State-guided development needed for post-COVID-19 recovery 0 88

The Biznomics team met with the Governor of the Central Bank of Sri Lankan Prof. W.D.
Lakshman to discuss the economic situation in Sri Lanka. In a candid discussion,
Governor Lakshman shared his thoughts on development finance, Central Bank
independence, and the need for state-guidance in reviving the Sri Lankan economy in
the aftermath of the COVID-19 pandemic. The following are excerpts:

 Q. How can Sri Lanka meet its long-term development finance needs?

The modern banking system in this country was started to support its emerging export economy, coffee to begin with and tea and rubber later. Banks have, from the beginning, been geared towards supporting trade activity, short term finance, and working capital requirements. That was the accepted role of commercial banks set up here. There has historically been the need for long-term funding for new economic activities that commercial banks failed to supply. So, the need for a bank to provide finance for development was felt from the very early stages of attempted diversification of our economic activities, in the last stages (the State Council days) of the colonial period. Hence the appointment of the Banking Commission or the so-called Pochkhanawala Commission by the name of the principal commissioner, to examines conditions in the prevailing banking system and to propose a new state-aided bank to provide banking and credit facilities for agriculture, industry, and trade. The newly started stated-aided bank following recommendations of this Commission, the Bank of Ceylon (1939), however, developed itself into a customary commercial bank specializing in trade finance.

After political independence, the very first development bank was set up in this country, on recommendation of the World Bank. The recommendation was made by the World Bank team of scholars, sent to Sri Lanka in the early 1950s, in their extensive study published under the title Economic Development of Ceylon. The team had recommended, among other things, the creation of an institution to provide long-term development finance for projects. The institution so established in 1954 was named the Development Finance Corporation of Ceylon (DFCC). The next attempt in the move towards setting up development banks in Sri Lanka was in 1979 under the
government of Mr. J R Jayewardene. The institution so set up was named the National Development Bank (NDB).

Both these banks found, with the passage of time, for whatever reason, that they could not continue with the development banking business and as an easy solution to the problem, NDB and DFCC were allowed to begin deposit-taking and commercial banking activities in 2005 and in 2015, respectively. Having got that authority to work as commercial banks, these two institutions have completely ignored their original mandate of development banking.

I strongly believe that in order to provide the funding required for new activities for sustainable economic development, long-term funding institutions are needed. They could be called development banks, or investment banks, or enterprise banks – there are slight differences in these bank types – but the need is for an institution that can provide financing for new projects and new industries. I strongly believe that we have to take development banking forward again with a firm foundation in terms of funding and commitment so that the idea isn’t abandoned before the role of the bank is fulfilled.

Q.With the Central Bank’s easing of monetary policy and provision of relief, how do
you ensure that money goes to productive sectors?

Monitoring mechanisms are available to us to ensure that the credit is given to the intended sectors and not to something else. We have mechanisms to examine the banking sector and the licensed financial institution sector including leasing institutions.

Most of the credit goes out through the banking sector, for which we have a strong supervision department right here at the Central Bank. There are regular inspections and investigations of the activities of this sector, and also of the non-banking financial institution’s department. We closely examine where the credit goes, and whether the institutions adhere to the relief measures introduced by the Central Bank such as applicable interest rates.

There are still difficulties and delays in the achievement of Central Bank’s Monitoring and supervisory functions. These difficulties were observed particularly strongly over the last few months, due to the urgency and complexity of the COVID – 19 associated financial needs. Therefore, I have learned from this experience the CBSL has established a separate section by the Name of Financial Consumer Relations Department on 10.08.2020 and also built up a call center available to the general public to bring their complaints to our attention directly and with less hassle.Q. The previous government pushed a certain agenda about Central Bank’s
independence. Can you share your thoughts on this concept?

On this subject, I have my own personal interpretation. Some say the Central Bank should be considered a completely independent institution, standing away from the other state structures. Important state institutions include the office of the president, the Presidential Secretariat, Cabinet of Ministries, The Treasury, and various other departments. I don’t take the view that the Central Bank is a separate institution from the rest of the state. It is part of the state sector, but, it would be good if the Central Bank is given the authority to think independently to some extent, so that we can bring a new perspective to the rest of the state sector, if needed, particularly in the
management of the monetary sector of the economy.

That kind of operational economy, without building up a barrier between the Central Bank and the rest of the state sector, will be useful and productive. A complete separation between the Central Bank and the rest of the state sector would create a complete breakdown of relationships and a failure of the state’s role in the economy and society.

On another note, although we tend to talk about the monetary sector and the real sector as two different things, in practice they work together. In order for the Central Bank to play its role, in monetary and financial matters it must work together with the rest of the real sector of the economy. For example, the actions of the Central Bank could guide the real sector to achieve acceptable employment conditions, rapid economic development, improvement in productivity, and desired conditions of poverty reduction and relative equality. The Central Bank has to work together with the rest of the state sector to guide the economy in a direction that is decided nationally by the electorate.

Q. Many countries are moving towards diversifying away from the U.S. dollar
dependency, where does Sri Lanka stand on this development?

Everyone realizes the risk of concentrating a country’s foreign assets in the denomination of a single currency. Due to past policies, our foreign assets are largely in US dollars. More than 85 percent of our asset portfolios are in US dollars, and a small amount is in other currencies. This is a problem that has to be sorted out, but our move towards diversification has been slow. Given the way, the world economy is organized and international trade is conducted, this diversification is difficult to achieve in a small country. In fact, dollar concentration would have increased over the last ten years. About four years ago, we had around 22 percent of our foreign assets in gold, but not in many non USD currencies after selling off part of the gold stock we now have only about 6 percent of our reserve in gold. The USD concentration of reserves has been dictated by our trade patterns, the pattern of paying for imports, and more specifically, the majority of the outstanding debt prepayments are in USD. Even traders in non-dollar zone countries seem to prefer to conduct transactions in USD.

By about 2015, something like 20 percent of our imports were from China and a similar amount from India. India is of course a dollar dependent country, but China has its own currency which they are thinking of developing as an international reserve currency. However, Chinese traders are expecting payments in US dollars. So, there are challenges in trying to diversify the foreign asset basket in a country like Sri Lanka. Despite these practical difficulties, we do have to work more towards diversification which is a very long-term goal tied to our development and trade patterns.

Q. In your academic work, you have provided strong critiques about Sri Lanka’s development path so far and our relations with the Bretton Woods institutions. Do you still hold to these critiques?

I have not changed my views. However, I am working in an organizational set up that is guided by the liberal, or rather ‘market-oriented’, framework. In this framework, liberalization is the ultimate goal. For example, many of those who work in this framework do not accept policies like import restrictions as part of the tool kit of economic development. Ironically, import restrictions are accepted as a last resort in situations such as the current COVID-19 pandemic. But even under the ‘new normal’, they expect a trading system without state control – a market guided trading system. The belief is in providing “ level playing fields” in the promotion of economic activities for development and the practices of “picking winners” which have worked beautifully elsewhere, and anathema to neo-liberal thinking.

I have argued, and continue to argue, that there has to be selective promotion (and also discouragement) of economic activity on the basis of a long-term vision for the economic development of the country. For example, in a small developing country like Sri Lanka, there has to be a strong manufacturing base developed using whatever
mechanisms have been used by other industrialized nations – including certain control regimes. But there is a strong pressure to allow these things to be determined by market forces. It is argued that markets will indicate where our comparative advantages are. But the comparative advantage is something which has to be created, it is not a given

After I was appointed Governor of the Central Bank, I had the opportunity to talk with a senior regional representative of the International Monetary Fund (IMF) and presented some of these ideas. The said IMF representative happened to be a Korean, but he was not talking on the basis of Korea’s actual development experience but on the basis of what he had learnt from economic texts. In contrast, a very famous Korean friend in
Cambridge, outlining Korean development experience very effectively; happens to be one of the most effective development economists in the world professing the need to guide or govern markets to achieve growth and development.

People who hold alternative views to neoliberalism are now a minority in the world economics profession. In the 1980s and 1990s neo-liberalism really captured the dominating position in academia and almost all Central Banks. Therefore, the concept of state-guiding of markets is not accepted by these theoreticians though in practice it happens in industrialized countries all the time.

That said, COVID-19 has been a major game-changer for the entire world. Sri Lanka was no exception. We need a strong state-guided system to take the economy in a direction that is accepted by the local people in the aftermath of this pandemic. In this struggle to build up an alternative economic policy framework for successful economic development, which the people are demanding, I hope we in the Central Bank would join hands with the rest of the State System.

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