Business Times

Cold war between Treasury, Central Bank

Confusion, fury over devaluation

The devaluation announcement in the budget by President Mahinda Rajapaksa, which caught everyone by surprise, has turned into a cold war between the Treasury and the Central Bank (CB). While the Treasury is responsible for the country’s fiscal policy, the CB is entrusted with monetary policy which involves the maintenance of an effective foreign exchange mechanism.

Traditionally the CB provides guidelines on exchange rates and dictates this policy, raising issues of whether the Bank’s credibility has got eroded particularly since it was defending the exchange rate policy against everyone including the IMF.

“Has the Treasury taken over a traditional function of the Central Bank?” asked one analyst
The Business Times reliably understands that the announcement also caught the CB unawares, implying they were not fully consulted on the 3 % depreciation aimed at boosting exports.

“CB officials are furious over the move particularly because they were defending the currency against calls even by the IMF to allow it to float to realistic levels,” sources associated with the CB said.
A senior CB official, who spoke on condition of anonymity, accused Treasury Secretary Dr. P.B. Jayasundera of caving into pressure from top exporters who have been adversely affected by the over-valued rupee which some economists say is as high as 20 %.

In defence, a senior Treasury official, who declined to be named, said the announcement was made by the President as Finance Minister and the CB’s credibility has not been affected. “The Central Bank on the other hand has failed in its responsibility in maintaining a competitive currency,” he said. Inflation and other issues have to be managed.

Exporters have been raising issue with the held-back rupee against the dollar and other currencies while the CB said a weaker rupee would adversely impact on imports. CB officials said inflation had been maintained at a low level in the past three years owing to the current policy. Bankers said the budget announcement unnerved the market and raised serious credibility issues for the CB.
“Foreign investors were going by CB pronouncements over the years of a stable exchange and suddenly that has changed,” one banker said. There were unconfirmed reports that foreigners owning treasury bonds and bills were pulling out their money. It is a loss for those who purchased rupee-convertible bonds some three years ago.

The move is expected to lead to an increase in exports and make Sri Lankan exports more competitive while the cost of imports of essentials like fuel, milk powder, dhal, sugar, etc will rise by 3%, thereby adding further burdens on the people and inflationary pressure.

“There was no reason to do this as exports were expected to rise by 28 % this year. Our public debt repayment will go up by millions of dollars. The deficit will shoot up and debt serving alone will cost many billions more. The cost of debt finance will also rise,” the senior CB official said adding: “Our annual oil bill is $3.5 billion and now we would have to pay an additional Rs 11 billion.”

Foreign exchange experts said credibility is the bedrock of investment sentiment and this has been largely affected. “How can the CB maintain an exchange rate policy when the government can suddenly intervene?” said one expert.

However the senior Treasury official said the Central Bank (Governor Ajith Nivard Cabraal) is also dealing with matters that strictly doesn’t come under his purview, citing a recent example where the Bank commented on on the land take-over bill.

It was also pointed out that the Bank comes under the Finance Ministry the official head of which is the Treasury Secretary. Credibility issues also arise with laws to revive underperforming and under-utilised assets where the government promised ‘no more acquisitions’, only to take over 37,000 hectares of land alienated to plantation companies, a week later via the budget.

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