The Autonomy of Bangladesh Bank - ECO 432 Term Paper

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The Autonomy of Bangladesh Bank

ECO 432 Term Paper

Submitted by:

Sardar Mohammad Imrose Sumaiya Mahabub

Kazi Sakif Zaman Reza Maria Matin

Samiha Moyeen

Table of Contents Introduction: ......................................................................................................................................... 3 Background: .......................................................................................................................................... 3 Theory of Autonomy: .......................................................................................................................... 4

What is Autonomy? ................................................................................................................ 4

The Rogoff-Conservative Model:....................................................................................... 5

Measuring Autonomy: .......................................................................................................... 6

The Legal Measure: ............................................................................................................... 6

The GMT Index .................................................................................................................... 6

Central Bank Independence and Governance: ................................................................. 8

Advantages and Disadvantages of Autonomy: .............................................................. 9

Relationship in Developing Nations: ............................................................................... 9

History of Central Banks’ Autonomy: ............................................................................................ 10 Does Bangladesh Bank have Autonomy in the True Sense? ....................................................... 11

The Political Autonomy of Bangladesh Bank.............................................................. 12

The Economic Autonomy of Bangladesh Bank ......................................................... 14

Case Study: The Reserve Bank of Australia & Bangladesh Bank ............................................... 18 Bangladesh Bank Reforms: ............................................................................................... 18

The Reserve Bank of Australia Reforms: ...................................................................... 19

Frameworks of Reserve Bank of Australia’s Reform: ................................................ 20

Data Comparison: ................................................................................................................ 21

Recent Trends and Observations: ................................................................................................... 26

Some Positive Trends.......................................................................................................... 27

Some Negative Trends ....................................................................................................... 30

Inflation in Bangladesh ...................................................................................................... 31

Conclusion and Policy Recommendation....................................................................................... 33 References: .......................................................................................................................................... 34

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

Rahman with a board of directors consisting of himself as the chairman, 8 directors, and 1

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

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).

Table # 1: Types of Independence 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

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

backed by the government. The bank has complete independence if the actual target is closer

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.

.

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. Legal Measure by Cukeiman, Webb, and Neyapti

ii. GMT Index by Alesina, Masciandaro, and Tabellini

iii. 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 criteria-

I. 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. Government involvement in policy decisions: the independence is greater as the policy

decisions are made with less and less participation of the government.

III. Goal of monetary policy: When price stability is given the maximum priority, a bank is

said to have a high level of independence.

IV. 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:

Political Autonomy Criteria:

i. Appointment of the Governor of the Central Bank without any influence of

the Government.

ii. Governor of the Central Bank to be appointed for tenure of more than five

years.

iii. Members of the Board of Directors to be appointed without government

influence.

iv. Board members to be appointed for more than five years.

v. There are no provisions where the government decides on who represents

the board.

vi. There are legal provisions aimed to protect during conflict with government.

vii. No need for to seek approval in devising monetary policy.

viii. The charter must include provisions aimed to seek monetary policy stability

as its core objectives.

Economic Autonomy Criteria:

i. Easy credit to government at market interest rate.

ii. Credit is extended on a temporary basis.

iii. Central Bank does not participate in the primary market for public debt.

iv. There must be a limit on government borrowing from the central bank.

v. There are no automatic procedures for the government to obtain direct

credit from central bank.

vi. Central Bank sets the discount rate.

vii. 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.

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

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 produces lower average inflation. Low prices signify a favorable effect on the economy

Complete independence is seen as a threat, questions the accountability of the central bank. Maintaining a low and stable inflation isn’t the only issue of concern

Absence of political influence allows the prices to be stable

Legal measures do not indicate the actual 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

raise questions as such: Is it the political involvement that is producing high inflation or are

the governors being fired because they are inept at controlling the inflation?

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

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.

Such will be achieved with the help of a model unearthed in various literatures relating to the

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

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

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

deserving for the position. Such a predicament also has had an adverse effect on the

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).

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

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

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:

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.

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

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

Australian Prudential Regulatory Authority (APRA) being delegated the responsibility of

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

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

only on reducing inflation but measures the weight of its actions on other aspects of

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

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 Reserve Bank Act mandates such

a provision and this has been exercised in the RBA over the years which yielded

fruitful results. In this process both the governement and the central bank are aware

of the same facts – implying that both tell the same story. Also, central banks need to

be informed about the economic activities elsewhere, such as fiscal policies, as it

deals mainly with monetary policies. All these policies are connected and it is a good

idea to devise policies which benefit all the aspects of economy. At times of

disagreement, the Treasurer’s view shall stand but he has to present both the Board’s

view and his arguments for overriding those views to both Houses of Parliament.

4) A Good Board – A very important part of the framework is that the decision making

authority of the RBA should repesent a ‘real world’ dimension when considering the

policy options. The Board has the delegatory authority to take any decision on behalf

of the RBA including those with regard to lowering interest rates. The Board follows

a proper hierarchy where only the Chairman is allowed to speak on behalf of the

Board and the rest comprises of decent, competent people who take their job quite

seriously as evidence suggests.

Data Comparison:

In the following, a comparison of CBIG index between the two central banks’ will be

highlighted. As one can observe, the RBA has been able to maintain a higher overall CGIB

index whereas BB struggled. However, recently, the index score improved.

Graph # 2: Comparison of CBIG Index of Australia and Bangladesh

Graph # 3: CBIG Index Score (1991 - 2008) – Australia

0

0.2

0.4

0.6

0.8

1

1.2

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

CBIG

Inde

x Sc

ore

Year

CBIG(Leg)

CBIG(Pol)

CBIG(Pstab)

CBIG(Frx)

CBIG(MonoPol)

CBIG(Acctrns)

Graph # 4: CBIG Index Score (1991 – 2008) - Bangladesh

It can be observed that Bangladesh’s legal index to be constant at 0.32 till 2003, but

dropped to 0.28 when the term of the governor of BB was reduced to four years from five

years. However, the legal index of Australia increased to 0.67 in 2008 after being constant

for a period of 10 years (1998-2007) at 0.6. A possible reason for this might be that the term

of the governor has been increased to a period of 7 years. When the governor’s term is more

than that of the elected government, it leads to less influence by the politicians. Although the

legal power to appoint the governor is same in both the countries, the recent change in

Australian dismissal process keeps the standard of the RBA better than BB. The RBA was

freed from the responsibility of regulation and supervision of the commercial banks but the

BB was not. All these lead to a lower legal index score of BB.

The political CBIG Index started off at 0.89 in 1991 but came down to 0.56 in 1996 and

2001 because of the government’s efforts to try to change the governor of BB during these

times. However, the index improved after the BB charter was changed in 2003. Reason why

BB scored poor than the RBA is that there was hardly any political influence in RBA but BB

had to consult the Ministry of Finance for every important decision. The turnover rate in

Bangladesh was strongly linked to changes in government and its representation in BB is

0

0.2

0.4

0.6

0.8

1

1.2

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

CBIG Index Score

Year

CBIG(Leg)

CBIG(Pol)

CBIG(Pstab)

CBIG(Frx)

CBIG(MonoPol)

CBIG(Acctrns)

also higher than the RBA. However, the 2003 BB amendment act aims to put an end to this

problem.

The RBA scores a perfect Price Stability Objective Index of 1.00 and one of the main

reasons of it is that it had always considered price stability to be one of its objectives.

Inflation targeting and interest rate forecasting are considered to be vital macroeconomic

tools in Australia. BB strived to implement the inflation targeting system with the help of the

government but no provisions about it were mentioned in the legislation. It was not until

2003 that price stability was included in BB’s charter and the highest score marked was 0.56.

The exchange rate policy index of BB used to be zero until the currency was floated in

2003 achieving the highest score of 0.33. However, the government retains some right and

only entitles BB to little power over the exchange rate policies. In contrast, the RBA has

been responsible for the exchange rate policies in Australia ever since the currency was

floated in 1983. Their immense success in this aspect of intervening and stabilizing exchange

rate movement lead to a relatively higher score of 0.67.

Prior to 2003 the monetary policy and deficit financing index of the BB was only 0.22

since it had to follow direct orders from the Ministry of Finance – implying a very low

operational independence. Later a Coordination Council was established of which the

Ministry of Finance is the Chair and the BB governor is a member to facilitate

communication. In contrast, the RBA marks a high score of 0.83 since 1991 implying that it

has been independently handling the monetary policy and deficit financing independence.

One of the main reasons for this is that the RBA does not provide money to the

government and is in charge of the overall monetary policy.

The accountability and transparency index of BB has gradually increased from 0.17 in

2002 to 0.39 in 2003 and finally to 0.72 in 2006. Improvements as such occurred primarily

for the amendment act in 2003 which identified accountability as one of its objectives

increasing the governor’s accountability to the parliament. Also the regular monetary reports

which have been published since 2006 have contributed to increasing accountability. The

RBA’s scores in this aspect have been 0.86 till 2006 and increasing to 0.95 in 2007 for the

board meeting’s minutes it publishes. Graph # 5: Comparison of Inflation of Australia and Bangladesh

Graph # 6: Comparison of GDP per capita of Australia and Bangladesh

From the graphs above, we can see that Australia’s GDP Per capita is far higher than

that of Bangladesh and it has also been successful in maintaining an inflation rate lower than

Bangladesh. We analyze the data and interpret the graph in the later sections of the paper.

What we are to look at in this segment is whether the high GDP per capita and low inflation

rate of Australia leads to a higher CBIG Index. In other words, the relationship between

high GDP and low inflation with CBIG is to be highlighted.

Recent Trends and Observations: Even though the CBIG and GMT index scores are poor and the amount of government

borrowing from BB has been increasing after 2002, the overall CBIG index score of

Bangladesh improved than previous. It can be said that even though Bangladesh Bank is not

as autonomous as the RBA, but it has gained more independence over the years. But the

question now remains whether BB’s autonomy affects the overall scenario in Bangladesh. If

we can find that along with poor autonomy the economy and development is curbed, we can

say that central bank’s autonomy is essential. However, if the results are seen that despite of

poor autonomy, the overall indicators of development are well in Bangladesh, an alternative

conclusion can derive.

Some Positive Trends

Graph # 7: Discount Rate of Bangladesh Bank Source: International Monetary Fund, 2009

Here we can observe that Bangladesh Bank has been able to maintain steady discount

rate throughout. There has not been any high fluctuation. After 2003, the discount rate has

been 5 %, which is lower than the call money rate (9% or higher). This shows that BB is

encouraging people to borrow money, which probably has a positive influence in our

investment and output.

Graph # 8: Gross Domestic Product (Current Prices) Source: International Monetary Fund, 2008

We can see that in terms of nominal rates, the GDP of Bangladesh has been increasing

throughout the years. Till about 2000, this growth was quite gradual, however, after that, the

growth has been exponentially high. This contributes positively to our economy and also to

help improve our lifestyle.

Graph # 9: Poverty Headcount Ratio

Source: World Bank, 2007 Graph # 10: Human Development Index

Source: World Bank, 2010

In Graph # 9 and 10 we can observe that along with the annual GDP increase, the total

poverty rate is decreasing and at the same time, the livelihoods of Bangladeshi people are

improving. So despite of poor autonomy, the people in general seem to be doing well.

However, there are obviously some areas for improvements which the following graphs

would depict.

Some Negative Trends

Graph # 11: Employment in Bangladesh

Source: World Bank, 2009 Table # 5: Corruption Perception Index – Bangladesh Ranked 134

Source: Transparency International, 2010

In the above graph and chart we can see that in terms of employment, the current

percentage of formal employment is decreasing. This could be caused by various factors (ie,

increase in the informal sector, decrease of child labour, etc). As one of the visions of BB is

to help generate employment in Bangladesh, we can see that there is no real contribution and

neither is there any initiative to do so. However, the primary cause for this is probably

corruption. For two years running (2008 and 2009), Bangladesh has been ranked as one of

the most corrupted countries in the world by Transparency International (score of 2.4 out of

10 in both years – the lower the value, the more corrupt a country). The autonomy of the

central bank will in no country assure the decline of corruption; however, the corruption

does have an effect on efficiency.

Inflation in Bangladesh

One of the biggest duties of BB is to maintain a stable inflation rate. As a small

population of Bangladeshis are privileged, the price level plays a vital role. If things become

expensive, for few people it would not make much difference, but for most, it would get

very difficult to function properly. The following graph shows the inflation rate (average

consumer prices) of Bangladesh in various years:

Graph # 12: Inflation Rate in Bangladesh

Source: International Monetary Fund, 2008 Here we can see that before 1990, the inflation rate in Bangladesh was very high. After

the Financial Sector Reform Program in 1989 (mentioned in the previous sections), the

inflation rate drastically fell. For about 10 years, it was low; however, there were years where

the rate peaked to very high levels (1995 and 1998). The reason for this is not poor monetary

policy, but natural disasters (a high percentage of our GDP is contributed by the agricultural

sector). The BB was successfully able to restore the price level to a lower rate the following

year, indicating good monetary policy makings. Moreover, the global financial crisis of 2008

did not have any immediate effect on Bangladesh because the governor of BB (during that

period) Dr. Salehuddin Ahmed was able to analyze, understand the situation, and took

precautionary measures (as discussed in a seminar by him at BRAC University).

It is also seen that after 2000, the inflation rate has been increasing, and continues to.

Even though the price level did increase, the change was more gradual and it was easier for

people to cope up, instead of just suddenly having high prices the next morning (regardless

to say high price levels is not good for the poor people of Bangladesh). It must be kept in

mind as well that most of the inflation that took place in Bangladesh recently was due to

cost-push inflation, not necessarily poor monetary policies. BB has been able to keep up an

acceptable inflation rate, but this time, compared to previous data, the change/increase is

more gradual and adaptive.

Conclusion and Policy Recommendation

In written constitutions, Bangladesh Bank is autonomous, however in theory it is seen

that Bangladesh Bank’s independence is limited. But the question remains whether central

bank’s autonomy is necessary for Bangladesh at this stage. We can see that despite poor

scores in the GMT index and CBIG index, Bangladesh Bank has been performing quite well.

The growth in our GDP, poverty reduction, and improvement in the human development

index all tends to show that the management board of Bangladesh Bank is not completely

controlled by the government, but then again, the poor condition of employment and the

inflation rate is growing every year beyond 5-6 % which indicates that there are still rooms

for improvement.

Bangladesh today is a developing country and most likely that is the prime cause of this

poor autonomy. However, we gave seen that the practical benefits of autonomy is vast. If

Bangladesh wishes to be a developed country in the future, a strong financial sector and

price stability is needed, for which the autonomy of the central bank is beneficial. The

holistic development of our country will only be ensured if we can help curb down

corruption, improve education, provide more chances of employment, etc.

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