New Central Banking Act – Will it destroy or upgrade the country’s money and monetary system?
The media reported that the Cabinet, subject to further
discussion of the views, approved a new Act as an improved version of the
present Monetary Law Act (MLA) to facilitate operations of the Central Bank (CB)
more effectively and efficiently in line with present requirements. The CB
Governor repeatedly stated that new legal provisions would be introduced to
grant the autonomy to the CB as a part of new macroeconomic management policy
framework agreed with the IMF
As the proposed Act is not available for public information,
it is not possible to comment on the efficacy of the new Act as compared to the
MLA that has been tested for 72 years with several amendments introduced from
time to time without hurting the its macroeconomic policy framework. The architect
of the MLA is John Exter, an Economist of the US central bank, the Federal
Reserve System established in 1913.
Therefore, this short article, hoping that legal officers of the CB are smarter macroeconomists than John Exter to draft a new Act to replace the MLA, is released to highlight the macroeconomic management framework introduced through the MLA in 1949 to drive the post-independent Sri Lanka for economic development through an independent monetary system in place of the Currency Board System.
Salient Features of the MLA
The salient features of the macroeconomic framework laid down
in the MLA for independent Sri Lanka are as follows.
- The MLA was enacted to establish the monetary system of Sri Lanka and the Central Bank as the authority to administer and regulate the system and to conform and impose upon the Monetary Board of the powers, functions and responsibilities necessary for the purposes of such administration and regulation and to provide for connected matters.
- Accordingly, the Monetary Board is the corporate body and is authorized to determine several policies or measures in the MLA in addition to vesting it with the powers and functions of the Central Bank where the Monetary Board is generally responsible for the management, operations and administration of the Central Bank. Therefore, the Monetary Board is the monetary authority in the country.
- Therefore, the MLA first established the monetary unit or standard for the country and entrusted it with the Monetary Board for administration and regulation in terms of policy actions authorized in the Act. Accordingly, the standard unit of monetary value in the country is rupee, represented by the signs “Re.” and “Rs” and divided into one hundred units, each of which is called a “cent”. Then, several provisions have been made to determine the par value and parities (exchange rates) of the rupee. If there is no standard monetary unit in law, people may use different monetary units such as foreign monetary units (e.g., US Dollar and Pound) to serve as money freely.
- Accordingly, the MLA creates the means of payments within the monetary unit where currency notes and coins are created as the official legal tender for payments. Currency is the financial liability of the Central Bank and issued on behalf of the government. However, this liability is not a liability covered by any asset or a class of assets of the Central Bank or the government in line with business accounting and bankruptcy laws, but a liability to repay any currency on demand with currency notes and coins of different denomination to the holder. Therefore, currency is not a repayable liability in business contracts. In private monetary systems prior to the present state money system in countries, governments determined the standard monetary unit such as Dollar in the US and Pound in the UK and private banks operated banking through their owned branded currency notes and coins in such monetary units. Therefore, the standard monetary unit is the foundation of a monetary system to serve the functions of money, i.e., a means of payment, an unit of account, a liquid store of value and a medium of deferred payments.
- The national monetary policy is stipulated with principles and rules to ensure that the monetary system is used for macroeconomic objectives stipulated in the MLA. In the monetary policy, the Monetary Board is empowered to regulate the supply, availability and cost of money or legal monetary unit by having regard to the monetary needs of particular sectors of the economy as well as of the economy as a whole and to maintain the par value of the rupee and so to regulate its exchange with other currencies as to assure its free use for current international transactions. These principles and rules have been stipulated under domestic monetary stabilization and international monetary stabilization categorized under the national monetary policy. The most part of the MLA relates to actions authorized on the national monetary policy as the MLA governs the monetary system of the country.
- The Economic Research Department and Director of Economic Research were created in the Central Bank as independent authorities to carry on research on money and banking and other economic subjects of general interest to guide the Monetary Board in policymaking and for information of the public.
- As the monetary system runs on the banking system, the Bank Supervision Department and Director of Bank Supervision were created in the Central Bank to regulate and supervise banks to promote their prudence and stability. The Monetary Board also was given wide powers to regulate banks and resolve problems banks including emergency credit facilities (or lender of last resort) and deposit insurance. This was necessary as there was no bank supervision framework in 1950. However, since 1988 the Banking Act has been in place, but MLA bank supervisions and regulation powers have been in prime use.
- The Monetary Board was empowered to establish any other Departments and branches, agencies and correspondents in other places in the country or abroad for the proper conduct of the business of the Central Bank.
- Initial four objects of the Central Bank that should be secured as far as possible by actions authorized in the MLA were as follows.
1. The stabilization of domestic monetary values
2. The preservation of the par value of the Ceylon
rupee and the free use of the rupee for current international transactions
3. The promotion and maintenance of a high level of
production, employment and real income in Ceylon
4. The encouragement and promotion of the full development
of the productive resources of Ceylon.
Amendments introduced in 2002 resulted the following two objects of highly conceptual context that raises grave issues relating to assessment and measurement on the performance of the Central Bank and Monetary Board with regard to objects.
1. Economic and price stability; and
2. Financial system stability, with a view to encouraging and promoting the development of the productive resources of Sri Lanka.
It is seen that analysts in the Central Bank as well as outside lightly talk about the objectives of the Central Bank as economic and price stability and financial system stability in their own interpretations without making any reference to the text “with a view to encouraging and promoting the development of the productive resources of Sri Lanka” which is the condition imposed on the outcome of the objectives.
- Several fiscal functions were assigned to the Central Bank to ensure that the fiscal policy evolves in harmony with the monetary system. Fiscal agent, public debt management, financial advisor, banker of the government and limitation on advances to the government are some of them. Certain powers are assigned to the Monetary Board to issue directions to state institutions on fiscal operations and to approve foreign loans of the government as well as loans raised by state institutions. All these provisions are to ensure that fiscal operations are not impacting the monetary conditions of the economy regulated in the monetary policy by the Monetary Board.
- Annual Report, financial statements, profit and loss calculation, distribution of net profit to the government and capital have been stipulated in the MLA. As the capital is fully owned by the government, it is a fully government owned institution. The profit of Central Bank is a simple operation as it does not pay interest on currency liabilities that are never repaid and charge interest on loans granted to the government and banks and foreign assets undertaken through printing of money at lowest risks. Therefore, the Central Bank does not require financial experts to run its operations to maximize profit as in the case of business firms as money printing business never can realize losses unless it is mismanaged. Therefore, central banks generally operate through banking for the government (taking deposits and lending) where the overall magnitude of risks involved in operations with private banks is negligible.
- The Minister of Finance is authorized to issue directions to the Monetary Board as to the monetary policy of greatest possible advantage of the people of the country in view of the opinion of government while the government taking its responsibility. This is because it is the elected government that should accept the responsibility of all policies of the state institutions and not by unelected officials who operate the institutions.
Overall Comment
In view of above highlights, it is necessary that the
lawmakers fully understand the provisions of the MLA long with the Exter Report and its macroeconomic management
framework legally implemented in Sri Lanka within the Constitution.
Some may comment that the current economic crisis is a
result of lapses in the MLA to resolve new problems. It is not correct if the relevant provisions in the MLA are understood
literally.
In fact, the economic crisis is a result of the failure of
the Central Bank/Monetary Board to implement the monetary system in compliance
with the MLA. The government debt and foreign currency problems which are the roots of the present crisis are the results of the mismanagement
of the monetary policy and fiscal functions in violations of the principles and rules laid down in the MLA.
Therefore, if the Monetary Board finds the MLA as the scapegoat and proposes a new Act to replace the MLA under the cover of the IMF, it is highly likely that the major provisions relating to the monetary unit, monetary system, banking stability, prudence of monetary policy instruments including their risks and diversity will be wiped out without any notice. It is the common habit of bureaucrats to enact new laws to cover up their failures at the time of national crises. Such new laws passed in hurry are involved in new mismanagement of public duties.
If the macroeconomic
management framework set out in the MLA is lost, the monetary system including
the banking system will confront havoc in due course and operations of the Central
Bank will encounter conflicts on a daily basis. This will delay the recovery of
the economy for decades. In that instance, the good name of the present Minister of Finance who submits the new Act to the Cabinet and Parliament will be encrypted in the economic history of Sri Lanka unlike J R Jayawardena for the MLA and establishment of the Central Bank as a milestone of the economic development of the independent Sri Lanka.
I hope that at least one expert who is knowledgeable in the MLA with Exter Report and global central banking literature will read the new Act carefully to ensure that the country's monetary system advances without major disturbances and crises. I know that it will not happen in the Central Bank as the officials are only concerned about drafting sections/areas allocated to them in micro manner in limited office hours.
Since we do not have an expert like John Exter to take the responsibility
of the new Act, somebody must be responsible for such a national task as lawmakers
will not understand the technical/macroeconomic meaning of any provisions in the Act, given
their technicalities. Further, the relevant authorities must submit the Act to
the Parliament with a report similar to the Exter Report carrying explanations
for each provision.
It is highly advisable that if the new Act along with a Report
is made available to the general public for information and comment because the
proposed new Central Bank is not a private institution belonging to the new Monetary Board,
but an apex public institution funded by the public to be responsible for
securing the public confidence in Sri Lankan monetary unit and the monetary
system behind it, given the fact that currency is issued on behalf of the governments are the Monetary Board/Central Bank functions through the authority granted by the public.
P Samarasiri
Former Deputy Governor, Central Bank of Sri Lanka
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