The media reported that His Excellency the President blasted
the Central Bank officials during a meeting held at President’s Office on 15
June 2020. The core of HE’s talk was that the actions taken by the Central Bank
during the past few months since the spread of the pandemic were par below what
it should have been. IS THAT TRUE?
The Central Bank
Objective
The Central Bank has two main objectives to fulfil; maintain
low inflation and maintain financial system stability. The focus of this piece
is on the former, which is responsible for state of economic activity. Majority
of the central banks around the globe has one core objective: maintain low
inflation. Accomplishing this objective has wide range of benefits; the
foremost being that it creates an environment to have sustainable economic
growth. The CBSL was able to maintain low inflation during the past decade,
using its main tool, the interest rate. The value of maintenance of low and
stable inflation prevails when it is not observed. For example, recently, the
lack of low inflation required the country Zimbabwe to abandon local currency
and adopt US dollars, amidst many other economic hardships experienced by the
general public.
So, if the CBSL was successful so far of its objective of
price stability, why blame. HE’s claim was that the CBSL did absolutely nothing
during the pandemic to support economy. In such a context, as HE rightly points
out a central bank’s role is to pump sufficient money to the financial sector
at appropriate levels for the economic revival. Did not the CBSL do that?
So the CBSL has done nothing during the pandemic until 15
June 2020?
The CBSL recognised immediately the will be impact of the
pandemic, where it published in a press release on 30 January 2020 which was
praised by international media working on central banking
(centralbanknews.info) as the CBSL was the first central bank to mention
economic impact of COVID-19 spread. Since then, until 14 June 2020, the CBSL
has carried out a series of measures to support the economy. First and
foremost, the CBSL excessively supported the government by carrying out a
Treasury bill purchasing programme, which purchased (or printed new money) at
unprecedented levels of around Rs. 240 billion (or 1.5% of GDP) worth Treasury
Bills. Treasury bill is government’s short term financing method, the CBSL
purchase helped the government to honour its short term financing
responsibilities and also reduce cost of debt. Treasury bill interest rates
dropped drastically with the CBSL purchasing programme. The CBSL reduced policy
interest rates by 1.5% and reduced statutory reserve requirement ratio by 1%
releasing around Rs. 60 bn to the banks to loan out and provided ample money to
the market through central bank open market operations. By 14 June, banks had
excess money of around Rs. 100 bn which could be loaned out to the private
sector. Also, the CBSL capped pawning related loans at 12% and imposed caps on
credit card advances. In addition, the CBSL provided Rs. 27.5 billion towards a
4% working capital loan programme of Rs 50 billion, where the remaining balance
was to be provided by the government.
Below table summarises
major money and interest related actions taken by the Central Bank during the
pandemic:
Some of the policies implemented by the Central Bank
during the Pandemic
| Date |
Action |
Outcome |
| 30-Jan |
Cut interest rates by 0.5% |
Lower market rates |
| 30-Jan |
Credit support to SMEs |
More loans to SME sector |
| Since March |
Treasury Bill Purchasing Programme |
Released Rs. 240 bn (or 1.5% of GDP) to the
Government |
| 17-Mar |
Cut interest rates by 0.25% |
Lower market rates |
| 17-Mar |
Lower SRR by 1% |
Release Rs. 60 bn to the banks to make loans |
| 27-Mar |
Rupees 50 Billion working capital loans at 4% |
More loans to SME and other sectors |
| 3-Apr |
Cut interest rates by 0.25% |
Lower market rates |
| 27-Apr |
12% maximum interest rate on Pawning |
Lower market rates |
| 11-May |
Cut interest rates by 0.50% |
Lower market rates |
Why the CBSL could not provide these easing measures and
more, at once?
The CBSL makes decisions
based on data. The management analyses available information and makes
decisions. The difficulty in central bank decision making is that the
realisation of full impact of the decisions may take more than two years. For
example, excessive lowering of interest rates or provision of fresh money to
the economy, may lead to unwarranted price hikes in few years time. Excessive
money in the market at low interest rates makes easy private sector loans
leading to excessive money in the economy than goods in the market. This simply
inflates prices and if not handled carefully could lead to hyperinflation.
Hyperinflation is simple excessive acceleration of prices of goods over time,
too much money chasing too little goods! For example, a loaf of bread today
priced at Rs. 50 could be doubled next day. This is exactly what Zimbabwe and many
other countries experienced in the history, as mentioned at the beginning of
the note. History repeats!
So why HE blames the Central Bank?
It appears that the
President’s office was so busy with other things but had no time to update HE
of the series of policy measures that the CBSL had already implemented during
the pandemic as mentioned above. If he had to be known at least few of the
above polices, he would have taken a different stance!
HE’s main point was the inability of CBSL’s financing of Rs.
150 bn working capital loan. If the government had enough leeway of borrowing,
the CBSL would have bought more Treasury bills and finance the programme.
However, unfortunately, the government has run out all the leeway!, and asking
the CBSL to finance. The CBSL is governed by the Monetary Law Act. All the
tools that the CBSL uses should be consistent with the law. Accordingly, as was
told, weeks of discussions and deliberations had provided a complex way to
finance the loans within the law, which was approved by the Central Bank’s
board on 15 June 2020.
May HE the President recognises that the CBSL is not a
regular government department but an institution which has a different mandate
and expected to be independent of politically elected leaders for the benifit
of the general public. However, this does not mean that the CBSL should not
support government’s economic programme.
Why not the Central Bank become a part of the Finance
Ministry, so HE has the full control of the proceedings and issue heaps of
money to the economy?
Central banks around the world possesses some sort of
independence from the government. But why? As mentioned above, the actions of
central banks today affects fully in two or three years time. However, the
politicians, who are in short political cycles want to stimulate the economy
today by pumping money and be elected for the next term. Therefore, politicians
want keep printing money without thinking of possible economic hardships in the
medium term. The following Sinhalese old adage sumarises the situation:
kakuluwa diya kelinne wathura natakan withrai!. Accordingly, central banks
around the globe, including the CBSL, has been rightfully formed to be
independent to a certain extent of the politically elected parties.
Conclusion
The CBSL had carefully implemented an array policies to lower
market interest rates and pump money to the economy through various tools
during the pandemic to revive economic activity. The stimulus packages provided
to the economy overtime is expected to improve money circulation in the economy
when the commercial banks commence making loans. The type of meetings that HE
the President chaired releasing unnecessary pressure on the activities of the
CBSL, would never help either the economy or the general public at large. The
repercussions of non independence of the CBSL and pressuring printing of money
excessively which is not consistent with economic conditions, could be
devastating, primarily in terms of excessive hikes of prices of goods in years
to come. All seem to have forgotten that inflation was well managed during the
past decade or so and has taken it for granted! The educated and other people
who are overjoyed by HE’s talk at the said meeting will realise the importance
of careful handling of central bank decisions on a day that price stability is
lost!
Once an American comedian Will Rogers mentioned in 1930’s
“there have been three great inventions since the beginning of time: fire, the
wheel and central banking”
-by a person who loves central banking
19 June 2020
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