Indrajit Failed in 201811 min read

Both growth¹ and inflation² have fallen below the targets set by the Central Bank. GDP growth for the fourth quarter is less than 4% with all previous quarters also being below that figure. Inflation was also below 4%. The public was expecting both figures to at least touch 4% as communicated by the Central Bank. This failure however is going unnoticed due to the constitutional treason that has taken place.

The country has been downgraded by the ratings agencies. The monetary board has failed in setting rates. There has been a large foreign currency outflow. The Central Bank has failed on numerous fronts. So why does the country do so poorly especially in comparison to its peer group?

Low Bar

We are after all a country wherein the judiciary and parliamentary speaker are highly rewarded for simple achievements. The judiciary took multiple sittings to decide that the president cannot dissolve parliament. The speaker recognized the largest group in parliament. The former question can be answered by an A level politics student and the latter by a child³.

The Central Bank in this regard does not compare itself actively with India. It would not do well. Instead it chooses its peer group based on the question at hand and the availability of accessible data. Sri Lanka does, according to its website, stick to the Special Data Dissemination Standard⁴. The standard was created in 1996. It was established to guide members that have, or might seek, access to international capital markets in providing their economic and financial data to the public⁵.  Sadly even when the figures are updated they are not made easily comparable to regional countries. Comparison will increase expectations and bring about a competitive spirit.

Implementing Unified Payments Interface⁶ and/or Aadhar⁷ alone could revolutionize access to finance. It has done so in India. This would also provide a useful counter narrative for the CBSL when it is being criticized for its many failures. Instead the CBSL chooses to maintain antiquated KYC forms and harass companies like FrMi and Dialog when they try to innovate in this space. India would happily give us the technology and expertise for free.

Technology has improved significantly with regards to verification. The ability to unlock a modern cellphone is a far greater verification check than the ability to reproduce a signature. KYC is only really required when accounts opened are in danger of some form of money laundering. Allowing accounts under 50,000 lkr to be operational with minimal KYC and only requiring verification after a generous time period or balance threshold will help digitize our financial sector. This would then reduce the bricks and mortar footprint of the sector.

Inflation and Growth Weightings

The Central Bank had a de facto inflation targeting mechanism in 2018. It will achieve formalization of this mechanism in January 2019. The CBSL, as mentioned earlier, failed on these two measures. Growth can in certain scenarios benefit from lower interest rates. This however may come at the cost of inflation. The CBSL has to take both into consideration when influencing and setting monetary policy. Most businesses have called for lower interest rates.

Growth over Inflation

Sri Lanka is a poor country. Many do not have access to collateral for credit. The primary source of income for the lower socio-economic groups is employment. The reason that Mahinda Rajapaksa remains very popular with Southern voters is that he was willing to throw caution to the wind and spend. Chinese projects on the whole though macro-economically disastrous are not unpopular. Some projects are highly beneficial to the country.

Four Chinese companies working on major projects as stated by Saman Kelgama⁸ were able to bring up to 26,000 semi-skilled and unskilled workers to Sri Lanka during the Rajapaksa regime. This was done with little overt resistance. Chinese labor is highly productive according to leadership at Access Engineering⁹. It also as with the Shangri La creates lots of desirable jobs for Sri Lankans.

The governor defends his aversion to inflation by characterizing it as highly regressive on the population. This is however not true when it comes to interest rate policy. This is implied in the UNPs call for lower interest rates and Rajapaksa’s lack of concern for high nominal rates. This is because jobs are more important than inflation when it comes to measures of regression. In other words the negative income effect of inflation is offset by employment opportunities in lower income households during periods of high growth.

Lower Bound for Inflation

The reason that the inflation target is set as a range is because unexpected or negative (deflation) rates of inflation are bad for the economy. It makes it difficult for businesses to plan. In instances of deflation it pushes consumption to a later stage in hope of lower prices which quickly becomes a never ending cycle.

It is further made worse as the demand for goods and services is only modulated by interest rates. People tend not to borrow to pay for the goods that make up the inflation index. Investment however is highly dependent on interest rates. Many would argue that as seen with apartment prices, Sri Lanka is in a deflationary scenario. The monetary board has to consider broader prices within the economy when setting interest rates.

Debt Issuance

The general public still remains closed to public and corporate debt markets. Reforms articulated as well back as 2013 in Policy Decisions to develop the Corporate Bond Market¹⁰ are yet to be put in place. A few easy reforms from the paper are reproduced below;

“2. Trading Platform

1. Our policy on a trading platform is an order matching, anonymous, screen based electronic trading platform considering the benefits of reduced transaction costs and time efficiency in executing trades.

10. Central Clearing Corporation

a. Support the view of the necessity on a Clearing Corporation to mitigate counter-party risks.

18. Benchmark Yield Curve

a. A long-term (preferably up to 10 years) yield curve for Government securities to be developed and maintained with frequent issues by the CBSL which is crucial for pricing of corporate bonds.”

A dual currency board would be nice as well. It would be a much better way to protect JKH from a hostile takeover. Technology and expertise can be borrowed if needed. If the Stock Exchange and the SEC are not able to achieve this, the people running those institutions should be let go. The SEC has no directives issued in 2018¹¹ according to their website. We won’t miss them.

The CBSL also screws over the country by issuing debt in a manner that creates little liquidity. Minimum subscriptions are too high and the market is not accessible. This increases the cost of borrowing for the country. To put it in words that incite action, one would be ill advised to hire a CBSL employee to the board of a large bank. This is because they show little understanding of the liquidity premium. People have made some quite profitable trades on the highly illiquid debt board of the CSE.

Banking Regulation

During the attempted coup, board appointments were made at the Bank of Ceylon¹⁴. Switching around management on political whims and doing so with minimal documentation is not in the interests of banking stability. Regulation preventing the sudden reconstituting of the board of systemically important banks is called for. Reasons for changes in the board must be made public and go through considerably scrutiny by the regulator. At the very least people with experience in banking should be considered as being suitable.

The CBSL has categorically stated that it would not extend credit to a reckless treasury. Such statements are not consistent with the lack of oversight on board appointments. The governor has previously mentioned that the subsidy on fuel and electricity is financed through the balance sheet of the state banks. His use of the word subsidy in this regard is questionable.

A welfare oriented state looks to improve the plight of people at the lower end of the income spectrum financed by placing taxes on those at the higher end. Subsidy on fuel benefits people who burn fuel. The rich burn exponentially more fuel than the poor. The subsidy benefits the rich. Electricity costs in Sri Lanka are high. This is quite blatantly due to questionable power purchase agreements that the CEB signs on our behalf. Financing provided through the state banks allows for the avoidance of parliament and is in affront to our democracy.

The State owns the majority of financial institutions in the country (by asset base). Lending is politicized and highly concentrated. There exists significant SOE debt that will have to be written off or absorbed by the treasury. Massive systemic risk is caused by the non-prudent actions of all state owned financial institutions. The CBSL should look to fix this if it is considered with stability. Instead the CBSL focuses on the NBFI sector which in terms of asset base is insignificant to the whole system.

Financial Sector Consolidation

In many instances the actions of the Central Bank can be attributed to incompetence. In this area though the actions of the Central Bank are blatantly corrupt. No notable consolidation has taken place in the period of 2018. Companies with shared ownership and multiple finance licenses have not been pressured to merge. No state owned institution with a similar license holding structure has been pressured to merge.

The Central Bank has instead imposed capital requirements that are not proportionate to an institutions lending portfolio. The directive on the 23^rd of February¹² exists to force smaller market players to initially be put into difficulty and then forced into merger. The capital market remains depressed making such hostile acquisitions highly profitable. This when taken with the scale of the NBFI system leads one to believe that the intentions of the CBSL are not financial market stability.

Ownership structures contrary to recent statements¹³ have become more concentrated under CBSL policy. LOLC has seen the exiting of the Orix Corporation. New entrants into the NBFI sector have questionable sources of funds and show no track record in the business. Promoters of microfinance who have partaken in the most unscrupulous lending practices will benefit through mergers with less risky loan books.

The CBSL should in line with the Right to Information should proactively disclose what it aims to achieve with its actions with financial sector consolidation. Such a simple hurdle, though usually ignored by the CBSL¹⁵, should be one that precedes any policy in a democracy. Soft pushes and massive incentives to consolidation might be more effective.

Setting a Precedent

The governor continuously talks about how a Central Banker is expected to resign if they fail to achieve preset objectives. Sadomasochism is not the answer. Additionally resignation at this point would be counterproductive. Instead the CBSL should push through on its current plans. Simple tweaks and openness would help clear allegations of criminality with regards to the financial sector consolidation plan. The docking of pay to senior CBSL staff seems a reasonable compromise for the overall failure for the year in review. This would align the CBSL staff in line with its broader objectives. One could even bring in Urjit Patel in an advisory role to help keep up with India.

The governor in his public persona recalls his most embarrassing moment as that of being out for a duck during his school days¹⁶. Though this may just be a conversational piece which quite deftly brings out his enviable education and athletic achievements it may need some rethinking. His failures as a central banker will be remembered for a longer period and by much more important people than rich public school boys. In terms of policy direction though the governor has shown himself to be better than all his contemporary peers. Policy on the exchange rate, credit growth, and bank recapitalization are notable achievements. Will he fail in 2019?

Footnotes

1. http://www.lankabusinessonline.com/sri-lanka-gdp-2-9-pct-for-the-third-quarter-2018/
2. https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/press/pr/press_20181121_Inflation_in_October_2018_e.pdf
3. http://www.ft.lk/columns/-In-the-opinion-of-the-President–doesn-t-mean-arbitrary-choice–but-going-by-simple-arithmetic/4-667988
4. https://www.cbsl.gov.lk/en/statistics/data/special-data-dissemination-standard  
5. https://www.imf.org/en/About/Factsheets/Sheets/2016/07/27/15/45/Standards-for-Data-Dissemination
6. https://www.npci.org.in/product-overview/upi-product-overview
7. https://uidai.gov.in/
8. Title: China-Sri Lanka Economic Relations: An Overview, Journal: China Report Volume: 50 Issues: 2 131—149 Author(s): Kelegama, S., Publisher: Sage Publications, Year: 2014
9. CSE CSBA presentation- https://www.youtube.com/watch?v=vvCIdh6q8x4
10. http://www.sec.gov.lk/wp-content/uploads/consultation-paper-v3..pdf
11. http://www.sec.gov.lk/?page_id=5350
12. https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/laws/cdg/Finance_Business_Act_Directions_No_2_of_2017_e.pdf
13. http://www.ft.lk/financial-services/NBFIs-operate-according-to-shadow-directors–mandate–Regulator/42-668878
14. https://cdn.cse.lk/cmt/uploadAnnounceFiles/7661543385113_861.pdf
15. http://www.dailymirror.lk/article/Central-Bank-ordered-to-release-EPF-data-159248.html
16. http://life.dailymirror.lk/article/fashion/indrajit-coomaraswamy/54/11408