Is the Bank of Thailand Overly Independent?

Thailand’s slow rate of economic growth is a major concern. Real GDP growth in 2023 was 1.9 per cent, the lowest in ASEAN, except for Brunei and Singapore (Figure 1). The country’s economic planning agency, the National Economic and Social Development Council, recently downgraded its projection of growth for 2024 to between 2.0 per cent and 3.0 per cent, down from the previous projection of 2.2 per cent to 3.2 per cent. Some commentators think even that is overly optimistic.

Southeast Asian GDP growth rates

Figure 1: Real rates, in per cent

The government led by the Pheu Thai Party (PT) is urgently searching for ways to stimulate growth. Its focus is heavily on demand-side factors rather than productivity. Monetary policy seemingly offers one such opportunity to stimulate demand. The government would like the central bank, the Bank of Thailand (BoT), to lower its interest rate. The central bank has so far declined, pointing out that its legal mandate is to control inflation.

In a speech in early May, Ms Paetongtarn Shinawatra, leader of PT, claimed that the BoT’s independence is an obstacle to good economic policy: “If the BoT doesn’t understand and cooperate with the government [in its efforts to tackle economic problems], we can’t win.” The speech acknowledged the legal independence of the BoT. The central bank was established in 1942 and its independence is protected by law, but not by the constitution. Of course, laws can be changed and the government always has the power to replace the BoT Governor. The current Governor, Mr Sethaput Suthiwartnarueput, was appointed by the previous military government and his term has only one year to run.

A potential difference of perspective between politicians and central banks, as illustrated by Ms Paetongtarn’s remarks, is precisely the reason for laws supporting the independence of central banks around the world.

Perhaps unfairly, critics attacked Ms Paetongtarn’s economic competence, characterising the speech as merely parroting the views of her father, former Prime Minister Thaksin Shinawatra. Mr Thaksin, currently on parole, is a well-known critic of BoT independence. The Prime Minister, Mr Srettha Thavisin, subsequently met with the Governor of the BoT. He then announced that there was no intention to replace him or to change the law. The Finance Minister later did the same. The implied threat to the BoT’s independence was obvious.

Frustration with central bank independence is common among populist governments. During his four years in office, President Donald Trump regularly berated the US Federal Reserve for allegedly keeping US interest rates too high. A potential difference of perspective between politicians and central banks, as illustrated by Ms Paetongtarn’s remarks, is precisely the reason for laws supporting the independence of central banks around the world.

The theory behind these laws is that governments, democratically elected or not, tend to have a shorter time horizon in their thinking than is required for maintaining price stability. Central banks are considered capable of making credible commitments that can shape market expectations of future rates of inflation. Virtually all high-income countries today have laws intended to shield central banks from short-term political pressures inconsistent with long-term price stability. But central banks are never completely independent of governments, and probably should not be. Governments are (sometimes) elected. Central banks are not. Their “independence” may be legally enshrined, but it is always conditional.

A well-known World Bank study from the 1990s found that among developing countries, there was a positive association between the rate of inflation and one objective measure of central bank independence — the rate of turnover of central bank governors. Seemingly, the greater the rate of replacement of central bank governors, the greater the resulting rate of inflation.

There is a potential problem of causality underlying that conclusion. If central bank governors fail in their duty to control inflation, they are presumably more likely to be replaced. So, it is not fully clear what is causing what. Does the correlation between rapid turnover of governors and higher inflation arise because high governor turnover indicates the erosion of central bank independence, leading to higher inflation, or does it arise because high inflation reveals that governors are not doing their job and are therefore replaced? Correlation does not necessarily mean causation.

Central Bank Independence

Figure 2: World Bank Index of ASEAN countries, 2017

Based on these and other empirical findings, the World Bank maintains an ongoing index of central bank independence. The higher the index for a particular country, the greater the estimated degree of independence. Other indices of central bank independence have also been proposed. The latest World Bank data are for 2017. Figure 2 shows these data for the 10 ASEAN countries. Among these countries, Thailand is the second lowest after Vietnam. These data do not suggest that the BoT is overly independent, but rather, quite the opposite.

Still, there is another side to this argument. The capacity of central banks to make commitments can itself become a problem if these commitments are not believed. A blemish on the BoT’s otherwise distinguished record was its mismanagement of the country’s exchange rate in mid-1997. For decades the BoT had regarded a fixed exchange rate as central to achieving domestic price stability. In early 1997, financial markets expected a devaluation of the baht despite the BoT’s assurances of no change in the exchange rate. The BoT maintained its fixed exchange rate for far too long in the face of what became a massive capital outflow, leading to the loss of the Bank’s foreign exchange reserves.

When the baht was finally floated, the market-driven depreciation was massive, causing a severe recession and bringing economic hardship to many Thai people. The loss of confidence spread to other Asian countries with similar fixed exchange policies, a disaster now known as the 1997-99 Asian Financial Crisis. It is debatable whether less central bank independence would have been better in this case, but it seems possible. Like everyone else, central bankers can make big mistakes.

2024/178