Independence key for central bank

By Chao Wen-heng 趙文衡  / 

Fri, Jan 12, 2018 - Page 8

Central bank Governor Perng Fai-nan (彭淮南) is to step down next month and President Tsai Ing-wen (蔡英文) is looking for a replacement. There have been reports that many people covet the position, but if political forces or factions were able to intervene in the operations of the central bank, it would lose its crucial independence.

Although Perng, thanks to his prestige and expertise, has been able to maintain the bank’s independence, he did not complete the task that really matters — the institutionalization of its independence. This means that without Perng, there is a risk that the bank will now become exposed to the danger of intervention by political and interest groups.

Central banks have the power to make monetary policy. Every move they make has a profound impact on the economy. All industries and interest groups desire central banks’ policies to develop in a direction that is beneficial to their own interests. Therefore, be it the US Federal Reserve or Taiwan’s central bank, the board of governors’ decisions are always a focus of attention.

However, the central banks’ policies should be made from the perspective of overall economic development in the best interest of all. It should not favor specific interest groups.

This makes the independence of the central banks’ decisionmaking body very important: The US and Europe even regard the central bank’s power of making monetary policy as a fourth estate, independent of the executive, legislative and judiciary powers.

In terms of the system, Taiwan’s central bank enjoys far less independence than its counterparts in the US, the EU and Japan. Several years ago, the Legislative Yuan passed an amendment to the Organizational Act of the Executive Yuan (行政院組織法) that placed the central bank under the Executive Yuan, thus removing it from the list of independent bodies. Since then, the bank has become one of a very small number of central banks in the world that is legally not independent.

It is astounding that the legislature in Taiwan, a nation that takes pride in having joined the ranks of advanced countries, would pass such a law. The intention of political forces to have a hand in the central bank’s operations is abundantly clear.

This highlights Perng’s importance. Since 1998, with his excellent reputation and expertise, Perng has shouldered the heavy responsibility of guarding the bank’s autonomy and shielding it against inappropriate political pressure. It will be very difficult to find a successor with the same ability and aspirations as Perng, who, by stepping down, will leave behind a central bank lacking the strength to resist political interference.

Without Perng guarding the bottom line, the bank could be forced to deregulate the non-delivery forward (NDF) — a cash-settled, short-term forward contract in a thinly traded or nonconvertible foreign currency against a freely traded currency — and it could also be forced to relax the maximum mortgage on high-end homes.

The Executive Yuan, legislators and other elected representatives, as well as interest groups, are likely to intervene in the formulation of monetary policy, and the exchange rate and interest rate will become targets for lobbying.

The interest rate will no longer be based on the central bank’s judgments of the situation at home and abroad, but on the outcome of the struggles among political forces and interest groups. Intervention by powerful forces will make financial inspection an empty formality, which could ruin public confidence in the financial system.

Even worse, inappropriate political intervention will result in the bank making the wrong decisions on major policies.

My research on financial crises shows that one or two policy mistakes by the central bank could be enough to trigger a disastrous financial crisis. If that happens, all the government’s efforts to develop the economy will be undone overnight.

In the past, owing to the central bank’s professional and independent decisionmaking, Taiwan appeared to be immune to financial crises. In the post-Perng era, these two advantages could be weakened, thus also weakening Taiwan’s immunity to financial crises, and this is a major concern.

All this is not meant to stress the importance of Perng, but rather the importance of an independent central bank. It is very likely that the departure of Perng will seriously weaken the bank’s independence. The Organizational Act of the Executive Yuan and the Central Bank of the Republic of China (Taiwan) Act (中央銀行法) should be amended as soon as possible to complete the fundamental institutionalization of the central bank and to enshrine it in law.

The best way to complete the institutionalization of the central bank would be if Perng stayed on. No one better understands the importance of the bank’s independence than he does, and no one would be a more effective promoter of the bank’s institutionalization. However, Perng seems to be determined to leave and it appears that he will not accept any counteroffer.

As the main pillar propping up the bank, Perng’s withdrawal is not the responsible thing to do at this moment. If in the end Perng will not stay on to finish the task, his successor will have to make the institutionalization of the central bank’s independence the first order of the day when they take office, in order to ensure lasting order and stability.

Chao Wen-heng is an associate research fellow at the Taiwan Institute of Economic Research.

Translated by Lin Lee-kai