New MLA to clip FinMin’s voting powers in monetary policy formulation

The almost 70-year old Monetary Law Act (MLA) is currently being amended to take away the voting powers of the Finance Ministry at the Monetary Board, as the amended law aims to provide greater autonomy for the Central Bank over monetary policy formulation, free of political influence.  

To this effect, the Cabinet of Ministers has already approved a policy note, which contained amendments to the existing MLA, including the one to do away with the voting rights of the Finance Ministry, in determining the country’s monetary policy, the International Monetary Fund (IMF) said.
The Monetary Law Act No.8 of 1949, which defines the administrative and regulatory functions of the Central Bank, allows the Secretary to the Ministry of Finance to sit on the five-member Monetary Board as an ex-officio member.  The Secretary to the Ministry of Finance holding voting powers, acts as an important conduit between the government and the Central Bank for effective macro-economic management.

A harmonized monetary and fiscal policy has been made possible by this arrangement as an effective relationship between the two enables maintaining a total demand in the economy at a level equal to the total supply – a difficult task to achieve price stability in the economy. 

But some argue that the presence of the Finance Ministry Secretary in the Monetary Board makes the Central Bank subservient to the Finance Ministry.

But the whole relationship between the Finance Minister and the Central Bank depends on the former’s maturity, according to John Exter – an American economist and the founder of Sri Lanka’s Central Bank.

The Central Bank with technical support from the IMF, adopted a comprehensive roadmap for transitioning to an inflation targeting regime in setting the monetary policy and greater exchange rate 
flexibility by 2020. 

A key milestone in the roadmap is to revise the MLA to strengthen the Central Bank’s mandate, autonomy, governance arrangements, transparency, and accountability.

As part of this process, the Central Bank undertook to move towards a flexible inflation targeting regime and establish a market-based exchange rate system to achieve price stability. 

This is against the monetary targeting framework for monetary policy management, which the Central Bank had been pursuing for price stability since the 1980s. 

However, the monetary targeting has become a less meaningful framework for monetary policy conduct in the present day, given issues such as the instability in the money demand function amidst financial innovations and the weakening relationship between money and inflation, the Central Bank roadmap stated. 

Price stability is where a low, stable and predictable level of inflation fosters sustainable long term economic growth and employment in the country. 

Price stability is instrumental in keeping nominal interest rates low, thereby enabling an economy to exploit its growth potential while both consumers and producers can make economic decisions with confidence and certainty.

However, some economists argue that the inflation targeting is a ‘suicidal attempt’ as the Central Bank becomes responsible for the inflation generated by fiscal excesses.

The amendments to the MLA nevertheless also include restrictions on the Central Bank to finance the fiscal deficit created by the government. 

The amendments to the MLA are expected to be presented to Parliament in March 2019, and they are to come into effect from the second quarter of 2019.