Although NRB Act 2002 has granted legal provision for autonomy, it has not made institutional arrangements for central bank accountability and transparency except for its requirement to issue an annual monetary policy statement

The monetary policy framework of Nepal needs to be changed. It is old-fashioned given the changing nature of the economy and the format that other countries have followed.

The genesis of its present framework dates back to the legislative reforms initiated in the financial sector in the early 2000s. The most important legislative reform was the NRB Act 2002, which not only granted the central bank independence but also ushered in the practice of issuing an annual monetary policy. The new Act heralded transformative changes in monetary policymaking in Nepal in the initial years of its introduction.

While the context of granting the central bank independence was to secure financial sector stability in Nepal, the core mandate has been placed on price and external sector stability. Ever since, the format of the monetary policy has been structured along the lines of discussing the stance, objectives, targets, instruments of monetary policy and measures for financial stability and inclusion. The positive aspect is that it has been educative for those interested in Nepal’s monetary policy. However, in the process, the monetary policy statement has turned out to be so voluminous that it has become challenging in implementing it fully. The Nepal Rastra Bank (NRB) has issued 17 monetary policy statements so far using this format and is on the verge of issuing its 18th.

One way of changing the framework is to review the current fixed exchange rate-based monetary policy strategy. This strategy does not provide much maneuvering power to NRB. Instead, it reduces the role of the monetary policy to defending the peg and importing inflation from India, the country with whose currency, the Nepali rupee is pegged. Reviewing the strategy is key to making the exchange rate an effective channel of monetary policy.

The second way is to adopt the short-term interest rate formally and decisively as an operating target of the monetary policy. Since August 31, 1989, interest rates have been liberalised. NRB does not control them directly. However, lately, Nepal Bankers Association is tacitly controlling the market interest rates with informal support

from the authorities. As long as this tacit agreement continues, open market operations and the interest rate corridor will not work. In this process, the interest rate as the channel of monetary policy becomes defunct.

The third way is to develop a strong fulcrum of central bank independence, accountability and transparency. It is said that central bank independence is meaningless in the absence of accountability and transparency. Accountability and transparency demand reasoning, and thus preventing the central bank authorities from being anarchists. Although NRB Act 2002 has granted legal provision for autonomy, it has not made institutional arrangements for central bank accountability and transparency except for its requirement to issue an annual monetary policy statement. We need to develop accountability metrics to hold the central bank accountable for its monetary policy actions.

Strengthening accountability requires the system of issuing explicit numerical targets for NRB to hold it accountable for its actions. If we look at India, the Reserve Bank of India has been successful in keeping inflation within its corridor of 2 to 6 per cent. It recently set the inflation target of 4 plus minus 2 per cent for a medium-term of five years. Likewise, the UK has adopted a system of the Chancellor of the Exchequer issuing an open remit letter to the Governor of the Bank of England, setting the inflation target and designing an institutional arrangement for achieving it.

The fourth way is setting up a monetary policy committee (MPC). Monetary policy, being a technical subject, requires designated technical authorities to avoid whims and fancies in its formulation. Instead of relying on a single authority, many countries, including India, have instituted an MPC. NRB Act 2002 has not envisioned an MPC, but a legislatively constituted MPC is needed to avoid policy errors of long-term consequences. Establishment of an MPC will pave the way for a better institutionalised decision-making process in Nepal. To use the words of Raghuram Rajan, the former governor of Reserve Bank of India, “With the MPC, which is truly revolutionary, we are abandoning the ways of the past that benefited the few at the expense of the many.”

The fifth way is by overhauling the monetary policy decision-making process. Nepal’s monetary policymaking process lacks transparency. Monetary policy decisions are consensual and not taken on the basis of voting. Under this system not only do some members become passive, but also their rationale behind their decisions is not given. Many countries, including India, have started pursuing majority (voting) based decision-making process. Votes and written statements for the rationale issued by members are released to the general public.

When the monetary policy follows this process, the central bank’s independence will be justified, accountability will be ensured and transparency will be enhanced. The length of the monetary policy will be shorter and content will be precise. Legislative reforms are needed in Nepal to change the old fashioned format into a modern one like those of other countries.

Thapa is former executive director, NRB