CBL’s Monetary Policy Priority: Portability or Stability? Implications of the New LD500 Banknotes

By Paul Columbus Collins, PhD


The Perspective
Atlanta, Georgia

August 10, 2016

                  



 
 
 
 
Liberian Currency

The Central Bank of Liberia (CBL) recently held a press conference to provide information to the Liberian people on the rapid depreciation of the Liberian Dollar (LD) currency against the United States Dollar (USD) currency.  This appeared to have been a communications strategy to either allay the fears of the Liberian people, who were concerned about the seeming free-fall (depreciation) of the LD currency, or a conference to reassure all that the CBL was aware of the situation, and taking steps to contain the free-fall of the LD.

Remember that the institution responsible to manage the monetary policy of the Republic of Liberia is primarily the CBL, as per the delegated authority stipulated in the CBL Act of 1999 (revised) and the Financial Institutions Act of 1999 (revised).  The key objective of monetary policy is to ensure price stability in the economy.  This means appropriate policy actions should be taken to prevent prices from going up (inflation) or down (deflation) too fast, so as to maintain the purchasing power of the LD.  When the LD currency depreciates continuously, it ceases to act as a store of value, and as a unit of account. This leads to greater preference for a more stable currency- the USD, which can have the likely effect of resulting into the depreciation of the LD. 

So, the press conference of the CBL looked at causes of the free-fall of the LD.  Some plausible arguments were presented to the Liberian people:

  1. The drawdown of UNMIL, which is supposed to have affected net remittances. Net remittances are the differences between remittances or transfers of USD coming into the country against transfer of USD out of the country.  If net remittances are negative, it means more USD were transferred out than received into the country.  This is supposed to have an adverse effect on the exchange rate, causing the exchange rate to depreciate against the USD (however, our net remittances have been solidly positive except for 2009 and 2010 when we experienced negative net remittances).
  1. Another argument proffered by the monetary authorities is that our persistent trade deficit on our Balance of Payment account is responsible for the rapid depreciation of the LD.  This is because of our heavy dependence on imported goods, and our weak international trade performance, in which we do not generate sufficient income abroad that are repatriated, to offset our heavy demand for foreign currency, in order to pay for our demand for foreign goods and services.  The effect therefore is persistent decline of the LD against the USD.

Ordinary Liberians however, have hinted that the reason for the decline of the LD is because the monetary authorities are flooding the economy with LD, and thus fueling the free-fall of the LD against the USD.  This theory became very popular when the Ministry of Finance and Development Planning announced that it would pay most of its domestic debt in LD.  In fact, the exchange rate plummeted from around LD90 to around LD98 (to purchase USD) to 1USD immediately this policy action of the Government came into effect.

Whilst the entire country was looking to see how the monetary authorities intended to stop the free-fall (i.e., stabilize) of the LD, the CBL announced that it was introducing a new LD500 banknote, to surpass the current highest denomination LD banknote of LD100.  The question that therefore comes to mind is, what is the CBL’s current priority here: stabilizing the LD; or making LD more portable?

The issue of circulating a bigger denomination banknote has always been on the table at the CBL, to address the cash management objective of ensuring that LD become more portable and convenient to carry around.  With the biggest denomination banknote of LD100, which is equivalent to USD1.02 (assuming current exchange rate of LD98 to 1USD), carrying around large sums of money in LD is not very convenient, especially since our economy is a cash economy, that is heavily dollarized (meaning, almost everything is priced in USD, even if paid in LD).

Is it therefore the intention that, by making LD very portable and convenient to carry around, greater demand of LD will occur, which in turn, will reduce the demand for carrying around USD, thus helping to stabilize the LD?  If yes, how does portability affect net remittances or the persistent trade deficit that the CBL alluded to as plausible causes of the free-fall of the LD?

How also does the introduction of the new LD500 banknotes affect the amount of LD currency in circulation? Normally, when central banks introduce new banknotes, it is to replace mutilated banknotes, so that the currency in circulation is not affected, but remains the same.  A second reason for printing money is to meet the demand for more money by a growing economy.  Is the CBL therefore going to be withdrawing mutilated banknotes before infusing the economy with their new LD500 banknotes? Or is there a demand for more LD because of our growing economy?

Already there are concerns about the amount of currency in circulation, and the plausible effect this is having on the exchange rate of the LD and the USD.


CURRENCY IN CIRCULATION VS EXCHANGE RATES

YEAR

C-I-C in L$'M

% Change

AVERAGE LRD/1USD

% Change

2005

       2,379.3

 

55

 

2006

       2,813.9

18%

59

7%

2007

       3,594.4

28%

62

5%

2008

       4,090.0

14%

63

2%

2009

       4,583.4

12%

68

8%

2010

       5,550.6

21%

70

3%

2011

       7,251.6

31%

72

3%

2012

       8,614.2

19%

72

0%

2013

       9,468.0

10%

82

14%

2014

       9,367.6

-1%

85

4%

2015

       9,505.9

1%

89

5%

Source: CBL annual reports 2005 to 2015. The calculated correlation coefficient of the two arrays of data sets, C-I-C (currency in circulation) and Average Exchange Rates, is 0.93, indicating a strong direct relationship; i.e., if one goes up, the other also goes up.

Depicting this relationship graphically shows that increases in currency in circulation are accompanied by increases (percentage wise) in the exchange rates:

Big denomination banknotes also have security implications.  Counterfeiters and money launderers usually do business almost exclusively with large value banknotes, as they are more profitable and conveniently portable, compared to smaller denomination banknotes.  We are already having counterfeiting challenges with the LD100 banknotes.  The LD500 banknotes will take our worries to a higher level, naturally.

Another consideration is whether the introduction of the LD500 banknotes could be for profit motive? There is a cost attached to printing or minting money.  In Liberia, we currently do not have coins in circulation, so let’s just talk about banknotes that are printed by the Central Bank.  Of course, the Central Bank only prints LD banknotes, not US banknotes.  Based on past experience (2010), about the time the exchange rate was L$70 to US$1, it cost the CBL five US cents to print one leaflet of LD banknote.  This cost per banknote was lower than the face value of each banknote in all denominations, resulting into a profit to the CBL for all denominations of banknotes printed.  The table below shows the profit the CBL made for each leaflet of the various denominations printed.  You can say this created some kind of incentive to print money, especially since the value to the CBL was higher than the cost.  Multiplying the net profit per banknote by the quantity of banknotes in each denomination would give the total profit earned by the CBL for that denomination. 


LD Banknote

LD70=USD1

Value in USD

Printing / freight Cost

Net Profit per banknote

 $             5.00

 $        70.00

 $              0.07

 $              0.05

 $       0.02

 $           10.00

 $        70.00

 $              0.14

 $              0.05

 $       0.09

 $           20.00

 $        70.00

 $              0.29

 $              0.05

 $       0.24

 $           50.00

 $        70.00

 $              0.71

 $              0.05

 $       0.66

 $         100.00

 $        70.00

 $              1.43

 $              0.05

 $       1.38

    Source: Central Bank of Liberia
For this profit to be earned however, the CBL must have put the banknotes into circulation to form part of the base money.  Base money, also called monetary base, Central Bank’s money, or money base, is money in the public domain, bank vault cash balances, and bank reserves held by the Central Bank. These are the bank accounts on which credit institutions keep the liquidity required for their day-to-day operation, and which are used to meet their reserve requirements.

Assuming the cost of printing banknotes remains constant, which is more likely than not, the table would look like this at current exchange rates in 2016:


LD Banknote

LD98=USD1 (to purchase USD)

Value in USD

Printing / freight Cost

Net Profit per banknote

$5.00

$98.00

$0.05

$0.05

$0.00

$10.00

$98.00

$0.10

$0.05

$0.05

$20.00

$98.00

$0.20

$0.05

$0.15

$50.00

$98.00

$0.51

$0.05

$0.46

$100.00

$98.00

$1.02

$0.05

$0.97

$500.00

$98.00

$5.10

$0.05

$5.05

So clearly there could be a profit motive here, don’t you think so?  Depending on the quantity of LD500 banknotes printed, the CBL could make a profit of US$5.05 for each LD500 banknote.  If the CBL dumps LD10 million of LD500 banknotes into the economy, that would net the CBL a profit (seignorage) of at least US$100,000.  LD20 million could lead to US$200,000 profit.  Etc., etc… Of course, the smaller denomination banknotes are likely to go the way of the coins (i.e., cease to exist), as they would not only be unprofitable to print, but an inconvenience to carry around.

I would have preferred a different policy action to address both the concerns of ‘stability’ and ‘portability’, instead of a policy that seems to focus only on ‘portability’, when our main concern is ‘stability’: Resetting the LD currency, i.e., redenomination of the LD. 

Redenomination is the process of changing the face value of banknotes, usually through decimalization of the currency.  For instance, the existing LD banknotes could be divided by 100 to decimalize the face values of the various LD banknotes, so that the LD5 would be equivalent to a redenominated LD currency.  The table below shows the effect of this redenomination:

CURRENT LD BANKNOTES

Value of Old LD in NEW LD

REINTRODUCE

                  5.00

          0.05

5 cents Coins

                10.00

          0.10

10 cents Coins

                20.00

         0.20*

25 cents Coins*

                50.00

          0.50

50 cents Coins

             100.00

          1.00

1 Dollar Coins or 1 Dollar Banknote

 

          5.00

5 Dollars Banknote

 

        10.00

10 Dollars Banknote

 

        20.00

20 Dollars Banknote

 

        50.00

50 Dollars Banknote

 

     100.00

100 Dollars Banknote

 
*Instead of introducing new coins of 20 cents, the CBL could use the 25 cents coins, so that we can always use our existing coins that are currently locked up in the CBL’s vaults. 

The new banknotes would also have enhanced security features and markings that easily distinguish them from the old banknotes.  Finally, LD100 of the current banknotes would be equaled to LD1 of the new banknotes, as depicted in the table.  

Ghana recently redenominated its currency when the old Ghana cedi could not be stabilized.  Many countries have done redenominations to achieve the same objectives of stabilization and portability, including Germany in 1873; Britain in 1971; South Africa in 1961; Australia in 1966; New Zealand in 1967; Turkey in 2005; etc., etc., etc.

To conclude, I believe the priority of monetary policy should be about stabilizing the LD, not just enhancing portability by introducing new higher denomination banknotes. The introduction of higher denomination bank notes has several implications, including the risk of counterfeiting; the risk of increasing the money base which could result into further depreciation of the LD; and the resultant inflationary impact due to the declining purchasing power of the LD currency. A more effective policy could be a recalibration of the LD through decimalization, as this would have the dual effect of restoring stability and portability.  This is what countries do in the face of persistent undesirable devaluation of their currencies.  Of course, in the long run, to preserve stability, sound economic policies will be required to improve our terms of trade and ensure our economic fundamentals are right.


About the Author: The author holds a PhD with emphasis in Economics; is a Fellow of the Association of Chartered Certified Accountants (ACCA); is a Certified Internal Auditor (CIA); and a Certified Public Accountant (CPA).


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