Should Sri Lanka cancel central bank?

What was good for Sri Lanka under British colonial rule 75 years ago may be worth a try again. Or at least that’s what Mark Mobius, the former emerging markets guru at Franklin Templeton Investments, seems to be suggesting. To regain the confidence of investors, the bankrupt Indian Ocean island could consider swapping its central bank with a currency board, he says.
Mobius has a point. A central bank with discretionary power over domestic interest rates wields enormous power, but not all can exercise it responsibly. If powerful politicians — like Sri Lanka’s President Gotabaya Rajapaksa and his brothers — are going to wreck fiscal management with disastrous tax cuts and ruin agriculture with a ban on fertilisers, and if the monetary authority is simply going to enable that recklessness by printing money, then the country may be better off ditching the bank in favour of a set of rules.
Ultimately, that’s what a currency board boils down to: a protocol. Anything that requires judgment — such as setting interest rates, bailing out troubled lenders, helping the government raise funds on the cheap — goes out the window. National money is backed 100% (or more) with liquid, risk-free assets held in the foreign anchor currency.
In other words, a pure currency board for Sri Lanka won’t resemble Argentina between 1991 and 2001: That system had too many cheat days in its diet. The right model is the Hong Kong Monetary Authority.
Even in Hong Kong, which has run a currency board since 1983, rumors of an impending demise of the peg start to swirl whenever local interbank rates go out of kilter with U.S. rates — as is the case now. But those rumors are always exaggerated. Yes, the Federal Reserve has turned hawkish, and Hong Kong must, therefore, expect strong capital outflows in the months ahead. But it’s no big deal.
The HKMA will automatically sell US dollars to the banking system when the local currency drops to
the weaker end of its HK$7.75-HK$7.85 convertibility undertaking, sucking out domestic liquidity so that, as Bloomberg Intelligence strategist Stephen Chiu notes, “local rates may
also rise and catch up with the US rates, hence supporting the Hong Kong dollar eventually.”
Sri Lanka, too, can adopt such a self-executing code, provided it can find the right anchor and an appropriate conversion value. Its rupee has been unofficially pegged to the US dollar since October 2021.
However, after dwindling foreign-currency reserves forced the previous central bank Governor Ajith Nivard Cabraal to drop the peg
last month, the Sri Lankan rupee collapsed — from about 201 to the dollar to around 350.
Such volatility could be eliminated by giving the exchange rate a strong mooring — of the kind that existed in Sri Lanka’s own past.

—Bloomberg