The Nepal Rastra Bank, Nepal’s central bank, published its monetary policy for the fiscal year 2021/22 on August 13. Earlier, it was on course for making it public in the third week of July. The delay was due to the change in government. After the Supreme Court on July 12 reinstated the dissolved House of Representatives and ordered Sher Bahadur Deuba to be appointed as new prime minister, KP Sharma Oli resigned on the 13th. Deuba took the oath of office the same day, appointing Janardan Sharma of the Communist Party of Nepal (Maoist Center) as finance minister. A new coalition government and a new finance minister meant a possible change in fiscal policy, which the monetary policy supposedly needed to accommodate.

The 165 lawmakers that voted for Deuba in the reinstated parliament belong to a disparate group. Besides Deuba’s party, Nepali Congress, lawmakers from the CPN (Maoist Center), the main opposition within the Communist Party of Nepal (United Marxist-Leninist), both factions of the Janata Samajbadi Party, and the Rastriya Janamorcha supported him. In essence, he has many sides to please while Cabinet portfolios are limited. Budget is one other tool he can use. On August 10, Minister Sharma told Parliament that the government is revising the budget presented by Bishnu Prasad Paudel, his predecessor. By convention, the Nepal Rastra Bank tries to incorporate a new budget in its monetary policy. But it does not have to.

Objectives of the Nepal Rastra Bank

As per the Nepal Rastra Bank Act, 2002, (1) the objectives of the bank are: (a) to formulate, and manage, monetary and foreign exchange policy needed to maintain price and balance of payment stability for the achievement of economic stability and sustainable development of the economy; (b) to raise public confidence toward the banking and financial system by making the sectors stable and by increasing access to financial services; (c) to develop a secure, healthy and efficient payment system. (2) The bank, without adversely impacting the objectives outlined in subsection 1, will extend cooperation to the government of Nepal in the implementation of economic policy.

Sub-section 2 under section 4 is vague, but nowhere does it say that the bank needs to consult the government. Here is the issue: The bank’s seven-member board of directors is chaired by the governor—currently, Maha Prasad Adhikari, who began his five-year term in April last year. Secretary of finance and two deputy governors fill up three slots. The other three members are government appointees from among renowned persons in the fields of economics, money, banking, finance, commerce, management, and commercial law and from among deputy governors. The finance secretary also chairs a three-member committee to recommend three names to fill the governor’s post. The board’s decisions are majority-based.

The presence of the finance secretary can create conflict. He is a bureaucrat but will, in all probability, toe the line of whoever is in power. In the current government, the main parties involved—Nepali Congress, CPN (Maoist Center), Janata Samajbadi Party, and the Madhav Kumar Nepal-led faction within CPN (UML)—all adhere to different political philosophies and have their own sets of priorities. Deep down, they all want to win the next election. The party in power would like to go to the voters and brag that the country did well under its leadership. The primary focus is growth—at any cost. Central bankers, on the other hand, need to seek maximum employment with as keen a focus on price stability.

Fiscal versus monetary

We often hear of politicians clashing with central bankers—in emerging economies as well as developed ones. In March, the Turkish lira collapsed 15 percent after President Recep Tayyip Erdogan sacked the country’s central bank governor. Naci Agbal had been raising interest rates as inflation was running above 15 percent. Erdogan the politician could not stomach tighter monetary policy. Or take India, where Urjit Patel resigned as Reserve Bank of India governor in December 2018 over differences with Prime Minister Narendra Modi as the latter, ahead of elections, sought to increase government spending by transferring some of the central bank’s $132 billion in cash reserves.

Even the world’s leading economies are not immune to this controversy. In the US in 2019 and early 2020, President Donald Trump openly and routinely urged Federal Reserve Chairman Jerome Powell to lower rates, even using derogatory Twitter posts. In the nineties, Chairman Alan Greenspan was blamed by President George Bush for his 1992 loss to President Bill Clinton for not lowering interest rates enough during the 1990-1991 recession. Such actions only give fodder to critics who question Fed’s independence. In Japan, the Bank of Japan was criticised in late 2012 for making markets wait longer than usual for a monetary policy announcement; critics regularly point out that the bank is subject to political interference.

Ideally, politics and central banking should be like oil and water. But we do not live in a perfect world. The issue is crucial in markets such as Nepal’s that are just getting off the ground. Governments that do not acknowledge the significance of the central bank’s independence will sooner or later face a revolt in markets. From this perspective, the 2016 second amendment of the Nepal Rastra Bank Act added section 106 C, which states that (1) the government of Nepal may give directives to the bank as relates to currency, banking, and finance and that (2) it will be the bank’s duty to abide by those. This is a huge red flag, as it gives politicians ample space to interfere. This section should be deleted, and the finance secretary should not be a part of the board.