Musharraf's visit to the State Bank

President Musharraf's first visit to the State Bank after Shamshad Akhtar took charge as Governor of the central bank from 1st January, 2006 turned out to be a good opportunity to review and appraise the monetary policy issues of the country.
The tighter monetary stance maintained by the State Bank of Pakistan (SBP) in the recent past, according to the Governor, had largely been effective in bringing inflation down and liquidity conditions in the market would continue to be closely monitored in future in order to keep inflation in check.
"The conduct of monetary policy tends to be quite complicated when the money supply grows at a pace faster than nominal GDP as this gives rise to inflationary pressures, and in doing so the contribution of government borrowings from the central bank has a major role to play, and needs to be checked."
While briefing Musharraf on SBP's future vision and strategy, the Governor said that the central bank was well on its way to implement second-generation reforms both in the financial sector, and within the SBP, in terms of strengthening governance standards and modernising it in line with international best practices.
In its efforts to strike a balance between its dual objectives of controlling inflation and promoting economic growth, the SBP works in close collaboration with macro-economic goals of the government. It is also encouraging the banks to devise innovative products to encourage savings that would induce people to save and hence reduce the savings-investment gap.
Although days of directed lending were over, the SBP also continues to encourage the banks to serve the needs of SMEs, agriculture and micro-finance sectors due to their role in poverty alleviation.
President Musharraf supported SBP Governor's vision about the need to continue the reform agenda and asked the banks to share their record high profits with the depositors by increasing rate of return on deposits. Banking spread had increased to a record level of 7.25 percent while average rate of return was just over three percent.
This low return was insignificant especially in the wake of 8.4 percent inflation rate. The President expressed the hope that during 2005-06 revenue collection would exceed by Rs 50 billion and exports may touch $18 billion but the gains to the economy would only be meaningful when they reached the common people. He also reiterated the need to further strengthen the tax-to-GDP ratio.
On a technical or conceptual level, the President's visit to the SBP was, in our view, extremely useful in understanding and clarifying monetary policy issues. Since inflation is the major problem now confronting the country, he was told about the role of the State Bank to contain price pressures in the economy and the degree of success it had achieved in this vital area.
Some deceleration in the rate of increase in the price indices in the recent months was offered as a proof that monetary policy was on the right track. The Governor's presentation conveyed to the President in a subtle manner that part of the blame for inflation was also to be shared by the government which must reduce its borrowings from the State Bank to contain liquidity in the economy.
The President also hit the nail on the head when he highlighted the widening spread between the deposit and lending rates of the banks and referred to the negative rate of return to the depositors which was holding back the saving rate in the economy.
A higher tax-to-GDP ratio as emphasised by the President would not only reduce the need of the government to borrow from the banks but would also be helpful for the economy in so many other ways.
The real problem, however, is not the dearth of awareness but the lack of will and hence progress in areas referred to by the President. For instance, tax-to-GDP ratio continues to be dismal despite the fact that the need to raise this ratio continues to be highlighted at every forum and in every document.
The government needs to take concrete and effective steps to ensure that the needful is done for better prospects of the economy. The State Bank also needs to impress on the banks to give a better rate of return to the depositors for curbing consumption and promoting savings for the sake of a self-reliant economy.
If persuasion fails, the central bank may think of some other options. In the presentation, Shamshad claimed credit for bringing down the rate of inflation by tightening the monetary policy.
She was obviously referring to a lower rate of inflation than last year. In our view, such a development may be somewhat satisfactory but inflation rate is still at an unacceptably high level and the State Bank's job by no means is over yet.