yiput's™ Central Banking (8B!) 5 Chapter 3- Contemporary Issues 3.1 Introduction 3.2 Autonomy of the Central Bank 3.3. Independence of the Central Bank 3.4 Credibility, Accountability and Transparency of the Central Bank 3.5 Questionsking (8 cy of al RRR ER See Contemporary Issues woo 29 3.1. INTRODUCTION: The central bank of any economy is the pivot around which all financial activities resolve around. Its role is vital for economic development. Through _ its regulatory, supervisory and promotional functions, the central banks have enabled the economies to achieve reasonable growth with price stability. With the introduction of liberalization, privatization and globalization the role of the central bank has become all the more important. By establishing proper institutions, introducing technological advancement and by putting legal framework, the central banks have been facing the challenges of the post liberalisation era. The banks are making continuous efforts to strengthen the financial system and protect the economy from wide fluctuations. Among the emerging economies, the Reserve Bank is quite successful in ensuring financial stability. 3.2. AUTONOMY OF THE CENTRAL BANK: From the 1980s the autonomy of central banks has become a major topic for discussion. The two decades 1980s and 1990s witnessed many radical reforms and structural changes in many countries. India is no exception. In 1991, economic crisis forced the government to introduce New Economic Policy (NEP). Revolutionary changes were made in various sectors and opening up of the economy set the tone for competition. In the process of implementing reforms and achieving their objectives, both the government and the central bank had differences of opinion andeae central Banking (Bay) | 30 wr the concerns of the Centra] scope for the government t0 oT ed omy in Bank and undermine its autonomy J ashes ned Autonomy and independence are SS P epalibankcg though in the context of the banking ees dependent. Both | any country can be autonomous put not totally indep' ee the government and the central bank have to we af cooperate with each other to achieve theit respective goals. In the absence of consensus, conflicts arise leading to doubts about the autonomy of the central bank. The rapid changes taking place various countries in terms of technological developments, changes / in policies, economic system etc., the question of autonomy of central banks has acquired much significance in recent times. The evolution of central banking throws light on this issue and | indicates the nature of autonomy granted to central banks. Originally many central banks were private banks and they had | autonomy till the First World War. During the Second World War autonomy was clipped and they became subservient to the ‘ government. The relationship between the central bank and the : government is different in different countries, While the Federal Reserve System'is autonomous, the Bank 6 Engiind Which wie : very much an autonomous bank in the 18th and 19th became subservient to the government in the 20th ee recent times once again many central. banks “esa Be autonomy with a clear mandate of anaes ve acquired inflation targeting. control through The development of any economy ane policies namely the fiscal policy and the m, ‘Son two. vital the fiscal policy is the domain of the gay. Policy. While nment, the monetaryanking (BBI) e Centra) ynonyms, | bank of ient. Both nate and ils. In the about the 3 place in , changes, mnomy of mes. issue and al banks. they had orld War nt to the k and the ie Federal vhich was centuries, try. In the acquired I through two vital icy. While “Monetary — a 1. Contemporary Issues ee > policy is framed and implemented by the central bank. A close coordination between the two is required for achieving the objectives of both the policies. When the objectives differ, the question of supremacy and autonomy arises. For example governments in developing countries would like to pursue a liberal credit policy to spur growth, the central bank may not agree with the government in its pursuit of inflation control. Monetary policy formulation and implementation provides autonomy to central banks. Interference by the government in this area leads to erosion of autonomy. Apart from traditional functions, central banks perform wide variety of functions. Today central banks are actively involved in developing the financial markets, management of public debt and foreign exchange reserves, implementation of prudential norms, setting up of institutions for specific purpose etc. In all these areas, there is scope for divergence of opinions between the government and the central bank resulting in ambiguity about autonomy. A central bank can have greater autonomy if it has financial autonomy, autonomy in personnel management and in formulating and implementing monetary policy. These are also the area for conflicts between the government and central bank. In the post liberalized era and with the emergence of the World Trade Organization, sweeping changes are taking place worldwide. Many challenges economic, political, socio-cultural — are faced by nations. To face these challenges a close coordination and a high degree of cooperation is required between the central government and central bank. Therefore both monetary policy ae)vi pul’s™ Central Banking (8g)) 32 cre and fiscal policy have to align W" as objectives in the present day globalise th each other to achieve the FACTORS LIMITING AUTONOMY: a The autonomy of the central bank is limited by certain factors. They are: (The objectives of fiscal policy and monetary policy may be conflicting in nature. For instance the government may be in favour of a liberal credit policy to accelerate growth while the central bank may not be willing to do so to avoid an inflationary spiral. (2) The public sector banks owned by the government play a predominant role in the Indian banking sector. The government is the main decision making authority limiting the powers of the RBI to supervision. Sometimes the government in pursuit of its objectives ma‘ against the norms prescribed by the bank. For i vee ey - Sor instance waiver ~ farm = by the government is often objected by central bank leadi i in = ng 10 a conflict of interest between the (3) The budgetary operations of the governm ir the monetary policy {i ent also influence “I himiting autos bank. momy of the central (4) Sometimes public debt - management Policy of the central bank arg function and monetary Public debt may be Ree yy oo with each other. Projects which are not productive jn aa to finance ion of the centralanking (BB) hieve the in factors. y may be may be in | \while the © avoid an ent play a | ctor. The ty limiting times the gO against \ce_ waiver bjected_ by etween the © influence the central EF TEN WLLL 218 en 33 Contemporary Issues ver bank. If the government overrules then autonomy of the bank gets limited. 6 Appointment of top officials and personnel management is another area where government's interference limits autonomy. For example, the top officials in India are appointed by the government limiting the freedom of the RBI. (6) In the recent times in India, issues like .demonetisation, transfer of profits to the government, usage of cash reserves, increase in non-performing assets and the corrective action to be taken etc. often lead to a dissent between the government and the central bank. The above discussion clearly indicates that complete autonomy to the central bank is not possible given the nature of the banking system and challenges faced by the economy. However there is widespread consensus that the central bank should be independent in its functioning. AUTONOMY OF THE RBI: In the initial decades of planning, the monetary policy of the RBI was tuned according to the priorities of the government. To lift the economy from underdevelopment, the government had to follow a liberal fiscal policy. High levels of poverty, vast iequality in income distribution, excessive dependence on agriculture, backwardness of various regions and poor industrial and service sector developments were compelling factors to the Bovt. to give predominance to fiscal policy over monetary policy. Hence in the initial years of planning, the RBI had limitedee ae F viput’s™ Central Banking (ggy nts and policies like nationalisation el + bank @ 1980, emphasis on priority of private sector ban! ie cilia secon bani : ionary rol Be sector lending, expansi sh ie ebay ieian th er monetary policy- autonomy. Many developm' s in 1969 an administered interest rates, influence of the government ov The liberalisation process started in 1980s in many countries, With the introduction of LPG in 1991 in India, the scope for central bank’s autonomy increased. The new economic policy in 1991 ushered in radical changes in the Indian economy. Abolition of industrial licensing, encouraging competition, limited role to public sector while enhancing the role of private sector, allowing FDI and foreign technology etc. changed the nature of the Indian economy from an inward looking economy to an outward looking ‘one. Substantial reforms were introduced in the banking sector as per the recommendations of the Narasimham Committee. Some of the notable reforms are deregulation of interest rates, entry of | private and foreign banks, introduction of prudential norms, dilution of government's equity in public! cece Seen introduction of information technology and innovations in banking sector etc. Along with the ch: ii Wblity of tune ns PaINg sector, introduction of convertibility of rupee in the current ee 2 monetization of budgetary deficit, a a unt, withdrawal liquidity adjustment etc, enhanced bere 2 . and long term for its autonomy. At the same time complete tho RBI and scope Both the government and the central bank haved nomy is a = ‘ cooperate with each other to achj € optimum, (0 coordinate ; results. iaEne errr es oe ‘ing (BBI) ail contemporary issues ror = patiaion 3.3 INDEPENDENCE OF THE CENTRAL BANK: on priority ctor banks, Many economists and research scholars often argue that an indicate the independent central bank would be more professional in its working and will be able to discharge its functions effectively. It is : not necessary that the central bank should be completely eounries| autonomous, but it is necessary to have independence in its cere fo functioning. The issue of independence can be explained with ic aa ig reference to the central bank of India. i 7 a In the post-independence era, central bank had to participate in pr allowing! nation building along with the government. The liberal fiscal ihe lndians policy of the govt. was made possible by the accommodative Pr wong monetary policy of the RBI. This resulted in huge fiscal Bs) ad deficit leading to inflation. The influence of fiscal policy over eee monetary policy started changing since the 1990s when i wi al government's role in various sectors started getting diluted. Many E reforms initiated in the banking sector also necessitated oss supervision and monitoring of the RBI and also greater autonomy = banks to the banking sector. aS en The independence of the RBI becomes a tricky issue due to the following: troduction of Hisiveal_ et (1) Even today the top officials are appointed by the govt. long term 2) Public sector banks are owned by the government. Ee scope (3) The RBI is the banker to the government. Hence it is isa myth. obligated to follow the directives of the government. ee and (4) Public debt management is another function of the RBI While debt has to be mobilized at a lower rate,viput’s™ Central Banking (Bg) interest leading toa inflation controlineeda’alhigher rate of 8 oe my els the central (6) Gove's socio-economic abject ofters comP! a bank to reverse its policies of financial prudence and give in to populist policies. no control over the budgetary policy the budgetary provisions ply. This affects the The central bank has of the government. However have huge impact on money SUP] | functioning of the RBI. 6) (7) The central bank's policies, finances and operations are influenced by the government. Many of these factors are common to many countries. Thus ! independence to the central bank is limited and it is within the parameters set by the government. 3.4 CREDIBILITY, ACCOUNTABILITY AND TRANSPARENCY OF THE CENTRAL BANK: | CREDIBILITY: i The credibility of any institution depends on its objecti p organisational management and the means b : objectives, are achieved and also consistency of its polici y which objectives premier institutions having their Seca eo Central banks are. fulfil, The evolution of central banking tae fatire of a central bank fun 4) eee om anker to 3 Sovernment and public debt, foreign exchange mar es a Bement, develop INE | commercial banks to a multi-faceteqcontemporary issues wee 37 system etc. Their functions are distinct from other banks and they have to be given a free hand in discharging their functions. he central } Central banks, worldwide have to frame their policies and use , and give their instruments in consultation with the government. Thus independence for central banks is limited. However both can have al a consultative approach and sort out things amicably. For ary policy | sample regarding inflation control, the concept of ‘inflation ae targeting is gaining popularity. Here the expected rate of inflation aHects: ti i is estimated and policies are framed accordingly. Once the target is fixed by the govt., operational freedom should be given to the rations are central bank to achieve it. The credibility of the central bank lies in using its instruments and achieving the targets. The tries. Tha central bank should make its stand clear on vexed issues Ca, oa like public debt management, subsidised credit, populist policies of the government like loan waivers etc. and advise the government accordingly. This enhances the credibility of the central bank. The Reserve Bank of India has emerged as a credible institution NK: over a period of time. Though it is influenced by the government in its policies and objectives, it has played its own role in | developing the financial system. Even though it lacks autonomy, 'S objectives, | _ it has made its stand clear on conflicting issues in the interest of ich objectives | the nation. ee are | ACCOUNTABILITY: indate to . the chan, ging When central banks are empowered by the governments, Yetnment and accountability becomes easier. If the banks are given a clear a Managing mandate and operational freedom, they can be made accountable lym for the outcome. Central banks having a clear mandate withoutam Vines viput's™ Central Banking (80 38 roo icult to achieve the target. In operational freedom, will find it diff es talent ies Financial se Jabour market etc. are rowth. For the reforms soe ike India, og countries like = the case of developing cow : ctor reforms, fiscal functions: reforms, reforms in the forex market, pur §) uired in developing countries to § é : , a os d cooperation 1s required to succeed, better coordination an‘ ie ment. Accountability will between the central bank and the gove s and better governance and have to perform diverse ensure optimum use of resources control. TRANSPARENCY: Along with autonomy. and accountability, another aspect which is gaining importance in central banking is transparency. The emergence of WTO and the consequent liberalization of world trade have resulted in increase in international tra and transactions. The flow of capital between nations also increased. Central banks are adapting to the changes following international standards. Central banks are expected be more transparent related to their policies and outcomes. | higher degree of transparency leads to better credibility institution. 2 sredkbility of Generally it is believed that central banks ar transparent. Central banks wish to have an announce sudden policy changes. They ; They are also under of the government and the influence of eat x policies and functions are well known, ai can provide information to the public at Che this,Contemporary Issues ow 39 In the 1990s, Latin American countries and South Eastern countries faced a severe economic crisis, Since then there is a greater demand for transparency on the part of the central bank to } avoid reoccurrence of the crisis. Transparency on the part of the reforms f central bank means making public the following: (1) Announcement of the monetary policy and review, if any. ince and (2) Methods to achieve the objectives. (3) Organisation and management. (4) Providing reliable data on monetary issues. or: aspect | sparency. zation of 6) The outcomes or achievements and failures of the policy initiatives. Transparency on the part of the central bank will prepare the nal trade” public to accept changes without much opposition and adapt tions has themselves to the changes. anges Dy Transparency is given a lot of importance by many central ‘pected t© | banks in the post liberalized era. The following methods are adopted to impart transparency. (1) Publication of Annual reports. (2) Quarterly or monthly reports about monetary secrecy to developments. the control (3) Report on inflation targeting, measures taken and nt on their outcome. Mitral banks. (4) Use of print media and electronic media for dissemination of information. SRE ———— 7 Ito iy vipul’s™ Central Banking (28) 40 ‘ ments and poli | (5) Use of official website to notify develop Policy changes. i and conferences | (® Open discussion through seminars involving all the stakeholders. sions between the central bank's (7) Disclosure of discus . officials and the government. ) International institutions like the IMF, the Bank for International Settlements (BIS) and others have framed intemational standards for transparency. The interdependence ’ economies due to globalisation makes it necessary for central | banks especially in developing countries to adopt internati J standards for transparency while keeping in mind the d tequirements. Transparency on the part of the central help the financial markets to respond to the policies changes if any positively. This enables the central bank to stability of the market and it also enhances its reputation. ali 3.5 QUESTIONS: (1) (A) Fillin the blanks: { eu *" Sutonomy ofa central bank is imited by ! i BA “BS, (b) Transparency Imps org (©) —____ has framed the rules fy at global level. Transparency at (8) Top fil of he banking sector 2 ae india ae ie ee @Ppointed by t ) [Ans.: (a) government intervention; = a ae i International Settlements; (d) = ibility; (C) The"a 41 contemporary Issues : id Poligy : (B) Choose the correct alternative and rewrite the sentences: (1), The major weakness faced by central banks in emerging = nferences economies are . (May 19) (a) Weak financial system (b) Financing government debt al bank's (c) Both (a) & (b) (4) None of the above (2) Indian Rupee is fully convertible in the (a) Current-account (b) Capital account (c) Both (a) & (b) Bank — for (a) None of the two » fram ed [Ans.: (1 -c); (2- a)] ndence of| : (2) State whether the following statements are True or False: or central ri (a) The RBI is totally autonomous and independent of the ema aa government. (May 19) : Onteaa (b) Liberalisation has led to more responsibilities for the central ntral bank pane licies and (c) The Bank for Intemational Settlements frames prudential k to ensure norms for the banking sector. ~( ibility and [Ans.: (a) False; (b) True; (c) True] (3) Explain the terms ‘autonomy’ and ‘independence’ with reference to central banks. Are central banks really autonomous? | (4) Explain the concepts of credibility and accountability in detail. (5) How does transparency of central banks’ operations improve their credibility? i bani: (6) How can central banks ensure transparency? aronoy at 1 (7) Explain meaning of autonomy of the central bank. Also explain the factors limiting autonomy of central bank. (May 19) Pointed by thé ) The Bank 1%