The New Governor of the Central Bank of Somalia’s Nearly Impossible Mission

The task that is in front of him appears daunting and nearly impossible in the short run. It is to his credit that he agreed to accept this position and is a testament to his sense of duty to his birth nation and may be to his sense of adventure or courage. Reconstituting a reasonable monetary system where none exists may be a challenge that is too big for one person no matter how good he may be unless the President and the government give him the freedom and support he needs to do what he must.

This article will focus on the challenges the new Governor is going to face in order to fulfill his obligations.

The office of the Governor of the Central Bank of Somalia is a constitutional office with specific constitutional mandate and responsibilities. Article 123 (3) of the new Constitution assigns the CBS the following main functions: produce currency, control inflation, stabilize exchange rates and establish a sound banking system. In addition, the Constitution states that the CBS has full authority to execute the monetary policy of the nation. Implicit in this statement is that the CBS is expected to do its job without political interference. This assurance provides the CBS the independence it needs to do discharge its functions based on what is best for the economic health of the nation. The role and responsibilities of the CBS are clarified and defined by the Central Bank of Somalia Act, 2011.

As the new Governor assumes his position, the only function that the CBS can implement quickly is the production of Somali currency. However, the execution of this task also comes with its own pit falls and may not necessarily be his top priority at this time. The normal central bank levers to control inflation are non-existent or limited. Stabilization of exchange rates is going to be hard unless the CBS wants to adopt fixed or floating exchange rate regime instead of a flexible exchange rate regime where exchange rates are determined by the market forces.

Establish a sound banking system: The first and most important task of the CBS and its new Governor is establishing a sound banking system before he worries about inflation, exchange rate and currency production. However, this may not be as challenging as it seems. The CBS has the authority it needs to regulate and license banks under the Financial InstitutionLaw No. 130 of 22 April, 2012 enacted by the previous transitional federal government.

The task of creating a banking system is made relatively easier by the fact that there are already quassi-banks, money transfer companies, in existence. These institutions provide some of the services that traditional banks do. The money transfer companies have the financial resources and branches or representatives in every region, town, and village. The first step will be to convert these money transfer companies to banks if their owners so wish and meet requirements under the law. There is also pent-up demand from Somali Diaspora and local entrepreneurs to create banks in collaboration with foreign banks.

Produce currency: It is good that the authority to produce the national currency in going to be in the responsability of the CBS and not the politicians or other government officials. Assuming a total control over the national currency is not as easy as it seems, then, of course in the current climate in Somalia nothing is easy. Somalis use different currencies including the US dollar as means of exchange for goods and services. US dollars are normally used for purchasing big ticket items and the Somali Shilling is widely accepted and is used mainly for small transactions.

The country is flash with money printed by various warlords and transitional governments along the way. There is probably more post 1991 currency in circulation than there is currency produced legitimately by the CBS. It amazes me, and is contrary to basic economic theory, that people accept Somali currency as means of exchange knowing full well that the money they are accepting in exchange for their goods and services may in fact have been printed by a warlord and is not backed by a legitimate authority. The faith in the Somali shilling currently in circulation is based on the expectation that others will accept it and if or when the CBS produces a new currency it will honor the Somali currencies produced since 1991. This expectation complicates the task of the new central bank and limits its options.

A more serious challenge politically, which is beyond the control of the technocrats running the bank, is how to deal with the new currency created and printed by the semi-autonomous region of Somaliland.

Stabilization of exchange rates: Before the stabilization of exchange rates can be undertaken, the government in consultation with the CBS has to determine what exchange rate system the country will use. Fixed or managed floating exchange rate systemwill be the easiest to stabilize. In both cases, the authorities will establish a fixed exchange rate or acceptable range and then the CBS has to defend it. In other words, the bank will sell or buy foreign currency to maintain a predetermined exchange rate or band. For that, the CBS needs huge foreign currency reserves which neither the bank nor the government of Somalia has. It will also make inflation control even more challenging since the purchase of a large amount of foreign currency will require supply of large quantities of the national currency to the market thereby increasing the inflation rate. Really, the only viable option is to have a flexible exchange rate system and to intervene in the exchange rate market to smooth expected fluctuations with occasional sell or purchase of foreign currencies. These type of moderate stabilization actions may enable the CBS fulfill this function.

Inflation control: In order for any central bank to control inflation it must be able to exert appropriate controls over the nation’s money supply. To properly discharge this function, the CBS needs a functioning financial sector. A country’s money supply consists of currency (paper and coins) and deposits in the commercial banks. Currency is normally a small fraction of a country’s money supply. Deposits in the commercial banks play a much larger role in a country’s money supply than the currency in circulation do.

In order to control inflation, central banks have two basic tools in addition to direct regulation of the banking system: a) open market operations where the CBS buys bonds to increase the money supply or sells bonds to reduce money supply b) Bank rate where the bank varies the interest it charges to banks for borrowing from it. Unfortunately, there is no bond market and no functioning banks in Somalia. Even if both tools were available options, the purchase and sell of interest bearing bonds and charging interest rate to banks to borrow from CBS, would have to meet the constitutional test.

Given the laws governing the conduct of the CBS and the banking sector were enacted prior to the new Constitution of the Federal Republic of Somalia, they may not necessary be compliant with the requirement of the Constitution. A cursory review of the Constitution, the Financial InstitutionLaw No. 130 of 22 April, 2012 and the Central Bank of Somalia Act 2011 suggests that both lawscould benefit from a review to ensure that they are compliant with the requirements of the new Constitution.

Remember that the new Somalia Constitution clearly states that Islam is the state religion and no law which is not compliant with the general principles of Shari’ah can be enacted. Of course, if these widely used tools around the world are found not to meet the constitutional test, then one day Shari’ah compliant bonds could be created and fees charged to banks for borrowing from the CBS can be structured to meet this constitutional requirement. This means in the short run, the CBS has no effective tools to control inflation at least until such time that there is a functioning banking system and a bond market. Once the financial system of the nation is reconstituted, then the CBS could use the these tools or require banks to keep certain level of idle reserves of money to reduce money in circulation to affect the money supply.

The challenge of reconstituting Somalia’s monetary system is immense, and the new Governor needs all the support he can get.

To empower the CBS, the president, the government, and the parliament should give the new Governor all the tools and resources he needs to do his job. Furthermore, the Governor cannot do this job alone and he is expected to have the support of a qualified Deputy Governor and the expertise of a five member board. The President and the Prime Minister should immediately complete the appointment of the bank’s senior management team based on qualification and experience alone and nothing else. The job of the CBS is too important to subject its senior management team to the normal political and tribal horse trading. In other words, the 4.5 formula which is generally used to distribute political offices and parliamentary seats has no place in these highly sensitive positions.