Ethiopia: Only an Autonomous Central Bank Can Address Inflation

Kenya: Chief Justice Maraga Launches Bench Book for Criminal Cases

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One of the major macroeconomic headaches in Ethiopia is inflation. There are a number of measures the government can undertake to deal this problem, but they will not work unless the National Bank of Ethiopia (NBE) is independent of the machinations of the executive body, writes Abdulmena Mohammed ([email protected]), a financial expert with 15 years of experience.

An economic forum was held early this month, attended by leaders of the business community, and representatives of the National Planning Commission and the Ethiopian Development Research Institute.

The brunt of the participants' criticism was levelled at the National Bank of Ethiopia (NBE), with its most recent transgression in their eyes being the devaluation of the Birr by 15pc against a basket of major currencies last year.

It was also evident that the central bank has lost the battle against inflation, one of the major macroeconomic woes afflicting the economy for the past decade.

Inflation, which had remained in single digits since 2015, soared to double digits in the past year. Despite dropping slightly in August to 13.4pc, it is still far higher than the targeted single digit annual inflation rate for the entirety of the second edition of the Growth & Transformation Plan.

Many factors have contributed to soaring inflation such as an expansionary fiscal policy, devaluation, supply constraints and political instability. And given the fragile political situation, an unrealistic revenue target and expanding loans from the central bank that will likely be much higher than planned, inflation will likely remain in the double digits.

But an element that will make fighting inflation most difficult is the lack of autonomy of the institution tasked with managing the nation's currency. The government's overwhelming focus on economic growth has forced the central bank to take measures contrary to what it was established for.

The central bank's independence is very crucial for fighting inflation. The degree of independence depends on the level of its freedom in setting objectives and targets, its institutional autonomy and to whom it is accountable.

There are few central banks that are free to set their objectives, such as the Federal Reserve. It has the discretion to set monetary policy objectives, which is contrary to cases in many countries.

The main objectives are maintaining price, exchange rate and financial system stability. Tasking the central bank as the fiscal agent of the government is also common in many countries including Ethiopia.

Targets such as a pre-set level of inflation are stipulated to monitor the achievement of objectives. Mostly, targets are set by the government in consultation with monetary authorities, with the central bank granted operational independence to use monetary policy instruments to achieve them.

Ethiopia, Kenya and Ghana have similar monetary policy objectives, including target level inflation. The government of Ethiopia plans to keep inflation in the single digits, while in Ghana, a clear target for the annual inflation rate is set and spelled out in every year's budget statement.

There are two areas that are detrimental to achieving the monetary policy objectives of a central bank.

First, there is the accountability of a central bank. In Ethiopia the NBE is accountable to the Prime Minister, whereas the Bank of Ghana is accountable to the parliament and the wider public.

The other highly related issue is how the appointments of a management team and a board of directors of a central bank are made. If this task is given to the executive organ of a government, the independence of a central bank will be compromised.

The Prime Minister appoints the board of directors, the governor and vice governor of the NBE. The appointees in several cases have been known to be members of the incumbent party.

The management team of the Central Bank of Kenya, comprising the governor and two deputy governors, are hired through a transparent and competitive process and have to be approved by parliament. Similarly, the board of governors of the Bank of Ghana are appointed by the president in consultation with the council of the state. In both countries there are detailed rules regarding reappointment and the various committees.

Another crucial factor, which could mean the difference between achieving monetary objectives or not, is the lending practice of the central bank to the government, which has serious implications in fighting inflation. The lending is done in consultation with the National Bank and is stipulated to be consistent with maintenance of price and exchange rate stability.

Yet, there is no explicit limit on the size of lending. Expanding the budget deficit made maintaining the balance between lending to the government and maintaining price stability difficult. So the central bank's primary role in maintaining price stability was sidelined.

Ghana and Kenya have strict rules regarding borrowing from the central bank. The Central Bank of Kenya provides advances to the government secured by negotiable securities maturing in a year to offset fluctuating government revenues. The advance bears market interest rates, while total advance should not exceed five percent of gross recurrent revenue of the government.

Ghana has also put similar restrictions on lending from the central bank. The total loans, advances, purchases of treasury bills and other securities together with money borrowed by the government from other banking institutions and the public at the close of the financial year should not exceed 10pc of the revenue of the fiscal year.

By such parameters, the National Bank is far less independent than the central banks of Kenya, Ghana and Nigeria. At times, it does not seem to be anything more than a department inside the Ministry of Finance & Economic Cooperation.

Lack of independence of the central bank has hugely contributed to inflation in the past decade. Despite it being autonomous by law to conduct its operation, its accountability to the executive branch of the government and the provision that allows lending to the government without approval from the parliament has failed the NBE from doing its tasks.

Fighting inflation requires revising the central bank's establishment proclamation. The revision must include that the governor of the NBE should be accountable to parliament and the broader public, while parliament should appoint members of the board.

Members of the incumbent party should not be allowed to sit in its board. The management team should be hired on a transparent and competitive basis. Loans to the government should be highly restricted, and interest rates should be punitive.

The central bank has not been designed to be an autonomous body for nought but to address macroeconomic bottlenecks such as high inflation.


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Publish date : 2018-10-08 10:05:30
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