How lack of central bank independence contributed to economic crisis in South Sudan
By Garang Atem Ayiik (Gatem), Nairobi, Kenya
January 18, 2017 (SSB) — This week, H.E President Salva Kiir issued a decree relieving top officials in central bank of South Sudan and appointing a new governor and his deputy. As expected, the President is concerned about hyper-inflation that is causing misery to citizens.
Author of this article believe that strong institutions, manned by strong people, play complementary role in meeting an institutional goals.
Without significant changes to central bank’s operation; so long as a central bank remain as an ATM of executive, so long technical staffs’ capacities are not enhanced, recent changes in central bank can be analogized to “changing monkeys on trees, but leaving the forest intact.”
On central bank governance, economists agreed that a good central bank is built on three pillars – independence, accountability and transparency. Any form of governance adopted by a central bank, has an impact on achieving its main objective of macroeconomic stability.
This is a first article on two series of articles on central bank’s independence. This article looks at role of lack of central bank independence in current economic crisis in South Sudan. Part 2 will look at justifications and evidences for central bank’s independence.
So why do economists think a good central bank should be independent? First, independence insulates central bank from political interferences that might force central bank to pursue a short term political interest that might clash with long term macroeconomic stability.
On 11 November 2013, central bank proposed a devaluation/liberalization of exchange rate policy. Fixed exchange rate had four flaws. First, it led to growth of shallow banks that offered no conventional banking products, but preyed on foreign currency;
Second, allocating dollars to banks and bureaus created inequality and distributive injustices; third, allocation of dollars on non-market model institutionalized rent-seeking; and fourthly, fixed exchange rate passed an obligation to central bank to maintain un-sustainable fixed exchange rate.
On 14 November 2013, author of this article was one of the guest on Wake-Up Juba who was invited to discuss devaluation of the exchange rate policy. At that time, the author supported devaluation with some caveats.
On 15 November 2013, parliament colluded with executive to rescind the liberalization of exchange rate on 15 November 2013 without a due diligence to its sustainability or consideration of other alternative policies. Policy timing matter a lot.
November 2013 devaluation was rescinded because the executive and parliament colluded to pursue a short-term interest of stable short-term exchange rate but ignored long-term impact. As a result, central bank used-up all reserves to defend a fixed exchange rate consequently, central bank was forced to devalue in December 2015.
The price for refusing devaluation in November 2013 at 4.5 SSP was to devalued pound in December 2014 at 18 SSP per a dollar. By December 2014, the central bank ran out of reserves to play a meaningful role in influencing the exchange rate causing current hyper-inflation.
Government now sell its dollars to the highest bidder to remain afloat. If government is not surviving from devaluation, why has devaluation policy not been reversed as was the case in November 2013?
As short-term existence of the government is threaten, devaluation now helps government net-in more pounds to continue in operation. But macroeconomic instability has exposed citizens and businesses to hyper-inflation and loss of assets’ values.
The second argument in support of an independent central bank is to protect central bank from a fiscal policy dominance that might steer away central bank from its main objective of macroeconomic stability.
In 2014, the President created 28 states in December 2015 and later increased to 32 states in January 2017. In 2016/2017 budget, only about 3% of the budget was allocated to the states which was a significant reduction from previous years’ budget.
2015/2016 and 2016/2017 budgets were largely financed through deficit financing. This impacted seriously on inflation that is now in hyperinflation. Deficit financing increases money supply in the economy which accelerated inflation.
An independent central bank can’t finance a political decision that impact negatively on its objective of macroeconomic stability. Non-independent central bank can be used to pursue a short term objectives that meet short-term need of elected executives. This objective might clash with national macroeconomics stability objective of a central bank.
In some countries, though a central bank is a lender of the last resort, it is limited by law – say only 15% of previous audited government’s income can be financed through deficit financing. In South Sudan, a central bank has been used to achieve fiscal policy objective, ignoring monetary role and hence the current hyper-inflation.
Third, Joseph Stigler pointed out, when institutions are not properly regulated, they can be easily captured by interest groups to pursue a predatory interest.
As custodian to public finance, if banks’ reserves are not protected, they can be easily use to meet fiscal policy objective at expense of monetary policy. Current shortage of dollars and pounds when demanded by banks point to this issue.
An independent central bank work well where separation of powers between arms of government work; citizens are well informed; parliament provided an oversight to central bank and executives; and citizens provide oversight to parliament through elections.
Though fixed exchange rate was not sustainable, the central bank accepted the risk of maintaining a fixed exchange rate. It can be argued that the central bank was captured by interest groups to pursue a predatory interest was more justifiable.
In days leading to first multi-party election in Kenya in 1990s, it was alleged that President Moi used central bank to finance his campaigns. As a result, economy stagnate, inflation surged, state’s brutality and corruption rose, and many banks collapsed.
There are many similarities between current South Sudan’s economic situation and Kenya case in 1990s as documented in autobiography of Micah Cheserem, former governor of central bank of Kenya.
In sorting out mess in Kenya’s financial sector, President Moi agreed to a comprehensive review of central bank’s operation including granting it full independence.
President Moi’s Kiswahili phrase of “siasa mbaya, maisha mbaya” loosely translated to “bad politics, bad life” could be from lessons he learnt from 1990s bad economic management. South Sudan should learn lessons from current economic crisis and initiate genuine reforms.
The author, Garang Atem Ayiik, is a PhD student of Economics at the University of Nairobi in Kenya. He is an independent economic commentator on South Sudan’s economic policy. He can be reached at garangatemayiik@gmail.com
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