Central bank should enjoy more 'instrument independence'

Central banks in countries like Bangladesh should enjoy more 'instrument independence' in determining monetary policy, vital for moving an economy.

Simultaneously, said a noted banker of India, there has to be close dialogue and coordination between the central bank and the government to ensure close link between monetary and fiscal policies.

"It is in the best interest of the government itself to cede certain areas to the central bank (CB)," said Dr. Chakravarthi Rangarajan, the former Governor of the Reserve Bank of India (RBI) at a public lecture Sunday in Dhaka on central banking.

Bangladesh Institute of Bank Management (BIBM) organized the event in memory of the late A K N Ahmed, the second Governor of Bangladesh Bank.

"Monetary policy is part of overall economic policy. Monetary policy and fiscal policy running in different directions can impose a burden on the economy," Dr Rangarajan told his audience from Bangladesh's banking sector.

"Therefore, there has to be a close dialogue and coordination between the central bank and the government."

Mr. Rangarajan, who was also Chairman of the Prime Minister's Economic Advisory Council of India in his long illustrated career, also noted that there are some advantages in specifying the areas in which the central bank has a clear mandate.

"Central banks like Reserve Bank of India and Bangladesh Bank perform multiple functions. They are not only monetary authorities but also regulators of banks," he noted.

"This, in some ways, complicates the autonomy question," he said about the ways of central banking in countries like these.

"As a regulator, they have only the freedom other regulators enjoy. Thus, in determining the mandate to Central Bank, the government has complete authority.

"However, once the mandate is given, the Central Bank must be given the freedom to take such actions as it deems fit-which is sometimes called 'instrument independence," the former RBI Governor explained.

Rangarajan also observed that among the various objectives such as price stability, growth and inflation stability, the dominant objective for central banks particularly in developing economies must be price stability.

"In this regard, having an inflation target helps," he said. "It gives, in a sense, greater precision to the concept of price stability. This framework would require that the monetary authorities should keep inflation within the target level."

In a flashback on the 2008 global financial crisis, Rangarajan termed it a reflection of both monetary policy and regulatory failures.

"While regulatory failure bore the primary responsibility, monetary policy played a facilitating role," he said.

"We need to draw appropriate lessons from the crisis. The regulatory framework needs to incorporate both micro-and macro-prudential indicators," suggests Rangarajan, also a former member of Rajya Sabha.

Speaking on the occasion, Bangladesh Bank Governor Fazle Kabir said the central bank of Bangladesh has given considerable focus on macro-prudential policy to ensure financial stability in the country.

"A set of dedicated macro-prudential policies like loan-to-value limits, reserve requirement, advance-to-deposit ratio, cap on capital-market exposure and countercyclical capital buffer applied by Bangladesh Bank have been proven to be very effective in addressing systemic risks of country's financial sector," he told the meet.

"In addition, Bangladesh Bank has also developed a 'Central Database for Large Credit to prepare a 'Corporate Watch List while a 'Systematic Risk Dashboard is being published on a half-yearly basis," the Governor said.

He also said the formation of 'Financial Stability Council' is under process while the Bangladesh Bank has also established Financial Stability Department to deal with macro-prudential aspects of the financial system.

[email protected]