ISSN: 1391 - 0531
Sunday, January 21, 2007
Vol. 41 - No 34
Financial Times  

Monetary Policy - an independent Central Bank exercise

By Sunil Karunanayake

Given the inflationary trends compounded by the budgetary constraints and the threat of increasing oil prices, Sri Lanka’s economy seems somewhat vulnerable with escalating defence expenditure and increasingly unsettled conditions. Perhaps within this rather bleak environment it was opportune that the Central Bank released its Road Map for Monetary and Financial sector policies recently.

Containing inflation, managing a stable exchange rate, generating employment and sustaining economic growth are key tasks of Central Banks. These objectives are achieved by managing the money supply through which interest rates are controlled. This process is known as the Monetary Policy.

Monetary policy uses instruments such as open market operations, policy interest rates, setting reserve requirements or trading in foreign exchange markets. Thus this policy plays a key role in governance of countries. Monetary policy is considered expansionary when money supply is increased and ‘contractionary’ when the money supply is decreased. It is the global practice that monetary policy is executed independent of the executive by Central Banks.

Open Market operations aiming at specific short term interest rates are considered a key tool in the monetary policy management dealing with currency and credit. Theoretically Central bank independence is expected to avoid manipulations that could affect political goals.

Monetary targeting to curb inflation
As per the announcement made by the Governor, the Central Bank will be following a monetary targeting policy in conducting monetary policy to attain economic and price stability. Australia and Canada too follow this method. Under this policy the Central Bank will work towards target inflation as measured by the Consumer Price Index and periodic adjustments will be made to the interest rate.

The Bank has also cautioned commercial banks who use the reverse Repo window for regular funding and in future this facility will be not be made available on days the liquidity surpluses exist in the banking system. Given the inflationary impact of this situation the Central Bank hopes to verify whether such symptoms are caused by structural deficiencies of the banks.

The supervision and regulation of non banking institutions, on-site examinations of leasing companies and broad-basing of share ownership of banks would certainly reduce risks to the financial stability.

The Central Bank’s proposal to set up a voluntary contributory social security system to support the informal sector employees is most welcome.

Oil & war major risk factors
The Central Bank takes due cognizance of the threat posed by escalating oil prices and its cost push effect on the inflation and secondly the issue of strengthening the threat against terrorism. It is these two factors that govern the destinies of the country.

Both these are likely to exert high pressure on budget deficit and may even pose a threat to the rapid infrastructure development planned by the government funding. Rising oil prices too could affect the reserves and a challenging period awaits the policy makers while the brunt of the burden will have to borne by the public. However the Central Bank places an ambitious 7.5 per cent growth target for 2007.

Role of government institutions
Governance, management, and strong institutions are equally important as the monetary and financial stability. In this regard Sri Lanka yet seems to be getting its act wrong, judging by the recent events.

Perhaps President Mahinda Rajapaksa must be highly disappointed by the performance of some heads of key government institutions that caused much embarrassment to him.

Most critical were the Tea Research Institute and Sri Lanka Tea Board two institutions guarding the destinies of the country’s most treasured export crop where the Chairmen had to be changed. The confusion in the Tea Board prevails to date; these are not healthy signals for an economy under continuous stress. Then the two ailing energy giants - electricity and petroleum too have seen such changes while media reports have also appeared on a similar crisis at the country’s premier state owned bank.

The railway’s potential cost reducer for passenger and goods transport is heavily underutilized and is in a parlous state. These are all key public institutions exerting strong influence on the economy and growth process and the management incompetence and lack of continuity could be very adverse to the country at a heavy price to the public.

Industrial disputes & state expenditure
The government’s decision to set up a cabinet sub committee to settle industrial disputes to curtail mass worker demonstrations and chaos in the city at much detriment to the innocent public is laudable.

While the Cabinet sub committee is a good start we expect this to mature to a competent government body much on the lines of the Employers Federation as Ministers may find it difficult to manage these effectively given the heavy demand on their time.

Speaking of government expenditure and budget deficits and the consequent inflationary trends, it’s time that the government takes strong measures to eliminate waste in the public sector. Given the increase of ministries which has been the pattern of governance since the ‘90s a fair amount of government revenue is spent on housing various ministries that keeps coming up; probably some ministry or other housed in rented premises is not a uncommon sight.

Some effort should be made to curtail wasteful expenditure associated with these, like the “Sethsiripaya’ concept which put several government agencies under one roof and also took congestion out of the city.
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Copyright 2007 Wijeya Newspapers Ltd.Colombo. Sri Lanka.