CHAPTER 13

(Excerpted from N.U. JAYAWARDENA The first five decades)

NU’s Rise to the Top

The peak of NU’s career in the public service – and what he considered the most gratifying period in his professional life – was his rise to become Deputy Governor, and then Governor, of the newly created Central Bank of Ceylon. While his period in the bank lasted four years, his term as Governor, which was cut short, lasted just sixteen months. However, his legacy is such that the creation of the Central Bank is inextricably linked with his name, as NU had been closely associated with the Bank even in its embryonic stages and had set up exchange control operations, which became the largest department of the Central Bank during its early years. The experience accumulated during his period in government service, along with his economic and business administration training, made him one of the few government officials who grasped the theoretical dimensions of the role of a central bank. As Controller of Exchange he also had experience in some of the functions of central banking.

Many countries of Asia and Africa in the post-colonial phase regarded the creation of a central bank as both an economic necessity and a symbol of political prestige, marking the shift from colonial rule to national independence. The well-known writer on central banking, R.S. Sayers, of the London School of Economics, notes that: “Colonies which have become politically independent have regarded a central bank as an outward and visible sign of independence, and the lack of one as signifying continued subjection,” adding that this has been “an important aspect in Ceylon and Burma, where central banks have been established since the [Second World] War” (Sayers 1982, p.114, emphasis added).

In contrast to the public interest evoked by the Banking Commission of 1934, the importance of a central bank at this time had hardly become an issue of public discussion, since the role and operations of a central bank were a far more extensive and complex subject, requiring a higher level of understanding of monetary and banking matters and their connection with the long-run development of the economy.

Central banks are essentially “bankers’ banks,” because they have powers of note issue, of setting reserve levels as well as interest and exchange rates, overseeing monetary matters and supervising the activities of commercial banks. Sayers argued that, “the essence of central banking is discretionary control of the monetary system”:

We must have central bankers to exercise… influence on the monetary system … there is no code of eternal rules for them to follow. They have to adapt their ways to the shape of the community’s constantly changing financial habits. (ibid, p.7)

NU taking a rare break

John Exter’s Arrival

In July 1948, J.R. Jayewardene sought the assistance of the United States to help set up a central bank, submitting his request via the US Embassy in Colombo. There was some speculation in Sri Lanka about why the government preferred an American to a British expert. JR argued that the government preferred a non-British person, “because of the supervisory influence which the British people had over us for about 150 years” (quoted in Gunasekera, 1962, p.261).As a result of this request, the Board of Governors of the Federal Reserve Bank of New York offered the services of John Exter, who was the economist covering the Far Eastern region in the Division of Research and Statistics in the New York Federal Reserve Bank.

Born in 1910, Exter was two years younger than NU. After obtaining his undergraduate and further degrees from Worcester College (1928-32) and the Fletcher School of Law and Diplomacy – both in Massachusetts – he had gone on to do his postgraduate studies in Economics at Harvard in 1939, “determined to discover what had caused the devastating Great Depression” (interview in The Money Changer, June 1991). He joined the Reserve Bank after a stint at the Massachusetts Institute of Technology (MIT) during World War II. John Exter would rise quickly through the ranks, becoming a Vice-President of the Federal Reserve, a year after his return from Sri Lanka in 1954. Like NU, Exter was to eventually join the private sector, becoming in 1959 Vice-President of First National Bank – better known today as Citibank – which was at that time, the world’s second-largest bank.

Cousins

Initially, the Federal Reserve Board agreed to send John Exter to Sri Lanka for six months. Exter arrived, along with his wife Marion, at the beginning of 1949, after completing an assignment advising the Philippine government on the establishment of a central bank. In Sri Lanka, Exter was provided with the services, in a “consultative capacity,” of NU, who was then Controller of Exchange, and of D.C. (Douglas) Gunasekera, Senior Assistant-Controller of Exchange (Exter Report, p.iii). The latter served as Exter’s secretary. Exter worked from the premises of the Exchange Control Department, which was at that time located in the Simes Building in the Fort. In addition, he was assisted by H.N.G. Fernando, who was the Legal Draftsman, and T.A.P. Ariyaratne, who served as his stenographer.

Economics of NU and John Exter

Exter may have been pleasantly surprised to find in NU not only an able and experienced economist but also a likeminded believer in the free market. NU would have appreciated an economic system that encouraged and rewarded personal initiative and enterprise, rather than one catering to the political and electoral concerns of politicians. Furthermore, he had made his way up the system through his own merit and hard work – without the benefit of personal connections. NU by this point had gathered vast experience on many aspects of the economy, financial institutions, commerce and industry, and had seen at first hand the consequences of government interference and political expediency. As Controller of Exchange, he had witnessed how government interference created “distortions in

the market.”( NU had disagreements with senior bureaucrats and politicians, including Oliver Goonetilleke, on the issue of food subsidies and, as we have seen, on state-run industries. NU was horrified when OEG did not gradually reduce food subsidies after the war, as these were meant to be temporary wartime measures. As Controller of Exchange, he expressed reservations about exchange control being the best means to solving the economic dilemmas facing Sri Lanka (see Chapter 12).

While coming from an entirely different background and set of experiences from NU, John Exter had arrived at a set of similar conclusions. Exter had entered Harvard for his graduate studies in 1939 – one year after NU completed his postgraduate studies at LSE, and three years after Keynes had published his classic work The General Theory of Employment, Interest and Money. According to Exter:

The principal professors of economics at Harvard had just grabbed Keynesianism and run away with it. It was like a new religion… I should not say that I rejected Keynesianism right away. I had it pumped into me in those early years and actually taught it in the entry level economics course at Harvard.

Exter recalls, however, that he had “his serious doubts” and “became more and more skeptical” of the interventionist prescriptions of Keynesian economics (Exter, quoted in The Money Changer, June 1991).

The Exter Report

The terms of reference for Exter’s assignment were mainly twofold to report on the organization and functions of a central bank and to frame proposals for its draft constitution (Exter Report, 1949, p.v). Initially, Exter submitted an interim report to the Minister of Finance in June 1949, with “specific preliminary recommendations regarding the monetary system, the organization of the Central Bank, the principles of monetary administration and instruments of central bank action” (ibid, p.iii). Exter’s final report, published as a Sessional Paper, was subtitled Report on the Establishment of a Central Bank for Ceylon. The report – popularly referred to as “The Exter Report” – outlined the proposals for the establishment of an independent monetary authority with “broad powers to administer and regulate the entire money, banking and credit system,” and to enable it to effectively “administer and regulate a new currency system for Sri Lanka.”

The first part of the report gave a general overview of central banking as it stood at the time, as well as an analysis of the weaknesses of the monetary system prevailing in Sri Lanka in the context of the post-colonial and post–Bretton Woods world. The second part contained the draft bill, which set out the provisions for a new monetary system for Sri Lanka, including the creation of a Central Bank for Sri Lanka and a delineation of its powers and authority. This part was interspersed with comments on some of the technical clauses to help make them more intelligible to non-specialists. In the acknowledgements section of the report, Exter expressed his appreciation for NU’s assistance, stating that he had “drawn heavily”

upon NU’s “unrivalled understanding” of the Sri Lankan economy (Exter, p.56). (Exter also thanked several other persons, including D.C. Gunasekera, his Secretary, who was “my first and most tactful critic and saved me from many pitfalls”; H.N.G. Fernando, the Legal Draftsman, to whom he was “especially grateful” in the drafting and the revising of the bill; his stenographer T.A.P. Ariyaratne; D.S. Appathurai and D. Perera, who assisted him in preparing the statistics and research material; as well as J. Tyagaraja, C. Loganathan, V. Sanmugam and P. Sangarapillai, who had submitted memoranda in response to Exter’s invitation advertised in the press to the public, to present evidence and views on the proposed creation of a Central Bank.

Debate in Parliament

The draft legislation for the establishment of the Central Bank – which when enacted became known as the Monetary Law Act No. 58 of 1949 – was presented in the House of Representatives by J.R. Jayewardene at the end of October 1949. Shortly afterwards, the Exter Report was also made available. While tribute was paid by both sides of the House to both the report and the bill, the debate was lively and dominated by opposition members, including Colvin R. de Silva, N.M. Perera, and C. Sunderalingam, as well as S.A. Pakeman, Professor of History at the University of Colombo, who was an Appointed Member of Parliament. Colvin R. de Silva praised the report: “it is… admirable in its clarity and directness, its succinctness and sustained relevance to the matter at hand.” Underlining the complexity of the subject, he further added that:

Anybody who reads through the Report will note a certain undercurrent of anxiety flowing from a consciousness of the immaturity and inexperience of us in this country in relation to the abstruse subject, not only of banking in particular, but of financing in general. (Hansard, 24 Nov. 1949, p.827)

While the creation of a Central Bank for Sri Lanka was uncharted territory, many members of parliament had studied the bill carefully. One issue that arose was the question of a suitable Governor for the Central Bank. Some members, including Colvin R. de Silva, N.M.

Perera and T.G. Jayewardene, argued that there were no Sri Lankans with the proper qualifications. N.M. Perera pointed out that the job was a “peculiarly technical job,” and that the Governor would need to be cognizant of: all complicated open market operations in Ceylon, understanding the correct moment to sell… or buy… securities,… to raise… discount rates,… the correct moment to control, raise or reduce the reserve ratio (of banks)… [and] the international financial implications… (Hansard, 22 Nov. 1949, pp.732-33)

J.R. Jayewardene and C. Suntharalingam, however, were the only two members who supported a Sri Lankan governor. As J.R. said:

It might be well to mention that in no central bank anywhere in the world is a non-national in charge. I do trust Ceylon will not be the only exception. (Hansard, 25 Nov. 1949, p.935) C. Suntharalingam argued the case for appointing a Sri Lankan even more ardently, and suggested that one of the prime candidates should be NU:Am I to believe that in this country we have no persons with a knowledge of currency, of finance and banking? I know some of them intimately. There is mention of their names in the [Exter] Report. Look, Mr. Speaker, here is one of our best men who is called upon to function in a consultative capacity. (ibid, p.894, emphasis added)

(The person functioning in a “consultative capacity” was NU (see The Exter Report, p.iii).

On 25 November 1949, the Monetary Law Act (No. 58 of 1949) was passed in parliament. During the debate J.R. Jayewardene stated that:With the establishment of the Central Bank we are taking… ultimately into the hands of the Government one of the most important institutions that the British ruler has left in Ceylon, the commercial banking system. (ibid, p.723)

The event was hailed by many members of parliament. N.M. Perera called it “perhaps the most important Bill that has been placed before this house”; and Thomas Amarasuriya dubbed it “the Magna Carta of economic independence” (ibid, pp.718 & 725). It was also referred to as “a landmark in the progress of the people of Ceylon to economic freedom” (Central Bank, c.1975, p.9). The Central Bank was inaugurated on 28 August 1950. The government appointed John Exter to be the first Governor of the Bank, with N.U. Jayawardena as Deputy Governor.

The Independence of the Bank

The Exter Report made reference to the dilemma of creating the proper balance between coordination with the government and the independence of the Central Bank, stating that “this problem has vexed law-makers for many years,” and that “in most countries the exact relationship has not been precisely defined” (Exter Report, p.12). It was equally important to protect its officers from political meddling. The Monetary Law Act was framed in careful terms and set out in such a way as to bring this about. The Bank was an independent government institution with wide powers.

The main governing body of the bank was the Monetary Board, which was composed of three members – the Governor of the Bank, an Appointed Member, and the Secretary of the Ministry of Finance.The authority to appoint the Bank Governor and the Appointed Member rested with the Governor-General and was to be made on the recommendation of the Prime Minister, effectively limiting any parliamentary interference. Furthermore, the legislation strictly barred members of parliament from holding the post of Governor. Restricting the board to three members was intentional, since “a small board was likely to be more effective than a large one.” It was also felt that the Secretary of the Ministry of Finance was needed on the Board, “to ideally achieve continuous and constructive cooperation between the Monetary Board and the Government” (ibid,p.13).

As further safeguards against political interference, the Governor, Deputy Governor and the Appointed Member posts were set for a fixed and renewable term of six years. The Bank exercised sweeping powers over the monetary system and monetary policy as well as over banks, both commercial and state owned. Significantly, the Exter Report argued for omitting any clauses that would give discretion to the government to issue directions to the Central Bank, even though legislation in England and Australia provided such provisionsin their laws. (The Exter Report (p.12), provided the following reasoning: Such formula may be called for, as it was in England, in order to clarify the relationship between a central bank and a government at the termination of a long period of private ownership and control of the central bank.

It does not seem to be necessary in the case of Ceylon where a central bank is being established which from the very beginning is to be entirely under Government auspices. Such formulas come very close to making central banks departments of finance ministries. J.R. Jayewardene had tried to prevent the inclusion of such provisions in the draft bill, but had been unsuccessful. Specific clauses in the legislation protected officers and other employees of the Bank from political interference.

Section 45(1), not only stringently ensured the confidentiality of records of individuals and institutions, but was framed in such a way as to circumvent attempts by politically motivated persons or parties within and outside of the Bank to victimize any person or party; and Section 45(2) offered protection for Bank employees as well. (Sec. 45 (1) states: “Every officer… of the Central Bank shall preserve and aid in preserving secrecy with regard to all matters relating to the affairs of any banking institution, or of any client of any banking institution… and any such officer…who communicates any such matter… or permits any unauthorized person to have access to any… records relating to any banking institution shall be guilty of an offence (emphasis added). Sec. 45 (2) states: “No officer… of the Central Bank shall be required to produce in court any book or document or to divulge or communicate to any court any matter… coming under his notice in the performance of his duties.”)

By Kumari Jayawardena and Jennifer Moragoda ✍️
In studying Ceylon’s economic and financial problems,
I have drawn heavily upon Mr. N.U. Jayawardena’s unrivalled understanding of the operations of the Ceylon economy.

(John Exter, 1949, The Exter Report, p.56)