Printing money: Our way out in 2022 too?

By Vinu Opanayake  

The term ‘money printing’ has gained profound traction in the past year, thanks to the Central Bank of Sri Lanka (CBSL). The country had printed a whopping Rs. 130 billion in October 2021 alone. According to the available data, from December 2019 to October 2021, the CBSL has printed Rs. 2.8 trillion.

As of end December, Central Bank’s Treasury Bills were around Rs. 1.4 trillion while banking sector overnight liquidity injections were around Rs. 467 billion for the year.

Money printing in a country means printing a currency of a government by an authority approved by the respective government. The CBSL has the sole right and authority to issue currency in Sri Lanka which includes both currency notes and coins as stipulated in the Monetary Law Act No. 58 of 1949.  

The incumbent CBSL Governor Ajith Nivard Cabraal is of the view that money printing does not lead to inflation. However, this week, The Sunday Morning is determined to find the impacts to the Sri Lankan economy, if the CBSL continues printing money like it did last year.

Money supply and inflation 

Emeritus Professor Sirimevan Colombage, an eminent economist who served on the academic staff of the Department of Economics, University of Ceylon, Peradeniya, before joining the CBSL, told us that the foremost factor that had led to increase in money supply and in turn high inflation was the fact that CBSL had adopted the Modern Monetary Theory (MMT) in 2020. 

MMT argues that a government can create its own money it needs as much as it wants, in a manner that does not generate inflation. So basically, MMT states that printing money cannot alone be the cause of inflation. In addition to this, ABC Australia noted that MMT says (promoted famously by former British Prime Minister Margaret Thatcher) that national governments must tax or borrow before they can spend is wrong.

It further added that MMT economists say that inflation would only be a problem (in a country like Australia) if the federal government spent too much money into an economy that was already running at, or close to, full capacity. 

On the other hand, headline inflation, as measured by the year-on-year (Y-o-Y) change in the National Consumer Price Index, increased to 11.1% in November 2021 from 8.3% in October 2021, according to the Statistics Department of the CBSL.

Meanwhile, on an annual average basis, the NCPI increased to 6.2% in November 2021 from 5.7% in October 2021, the statement said.

According to Prof. Colombage, the broad money supply (M2), defined as the narrow money supply (currency and demand deposits) plus time and savings deposits held by the public with commercial banks rose by 17% over the last 12 months. This was due to a 23% increase in the net domestic assets of the banking system mainly caused by the rise in Net Credit to the Government (NCG), Colombage stated.  

He added the increase of 38% in NCG was a reason for the hike in money supply as Bond Currency Derivatives (BCD) disbursed by the CBSL and commercial banks rose by 156% and 15%, respectively. Further, CBSL and other Licensed Commercial Banks (LCBs) lending to the Government amounted to Rs. 1.65 trillion as of December 2021.

The Government obtained as much as Rs. 1,658 billion of net credit from the CBSL and commercial banks during the last 12 months. This reflects the extent to which liquidity is injected into the market by way of bank lending to the Government.

Explaining further, Colombage noted that the CBSL had adopted to maintain an unrealistic exchange rate to avert the adverse effects of rupee depreciation.  

Former CBSL Governor Prof. W.D. Lakshman, a few days before his retirement, issued a directive to all the banks, advising them to keep the selling rate of the US Dollar below Rs. 203. The banks have so far kept up with the directive, which has resulted in reluctance among exporters to convert their dollar proceeds into the Sri Lankan Rupee (LKR) and a drop in worker remittances. 

“The Central Bank has lost its grip on the exchange rate and interest rate. An open economy cannot sustain in this environment. There is in fact a close connection with the inflation and money supply,” Colombage stated.

According to him, the year-on-year inflation, measured in terms of the Colombo Consumer Price Index (CCPI) rose to 9.9% in November 2021, almost reaching the double-digit mark for the first time since 2009.

If monetary management has to be kept away from political pressures that ultimately lead to inflation, Prof. Colombage suggests that the Central Bank’s independence becomes crucial.

It should be noted here that the then Governor of CBSL, Dr. Indrajit Coomaraswamy, in 2019 drafted a Central Bank Bill, which would increase the independence of the CBSL.

Under this Bill, the Monetary Board will be solely responsible for monetary policy formulation and implementation of the flexible exchange rate regime in line with the flexible inflation targeting framework. Neither the Treasury Secretary nor any member of the Government would be members of the Monetary Board.

The second major change that would be brought about is that the CBSL would not be allowed to participate in primary auctions. “The Central Bank shall not purchase securities issued by the government, by any government-owned entity, or any other public entity in the primary market,” the Bill states. 

“This would prevent the Central Bank from participating in primary auctions that take out high-powered money in the most inflationary form of financing off the budget. It leads to Balance of Payments (BOP) pressure, inflation pressure, and asset bubbles. It is really not a good thing and by law, the Central Bank will be able to do away with that,” noted former CBSL Governor Dr. Coomaraswamy at his final Monetary Policy Review press briefing in late November 2019.

However, the current Government which was the Opposition in 2019, was not in favour of the CBSL becoming independent. Accordingly, after they came into power, they discarded the proposed new Central Bank Bill.

Cabraal in denial

When asked whether the CBSL would continue printing money this year as well and how it would address its impacts on the economy particularly in terms of increased inflation, Cabraal said the following on Wednesday (5):  

“CBSL’s Treasury Bill holdings have reduced since I assumed duties as Governor. Hence, contrary to your assertion, it is the reverse that has happened. Over 80% of the increase in the CCPI last year has been due to supply-side shocks and not due to the increase in Treasury bill holdings of the CBSL.”

In October last year, Cabraal stated that inflation had increased due to supply-side shocks from the global market changes, and certainly not because of the money printing by the CBSL.

Cabraal added that the CBSL could not take responsibility when it came to supply as it was affected by the circumstances that take place in foreign countries or globally.

However, with regard to the global impact of price hikes, the value of the LKR impacts the price, and the CBSL said that it was working on that matter. 

A supply-side shock is an event that leads to a reduction of the production capacity of goods or services at a given cost.

While different proponents of MMT have proposed slightly different views, some of the key ideas are that governments can increase deficit spending without a problem and that they can also print money. Still, others argue that money can be printed to repay bonds, and therefore there will be no default on debt. 

However, it is important to remember that the comparison of a government to a household only goes so far. This is because sovereign nations can print money that a household cannot. Some believers of MMT claim that in an environment where a country hasn’t reached full employment, printing money or quantitative easing doesn’t cause inflation. Some others argue that if inflation picks up, taxation can be used to take spending power and reduce inflation. 

Crossing money supply boundary line

University of Colombo Professor in Economics Sirimal Abeyratne told us that the country had already crossed its money-printing boundary line and added there was an extent for the money printing to go on, particularly during a recession, as aggregate demand, consumer demand, business demand, and international trade get disruptive during a recession. 

“There is some degree for money printing because as the result of substitute aggregate demand, inflationary pressure goes down and this is why some countries find it possible to keep on printing money. This is particularly the reason which rich countries like the US, European Union, and Japan could print enormous amounts of money during the last 10-15 years,” he added.

He stated that developing countries like Sri Lanka too could do this but the amount of money printing had to be very limited as when the money was being printed, obviously the exchange rate comes under pressure, and added that this was one of the reasons why Sri Lanka had to go for import controls as otherwise it could have resulted in widening the trade deficit of the country much further.  

“But now, we have crossed all these lines. We already have a commodity shortage and inflationary pressure, so it is high time to contain the money printing otherwise we will end up aggravating our inflationary pressure,” Abeyratne added.

When asked how Sri Lanka could address the issues alternatively that it was now hoping to address by printing money, Abeyratne stated that it was a policy dilemma policymakers had to address. He added that the blame should not be put on the pandemic as Sri Lanka had been having fundamental economic errors way before the pandemic’s entry into the country.

“We are always caught up in this policy dilemma. Our investments have to grow and exports have to grow. These are the two main factors. I do not think the Government has any interest in looking at these two matters. Instead of doing this, opting for money printing might temporarily postpone the issue but affect the economy,” he concluded. 

According to a study done by CBSL Assistant Governor Swarna Gunaratne, the money printing authorities should print money only to match the value of overall transactions in the economy. She added that when economic and business activities grow in a country, there should be an increase in total money supply as well to facilitate such transactions. Therefore, after estimating the expected economic growth of a country (in nominal terms) for each year, the monetary authority is responsible for adding new money to the economy only to the extent to meet that amount of growing transactions.

“If money is printed and released over and above the required amount, the result will be the increased demand for goods and services creating inflationary pressures in the economy. Therefore, the main responsibility of a Central Bank is maintaining the country’s aggregate stock of money (money supply) in such a way that does not create inflationary pressures beyond the country’s tolerable level,” Gunaratne added.  

Economists have maintained that if a country prints a certain amount of money that might fit its actual output, money printing could be healthy for an economic system, but whether the current level of money printing in Sri Lanka will shape its post-Covid output remains to be seen.