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"Our economy was and is both small and open. Financing the budget deficit through Central Bank credit creation appeared to us as an invitation to disaster. There was no effective way of exchange control in an open trading economy like ours to deal with the inevitable balance of payments troubles." |
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"Our economy was and is both small and open. Financing the budget deficit through Central Bank credit creation appeared to us as an invitation to disaster. There was no effective way of exchange control in an open trading economy like ours to deal with the inevitable balance of payments troubles." |
Let's have some fun guessing which country this is all about.
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"We all grew up under difficult conditions and did not believe anybody owed XX republic a living. The way to better life was through hard work, first in schools, then in universities or polytechnics and then on the job in the work place. Diligence, education and skills will create wealth, not Central Bank credit." |
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XX Republic is obviously not Zimbabwe, our favorite comparator country. Zimbabwe also believes in Central Bank credit. Nor Sri Lanka. Us leftist lotus-eaters, of course, are devout believers in Central Bank credit. We not only believe the world owes us a living, but that the government does too. ?
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The government is happily selling treasury bills to Central Bank and printing money to give subsidies according to the Rata Perata economic policy.?
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But don't go away folks, there is some more.
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"Against this backdrop of leadership thinking, it is hardly surprising that the CBS (Currency Board System) was preserved with its legal requirement to back the currency note issue with at least 100 per cent overseas assets. Actually, these assets stand at 110 per cent of because it is only after this level has been reached that the earnings of overseas assets can be transferred to the government's Consolidated Account. |
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Sorry to say, none of our leaders thought this way, even Presidents JRJ and Premadasa who were market oriented. Not only that, the Central Bank of Sri Lanka is forced to give provisional advances to government, in addition to profit transfers. A bunch of the stuff would be paid to the government in January 2005, according to tradition.
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In early January 2001 Central Bank t-bill holdings were Rs 66.9 bn. By the time the President did her deed in November 2003, almost the entirety of the currency issue in Sri Lanka was backed by foreign reserves (net foreign assets). Central Bank holdings of t-bills, (which form the bulk of domestic assets), were down to Rs 3.4 bn by end of October 2003 and inflation was touching zero.
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See how closely the Central Bank t-bill stock matches inflation, with just a couple of months lag. As of last week, Rs. 76 bn of our currency issue is again backed by t-bills, which are in effect, IOU's issued by a cash strapped treasury. The position is even worse than in 2001.
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A couple of weeks back a Central Bank statement said media reports that Rs. 50 to Rs. 60 bn was 'printed' was misleading. The argument was that a large proportion of the t-bills were being bought to compensate for the reserve outflow (loss of net foreign assets). But the Central Bank's claim, that only Rs. 20 bn was 'printed' is also a bit disingenuous.
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That is because the reserve outflow is largely caused by government deficit spending, and bad policy. The government is, in effect, stealing Central Bank reserves to give subsidies. In return the treasury is giving Central Bank IOUs.?
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Just one example to illustrate this. The Lanka IOC prospectus showed that the government has to make good Rs. 1,895 mn worth of subsidies on petroleum imported up to July. (The CPC subsidy is said to be in the region of Rs. 13 bn.)
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The path goes like this, though there would be a timing difference based on the actual sequence of events.
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The government issues Rs. 1895 mn worth of treasury bills to Central Bank, gets the 'printed' money, and gives it to LIOC to cover the subsidy. LIOC goes to the forex markets, gets US $ 1.8 mn and imports the petroleum. But, because there is a balance of payments deficit, this money comes out of Central Bank reserves.
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Let's assume it happened the other way. LIOC goes to the forex markets, gets Central Bank reserves to import the petroleum. The government then gives a t-bill to Central Bank; gets it to 'print' the money, and gives the lot to LIOC. It is the same merry go round, whichever way you look at it.
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If energy prices are adjusted, we would have either have recovered it out of export pricing, and consumption would also have fallen.
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To get back to our story:
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Cabinet's collective purpose in retaining the CBS was threefold. First, to inform the financial world that our objective was to maintain a strong convertible XX Dollar. This remains the best protection against inflation. When nearly two-thirds of our citizens' expenditure is spent on imported goods, a strong XX Dollar helps keep consumer prices down. ? The second purpose was to inform our citizens that if they wanted more and better services, they must pay for these through taxes and fees. There is no free lunch here. |
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By now some readers must have already guessed what the XX republic is. For those who haven't, we will give another clue. In this country, the Head of the monetary authority (the equivalent of our Central Bank Governor) is a senior cabinet minister, more often than not, the Finance Minister.
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"World Bank experts advised us against this. Since the Monetary Authority of XX was effectively a Central Bank, the Chairman should be an independent person with sufficient authority to resist a Finance Minister's request for money to finance the budget deficit. The World Bank believed that putting the Finance Minister in charge would be like asking a cat to look after fish. But XX had always worked on the principle that government expenditure on education, defence, social and economic services, etc, must be paid out of government revenues ? taxes and fees. It is the Finance Minister's prime duty to balance the budget and if possible, accumulate a surplus for a rainy day. Successive Finance Ministers have been doing just this. They do not need an independent Central Bank Governor to persuade them not to run budget deficits. The World Bank's anxieties were misplaced. |
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Of course, nobody could be blamed for thinking that the Finance Minister of XX republic is a god or some such semi-divine figure, who is beyond the foibles that normally afflict mere mortals.
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XX republic of course is Singapore. How could it be any other place, you would be asking yourselves by now.
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The highlighted words are extracted from a speech delivered by Dr Goh Keng Swee, Lee Kwan Yew's first Finance Minister, on the 25th anniversary of the founding of the Board of Commissioners of Currency of Singapore. Singapore is no longer supposed to be operating textbook currency board system, after its currency was floated in 1973. But then, they never do anything by the book, unless it helps the country.
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Prime Minister Lee became friends with Dr. Goh when he was studying at the London School of Economics. Dr Goh and a Dutch economist called Dr. Albert Winsemius were the architects of Singapore, as we know it today.
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Lets return to Dr Goh's speech.
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"What would happen if a future government, returned by a complacent electorate, were to do what the World Bank feared? Democratically elected governments the world over are exposed to the temptation of winning votes through promising better and cheaper services and at the same time lower taxes. Rich countries have the resources to get by for a few years by borrowing on the international markets, but in poor countries, punishment comes quickly in a cruel way ? high rates of inflation, economic decline and political instability. These three factors reinforce each other in a way which makes escape from misery difficult." |
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This is why we the 2005 budget of our country is bit scary. The kids in our trade chambers who praised the budget should grow longer nails and learn to scratch below the surface and see how scary it really is.
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The CCPI jumped again in November from 12.1 to 13.1%. The Sri Lanka Consumer Price Index has not been heard of since September, when it was 14.4%. CCPI point to point was 16.2% in January 2001. Its only 13.1% so far.
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The rupee is also getting a Christmas break from deferred payments. Its early days. The public sector salary hike has not hit the ceiling yet.
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We are trapped now 'in a way which makes escape from misery difficult,' to use Dr Goh's words.
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The Chinese or Japanese Central Banks will not buy our government debt and help finance the current account deficit. They will buy American debt in its own domestic currency, but Alan Greenspan said only last week that even that is not likely to work for much longer, jolting the markets. A weakening dollar should have helped us, but so far, it has not because we have bigger problems than the US.
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Foreign investors and analysts know all this.
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This is why Sri Lanka Telecom, a domestic triple A rated firm, well managed by NTT and local staff, which also has dollar revenues from in payments, only gets a B+ international rating.
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It cannot go higher because our country is badly managed, and the implied sovereign rating is a junk number. Even India gets only BB+, despite having record foreign reserves.
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If Sri Lanka goes for sovereign rating now, as the government has said it wants to, what kind of a junk rating would we get? Can we even get BB-?
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Our Finance Minister said just before the budget that controlling the budget deficit is 'pathetic' and 'outdated thinking'. That is a frightening thing for any finance minister to say. Singapore has constitutional provisions against printing money.
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"In Singapore, an irresponsible government does not need a Central Bank to finance lavish spending as a means to win popularity. We have substantial overseas reserves, which can serve this purpose. But if the electorate, misled by soft-headed opinion makers, persists in wanting the good life without working for it, constitutional safeguards cannot stop foolish behaviour for all times. What will happen if the electorate chooses this option is that after a brief period of high living, Singapore will spiral downwards and eventually become another miserable developing country." |
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Have you seen the Marxist cabinet ministers of our miserable developing country, gravely pontificating on TV, eulogizing the budget? Don't you want to cringe in shame for our country and its leaders?
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However, they will get popular, and will eventually blame the SLFP for everything that happens in 2005 and probably get away with it.
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One Marxist minister, who is apparently driving policy in our government, said in a talk show last week that this is the first budget that allowed Sri Lankan children to drink mothers' milk.
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What the...? You may well ask.
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He was apparently referring to the extension of the maternity leave by another three months, which will make the disparity between male and female salaries even wider, and make professional women lag further behind their male colleagues, when (and if) they come back to work from childbirth after being absent for half a year.
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Can you imagine a Sri Lankan husband allowing a wife to go back to work in 3 months, when she can have a free lunch for another three months? Dear working mothers, you will have to pay dearly for the three months, in terms of lost career progression and lost future economic security for your child, in this high inflation, miserable developing country. There is no free lunch you see, as Dr Goh said.
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But mere monetary economics is no match for Marxist ideology, which is driving this miserable developing country forward (or backward), at this point in time.
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We will leave you with another quote, extracted from "The Panamanian Monetary System. Monetary Economics," written by a guy called HG Johnson,
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"Monetary history is full of cases where governments hungry for money that they wanted to spend on projects they considered desirable obtained the money not by taxes, but by pressing the central bank to buy more government debt than was prudent from the view of defending the stability of the currency. As a result, central bank runs its international reserves and liquidity position dangerously low, and the government is driven into exchange and trade controls and eventually into currency devaluation. Both involve not only deceit and robbery of the domestic public whose money is reduced in value by a sort of arbitrary tax imposed on it but perhaps more important, the destruction of foreign confidence in the currency and in the country and its government, which is harmful especially to foreign investment in the country's economic development." |
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P.S. This column was inspired by a reader who sent us Dr. Goh's speech. Many thanks. Readers who are interested in going through the entire speech of Dr Goh, where he takes on, no less a person than Keynes, please click this link. ''Why a Currency Board?'
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There are also a lot of stuff on the Monetary Authority of Singapore website. The link is www.mas.gov.sg. You can read the various speeches given by Singaporean ministers, some of which are veritable Ph.D theses on their own right.
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Also, this link has some good learning resources, inflation, money and so on.
http://www.mas.gov.sg/masmcm/bin/pt1Economic_Explorer_Series.htm
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There are some educational presentations on Singapore's monetary and fiscal policy, which should be made compulsory reading for all our members of parliament, (after they are taught how to use internet explorer and a mouse.)
This is the link http://www.mas.gov.sg/masmcm/bin/pt1Public_Lectures_Seminars.htm
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And go to the section on parliamentary questions. Then you will realize why we are miserable developing country and why Singapore is Singapore. Check this question in particular, which refers to IMF concerns about the MAS Chairman's multiple roles. The current Chairman is Senior Minister Goh Chok Tong.
http://www.mas.gov.sg/masmcm/bin/pt1Reply_to_PQ_on_SGD_Exchange_rate_n_Multiple_roles.htm
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