The Hindu Business Line : Central bank autonomy keeps inflation low

I strongly urge the denizens of both the Finance Ministry and the Reserve Bank of India to go through the Working Paper (No.07/88) brought out by the IMF last month titled Central Bank Autonomy: Lessons from Global Trends.

It is a thoroughgoing evaluation of the degree of autonomy enjoyed by 163 central banks as of 2003-04.

Based on an exhaustive study, it comes to the significant conclusion that central banks which enjoy a great measure of `political and economic' autonomy are not only able to keep the average level of inflation low and under check, but also cushion the impact of political vagaries on economic prospects, enhance financial system stability, and boost fiscal discipline without any real additional costs or sacrifices in terms of output volatility or reduced economic growth.

Another interesting finding is that a move from nil to full autonomy increases the likelihood of maintaining low inflation by about 50 per cent.

Overall, it is seen that real functional autonomy for Central Banks has conspicuous beneficial multiplier effects on the country's macroeconomic performance as well.

The paper defines political autonomy as the ability of central banks to select the final objectives of monetary policy, based on the following criteria: (1) No government involvement in the appointment of the Governor or the Board of Directors; (2) A minimum of five years tenure for both the Governor and the Board; (3) No mandatory participation of government representative(s) in the Board; (4) Authority vested in the Central Bank by law, without any approval, intervention or interference by government, to pursue monetary stability as one of its primary objectives and to formulate monetary policy and set the policy rate in its best judgment; and (5) The existence of provisions in the law that strengthen the Central Bank's position in the event of a conflict with the government.

Economic autonomy

The central bank's economic autonomy is posited on the non-participation in the primary market for public debt and the absence of any prescriptive right of the government to obtain direct credit from it.

Even when the credit is extended at the Bank's discretion, the guiding principles should be that it is for a limited amount and for a temporary period and at market interest rates.

It is best that the central bank has no responsibility, either exclusively or in conjunction with any other entity, for overseeing the banking sector.

(There is, however, divergence of views on this last indicator: The paper itself points out that many central banks in emerging markets and developing countries, as also in a few large advanced countries, have retained some form of involvement in financial supervision.

In fact, it is not infrequent for central bank laws to prescribe the soundness of the financial system as one of their statutory obligations.)

Not surprisingly, central banks in advanced economies enjoy greater autonomy than those in emerging markets and developing countries.

The paper notes that participation in currency unions has helped to enhance the autonomy of central banks, both among advanced economies and developing countries.

The Tables displaying the relative rankings of the countries on the various aspects of their central banks' record make fascinating reading.

The scores obtained by India in respect of political and economic autonomy (on a scale of 0 to 10) are 2 and 6 respectively. This should trigger plenty of introspection.

B. S. RAGHAVAN

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