Hands off Nepal Rastra Bank autonomyA central bank that cannot say no to election-driven politicians is at risk of losing its credibility—especially in the case of a developing economy.
In several developed countries, there is a growing tendency for the executive branch to want to exercise influence over central bank autonomy. This is primarily the by-product of the 2008/2009 financial crisis. In its wake, the global economy tanked and major central banks aggressively eased. Economies have recovered, but rates stay low. The benchmark rate is at 1.55 percent in the US and in the negative territory in Japan and the eurozone. In Nepal, too, lawmakers reportedly are discussing whether they should rein in the role of the Nepal Rastra Bank (NRB) governor. If this becomes codified in law, it will be an unfortunate development in Nepal’s history of central banking; it will amount to legislative encroachment.
Globally, examples abound of confrontations between central banks and heads of government. In the early 1990s, President George HW Bush blamed the Alan Greenspan-led US Federal Reserve (known popularly as the Fed) for contributing to his defeat in the 1992 presidential election by not cutting interest rates to prevent a recession. Since the financial crisis, governments increasingly have been willing to infringe on central bank autonomy. The excesses that led to that crisis continue to linger. Debt was at the crux of the problem, and that has only grown. Politicians would like to win the next election, and want more stimulus—essentially short term fixes to a long term issue. It is the central banks that need to act like the adults in the room.
Government-central bank showdown
Until December 2018, the Fed was considering hiking the fed funds rate at least twice in 2019. President Donald Trump, facing another election this year, repeatedly criticised Chairman Jerome Powell, whom he appointed, for not adopting a more accommodative monetary policy. Come 2019, the policy rate was cut by 75 basis points. Yes, economic winds did slightly shift downward, as the US-China trade war took a toll. But many argue Trump’s aggressive posture likely forced Powell’s hand. Trump even calls for the Fed to pursue negative interest rates—like its counterparts in the eurozone and Japan.
Japan has had negative rates since early 2016. Haruhiko Kuroda has led the Bank of Japan (BoJ) since March 2013. He succeeded Masaaki Shirakawa, who, under huge pressure from Prime Minister Shinzo Abe to open the monetary spigot, left three weeks before his five-year term ended. Campaigning for the general election in December 2012, Abe called for unlimited monetary policy easing. ‘Abenomics’—based on the so-called three arrows of monetary easing, more government spending and structural reforms—aimed to raise inflation and weaken the yen. The BoJ at the time was already massively buying government debt. Under Kuroda, an advocate of looser monetary policy, the bank has begun buying corporate bonds.
Raghuram Rajan, the Reserve Bank of India (RBI) governor between September 2013 and September 2016, knew the price of not toeing Prime Minister Narendra Modi’s line the hard way. Having insisted he would lower rates only when he was confident inflation was under control, Rajan was not offered a second three-year term. There have been several rate cuts under his successor Urjit Patel. In Turkey, inflation was over 25 percent in 2018, but President Recep Tayyip Erdogan was openly telling the Central Bank of the Republic of Turkey not to raise rates. Governor Murat Çetinkaya stood his ground. In July that year, Erdogan by presidential decree gave himself the authority to appoint the central bank governor. Çetinkaya was sacked one year later.
Monetary policy no panacea
The issue in all these instances is that these are autonomous bodies. This is true with the NRB as well. The Nepal Rastra Bank Act 2002 states that the bank shall be an autonomous and corporate body with perpetual succession. Its primary job is to carry out monetary policy. Fiscal policy falls under the purview of the government. These two tools don’t necessarily have to complement each other. During the bad times, the government tries to stimulate the economy through measures such as taxation and spending and the central bank does its bit by lowering interest rates and reserves, among other actions. But there are times when resources increasingly are constrained; politicians being politicians would like the good times to continue. This is when the central bank needs to hit the brakes.
Monetary policy has its limits. This is increasingly becoming clear in major economies like Japan, the eurozone and the US. Central banks want a little bit of inflation in the system. But ever since the 2008/2009 crisis, inflation has come up short. This, despite the trillions of dollars of fabricated money these banks spent in purchasing all kinds of securities, including Equity Exchange Traded Funds (Equity ETFs) in the case of Japan. Now, the BoJ, the European Central Bank and the Fed—the former two in particular—have been calling for aggressive fiscal spending. Nonetheless, these economies are already up to their ears in debt. At a time of decent economic growth, the US is running a $1 trillion budget deficit, with a debt (federal)-to-GDP ratio of over one.
Nepal can learn from this. Last May, the 2019-20 federal budget aimed to spend Rs1.53 trillion in the current fiscal year. In a mid-term review mid-February, Finance Minister Yubaraj Khatiwada revised it down to Rs1.38 trillion. Capital spending was revised lower from Rs408 billion to Rs327 billion, of which only one-fourth was spent in the first seven months. The economic growth projection was left unchanged at 8.5 percent. In a situation like this, an NRB that is mandated to be compliant can be asked to stimulate the economy through monetary measures. In 2018, the Modi government reportedly asked the RBI to relax lending standards to small businesses and tried to tap into the bank’s excess reserves to help fund its fiscal deficit.
Developed economies have one advantage—size. As much as investors may want to rebel against Trump’s attack on Fed policy, the fact remains that the US is the largest economy in the world and the dollar is the world’s reserve currency. Nepal does not have this luxury. Being a least developed country with aspirations to wear a ‘developed’ tag someday, it cannot afford to antagonise foreign direct investment, which is what might end up happening should the NRB lose its credibility. A central bank that does not—and can not—say no to election-driven politicians is an open invitation for an expansionary monetary policy risking inflation and a lower rupee, among others. If anything, lawmakers should be discussing how to make the central bank more independent, not less.
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