Benefits of the SBP autonomy

Central Banks are not in the business of making profits. They have been set up with the mandate to manage monetary policy, credit and liquidity, maintain stable exchange rate, supervise and regulate the banking system and ensure a smooth payment system. Progressive Central Banks do record exchange gains and losses in their transactions under the new International Accounting Standards.
The State Bank of Pakistan (SBP) has also switched to international accounting standards in order to provide maximum disclosure and transparency since 2001 and, therefore, has started showing losses and gains in its financial statements under these new standards. India and China do not follow these standards and, therefore, the comparison with them is totally invalid. But these exchange losses are purely notional in nature.
Let us see as to how these losses arise. Foreign Reserves are translated into Rupees at the prevailing exchange rate of the last day of the fiscal year. When the Rupee appreciated from Rs 60.02 /$ to Rs 57.81 /$ in FY 2002-03 the foreign exchange reserve holdings of SBP worth $ 9.993 billion (as on 30th June 2003) were translated into Rupees. This resulted in translation loss of Rs 12.951 billion which was shown in the Profit and Loss (P&L) Account for the year, as compared to translation loss of Rs 4.596 billion in the previous year when foreign exchange reserves were worth $4.805 billion only. The translation loss for the said year was due to appreciation of Pak rupee from Rs 63.98 /$ to Rs 60.02 /$. In 2003-04, SBP however showed exchange gains amounting to Rs 3.373 billion due to depreciation of currency from Rs 57.81 /$ on 1st July 2003 to Rs 58.16/$ on 30th June 2004. The Bank's foreign exchange reserves at 30th June 2004 stood at $11.110 billion. The moot point to note is that the SBP's hard currency reserves in foreign exchange had risen at the same time that it was showing exchange losses in Rupees in order to conform to the accounting conventions. Accounting losses cannot hide the fact that SBP's real asset accumulation in hard currency had made an impressive jump.
The second way the SBP makes profits is by earning interest on T-Bills issued to the Government of Pakistan (GOP). When the interest rates decline, expenditure on the interest payment incurred by the Government in its budget is reduced and correspondingly the interest earnings of SBP are reduced. In overall terms, however, the transfer payments from SBP to GOP in form of profits are reduced, but the GOP is able to make savings on its interest payments to SBP and utilise these savings for higher development expenditure. So the country is better off although the SBP's profits are eroded.
What have been the benefits of SBP's autonomy during the last five years? The list is quite exhaustive but, as an informed observer, I can cite the following:
1. SBP's autonomy has helped bring down average lending rates from 14.80 in 1999 to 7.28 in 2004. Private sector credit in 2003-04 rose to an all time high of Rs 325 billion stimulating aggregate demand in the economy. This, in turn, led to better utilisation of manufacturing capacity and expansion. Investment rate increased by 22 percent in 2003-04 the highest in Pakistan's history primarily due to this high private sector credit disbursements.
2. SBP's autonomy has allowed the country to accumulate foreign exchange reserves of $12 billion - twelve times the level achieved in 1999 and the highest ever recorded in Pakistan's history. This safe cushion has reinforced confidence in Pakistan's currency, restored the credibility in SBP lost after the freezing of Foreign Currency deposits in May 1998 and saved from the risks of financial crisis. More recently, the country was protected from the adverse effects of oil price shocks because of this cushion of high foreign reserves. I shudder to think as to what would have happened in 1999 if we were faced with a similar situation.
3. SBP's autonomy has enabled it to pursue innovative means of accumulating foreign currency by purchasing workers remittances in 2000 and 2001 from open market and thus avoiding default on external payments. These purchases enabled SBP to make timely debt servicing payments of $ 8.86 billion during these two difficult years.
4. SBP's autonomy has led to a complete restructuring and strengthening of the financial sector. All indicators of financial soundness such as capital adequacy, profitability and liquidity have improved in the last five years and are now quite strong compared to many countries in the Asia Region. This strength of financial sector has relieved the Government of the recurring burden of financing the losses of nationalised commercial banks and DFIs amounting to billions of rupees through its budget. The banks are now paying three times more taxes on their profits to the CBR compared to 1999.
5. SBP's autonomy has been responsible for the acceleration of commercial bank lending volumes to the agriculture sector and particularly small farmers. Commercial bank lending to agriculture has multiplied several fold between 1999 and 2004 and amounted to Rs 39 billion compared to Rs 74 billion. Revolving credit scheme introduced by the SBP has shifted the choice of repayment timing from the banks to the borrower.
6. SBP has facilitated channelling up of bank credit to the middle classes. It is now possible for the middle-income groups to purchase houses, apartments, cars and motorcycles, domestic appliances on instalment basis through consumer financing products launched by the banks and leasing companies. More than one million households have availed of these facilities during the last five years adding to their purchasing power, resorting to forced saving out of their incomes and helping faster industrial growth (14 percent in 2003-04).
7. SBP has established itself as a credible and independent source of analysis, commentary and forecast of the economy for the Parliament, Media and public-at-large. The Annual and Quarterly reports are regularly placed before the National Assembly and the Senate. The Parliamentary Committees hold regular hearings on the various issues relating to the conduct of SBP and invite the Governor to defend his position. The autonomy is accompanied by accountability.
8. SBP has ushered in a new era of Islamic Banking in the Country in accordance with the decision of the Shariah Appellate Bench of the Supreme Court. Two full-fledged Islamic Banks are already functioning and 25 branches of conventional banks are dedicated for Islamic Banking products. For the first time a large number of devout Pakistani customers who had avoided conventional banking have switched to Islamic banking.
9. SBP has opened doors for the poor of this country who can now borrow without any security or collateral from the microfinance institutions. Almost half a million families have obtained such loans in the last five years. Four micro finance banks have already started their operations and several others are in the pipeline. The aim is to cover at least three million poor families of the country under Microfinance and help them lift out of poverty.
10. SBP has introduced many new financial instruments such as long tenor Pakistan Investment Banks, Term Finance Certificates, Commercial Paper, Derivatives and strengthened the markets by setting up Karachi Inter-bank Offer Rate. This rate has become the benchmark for corporate and inter-bank lending.
11. SBP has liberalised foreign exchange regime by allowing the banks and authorised dealers the freedom to carry out all transactions without prior approval of the SBP. Pakistanis and non-Pakistanis can bring in capital in the form of foreign exchange and repatriate remittances, profits, dividends, and royalties freely without any restrictions. FDI flows reached almost $1 billion in 2003-04 compared to $ 469.9 million in 1999-2000.
12. SBP has dealt with the stock of Non-Performing Loans (NPLs) of the banks, inherited in 1999, in a transparent and innovative ways by heavy provisioning, accelerated recovery through BPD Circular No. 29, auctioning through CIRC and referring wilful defaulters to NAB. These measures have brought down the gross NPL to gross advances ratio from 22 percent in 1999 to 11 percent in 2004 and net NPL to net advances ratio of commercial banks to 3.6 percent. As many as 51,000 borrowers have benefited from BPD Circular No. 29 and a large number of sick units and industries have either revived or are in the process of revival. The quality of assets has improved dramatically since 1999 as the default rate has come down to less than 5 percent, which is comparable to international norms. More than 95 percent loans are recovered on time adding strength to the banking sector.
13. SBP has promoted automation, electronic banking, ATMs, on-line banking, customer service call centers, improved branch layouts and spread of banking to geographical areas beyond the big cities. The competition for ensuring convenience to customers has raised the service standards in the banking industry.
14. Finally, the prudent economic management by the State Bank of Pakistan and the Government of Pakistan has freed the people of Pakistan from the strangulation of the IMF. After a long time the country has regained its economic sovereignty.
Are these notional exchange losses of the SBP due to fluctuating exchange rate and lower interest earnings of the SBP anywhere comparable to these huge benefits the country has derived from the autonomy granted to the Central Bank. An ideologically driven rhetoric and highly biased and factually inaccurate opinions should not lead us to the dark days of the 1990s.