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Listing Central Bank under PM: Unworkable

legally and operationally but a step toward


banks independence
The Central Bank under the Prime Minister- January 26,

2015
The gazette notification issued by President Maithripala Sirisena allocating
subjects and institutions among different ministries has placed the Central
Bank of Sri Lanka under the Ministry of Policy Planning, Economic Affairs,
Child, Youth and Cultural Affairs headed by Prime Minister Ranil
Wickremesinghe (http://www.ft.lk). This is a departure from the previous
practice of listing the Central Bank under the Ministry of Finance.

Confused markets speculate on the reasons


The market has not been able to comprehend the reason behind this
unprecedented move. Some websites had attributed it to a conflict of
interest which the current Minister of Finance, Ravi Karunanayake, is
alleged to have with the Central Bank.
It would appear that the logic behind this move has been much more than a
simple conflict of interest since the Government could have avoided it by
appointing someone else to the post. On examination of the detailed facts,

it appears that the objective of the Government has been to make the
Central Bank an independent institution in the long run.

A new role for Ministry of


Policy Planning and
Economic Affairs
The Ministry of Policy Planning
and Economic Affairs, according
to the gazette notification, has
been assigned the functions of
formulation of monetary policies
and macroeconomic
management in coordination with
the Central Bank of Sri Lanka
and liaising with donor agencies
and international financial
institutions, among others.
Thus, the monetary policy is no
longer an exclusive preserve of
the Central Bank and liaising with
international financial
institutions, namely, IMF, World
Bank and ADB, is not a function
of the Minister of Finance though
he is the Governor of Sri Lanka in
all these three institutions. In the
new arrangement, the Governor
of the Central Bank is supposed
to report to the Prime Minister as
the Minister of Policy Planning and Economic Affairs and
receive instructions from him with respect to major
administrative decisions concerning the bank.
To facilitate this new arrangement, the Ministry has been given
responsibility for implementing some of the legislations, but not all,
pertaining to the functioning of the Central Bank. They are the Monetary
Law Act, Exchange Control Act, Banking Act and the Loans Recovery Act.
However, no mention has been made in the gazette notification about the

other important legislations that come within the purview of the Central
Bank such as those relating to finance business and anti-money laundering.

A central bank subservient to the Ministry of Finance


A criticism levelled in the past against the arrangement in which the Central
Bank functioned under the Ministry of Finance, despite its statutory semiautonomy, has been that it has become subservient to the Ministry. As
such, though it had independence in deciding on monetary policy, critics
had charged that its policies had in reality been dictated by top officials in
the Ministry of Finance. This has been made possible by the presence of the
Secretary to the Ministry of Finance on the Monetary Board, the policy
deciding body of the Central Bank, with voting powers. John Exter, the
architect of the present Central Bank, had clarified in the report he
submitted to the government on the establishment of a central bank in
Ceylon, known as the Exter Report, why this arrangement had been made
in the structure of the Central Bank. According to him, it will allow a better
coordination between the government and the Central Bank with respect to
policy by permitting the Minister to make his views known to the Board
through the Secretary to the Ministry of Finance (p 13).
However, he made a qualification that its effectiveness depended on the
maturity and experience of the people occupying the high positions in
government and in the Central Bank. Thus, the Secretary to the Ministry of
Finance was expected to function as a conduit between the Minister and the
Monetary Board and not as a super-official steamrolling over its decisions.
But over the years, Exter was defeated by some of the officials who had
occupied the topmost position in the Ministry paving the way for critics to
justify their charge of having a subservient Central Bank.

A previous attempt at making the Central Bank independent


Thus, a strong call was made in late 1990s for freeing the Central Bank
from the crutches of the officials of the Ministry of Finance. It required a
complete overhaul of the legal structure of the Central Bank by bringing in
a new legislation to make it independent from the Ministry of Finance but
still accountable to Parliament.
The Cabinet Sub-Committee on Economic and Monetary Affairs headed by
Prime Minister Ranil Wickremesinghe during 2002-4 had accepted in
principle that a new central banking legislation should be introduced

making the Central Bank independent in line with emerging global trends.
Accordingly, under the guidance of the then Governor A.S Jayawardena, a
new central banking legislation was drafted by a Committee headed by this
writer with technical assistance from IMF.
The new legislation proposed, among others, to make the Central Bank and
not the Monetary Board the legal body, expand the size of the Monetary
Board by making the Deputy Governors vote carrying members and permit
the Secretary to the Ministry of Finance to attend the Board meetings
without power to vote. But before the new legislation could be discussed
with the government, Ranil Wickremesinghe administration was voted out
of power. The new administration that came to power, especially the top
officials at the Treasury, did not like the idea of a diminished role for the
government and decided to shelve the draft legislation. As such, it may still
be dusting in the archives of the Central Bank.
Goal is laudable but the legal structure and hardcore economics are
unsupportive
Given this background, the new arrangement made by the present Ranil
Wickremesinghe administration may be viewed as a step taken toward
making the Central Bank independent from the undue pressures of Treasury
officials.
However, since the laws have not been amended suitably, it will lead to
several practical complications in terms of macroeconomic management
and prevailing legal provisions.

Macroeconomic management requires close coordination among key


policies
Macroeconomic management involves the management of three key
policies, namely, the monetary policy, fiscal policy and exchange rate
policy, in order to facilitate the optimum economic growth for a country. Of
these policies, monetary policy is a prerogative of the Central Bank, fiscal
policy of the Ministry of Finance and exchange rate policy of both the
Central Bank and the Ministry of Finance. These three policies are
interrelated and interdependent. As a result, the Central Bank cannot attain
the objectives of its monetary policy if the fiscal policy pursued by the
Ministry of Finance does not fall in line.
For instance, assume that the Central Bank seeks to attain an inflation free
world by tightening its monetary policy. The bank is required to increase

interest rates and cut money supply by restricting credit levels. The
objective is to maintain the total demand in the economy, also known as
aggregate demand, at a level equal to total supply known as aggregate
supply. But if the Ministry of Finance follows an expansionary fiscal policy,
then, the aggregate demand will increase defeating the objective of the
tight monetary policy pursued by the Central Bank.
With increased aggregate demand over aggregate supply, the economy will
get overheated making price stability a difficult goal and causing a
consequential fall in the exchange rate. Hence, both the Ministry of Finance
and the Central Bank will have to work very closely if they want to do
proper macroeconomic management.
To facilitate this close working arrangement, the Monetary Law Act has
provided for the Secretary of the Ministry of Finance to sit on the Monetary
Board functioning as a conduit for such cooperation. Hence, the umbilical
cord connecting the Central Bank with the Ministry of Finance cannot be
severed by a mere delisting of the Bank from the Ministry.

Minister of Finance, a protective barrier


From a legal standpoint, it is the Minister of Finance who has been
mentioned by name in all the legislations relevant to the Central Bank.
Thus, the Central Banks relationship with the Government is through the
Minister of Finance though it has not been explicitly spelt out in the
Monetary law Act. But, in many recent central banking legislations such as
those found in Bhutan or Nepal it has been explicitly provided for that the
Government should communicate with the Central Bank only through the
Minister of Finance. In the inverse, the central bank too cannot directly
communicate with the government and it has to do so through the Minister
of Finance. Hence, the Minister of Finance is the protective barrier between
the government and a central bank that assures its independence and
thereby helps it to attain its goals.
The Monetary Law Act which is the legislation governing the Central Bank
has stipulated the role of the Minister of Finance in relation to the Bank.

Ministers role in key appointments to the Central Bank


Section 12 stipulates that the Governor is appointed by the President on the
recommendation of the Minister of Finance. The three private members are

appointed to the Monetary Board by the President again on the


recommendation of the Minister of Finance in terms of Section 8(2)(c). The
salary of the Governor is also fixed by the President on the Finance
Ministers recommendation as per Sections 12(3). Under Section 14(2), the
allowances payable to the other Board members are directly fixed by the
Minister in consultation with the President. The concurrence of the Minister
is needed for the Monetary Board to appoint Deputy Governors to the Bank,
as per Section 22. Ministers concurrence is also needed for the Monetary
Board to release a Deputy Governor to serve in the government or as a
director of a bank according to Section 23(3). The Minister also has powers
to recommend the removal of the Governor or private Monetary Board
members (Section 16) to the President under circumstances stipulated in
the section under reference. Similarly, the concurrence of the Minister is
needed for the Monetary Board to remove a Deputy Governor under Section
23(2).

CBs reports to the Minister


There are a number of reports which the Central Bank has to submit to the
Minister of Finance in terms of the Monetary Law Act: Annual Report of the
Bank (Section 35(1)); a special confidential report whenever there are
abnormal changes in the money supply or price level or economic
disturbances threatening the monetary stability (Section 64(1));
continuation of the submission of those reports until the country is free
from such threats (Section 64(3)); a special confidential report whenever
there is a serious decline in international reserves (Section 68(1); a special
confidential report before the 15th of September of every year to enable
the Minister to prepare the annual budget (Section 116)

Currencies are Finance Ministers prerogatives


The currency issue is a joint exercise done by both the Minister of Finance
and the Central Bank under the Monetary Law Act. Every currency note
issued by the Central Bank shall have the signature of the Minister of
Finance in facsimile (Section 53(2)). The Ministers approval is needed for
the Central Bank to prescribe the denominations, dimensions, designs,
inscriptions, and other characteristics of currency notes (Section 53(1)). A
similar approval of the Minister is needed for the coins to be issued by the

Central Bank in respect of metals, fineness, weight, size, designs,


denominations and other characteristics (Section 53(3)).
A new Section 52A has been introduced to the Monetary Law Act in 1998
requiring the Minister to approve of the issue of commemorative notes and
coins. Section 39(c) stipulates that if the Monetary Board decides to
transfer a part of its profits to the government, the manner in which it
should be done should be decided in consultation with the Minister.
The Minister of Finance cannot issue directives to the Central Bank as in the
case of other public sector institutions. Yet, in terms of Section 116(2), if
there is a difference of opinion between the Minister and the Monetary
Board about the appropriate policy to be taken, the Minister can direct the
Board to adopt the policy he prescribes by taking responsibility for the
consequences of such direction.

Finance Ministers powers are inalienable


This list is not exhaustive and does not cover the powers, duties and
obligations of the Minister of Finance under other legislations such as the
Exchange Control Act or the Banking
Act. However, they are all inalienable and therefore, the Minister is
responsible to Parliament and to the nation for them. It may be an awkward
position for the Minister of Finance to be responsible for work for which he
has no role to play. Hence, though the objective of listing the Central Bank
under PM is laudable, it is not workable under the prevailing legal structure.
It will get into serious trouble in the event of a recalcitrant person
occupying the portfolio of finance.

A Governor walking on a tightrope


Human nature is such that when people are forced to have divided loyalty,
they cannot serve either party well. This may be the biggest challenge to
be faced by the Governor of the Central Bank in the period to come. His role
will be similar to that of an acrobat walking on a tightrope balancing
carefully every step he makes forward. Any imbalance will mean that he will
fall off the rope thereby having to deviate from the goals which he is
pursuing to attain in the Central Bank.
However, it may not be an issue if, as Exter expected, people in high places
are with maturity, experience and wisdom. But, if these qualities are not
present in them, it will invariably lead to conflicts and most of their
professional time will have to be spent for resolving them. To avoid such a

situation, it is necessary that all those in high places should work in


appreciation of each other toward the final goal of making the Central Bank
a more responsible institution forgetting their personal differences.

Arjuna Mahendran receives the letter of appointment as the Governor of the Central Bank from
President Maithripala Sirisena on Friday

Amend the central banking laws as a part of the 100-day program


With an unsupportive legal structure, the present arrangement, though
laudable, is unlikely to work properly. Hence, within the 100 day
constitutional reform programme, it is advisable to introduce appropriate
legal reforms to the Central Bank as well.
For that, the wheel need not be reinvented. It is just a matter of retrieving
the dusting draft central banking legislation from the archives of the Central
Bank and introducing it with suitable amendments after an economy-wide
consultation with all the stakeholders. Unless this is done as a matter of
urgency, the current arrangement is fraught with failure.
(W.A Wijewardena, a former Deputy Governor of the Central Bank of Sri
Lanka, can be reached at waw1949@gmail.com )