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New law fixes central bank's independence

FINANCE Minister Tarrin Nimmanahaeminda looks upon himself as an architect of the modern Thai financial system. When he took over the finance portfolio in November 1997, at the height of the Thai crisis, he set his aim at stabilising macroeconomic conditions, reforming the financial sector and putting the economy back on a growth path.

One of Tarrin's top missions in financial-sector reform was to restore confidence in the Bank of Thailand. Apart from modernising the financial institution law, he also set his sights at overhauling the central bank by instituting organisational and legislative changes.

The central bank was in a big mess then. Its organisation was, and still is, modelled after a pyramid structure, on top of which sits the governor. The governor calls all the shots within this sacred temple. Most of its officials have had little experience in the financial markets. The central bank's Court of Directors is simply a decorative gallery.

In the face of the economic crisis, the beleaguered central bank became a punching bag. From its left pocket, it had been madly giving out money to insolvent banks and finance companies to prevent their collapse because it was obliged to provide a wholesale guarantee to public deposits. The Financial Institution Development Fund, the lender of last resort, has now ended up with Bt1.3 trillion in debt. The FIDF is chaired by the central bank governor and operated mostly by senior central bank officials.

From its right pocket, the central bank had already lost all of its US$30 billion in foreign exchange reserves. Most of these heavy casualties took place in the first half of 1997 when the baht came under a fierce assault from hedge funds and foreign currency speculators. Moreover, the local banks and corporations, which had been saddled by US$70 billion in foreign currency debts, were buying dollars crazily to reduce their foreign debt exposure.

With dwindling foreign exchange reserves, the central bank bought time by borrowing dollars from financial markets through foreign exchange swap agreements. Yet this could not continue forever. By July 2, 1997, the central bank caved in to pressure to alter the foreign exchange rate system by floating the baht. All hell broke loose. A month later, the bank sought a US$17.2 billion bailout from the International Monetary Fund.

Who was to blame for the Thai crisis? Naturally, there were attempts to find scapegoats. The central bank officials would be quick to say that the crisis took place because of the inconsistent economic policies or wrong signals of past governments, which came and went quickly. The Chuan government would retort that the crisis had one of its roots in the failure of the central bank to prudently supervise the financial system and from its mismanagement of the foreign exchange regime.

The mother of all mistakes was the central bank's loss of all of its foreign exchange reserves. When Thailand turned to the IMF for help, it was looked upon as an insolvent country.

To be fair, the central bank should take half of the blame. Only Rerngchai Marakanond, the former central bank governor, has had the courage to apologise to the Thai public over the mistakes committed during his tenure. Most of his central bank colleagues have never admitted their faults. Well, it's time for this culture to change.

Last week the Cabinet endorsed a draft amendment of the Bank of Thailand Act, which would substantially reform the institution for the better. There has been a sharp conflict between Tarrin and MR Chatu Mongol Sonakul, the central bank governor, over the wording of the legislative draft, although both are in favour of an independent central bank. But Tarrin appears to have lost a PR war. Ironically, since he was viewed as a politician who was trying to steal independence away from the central bank, he was responsible for most of the legislative amendments to change the face of the bank.

Chatu Mongol fought hard to achieve independence as guaranteed by the written law to the central bank. For instance, Tarrin would have liked the draft to suggest that the central bank should "support" the policy of the government, as is written in British law. Chatu Mongol insisted on changing the wording from "support" to "take into consideration" the policy of the government. And the governor got what he wanted.

Under the legislative reform, the central bank will narrow its scope to maintaining price stability, through inflation targeting, and to guarding the financial system. The Court of Directors will be empowered as a check-and-balance to the governor. Although the Cabinet will appoint the governor, the Court of Directors will set the governor's salary. The Court of Directors will also nominate the deputy governors. The governor will serve a five-year term, which can be extended only once.

The new law will make it more difficult for the finance minister or the Cabinet to remove the governor. It clearly states that the governor cannot be removed from his office if, in his oversight of price stability and the financial system, he uses his honest judgement (even though his performance might fail to live up to some expectations). The governor can only be removed if he is totally inefficient or simply a crook.

But the governor is not running his office from an ivory tower. He will have to report to the Cabinet and Parliament. The Finance Ministry cannot simply ask for money from the central bank if it wants to balance its check book. In case it needs to go for budget deficit spending, the Finance Ministry has to borrow the money from financial markets. Only in time of emergency is the Finance Ministry allowed to borrow money from the central bank. Still, to maintain monetary discipline, the money has to be returned to the central bank within a one-year period.

Another important reform item in the draft amendment is that the Finance Ministry will hand over the supervision of the financial system to the central bank, which will have the power to issue bank licences, set new supervision rules, and impose penalties on financial institutions.

These reform measures - which will significantly enhance the independence of the central bank - have not been given their due attention, for the focus now is on consolidation of the accounting books of the central bank's Note Issue Department and Banking Department. This change is part of the legislative reform. Tarrin would like to use some surplus gained from the account consolidation to reduce the burden of the FIDF. He has not said how much money he wants. But Chatu Mongol does not want to give the money to the FIDF for fear of creating a bad precedent. He does not hold that the FIDF is the central bank's left pocket.

This conflict has unfortunately marred the legislative drive to shake up the central bank. There is not a word of apology for past mistakes. Nor is there a word of appreciation for reform efforts. Central bank officials have forgotten that independence or trust is what they have to earn from the public - not from the written law.




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