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Ex-Finance Minister Mangala Samaraweera Writes Letter to Prime Minister Mahinda Rajapaksa In Defence of the Central Bank After President Gotabaya Rajapaksa castigates CB Officials Publicly

Sri Lanka’s ex-Finance Minister Mangala Samaraweera has come out to defend the central bank after it was slammed by President Gotabaya Rajapaksa for inaction saying a credit guarantee scheme is needed to help move loans.

Ironically Samaraweera’s economic program was hit by monetary instability in 2018 triggered by pro-cyclical rate cuts and liquidity injections which led to a collapse of the currency in that year, leading a fall in demand, slowing growth and a spike in inflation in 2019 (stagflation).

In an open letter to Prime Minister Mahinda Rajapaksa who is also finance minister Samaraweera said the central bank has taken a number of initiatives after the Coronavirus crisis.

The central bank had cut rates, cut the reserve ratio, bought Treasury bills injecting liquidity and lost foreign reserves.

“Sri Lanka’s current economic woes are fundamentally fiscal, not monetary,” Samraweera claimed though his economic program which contained steep fiscal corrections went up in flames amid monetary instability.

“Therefore, there is only a limited role for monetary policy in this crisis.”

Samaraweera said an inter-agency committee should have been set up to come up with solution instead of slamming the central bank.

“Also in response to the President’s demands the CB has further eased the Statutory Reserve Requirement – this simply provides even more liquidity to the system when there is already sufficient and in fact excess liquidity in the market,” Samaraweera said.

“The problem is not liquidity. The problem is credit risk. The banks do not want to lend to businesses that have become high risk due to COVID because a default in such lending can directly lead to the loss of depositors’ savings.

“On the one hand the CBSL is castigated for allowing finance companies to fail and on the other hand they are being asked to push banks to lend to risky businesses setting banks up for failure as well.”

In 2018 April just as credit picked up the central bank injected 60 billion rupees into money markets and the rupee fell from 153 to below 160 in May.

Samaraweera said the money supply had gone up but inflation had not gone up – yet.

“A Central Bank’s role is to manage the supply and cost of money in order to achieve price stability,” he said.

“The cost of money has come down dramatically, the supply of money has increased to a more than satisfactory level, and inflation remains under control. In other words – the Central Bank has done its job,” he claimed.

The effects of sudden expansion of reserve money are first felt in the currency in a pegged exchange rate regime, which may trigger import controls and only later in inflation.

Samaraweera suggested that the Treasury buy long dated corporate bonds, which can be sold down later in the secondary market.

He said a Special Purpose Vehicle vehicle could be set up to invest in small and medium enterprises, which could later be divested.

Neither moves would involve printing money, worsen foreign exchange shortages or threaten the ability of the Treasury to repay foreign loans and contribute to any future sovereign default unlike central bank re-finance, analysts say.

However the budget deficit is set to rise to over 8.5 percent of GDP this year, which means more money would have to be raised.

Samaraweera also proposed a loan guarantee fund, which would provide partial guarantees for loans provided by banks. He said beneficiaries could be required to retain workers.

Guarantees do not involve the Treasury raising money disrupting its bond program. If credit guarantees are used to encourage banks to give their own deposits, there is no threat of increasing sovereign default unlike central bank re-finance analysts say.

“A government must build up reserves to respond to a crisis,” Samaraweera said in a reference to a so-called ‘fiscal stimulus’ made before the Covid crisis hit.

“Unfortunately when the government throws away all its reserves by slashing its revenue sources before the crisis, it leaves itself weak and helpless when the crisis hits.

“When this happens there is no point running to the Central Bank and asking it to print more money.

“The Central Bank as an independent professional institution has acted with responsibility thus far – but it is now being pushed to the brink. Today Zimbabwe reported inflation for May at 785% – soon it could be Sri Lanka.”

Courtesy:Economy Next