WAS THE CENTRAL BANK OF SRI LANKA SLEEPING DURING THE PANDEMIC?

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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