L Wilson Kamit: Central bank independence - the first seven years
Paper presented by Mr L Wilson Kamit, CBE, Governor of the Bank of Papua New Guinea,
at the 2008 Waigani Seminar, University of Papua New Guinea, Port Moresby, 14 August
2008.
* * *
Distinguished guests, ladies and gentlemen, may I firstly thank the Organising Committee for
the invitation to participate in the 2008 Waigani Seminar.
I propose to discuss our experiences on governance issues at the Bank of Papua New
Guinea during the last seven years. The book "Money and Banking in Papua New Guinea"
(BPNG, 2nd edition 2007) provides detailed discussion on the country's development
policies, the Central Bank, macroeconomic management and how the economy performed
from 1973 to 2005.
My talk is divided into three parts:
1. Background
2. Central bank reforms
3. Our experiences
1. Background
Following the attainment of nationhood in 1975, PNG went through a phase of low but steady
economic growth until 1989. The 1990s, often referred to as the "lost decade" was
characterized by serious management challenges by successive Governments. The closure
of the Bougainville copper mine in 1989, excessive government spending over and above the
appropriated amounts and a run down on the foreign exchange reserves led to the balance
of payments crisis and the abandonment of the Hard Kina Strategy in 1994. Again, gross
fiscal mismanagement and a break-down in good governance combined with the El Niño
drought of 1997/98, the Sandline crisis, and the Asian Financial Crisis led to the country
facing near-financial collapse at the end of the 1990's.
The financial system came under stress during this time. Government financing through
borrowings from the central bank reached its height. A good portion of the increased
government spending was for imports, which led to a high usage of the already low
international reserve levels. These had the effect of: limiting the effectiveness of the central
bank's operations; increased money supply; very high level of liquidity and increased interest
rates; depreciation of the kina; and high inflation.
Political influence through frequent changes to the Bank's Governors disrupted monetary
policy management. Between 1997 and 1999, we had four Governors, one stayed for only
four months.
There was a break-down in governance, serious mismanagement, fraud and outright theft
that contributed to the stress within the financial system. The Government-owned
commercial bank, controlling fifty percent of the banking business, was mismanaged and on
the verge of insolvency. Pyramid (Ponzi or fast-money) schemes were flourishing, supported
by people in authority, and a large superannuation fund was close to bankruptcy as a result
of corrupt practices by the trustees and management. In all the large superannuation funds,
total ignorance and incompetence of management, board and ministerial control on the
decision making process, resulted in serious failures. There was lack of confidence in the
financial system and the economic management of the country, which also contributed to the
depreciation of the kina.
Given all these developments, it was apparent that major reforms were needed to enable the
central bank to rectify the problems within the financial system and instil confidence in the
economy. Reforms to the financial sector were part of an overall structural reform
programme introduced by the Government that included strengthening public expenditure
control, enhancing the effectiveness and transparency of development spending, initiating
privatisation of and instilling operational discipline in large state enterprises and carrying out
comprehensive civil service reforms.
The legislations governing the Central Bank's operations and activities were considerably out
of date by the end of the 1990's. The Government therefore decided to revamp the whole
financial sector by introducing four new major pieces of legislation. These are the:
1. Central Banking Act;
2. Banks and Financial Institutions Act;
3. Superannuation Act; and
4. Life Insurance Act.
The Bank of PNG still administers the Savings and Loan Societies Act 1995 and is in the
final stages of replacing it with a modernised legislative framework for this segment of the
financial system.
My presentation will concentrate on the Central Banking Act as this relates to "central bank
independence" and governance issues relating to the financial system under the Bank's
regulatory responsibility.
The Bank of PNG currently has regulatory oversight over 58 licensed financial institutions.
There are 4 commercial banks, 9 finance companies, 2 micro-finance institutions and 21
savings & loan societies. There are 14 institutions in the superannuation industry, comprising
7 trustees/authorised superannuation funds, 2 investment managers and 5 fund
administrators. Of the 8 in the life insurance industry, 5 are life insurance companies and 3
are brokers. The table and chart below indicates the growth in asset size of the licensed
financial institutions since the reforms began in 2000.
Financial System - Assets
16000
Banks & Finance Companies
Savings and loans Societies
Life Insurance Companies
14000
Superannuation Funds
Total
12000
10000
8000
K'mn
6000
4000
2000
0
2. Central bank reforms
Central to the financial sector reforms were structural reforms at the Bank of PNG, which
were considered necessary to achieving stability of the economy in the medium term. Giving
the Central Bank more independence and power in the conduct of monetary policy and
strengthening financial sector supervision was in line with worldwide trends. The consensus
in the 1990s was that central banks contribute positively to economic stability and maintain
credibility if they have a sufficient degree of autonomy and are independent of political
interference.
When designing our new Central Banking Act, we had the opportunity to access assistance
from the International Monetary Fund (IMF) and the World Bank We also looked at the
British, Australian, New Zealand, Israel, Hong Kong and Singapore experiences.
Whilst we consulted widely, the new legislation was our own product, using the world's best
practises but tailored to PNG's conditions. It is not a mirror image of other legislations and is
at the forefront of financial sector legislation.
The Central Banking Act 2000 was enacted by Parliament in April 2000. It had the following
features that give greater central bank independence.
1) A clear and focused set of objectives - monetary policy objective of achieving and
maintaining price stability which is used by the central banks of all Organization of
Economic Co-operation and Development (OECD) countries as the main objective if
not the only one.
2) Independent from Government involvement and implementation of central bank's
policy and operational functions - the Governor is solely responsible and
accountable for monetary policy. The Governor also has sole responsibility for
licensing and supervising the financial system, exchange rate management, and
exchange control regulations.
3) An independent Governor - The Governor is appointed by the Head of State
(Governor General), acting on advice, for a term of between 5 and 7 years, beyond
the electoral cycle, and is limited to 2 consecutive terms (not more than 14 years)
The removal of a Governor is on the recommendation of the Bank Board.
4) Government financing from the central bank is limited to an overdraft of K112 million
for bridging finance purposes only (for short-term cashflow mismatches) and is
repayable within 6 months. Access to the facility is at the discretion of the Governor.
5) Independent Board - comprising the Governor who is also the Chairman, the two
Deputy Governors and a wide community representation with five ex-officio
members (presidents of the PNG Council of Churches, Chamber of Commerce,
PNG Trade Union Congress and Institute of Accountants, and Chairman of the
Securities Commission). The Minister can appoint 3 members (non ex-officio) to the
Board.
As with the Central Banking Act, the new Banks and Financial Institutions Act (BFIA) was
enacted in 2000 which broadened and improved the regulation, supervision and control of
the banks and finance companies, introducing international best practises. The Bank also
assumed regulatory oversight of the life insurance and superannuation industries. With the
exception of the general insurance industry, the National Development Bank, the Port
Moresby Stock Exchange and a Unit Trust, the Bank of PNG is now basically overseeing the
whole financial system.
3. Our experiences
Granting greater independence to central banks is now seen as important to ensuring sound
monetary policy management and implementation. Our experiences show that legislation
changes were crucial to guaranteeing central bank independence. This however had to be
undertaken within the context of an overall reform package for the whole finance industry.
Piece-meal legislative changes, on their own, are not effective. There has to be political will
to ensure these changes take place. The Central Bank independence was reaffirmed in a
public announcement by the Treasurer in November 2007. This was done to dispel
comments that the independence of the central bank should be curtailed or diluted.
Formulation and conduct of monetary policy for price stability
In carrying out its responsibilities under increased independence, the Central Bank has to
perform and be more accountable and transparent to the Parliament and the public.
Before 2000, monetary policy was formulated for a year horizon and announced in the first
quarter of each year. The objective of monetary policy was broadly stated as that of providing
sufficient liquidity for the non-mineral private sector to grow at a sustainable rate. Monetary
policy was accommodative of fiscal operations of the Government and preoccupied with
financing fiscal deficits, especially in the 1990s. The formal process involved the Governor
presenting the monetary policy stance to the Bank Board for its approval. Then it is
forwarded to the Finance Minister for his endorsement. There can arise a conflict of interest
between fiscal and monetary policy, and issue governance and integrity of monetary policy.
From July 2000, under the Central Banking Act 2000, debt management and monetary policy
per se were clearly separated with a clear and specific objective for the latter - that of
achieving and maintaining price stability. The Bank can formulate monetary policy for any
term it decides. For transparency purposes it must report to the public on a six-monthly basis
a Monetary Policy Statement (MPS), which involves a review of the monetary policy stance
and if necessary a change in the stance is made. Under the Act the Governor has the
authority and mandate to decide on and implement the monetary policy stance without
having to go to the Board and the Treasury Minister for their approval as was the case
previously.
Price stability entails low inflation, low interest rates and stable exchange rate. Our own
research (Sampson, Nindim, Marambini and Yabom, 2005)1 shows there is a strong link
between exchange rate movements and inflation. Given this link, the Bank ensures that
volatility in the exchange rate is smoothened out through its intervention in the foreign
exchange market on either side of the market, while not trying to determine the long term
trend of kina exchange rate nor targeting a specific rate. Stability in the exchange rate,
together with other factors such as prudent fiscal management, can then lead to stability in
price and other macroeconomic conditions.
Complementing the MPS is the monthly announcement of the monetary policy stance
through the key short-term policy interest rate - the Kina Facility Rate (KFR), introduced in
February 2001.
For effective management of monetary policy the Bank has introduced new instruments such
as Central Bank Bills and Repurchase Agreements, and put in place new prudential
requirements and standards for supervision of the financial system. Operational
arrangements have been implemented for a transparent and market-related relationship with
the Government, including an Agency Agreement for our role as banker to the Government
and agent for trade in government securities and the registry function.
The legislative reforms in 2000, prudent management of fiscal and monetary policies in the
2000s, increased foreign exchange reserves and the stability in exchange rate - driven
largely by the high international commodity prices, have enabled the Central Bank to achieve
and maintain price stability (low inflation)2 in the 2003 to 2007 period. These are shown in
the following charts foreign exchange reserves, interest rates, exchange rates and inflation
rates.
International Reserves
3000
2500
2000
n
$'m
1500
US
1000
500
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008*
*As at 12 August
Interest Rates
25
Interest rate on deposits
Interest rate on loans
20
KFR
28 days T'bill / CBBs
15
%
10
5
0
00 01 02 03 04 05 06 07 08
'99 '99 '99 ' '00 '00 '00 ' '01 '01 '01 ' '02 '02 '02 ' '03 '03 '03 ' '04 '04 '04 ' '05 '05 '05 ' '06 '06 '06 ' '07 '07 '07 ' '08
2
Jul Jul Jul Jul Jul Jul Jul Jul Jul
Apr Oct Jan Apr Oct Jan Apr Oct Jan Apr Oct Jan Apr Oct Jan Apr Oct Jan Apr Oct Jan Apr Oct Jan Apr Oct Jan Apr
P ri c e s ta b ili t y (low i n flation) does not mean n o in crea se in do mestic pric es as is the common pe rc e p ti on.
There are increases but at a low rate for a continued Mo perio nth d of time.
Exchange Rates
0.7 0.7 130.0 130.0
120.0 120.0
0.6 0.6
110.0 110.0
100.0 100.0
0.5 0.5
90.0 90.0
80.0 80.0
AUD AUD
0.4 0.4
& &
70.0 70.0
TWI TWI
& &
USD USD
60.0 60.0
0.3 0.3
50.0 50.0
REER REER
40.0 40.0
0.2 0.2
30.0 30.0
20.0 20.0
0.1 0.1
10.0 10.0
0.0 0.0 0.0 0.0
Jun-00 Jun-00 Jun-01 Jun-01 Jun-02 Jun-02 Jun-03 Jun-03 Jun-04 Jun-04 Jun-05 Jun-05 Jun-06 Jun-06 Jun-07 Jun-07 Jun-08 Jun-08
Dec-99 Dec-99 Mar-00 Mar-00 Sep-00 Sep-00 Dec-00 Dec-00 Mar-01 Mar-01 Sep-01 Sep-01 Dec-01 Dec-01 Mar-02 Mar-02 Sep-02 Sep-02 Dec-02 Dec-02 Mar-03 Mar-03 Sep-03 Sep-03 Dec-03 Dec-03 Mar-04 Mar-04 Sep-04 Sep-04 Dec-04 Dec-04 Mar-05 Mar-05 Sep-05 Sep-05 Dec-05 Dec-05 Mar-06 Mar-06 Sep-06 Sep-06 Dec-06 Dec-06 Mar-07 Mar-07 Sep-07 Sep-07 Dec-07 Dec-07 Mar-08 Mar-08
USD USD AUD AUD TWI TWI REER REER
Source: Source: Bank Bank of of PNG PNG
Inflation
25
Headline CPI Exclusion-based underlying CPI
20
15
%
10
5
0
-5
04 05 06 06 07
'99 '99 '00 '00 '01 '01 '02 '02 '03 '03 '04 '05 '07 '08
M S M S M S M S M S M S' S' M' S' M S' M
M
Qtr
BIS Review 99/2008
Supervision
With respect to supervision, our independence allowed us to clean up the financial sector. In
2000, we replaced the board and management of the troubled Government-owned PNG
Banking Corporation. It was revamped and successfully sold off under the Government's
privatisation programme in 2002. The commercial banks were able to perform well following
the reforms. The chart below shows the decline in non performing loans (NPLs) since 1999.
Non Performing Loans
300
250
200
150
K'mn
100
50
0
1999 2000 2001 2002 2003 2004 2005 2006 2007
The clean up process included closing down 86 dormant savings and loan societies, placed
other financial institutions under management, with a view of enabling them to trade
themselves back into business, and liquidated a number of financial institutions that have
been mismanaged and were beyond rescue. The Superannuation Act also enabled the Bank
to effectively supervise the industry as reflected in the chart below, which shows a rapid
increase in the profitability of the superannuation industry.
Superannuation Funds - Profit After Tax
1200
1000
800
600
K'mn
400
200
0
1999 2000 2001 2002 2003 2004 2005 2006 2007
Transparency, public awareness, clear communication and close liaison between the Central
Bank and the Government, commercial banks, other financial institutions, the business
community and the general public is also an important element of good governance. Regular
consultations take place at the senior management and technical levels, explaining changes
to policy or operations with the other stakeholders (Government, commercial banks, etc). For
this, we must be objective in the advice we give and be professionally and technically
competent in the analytical work we do. The success of any changes introduced by the
Central Bank depended on the support and cooperation of others within the financial system
and the community.
For Papua New Guinea, we had to act at a time of crisis, which is not the most desirable
environment to implement such reforms. However, in my judgement, the outcomes were very
favourable and the results very positive.
The way ahead
There are several challenges we face at the Central Bank as we move into the new
millennium. These are:
•
Policy objective - maintaining price stability to assist economic activity.
•
Financial inclusion - how to get the un-banked portion of our population into the
formal financial system.
•
Financial Awareness and literacy - to educate the populace on financial matters and
awareness against fast-money scams.
•
Financial crime - improving ways of dealing with perpetrators of money schemes,
financial fraud and theft, proceeds of crime, etc.
•
Statistics - we continue to struggle to get reliable and timely data on other
nonbanking and financial sectors. Such information as the national accounts is
outdated as well as the inflation basket.