Sri Lanka needs a currency board
The war in Ukraine has generated an economic tidal wave that is sweeping through countries near and far. Among the furthest is Sri Lanka, half a world away from the battlefield, where soaring food and fuel prices accelerated a downward spiral that was already underway.
The island has been rocked by street protests that led to the resignation last month of Prime Minister Mahinda Rajapaksa, the brother of President Gotabaya Rajapaksa, and his cabinet. Saving Sri Lanka from economic collapse and socio-political disaster will require drastic action.
With a new Prime Minister at the helm in the person of Ranil Wickremesinghe, Sri Lanka must deal with the serious economic crisis it is facing, starting with putting its public finances in order.
There’s no time to lose. With about $7 billion of the country’s $51 billion in external debt due this year, a debt moratorium has been put in place. Moreover, the 600 million dollars that the World Bank granted to ensure essential food imports will not be enough to stop the financial hemorrhage.
With public coffers near empty, mounting balance of payments pressures and a massive debt overhang looming, the first priority should be a plan to address Sri Lanka’s dire fiscal situation, including an effective implementation mechanism. .
Such a plan should include all the standard consolidation measures, such as eliminating waste and tightening budget management. But, with confidence in public finances dwindling and the value of the rupee collapsing, Sri Lanka must also take the most drastic step of installing a currency board.
In such a system, the exchange rate would be fixed by law and the central bank should be able to cover the entire monetary base with foreign exchange reserves. By depriving the government of its discretion to run large deficits, a currency board would relatively quickly restore the credibility of Sri Lanka’s finances.
Once established, the council would provide needed solutions to Sri Lanka’s economic problems, with particular emphasis on stemming the decline of the rupee.
Yes, a currency board is a form of shock therapy. But that is what the current crisis in Sri Lanka demands. And, in fact, because it can be installed immediately and does not require any immediate reforms affecting public budgets, state assets or commerce, a currency board is equivalent to a faster and more effective medicine than the long dose of austerity often proposed.
The record speaks for itself. The most acclaimed modern currency board was established in Hong Kong in 1983. But examples of successful currency boards abound. Indeed, in more than 50 countries where currency boards have been set up, they have always succeeded in restoring confidence in public finances and the national currency.
In 1992, Estonia established its currency board in record time – just 30 days – to support the transition from the Russian ruble to the new krone after independence. Its success inspired Lithuania, another post-Soviet state, to establish a currency board in 1994.
Lithuania – a country I represent in Sri Lanka as Honorary Consul – has been hailed by the International Monetary Fund for its economic transformation, in which the currency board has played a central role.
In Bulgaria, a currency board put an end to a hyperinflation crisis in 1997. The country quickly turned its budget deficit into a surplus and tripled its foreign exchange reserves. Today, it has one of the lowest debt-to-GDP ratios in the European Union.
Critics argue that currency boards are only suitable for small countries and that a weak banking system will reduce its impact. But none of this would prevent a currency board in Sri Lanka. We are an island of 23 million people and there are no weak banks operating in our country.
Mr. Wickremesinghe, with whom I have discussed this proposal, believes that some version of a currency board should be incorporated within the central bank, rather than as an independent entity.
But the problematic past performance of the Central Bank of Sri Lanka, including its history of politicization, makes this suggestion a failure, despite the increased credibility and international goodwill brought by its new governor, P Nandalal Weerasinghe. In any event, a currency board is a very different creature from a central bank, due to its strictly limited functions.
Shaken by the crisis, Sri Lanka must finally confront its financial demons head-on. It will be a tough fight. But a currency board – which deprives the government and central bank of the ability to mismanage the budget and the exchange rate, thereby restoring the credibility of our economic governance – greatly improves Sri Lanka’s chances of victory.