Asking a wings-clipped Finance Minister to fly is

a classic repeat of Dunna Dunugamuwe

An unorthodox and illogical functional allocation

Monday, 12 June 2017

President Maithripala Sirisena has issued the

Extraordinary Gazette Notification dated 7 June 2017 allocating functions among
the newly sworn-in Ministers a week ago. In this notification too, the Central Bank
and state banks have not been returned to their legitimate home, the Ministry of
Finance. Hence, the Central Bank will continue to be under the Ministry of
Economic Affairs and the state banks under the Ministry of State Enterprise
Development.

This had been a temporary arrangement made during the First 100 Day
Development Initiative undertaken by the new yahapalana government
immediately after the Presidential Election in January 2015. But it was continued
even after the Parliamentary elections in August 2015 and now even after a new
Minister of Finance has been sworn in.
This functional allocation was unorthodox and illogical. It was unorthodox
because it was the first time that they were taken away from the purview of the
Ministry of Finance. It was illogical because it violated the principle of categorising
similar functions in a single ministerial portfolio. A Government observing that
principle helps it to coordinate its interagency and intraagency work effectively,
efficiently and smoothly.

The error was immediately pointed out to the Government

When the Central Bank was taken away from the Ministry of Finance and listed
under the Ministry of Policy Planning and Economic Affairs in January 2015, this
writer immediately drew the attention of the Government to its folly in an article
in this series (available at:
http://www.ft.lk/article/384736/Listing-Central-Bank-under-PM--Unworkable-
legally-and-operationally-but-a-step-toward-bank-s-independence).

It was argued in the article under reference that the particular arrangement was
unworkable both legally and operationally. The only plus feature of the particular
work allocation was that it was a temporary measure limited to the 100-day
period and during that period, the Government could introduce legislation to
update the functioning of the Central Bank.

There was no need for drafting a new law for that purpose, it was pointed out in
the article. That was because the Central Bank, under its modernisation project,
had drafted in 2004 a new Central Banking Law with technical support from IMF.
The Government headed by Prime Minister Ranil Wickremesinghe had agreed in
principle that such legislation was necessary. But before the Government could
do anything in practice, Parliament was dissolved.

At the General Elections held following the dissolution, a new Government came
to power and that Government did not think it necessary to introduce a new
central banking law. Thus, the draft law was shelved and it may still be dusting in
the archives of the Central Bank.

The Yahapalana Government could have picked it up from its dusting place,
updated it to reflect the current trends and enacted it in Parliament. But this did
not happen. Instead, the Government dragged its feet on all economic reforms,
including the reform of the Central Bank.

Ministry of Finance is the owner of state banks

The Ministry of Finance holds ownership over state banks since it is the Treasury
which has capitalised them. Hence, it is the Minister of Finance who should
appoint their directors and exercise control over them. But when they are listed
under another ministry, the Minister of Finance loses control over them. Yet,
Minister of Finance is held accountable if they do not perform well or become
insolvent. It is a peculiar situation where the Minister of Finance is required to
take responsibility without powers.

The danger in such an arrangement is that the Minister of Finance who has no
responsibility for state banks resorting to scrape the bottom of the bowl to fill his
coffers. This was exactly what had happened in 2016 when the Finance Ministry,
through a directive, got state banks to transfer almost all of their profits to the
Treasury. It has impeded the internal capital building of state banks prompting
rating agencies to take a serious note of the capital distress in Sri Lankan banks.

Rationale of returning Central Bank to Ministry of Finance

Why should the Central Bank be listed under the Ministry of Finance? There are
many reasons for that. In the article under reference, the following points were
highlighted by this writer for the attention of the Government. But it was to no
avail since even after the General Elections in August 2015, both the Central Bank
and state banks continued to be listed away from the Ministry of Finance.

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, the Ministry of Finance and exchange rate policy, 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
to 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 thither government agencies and a
central bank. Such an arrangement is necessary to assure its independence and
thereby help 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 15 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, listing the Central Bank under the Ministry of Economic Affairs 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.

Returning the Central Bank and the state banks to Finance Ministry a must

It was a mistake made by the Government to take the Central Bank and state
banks away from the Ministry of Finance. It has led to conflicts, practical
difficulties and legal issues. Without the Central Bank and state banks within the
Ministry of Finance, the new Finance Minister Mangala Samaraweera is like a bird
whose wings have been clipped. Obviously, such a bird cannot fly, though the
President had wanted that bird to make a quick upward flight lifting the economy
also along with him.

The appointment of a new Finance Minister was the last chance which the
Government had had to rectify its earlier mistake. But that chance has not been
used by the Government. The new Finance Minister and his State Minister are
expected to take the slowing economy back to its long-term growth path within
the next two years. Without powers, those posts are simply bloated glories with
perks and official privileges. The country today needs concerted action and not
glorious positions. Since the Government has failed to use this last chance wisely,
the economic ship will continue to drift in the high seas without direction.
A reminder of Dunna Dunugamuwe

The present work allocation is a classic example of the non-working situation

depicted in the Sinhala folk rhyme Dunna Dunugamuwe taught to school
children in their primary classes. It says that the factors that help shoot the deer
are in three different places far apart from each other: The bow is in
Dunugamuwe, arrows are in Kithalagamuwe, the archer is in Negombo and the
deer is sounding its presence in Sabaragamuwe.

Does it mean that those who have made the work allocation in question have
forgotten the moral of this poem which they would have learned in their primary
classes?

(W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka,
can be reached at waw1949@gmail.com).
Posted by Thavam