What Happens When A Central Bank Is Broke?

"International financial institutions and development partners become less willing to lend to country’s developmental projects. No one likes a broke guy. You are never given unless you prove you don’t need it".

By Morris Madut Kon

A few days ago, South Sudan’s top bank declared that it had run out of foreign exchange reserves, effectively rendering it bankrupt. Yes, Central Banks can go broke, and this has happened in several developing countries before. It’s worth noting that this did not just occur overnight, it was long overdue – a result of years of inaction and poor monetary planning.

So how did we get into this mess? What are the consequences? And how do we get out of it? Here is my take:

How We Got Here:
South Sudan has been battered by years of senseless conflict that we are less willing to resolve. Coupled with plummeting oil prices, non-diversified economy, a devastating global pandemic that has disrupted international trade, virtually non-existent financial system and deeply entrenched corrupt practices, it shouldn’t be surprising that our lender of last resort, the market marker of last recourse activities is on the verge of a fiscal collapse.

What are the Consequences?
Central Bank is the official cashier of the government. It makes payments on the government’s behalf, including settling of local and foreign debts, payment of civil servants, spending on social amenities etc. A broke central bank is an insignia of a broke nation. With empty coffers, a nation is unable to settle multilateral financial commitments (which are done in hard currency), a situation loosely referred to as “Sovereign Default” – a serious disdain on the image of a country and its leaders. Recent embarrassing debuts at the EAC and AU were just a tip of an iceberg.

When a nation’s reserves are depleted, it disincentivises foreign investors. International financial institutions and development partners become less willing to lend to country’s developmental projects. No one likes a broke guy. You are never given unless you prove you don’t need it.

Basic items become increasingly unaffordable for the ordinary citizens. Heightened struggle for the little resources increases rivalry, leading to social unrest. In the longest run, if no effort is made to resolve the crisis, serious chaos unfolds and the nation falls deeper into socio-economic abyss.

What is the remedy?
A country holds reserves in hard currency to enable it intervene directly in foreign exchange, influence exchange rates and maintain stability of the local currency. When reserves are depleted, it becomes increasingly impossible to control exchange rates, leaving the local currency on a free fall as evidenced by recent sharp depreciation of South Sudanese Pounds against US Dollar.

In a normal economy, the conventional balance sheet of the Central Bank, as Willem Buiter would say, is “uninformative about the financial resources it has at its disposal” and about its ability to act effectively as the brain behind a country’s economic stability. This means it should always be possible for the Bank of South Sudan to ensure its solvency through seigniorage ( profit made by printing currency), as long as the bank doesn’t have crazy foreign exchange-dominated liabilities.

Again, this works as long as there are adequate real resources at the bank’s disposal to increase issuance of nominal base money. But ours is NOT a normal economy so we must look for alternative solutions.

In the short run, I would agree with what our veteran journalist, Jacob Jiel Akol, suggested earlier: set up an economic reform committee, consisting of trustworthy and experienced economists, to advocate financial bailout.

Additionally, serious mechanisms must be put in place to address corruption within the bank. There are reports that top bank executives are also involved in the black-market dealings, becoming overnight millionaires to the detriment of the masses. There is a need to strengthen the central bank legislatively to avoid political interferences.

If we are honest about coming out of this crisis, and for the greater good of the country, we must be willing to accept painful sacrifices, including resigning from the bank and allowing other competent persons to serve.

Finally, if the nation is to grow economically, the ongoing political chaos must be resolved. At the executive level, the President and his Five Vice Presidents must be willing to put the country above their political interests and come up with a comprehensive roadmap to South Sudan’s socio-political and economic salvation. The politics and economy are inextricably intertwined. There will be little economic progress as long as our nation remains in a perpetual state of war with herself.

With regard to latest Press Release about the bank “buying gold and gum arabic” to “diversity the economy”, I find the statement laughable for reasons I will address in my next post.

Source https://www.google.com/url?rct=j&sa=t&url=http://www.gurtong.net/ECM/Editorial/tabid/124/ID/22143/Default.aspx&ct=ga&cd=CAIyGjVjYWMzMDRkNTczNGIxNjg6Y29tOmVuOlVT&usg=AFQjCNFKuuy7RQHg0jq6kRTe6xhneB2qZg