The Autonomy of Bangladesh Bank

Introduction: It is sometimes criticized there is a glass wall around the Bangladesh Bank which prevents it from being independent – BB is only autonomous by name but not in practice. The purpose of this term paper is to identify whether BB is actually autonomous or not; if yet, then to what extend – both in theory and in practice; and then see the effects of their policies in recent economic trends to recommend some policy for future developments. The following order will be maintained to facilitate the understanding of this paper: ?

Background of Bangladesh Bank ? Theoretical Aspects of Autonomy ? History of Central Banks’ Autonomy around the World ? The Identification of the Extend of Independence of Bangladesh Bank ? Case Study of the Reserve Bank of Australia to Observe the Practical Benefits of Central Bank Autonomy and Compare with Bangladesh Bank ? Observe Recent Trends to Construct Conclusion ? Policy Recommendations. Background: The Bangladesh Bank is the central Bank of Bangladesh. The governor is Dr. Atiur secretary to assist him.

The vision of the Bangladesh Bank is: “To develop continually as a forward-looking central bank with competent and committed professionals of high ethical standards, conducting monetary management and financial sector supervision to maintain price stability and financial system robustness, supporting rapid broad based inclusive Page 3 Rahman with a board of directors consisting of himself as the chairman, 8 directors, and 1 economic growth, employment generation and poverty eradication in Bangladesh” (Bangladesh Bank). The main functions of BB are: ? Formulating monetary and credit policies; ?

Managing currency issue and regulating payment system; ? Managing foreign exchange reserves and regulating the foreign exchange market; ? Regulating & supervising banks and financial institutions, & advising the government on interactions & impacts of fiscal, monetary & other economic policies. Now that we have given a brief introduction of Bangladesh, we shall start analyzing the interested topic. For understanding the effects of autonomy, we first need to understand what autonomy for central banks actually mean. In the following section, the theoretical and historical account of central bank autonomy will be elaborated.

Theory of Autonomy: What is Autonomy? The term autonomy, or independence, in context of Central Banks, refers to how freely the monetary policy makers can conduct policies with little or no interference from the government. Also referred to as the “autonomy” of Central Banks, the definition of independence considers two important aspects. They are political independence and economic independence (concepts elaborated later on in the chapter in relation to Bangladesh), However, nowadays these aspects have more popular names: “Goal independence”, “Target independence” and “Instrumental independence” (Lybek).

Goal Independence: Allows the Central Bank to decide its own monetary goal and/or exchange rate system, exclusive to the direct influence of the politicians. In the case of a floating exchange rate system, the central bank solely concentrates on the monetary policy. Some common monetary goals are maintaining price stability, controlling money supply or increasing real growth in the economy Page 4 Table # 1: Types of Independence Target Independence:

When the central bank is goal dependent, i. e. the state decides the macroeconomic objectives, it lets the central bank set the target value to the goal and to come up with the policy instruments with which it will achieve the target. For instance, if the state wants to keep the inflation rate at a low level of 2 percent, it will probably adopt a contractual monetary policy where the interest rate is set at a very high level Instrumental Independence: This is probably the least independent dimension among the three that we have been discussing. The government “consults” the central bank and sets the monetary target.

The Central Bank is said to be instrumentally independent as it is free to choose the policy tools to attain a macroeconomic goal. Besides that, it is both goal dependent and target dependent on the government. The instruments applied by the bank are: Open-market operations, discount lending and reserve require The Rogoff-Conservative Model: When modeling the independence of a central bank, the Rogoff-conservative central bank model should be mentioned. In this model, the weight placed on inflation determines independence.

When the central bank places a heavier weight on the inflation rate than the government, the bank is referred to as a “Rogoff-Conservative Central Bank:. This exhibits both goal independence and instrument independence, because first, the bank wants to reduce the inflation rate to a level much lower than that favoured by the government. Second, it can freely use desired monetary tools necessary to achieve the target inflation rate. In an alternate model, the Central bank’s monetary objectives are weighted against the government’s objectives.

For example, if the central bank supports a real output target which is feasible with the natural rate of unemployment in the economy but lower than the target to the bank’s target and if no weight is placed on the government’s objectives. Conversely, the bank has no independence if the actual is heavily weighted on the government’s objectives. . Page 5 backed by the government. The bank has complete independence if the actual target is closer Measuring Autonomy: There are several index and formulas derived to measure centre bank autonomy.

For this paper, we can to elaborate on three specific measurements or criteria: i. ii. iii. Legal Measure by Cukeiman, Webb, and Neyapti GMT Index by Alesina, Masciandaro, and Tabellini Central Bank Independence and Governance (CBIG) The Legal Measure: According to Cukierman, Webb, and Neyapti (1991), the legal measure of independence of a central bank is based on four criteriaI. Appointment of chief executive: A bank is viewed to be more independent if the chief executive is appointed by the central bank and not the prime minister or the finance minister, and has a long term of office. II. III. IV.

Government involvement in policy decisions: the independence is greater as the policy decisions are made with less and less participation of the government. Goal of monetary policy: When price stability is given the maximum priority, a bank is said to have a high level of independence. Government borrowing from central bank: Finally, the level of independence is greater if more restrictions are placed on the ability of the government to borrow from the central bank. The GMT Index Messrs Grilli, Masciandaro and Tabellini via their formulated index called the GMT index (1991) measures the independence of central banks.

This index, with the contributions of Cukierman (1992) divided the autonomy of Central Banks into two parts: Political Autonomy and Economic Autonomy. Each of these was to be subdivided into multiple categories as follows: Page 6 Political Autonomy Criteria: i. ii. iii. iv. v. vi. vii. viii. Appointment of the Governor of the Central Bank without any influence of the Government. Governor of the Central Bank to be appointed for tenure of more than five years. Members of the Board of Directors to be appointed without government influence. Board members to be appointed for more than five years.

There are no provisions where the government decides on who represents the board. There are legal provisions aimed to protect during conflict with government. No need for to seek approval in devising monetary policy. The charter must include provisions aimed to seek monetary policy stability as its core objectives. Economic Autonomy Criteria: i. ii. iii. iv. v. vi. vii. Easy credit to government at market interest rate. Credit is extended on a temporary basis. Central Bank does not participate in the primary market for public debt. There must be a limit on government borrowing from the central bank.

There are no automatic procedures for the government to obtain direct credit from central bank. Central Bank sets the discount rate. Central Bank has no role to oversee the banking sector/share this role with another organization. There are a number of criterions that must be considered to assess the degree of autonomy of any Central Bank. Should any of these are fulfilled, a point is awarded. Based on these values the respective indices are constructed (political and economic) which are then averaged to get an overall rating of a central bank.

The higher the score, the more independent a central bank is. Page 7 Central Bank Independence and Governance: The Central Bank Independence and Governance (CBIG) Index is a measure of the freedom from political and financial market pressures that the central bank can pursue during its operations. Several models have been brought forth by different authors but the model suggested by Ahsan, Skully, Wickarmanayake (2006, p. 60) best predicts the CBIG Index. It is as follows – CBIGOverall = w1CBIGLeg + w2CBIGPol + w3CBIGPStab + w4CBIGForx + w5CBIGMonPol + w6CBIGAccTrans

Where, CBIGLeg = Legal Index of CBIG (measures the independence that a central bank is granted by its acts) CBIGPol = Political Index of CBIG (measures the political influence on the central bank operations) CBIGPStab = Price Stability Objectives Index of CBIG (is the guideline provided to the central bank to consider price stability as its main monetary policy objective) CBIGForx = Exchange Rate Policy Index of CBIG (refers to the function of the central bank under a fixed and a floating exchange rate system) CBIGMonPol =.

Monetary Policy and Deficit Financing Index of CBIG (refers to the devising of monetary policy, choosing the final target and regulating the government budget financing) CBIGAccTrans = Accountability and Transparency Index of CBIG (the imposition of the rule that the central bank is bound to disclose its policy changes and monetary policy statements to the public) Weight = w1= 5/26; w2= 3/26; w3= 3/26; w4= 3/26; w5= 6/26; w6=6/26 Page 8 Advantages and Disadvantages of Autonomy: The following table summarizes the pros and cons of autonomy: Table # 2: Pros and Cons of Autonomy Advantages Disadvantages.

Greater goal and instrument independence Complete independence is seen as a threat, produces lower average inflation. Low prices questions the accountability of the central signify a favorable effect on the economy bank. Maintaining a low and stable inflation isn’t the only issue of concern Absence of political influence allows the Legal measures do not indicate the actual prices to be stable relation between the central bank and the govt. Gap is huge in developing nations. Alternate measure by Cukierman: governor turnover Positive correlation between inflation and governor turnover in developing nation. Relationship in Developing Nations: Governor turnover measures how frequently a central bank changes its governors.

The shorter the term in office, the stronger is the involvement of the government in the central bank’s operations, the less is the independence of the bank. In developing countries, there is a positive correlation between inflation and governor turnover. Advocates of independence would say that this is a strong evidence of how the government’s interference in the central bank prevents the bank from making proper decisions regarding price stability. But others the governors being fired because they are inept at controlling the inflation? Page 9 raise questions as such: Is it the political involvement that is producing high inflation or are History of Central Banks’ Autonomy:

During the 1950’s, there was a financial crisis where the Federal Reserve had lost its independence and so did the Bank of England. In 1951, it regained its independence and the policy of independence was quite successful on lowering average prices. Under the Bretton Woods era (mid 20th century), which was the post war period, the countries were committed to fixed exchange rates so they could not conduct efficient monetary policy. At the time, their goals were constrained by the gold convertibility. This period has high inflation, and because of the gold convertibility problem, the banks could not use monetary policy or set their goals and targets.

This again strengthens the fact that central bank independence is a primary determinant of a country’s inflation. After this period when some major central banks like the European Central Bank and the US Federal Reserve, went for central bank independence, their policies and goals resulted in sufficient lowering of the average rate of inflation. After this in the 1990’s many developing countries adopted central bank independence. From the brief survey of the histories of the Bank of England and the Federal Reserve several policy lessons can be discerned. First, central bank independence can be helpful in dealing with financial crises. This was the case in Western Europe during the classical gold standard era.

The Bank of England and its counterparts in Western Europe as publicly chartered banks of issue effectively maintained a credible nominal anchor and served as an effective lender of last resort to the financial system. They operated in a rules based regime. Second, based on the experience of the Federal Reserve in the interwar period, central bank independence can be harmful if it is based on a flawed policy doctrine or a structurally flawed institution. As mentioned previously, there are mainly three types of independence: – goal independence, target independence and instrument independence. Studies show that a bank Page 10 cannot have all three kinds of independence simultaneously. They mostly have any one of the three.

If we look at UK, the Bank of England lacks goal independence. This is because the country’s inflation rate is set by the government. The Bank of England, even though it lacks goal independence, it has high instrument independence because it is able to manipulate its instruments and set its tools without the interference of the government. On the other hand if we look at the US Federal Reserve, the goals are set by a legal charter, but they are very vaguely described, thus, they translate these goals themselves into operational goals. When the banks are not independent, certain targets for the policy is set politically, so the Banks will choose the best means to achieve that target.

The importance of central bank independence comes to the forefront here primarily because politicians may seek to compel the central bank to adopt measures that although in the short-run may boost economic growth, in the long run will lead to an undesirable rise in inflation. Economic growth will meanwhile return to its original level, or even sink to a lower level (as a result of the higher inflation). A sufficient degree of independence from political influence allows the central bank to resist such pressures. Does Bangladesh Bank have Autonomy in the True Sense? As considerable time and effort has been assigned to the history and the current state of central bank autonomy all over the world, we may now focus on the independence of Bangladesh Bank (i. e. the central bank of Bangladesh); its respective degree and its subsequent causes. topic in question.

This will later be followed by the observations and outcomes which had given rise to such a result. As we analyze Lybek’s definition of the autonomy of a Central Bank, we find that Bangladesh Bank fall under the category of Target autonomy. This, being one of the broader forms of autonomy may project Bangladesh Bank to be relatively self-ruling. However such Such will be achieved with the help of a model unearthed in various literatures relating to the Page 11 a statement may prove to be otherwise as the definition proposed by Lybek focuses on the “monetary policy aspects and not on the supervision and regulation of the financial sector” (Ahmed, 2009).

This is particularly significant in the case of Bangladesh owing to the fact that whatever provisions might there be on paper may not necessarily be applicable (or more importantly enforceable) in actual terms. To consider the operational aspects of Bangladesh Bank’s autonomy along with its planning, there was a need to adopt a model more appropriate and able to weigh in the dynamics of the Bangladeshi scenario. The answer would be found in the works of Messrs Grilli, Masciandaro and Tabellini via their formulated index called the GMT index (1991). The following tables will be analyses of BB’s performance and the graphical representation of the GMT Index. The Political Autonomy of Bangladesh Bank Table # 3: Political Autonomy in Bangladesh Bank Page 12 Observations from Table # 3: ?

The Governor who is the Chief Executive Officer of the Bangladesh Bank is also the chairman overseeing the Board of Directors of the institution. His appointment however is made directly by the government and for tenure of four years thereby leading to a score of zero in the first two criterions. It may be added that the appointment of the one in focus has not been in a situation where “competent candidates for the post of governor are officially short- listed and the list made public” (Ahmed, 2009). ? As in the case of the Board of Directors of BB, there are to be nine members including the Governor, of which four are to be from a civil society and three are to be from the executive panel of the government.

This explains nought values for points three and four. In addition the fact that the tenure of board members from the executive bench is to remain at the discretion of the government (point 5) reduces political autonomy to a greater degree. ? The analysis of the sixth point will be discussed later as it coincides with arguments stated afterwards. The last two criterions will not be discussed as BB is already fulfilling them. Analysis: 1) The inclusion of members from the executive bench in the Board has raised many eyebrows amongst many specialists in this arena.

This arises from the ironic situation that the government is appointing its own agents (i. e.the exec members) to ensure that the goals of the government are realized by those whom the government had appointed (the governor and from the civil society) as those most capable and transparency of the monetary body. This is owing to occurrences where the political entities in the board have used their influence to promulgate decisions which were more beneficial to the incumbent government’s political agenda and less to the economic benefit of the nation (in the long run). Examples include cases where loans have been rescheduled for loan defaulters who were aspiring to stand under the banner of the ruling party in the National elections (Ahmed, 2009). deserving for the position. Such a predicament also has had an adverse effect on the Page 13.

2) As capable as the appointed governors may be there has not been an instance where one has been reappointed (which is possible under law if he/she is below 65 years of age). In other words there has been a new governor every four years. Such trends in the change in governors and the political victory of an alternate party (AL/BNP) are uncanny. These regular alternations have also led to a high value of governor turnover which is not advised in developed nations. 3) The Bangladesh Bank seems to have inherent restrictions in the in the financing of its operations too. One is able to state as such as the BB has to rely on the deliberation of the Ministry of Finance for issues such as pay rises of its employees.

This is despite the fact that the BB prepares its own budget and has its own source of earnings (Bangladesh Bank Order, 2003). The Economic Autonomy of Bangladesh Bank Table # 4: Economic Autonomy of Bangladesh Bank Page 14 Observations from Table # 4: ? The first three criteria are the ones that should be of most importance as it provides a clearer picture regarding the dependence of the Bangladesh Bank in the financial sector. In the case of credit provision, one sees that Bangladesh Bank has little on its way to control the flow of credit to the government or the ability to provide them at rates which are relatively favorable compared to market rates (point 5).

Analysis: 1) A vital factor in assessing the degree of economic autonomy of any central bank would be to monitor its provision of credit to its own government. In the case of BB, it emerges that BB does not have the authority to restrict such flows of money (Financial Sector Review, 2006, p. 74). The following data gives a clearer picture: Source: Bangladesh Economic review, 2005, MoF, GoB The chart above highlights that there has been significant increases in government borrowing since 1995-1996. Incapacity of the government to meet its revenue targets followed by reductions in foreign aid has left with the government relying heavily on the BB.

These huge amounts of credit were funded via the BB’s express participation in the primary market (criteria 4, economic autonomy). Such actions have had repercussions on the effectiveness of the BB as the reduced money supply not only diminishes the effectiveness of future monetary policies but also Page 15 increases the risk of a crowding-out effect in the ‘private sector credit’ (Ahmed, 2009). Many have voiced their collective opinion that there should be amendments made in the charter of the BB to vest it with powers to deny such favors in the interest of the economy. 2) A significant portion of the loans have been allocated to numerous public- sector enterprises (e. g.

Bangladesh Petroleum Corporation) of which most perform poorly due to the existence of politicized unions, substandard asset and liquidity management and problems related to human resource management. This makes these institutions contribute to the “largest share of Non-performing asset” of BB (Bangladesh Bank Annual Report 2004-2005). According to INVESTOPEDIA a non performing asset is a debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The nonperforming asset is therefore not yielding any income to the lender in the form of principal and interest payments. As the criterions pertaining to the GMT Index have been discussed extensively, we can now have a final look at the index itself.

The following graph describes how the BB’s autonomy fares with the rest of the world. Included in the chart are the autonomy indexes of three broad classes: advanced economies, emerging markets and developing countries: Page 16 Graph # 1: Bangladesh Bank Autonomy – Comparative Perspective Source: BB reform: changes and challenges, 2006, p. 18 Calculation: Political Index= (2/8) =0. 025 Economic Index= (1/7) = 0. 143 BB Autonomy GMT Index= (0. 25+0. 143)/2 = 0. 196 As commented by Ahmed in his paper, the results of the BB’s autonomy are suggests that it is lagging behind even in comparison to the central banks of developing economies (ie, India, Sri Lanka, Pakistan, etc).

Additionally it is only the case of the BB where the mean score of the economic index is lower than that of the political index. This goes on to support previous arguments that there is an excess of political influence in the functioning of the BB compared to its foreign counterparts. Whether or not increased independence will benefit Bangladesh is a completely different issue and the subsequent sections of this paper will focus on this. Page 17 Case Study: The Reserve Bank of Australia & Bangladesh Bank Now that we have a firm understanding of Independence of the central bank, lets focus on its implications on the central bank of Bangladesh (Bangladesh Bank – BB).

However, before delving into scrutiny we are to derive some basic principles from a country which has already undergone autonomy of its central bank and has been successful in devising its monetary policies. For availability of data, and the amount of research work already done in this topic, we’ve chosen the central bank of Ausralia (Reserve Bank of Australia – RBA) which, in our opinion, befits the purpose of our research as we can see the explicit benefits of central bank autonomy. This segment of the paper thus compares the central bank of Australia (a developed nation) to the central bank of Bangladesh (a least developed nation). The comparison will be carried out mainly in two forms.

First, we are to see whether a country with higher GDP per capita and lower inflation rate also has a higher CBIG (Central Bank Independence and Governance) than that of a country with lower GDP per capita and higher inflation. Secondly, any difference is to be identified and possible areas of improvement for BB will be highlighted based on the empirical evidences provided from the analysis of the functions of the RBA occuring over the period 1991 to 2008. Bangladesh Bank Reforms: BB was established under the Bangladesh Bank Order (1972) immediately after the independence of the country in 1971, when it served mainly as a department of the government.

Since then it has undergone major developments but the most significant change came through when the government adopted the Financial Sector Reform Program (FSRP) in 1989. Results of the FSRP was a change, in 1990, to an indirect monetary management from a rather direct intervention which was in practice back then. More recent developments include those stipulated by the Bangladesh Bank Amendment Act which came into enforcement from 2003. This Act reduced the term of the governor of BB to a period of four years from five years and mandated the appointment of four directors, who are not Page 18 government officials, as the bank’s central management board.

Also, importance was given to functions such as domestic price level stability and introduction of a floating exchange rate system. A co-ordination council was also formed to facilitate balance of the central bank’s policies with those of the government. A list of panoramic objectives with regard to the interest of Bangladesh’s welfare in various aspects were also specified in this Act. Another ground breaking implementation for development of the BB was the Central Bank Strengthening Project (CBSP) in 2003. Success of CBSP includes the establishment of a Policy Analysis Unit (PAU) in July 2005 to increase the research and policy analysis capacity of BB.

From January 2006, BB has been publishing half yearly monetary policy statements as well as their research papers to promote transparency since those explain their monetary policy strategy and implementation tools. The Reserve Bank of Australia Reforms: The RBA has undergone many changes since the time of its inception in the year 1959 under the Reserve Bank Act. It was initially operated by the central banking division of the government owned Commonwealth Bank of Australia and had set objectives such as currency stability, full employment and economic proseperity and welfare of the the citizens of Australia. Since 1959, the RBA enjoyed indepence to some level but amendments in the the 1980s and 1990s further strengthed its position.

These included several reforms occuring over the years such as the responsibility of public debt management being lifted off RBA in 1986, official announcement of price stability to be an objective of the RBA in 1993, agreement between the governor and the treasurer acknowledging RBA’s independence in 1996, introduction of publication of quarterly monthly monetary policy instruments highlighting its perception of the economy and its course of action and the newly formed supervision and regulation of commercial banks in 1998. The independence and governance fostered faster after the government signed the statement on the conduct of monetary policy with the RBA in 2007.

This increased the statutory independece of the governor and deputy governor to that of the Comissioner of Taxes and stated that their appointment was to be conducted by the Governor-General in Council and can only be terminated upon approval of each House of the Parliament in the same session of the Parliament. Previously these Australian Prudential Regulatory Authority (APRA) being delegated the responsibility of Page 19 were done by the government alone. From the 6th of November 2007, the RBA has started publishing its board meeting’s minutes and later since February 2008, it published cash rate announcements and short statements explaining bank’s decisions even if interest rates didn’t change. Frameworks of Reserve Bank of Australia’s Reform: The fact that the RBA has enjoyed indepence to such a great extent has also given rise to extra responsibilities amongst which is greater accountability. The RBA has been very successful in this respect.

The bank has developed a framework of its own which ensures its independence and proper execution and is mainly based on four aspects as oulined below – 1) Multiple objectives – The central bank often has to deal with the trade off between inflation and unemployment. It is generally known that these trade-offs don’t occur in the long run and by long term, a period of five years or mone is referred to. However, in the short run these trade offs do take place and it is up to the discretion of the central bank to take decision at times, say for example, when inflation goes off the track. Decisions have to be taken to bring inflation back to its normal level constituting a real trade off with employment.

Central banks can thus perform better if their objective is not only to control inflation but other aspects of the economy as well. During the second half of 1994 when there was an expectation of the interest rate to rise above 2-3 percent at a certain period, the central bank resorted to a fairly strict monetary policy to limit the rise in inflation and the period over which it would occur. It was argued that such course of action benefitted Australia from the loss it could have incurred by following a more stringent monetary policy – in terms of lost jobs and output. This shows the multiple objectives of the RBA where it focuses not the economy as well – such as employment, output and so on.

2) A flexible inflation target – Inflation target can be deemed to be an anchor for inflation expectations and a way to make the monetary policies more deciplined. However at times of dire need a flexibility helps the central bank to perform better. The RBA has a target of maintaing 2 – 3 percencent inflation but this rate is flexible. It is also consistent with the multiple approach concept since inflation has a cyclical effect on only on reducing inflation but measures the weight of its actions on other aspects of Page 20 employment and output – policies are allowed for only if their benefits outweight the costs of lost employment and output.

3) Consultations between the Bank and the Treasurer – The Reserv