State Bank becomes autonomous

This is an abridgement of Chapter 11 of Volume IV of the History of State Bank of Pakistan, authored by Mr M. Ashraf Janjua, Former Dy. Governor SBP, attempted for Business Recorder by Chaudhry Rashid A. Javed of AAJ TV to remind the readers as to when the idea of autonomy of the State Bank struck its policy makers; how many years elapsed to ultimately reach the coveted goal; and how important is it for the managers of the Central Bank, the Governors in particular, to protect and preserve this hard won autonomy.
There is a growing awareness in the academic as well as political circles of the need for autonomy to the Central Bank even in well-governed countries. The Central Bank should have full control on its balance sheet, to regulate reserve money base and influence interest rate in performing its function of promoting price stability.
In a poorly governed country that lacks proper checks and balances on the use of political power, and has no tradition of respect for national institutions, autonomy to the Central Bank is all the more important. This write-up is devoted to the description of ups and downs in legal provisions regarding the autonomy of the State Bank of Pakistan over the years, obstacles in the exercising of such an autonomy and related developments.
DEVELOPMENTS PRIOR TO JULY, 1993: The seeds of the autonomy of State Bank of Pakistan were sown when Governor S. U. Durrani told the shareholders of the Bank on the occasion of the 23rd Annual General Meeting on 18th September, 1971 that:
"In all its actions and policies the Bank will be guided by the objective enshrined in its Charter. While lending whole-hearted support to Government for the achievement of its economic goals, our aim will be to develop a truly independent Central Bank outlook on vital policy matters completely unfettered by noneconomic considerations".
The determination "to develop a truly independent Central Bank outlook" at a time when on paper there was nothing to support it, spoke a lot how important an independent Central Bank could be for a country facing the challenge of economic development. It clearly spelled out that the objectives enshrined in the Charter could be best achieved only if the State Bank was free to judge the vital policy matters by considerations of efficient macro-economic management rather than by populist political considerations.
Over the years, the State Bank continued asserting its independent outlook on various policy issues. However, in terms of State Bank Act, 1956 and other pieces of legislation that governed its working, the State Bank remained virtually an attached department of the Ministry of Finance and its substantive policy actions were subject to government's approval. It was not until July, 1993 that the first concrete steps were taken to detach it from the Ministry of Finance under the umbrella of financial sector restructuring.
The autonomy of the State Bank was further weakened under the Banks (Nationalisation) Act, 1974. Along with the nationalisation of the State Bank of Pakistan and scheduled banks under this Act, the Pakistan Banking Council (PBC) was created and assigned the functions similar to those of the State Bank, including powers to inspect banks and issue instructions in the matters of credit management and administration. It is significant to mention that nationalisation of the banking system was carried out without consulting the State Bank.
The Federal Government decided to nationalise banks before awaiting the results of Banking Reforms which were introduced in May, 1972 on the basis of recommendations in a report of the State Bank. This report did not suggest nationalisation as an option.3 This itself shows what position was given at that time to the State Bank in the decision-making process.
With the nationalisation of banks, the central banking functions were taken over by the Ministry of Finance, with the State Bank playing a second fiddle in the area of money and banking. Also, the Ministry of Finance assumed a dominant role in macroeconomic management in the country in the context of expansion of public sector which began to operate in almost all areas including production, distribution, trade and services sectors.
As the public sector required substantial amount of financial resources to meet the rising level of expenditure, the nationalised banking system with a weak Central Bank provided to the Ministry an excellent opportunity to have an easy access to bank borrowing to finance public sector operations. Above all, it made possible for the government to ignore the fundamental budgetary problems and postpone for long time the difficult policy decisions that needed to be taken following decline in foreign aid.
There were other developments also that adversely affected the authority and effectiveness of the SBP. First, in the 1970s there was an upsurge in trade union activities in the country, encouraged by the then government. Second, the country' had inherited a feudalistic structure of land ownership in the agricultural sector, creating a wealthy class of absentee landlords coexisting with toiling peasants.
The post-Independence pattern of industrialisation of the country, pampered by quantitative import restrictions and tariff protection, overvalued exchange rate, and low real rates of interest, and based on patronage and privileges given by the government, led to concentration of income and wealth in the urban areas as well. As banks relied on collaterals rather than cash flow analysis in their lending policies, an uneven distribution of income and wealth in both the urban and rural areas, in turn, led to concentration of credit in a few hands, a few cities and a few sectors.
As a result, a small group of rich and powerful landlords and businessmen emerged within the protective walls of' public policies that began to dominate the economy. They borrowed at subsidised or low real rates of interest from the banking system while the small depositors, who accounted for a large proportion of total deposits, were paid mostly negative real rates of return on their savings. This type of interest rate structure, combined with a rising level of loan defaults, became an instrument of transfer of resources from the poor to the rich, and a significant source of "rental income" for the rich and powerful segments of the society.
With the passage of time, the interlocking of trade, industry, banking business and political and bureaucratic power base made it increasingly difficult for professional institutions like the SBP to play their proper role in the affairs of the country. Third, government control on staffing, promotion and remuneration policies of the SBP made it a less attractive place to work and led to brain drain, resulting in a gradual deterioration of its skill level and professional standing. Brain drain from the existing pool of talent was reinforced by stoppage of recruitment of young professionals under trade union pressure in early 1970s.
The cumulative impact of all these developments and factors was that by late 1980s, the SBP was completely marginalised, monetary policy became subservient to the fiscal requirements of the public sector, government-directed credit at subsidised interest rates became a large component of credit to the private sector, political and bureaucratic interference in the banking business was rampant, trade union leaders became powerful, supervision of banks fragmented, banks' loan portfolio got infected and banking services deteriorated. Quoting from the minutes of the meeting of the Central Board of Directors held on 28th November, 1990, "Director Shahid Hamid enquired as to how and to what extent the State Bank could help in containing the recent price spiral.
The Chairman informed the Director that State Bank could only indirectly influence the expansionary trend by controlling monetary expansion. But the State Bank has no effective control on the expansionary forces emanating from fiscal operations of the Government". Notwithstanding this degree of co-operation in the most important policy area of the State Bank's responsibilities, namely, conducting of monetary policy, differences in administrative and business policy matters cropped up between the Bank and the Government. As a consequence, the incumbent Governor, Mr I.A. Hanfi proceeded on four-month leave with effect from 2nd September, 1989. The leave was extended till 28th February 1990 when Mr Hanfi resigned.
At the same time, inability and unwillingness of the government to make adjustments in its spending levels, in the light of decline in the availability of foreign assistance, led to substantial bank borrowing, accumulation of internal and external debt, a rising rate of inflation, depletion of foreign exchange reserves and increased external vulnerabilities. As the SBP was treated almost as an attached department of the Ministry of Finance, its independent voice in macro economic matters was silenced, and even release of its Annual Report was made subject to the approval by the Ministry of Finance.
The governors of the SBP who tried to give independent advice on macro economic policies or showed resistance to government interference in the banking sector were eased out prematurely. In short, by early 1990s the economy was faced with serious macro economic problems, the banking system had become highly vulnerable and the SBP was so weak that the Ministry of Finance was effectively deciding even matters that routinely fall in the jurisdiction of a central bank.
THE FIRST ROUND OF REFORMS FOR SBP AUTONOMY:
In July 1993, political developments necessitated holding of new parliamentary elections within ninety days under the supervision of the army, and civilian affairs were handed over for this period to a caretaker government led by Mr Moeen Qureshi, a retired senior official of World Bank. Given the fiscal mismanagement, mounting external and internal debt, excessive public sector borrowing to finance rising budget deficits and a sharp deterioration in the quality of loan portfolio of banks and their services, the Caretaker Government concentrated on economic policy matters.
It recognised the need for financial sector reforms, anchored around an autonomous and strengthened SBP, as an important step towards better macro economic management and good economic governance of the country. Accordingly, at the request of the Caretaker Government, the SBP prepared in August 1993 a paper containing proposals to give autonomy to it and to separate monetary policy from fiscal policy of the government.10 Contents of this paper are summarised below:
1. The State Bank as Economic Adviser to the Government:
i) Governor, State Bank should be invited as a routine matter to participate in such meetings and fora of the Government of Pakistan including cabinet meetings where economic and financial policies are an item on the agenda. .
ii) Governor, State Bank should prepare an independent quarterly report on the state of the economy to be submitted to the Prime Minister.
iii) Governor, State Bank should be included in warrant of precedence in the same group that includes Secretary Generals of the Government of Pakistan.
iv) The practice of clearance of the State Bank' s Annual Report from the Finance Division prior to its submission to the Central Board of Directors for approval should be discontinued.
v) Co-ordination between the monetary and fiscal policies should not be perceived as one way affair with the Ministry of Finance intervening in the regulation of banking sector and formulation of credit policy.
2. Administrative matters of State Bank of Pakistan:
i) Once approved by the Board, all administrative proposals should be allowed to be implemented without prior clearance by the Ministry.
ii) State Bank should not be treated at par with non-statutory bodies and therefore circulars meant for them should not be automatically applied to the State Bank.
iii) Government and its agencies should not issue any directives to financial institutions, except through the State Bank or at least the State Bank's clearance must be sought before such actions are taken.
iv) Section 5(i) of Banks (Nationalisation) Act of 1974 should be interpreted in a very limited manner in so far as the State Bank is concerned.
3. Formulation and Execution of Monetary Policy
i) The nationalisation of Pakistani banks, including the State Bank in 1974, effectively transferred control of the financial sector to the Finance Division. In practice and through several legislative and procedural changes, the monetary policy functions of the State Bank have largely been taken over by the Finance Division.
ii) In order to return to the State Bank the powers relating to the conduct of monetary policy and control over the banking system the following steps would need to be taken:
a) The decisions and policy on reserve requirements should be vested in the State Bank, which at present rests with the government. Accordingly, Section 36(1) (2) of the SBP Act, 1956 should be amended to give this power to the State Bank's Central Board of Directors.
b) Section 29 of the BCO, 1962 needs to be modified to vest power of change in liquidity ratio with the State Bank's Board of Directors.
c) Exchange rate policy should be made an integral part of the functions of the State Bank.
d). The State Bank pays no rate of return in any form on current account. This deprives it from using reserve requirement as a more effective instrument of credit control. In case of reserve requirements there is need for a waiver in this regard.
iii) The functions assigned to the PBC overlap with those of State Bank. The PBC should be dissolved.
iv) The Banking Policy Committee should be abolished.
v) Financial institutions which violate the instructions of the State Bank should be dealt with by the State Bank strictly according to the law without any interference from the Government.
When the paper came for review in an inter-governmental meeting. the Finance Minister and Special Adviser to the Prime Minister fully supported the proposals meant to give to the SBP a measure of autonomy but the senior bureaucrats of the Ministry of Finance showed a lukewarm, if not a hostile, attitude to the proposed reforms. Notwithstanding the bureaucratic inertia, it was decided by the Caretaker Government to go ahead with the proposed reforms.
The SBP was aware that the Caretaker Government was there only for three months, that there was a reluctance on the part of the bureaucrats of the Ministry of Finance to part with the control it had acquired over the SBP and the banking system, and that ordinances, even if those were promulgated by the Caretaker Government, would have to be subsequently ratified by the Parliament for their continuity beyond four months. It was also a recognised fact that new governments were usually briefed by the bureaucrats who had a way to bring them around their own viewpoint, particularly in matters like the autonomy of the SBP, involving abdication by the government of some of its acquired rights. In this perspective, the SBP had to make a judgement as to whether a set of ordinances were to be proposed covering all aspects of banking, or a modest beginning could be made by focusing on a few key areas.
The former approach would have completed the legislative task in a single effort. However, it was likely to face strong resistance from the bureaucracy, and the ordinances involving transfer of substantial functions to the SBP could have been allowed to expire by the subsequent political government without their passage by the Parliament. After due deliberations, the SBP decided to follow the second approach of focusing mainly on its autonomy, and proposed only key changes in the State Bank of Pakistan Act, 1956, the Banking Companies Ordinance, 1962 and the Banks (Nationalisation) Act, 1974 on pragmatic considerations of their likely acceptance by the Ministry of Finance and their subsequent sustainability in the Parliament..
The SBP proposed the following amendments in the State Bank Act, the Banking Companies Ordinance, and the Banks (Nationalisation) Act, intended to give autonomy to the SBP:
(a) Section 9 of the State Bank Act was to be changed to redefine the role and composition of the Central Board of the SBP and its rules of business.
(b) Section 9 A was to be added to the Act to give the Central Board of the SBP authority to regulate and supervise monetary and credit system and to determine the permissible level of government borrowing.
(c) Section 10 of the Act was to be amended to make the tenure of the Governor for a non-renewable period of five years.
(d) Sections 14 and 15 of the Act were to be amended to ensure that the Governor could not be removed except for "breach of the trust" and "misconduct", and that also on the basis of a defined procedure.
(e) Section 36 of the Act was to be amended to remove the requirement of government approval for changes in cash reserve requirements.
(f) Section 54 of the Act was to be amended to remove the requirement of government approval of the important decisions made by the Central Board;
(g) Section 29 of the Banking Companies Ordinance was to be amended to give to the SBP authority to change the liquidity ratio without Government approval; and
(h) Section 9 of the Banks (Nationalisation) Act was to be changed to dissolve the Pakistan Banking Council.
In view of the Prime Minister's public commitment to give a measure of autonomy to the SBP, and open support of the Finance Minister and the Special Adviser to the Prime Minister to the amendments proposed by the SBP, the bureaucrats of the Ministry of Finance did not oppose these proposals. However, they recommended additional provisions to dilute, if not completely neutralise, the purpose and impact of the SBP-proposed amendments. The most significant suggestion was to create a "Monetary Board" (with the Finance Minister as its chairman and the Federal Finance Secretary as one of its members) to supervise the work of the SBP.
The SBP did not agree with the proposal for the creation of a Monetary Board having supervisory authority over the SBP. Instead, it negotiated a compromise solution of creating a "Monetary and Fiscal Policies Co-ordination Board", which was to have no supervisory relationship with the SBP and was intended to be a forum to co-ordinate fiscal, monetary, foreign trade and exchange rate policies.
Based on the above compromise, the Ministry of Finance was to get approval from the Cabinet of the amendments in the State Bank Act, the Banking Companies Ordinance, and the Banks (Nationalisation) Act, translate them into Ordinances, and issue them after the approval of the President. Amendments in the State Bank Act and the Banking Companies Ordinance,1962 were indeed made on October 5, 1993 on the above lines, when two separate Ordinances were promulgated.
However, the Ministry of Finance delayed submission to the President of the third ordinance, proposing amendment in the Banks (Nationalisation) Act, 1974 for the dissolution of the Pakistan Banking Council. As a result, the term of the Caretaker Government expired before an ordinance on the subject could be issued. This left the Pakistan Banking Council in the field to continue to act on behalf of the Ministry of Finance in banking matters, contrary to the intention of the Caretaker Government which had decided to abolish it in order to leave the banking system in the exclusive jurisdiction of the SBP.
MODIFICATIONS TO DILUTE THE INITIAL AUTONOMY:"
Under the Constitution, an ordinance has a life of four months and for its continuation beyond that period, it needs to be either re-promulgated or approved by the Parliament to make the statute a permanent law.
It was expected that the ordinances promulgated on October 5, 1993 would be approved by the newly elected Parliament before February 4, 1994, as the two major political parties of the country were briefed in advance by the Caretaker Prime Minister in this and other economic policy matters, and they were supportive of the action taken by the Caretaker Government. Instead, the new government re-promulgated on December 31, 1993 the Ordinance relating to the State Bank Act with several changes that diluted the autonomy of the SBP. These changes were made 'without consulting the SBP, and were reported to have been adopted on the recommendations of the Ministry of Finance.
There was a strong reaction in the press and professional circles to the watering down of the autonomy given to the SBP by the Caretaker Government. The press carried articles by experts and statements by national leaders criticising the Government for diluting the autonomy and for not taking the original ordinances to the Parliament for approval.
Two of the newly appointed members of the Central Board of the SBP, both academics namely, Dr Tariq Banuri and Dr Waseem Azhar, resigned in protest. To counter the mounting criticism, the then Finance Secretary defended the changes publicly by holding a press conference. The press briefing by the Finance Secretary was carried by all the newspapers in their respective issues of January 5,1994, in which he claimed that the new ordinance had enhanced the autonomy of the SBP.
The opposition political party, which was in majority in the Senate, and had publicly criticised the dilution of the SBP autonomy, debated in the Senate the Ordinance issued on December 31, 1993, and rejected it with an overwhelming majority of votes. The action of the Senate created a very anomalous situation. It had the consequence that even if the original or revised Ordinance was to be approved by the National Assembly, it could not become a law unless the Speaker of the Assembly was to declare it to be a "money bill", which is not subject to Senate ratification. Rejection of the Ordinance by the Senate also meant that, unless a solution was found, on the expiry of the earlier Ordinance on February 4, 1993, the State Bank was to be governed once again by the pre-October 5, 1993 legislation.
Given the political power structure in the Senate and the National Assembly, the prospects of a compromise seemed dim. However, earlier the IMF had made parliamentary approval of the Ordinance as a prior action for Board consideration of ESAF/EFF arrangement, which was critically needed in view of the country's precarious balance of payment position. In the circumstances, the Government decided to take to the National Assembly for approval its own version of the Ordinance and ask the Speaker to declare it a "money bill".
The National Assembly passed it on February 8, 1994 and the Government promulgated it as a new law on February 14, 1994 after the consent of the President. The bill was declared "money bill" by the Speaker of the National Assembly, thus taking it out of the jurisdiction of the Senate. At the same time, the original Banking Companies (Amendment) Ordinance, 1993 was also approved by the National Assembly and enacted into a law.
There is no doubt that some of the original proposals were diluted in one of the bills approved by the Parliament. Nevertheless, these bills gave the SBP a measure of autonomy that it had never had before.
SECOND ROUND OF REFORMS TO STRENGTHEN SBP AUTONOMY:
In the subsequent period, the SBP adopted a dual approach of effecting improvements in the banking sector, based on new laws, and simultaneously lobbying for further changes in the legal and institutional framework. In the internal meetings and confidential correspondence, the SBP began to make a strong case for a reduction in budget deficit and lowering of government borrowing from the banking system, and lessening of government interference in the affairs of banks.
For example, in an exhaustive paper entitled " Major Policy Issues and Important Economic Policy Decisions Required to be taken in Pakistan" sent on May 25,1996 to the President of Pakistan, the Governor SBP stated bluntly that "the budget is basically out of control from all directions: (a) expenditures exceeding budgetary allocations;(b) revenue falling short of targets; (c) saving schemes not producing resources expected of them; (d) corporations lacking financial discipline and being unable to control their spending and make due payments to the Government; (e) provinces lacking the will to impose taxes but having unlimited appetite to spend; and (f) slow foreign aid utilisation" The Paper added that "we must control government borrowing on a sustained basis. Jugglery of statistics at the end of each quarter to show a reduction in borrowing fools nobody, least of all the economy". As regards monetary policy, the Paper warned that "monetary policy is currently hostage to (a) large budget deficits, (b) inefficient and corrupt public sector banks and developi'nent finance institutions, and (c) vested interests determined to exploit the banking system to their advantage."
The Paper also gave concrete policy recommendations to address macro economic problems. Similarly, in another note entitled "Review of the Banking System with Special Reference to the Availability of Industrial Credit and Export Finance" sent on April 6,1997 by the Governor SBP to the Minister of Finance and the Minister of Commerce it was pointed out that "for the monetary policy to be conducted efficiently and private sector to be treated fairly, it is imperative that not only the volume of government borrowing should be reduced to increase space for the private sector but it should also not obtain any interest subsidy.
Excessive government borrowing is also not justified in view of the large debt that has got built up by now and the need to contain inflation and to reduce pressure on the exchange rate and foreign exchange reserves of the country." This was supplemented by issuance of public statements and annual reports with independent analysis of macro economic developments and policies.
For the first time in 1993, SBP annual report was published without government clearance and it has become an established tradition by now. Moreover, views of the Central Board on the state of the economy were made public at the end of each Board meeting. Gradually, the political leadership, particularly the President and the Prime Minister, began to realise the merit of SBP autonomy.
While these were welcome developments, there were still several difficulties in the way of enforcement of the autonomy of the SBP. There was an ambiguity in the law about the authority to determine government borrowing from the banking system and respective roles of the Central Board of the SBP and the Monetary and Fiscal Policies Co-ordination Board. Some of the specialised credit schemes were still in operation, and proposals for new ones continued to be made by the Government.
The Ministry of Finance and the Pakistan Banking Council did not stop interference in the functioning of commercial banks, particularly in their lending, staffing, and management policies. Not only the Pakistan Banking Council and the Ministry of Finance were continuing to interfere in the day to day running of nationalised financial institutions, even the Prime Minister's Secretariat became very active in giving direct directives to banks in staff matters and lending policies.
The boards and presidents of these institutions being under administrative control of the Ministry of Finance, felt obliged to follow such instructions even if those were against their policies or business interests. Even then, they were frequently appointed and removed on political considerations. In the circumstances, the SBP was convinced that a second round of reforms was needed to complement legislative and administrative measures taken since 1993.
A second round of reforms was enacted in May 1997. A major political development took place on November 5, 1996, when the President of Pakistan dissolved the National Assembly and removed the then Government mainly on the charges of economic mismanagement. He also installed an Interim Government that was to hold new election within 90 days.
The SBP wrote a letter to the Interim Government soon after its assumption of office, outlining the need and scope of additional financial sector reforms. Because of its relevance and substance, the letter is reproduced below:
"Financial sector reforms should be on the top of the agenda of the Interim Government, if corruption is to be controlled and the quality of 'governance' improved. Changes in Management and Boards of the banking institutions in the public sector, desirable as they are to put persons of integrity and competence in place of political appointees, would have only temporary and marginal effects. We must attach the fundamentals of the system and ensure institutionalisation of processes if a lasting improvement is to be effected in the management and lending policies of the nationalised financial sector. Accordingly, I propose the following changes that may require amendments in the Bank Nationalisation Act and, may be, in some other laws.
The Pakistan Banking Council has been one of the main organs for the implementation of the agenda of governments in the public sector financial institutions and a vehicle for interference in their operations. I have used all my energies in the past three years to improve the role of the State Bank in the conduct of monetary policy and regulation of the financial sector. It is, however, my firm view that State Bank autonomy cannot be effective nor can be rot in the banking system be stopped with the continuation of the Pakistan Banking Council. Accordingly, the Nationalisation Act should be changed through an ordinance to abolish the Pakistan Banking Council.
The Banks (Nationalisation) Act should also be amended to take away chairmanship of the Board from the Chief Executive of a financial institution; the Chief Executive should only be a Board member. The functions of the Board should be redefined in terms of policy formulation and those of the Chief Executives in term of execution of policies. A clear criteria and institutional process for appointment and replacement of Chief Executives and Boards should be included in the Banks (Nationalisation) Act through an appropriate amendment, with guarantee of tenure and enhanced accountability of the Chief Executives and Boards.
Once the Government has appointed the Chief Executives and the Boards through a defined institutional process, it should be explicitly prohibited from issuing any directives to banking institutions in the public sector with regard to appointment/promotion/transfer of the staff and officers and for lending, write-off rescheduling or restructuring of loans.
The authority for licensing of' the deposit-taking institutions should be taken away from the Government and exclusively given to the Board of Directors of the State Bank of Pakistan. The foreclosure law needs to be quickly changed to make it more effective for recovery of bad loans.
The above action, along with changes in management and Boards of public sector financial institutions and strengthening of the supervisory capacity of the State Bank, can go a long way in addressing the problems that are being faced by the financial sector'. Once these changes are made, several changes in prudential regulations and enforcement mechanism could be introduced by the State Bank of Pakistan. This could be followed by restructuring and privatisation of banks and DFIs".
The President and the Interim Prime Minister decided to carry out additional reforms in the financial sector on the above lines and directed the Ministry of Finance to draft the necessary ordinances to abolish the Pakistan Banking Council, clarify the respective roles of the Government and the Central Board of the SBP in the formulation and implementation of monetary policy, make it explicit that government interference in the banking system will be illegal, institutionalise the process of appointments of presidents and board of the financial institutions in the public sector and transfer to the SBP some of the power that the Government had retained in the matter of banking supervision.
The initial draft ordinances submitted by the Ministry of Finance to the Cabinet for approval deviated substantially from tile above recommendations. It necessitated for the SBP to bring the matter to the attention of the President. and the consideration of the draft ordinances by the Cabinet was postponed. The President took personal interest in these reforms to ensure that no bureaucratic tactics were used to either dilute the reforms or stall them. Accordingly, new ordinances, drafted in line with the above recommendations, were submitted to the Cabinet for approval.
The government that came into power after the elections promptly placed these Ordinances before the National Assembly without any amendments. The only amendment that was added was the one relating to trade union activities that was proposed by the SBP as a new section (27B) of the Banking Companies Ordinance. The national Assembly passed all the three ordinances without amendments.
The main provisions of these amendments intended to strengthen the autonomy of the SBP were as following:
(a) Section 9A and 9B of the State Bank Act pertaining to the respective roles of the Central Board of the SBP and the government-dominated Monetary and Fiscal Policies Co-ordination Board were rewritten to remove ambiguity that had led to their differing interpretations by the Ministry of Finance and the SBP. The revised Section 9A of the Act gave to the Central Board an unambiguous authority to formulate and monitor monetary and credit policy, determine and enforce the limit of credit to be extended by the SBP to the Federal and provincial governments and public sector corporations and decide overall expansion of liquidity.
(b) A new provisions was added in Section 9A requiring the Central Board of the SBP to submit a quarterly report to the Parliament on the state of the economy. It was expected that these reports would be debated in the Parliament and released to the press, which would generate a timely debate on macro economic policies, both within the legislative branch of the Government and public at large.
(c) In the light of the experience, it was necessary to create a firewall between the government and banking system and for that purpose a new section 46B26 was added to the Act, prohibiting a governmental or semi-governmental body or agency from issuing any directives, directly or indirectly, to any banking company or any other financial institution regulated by the State Bank of Pakistan which was inconsistent with the policies, regulations and directives issued by it.
(d) Banks (Nationalisation) (Amendments) Ordinance, 1997, had three main new provisions. (i) The Pakistan Banking Council was to be dissolved with immediate effect. (ii) It was stipulated that Boards and Presidents of nationalised commercial banks and other financial institutions in the public sector were to be appointed by the Federal Government in consultation with the SBP from amongst the list of professional bankers to be determined, maintained, and verified by the SBP. (iii) The responsibility of the Board and President of a nationalised bank were clearly defined to discourage outside interference.
(e) Banking Companies (Amendment) Ordinance, 1997, made several changes intended to replace the Federal Government by the SBP in several decision making processes, enhancing SBP authority, and, in addition, giving it power of prosecution of those persons who knowingly acted in a manner causing loss of depositors' money or of the income of the banking company.
(f) A new section was added in the Banking Companies Ordinance, 1962, (Section 27B) to curb illegal activities of trade unions, and
(g) The new loan recovery law made it easier to set up banking courts, adjudicate cases at a faster speed and execute decrees issued by the courts. It also placed the SBP in the central stage of recovery effort.
OBSTACLES TO THE ENFORCEMENT OF THE AUTONOMY LAWS:
The implementation of the new legal framework was not easy. As is evident from the previous sections, the changes in laws were intended to ßlimit interference of the government and trade union leaders in the monetary and banking sector and to institutionalise the process of decision making with regard to monetary policy and banking business under the guidance of the SBP. In actual practice, there was a general lack of respect for new laws. Resistance to new laws was shown by all the vested interest groups, which were targeted to be restrained from their activities in the first place.
The Government of the then Prime Minister, Mian M. Nawaz Sharif, had given a substantial, in fact, an unprecedented, measure of autonomy to the State Bank by amending the SBP Act in May, 1997. However, the situation on ground did not change much.
The government had not fully realised what the consequences of giving autonomy of the State Bank could be. On 19th January, 1998, in the Business Advisory Council meeting in Islamabad, the powerful business lobby, very close to the Prime Minister, complained of inadequacy of credit facilities and accused the Governor, State Bank of being rigid and not looking into requests for long-term project financing. When asked by the Prime Minister to respond, the Governor quoted figures saying that there was no shortage of credit.
In the ensuing exchange of views of the situation and State Bank's credit policy, the Governor stood firm and said that further financing could not be extended to loan defaulters, for projects based on dubious feasibilities and those who did not offer adequate collaterals. The Prime Minister's reaction, as reported in the national press, was less than elegant.
According to one of the press comments, "Prime Minister's comments were certainly a gross violation of the autonomy of the State Bank and he had sought to create the impression that the Governor was like any other employee of the Government. Another comment in the press was that ". . . the Governor felt like resigning because he was not in a mood to oblige the private sector despite the fact that the Prime Minister wanted him to do so."
On 20th January, 1998, one day after the Business Advisory Council's meeting, Dr Muhammad Yaqub tendered his resignation "due to personal reasons". There was strong reaction in the national press and, without exception, the national press not only defended the autonomy of the central bank but also paid glowing tributes to the Governor's competence, integrity and courage.
The Government did not accept the Governor's resignation. The Government did this, firstly because they needed Dr Yaqub, who was well regarded in the international lending agencies, to deal with an important forthcoming visit of IMF, and secondly, the Government was unable to find a suitable replacement of Dr Yaqub, although several dark horses were waiting in the wing.
In the matter of government borrowing from the banking system, some success was achieved in enforcing the law but borrowing by the Federal Government for budgetary support could not be restrained. Historically, provincial governments were given specific limits of borrowings in the form of "ways and means" advances to tide over the imbalance in their receipts and payments. In the past, these limits were exceeded at will by most of the provincial governments. After 1993, the SBP made it clear to provincial governments that they would need to remain within their agreed limits.
In the enforcement of laws on provincial governments, the Federal Government broadly supported the stance taken by the SBP. The then Prime Minister, Benazir Bhutto, wrote letters to provincial Chief Ministers urging them to live within the limits prescribed by the SBP. When some of the provincial governments failed to abide by the agreement and the law, the SBP began to dishonour their payment orders in excess of the limits for the first time in the history of the country.
There were strong protests lodged by the provincial governments with the SBP, and they sent communications to the Federal Government for intervention. However, in the case of provincial governments, the Federal Government took a principled approach of supporting adherence to the limits. After initial strong reactions, provincial governments reached new agreements with the SBP to gradually reduce their debtor balances to limits set up with mutual consent.
In the case of the Federal Government, the SBP has failed to enforce the laws. Most of the time, targets of its bank borrowing were agreed in the context of the arrangements with the IMF, and question of a dispute between the SBP and the Federal Government on the target of borrowing did not arise.
In addition, initially the Ministry of Finance refused to accept the new law in the matter of interest rates, and insisted on having the right to determine the cut-off rates in auctioning of Treasury bills to raise resources for the Federal Government. as was the practice in the past. For example, the Additional Finance Secretary (Budget) sent a letter to the Governor SBP on March 15, 1995, stating, among other things, that "in any case, market offerings/ rates should be cleared with the Finance Secretary before acceptance by the State Bank of Pakistan" In response, the Governor wrote a letter to the Adviser to the Prime Minister for Finance and Economic Affairs on March 19, 1995 objecting to the tone and the contents of the letter of the Additional Finance Secretary (Budget) and reminding that "under the amended State Bank Act both the monetary policy and government borrowing are required to be determined by the State Bank of Pakistan ". However, after exchange of several communications, it was settled that interest rate determination was the responsibility of the SBP and that fiscal agencies must take them as given in their resource use and resource planning.
The Federal Government defied the new laws in spirit and in many instances even in letter, in other areas as well. Notwithstanding the provisions of a new section (section 46B) of the State Bank Act, the Ministry of Finance as well as the Prime Minister's Secretariat continued to issue directives to banks that were inconsistent with the policies and regulations prescribed by the SBP. Similarly, in the case of the appointment of the Boards and Presidents of the financial institutions in the public sector, the Federal Government did not adhere to the legal framework, and the principles enunciated in the law were violated at one time or the other.
The Federal Government, which used to have a free hand in these matters in the past, did not follow the new legal requirements in every case. In many instances, it would select an individual for appointment and then advice the SBP to include his name in the list, and ignored the requirement of consultation with the SBP. In some cases, it made appointments without following the law at all. In the first year alone, there were about eleven such violations. In all these cases, the SBP reminded the Federal Government that they were in violation of the new law but could not change the outcome.
The trade unions, another group that had exerted enormous influence on the functioning of nationalised financial institutions in the• past, also reacted negatively to Section 27B of the Banking Companies Ordinance (BCO) that prohibited them from using bank facilities to promote trade union activities, barred them from carrying of weapons into bank premises and restrained them from conducting trade union activity during office hours and indulging in physical harassment or abuse of officials.
In an environment in which rule of law is not observed, and the court system has weaknesses, enforcement of laws will continue to be difficult and test the resolve of leadership in the banking sector. However, there is no doubt that a persistent effort by the SBP will ultimately lead to a new tradition of adherence to the rule of law.
Notwithstanding the above-mentioned obstacles, there is a wide national and international recognition that the SBP's independence and stature was increased in the 1990s.
Dr Muhammad Yaqub resigned as Governor, State Bank, on 5th November, 1999 to join the National Security Council as a member. He was succeeded by Dr Ishrat Husain, a former civil servant and a former Director of the World Bank, who took over on 2nd December, 1999. Dr Ishrat Husain continued the process of reconstructing the Bank which was initiated by his predecessor. Also, under his chairmanship the Central Board of Directors made decisions regarding Bank's administration and its future development including the recruitment of staff at all levels, salary structure and other perquisites of the Bank staff, new initiatives in the areas of information technology (IT), reorganisation of the Bank, domestic and foreign training programmes for State Bank officials at all levels.
A major development initiated by Governor, Dr Ishrat Husain was the setting up of two subsidiaries, ie, i) State Bank of Pakistan Banking Services Corporation (Bank); and ii) National Institute of Banking & Finance (NIBAF). Full impact of these substantive changes on efficiency, productivity, quality of decision-making in the Bank and advice to the Government will take some time to materialise. Dr Ishrat Husain, both as a Central Banker and a well-known development economist, contributed both to the formulation as well as implementation of macroeconomic policies.
These developments, on balance, contributed to a visible reduction in the macroeconomic imbalances of the economy ie balance of payments, fiscal position and price situation. There was a movement of fiscal, monetary and exchange rate policies towards convergence rather than conflict.
Two areas relating to the autonomy of the Central Bank need to be mentioned, ie management of monetary policy and State Bank's policy statements in the Annual and Quarterly Reports. As regards monetary policy, the State Bank has, by and large, resisted any Government pressure to influence the cut-off rate on the auctioning of public debt although there have been occasional consultations with the government authorities on the amount of Government Bonds to be issued, etc.
As for the periodic reports of the Bank on the economic situation and developments, there is a view that the State Bank has not fully asserted its autonomy. The Central Bank of the country, should primarily, though not exclusively, confine itself to policies relating to financial flows, namely, monetary policy and credit management, exchange rate policy, capital flows and payment systems. More specifically:
a) At the macro level the State Bank should:
i) Conduct monetary management for short-term and medium-term price stabilisation, and exchange rate management for sustainable balance of payments;
ii) Develop payment systems and financial infrastructure which are essentially long-term objectives.
b) At micro level, the State Bank should attend to sectoral objectives like prudential regulations, supervision and lender of the last resort role including deposit insurance, etc.
As regard the policies relating to projections and data etc relating to the real sector, this should essentially be the concern of Government ie various Ministries, Planning Commission, Federal Bureau of Statistics, etc. These projections and their monitoring involve all these institutions. The State Bank should, in general, accept Government-determined growth and price targets for determination of the size of Annual Credit Plan and management of monetary policy, unless it has unassailably sound basis to challenge the accuracy of estimates including the methodology used or actual performance.
LESSONS FROM EXPERIENCE:
As regards its autonomy the State Bank of Pakistan has gone through various phases both in terms of provisions in the legal documents governing the operation of the Bank, and the personalities involved. On the basis of the experience both before and since 1993 when the Bank was first given a measure of autonomy by the interim Government headed by Mr Moin Qureshi, several conclusions can be drawn:
-- First, any reform needs a lead institution and that leadership is difficult to emerge from those institutions and individuals that were responsible for the existing state of affairs and/or benefited from the status quo. The task becomes even more difficult if the political institutions have not matured to the stage in which political leaders hold definitive views of their own on major economic policy issues, and they depend on civil servants for policy advice as well as for implementation of reforms.
-- Second, changes in laws are a necessary but not a sufficient condition to produce results. Laws are as good as their implementation and, if those were not taken seriously, further changes in laws would not produce results. In fact, there is a danger that continuous preoccupation with refinements in laws may distract people from the fundamental issue of ensuring the rule of law. Initially, the SBP had to concentrate on the improvement of the legal framework. It now needs to shift its focus from further refinements in laws to the enforcement of the existing ones.
-- Third, traditions take longer to break than enactment of laws and, therefore, institutions and groups that lead the process of reform would need to persist in their effort beyond the legislative changes to achieve results. While changing the laws required a great deal of effort, it is obvious that their enforcement is even more difficult. In such an environment, a determined effort would be required to enforce the laws to achieve and sustain autonomy in practice. If enforcement is weak there is a real danger that the vested-interest groups may hide behind a strong legal framework to conceal the ground realities.
The author is of the view that two things are necessary to enforce the legal provisions relating to autonomy of the State Bank, namely, i) the knowledge, experience and character (including the risk-taking feature) of the Governor's personality.
He should be a visionary and should be able to take along with him the Board of Directors or any other authority that formulates policies; and ii) highly qualified, competent and experienced staff in departments dealing with research and policy, who can provide to Governor with analysis of various relevant policy options and their consequences for macroeconomic management including in particular the financial sector. Short of this, it is unlikely that a Central Bank would have autonomy or be independent, even if there are liberal provisions in the relevant pieces of legislation.
-- Fourth, Autonomy does not mean that co-ordination of macro economic policies is not essential. In fact, autonomy warrants more and effective co-ordination of macro economic policies. However, it is important that, along with effective co-ordination, the SBP develops and sustains a reputation for independence of analysis and views. Professional independence is of critical importance to ensure credibility and sustainability of SBP autonomy over the long run, and to fulfil its obligations as enshrined in the amendments in the laws.
-- Fifth, it is important to accept fragility of reforms including the granting of autonomy to the Central Bank and watch out that those who may have been placed in a disadvantageous position in terms of their power base do not reverse the process either in law or in practice. The risk of reversal in practice, if not on the books, is a real one in Pakistan.
-- Sixth, lately the incumbent Governor60 has placed great emphasis on the training for the State Bank employees at all levels. In addition, the scope of recruitment and outsourcing has been enlarged. However, training and professional strengthening of the SBP will bear fruit with a time lag because human resource development is a time-consuming process, and needs to be sustained over a long period.
-- Seventh, according to the amended State Bank Act, the Bank is required to "submit a quarterly report to the Majlis-e-Shoora (Parliament) on the state of the economy with special reference to economic growth, money supply, credit, balance of payments and price developments." When this provision was made in the Act, it was expected that the parliament would have meaningful discussion on these Reports.
While the State Bank has been discharging this responsibility faithfully ever since the introduction of this provision in the State Bank Act, neither the National Assembly nor the Senate has reportedly discussed any of these reports. So far, this provision has hardly served any purpose beyond being a formality. Parliament can render a great service to the country by discussing and disseminating its views about economic problems and economic policies.
-- Finally, the policy of nationalisation of financial institutions has rightly been reversed and all the Nationalised Commercial Banks (NCBs), except National Bank of Pakistan and First Women Bank, have already been privatised. Consideration needs to be given to restoring the ownership of the State Bank to its prenationalization status. Thus, representation of private shareholders on the Board of Directors of the SBP, and the Governor presenting his Annual Address and Annual Report on the Economy to the shareholders, as was the practice before 1st January, 1974, can further strengthen the autonomy of the State Bank and make its operations more transparent and accountable.