There is growing concern around the world that the independence of central banks is under threat. From the US to India to Turkey and even Switzerland, central banks are facing unprecedented criticism or new legislation that may reduce their independence.
South Africa has certainly not been spared. As part of its election manifesto, the ANC has adopted the position that the South African Reserve Bank should “pursue a flexible monetary policy regime, aligned with the objectives of the second phase of transition”.
Although the party says it does not want to take away the bank’s independence, it nevertheless wants to change its constitutionally-given mandate. It is a position that is only emboldened by what is happening elsewhere in the world.
James McCormack, the global head of sovereign ratings at Fitch, recently noted that central banks “are being increasingly viewed by governments as ripe for a broadening of their remit”.
Signs of trouble
Delivering the annual Stavros Niarchos Foundation lecture at the Peterson Institute for International Economics in Washington DC on Monday, the governor of the South African Reserve Bank (Sarb) Lesetja Kganyago acknowledged that there are many ‘signs of trouble’ around the world. This, he noted, was a concern because of the textbook reason for why central bank’s need to be independent in the first place – the time inconsistency problem.
“[Governments] like to promise low inflation in future, but when the future shows up, they discover it’s easier to tolerate higher inflation instead,” Kganyago explained. “The solution to the problem is an independent central bank, with a clear mandate to control inflation.”
While this is obviously central to why they should be protected, Kganyago made the case that recent experience has taught him that it is actually of far broader importance. Having an independent central bank is a democratic necessity.
“We’ve been on the frontlines lately, the place where good and bad governance meet, and I promise you – in that situation, you really learn to believe in central bank independence,” he noted.
This is because it provides a buttress against the misuse of power.
“Independence ensured that the tremendous powers of a central bank – such as printing money, or licensing and supervising banks – couldn’t be taken over by politically connected individuals bent on looting the state instead of serving the citizens,” Kganyago said.
In this respect, the South African experience holds very particular lessons.
“We are all used to thinking about attacks on central banks as demands to cut rates for political reasons,” Kganyago said. “But I never once got a call or any other communication from the Union Buildings – the seat of the South African executive – telling me what to do with monetary policy. Similarly, my toughest public engagements haven’t been about interest rates; they have been about the financial system.”
Where the bank’s independence has most been threatened is its oversight role in the financial sector. The Sarb has faced three major threats in this regard.
The first was in relation to the Gupta family when South African commercial banks closed their accounts. The Sarb came under pressure to force banks to reverse these decisions, in violation of the law, and even to allow the Guptas to get their own banking licence. The Sarb was told that its role in issuing bank licences would be taken away if it didn’t.
That was followed by the collapse of VBS Mutual Bank, which the governor described as “a crude Ponzi scheme”. Despite it being “an insolvent, corrupted institution” the Sarb was heavily criticised for targeting a black-owned bank.
Thirdly, and in Kganyago’s view the strangest, was the Public Protector’s investigation into the Bankcorp bailout in 1985. This resulted in an order that parliament change the constitution to alter the Sarb’s mandate. This “flagrant disregard of the law” was ultimately thrown out by the courts, but the attack was nevertheless keenly felt.
A bigger issue
“When I reflect on what the Reserve Bank was doing during this period, I cannot say it was all about maintaining a credible commitment to sound monetary policy,” Kganyago noted. “The problem we were really addressing was the principal-agent problem. The people of South Africa were relying on their government to look after their interests, while some people were instead using public power to pilfer. The Sarb made that more difficult, which is why the bank was attacked.”
This is why Kganyago believes that central bank independence is a far bigger issue than simply ensuring sound monetary policy.
“Independence is a powerful defence,” said the governor. “Many times during my term we have reflected with gratitude on the foresight of our founding mothers and fathers, who saw what could happen in the future and gave us the constitutional tools to defend ourselves.”
This is the true nature of democracy. It is not simply about majority rule, but ensuring that there is always a balance to power.
“One of the gravest threats facing any society is the ruler who is more powerful than anyone else and therefore cannot be stopped by anyone, even when he is acting against the interests of the principals, the people,” said Kganyago.
“Not all leaders are bad – I have met many good leaders, and some who would have behaved better in easier circumstances. But a small portion of leaders are bad, and if you understand probability, then you know sooner or later most countries will get a bad leader. There is nothing undemocratic about buying some insurance against this eventuality, and independent central banks, like judiciaries, are useful parts of those insurance policies.”
Watch the full lecture here.