CHAPTER 12

Continued from last week

When at home, NU would spend most of his time ensconced in his study, which was lined with his bookshelves containing his evergrowing collection of books and journals. According to Neiliya, her father’s study was always the focal point of family activities, with NU, absorbed in his work, surrounded by his family who quietly carried on with their own activities. It was natural that NU, who had found refuge in books and libraries from an early age, felt most at home surrounded by his books.

Throughout his life, NU had a sustained interest in economic theory and applied economics. His personal collection of books and journals would eventually number in the thousands, and developed into one of the best private libraries on economics in Sri Lanka.

The Sterling Assets Agreements of 1948 & 1949

Since its time as a British colony, the Sri Lankan currency had been linked to the British sterling, and its sterling and dollar reserves were held, respectively, in a common “Sterling Pool” and “Dollar Pool,” together with the reserves of Britain and the other countries within

the British Empire. There were advantages in contributing to the Sterling Pool since this enabled the Sri Lankan government to borrow against their sterling reserves from the British government, in order to meet foreign-exchange shortfalls, and since most of Sri Lanka’s

trade up to this time had been with the other sterling-area countries. However, in times of competing demands for sterling- and non-sterling-based goods, and with the changing world economic order, there were growing disadvantages. This became increasingly apparent after the war left the British economy in shambles, and the

US economy began entering its ascendancy.

Britain had become a debtor country as a result of the war, and in essence, was unable to meet all the demands on the sterling balances and dollar reserves held in the respective pools. It became necessary for Britain to reach agreement on the rate of both sterling and dollar drawings allowed for each member country. These became known as the “Sterling Assets Agreements.” NU accompanied JR to the United Kingdom in March 1948 as a member of the Ceylon Government Financial Delegation, whose mission was to negotiate with the UK government regarding Sri Lanka’s sterling balances. The two sides reached agreement at the end of April. As part of the agreement, Sri Lanka was obliged to maintain her balance-of-payments deficit below sterling 3.5 million as well as to keep her dollar expenditure within Rs. 100 million during 1948.

A local currency note backed by the British sterling

All financial transactions Sri Lanka had with the outside world would now have to be regulated and monitored carefully, in order to ensure that Sri Lanka abided by the terms of this agreement. Exchange control was the mechanism for this. NU stayed behind in London for about ten days so that he could study the operations of the Exchange Control Department of the Bank of England (N.U. Jayawardena, 1949, p.10). After his return, in June 1948, in addition to his position as Controller of Exchange, NU was appointed Controller of Exports and Imports. ( The Department of Exchange Control had come into existence during World War II.

It underwent several reorganizations since its inception, according to the fluctuating needs of the time. Its operations were merged with the Department of Imports and Exports shortly after it was established, and the responsibilities of both were placed under one official, whose designation became Controller of Imports, Exports and Exchange. Their functions were again separated and an independent Department of Exchange Control was set up in April 1947 – with NU as the new Controller of Exchange. For a brief period the two departments were again brought under one official, when NU became Controller of Imports and Exports.

When the Central Bank was founded in 1950, the Department of Exchange Control came under this institution and NU continued to serve as its head as Deputy Governor (see N.U. Jayawardena, 1949, pp.1-7, for a brief administrative history of the Exchange Control operations up to 1948). Again, from August to October of the same year, he was away on duty leave in the UK and India – perhaps to obtain further technical guidance in these operations, which were new to Sri Lanka.

In the second quarter of 1949, a dollar drain of the sterling area began to reach critical proportions. By summer, it had developed into a serious crisis and an emergency meeting was called. The 1949 Conference of Commonwealth Finance Ministers took place in London over the months of July and August. After presenting his first budget in parliament, JR departed for London as head of the Sri Lankan delegation, which included NU.

In these negotiations, Sri Lanka made significant gains, including provisions for the establishment of sterling reserve accounts in the future Central Bank of Ceylon, which was soon to be set up, as well as the right to retain an independent reserve of up to US $1 million,

in gold or dollars out of its dollar export earnings. According to NU, “the most important provision in the new agreement was that relating to the retention of a gold or dollar reserve by” Sri Lanka (N.U. Jayawardena, 1950, p.4). This was an important victory – though a small step – towards monetary independence for Sri Lanka. This became even clearer after Britain devalued the sterling shortly after this meeting. As pointed out by NU in his 1949 Administrative Report as Controller of Exchange:

Had Ceylon been in a position to act otherwise and retain her dollar contribution as an independent gold or dollar reserve, she would not only have held her external assets in a currency convertible into gold instead of in sterling which she now finds blocked but she would also have avoided the depreciation in value of her reserves which she has had to suffer in consequence of devaluation. (. Interestingly, Sri Lanka was the only Commonwealth member that had a dollar surplus at the time. It also made a sizeable contribution to the dollar pool throughout the war period. According to de Silva and Wriggins: In 1948, Sri Lanka’s contribution was Rs. 120 million worth of dollars, 50% more than what was estimated at the time the Sterling Assets Agreement was signed, an amount, which represented two-thirds of India’s estimated drawings from the pool in 1949. In 1948, New Zealand’s drawings equalled Sri Lanka’s contribution to the pool. (1994, p.220) (ibid, p.4)

NU in his study

The New Economic Order

With the widespread devastation of World War II, it was imperative for the international community to formulate a new monetary and economic system, on the one hand, and to rebuild the economies and infrastructure of nations adversely affected by the war, on the other. In 1944, while the war was still raging, the Allied nations held discussions in Bretton Woods, New Hampshire, to create a new monetary system which would restore and facilitate trade and hopefully prevent the economic crises that were responsible in large part for World War II.

Cartoon depicting a British Commonwealth Conference

From these discussions, which became known as the “Bretton Woods Conference,” the International Monetary Fund (IMF) and the International Bank of Reconstruction and Development (The World Bank) were created as part of the effort to provide assistance to national economies to stabilize their money supplies and conserve foreign exchange, and to aid in post-war reconstruction. The dollar had become the strongest currency, since the US had the largest gold reserves at the time and the strongest industrial base.

In Sri Lanka, there was talk in some circles about the need to update the banking and monetary system to make it more responsive to the changing circumstances of the world economy. As early as 1945, J. Tyagaraja, who represented Mannar-Mullaitivu in the State Council, moved a motion to convert the Bank of Ceylon into a state-owned Central Bank. The Banking Commission Report of 1934 had started the process of redressing some of the weaknesses of the colonial system; however, deeper reforms were required. As later stated by J.R. Jayewardene:

with the advent of freedom and the consequential changes in the economic structure which the Government [had] undertaken… it is quite clear that the whole outworn and outmoded system must give way to something more modern. (Hansard 1949, 2nd Motion on the Monetary Law Act Bill)

Outmoded Systems

In 1949, fifteen years since the findings of the Banking Commission Report, there still were only a few foreign banks in Sri Lanka and one local bank – the Bank of Ceylon – created in 1939. Since 1884 and up until independence, the colonial government had managed the money supply through a rather archaic system known as the Currency Board. This was composed of three officials – the Legal, Financial and Chief Secretaries – whose functions were limited to issuing currency to cover the needs of the export-import economy and the colonial administration.

The Board was responsible only to the Governor of the island, however, it had no supervisory or regulatory powers over banks (Eramudugolla, 2004, p.1). In the Currency Board system, the Indian rupee served as the reserve currency and the money supply was directly related to the surplus or deficit in export earnings.

This system was completely inadequate to meet the new needs of independent and post–Bretton Woods Sri Lanka, where the dollar (which was the only currency backed by gold) was beginning to supplant sterling as the reserve currency. The Indian government had already agreed with the IMF to link their currency to gold in 1946. The devaluation of the British sterling in 1949 provided further impetus toward the need for ‘monetary sovereignty.’

In September 1949, the link between the Sri Lankan and the Indian rupee was finally abolished, and a direct conversion was permitted between the Sri Lankan rupee and sterling. However, there were still other areas that needed to be reformed.

In November 1949, NU was “entrusted with the task of making preliminary preparations in connection with the establishment of [a] Central Bank.” Accordingly, he was released from his normal duties in regard to exchange control, except for “dealing with any important or major questions of policy or principle that may arise” (N.U. Jayawardena, 1950, p. 11). Chapter 10 can read online on https://island.lk/wartime-in-sri-lanka/

(Excerpted from N.U. JAYAWARDENA The first five decades)
By Kumari Jayawardena and Jennifer Moragoda ✍️