Central Bank on suicidal mission?

Despite the Central Bank seen taking pride in their recent attempts towards an inflation targeting regime—a new way to determine interest rates— a group of leading economists in the country called the move “suicidal” and not in the best interest of the monetary authority.  The Central Bank last year undertook the exercise to setting up an inflation targeting framework under its Extended Fund Facility arrangement with the International Monetary Fund (IMF). The multilateral lender is providing the required technical assistance to the Central Bank in this regard, particularly in the areas of macro forecasting, modeling and policy analysis. 

The Central Bank calls flexible inflation targeting “an enhanced monetary policy framework”, as opposed to the existing monetary targeting framework. 

The United States Federal Reserve monitors consumer prices as its key gauge of inflation and has set a 2.0 percent target for more than five years as the ideal level to raise short-term interest rates. 
Both frameworks are used to achieve price stability or lower inflation— a key objective of any Central Bank.  

“I feel that is a suicidal attempt by the Central Bank. Inflation targeting means that Central Bank alone is accountable for price stability. That means the Governor of the Central Bank is accountable”, says Professor S.S. Colombage. 

Speaking at Sri Lanka Economic Association Annual Sessions during last weekend, Colombage asked why the Central Bank wants to become the scapegoat for the financial profligacy of the State which upsets price stability.  

He cited the recent development in New Zealand where the New Zealand Reserve Bank Governor had to resign for failing to maintain the inflation at the target level. 

“I don’t know why the Central Bank should take the responsibility for wrongdoing by others such as fiscal dominance which is the major cause for inflation”, inquired Colombage, who was a former Director of the Department of Statistics at the Central Bank.

Speaking at the same forum, Dr. Anura Ekanayake, an economist and a former Chairman of the Ceylon Chamber of Commerce echoed the same sentiments.

SLEA annual sessions is once a year gathering of eminent economists in Sri Lanka and abroad to deliberate on matters of national economic significance. 

At this year’s sessions, the economic fraternity discussed the challenges faced by Sri Lanka in modernizing its agriculture and industry sectors – a sine-qua-non for the US $ 82 billion economy to break from the shackles of mediocrity and achieve faster growth.   

Under flexible inflation targeting, the Central Bank will announce a medium term inflation forecast, which will determine the interest rates or the broader monetary policy by the Monetary Board. 
This is a clear shift from the current monetary management in Sri Lanka is based on a monetary targeting framework. In this framework, the final target, price stability, is to be achieved by influencing changes in broad money supply which is linked to reserve money 
through a multiplier.

According to both Colombage and Ekanayake, the danger lies when the Central Bank and the government move in opposite directions, where the former tames inflation while the latter is known to add fuel to inflation. 

Inflation is generated when the Central Bank prints money to meet unsustainable budget deficits generated by the government annually.  

Sri Lanka’s national inflation reached 8.6 percent in September, the highest 
since March. 

However, Dr. Chandranath Amarasekara, the Additional Director of Economic Research Department of the Central Bank said that the bank would migrate to flexible inflation targeting only if the government succeeded in containing the budget deficit to 3.5 percent of GDP by 2020 and maintain it below that level thereafter. 

Further the Central Bank is also trying to amend the Fiscal Management (Responsibility) Act 2003 to cease the practice of deficit financing by the Central Bank as it has been the habit for decades. 
Besides, the ability to maintain a realistic exchange rate through a non-interventionist policy will also decide the Central Bank’s transition towards the new framework. 

In recent times, the Central Bank has intervened only in very limited occasions through moral suasions in order to arrest the extreme volatilities and particularly to ensure that the currency is not overvalued. 

“Only if that happens we will move in to inflation targeting, if it does not happen we won’t”, Amarasekara said.