The draft Central Bank of Sri Lanka (CBSL) Bill which repeals the existing Monetary Law Act (MLA) has been gazetted and is now available for public viewing. Once in effect, it is expected to bring about sweeping reforms to the CBSL, transforming it into a more independent body. Inflation targeting framework will replace current monetary targeting framework by introducing a major change to current approach to monetary policy in an attempt to control inflation and maintain a healthy economic growth rate. The Bill also serves to formalize and institutionalize some of the current functions of the CBSL that have been carried out over the past decade.
In the new Bill, price stability continues to be the primary objective of the CBSL, but in addition, while doing so, the Bill gives the CBSL a mandate to maintain a healthy economic growth rate. A core objective of the CBSL, financial system stability, has been broadened to including the development and efficiency of the financial system.
The Changes to the Governance Structure
The apex body of the CBSL is called the Monetary Board and it is responsible for making all policy decisions related to the management, operation and administration of the Central Bank. The Monetary Board is comprised of 5 members including the Governor of the Central Bank. MLA does not explicitly prescribe the non-executive members of the Monetary Board to be experts in a given field.
Presently, the monetary policy of the country is set by the Monetary Policy Committee which is comprised of a set of top CBSL officials. When setting the monetary policy, they take input from another committee of external experts called the Monetary Policy Consultative Committee. It consists of a cross section of stakeholders including eminent professionals, academics and the private sector personnel who contributes to the process by sharing their expertise and experience
Instead of a single governing body, the new Bill will establish three boards called the Governing Board, Monetary Policy Board, and Executive Board.
- The Governing Board is charged with the responsibility of overseeing the administration and management of the affairs of the CBSL and the determination of general policy of the CBSL other than the monetary policy. The powers and functions of the current Monetary Board will be largely replaced by the Governing Board.
- The Monetary Policy Board is responsible for the formulation of monetary policy and implementation of a flexible exchange rate regime in line with the flexible inflation targeting framework.
- The Executive Board is charged with the dayto-day operations of the Central Bank.
One key change to be brought by the new Bill is the appointment of members who are experts primarily in the fields of economics and finance to the Governing and Monetary Policy boards. The Monetary Policy Board to be set up under the new Bill will amalgamate the Monetary Policy Committee and Monetary Policy Consultative Committee and will include four experts in economics or finance in addition to the Governor, Deputy Governors. In addition, the Governing Board will comprise of the Secretary to the Treasury, the Governor, and three members who have expertise in economics, banking, finance, accounting and auditing, law or risk management.
Key Provisions which Enhance CBSL Independence
The MLA does not include any specific provision with regard to the autonomy of the CBSL and can be regarded as a shortcoming in ensuring the independence of the CBSL.
The Governor is appointed by the President on the recommendation of the Minister of Finance and the Constitutional Council has no role in this appointment. MLA prescribes the Governor to be the Chairman of the Monetary Board and the Secretary to the Treasury to be an ex officio member of the same. In addition, the rest of the Board members of the Monetary Board are non-executive members who are appointed by the President, on the recommendation of the Minister of Finance, once the Constitutional Councils approves the postings.
In contrast to MLA, subsection (3) of Section 5 of the new Bill describes the CBSL as an autonomous entity and provide legislative power to shield the Boards and its employees from any influence or interference.
The Governor will preside over all three Boards proposed to be set up under the Bill. The Secretary to Treasury is a member of the Governing Board but not a member of the Monetary Policy Board. However, any member of the Governing Board may be appointed as an expert to the Monetary Policy board. Therefore, by extension it is possible to make the Secretary to the Treasury a member of the Monetary Policy Board as an ‘expert’ member. Currently, no major Central Bank in South Asia (Reserve Bank of India, State Bank of Pakistan, and Bangladesh Bank), other than the CBSL may explicitly appoint any representatives of the Treasury to their respective monetary policy making bodies. In this regard, this loophole in the provision may undermine the independence of the monetary policy from the fiscal policy.
The President, upon the recommendation made to the Constitutional Council by the Minister and with the concurrence of the Constitutional Council, appoints the Governor and the members of the Governing Board and the experts of the Monetary Policy Board. Therefore, the President’s power to appoint the Governor is also restricted, which strengthens the independence of the CBSL. Furthermore, as per the new Bill, the appointed members have to be experts in the fields prescribed in the Bill.
CBSL follows a ‘Monetary Targeting’ framework where the inflation is controlled through influencing the stock of money in the economy. In addition, CBSL selectively gets involved in the exchange rate market to defend the currency; commonly called a dirty float regime.
The Central Bank Bill has institutionalized ‘Inflation Targeting’ as the approach to monetary policy. The full implementation is scheduled for 2020. Inflation targeting is an increasingly popular central banking policy that targets a specific medium-term explicit inflation level where the Central Bank will respond to deviations primarily via influencing interest rates.
Sri Lanka will be the second country in South Asia to adopt inflation targeting after India. In 2013 India was experiencing inflation rate as high as 9.9%. Many initiatives brought the inflation down to 4.9% in 2016. Following its adoption in 2016, India saw a further reduction in inflation and by 2018 it declined to 3.6% overshooting Reserve Bank of India’s medium-term target of 4%.
It is unclear whether the Central Bank will operate a full-fledged inflation targeting framework or ‘lighter’ version of it once the Bill is in effect. The lighter version might involve continuing some element of exchange rate targeting by the Central Bank, similar to the past.
The Bill also institutionalizes operating a flexible exchange rate regime. In a flexible exchange rate regime, the exchange rate is primarily determined by market forces.
Several changes have been brought in to restrict the CBSL from a phenomenon known as ‘money printing’. Money printing occurs when the central bank increases the supply of money disproportionate to the activities of the economy. Excessive money printing is generally viewed by economists as unfavourable, as excess liquidity created via money printing can lead to inflation with a lag. At the moment the CBSL creates money via purchasing Tbills from the primary market, granting provisional advances or credit to the government, and purchasing foreign exchange from the government.
In order to operate an inflation targeting framework successfully, the CBSL should be able to control the stock of money effectively as the liquidity level affects inflation. As per the changes, the Bill would restrict the provisional advances to 10 percent of the government revenue of the first four months of the preceding financial year whereas MLA allows up to 10 percent of the estimated government revenue for the whole year. Moreover, the CBSL is explicitly prohibited from issuing credit to the government or any organization owned by the government. However, this prohibition does not apply to government-owned or publicly-owned banks and other financial institutions as the CBSL is the lender of last resort to the financial sector and it is critical to have Central Bank credit line available in the event of a financial crisis. The Bill also prohibits the CBSL from buying any security owned by the government or government owned organization from the primary market.
The CBSL independence is a critical factor to have some level of discipline in the monetary policy and the new Central Bank Bill is an attempt to strengthen the institution and bring reforms to achieve this goal. Restrictions on the money printing is a step forward towards ensuring stability in the money market. Inflation targeting can bring about robustness to the economy but most importantly, what’s crucial for the success of the inflation targeting framework is the commitment to the mandate and the accountability for the outcome