OF SUBSTANCE AND SPIRIT

(Last of two parts)

The IMF’s Tobias Adrian talked about 10 metrics aimed at helping central banks (CBs) and policy makers fortify CBs independence. Adrian was quick to point out that “this is the first new CB independence index in 30 years.”

These 10 metrics are: CB governor’s independence from the executive; CB’s governing body’s independence from the executive; budgetary independence from the legislature; monetary policy independence from the executive; primacy of price stability; long-term direct lending to the government; short-term lending to the government; financial independence; lending outside the financial system; state audit bodies role in ensuring operational efficiency of CBs.

He admitted to his audience at the Bank of Thailand in mid-June that many of these self-explanatory metrics are based on existing indices with new variables introduced including financial and budgetary independence, board composition, and the role of state audit bodies. Based on the views of central bankers themselves, Adrian stressed that the most critical component of CB independence is financial independence. To them, the least important is short-term lending to the government.

In the Philippines, one can only imagine what would happen to the independence of the Bangko Sentral ng Pilipinas (BSP) if it were to ask Congress for annual appropriation, or seek additional capital. Members of Congress could even investigate the Monetary Board why it has kept interest rate steady for more than a year, or closed an erring bank with strong political backing. 

Good, the 1987 Philippine Constitution explicitly mandated the establishment of an independent central monetary authority and implemented by Republic Act (RA) 7653 of June 14, 1993 by establishing a new autonomous and independent BSP in the same year. After a quarter of a century in 2018, RA 7653 was amended by RA 11211 increasing its capitalization from ₱50 billion to ₱200 billion. 

However, if indeed financial and budgetary independence is most critical, the continued independence of the BSP rests on the complete capitalization from ₱50 billion to ₱200 billion. But after the BSP charter amendment six years ago, only ₱10 billion was added to the BSP’s initial capitalization. With the establishment of the Maharlika Investment Fund, the full capitalization of the BSP could be further delayed because the BSP’s annual dividend that should be reverted to the central bank for capital build-up will instead be diverted to the investment fund up to P50 billion.

But as Adrian would remind us, CB “independence is significantly stronger in the countries where inflation targets are more firmly entrenched in central bank operations.”

Weaknesses are seen at the level of CB management as well as in its budget and financial operations, monetary policy and the prohibition of lending to the government and outside the financial system. Since financial independence is considered most important, any improvements here can offer the bigger “bang for the buck.” He recognized that future legal amendments may be necessary but long and winding. 

Instead, he advised the use of several IMF tools requiring no legislation. The first tool is the IMF Central Bank Transparency Code or CBT released in 2020. The Code has five pillars consisting of transparency in governance, policies, operations, outcome and official relations. Each pillar consists of various components that could guide CBs improve their transparency and communication practices that lead to policy credibility. 

The second tool is stress testing CBs’ balance sheets. Doing this will help them assess their own financial independence. As Adrian clarified, this is particularly helpful for many advanced, and for that matter even emerging, countries that expanded their respective balance sheets due to the exigencies of the pandemic. This should also be useful for CBs with large and active foreign exchange operations that expose them to interest rate and duration risks on their FX securities. Such risks should be properly considered in CB capital policies.

A quote from Adrian should resonate too many CBs “…a deteriorating CB balance sheet would negatively affect profit distribution — ultimately creating fiscal risks, including through the possibility of having to recapitalize the CB.”

We dread the day when CBs have to lobby with their parliaments for additional capitalization. They would be forced to bite the political bullet. 

The last tool is the CB operational efficiency review. This should require the CBs to rationalize their operational costs to achieve efficiency. Policy-related costs are left out but other costs including staffing, procurement, and other logistics costs are benchmarked against best practices. This will encourage CBs to avoid unnecessary expenses especially in staffing and procurement which may be subject to corruption.

While Adrian referred to the 10 metrics as the first in 30 years, an interesting article came out from the World Bank on “Measuring the Independence of Central Banks and Its Effect on Policy Outcomes” by Alex Cukierman, Steven Webb and Bilin Neyapti 32 years ago in 1992. They developed four measures: legal index; rate of turnover of CB governors; index based on a questionnaire answered by specialists in 23 countries; and an aggregation of the legal index and the rate of turnover. 

Their interesting finding: legal independence is not inversely proportional to inflation in developing countries but it is the rate of turnover of CB governors which turned out to be a better proxy for CB independence. 

We cannot therefore resist the temptation to conclude with the World Bank’s quote of Arnold Lobel’s 1972 comics: “Frog and Toad Together:”

“Willpower is trying hard not to do something that you really want to do,” said Frog.

“You mean like trying not to eat all these cookies,” asked Toad.

“Right,” said Frog. He put all the cookies in a box. “There, now we will not eat any more cookies.”

“But we can open the box,” said Toad.

“That is true,” said Frog. He tied some string around the box. He got a ladder and put the box up on a high shelf. “There, now we will not eat any more cookies.”

“But we can climb the ladder…”