As and when a country confronts a crisis, the habit of the bureaucracy across the world is to find scapegoats to coverup their lethargy, negligence and inefficiency in respective public duties. The frequent scapegoat is the lapses in relevant laws.
Everybody knows that the present Sri Lankan economic crisis is the failure of the Central Bank bureaucracy which mismanaged the public debt and foreign currency markets. However, the Central Bank bureaucracy has got the support of the IMF and political leaders to blame the Monetary Law (MLA) for the crisis by not giving the privacy or autonomy to Central Bank officials to run the monetary system and the central bank on the public funds as they wish.
As a result, a new bill to reestablish the Central Bank of Sri Lanka as proposed by the Minister of Finance with the approval of the Cabinet of Ministers has been published in the gazette on 23 February 2023. This is known as one condition for the approval of the IMF loan of US$ 2.9 bn for four years whereas the Parliament has to approve the bill for the disbursement of the loan.
By going through the provisions of the bill, I felt that nobody who got involved in the bill has any idea of what the monetary system is, what its role is for the economy and the duty of the central bank to administer the monetary system deliver its economic role as required from time to time. Further, none of them appears to have read the full text of the bill at least for checking the consistency and accuracy of contents. I plan to write a series of articles to express my views on the contents of the bill.
This article only focuses on the danger of the bill for disruption of the present monetary system of the country that has run for 72 years under the MLA framework without major problems.
Monetary System created by the MLA
A few highlights of the present monetary system are given below.
- The MLA has been enacted to establish the monetary system with a domestic monetary unit first and then to provide for the Central Bank to administer and regulate the system through the Monetary Board.
- The foundation of the monetary system in modern economies is the establishment of the standard unit of monetary value. This is to provide for the general public to use the monetary unit to serve the functions of money in the country and outside the country. Those are a means of payment, a unit of account, a means of deferred payment and a liquid store of wealth. In Europe and USA before state money was introduced, governments prescribed the monetary unit such as US Dollar and Sterling Pound to prevent multiple monetary units. Accordingly, banks produced different currencies in officially prescribed monetary units for own banking business undertaken in respective monetary units.
- Under the MLA, the Sri Lanka rupee represented by the signs of Re. and Rs. and divided into one hundred units where each unit is called a cent is the standard unit of monetary value. Accordingly, provisions have been made for determination of the par value and legal parities of the rupee. The par value is the value of the rupee against a reference asset such as gold or silver or other asset. Legal parities are the exchange rates for foreign monetary units.
- Accordingly, every obligations, transactions, liabilities, dealings, payments, etc., relating to use of money should be undertaken in the rupee. in the case of obligations stated in any other monetary units other than the rupee, they should be effected with the use of legal parities.
- Then, means of payments have been created, that is to create instruments for the medium of exchange function of the money. Accordingly, means of payments so created within the standard monetary unit are the currency (notes and coins) and demand deposits. The currency is the legal tender and the Central Bank has the sole right and authority to issue issue the currency in rupee (being the monetary unit in the country) on behalf of the government. The currency carries the general public trust or acceptance as they are issued on behalf of the government.
- Demand deposits are created by commercial banks in rupee, subject to withdrawal in legal tender upon demand, where acceptance or creation of demand deposits are subject to the control by the Monetary Board. Accordingly, demand deposits also are officially the legal tender.
- Then, the supply of money is defined to distinguish the total supply of standard monetary unit from the means of payment for the purpose of control of money and credit under the monetary policy. The subsequent inclusion of time and saving deposits and such other liabilities of banks and financial institutions in money supply without requirement to withdraw in legal tender is a weak definition of money supply but it is within the standard monetary unit.
How the new bill destroys the monetary system
The new bill has repealed above provisions except the issuance of the currency in Sri Lanka rupee as the legal tender. Therefore, the architects of the bill have not understood the difference between the monetary unit and the legal tender in the country. Accordingly, following observations are made.
- Hereafter, Sri Lanka has neither a standard unit of monetary value and nor an official monetary system to serve standard functions of money and monetary policy.
- Sri Lanka will have only the legal tender in physical form or currency notes and coins only to use for making payments where the means of payment in the country will be only the currency.
- As there is no Sri Lankan standard monetary unit and there are no official parities, no contracts or obligations relating to transactions denominated in rupees or foreign monetary units can be undertaken. Therefore, people can use monetary units of other countries such US Dollar and Euro to undertake such contracts or even own monetary united agreed by the parties.
- Accounting profession will not have a domestic unit of account. Therefore, accountants and auditors have to use foreign monetary units for their professions or create their own monetary unit for the purpose.
- The existing assets and liabilities in rupees prevailing in book entries with banks and financial institutions including the Central Bank will be unlawful as they are in the present unit of monetary value prescribed under the MLA.
- All banking and financial transactions should be 100% backed by the legal tender. Even the Central Bank has to print currency when it lends or buys assets.
- Electronic payments and fund transfers that take place in denomination of the rupee without currency will cease to operate as there is no standard unit of monetary value in Sri Lanka.
- Credit and deposit operations will cease to operate as all transactions should be in currency as there is no legal provision for contracts or obligations denominated in domestic unit of monetary values in books.
- People have to collect or stock currency as the liquid store of wealth unless banks provide the currency warehouse services backup by 100% currency.
- People should accept currency in the trust of the members of the Governing Board and officials of the Central Bank as issuance of the currency is a private business of the Central Bank.
- The Central Bank will undertake ad-hoc business operations as another type of state bank operating on state capital as provided for in the bill without a legally defined monetary unit and system to facilitate the economy.
As law makers in the country do not understand such technical elements of the monetary systems, they will approve any bill coming to their hands, especially when it relates to the IMF conditions treated as divine-given for Sri Lanka.
However, as soon as the new bill is approved, the monetary system will legally collapse and, therefore, economy cannot function without a legally prescribed domestic monetary unit.
As there is no prohibition of foreign monetary units or private monetary units in the bill, people can adopt multiple monetary units to serve the functions of money outside the Central Bank purview. As the Central Bank is not established to administer a domestic monetary unit or a monetary system other than the domestic legal tender, it will not have a purview to regulate such private monetary units.
Therefore, a wide spread financial and business panic can be expected as soon as the new bill is approved and implemented. Therefore, the new bill is not a solution to the present economic crisis, but it will definitely aggravate the present economic crisis.
Further, there are so many fundamental lapses and inconsistencies in the new bill in relation to the functions of the macroeconomic management and governance in the country read with the rights given to the public by the Constitution and in relation to conflicts of the autonomy. I will write a series of articles to educate the public on such issues.
Legal provisions relating to monetary matters in the new bill should be crystal clear as conflicts and interpretations can cause banking and financial panics in the present context of the economic and financial bankruptcy.
(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)
Former Deputy Governor, Central Bank of Sri Lanka
(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 10 Economics and Banking Books and a large number of articles publish.
The author holds BA Hons in Economics from University of Colombo, MA in Economics from University of Kansas, USA, and international training exposures in economic management and financial system regulation)