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Reforming the state bank of Vietnam towards an independent central bank: The application of new public management in Vietnam

Reforming the state bank of Vietnam towards an independent central bank: The application of new public management in Vietnam.In many open-richf inancially develop ed countries, the central bank (CB) p lays an imp ortant role in the develop ment of a sound and eff ective f inancial system in par- ticular, and economic develop ment and stabilization of the economy in general.



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Journal of Economics and Development Vol. 14, No.3, December 2012, pp. 99 - 112

ISSN 1859 0020

Reforming the State Bank ofVietnam towards an
Independent Central Bank:
theApplication of New Public Management inVietnam
Dang Ngoc Duc
National Economics University, Vietnam
Email: dangocduc@neu.edu.vn

Abstract
In many open-rich financially developed countries, the central bank (CB) plays an
important role in the development of a sound and effective financial system in particular, and economic development and stabilization of the economy in general. In
these countries, the governance of the CB is based on the three main principles of
New Public Management (NPM) known as the three ‘pillars’, which includes: (i)
central bank independence; (ii) central bank accountability, and (iii) central bank
transparency. Among them, central bank independence is considered the key and primary ‘pillar’. This implies that the reform of the central bank towards an independent entity thereby could be seen as one of the most important elements of a public
administration reform program in developing countries (LCDs), and Vietnam should
not be an exception. The State Bank of Vietnam (SBV) – as the Vietnam’s Central
Bank – has been operating successfully in the last decades and has contributed
greatly to Vietnam’s development. However, the dependence of the SBV on the
Government has shown a number of weaknesses that should be overcome as soon as
possible in the next stage of the development process, especially when Vietnam
becomes an official member of the World Trade Organization (WTO) in 2018. In this
paper, three issues will be covered, including: (1) The independent central bank and
its positive impact on the development and stabilization of the economy as a theoretical framework for discussion on the need for and the way of the reform of the central bank in developing countries; (2) a factual analysis of the SBV’s problems
resulting from its high dependence upon the government, as well as opportunities
and challenges of reforming the SBV towards an independent central bank; (3) recommendations for solutions to ensure the success of SBV reform in the future.

Keywords: Central bank, central bank independence, financial system reform, public
management reform, accountability, transparency, autonomy, State Bank of Vietnam.

Journal of Economics and Development

99

Vol. 14, No.3, December 2012

1. Independent central bank – the NPM
application in governance of the central
bank in developed countries

In all modernized economies, the central
bank (CB) is the government authority responsible for issuing currency, managing money
circulation, operating as the lender of last
resource to commercial banks, and as banker
to the government. Therefore, the CB plays an
important role in the development of a sound
and effective financial system as well as in the
economic development and stabilization of
developed countries. However, there is general agreement that in the relationship between
the CB and the government, the level of independence of the CB from the government
should be specified so that the bank can carry
on the above important role. Although over
recent years wide discussions continue on this
issue amongst not only economists but also
lawyers and politicians, it is a fact that the CB
in these countries is granted more power and
higher independence, and is called the independent central bank (ICB), in most openedrich and financially developed countries as
compared to those of “closed poor” and
financially repressed ones. An ICB could be
seen as the right way of governance of the CB;
this is a good explanation for the common
recent trend of reforming towards an independent CB in developing and transitional
economies.
It is very important to point out that it is
observed that the governance of a CB is
always aligned with the requirements of the
New Pubsh Management model (NPM) in
financially developed countries, which is con-

Journal of Economics and Development

sidered the irreversible trend of public management reform in the last 20th century until
now. In fact, for almost the entire 20th century
up to the 1970s, the bureaucracy was seen as
the optimal public administration model. As
described by Max Webber [9], to be effective,
a public administration should be characterized by five principles: (i) fixed areas ordered
by rules; (ii) an ordered hierarchy; (iii) a separate ‘bureau’ with its own files and records;
(iv) expert training; and, (v) full-time career
officials and management by rules. As commonly perceived, a bureaucratic administration should be hierarchical and impersonal to
be able to function properly and effectively.
However, this bureaucracy model has been
criticized as too bureaucratic and technically
inefficient since the 1970s-80s under pressure
of the economic liberalization movement.
While institutional economists argue that the
bureaucracy may nurture monopolies rather
than competitive markets, and bureaucrats
were driven by their self-interests rather than
public interests, management theorists urged
to adopt the modern management approach of
the business sector into the public sector as the
way to increase its efficiency and effectiveness. Consequently, the NPM model has been
initiated with five main features, including (i)
marketization of traditional public affairs visà-vis contractualism, application of the userpay system, promotion of competitive tendering and outsourcing, and fostering of privatization and equitization; (ii) result-oriented management which is characterized by adoption of
strategic planning, result-based budgeting and
reporting, and performance measurement; (iii)
100

Vol. 14, No.3, December 2012

delegation of managerial autonomy to agency
managers; (iv) decentralization and disaggregation; and (v) customer focus. The NPM usually relies on four common pillars of good
governance which include accountability,
transparency, predictability and participation.

Specifically applied to central banking, The
NPM model, as applied to the CB, is defined
by three key concepts, also called three ‘pillars’ (Lybek, 1998): (1) CB independence; (2)
CB accountability; (3) CB transparency. Of
these, CB independence (CBI) must be the
first and primary ‘pillar’. While the last two
pillars are self-explanatory due to their alignment with the main features of the NPM
model, the CBI needs more justification. As
discussed in Section 2, the CBI will shift the
relationship between CB and commercial
banks towards contractual and a market-based
nature, allowing bank supervision to be more
client-focused and result-based. In fact, all
such changes are the evidence of application of
the NPM model in the governance of the CB.
This implies that the reform of the CB towards
an independent model could thereby be seen as
one of the most important elements of the public administration reform program in developing countries, and Vietnam should not be an
exception.
2. The importance of CBI in stabilization
and development of the economy

The most essential advantage of CBI is
fighting inflation. Based upon a great deal of
real evidence, many economists believe that
with more independence the CB can carry out
a more creditable and efficient monetary poli-

Journal of Economics and Development

cy in terms of inflation control and formulation
of stabilization of the economy. It is argued
that the CB is functioning both as a ‘money
stock’ by issuing money and as a ‘money
pump’ by controlling over-supply of money
and by regulating money demand in the economy. Without, or with less, government intervention, the CB can regulate the money supply
based on the demand for money so that money
circulation will be kept stable. Inflation will be
controlled under desired levels, and particularly, no money will be issued to finance government budget deficits, which is one of main
sources of inflation observed in many countries.

The ICB can create sustainable real economic growth. According to Lybek (1999),
both the stability of the financial system and
interest rate setting are very important for sustainable real economic growth because both
have crucial effects on financial process in the
economy. Without the effect of an interest rate
setting mechanism of the CBI, the price of
using funds is often not reasonably directed by
the government, being too low or too high, so
that savings cannot be transferred well into
investments. The former situation will result in
limited capital mobilization and thereby there
will be a lack of capital for investments for
economic growth, while the latter will create
inefficiency of capital allocation.

It is also a fact that in most countries where
the CB is independent from government controls, where the CB even plays the role of a
macro-economic agency1, the relationship
between CB and commercial banks2 is contractual and market-based. There is no priority
101

Vol. 14, No.3, December 2012

Figure 1: Credibility of Monetary Policy and Reform of CB Legislation



 

    

    

  

    
   

  




Source: Lybek, T. (1998) “Elements of Central Bank: Autonomy and Accountability)

and directing mechanisms in lending to banks
as well as no intervention more to commercial
bank operations. Banking supervision under
ICB is always implemented with more direction of the activities of banks. These are
‘clients focus’ and ‘result-based management’
mechanisms. As a result, under these conditions, banking and financial market activities
are safe and sound and have greater efficiency
by having less poor investment “decision
made” or non-performing loans, as well as
having an adequacy of information, so that all
market participants know how and what to
expect. Thus, the CBI is the way to ensure the
soundness and transparency of the financial
system.
Journal of Economics and Development

Relevant to the realization of the impact of
ICB on the development of the financial system and the economy, there is a huge volume
of research and studies in the current literature.
This literature has distinguished different types
of independence, differently based on different
approaches. Debelle and Fisher (1994) và
have mainly based their work on the CB function while Lybek (1998, 1999) has approached
to the goal and target of independence and also
distinguished between the goal and target of
the autonomy. However, the general agreement on the types of independence could be
defined in a number of aspects including: (1)
Legal framework; (2) Policy goal design; (3)
Operation determination; (4) Management

102

Vol. 14, No.3, December 2012

tools. It is understood that the first aspect is a
basic condition and meaningful for the remaining aspects of independence. Indeed, all the
CB’s functional activities are ensured to be
implemented independently, based only upon
the law. In other words, these aspects reflect
the levels of independence of the CB, which is
whether the CB’s policy in goal designing,
operation determination and management
tools is defined under guarantee of law. If this
is the case then independence of the CB could
be seen to be at a high level. Furthermore,
from the other approach, these aspects would
be used as indicators to evaluate the ICB levels and as benchmarks for the destination of
reforming central banking towards an independent model.
The above discussion on the ICB benefits
and determination is quite useful to analyse the
current situation of the SBV in the context of
the banking reform in Vietnam that has been
taking place since the 1990s.

3. Recent reform of the banking system
and the State Bank of Vietnam

The reform of the Vietnam banking system
has been closely linked with the transition of
the economy from the centrally planned model
to the market oriented one, which was initiated
in 1986. The reform of the SBV is a part of the
banking system reform. Prior to the start of the
reform, there was only one bank in Vietnam,
namely the National Bank with the straightforward or hierarchical model of organization3,
carrying out the function of both a CB and a
commercial bank simultaneously; it was therefore a mono banking system. This system was

Journal of Economics and Development

a former Soviet one and applicable to the previous model of the economy, but no longer
suitable for the changes in the economy that
have been made since the 1986 renovation programs. In fact, the mono banking system could
not adequately support the economy and renovation programs. It also caused too many serious problems that had never been seen before,
and pushed the economy into a crisis period in
1986 - 1988. The programs of banking system
reform therefore have been implemented since
late 1988. Up until now, there have been many
important changes and accomplishments. I
would like to focus on only three substantial
changes related to this topic, due to the limited
scope of this paper. These are as follows:
Firstly, the change in the banking system
model and its operation mechanism is an institutional reform. From late 1988, Vietnam’s
banking system has been transferred into a
dual model, in which the State Bank of
Vietnam has granted the CB to act separately
from commercial banking, which is the role of
the four state owned commercial banks
(SOCBs) that had been generated4 at the time
to exercise the function of profitable or business institutions.

Secondly, two Ordinances were enacted in
1990 to define the legal framework for the
banking operation of the banking system’s
mechanism and activities. Based on the two
Ordinances (1990), the SBV had since 1992 no
longer continued to have relationships with
companies, including state owned enterprises
(SOEs), and has since then specialized in the
functional operations of the CB of the country.
The CB’s clients now are only the commercial
103

Vol. 14, No.3, December 2012

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