Autonomy of Central Bank

By Usvatte-aratchi-November 15, 2015

The Central Bank functions under the Monetary Law Act, which permits a high degree of autonomy from government in its day to day functioning. The Bank is financially independent of government and that contributes to its autonomy.The Secretary to the Ministry of Finance is a member of the Monetary Board which governs the Bank. That link provides a means of regular communication between monetary policy makers and government. The law provides for the relevant Minister to give written directions to the Governor on matters of policy. These provisions and the sensible behavior of politicians and governors had until 2005 assured the autonomy of the Central Bank. A touching instance of the appreciation of that autonomy is the news item in your newspaper of 10 November, where D.E.W. Gunasekera is reported to have said, ‘… the safest place for both funds (EPF and ETF) is the Central Bank.’. When the EPF act was being considered by the Cabinet in 1958 Trade Unions insisted that the management of EPF money be entrusted to the Monetary Board that governs the Central Bank and the EPF Act contains a clause to that effect. In 2002 or 2003, the senior management of the Bank considered that in order to avoid conflicts in objectives of the Bank, EPF, then mature with experience, be made independent of the Bank. When the proposal went to the Cabinet it was shot down because Trade Unions would hear none of it.

There are good reasons why the largest investment fund in the country should not be managed by the monetary authority of the country, the central bank. The central bank is responsible to society for maintaining price stability and the stability of the banking system. This will require the bank to vary interest rates to prevent rising or falling prices of any high magnitude. The effect of local interest rates on capital movements making the exchange rate move accordingly complicates the question. The central bank also may have to take other measuresto ease or squeeze credit. All these activities of the bank may have large or small effects on the small stock market in the country. To make matters complex the Central Bank is responsible for managing the public debt.

Under the last responsibility, the Bank is expected to keep interest cost to government low. That requirement puts a drag on raising interest rates, no matter what maintaining rice stability may require. Contributors to EPF expect the Central Bank to maximize returns on their savings. That requires the Central Bank to keep interest rates high, no matter the demands of price stability. In addition, EPF has the largest investible fund in the country, with power to move the small bond and stock markets whichever way it wishes. Now, a fall in bond prices is the inverse of a rise in interest rates. If bond prices fall, investors will move to buy bonds selling stocks, which makes capital expensive to entrepreneurs.

Since everything is connected with everything else in money, capital and foreign exchange markets, it is practicable and wise that different entities take decisions regarding monetary policy, investment of the largest pool of savings in the country and the management of the public debt for the government.Things were manageable when public debt was mostly owed to governments and intergovernmental financial institutions, and when total debt was small and absorbing only a small part of total government expenditure. That age when the Central Bank could juggle many balls in low air is over and it is time that the Central Bank was relieved of the burden of performing this magic. At some point, a ball is going to drop.

The enormous size of EPF funds in relation to bond and capital markets makes it a probable maker or breaker of markets. There were accusations that during Governor Cabral’s tenure the market for particular stocks were manipulated. These have neither been investigated nor withdrawn by the accusers. Besides these irregularities, the Bank can be under temptation to manipulate bond markets to make interest rates move with its desired direction to achieve objectives of monetary stability. However, this may conflict with the objective that the Monetary Board earns the high returns for EPF. It is best that a different set of people make judgements about the investment of EPF money and leave the Central Bank free to run monetary policy, as it considers most prudent.

There is the point raised by D. E.W.Gunasekera and emphasised by Trade Unions right from the inception of EPF. How much of that fear is imagined? Surely, it can’t be beyond the ingenuity of our lawyers to formulate a bill that can put up dykes that fingering politicians cannot breach. And surely, there cannot be a complete absence of men and women of integrity who can withstand pilfering fingers of politicians. With trade unions as a main stake there will be a formidable watch dog guarding poaching politicians from trespassing into forbidden territory. Serious thinking by trade unions leaders will give rise to an institutional arrangement that will keep EPF money safe and earning a reasonable return to savers. That kind of arrangement will relieve the Monetary Board of the kind of confusion that arises in policy making when it has been legislatively required to follow conflicting objectives.

I have argued earlier that requirements of public debt management puts the same kind of conflicts before the Monetary Board. There were a series of papers produced in the Bank, 2003-2004 on the subject and they can be very useful to reconsider the question.

Exchange control management is no longer as important as it was and the department will wither away as foreign exchange begins to move freely.

A smaller Central Bank with EPF, Public Debt and Exchange Control out of its portfolio will be free to pursue objectives of price stability and banking system stability. With that arrangement I wonder what ‘Regional Offices’ of the Central Bank espoused by Governor Mahendran will do.

Autonomy of the Central Bank seems now to be irretrievably broken. However one has hope. To the common man Prime Minster Wickremesinghe comes out as a man of immense good sense and he can preach to anyone of us convincingly the virtues of central bank autonomy. It is futile and indeed and not all together wise to imagine that in our market conditions the Central Bank can function independently of government policy. The provision in the Constitution that Parliament has control over financial matters cannot be invoked to deny the Central Bank autonomy in its normal functioning because the Monetary Law Act functions under the Constitution and that Law provides for the autonomy of the Bank. If Parliament wishes so do away with autonomy they had better change the Monetary Law Act.

We are witness to this deadly erosion of autonomy of universities to the extent that a senior academic was recently driven to write in this newspaper (October 07, 2015) ‘university autonomy: an empty word’. Please, please, let us not do that with the Central Bank. It is not simply the place where I first worked and who paid for the education of many overseas but also the place which provided a pool of expertise which governments over a long period of time tapped when they wanted such. One recalls Gamani Corea, W. M. Tillekeratne, M. R. P. Salgado, W. Rasaputram, J. B. Kelgama, P. B.Karandawala, A. S.Jayawardena and P. B. Jayasundera among those who worked with distinction at the call of the government of the day. This pool of ability was available because the Bank was autonomous to take decisions on training staff and nurturing them with much care in the Bank. I was associated for a short time as a consultant to a committee that decided on these matters. I recall the care with which each staff member’s career was discussed when opportunities opened up for training overseas and placement within the Bank. A rule applied mechanically that each staff member must be transferred out every five years would have denied us some of the most brilliant people to come out of the Central Bank. Let the Monetary Board and the Governor and Heads of Department at lower levels decide on these matters and let politicians keep their fingers in their own pie. As we have seen there are many juicy plums out there. The Governor may be a henchman of the President or a long standing friend of the Prime Minister who if however does not have the personality to keep those relationships in the background can only bring disaster to the Bank and the economy. If the Governor and the Board are incompetent find substitutes as provided in the law and not gangster fashion as when Chief Justices were removed and appointed in the recent past.

The supremacy of Parliament does not carry with it that there are no areas of autonomy within the law and that such autonomous institutions are not essential for the healthy functioning of a body politic, the same as you need small amounts of some minerals for animal bodies to function.The grand story about autonomy is the separation of powers in government. The demand for autonomy for some institutions including universities, central banks, media institutions and NGOs come from the fundamental fear of totalitarianism. So long as the force of gravity of government can keep these satellites in orbit let them have their own revolutions on their axis!