Wednesday, August 9, 2017

Nepal's central bank needs younger talents

It was published in The Kathmandu Post, 07 August 2017

Nepal Rastra Bank needs to be objective and pragmatic to maintain institutional credibility

The Nepal Rastra Bank (NRB) should ideally operate without courting much controversy over its internal management, operational modality, assessment of the economy, and the regulatory and supervisory mandate. Staying above reproach would ensure financial stability as well as the achievement of its two main macroeconomic targets—curbing inflation and boosting the growth rate. NRB needs to be as objective and pragmatic as possible to maintain institutional credibility and integrity on the execution of monetary policy.

Unfortunately, this supposedly impartial autonomous institution is in the news these days for all the bad reasons; including the leadership’s ill-intentioned plan to do away with the 30-year employment limit, ad hoc changes to monetary rules and regulations, and weak monitoring and evaluation of banks and financial institutions (BFIs).

One of the most controversial issues faced by the central bank currently is internal lobbying to do away with the 30-year employment limit for its employees. This has been a recurring issue since 2001, when such a provision was introduced under the financial sector reform project. Currently, employees are mandated to retire if they have served for 30 years or are above 58 years of age. NRB recently formed a new committee to suggest amendments to its employment regulations. Many suspect this to be a pretext to end the threshold on the years of service. This has generated mixed reaction within and outside of NRB. While some have expressed strong reservation over the intention to form the committee, others either have remained silent or are actively lobbying to end the limit on years of employment. 

There is no justifiable logic in changing current terms and conditions for employment. Some argue that ending the age limit on years of employment will ensure that a large proportion of senior employees will be able to retain their jobs for the time being, avoiding disruption to service delivery caused by retirement of old employees and loss of institutional capacities.

This is hogwash, as the NRB needs young talent in all its departments to effectively execute its policies, undertake research activities, and fulfil its regulatory and supervisory mandate. The marginal benefit of retaining old employees is far less than the marginal cost of hiring young people and training them to take on the required job responsibilities.  The central bank needs to attract top talent from domestic as well as foreign universities by offering attractive entry-level research or management positions. Importantly, a fresh breath of air is needed at NRB so that its actions are proactive rather than reactive. The latter has been the case for the past few years as NRB has repeatedly missed clear signals of disruptive credit flows and accumulation of unbalanced portfolio by BFIs.

NRB’s gain as well as the gain for the entire financial sector will be higher if the old guns follow the current employment regulation and make way for younger talent. The constant tussle among its old and new employees, politically-affiliated unions, and rolling out ad hoc management regulations undermines NRB’s credibility and distracts it from focusing on its main tasks: helping the government achieve growth and inflation targets without jeopardising financial stability, enhancing access to finance, and effectively supervising and regulating the financial sector.

Drifting away

The other important issues that are bogging down NRB are changes to set monetary rules and regulations, and weak monitoring and evaluation of BFIs. First, responding to the sudden credit squeeze—a result of the BFIs repetitive practice to accelerate credit growth more than deposit growth—NRB became overly accommodative by tweaking accounting rules in computing the credit to core capital-cum-deposit (CCD) ratio in its mid-year review of the fiscal year (FY) 2017 monetary policy. This ad hoc policy change was in effect a reward for the BFIs struggling to mend their ways after recklessly increasing credit to few unproductive sectors.

NRB allowed BFIs to discount 50 percent of productive lending, plus lending to deprived sectors and the agro sector at subsidised interest rates, while computing the CCD ratio. It gave some breathing space to BFIs to rework on their lending practices and meet the mandatory threshold of 80. However, NRB rolled back this provision in its FY2018 monetary policy. This kind of overly accommodative ad hoc measure has fostered a moral hazard, whereby BFIs continue to act recklessly , anticipating a reprieve from NRB in case of negative consequences. In doing so, they privatise profits and socialise losses. NRB has acted on behalf of the BFIs rather than acting as their supervisor and regulator, and committing to protect people’s deposits and return on savings. 

Second, the central bank failed to stabilise interest rates, which have remained volatile in recent years. Retail interest rates have gone up sharply, a result of the reactive working culture at NRB. Its monetary instruments to smooth liquidity flows have so far been ineffective. Recently, it changed its approach to maintaining retail interest rates between 3 and 7 percent. As long as NRB uses selling and buying of treasury bills and bonds as its main instrument to manage liquidity and monetary policy, retail interest rates will continue remain volatile. It’s a management problem as well as being a demand-supply problem. NRB needs to be more creative in liquidity management, and monitoring and evaluation of BFIs.

Lastly, in its monetary policy for FY2018 the central bank is aimlessly throwing arrows in all directions to achieve economic growth and inflation targets of 7.2 percent and 7 percent, respectively. NRB is yet to explain how it is going to achieve a higher growth rate than in FY2017, which itself was largely a ‘base effect’ blessing, by virtually keeping unchanged money supply growth and policy rates. Liquidity will likely be tight soon owing to the continuing deceleration of remittance income and the slow as well as uneven pattern of government spending

Meanwhile, a bloated budget dependent on large deficit financing is going to put upward pressure on interest rates. This is going to increase borrowing costs for businesses and individuals and eventually slow down economic activities, especially if the government is unable to spend the money it collects from taxes and borrowing. Given past experience, the FY2018 budget will likely be under spent. 

Orderly house

NRB needs to keep its house in order so as to be an effective regulator of the financial sector, a catalyst for enhanced financial inclusion, and a vibrant knowledge hub. Specifically, it needs to set an example by not tinkering its employment regulations to benefit old employees. Instead, it should allow young talent to take up challenging roles, thus fostering creativity, policy innovation and better service delivery.

It should also desist from rolling out ad hoc policy measures to reward moral hazard behaviour in the financial sector. A stop-gap, ad hoc policy as well as management style undermines its credibility and trust.