New MLA amendments to restrict financing fiscal deficit by Central Bank

June 05, 2018 (LBO) – Sri Lanka’s Central Bank said there will be new legislative amendments to Monetary Law Act (MLA) to restrict financing the fiscal deficit of the government by the Central Bank.

Currently, the Central bank has been compelled to purchase Treasury bills in the primary market at times without regard to monetary conditions.

The bank is also required to provide credit to the government through provisional advances of 10 percent of the estimated revenue of the government, each year.

Senior Deputy Governor of the Central Bank Dr. Nandalal Weerasinghe told media that with the introduction of Active Liability Management Act, this will not be required.

“Under the new Active Liability Management Act, the government can raise money in advance even for the next year borrowing program,” Weerasinghe said.

“So, there will be no need for the government to ask the Central Bank for 10 percent because they can raise it. So there will be no harm taking those provisions from MLA out.”

Weerasinghe, however, said that it does not necessarily mean that the Central Bank would not buy Treasury bills.

“Central Bank certainly needs T-bills, not because the government wants us to subscribe, it is because, for our own open market operations,” Weerasinghe said.

“So, we will have Treasury bills in our stocks depending on the market conditions and liquidity situations but it can’t be a demand from the government.”

Since Sri Lanka is moving towards a Flexible Inflation Targeting (FIT) framework by 2020, financing of the fiscal deficit by the Central Bank needs to be eliminated.

Economists say it is important to make the Central Bank fully independent before Sri Lanka adopts an inflation targeting as its monetary policy framework.

A crucial requirement for such framework is that the Central Bank should be freed from the clutches of the Ministry of Finance.

Senior Deputy Governor of the Central Bank said cabinet approval to amend the Monetary Law Act has been obtained in April 2018.

“New amendments to Monetary Law Act will be expected during the first quarter of next year; currently it’s being drafted,” Weerasinghe added.

New amendments are expected to improve the governance of the Central Bank while strengthening their independence and facilitate the adoption of FIT.

Although Central Bank has already committed to stabilizing inflation at mid-single digit levels, a precise target for FIT is yet to be decided.

Empirical literature suggests inflation in the range of 4 – 5 percent in transition economies would correspond to price stability.

Maintaining low and stable inflation will enhance the public confidence in the government, and also reduce government’s borrowing costs through lower average interest rates in future.