Battle heats up over central bank's independence

Dr Virabongsa Ramangkura is trying to shake up the Bank of Thailand, which he chairs.

Virabongsa has sent a signal that the central bank should scrap its inflation targeting policy. Targeting inflation, he argues, is outdated as an anchor of macro-economic management because of changes in the global economic environment, which is facing deflation and demand shocks. He prefers the central bank to promote growth and help create employment. Virabongsa likes to upset people. If he does not upset people, he is not doing his job.

Dr Prasarn Trairatvorakul, the governor, is holding his guard high. He is facing a series of policy challenges from Kittiratt Na Ranong, the deputy prime minister and finance minister, and Virabongsa. The government has sent Virabongsa to rock the boat. It remains to be seen for how long Prasarn will be able to hold on amid the political onslaught.

The inflation targeting framework, put in place after the 1997 financial crisis, is coming under attack. Before the crisis, the BOT relied on the fixed exchange rate system as an anchor of macro-economic stability. The baht, fixed at around Bt25 to the dollar, helped curb inflation and price volatility. But this fixed rate system did not hold in the face of capital account liberalisation. Capital that flowed in freely in the early 1990s created misallocation of resources and set the stage for an economic bubble. The bubble popped in 1996, followed by the baht attack in November that year. Capital outflow ensued, putting tremendous pressure on the fixed exchange rate system.

The central bank defended the integrity of the baht peg until it lost almost all foreign reserves. Eventually, by July 1997, it was forced to float the baht outright and sought a bailout from the International Monetary Fund.

It was MR Chatu Mongkol Sonakul, who settled into the central bank in 1998 and introduced inflation targeting. By doing so, the central bank let go of its control on the exchange rate, which would move freely according to market forces, and would concentrate on monetary policy management to ensure price stability. Another function of the central bank is to supervise the financial institutions.

In short, the central bank's mandate is to manage price stability and promote growth and stability. The mandate of the US Federal Reserve is similar. It aims to achieve price stability and ensure full employment.

Virabongsa's attack represents anti-thesis against the inflation targeting framework, with growth targeting as a hidden agenda. The government prefers high growth, as Thailand prepares to assume its role as a hub of the Asean Economic Community, through massive infrastructure investments.

With the euro crisis, minus growth in the euro zone, sluggish growth and high unemployment in the US, the global economic environment is turbulent. Many countries are putting up their guard through fiscal expansionary programmes to prevent a sudden drop in growth and employment. The Yingluck government, similar to the Democrat government, adopts a pro-growth policy. The fiscal programme is on a roll with deficit spending of Bt400 billion in 2012. On top of this are populist programmes that rely on off-budget spending. Businesses and the corporate sector love this loose fiscal policy because private investment has been sluggish - a long-standing problem since the 1997 crisis.

With this pro-growth agenda in mind, it comes as no surprise that the central bank finds itself in the hot seat. Traditionally, the Thai central bank has been a conservative institution. Between growth and stability, it is more inclined to go for stability by raising the interest rates whenever it sees signs of upward price pressure.

The Finance Ministry or government largely prefers an easing stance by the central bank to support economic growth.

But the conflict between the chairman of the BOT and the governor is building to a point of no return. So far the political side has attempted a series of measures to undermine the central bank. It also puts out signals that are in conflict with the policy practices of the central bank.

First, the government went to Parliament to force the central bank to assume the Bt2.2 trillion debt of the Financial Institution Development Fund. This to free up room for the Finance Ministry to create more debt.

Second, it issued legislation to force the central bank to participate in a Bt300 billion lending programme to help small businesses affected by the floods in 2011.

Third, the government wants to set up a sovereign wealth fund by using foreign reserves, US$10 billion for a start, from the central bank.

Fourth, it is tempted to use the central bank's reserves outright to invest in infrastructure projects, arguing that reserves of more than $170 billion are unnecessarily high.

Fifth, the government wants the central bank to push the baht lower to prop up exports. A weak baht is the mantra.

Sixth, it wants the central bank to cut the interest rate by at least 50 basis point or one full percentage point to promote growth.

This series of measures and arguments have put the central bank in a very difficult position because it is going by the textbook of macro-economic stability management. Both Kittiratt and Virabongsa have come out alternately to put pressure on the central bank to adopt a U-turn on its policy. Prasarn can only backpedal. He wrote an article in a BOT in-house journal, complaining about political intervention and lamenting the threat to the grand tradition of institutional independence as laid down by Dr Puey Unphakorn, the founder of the Bank of Thailand.

The battle continues. The pressure on the central bank to adopt a U-turn will not subside. The pro-growth camp appears to be winning over the pro-stability camp as the damage from global deflation hits Thai shores.