Echelon asked WA Wijewardena, the former Deputy Governor of the Central Bank and respected proponent of central bank reform, to tell us what he believed was the biggest problem with our economy, how we got to where we are, and why we citizens and our politicians continued to perpetuate economic policies that were clearly problematic.
In your view, what is the biggest misconception about the economy, or myth, that’s led us to where we are today, a country in default?
The biggest misconception that should be removed from peoples’ minds completely is the mentality that the state has to provide welfare for its citizens. The main reason behind this mentality is that during the last phase of colonial rule, even the colonial master – Great Britain – went for what is known as a welfare state prior to which they had the laissez-faire type policies where the government would do the minimum, and the private sector was expected to run the economy.
In the 1940s and 50s, specifically during WWII, a new concept called the welfare state was developed, for two reasons, one being to prevent the Western world from becoming a communist country because by then the Soviet Union had, under Stalin’s economic policies, demonstrated that communism was the best type of economic policy where the government could pre-plan and direct the economy. In the case of Germany, after WWII, they found the weaknesses in both the laissezfaire and central planning systems and they came up with the social market economy which was copied in 2015 by Ranil Wickremasinghe who repeatedly stated both in Parliament and numerous public addresses he made, that his policies were the highly competitive social market economy.
The mentality that has been inculcated in the minds of the people is that the government is there to provide everything free of charge by taxing others. This was possible in the 1930s and 40s when Ceylon had a lucrative plantation sector which generated a surplus that was taxed and passed on to finance free education and free health services.
But after independence, with calls to nationalize the plantation sector specifically made by Dr NM Perera and SWRD Bandaranaike, the planters did not reinvest their surplus in Ceylon. Instead, knowing that one day they’ll have to give it all up, they invested their surplus in East African countries such as Tanzania, Zambia, and Kenya where they started new plantations which resulted in these countries becoming major tea producers. With the resultant loss of surplus, the government could not continue with the luxury of providing feeless education and healthcare services.
But the mentality of the people was that there had been lots of injustice committed by the colonial masters, Western powers and the capitalist system, therefore the rest of the world owed them a living, and that is the mentality that has existed during the entirety of the postindependence period which politicians have capitalized on in order to win elections. That is why competitively they were proposing various schemes without knowing that they lacked the resources.
That’s one of the reasons why former Singaporean Prime Minister Lee Kuan Yew and Prof Joan Robinson, a Cambridge economist, remarked that Ceylonese are famous for enjoying the fruits of a tree that has not even been planted and that one day we would come up against the wall, and today that’s exactly what has happened.
So, who should we hold responsible for our current predicament?
It is not only the Gotabaya Rajapaksa administration that’s responsible for the current economic situation, but every administration since independence, and specifically our first Finance Minister JR Jayawardena. In 1942, he read Keynes’ “General Theory of Employment, Interest and Money” which was published in 1936, and became a fan. Strangely during that period, Margaret Thatcher who was a science graduate at Oxford had also read it and started questioning how wealth and prosperity can be created by printing money, in contrast to JR Jayawardena who was a convert.
Jayawardena submitted a report on this to the Ceylon National Congress of which he was the secretary, highlighting the type of policies independent Ceylon should adopt. According to him, trade should be in the hands of the local people, foreigners should not be given opportunities to do jobs here reserving them only for the Sri Lankan people, Sri Lanka should develop based on an agricultural economy and not on industrialization and all major industries should be in the hands of the state. Those were the suggestions he made in 1939 to the Ceylon National Congress. If you look at his first budget in 1947, it is no different to the budget presented by Gotabaya Rajapaksa in 2020.
That’s why when Ceylon became independent and we had to make the choice of either going with the currency board system or the central bank, he didn’t want to go by the British Bank of England to set up the Central Bank of Sri Lanka, because he thought the Bank of England even at that time, had been following more or less the laissez-faire type of policies. So, he invited an economist from the Federal Reserve Bank to advise him and that is how John Exter came and set it up.
By that time, John Exter had the experience of setting up the Central Bank of the Philippines, the same model that he copied and reintroduced to Sri Lanka. And in the Central Banking Law, permission was given to the central bank to provide liquidity funding to the government which has been abused by everybody because when the central bank invests in treasury bills in the primary market, the central bank has to print money and give it to the government, and all finance ministers liberally utilized that facility.
Even today if you look at the Gotabaya Rajapaksa administration, the total amount of treasury bill holdings of the central bank has gone up from about Rs400 million in 1990 to Rs2,400 billion, which shows the amount of central bank funding used by the administration to finance the budget. It was only in 1977 that Jayawardena realized his folly.
You have said elsewhere that Sri Lanka had two opportunities to address the central bank issue, but before we proceed, can you briefly explain the fundamental difference between a currency board and the Central Bank?
The fundamental difference is that if you go back to ancient times in Ceylon, the Kings issued coins that were made of precious metals like gold and silver. And for them to issue those coins they had to have gold and silver because we don’t produce them here. How the Kings acquired gold and silver to issue currency coins was by exporting more than what was imported, deliberately maintaining a surplus in the balance of gains and payments which came in the form of the importation of gold and silver that the kings would use to issue coins. They were therefore restrained in issuing coins by the amount of gold and silver that they had. In other words, whatever coins had been issued by ancient Kings, except Parakramabahu, had a backing because we knew a gold coin has a metallic value and therefore, the coins issued by them or even private parties, had 100% backing of a precious metal.
Similarly, in the case of a currency board, when the board wants to issue currency, it should be supported 100% by reserves for foreign exchange. For example, if Sri Lanka wants to issue one rupee, a rupee had been equated to one USD, the currency board can issue one rupee only if we get one USD. How does it get one USD, by having a surplus in the balance of payment or buying that dollar from the market, where the commercial banks and others will have to buy it or borrow it? So, if the currency board gets 10 US dollars it can issue 10 rupees, and if it loses five US dollars because of the deficit in the balance of payments it will have to withdraw five rupees and cancel it, so the currency was 100% backed by precious foreign exchange.
In the case of central banks, there’s no backing at all. If you look at the Central Bank of Sri Lanka today, the foreign reserves are negative to the extent of four and a half billion US dollars. Suppose the currency board that we had before the 1950s had issued one rupee and you were to come back and ask the currency board for the value of the rupee, they would take that rupee and give you $1. Our currency board was linked to the Indian rupee and British Sterling Pound so we had maintained all our reserves in Indian silver rupees which meant that politicians could not print money and the currency board could not lend a single rupee to the government if it did not have 100% backing in the board. This means that currency boards are solid whereas central banks are growing like an inverted pyramid.
Incidentally, Singapore is where it is today (far ahead of Sri Lanka) because when it gained independence in 1965, it adopted a similar policy that Shenoy had proposed to Sri Lanka, pushing them from a third-world country to a firstworld country, an opportunity that we missed, twice!
So, coming back to JR, you say we have had two opportunities to reverse course and avoid racing down the road that led to this economic crisis?
Yes, there were two occasions when he could have corrected it, one was in 1966 when he invited an Indian economist, BR Shenoy, a Professor of Economics at the University of Ceylon who counted current President Ranil Wickremasinghe’s father Esmond Wickremasinghe as a student of his, to recommend some economic policy reforms.
He submitted a very comprehensive report (which I discovered gathering dust at the J R Jayawardena centre in manuscript form) recommending some economic policy reforms which were far ahead of the time. Shenoy recommended the eradication of exchange and import controls, all price controls, the listing of all state enterprises on the Colombo Stock Exchange, and the floating of the Sri Lankan rupee. At that time, in 1966, nobody knew about the floating of the rupee because we had a fixed exchange rate system with floating and flexible exchange rates coming after 1971.
These recommendations were presented to the cabinet by Jayawardena who was the then Minister of State and Deputy Prime Minister, where it was voted out, his cabinet telling Prime Minister Dudley Senanayake that it was a conspiracy by Jayawardena to oust him.
Because Dudley Senanayake had already had a bad experience with the elimination of the rice ratio in 1952, he believed Jayawardena was indeed conspiring against him.
What politicians – be they government or opposition – are planning to do is get the votes by perpetuating that dependency system. They’ll face reality only when they are in power, and that is why ranil wickremasinghe had to go for the tax reforms that many are against. No politician has the backbone to stand up in a forum and say “this is enough, we cannot continue with this problem
The second opportunity came in 1978 when Jayawardena became the president. He invited Dr Goh Khen Swee, the man behind the economic miracle of Singapore, to come to Sri Lanka and advise him.
Dr Goh’s advice was based on his experience in Singapore and similar to BR Shenoy’s, but Jayawardena did nothing with it. So, what Jayawardena proposed in 1966 was killed by Dudley Senanayake, and then he himself ignored a similar proposal that he himself had commissioned in 1978!
Incidentally, Singapore is where it is today (far ahead of Sri Lanka) because when it gained independence in 1965, it adopted a similar policy that Shenoy had proposed to Sri Lanka, pushing them from a third-world country to a first-world country, an opportunity that we missed, twice!
But is not Jayawardena credited with liberalizing the economy?
Many think that in 1978 JR Jayawardena performed a miracle, but it is not so. Many think that he started the free market economy, but even today, tea cannot be exported without a license from the tea board, rice cannot be exported without a license from the government, and some of the major exports are still under licensing. About 90% of the imports under the Jayawardena regime were under the control of the government, major food items like rice, dhal and sugar were under the monopoly of the food commissioner and petroleum was under the monopoly of the government.
People are criticizing Jayawardena for opening up the economy, not knowing that it was R Premadasa and Chandrika Bandaranaike who were responsible for opening the economy. Jayawardena also went beyond bounds, like when the Mahaweli project had to be accelerated he created the Mahaweli Authority, a public cooperation into which all the Ministers began putting their people, resulting in it expanding to the point of becoming a burden on the state as was the case in most of the corporations. Jayawardena certainly has a place in Sri Lanka’s post and pre-independence history, but he’s not the person people are actually praising.
What I am suggesting is that this particular mentality that’s inculcated in the minds of the public where they expect everything free without making a contribution had been cultivated and inculcated by all politicians in Sri Lanka throughout post-independence history.
Don’t you think, that politicians in government and the opposition are still perpetuating this dependency? Even the media, in the way they frame their questions on economic issues?
Exactly. This dependency syndrome is cultivated in the minds of people from the time they are in their mother’s womb, it’s part of their genetic system, so you can’t change it. What politicians – be they government or opposition – are planning to do is get the votes by perpetuating that dependency system. They’ll face reality only when they are in power, and that is why Ranil Wickremasinghe had to go for the tax reforms that many are against. No politician has the backbone to stand up in a forum and say “this is enough, we cannot continue with this problem”.
How can the government propose tax reforms or any reforms that require painful adjustments, when people only blame politicians?
People expect, and feel entitled, to a free lunch, and politicians oblige. But who has to pay? While Sri Lanka continues to perpetuate dependency, Singapore very early on nipped it in the bud.
Singapore had a currency board system which they inherited from the British like us. In 1965, when they were separated from the Malay Federation, they had to make a choice whether they would establish a central bank like all the other newly independent countries, or continue with the currency board.
Goh Keng Swee Singapore’s first finance minister in their 25th Anniversary Trilogy wrote an article explaining why Singapore went for a currency board. Lee Kuan Yew and Goh Keng Swee belonged to what was known as the old guard of Singapore, and Swee says he also read Keynes’ General Theory and like Margaret Thatcher, questioned how printing money could create prosperity.
So, they decided to continue with the currency board system, and he said by doing that, they wanted to convey messages to three different parties. One was to their own citizens that if they wanted better public services they would have to pay for them, there’s no such thing as a free lunch. The second was to future politicians that if they wanted to incur vote-catching expenditure programs, they would have to bring that money from their homes and not money printed by the centre. The third was to the rest of the world, you leave your resources with us, we’ll prudently use them and ensure that you get the same rate of return as well as the money that you’ve invested with us.
These were the three messages that were conveyed by this old guard. Alternately, the older politicians from that time until today have stuck to this principle. Even today’s Prime Minister Lee Kuan Yew’s son continues to speak the same language: a language we’ve hardly ever heard in Sri Lanka.