Central Bank Autonomy | Institution | Monetary Policy | Populism
Is the independence of Nepal Rastra Bank under threat from politics?
The central bank’s autonomy is underscored only when its governor cannot be easily sacked
CRITICS OF NEPAL RASTRA BANK (NRB), the central bank of Nepal, like to say that it’s not doing enough for the economy. Such statement is likely to be heard even more before an election. Politicians want the economy to boom before an election, hoping to get re-elected. They signal unease when the central bank adopts hawkish measures like raising interest rates to subdue inflation, because it will alienate voters. But an independent central bank would give high priority to price stability without having to worry about electoral unpopularity.
The idea for the need of a central bank in Nepal started taking root in the 1950s. And NRB was set up in 1954, mainly to guide the development of the financial sector and supervise them. At first, the government could tell the central bank when to change interest rates. And when the government had a tight grip over monetary policy, inflation rose inexorably. But this changed after the global rise of central-bank independence in the last few decades, including NRB’s, too.
NRB has great independence now, but the tide keeps turning once in a while. On April 8 the government—or to be precise, Janardan Sharma, finance minister—suspended Maha Prasad Adhikari, head of the central bank. When asked, the finance minister said reasons for Mr Adhikari’s suspension were plenty—yet unfounded. The governor was criticized for not doing his job diligently to address the economic challenges facing the country, among others. The relation between the governor and the finance minister came to a head after the central bank withheld the suspicious Rs 400 million brought from the US to Nepal despite Mr Sharma’s insistence that the amount be released (the source of the amount is being investigated).
On April 19, however, the Supreme Court ordered that the governor was to be reinstated, though temporarily. Some say that Mr Sharma’s decision was purely political. The governor’s unwillingness to cooperate with the government as local elections approach provoked the ire of the coalition government.
This is the second time a sitting governor has been suspended. In 2000 governor Tilak Rawal was sacked by the Finance Minister, Mahesh Acharya. But the Supreme Court reversed the decision, and Mr Acharya resigned.
Prior to the appointment of the current governor, the appointment process was held under political influence, and the position for the monetary authority’s head remained vacant for three weeks following the departure of governor Chiranjibi Nepal.
No central bank is completely independent, though. It is normal for politicians to pressure central banks to introduce policies that boost their popularity. President Donald Trump demanded the Fed to slash interest rates. In Turkey President Recep Tayyip Erdogan is fighting a bitter war with the central bank. A respected economist, Raguram Rajan, was denied a second term for his unwillingness to cooperate with the Modi government. Although the Bank of England independently prepares the monetary policy, the government sets its inflation target.
Nepal’s economy continues to struggle with the pandemic. Job recovery has been slow for those who lost jobs during two years of the pandemic. Government coffers have been battered, though slowly recovering. Tourism and tourism-related activities remain well below pre-pandemic levels. Foreign reserves have been declining. The World Bank forecasts the economy to grow by 3.7% in FY22. Yet the government unrealistically expects to meet 7% growth in the current FY.
In January, however, the central banker admitted that such high growth would be impossible, given the current economic situation. It is no wonder then the pressure keeps growing on the central bank to trade monetary discipline for economic growth. And the central bank is being made scapegoat for politicians’ failures to revive the economy. Conversely, politicians would like to take credit when the economy does well.
Politicians in power have grown more worrisome lately after the central bank enforced stronger import control measures to ramp up foreign reserves to cover seven months of imports. When imports are restricted, both domestic output and consumption are hit, depressing economy further.
One important cause for the encroachment of the central bank’ independence is populism. The government has asked the central bank to pursue several goals simultaneously: subduing inflation; supervising the financial system; and reviving the economy. But the central bank has been too slow to tame the accelerating inflation (spurred by soaring energy prices), and the recovery from the pandemic has been slow. It raised the policy rate by 0.5 percentage points in August 2021, followed by 2 percentage points increase in February ahead of an election. All this has undermined voters’ faith in the government—the opposite of what the government wants before an election, to woo voters.
Another cause for fraying NRB’s independence is the way its heads are appointed. The government is responsible for appointing the central bank’s seven-member board of directors, and often fill the top positions with their own pliant people, creating enough room for interference.
But even so, appointed officials can be protected from external influence through various means. One way to ensure the central bank maximum insulation from politics is by making the appointment process multifaceted, meaning taking advice and recommendation from other bodies too in the selection of the governor and other officials and not just under the purview of a single political party.
Leave it be
Their objectives are different: the government wants growth; and the central bank wants price stability and maximum employment. But when the government keeps interfering in the workings of the central bank, the hard-won credibility of the central bank erodes. A weaker central bank may sap public confidence in the market, and could have dangerous consequences for the economy. The more the central bank is in the spotlight, the more its decision-making succumbs to outside pressure. This makes monetary policy political. All this is best avoided by leaving the NRB alone.
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