In two weeks' time, Parliament will be voting on an amendment bill proposing changes in the management composition and structure of the Reserve Bank.

In a nutshell, the South African Reserve Bank Amendment Bill closes any loopholes that may allow shareholders to possess more than the maximum limit of 10000 shares per shareholder. This is linked to the general management of the bank, as shareholders currently elect seven of the 14 directors, and voting rights are proportional to the number of shares held.

It also proposes to allow for the nominations of directors from a "broader base of society" by extending the number of directors to 15, in which shareholders, who currently elect seven directors, would now nominate seven and they would be subject to confirmation by a panel.

The amendment bill is creating a potentially politically charged situation in which the other seven directors would be presidential appointments, who do not have to be confirmed by the panel.

The panel doesn't yet exist.

It is part of the proposed amendment and is envisaged to consist of the governor, a retired judge, an individual nominated by the finance minister and three people nominated by the National Economic Development and Labour Council.

The panel, convened by the governor himself, is meant to review nominations of directors from shareholders, and the bill lays out some criteria that must be met by the nominees.

Central banks have been around for a while. Sweden is widely recognised to have established the first central bank, the Swedish Riksbank, in 1668. Quickly following in 1694 was the Bank of England.

Both were established as private entities, independent from government.

There was a wave of nationalisation, but most central banks have regained their independence in the past 30 years, limited mainly by the fact that they must report to their corresponding legislative entities. For example, the US Federal Reserve, which is the central bank of the US, must report to Congress.

A central bank uses a variety of tools to regulate the amount of money in circulation, and the level and structure of prices.

South Africans should follow this institution closely, as we are all affected by a series of decisions that maintain the purchasing power of our money and keep our standards of living from falling.

Monetary policy is the explanation behind the interest earned in our savings accounts. It is the basis upon which we are able to export our wine at certain prices. It is the force behind the prices of bread and milk.

Historically, there have been two main issues surrounding central bank operations.

One has to do with its degree of independence. An institution that regulates monetary policy should be aligned to the desired issues arising in the real economy, such as sector development, service delivery and employment.

Having said that, a central bank that is too closely aligned to the executive branch may become susceptible to political machinations and may implement policy that is in the best interests of the ruling party, as opposed to those of the country.

Generally, this issue has been settled in the court of public opinion, and there is no shortage of studies that reveal that the more independent a central bank, the less inflation an economy experiences.

That the South African Reserve Bank should operate independently and without influence from the executive branch is guaranteed by the constitution.

According to section 224 of the constitution, the bank, in pursuit of its primary objective, must perform its functions independently, and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters.

It can pursue policies on behalf of the country without regard to political party platforms, campaign promises and the like.

The second issue surrounding central bank operations, is one that the private sector has long dealt with, which is known as the principal-agent problem.
The owner always faces the challenge of ensuring that his goals and those of his managers are in alignment.

Democracy is itself a principal-agent problem as citizens (the principals) do not have complete control, nor at the very least, full information regarding the agents (elected representatives) that we have elected.

Why do we not have full control over public authorities?

First, they are in the business of public administration. That is to say, this is their work while we struggle with things such as our livelihoods, our children, etc.

Second, there is what is called asymmetric information, where one party has more information than the other. This is particularly crucial in matters that are fairly technical, such as monetary policy.

In the area of central banking, let's face it, they know more than we do about inflation, targets, exchange rates, etc. The skills and expertise of the agents play a crucial role in the outcome of the contracted task, and SA's monetary policy depends on the governor, deputy governors and directors.

However, operational independence is different from goal independence. The Bank's board cannot be allowed to take a direction outside of the country's national planning framework or that is not in the best interests of the people.

This is where accountability comes in. How do we ensure that the agents (directors) always act in our best interests?

Since there is no direct accountability mechanism between citizens and the Bank's governor and directors, the citizens of SA ensure the satisfactory performance of the governors and his staff through Parliament.

Parliament, our true voice in the central bank, bears the ultimate responsibility of monitoring the Bank's board.

Presidential appointments are essentially political appointments, and the panel simply puts too much distance between South African citizens and the country's highest monetary authority.

All nominations to the board, including the governor, should be vetted and ratified by Parliament, regardless of whether they come from the president or from shareholders.

Regarding the proposed amendment, parliamentarians should be asking themselves three questions with regard to whether the revisions in legislation enhance or undermine the accountability of the Bank: do the changes proposed undermine the national goals concerning monetary policy? Who bears final responsibility for the outcomes and what recourse do South Africans have if the outcomes are undesirable? How can Parliament better engage on monetary policy issue and how can we amend the bill to incorporate this?

So how democratic can a central bank be? The answer is: very.

Written by: Nancy Dubosse, head of research at Idasa's Economic Governance Programme

This article was first published in the Business Day, Thursday, 13th May 2010