s steamrolling the Monetary Board was
brought to public’s knowledge in another article published in January 2017
(available at: http://www.ft.lk/columns/steamrolling-of-central-bank-by-
minister-of-finance-an-unsavoury-development/4-593041). The Prime
Minister’s instructions to remove the direct placement of Treasury bonds with
primary dealers in 2015 was considered as an erosion of the independence of
the Monetary Board, in another article published in October 2017 (available at:
http://www.ft.lk/columns/Vision-2025-Part-4--PM-s-alleged-instructions-to-
remove-direct-placements-are-against-the-Vision/4-641107).

The objective of these articles was to put good economic sense to the politicians
in power so that they would refrain themselves from taking action to erode the
independence of the Monetary Board. However, now it appears that this
message has not been conveyed to the political leaders concerned. Hence, it is
now left to the civil society to raise its voice to prevent myopic politicians from
making attempts at subjugating the Monetary Board which result in the public
losing the value of money they hold.

Communication channel with Government is through Finance Minister

Karunanayake has alleged that the Monetary Board has kept the Prime Minister
in the dark. This refers to a communication gap between the Prime Minister and
the Monetary Board.

As highlighted by the architect of the Central Bank, John Exter, in the Exter
Report, the communication channel between the Monetary Board and the
government is through the Secretary to the Ministry of Finance.

Justifying why Secretary should be made a vote carrying member of the

Monetary Board, Exter has said that it would serve a bigger purpose. That is, the
Finance Secretary will function as the communication conduit between the
government and the Monetary Board.

On one side, he would make the views of the government known to the
Monetary Board. On the other, he would take the views and the position of the
Monetary Board back to the government paving way for a free dialogue
between the two bodies.

If the Prime Minister has been kept in the dark, that is due to the failure of the
Finance Secretary to keep the Minister informed and, if it had been done, the
failure of the Finance Minister to keep the Prime Minister informed. This writer
recalls that this communication channel worked effectively prior to 2009.

Current inflation is due to money printing in the past

Inflation is picking up today due to excessive money printing done in the past.
The main culprit in this case has been the Government which has borrowed
from the banking sector on a net basis. Between December 2014 and December
2016, the Ministry of Finance had borrowed from the banking sector on a net
basis a total of Rs 545 billion, an increase of 25% over the level in December
2014.

This is an instance of the Minister of Finance helping himself from the open
cookie jar freely. The consequential increase in money supply has increased the
total demand for goods and services over and above the total supply putting
pressure for the prices to increase. Thus, the fiscal dominance over the
monetary policy has been the one to be blamed for the current rising inflation.

The solution has been to keep the lid of the cookie jar tight so that the Minister
of Finance cannot put his hand into it freely and help himself. As a measure to
do so, the Monetary Board is now planning to introduce a flexible inflation
targeting system as from next year. It is encouraging that the consent of the
new Finance Minister and the Prime Minister has been given to the Monetary
Board to implement this programme.

An instance of rendering unto Caesar

In the old Roman Empire, political leaders often abused their powers quoting
that they were Caesar’s instructions. Thus, Caesar was blamed for every bit of
failure of the system. Are the criticisms levelled against the Monetary Board
today an instance of attempting to render it unto Caesar?
The next part will look at how far the Central Bank is responsible for the current
economic slump in the country as alleged by Karunanayake.
(W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka,
can be reached at waw1949@gmail.com.)

Posted by Thavam