Central Bank Independence in the new Bill - A new media show or a new public mandate?
The recent media is full of news hailing the independence or autonomy given to the Central Bank by the new bill. Some state that this independence now will drive the economy out of the present economic crisis. They believe the crisis as a result of the political intervention in the Central Bank to print the money for funding the budget deficit as the present monetary law (MLA) has barred the Central Bank independence. Although money printing is a subject of macroeconomics, world over it is mostly spoken by politicians, some of whom even do not know the definition and economic role of money. Most do not know principles behind central banking.
The present Central Bank Governor immediately after assuming duties on 8 April 2022 victoriously commented that high inflation at that time was a result of printing about Rs. 200 bn under refinance credit against his view and he would independently and professionally cut down money printing and control inflation. He never talked about lapses in MLA restricting his independence from the government.
However, money printing to fund the government through Treasury bills has risen by sugar high Rs. 765.5 bn (net basis) so far in 10 months and inflation escalated to red hot from 18.7% in March 2022 to 69.8% in September and 50.6% in February 2023 (on new base of 2021). Now, the media claims that the MLA has unreasonably caused this Governor also to loose the independence and professionalism and to print money to fund the government while seeing inflation skyrocketing faster than before. As such, the MLA is the scapegoat for ills.
The independence implied by the most media favoring the Central Bank is the freedom or privacy given to the Central Bank bureaucracy to manage the bank and print money in the way they think fit. The media tends to think that the Central Bank is the monetary government in the country outside the elected government and that this bureaucracy possesses the perfect foresight of the economy and, therefore, everything they do is divine-correct.
Therefore, this article is released to present the true story behind Central Bank independence proposed in the new bill.
General meaning of Central Bank independence
The Central Bank independence generally means the ability of the Central Bank to conduct the monetary policy without influence of or bias over the fiscal policy. This implies avoidance of temptation to decide interest rates, money printing and bank credit creation favourable to fiscal deficit financing as well as avoidance of operational conflicts that support the fiscal policy and fiscal related functions.
Accordingly, I found several provisions in the bill that can be used to gage the policy-making independence of the proposed Central Bank. I find that those provisions are in grave conflicts and confusions that do not help establish so called independence or autonomy as hailed by the media.
Therefore, this article is to highlight some of those provisions to enable the reader to understand the true nature of the Central Bank independence sought in the bill and public issues and concerns arising from such provisions. Accordingly, 13 selected areas in the new bill are briefly presented below.
My conclusion is: the new Central Bank independence is only the removal of the Secretary, Ministry of Finance, from the Central Bank Board and restriction on credit to the government on a hidden motive of money printing to promote risky credit operations of a wide range of financial institutions under the monetary policy.
13 major areas connected with Central Bank independence
1. Independence of the Governing Board
- New bill section 8 - Removal of the Secretary to the Ministry of Finance
This is seen as the major provision for ensuring the independence because the Secretary is widely considered as the conduit for the government's influence. As the government is above the Central Bank, the absence of the Secretary being a principal officer in the government may cause a loss of macroeconomic policy support to the Central Bank, especially as Treasury circulars constitutionally can supersede the decisions of the Governing Board on Central Bank's internal operations.
In the MLA, the Secretary as a member of the Monetary Board is the principal instrument used lawfully for the co-operation between the government and Central Bank. John Exter wrote that this co-operation would depend more upon the men occupying the key positions at particular times than upon any legal formula, no matter how carefully or elaborately it might be worked out. Therefore, a sufficient time has to pass to see the outcome of the independence gained by removing the Secretary from the Board of the Central Bank.
- New bill section 125 - Present Monetary Board members to continue
This provides for the continuation of current members appointed by the President to the Monetary Board under the MLA as the members of the Governing Board until the expiration of their present term. This is bad governance in the independence.
- First, these members are the politically appointed persons to the present non-independent Monetary Board as claimed.
- Second, the new Central Bank as an independent Central Bank requires newly appointed independent members to ensure that the new Board is also brand new independent.
- Third, the new Board will have three additional members with special expertise appointed under the independence principle and, therefore, will have a conflict between the old members and new members.
Therefore, a merely hat-change of the present four Board members is not in good governance of the new Central Bank.
As such, this provision is not only in conflict of interest but also fraudulent in nature seeking undue pubic advantages to present members. If this is brand new independent Central Bank, we must get a brand new board as it is the board that has to drive the new Central Bank independently in letter and spirit while assuming the responsibilities of its public outcome.
The reference given in this section to the Secretary to the Treasury is baseless as the Secretary to the Ministry of Finance is the term used in the relevant MLA provision.
2. Prohibition of lending to the state
- New bill section 86 (1) - The Central Bank shall not, directly or indirectly, grant credits to the Government or any public authority owned by the Government or to any other public entity. This also includes purchase of securities in the primary market. However, the Governing Board can determine on grant of credit to state owned banks and financial institutions.
- New bill section 86 (4) - The Central Bank may purchase government securities in the secondary market without circumventing the prohibition laid down in the above subsection. This is a meaningless provision because indirect credit can cover purchase of credit/government securities in the secondary market as indirect credit is not defined in the bill. In fact, purchase of government securities, whether in primary market or secondary market, is a form of credit to the government.
These provisions raise grave public concerns, some of which are noted below.
- First, in that context, the new Central Bank as provided for in the section 31 has to depend on private credit and securities for open market operations as the use of government related securities is a conflict with the independence. In that event, the Central Bank will have to accept risky private stocks and debentures as OMO instruments whereas the money printing and country's monetary conditions will be dependent on risky and volatile stock market.
- Second, the new Central Bank gets an open space to use its monetary policy to develop risk-taking private financial markets, especially securities of companies friendly to high ranking officials of the Central Bank.
- Third, as the country's private bond/debenture market is mainly the bank debentures issued for capital adequacy purposes, the new Central Bank dealing in bank debentures for OMO purposes is not only taking credit risks of its regulated banks but also a conflict of interest by the Central Bank becoming a Tier II capital holder of regulated banks.
- Fourth, central banks globally are legally prevented from the excessive use of private securities in OMO and monetary policy, given their excessive risks and conflicts of interest. Central banks in the US, UK and EU which are treated as most independent central banks largely use government related securities for OMO and credit operations. For example, 93.5% of the Fed balance sheet is the OMO portfolio of government securities ranging from short term to long term (more than 10 years of maturity). Nearly, 98.5% of monetary policy assets purchase program in the Bank of England is government securities whereas it is 79.5% in the European Central Bank. The MLA provides for trade of only government securities for OMO. Central banks including Sri Lankan Central Bank use interest rates of government securities as benchmarks to regulate market interest rates for monetary policy purposes. As such, government securities are used in the monetary policy because of the long-term public trust in government debt as against private debt even if the stock of government debt is excessive or defaulted at times. For example, government securities market in Sri Lanka is active at present, despite speculations over restructuring of domestic debt with a haircut.
- Fifth, the restriction/prohibition on grant of credit to state sector will not only destabilize the financial system but also cause the new Central Bank to go bankrupt in the event of private securities market crashes or downturns. Globally, central banks not only keep away from stick markets but keep banks also at arms' length of stock markets due to high risk profile.
- Sixth, the discrimination on grant of credit between private institutions and the government/state is a constitutional violation, given state credit falls under public finance controlled by the Parliament and all enactments of laws including the proposed Central Bank bill fall within Chapter VI of the Constitution. Therefore, the Parliament to enact the new Centrak Bank with the power to discriminate the state from the private sector for credit operations is unconstitutional.
- Seventh, the state central banking across the world is built on money printing primarily through credit to government in the secondary market where such moneys created in the monetary system are distributed across the economy through fiscal policy. Therefore, the new Central Bank challenge this model by resorting to risky money printing through private credit. Therefore, the fiscal activity in financial markets to fund the budget independently from the monetary policy will hinder functioning of financial markets and stability.
3. Continuation of provisional advances and primary purchase of Treasury bills
These two are cited as two major conduits of the loss of independence on the ground that the Central Bank is compelled to print money to fund the budget deficit.
However, the new bill also provides for continuation of grant of new advances and purchase of new Treasury bills for another period of six months (sections 126 and 127) subject to certain limits, i.e., in the case of provisional advances, total advances up to 10% of the government revenue of first four months of the last year and, in the case of Treasury bills, total outstanding up to one-third of Treasury bill borrowing limit approved by the Parliament.
Further, section 128 provides for continued holding of outstanding advances and Treasury bills and conversion of same over a period of ten years into negotiable debt instruments at market interest rates. These new debt instruments are to be sold under OMO monetary policy and no timeline is stipulated in the bill.
Therefore, the new bill does not relieve the Central Bank from issues relating to independence connected with existing credit to government, especially on conversion of the outstanding credit and relevant market interest rates at the time of conversion over ten year-period.
Therefore, such outstanding credit will exist in the Central Bank balance sheet during an indefinite period in future.
It should be noted that MLA provisions (sections 89 and 112) on provisional advances and purchase of Treasury bills are very restrictive and highly disciplined where only the Central Bank has grossly violated relevant provisions in extending credit to the government. Therefore, what is necessary is to rectify the violation immediately and not abolish the law.
4. Seeking fiscal support for Lender of Last Resort (LOLR)
The section 36(6) of the new bill relates to grant of liquidity support in exceptional circumstances to financial institutions at stability risks for a maximum period of 180 days. The Central Bank requires an unconditional and irrevocable guarantee of the government for any losses incurred by the Central Bank from such loans for the sake of public interest. This raises many public concerns over the purpose of the new Central Bank.
- First, this is the conventional LOLR facility of central banks implemented to avoid financial crises. It is the stability and public interest duty of independent central banks. Therefore, seeking government guarantees or fiscal policy support for the LOLR causes both independence and pubic accountability on the financial system stability which is the second object of the new Central Bank.
- Second, the liquidity or funding required in such financial crisis times will be huge and, therefore, government guarantees would add to fiscal deficits and price instability in the future.
- Third, the LOLR is conventionally offered to banks to ensure the banking system stability being the core of maintaining the financial stability. However, this new LOLR is expanded to cover a wide range of risk-taking non-banking institutions or shadow banks (ranging from finance companies to money brokers) which are not regulated at the same extent of banking institutions. This causes huge moral hazard problem across the financial system. In fact, after 2007/09 financial crisis, the US government removed the authority given to the Fed to grant emergency loans to systemically important businesses during crises because of risks and abuses.
- Fourth, if the government is not willing to provide guarantees, financial system will crash as the new Central Bank does not have LOLR powers that now are available in the section 86 of the MLA. This happened to the Bank of England in 2007 (consequent to reform implemented in 1997) at the onset of the global financial crisis in September 2007. In that event, the Central Bank will tell the public that it does not have such emergency lending powers and blame the government for the financial instability.
5. Credit operations with credit institutions (licensed commercial banks)
The section 87 of the new bill provides for the Central Bank to undertake credit operations with licensed commercial banks as an agent of the government, provided that the government provides funding or secures such loans. Terms and conditions on loans will be decided by the government. The nature of credit granted under this provision appears to be development related credit up to a maturity of 15 years. This raises two major concerns over the purpose of the new Central Bank.
- First, credit distribution to suit the economy and sectors is the responsibility of monetary policy of central banks world over. However, the new bill passes it to the fiscal policy. Therefore, the government has to borrow from the market for on-lending to priority sectors.
- Second, if the government wants to undertake the credit delivery role, it can do it through state banks as being done now without any direct liabilities. Therefore, the government does not need the new Central Bank as the agent for this purpose.
- Third, this provision causes a conflict of interest to the Central Bank in two ways. First, the Central Bank becomes a fiscal agent of the government. Second, such credit operations carried on behalf of the government can hinder or conflict with monetary policy targets related to credit or monetary expansion as credit terms and quantity are decided by the government.
6. Continuation of fiscal agent, banker and financial adviser to the government
The section 81 provides for the continuation of above services which are the major conduits for issues relating to the loss of independence. As a banker and fiscal agent, the Central Bank has to pay the checks drawn by the government even when the government is in short of funds at the Treasury account with the Central Bank and, therefore, the grant of overdraft by the Central Bank to the government is inevitable to prevent the default of the government.
In view of the current literature of these services, it is surprising the the new bill also provides for them. In fact, the government does not need them. It has state banks for banking and fiscal agent services. The proposed debt office also can provide services of fiscal agent and financial adviser. In relation to debt restructuring, the government has obtained services of financial advisors from outside even though the Central Bank is the financial adviser.
Despite all these banking and fiscal services provided by the Central Bank for the past 72 years, the government has had to default and faced financial bankruptcy leading the a historic economic crisis in the country.
7. Council for the Coordination of Fiscal, Monetary and Financial Stability Policies of the Central Bank
The Section 83 provides for the non-executive council chaired by the Central Bank Governor. Such committees and discussions are the avenues for problems relating the independence. If the Central Bank wants independence to conduct the monetary policy, it is advisable the it stays away from such policy discussions with the government because such committees have no purpose other than influencing the Central Bank.
8. Cooperation with the Government
The section 84 provides for cooperation with the government and public authorities and exchange views on policies. Such cooperation is the conduit for implementing policies in line with the government's views. Accordingly, government influence has been formalized in the bill by way of cooperation. The MLA does not have such a general cooperation clause.
9. Public funds to cover risks and bankruptcy of the Central Bank
As per section 4 of the new bill, the government is the sole owner of the Central Bank and is required to provide capital in amounts as determined by the Central Bank Board out of the consolidated fund.
The section 97 of the new bill recognizes the possibility of bankruptcy of the Central Bank, i.e., the value of assets below monetary liabilities and paid-up capital, and requires the government to finance the deficit. Adoption of international accounting standards with fair valuations applied for financial businesses and dealing with private securities in the monetary policy are the sources of such bankruptcy risks.
Money printing is necessarily a lucrative business. Risk-taking businesses operated on borrowing also make profit. It is hard to imagine how other businesses remain solvent in the economy if the Central Bank is insolvent in money printing business.Therefore, how the Central Bank in the new bill managed by world class economists makes losses to become bankrupt and expects bankrupt government to make the Central Bank viable through new capital without being subjected to restructuring (like other SOEs) are questions of common sense that should be answered by architects of the new bill.
As the currency is issued by the Central Bank as its liabilities, the law must require the Central Bank to hold quality assets to cover liabilities at all times without depending on the government. If the government is to be responsible for the solvency of the new Central Bank, the autonomy is meaningless and the government itself should run the Central Bank.
It is unethical to expect the government to provide capital through the fiscal policy to cover up the risks of private credit securities trades (inclusive of possible securities fraud) of the independent Central Bank used for monetary policy when the Central Bank is prevented from the trade of government securities. In the event, the government rejects requests for such capital infusions and commences forensic audits on such bankruptcy, the Central Bank will internationally loose its credibility. Therefore, the independent Central Bank must be required in law to stay solvent at all times without any dependence on public funds to cover losses because the new Central Bank is managed by independent professionals and experts.
As the Central Bank is a state institution established under the Constitution, the autonomy is questioned on the ground who protects the public funds relating to capital of the new Central Bank. Further, the authority given only to the Central Bank to print money also relates to public funds. Therefore, it is necessary to invoke criminal clauses to cover monetary policy operations and non-compliances with objects. Otherwise, the Central Bank will pay games on public powers of the autonomy on money printing.
10. Removal of the Governor, Members of the Governing Board and Deputy Governors
Provisions in the section 19 allow such removals based on qualitative reasons. Therefore, state authorities can interpret such reasons suitably to remove those who contradict or do not support the government policies and views. Further, Attorney General also is a part of this removal process in respect of Governing Board Members.
Therefore, the autonomy or independence is only a concept on paper which does not have any practical purpose or validity.
11. Monetary policy framework agreement
In terms of section 26, Minister's agreement on monetary policy framework with regard to inflation target and other parameters is required. The Minister also can revise it in intervals he prefers.
Therefore, if the the Minister is smarter, he will sign off the agreement only if the monetary policy is consistent with his macroeconomic policy framework. If the government has a smart Finance Minister conversant in macroeconomic policy gimmicks, he will effectively run the monetary policy too with the credible threat of removal provisions stated above.
Therefore, the Central Bank has lawfully lost the autonomy mentioned in the new bill.
In the event the Minister sign the agreement as part of the bureaucracy not understanding the Central Bank policy rhetoric stated in it, the Minister also is responsible for missing policy targets and flawed parameters which are normal in the monetary policy. As such, the Central Bank has found a scapegoat for the monetary policy.
Under present MLA, the Central Bank is fully independent in the conduct of monetary policy. However, when policy targets are missed, it blames the government for fiscal deficit and borrowing as the cause for missing targets. In contrast, when targets such as inflation are met due to fiscal actions such as price subsidies and price controls, the Central Bank boasts of its prudent monetary policy.
12. Exempted from taxes
The section 115 provides for exemption of income tax, custom duties and stamp duties. If the Central Bank is an independent institution who can print money for its business operations, there is no rationale for granting such fiscal policy support to enable the Central Bank to report profit.
As the Central Bank is to operate on private credit, such tax exemptions will be subsidies to the private businesses. Therefore, the exemption is against the present fiscal policy priorities advocated by the Central Bank itself in association with the IMF.
13. External influence and instructions
Under section 5 of the bill, nobody can influence anybody in the Central Bank. However, same section provides for all in the Central Bank to seek or take instructions from any person and seeking professional or expert advice in the exercise, performance and discharge of the powers, duties and functions under the Act.
This provision lawfully allows Central Banks officials to take advice and instructions from anybody state or private. If the President or the Minister or the Secretary to the Treasury has academic qualifications or practical exposure in economics, banking and finance subjects, anybody in the Central Bank can approach them and take policy instructions as outside parties are not prescribed.
If some opposition political leaders criticize specific policies of the Central Bank and arrange public protests in front of the Central Bank, relevant officials of the Central Bank have no barriers to revise the policies.
Therefore, this provision itself not only removes the independence and but also shows possible incompetency of the Central Bank officials to carry out their public duties as they are authorized to seek or take advice or instructions from outsiders.
It is difficult to understand why such instructions or advice are permitted because the Central Bank has the authority to collect relevant information required for policymaking.
In that context, this provision is nothing but and independence joke.
Concluding Remarks
Above comments show that the only independence awarded by the new bill to the Central Bank is to remove the Secretary to the Ministry of Finance from the Central Bank Board and to willfully restrict and discriminate its credit to the state. Therefore, the new Central Bank appears to be an anti-government state bank funded by the government to promote private sector risk-taking at a cost to the public. The repercussions would no doubt destabilize the Central Bank as well as the financial system fairly soon after the enactment.
The opening of the Central Bank to all categories of financial institutions covering banks and non-banking institutions from finance companies to money brokers and all types of private securities for credit and OMO under the monetary policy is a grave risk to the monetary and financial system in special and macroeconomy in general. This is against international best practices of central banking.
There is a greater possibility of the use of monetary policy credit instruments even to destabilize the elected governments if the Governor or some members of the Governing Board or Monetary Policy Board being politically exposed persons are persons against the incumbent government.
It is possible that the opposition will use the new Central Bank as the conduit to overthrow the government and then change the Act promptly under the new government so that the influence or intervention of the Central Bank in the new government would not exist. In fact, John Exter in his report predicted this type of legal amendment in future if the Central Bank does not cooperate with the incumbent government. It is no secret that all apposition leaders target the Central Bank in their constant attempts to destabilize the incumbent government. The money printing charge is a regular event. If high ranking persons in the Central Bank also support the opposition openly or covertly, the government would be in trouble, given the monetary and regulatory powers vested in the Central Bank.
The architects of the new bill are under the impression that persons appointed to the Central Bank are super-human with perfect foresight and divine character and, therefore, the new Central Bank will be the only perfect public institution that can maintain domestic price stability with an inflation target and financial system stability. Therefore, the proposed bill appears to be a new divine model of central banking to the world at present when all central banks in the world are heavily criticized for grave economic imbalances shown by four decades high inflationary pressures and supply side impediments and contractions whereas some countries like Sri Lanka have gone into bankruptcy consequent to policy mistakes and mismanagement of central banks.
Therefore, the public is advised to ensure that the new Central Bank will be a public friendly Central Bank and not a bureaucracy friendly Central Bank under the mask of so called autonomy or independence which is a conspiracy against the elected governments.
In my last article released on 26 February, I showed how the new bill disrupts the country's sovereign monetary unit and the monetary system that have existed for the past 72 years driving the improvement in the economic welfare of the general public by facilitating the production, savings, investment, income and employment until onset of the present economic crisis.
(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)
P Samarasiri
Former Deputy Governor, Central Bank of Sri Lanka
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