Tuesday, 29 September 2020

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CBSL’s Coomaraswamy: “Clear frameworks, macroeconomic stability are crucial”

Interviewed By Emmanuel Daniel

Central Bank of Sri Lanka Governor Indrajit Coomaraswamy talks about the structure of the central bank, institutionalising reforms and what the Sri Lankan economy needs to grow.

Dr. Indrajit Coomaraswamy first joined the Central Bank of Sri Lanka (CBSL) as a staff officer in 1973, working there for 15 years. He held various positions at the Ministry of Finance and Planning as well as the Commonwealth Secretariat. He became a member of the Monetary Policy Consultative Committee in 2013 and was named Advisor to the Ministry of Development Strategies and International Trade in 2015. He assumed the duty of governor of CBSL in July 2016. Coomaraswamy resigned from his position on 20 December 2019 citing personal reasons. He was succeeded by W. D. Lakshman.

In this interview at The Asian Banker Finance Sri Lanka Conference on 5 September 2019, the CBSL governor talks about the situation in the country, the reforms he has introduced, his goals during his term, and what can be done to give Sri Lanka’s economy a boost.

 

EMMANUEL DANIEL (ED): I started this morning's remarks by stating what brilliant minds you have here in Sri Lanka. Governor, I want to focus a few questions based on the structure of the central bank, a second set of questions on what you are trying to achieve and a third set of questions on some of the options that might be available to you.

What's interesting about your point about inflation targeting is that you introduced the term ‘flexible inflation targeting’. Being a central banker, you know that central bankers love the concept of inflation targeting because it's like a job description. It's like, ‘I've kept it within the range, I've done my job. I can go home now’. When you put in the phrase flexible inflation targeting, you are giving yourself permission to achieve a few other objectives around inflation. What are they?

INDRAJIT COOMARASWAMY (IC): The primary objective is going to be price stability, but financial system stability will also continue to be a core objective. So, primary objective is price stability; financial system stability is a core objective, a little bit lower down. They were both on an equal basis, going forward. That is not to say that we have in any way downgraded the importance of the central bank working towards financial system stability, but we want to have clarity in terms of what the primary function of the central bank is.

You see, we were second to Japan on almost any socioeconomic indicator in 1948, well ahead of Singapore. Lee Kuan Yew used Sri Lanka as a model. But, look at what other Asian countries have achieved and what we have achieved.

There's complex political, social and economic causality for what has happened in the last 17 years, but in my view, arguably the most significant causal factor has been almost continuous macroeconomic stress from the late 1950s onwards. Part of that economic stress came from exogenous factors like terms of trade decline, but also due to macroeconomic mismanagement, which has come about through a toxic combination of populist politics and a deeply entrenched entitlement culture amongst all of us as Sri Lankans. Those two have fed off each other and it has been kind of a negative feedback loop, which has pulled us back.

We need clear frameworks and macroeconomic stability is crucial, and so the central bank has to maintain price stability, that's the main thing. But financial system stability is also important. The productive development of the resources of the country is also important, but we do it within an inflation target. We've put in the word flexible so it is not an unchangeable target. For instance, if we need expansionary monetary policy for some reason, then the minister has the right to change the inflation target and to issue a gazette, and explain why he has changed it whether up or down, depending on the circumstance. That's why it's flexible.

ED: One of the amazing things that you're trying to achieve at this point in your personal career and as governor of Central Bank is to create institutional reform on the role of the central bank in a very stressed economy like Sri Lanka – with a lot of the political realities that you've personally seen over the years – safeguarding the independence of the central bank, at the same time giving it flexibility and a sort of a string back into the executive in order to be able to guide fiscal policy to some extent. That's what I seem to be seeing. Now, let me ask you a first question on that front. Why not print money but the ability to borrow money? Why are you giving yourself the ability to borrow money but not to print money?

IC: The borrowing function is only an agency function on behalf of the government. Up to now, we've had the Appropriations Act. Parliament passes the Appropriations Act for any given year, you have revenue, expenditure and a financing requirement. Then the government requests the central bank to raise the money to meet that financing requirement. There is a borrowing ceiling.

The government instructs the central bank as its agent to borrow up to the ceiling in any given year, the ceiling being set by Parliament. We are merely the agent. We borrow money from the domestic market as well as internationally to meet the government's requirement. On top of that, we have the Active Liability Management Act, which enables the government to instruct us to borrow money for liability management as well, but the central bank is only the government's agent in this function.

IC: If that is fuelling inflation, we will raise interest rates – that is what has not happened. The central bank, because of fiscal dominance historically, has not leaned in against over expansionary fiscal policies. If the government's policies are expansionary, then monetary policies will have to be restrictive. That is the framework we're trying to create.

Fiscal discipline the key to economic stability

ED: What is the goal that you would like to see a central bank achieve back into the executive in terms of fiscal discipline?

IC: If you were to ask for one thing that this country needs, that's fiscal discipline. Because deficit and debt dynamics, if you look at the metrics, we are way above our rating peers and that is the main source of instability in the system.

Now, I must be very clear, as things stand, we can manage the challenge we have. We have a medium-term debt management strategy and we have this Active Liability Management Act, which gives us the flexibility to raise money for debt servicing. This actually has significantly reduced the rollover risks; so much so that we had a political crisis in the fourth quarter of last year (2018), yet in March, we were able to raise $2.4 billion – a dollar denominated sovereign bond issuance. Given our rating and the rest of the economy, the price was not cheap, but it was three and a half times oversubscribed.

In June, two months after the April events, we were able to raise $2 billion, and that was three times oversubscribed. It's partly because I think we are beginning to put in place these frameworks, which give markets confidence and that is what we need to do. Now, we are trying to institutionalise them by entrenching them in law. That’s the whole idea behind the [new] Monetary Law Act.

Also, the one thing I forgot to say was this greater separation of the treasury and the central bank in the governance of the monetary board of the central bank. Historically, the Secretary of the Treasury has been on the monetary board. But at the time the Monetary Law Act [of 1949] was written, we had permanent secretaries. Now, the secretary of any ministry is politically appointed. It is not a good thing to have a politically appointed person on the monetary board.

ED: Maybe that's all you're trying to achieve, which is to depoliticise the monetary policy mechanism because around the world, that dialogue between executive and central bank is also valuable. And how confident are you that you will be able to bring about this structural change?

IC: It is. What we've got in addition, there's going to be a governing council with three independent members and a governor. There's going to be a monetary policy board with the specific remit of conducting monetary policy, which will have those three independent members and the deputy governors responsible. They have the technical expertise, the governor and an independent member from outside – an academic, somebody from a think tank – who has expertise in monetary policy. Separate from that, there will be a coordination council chaired by the minister, which will have the secretary of the treasury, the governor and the minister and secretary in charge of national planning.

The new Monetary Law Act has been submitted to cabinet, which has referred it to the public finance committee in Parliament. We've had a couple of sessions. That committee will submit a report, that draft will go back to cabinet and hopefully, we can get it enacted before the end of this political cycle.

ED: Let me ask you an additional question. You made comments about the banking sector and the innovations taking place in the banking sector. In some jurisdictions, the regulation of banking conduct is now being taken away from the central bank. They create different agencies for that. Do you think that Sri Lanka is ready for that? Is the central bank stressed by having to see the revolution taking place at the structural end of the banking system, in addition to some of the monetary issues that you're dealing with?

IC: This was something that was very closely studied around 2000-2001 as part of the modernisation of the central bank that took place under Governor Deshamanya A S Jayawardena. An informed decision was taken not to separate the two. This was at the time in the UK, the Financial Services Authority (FSA) had been separated.

ED: But the UK went through two iterations of that.  The original FSA wasn't great, but now they have the Financial Conduct Authority (FCA), which is a further tweaking of the whole process.

IC: Exactly, so Governor Jayawardena in his wisdom did not follow.

Anyway, at the moment, we feel it’s in our interest for the central bank to be responsible for the two, because though we have given a little bit of greater primacy to price stability, the two are very closely linked. Therefore, we think that having it under one roof has merit in our circumstances, but there are serious challenges to try to keep up with the structural changes that are taking place in the financial sector – and we are stretched.

My colleagues in bank division are working extremely hard to make sure that we have a supervisory framework that is supportive of the banking industry, while fulfilling our stability priority. Central banks are all about stability, so that has to be at the foundation, but we are trying to keep up. We're struggling to keep up as I think central banks all around the world are.

Increased exports to sustain economic growth

ED: In terms of the overall import of the Sri Lankan economy, wealth generation and GDP growth, remittance would be an important pillar and there will be economic activities like tourism, capital infrastructure and government spending and so on. Which of these are your topmost priority as potential wealth creators that you want to strengthen?

IC: From at the high level, what we really need to do is to increase our exports of goods and services, including tourism; because A, of our debt dynamics; and B, if you have a domestic market of 20 million people, clearly external demand has to play a very important role if you are to sustain 6% growth over a decade or more as a number of countries in Asia have done in the past; also, if you want to create higher value employment.

If you look at empirical evidence from around the world, the wages in the export sector, particularly exports driven by foreign direct investment (FDI), tend to be higher. We can no longer compete on low wages, but we can compete on the flexibility of our labour force and their capacity to learn. We need to create slightly higher value jobs. FDI-driven exports can give you that – of course, there are low tech sectors as well – but for us, I think a key priority is going to be to increase exports. If you look at the record around the world, whether you are as large as China or as small as Singapore, FDI has played a crucial role in export transformation. Those are the two things we need to do.

If you ask me about particular sectors, tourism is a low hanging fruit. We've had a bit of a setback, but already we are seeing recovery and I think it will bounce back – that's a big sector. The Exports Development Board has identified six sectors as priority sectors so those are out there as well.

Another one is shipping and logistics. Essentially, Colombo right now is India's largest port in terms of tonnage handled. It handles more Indian transhipment than any individual port in India. But we can't be a two-country port – Sri Lanka and India – we need to be a hub for the region as a whole and ideally have a global footprint. For that, we need certain reforms, but there's enormous potential of being essentially a shipping or logistics hub. Of course, if that comes, we are going to be more competitive.

ED: Absolutely. Last question, [with] some of your conceptual priorities, how different are you relative to some of your peers, especially from the larger countries? If you take India, China, the US, they're all issuing debt, printing money, reducing – it's a race to the bottom when it comes to interest rates. In fact, you're a beneficiary because there's no yield except in countries like Sri Lanka today. You are actually potentially a net beneficiary of the policies of these large countries, how are you diametrically different from them?

IC: People keep saying the US has all these trillions of debt, so why are you just bleating on about the level of debt in Sri Lanka? The thing is, [the US] has a reserve currency, the International reserve currency, and everybody wants to hold US Treasuries. It's a safe haven investment. The Chinese, the Japanese, the Koreans, the Southeast Asians have billions in US Treasuries. Nobody really wants to hold Sri Lankan debt unless you give them a very high premium and that has to be paid back. That's the difference between say, US issuing debt because it has the capacity to finance it, almost an unlimited capacity to finance it.

ED: India is issuing debt. Actually in India, the debt is issued more to the banking system.

IC: India doesn't issue as much debt. Actually, the Reserve Bank of India is not allowed to participate in the primary options. It issues debt but the central bank is not allowed to take on debt.

The leverage in the banking system is a problem there. In terms of the health of the banking sector, I know our non-performing loans (NPLs) has gone up but the underlying situation is not bad. If you look at all the metrics, the capital metrics, the liquidity metrics, et cetera, it's in reasonable shape if we can turn the economy around. My own hope and expectation are that once we get through this election period at the moment, everybody is in kind of wait and see mode. We need to somehow hang on to some decent macro fundamentals through the next six months. Hopefully with a clear outcome to the elections, we will see an upswing in the economy. All the other things that we've been talking about, if they come together, there’s enormous potential.

ED: Ladies and gentlemen, please join me in thanking Dr Coomaraswamy for his comments.

IC: Thank you very much.



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