VI Legal Infrastructure: Central Bank Autonomy key requirement for the development of the fi- some others are currently discussing amendments to Anancial sector is an institutional environment them. that is conducive to the effective and efficient for- To a certain extent, while the new laws have in- mulation and implementation of monetary policy. creased the autonomy and accountability of central The regulatory and operating frameworks within banks, none of the selected central bank laws meets which financial systems operate must be simple, un- all the indicators that are typically used to measure ambiguous, transparent, and sound. With regard to autonomy. In this study, the following indicators have the regulatory framework, the legislations governing been used: first, the primary objective of the central the conduct of banking business must follow sound bank should be price stability; second, the central principles. Given that the central bank acts as the nu- bank should be given sufficient authority to imple- cleus of the financial system, the central bank law, ment monetary policy without direct government in- particularly, needs to be clear and precise and must terference; third, the governor and other members of support the development of the financial sector. the bank's governing bodies should be isolated from Specifically, the law should be clear about the pri- short-term political influence; fourth, the economic mary objective of monetary policy and how to autonomy of the central bank should be guaranteed achieve it. On the basis of a growing body of empir- by provisions that limit direct credit to the govern- ical evidence, it is now generally accepted that the ment, prohibit the central bank financing of quasi-fis- primary objective of monetary policy should be cal activities, and ensure that the central bank is fi- price stability and that authority over the pursuit of nancially sound and solvent; and, finally, central bank this objective should be conferred on an autonomous accountability should be ensured through provisions central bank.13 If the authority over monetary policy, requiring prudent reporting on both monetary policy and in particular its implementation, is delegated to and the financial condition of the bank. an autonomous central bank having sufficient au- On the basis of these indicators, a single, un- thority to pursue price stability, uncertainties about weighted legal index of central bank autonomy was price signals are minimized as the signals become developed for this study (see Appendix I, Table Al). more reliable. Not only will this lower inflation and There are, of course, different ways of measuring au- keep it from rising again, but it will also help in allo- tonomy, and a legal index of central bank autonomy cating resources efficiently, leading to high and sus- may have some element of arbitrariness, partly be- tainable output of goods and services. The question cause very different factors are combined into one then is, to what extent have sub-Saharan African indicator and partly also because practices, as they countries been able to meet the requirements of an develop, may not be fully reflected in the central institutional framework that is conducive to finan- bank law. cial sector development? When the index was correlated with inflation rates During the 1990s, these countries took steps to in the selected countries, increased central bank modernize their central banking laws, which had autonomy was found to be associated with lower in- initially been created in the 1960s and 1970s when flation. However, central banks without much auton- central banks were being established. To date, ap- omy were still able to achieve relatively low infla- proximately one-half of the selected countries have tion, but only when the government's monetary amended or completely revised their laws, while policy was sound and credible. The ability to achieve relatively low inflation may have been facil- itated by their having a fixed exchange rate policy or 13 an IMF program (see Appendix I, Table A9). Never- A central bank has autonomy if it has sufficient authority theless, increased central bank autonomy, in general, (both de jure and de facto) over the level of reserve money to meet its primary objective and if it can use that authority without further increased credibility in monetary policy and the government's influencing it in a nontransparent manner. thus reduced inflation. As Table 5 shows, most sub- 28 ©International Monetary Fund. Not for Redistribution Objective tral bank laws include price stability or maintaining Table 5. Degrees of Central Bank the internal and external value of the currency as Autonomy for Selected Sub-Saharan part of other objectives. It is thus difficult to know African Countries, 1997 which objective is accorded priority at any given time or to hold the central bank accountable for its monetary policy actions. However, some of the Group 1 Group II Group III amendments currently being discussed, for instance, Angola* Botswana Kenya in Mauritius and Zimbabwe, give price stability ex- BCEAO Lesotho* Madagascar plicit priority. BEAC Namibia* South Africa As is true of central banks in general, all the se- Ethiopia Tanzania lected sub-Saharan African central banks also seek Ghana Malawi to ensure a safe and efficient financial system, in- Mauritius* cluding the payments systems. Safeguarding the in- Mozambique tegrity of the financial system is critical for the Rwanda transmission of monetary policy signals. Hence, the Swaziland obligations to ensure price stability and a safe finan- Uganda Zambia* cial system will often complement each other, but Zimbabwe* they could also conflict, particularly in the short run. Experience indicates that expansionary monetary Note: * indicates that the central bank law is currently under policy intended to mitigate problems in the financial review. See Table AI for index of autonomy. I: Index is less than sector often ends up aggravating them. For example, 12; II: Index is between 12 and 14; III: Index is 15 or greater. if borrowers, banks, and the general public believe that the government and central bank will always bail out problem banks, there is no incentive to deal promptly with underlying structural problems. Therefore, efforts to ensure a safe and efficient fi- Saharan African countries still confer only limited nancial system should generally be subordinated to autonomy on their central banks in the conduct of price stability, because price stability itself con- monetary policy. tributes to a sound financial sector. There are both benefits and costs in letting the central bank conduct banking supervision, but in Objective countries with less developed financial markets, the benefits may outweigh the costs.15 In particular, An autonomous central bank should have a single given that the central bank is the lender of last resort, objective, or, at least, one clearly defined primary close coordination is always necessary, and skilled objective, to avoid becoming subject to conflicting banking supervisors who are immune to political interests that cause time-inconsistency and credibil- pressure are crucial for efficient supervision. In the ity problems. A clearly defined objective provides selected countries, with the exception of those in the the central bank with some implied powers and also CFA franc zone and Madagascar, the central banks yields a more precise basis for holding the central are in charge of banking supervision. Indeed, in An- bank accountable for its monetary policy actions. gola, Ethiopia, Lesotho, Namibia, Malawi, Tanzania, Furthermore, price stability is, in the final analysis, and Zambia, the central bank also supervises other conducive to sustainable real growth. categories of financial institutions, such as building All the selected sub-Saharan African countries societies and insurance companies. have as an objective either price stability, the value Although overall authority for supervising the of the currency, or monetary stability. However, banking sector may rest with the central bank, in only a few of the central bank laws (those of some countries responsibility for licensing financial Angola, Kenya, Madagascar, South Africa, and institutions either is shared between the central bank Tanzania) give price stability explicit priority. Un- and the ministry of finance or takes place in consul- like many countries, South Africa includes price tation with, or with the approval of, the minister of stability as part of its constitution.14 The other cen- finance or even the prime minister. This setup is likely to make accountability difficult and increases 14The objective is stipulated in the South African Constitution of 1996 (Article 224(1)): "The primary object of the South African Reserve Bank is to protect the value of the currency in 15See for example, Tuya and Zamalloa (1994) and Goodhart the interest of balanced and sustainable economic growth in the and Schoenmaker (1995) for an overview of the pros and cons of Republic" (Government of the Republic of South Africa, 1997). placing banking supervision in the central bank. 29 ©International Monetary Fund. Not for Redistribution VI LEGAL INFRASTRUCTURE: CENTRAL BANK AUTONOMY the risk of relying on purely subjective criteria for Governing Bodies the granting of licenses and may even encourage rent-seeking behavior in the process. Thus, the bank- The Governor ing supervisor's authority should be made clear and The governor, as chief officer, is usually