Monetary Policy after SBP autonomy: The negative implications for savings, investment and growth of a monetary policy that was subservient to the financing requirements of the government, and was unable to use interest rates as a major instrument, were recognised in the nineties by the policy circles in Pakistan.
Accordingly, SBP was given administrative and functional autonomy, with guarantee of tenure to the Governor and SBP Board of Directors and some influence on the determination of government borrowing from the banking system through legislative reforms in 1994. As these legislative reforms were not adequate to control Federal government borrowing from SBP, SBP Act was amended again by the Parliament in May, 1997.
This time the revision was done much more carefully and professionally to ensure that excessive government borrowing from SBP and interest rate suppression on fiscal considerations was stopped completely, and SBP was given explicit authority to have complete control on its own balance sheet and on interest rate policy.
Specifically, it was stipulated in section 9A of SBP Act that "the Central Board {of SBP} shall, in order to secure monetary stability and soundness of the financial system, formulate monetary and credit policy - and determine, and enforce, in addition to the overall expansion of liquidity, the limit of credit to be extended by the Bank to the Federal Government, Provincial Governments and other agencies of the federal and provincial governments for all purposes."
In addition, the scope of Monetary and Fiscal Policies Co-ordination Board, set up under Section 9 B of SBP Act in 1994, was restricted mainly to reach an agreement on macroeconomic targets of growth, inflation and balance of payment and to co-ordinate fiscal, monetary and exchange rate polices. It was made clear at the end of the same section that "the Co-ordination Board shall not take any measure that would adversely affect the autonomy of the State Bank of Pakistan as provided in this Act."
Thus, all ambiguities were removed from the SBP Act by 1997 and SBP was given exclusive authority and responsibility for formulation and implementation of a proactive monetary policy with explicit power to "determine and enforce" government borrowing from SBP by all layers of government and public sector entities. This was a major step forward to enable SBP to control the growth of reserve money and of money supply.
TRACK RECORD OF MONETARY POLICY AFTER AUTONOMY Immediately following the banking sector reforms of 1994 and 1997, SBP began to formulate and implement an independent monetary policy with a view to containing monetary expansion within limits that would facilitate the achievement of inflation target agreed with the Government.
That was achievable only if Federal and provincial governments were to contain government borrowing from SBP within safe limits prescribed by SBP on monetary policy considerations. When governments failed to voluntarily contain their borrowing from SBP, SBP did indeed begin to use the legal authority to limit it. Initially, SBP started restricting borrowing by provincial governments from SBP within the approved limits.
When some provinces did not take SBP warnings seriously, the then Prime Minister Benazir Bhutto was informed and Prime Minister extended full support to SBP and, in response to its submission, wrote a letter to the provincial Chief Ministers in 1996 reminding them of SBP's legal powers to dishonour cheques issued by provinces in excess of their SBP approved borrowing limits. When some provinces failed to pay attention to the advice and the warning, SBP did stop payments of defaulting provinces on six different occasions.
A beginning was also made by SBP to indicate to the Federal government the amount of borrowing that it could resort to from SBP in the fiscal year 1997-98 based on monetary policy considerations, and the Federal government did begin to adhere to the limit prescribed by SBP.
The Monetary and Fiscal Policies Co-ordination Board also began to meet regularly to agree on targets of growth, inflation and external accounts that were used to determine safe limits of monetary expansion by SBP on the basis of a reserve management framework. Similarly, the sale of Government securities to commercial banks began to be based on auctioning conducted by SBP, and cut off rates began to be determined by SBP.
SBP also put in place a comprehensive framework of analysis to determine credit requirements of the private sector for the attainment of growth target and to ensure smooth flow of credit to the private sector. The safe limit of government borrowing was residually determined by SBP and communicated to the Government as an input to the scheme of budget financing. Accordingly, by FY1997-98 all legal, professional and procedural steps were put in place for the conduct of an independent monetary policy.
It was a promising beginning and continuation and further refinement of this framework would have changed the direction of budget financing in general and ensured containment of monetary expansion and inflation in particular. However, this promising beginning proved short lived and autonomy in the conduct of monetary policy was in practice abdicated by SBP early in Musharraf era with the result that printing of notes on the instructions of the government was resumed, and has since been continued, and resistance to government interference in monetary and banking affairs was abandoned by SBP in the name of "team work."
A casual reading of recent monetary policy statements makes it clear that SBP has by now no control on government borrowing from it and public sector has once again become the main engine of reserve money creation and monetary expansion. Similarly, the government, that had earlier begun to indicate only the volume of periodic borrowing from commercial banks and accept SBP decided cut off rates, seems to have reversed the practice, and the Federal Ministry of Finance has again begun to decide the cut off rates.
There is also no evidence of regular quarterly meetings of the Monetary and fiscal Policies Co-ordination Board, for reaching an agreement on inflation, growth and balance of payments targets and for co-ordination of monetary and fiscal policies, which is a legal requirement.
Without a limitation on government borrowing from SBP, and consequent loss of control on its balance sheet by SBP, and with no authority to determine cut-off rates for government borrowing from commercial banks, SBP has in practice lost control over interest rate policy, over reserve money and over monetary policy.
SBP has gone a step further and delegated its responsibility for the formulation and implementation of credit policy to a Committee, which includes outsiders. By failing to discharge its statutory responsibility and by abdicating its central role to "determine and enforce" government borrowing from SBP, SBP has become a party to fuelling of high inflation that is being experienced in the country.
There have been lame excuses given by some senior SBP officials for this state of affairs, and they have publicly stated that SBP did not have the power to stop the government from borrowing from SBP or from determining its cut off rate, and that a new law was required if it was to be done. Those SBP officials must not have read/understood the revised SBP Act because the fact is that the law was carefully revised on monetary policy considerations in 1997 and it is unambiguous and it is there giving authority to the Central Board of Directors to "determine and enforce" the limit on borrowing by government from SBP. The law cannot implement itself and, for that matter, any new law will also meet the same fate, if kept merely lined up in the shelves in SBP offices or in its library.
In the context of the unwillingness or inability of SBP to enforce the law, let us learn from the experience of other institutions having constitutional or statutory autonomy. Pakistan had long periods of unconstitutional governments not because the Constitution was not there or it was ambiguous but rather because it was not respected and followed in practice, and similarly the superior courts of Pakistan did not exhibit independence till very recently not because their independence was not guaranteed by the Constitution but because there was no will to exercise that independence in practice.
In the same way, monetary policy of SBP has been practically subordinated to the fiscal requirements not because there was no law but because there was no respect for the law and/or not enough courage to enforce the law. It may also be kept in view that if the existing provisions of Section 9A and 9B of SBP Act are removed/modified using one pretext or the other, SBP would never be able to get back the statutory authority that it has on books now in the matter of government borrowing from the banking system.
Most governments would find it convenient to indirectly and indiscriminately continue to rob people through money creation and inflation rather than to directly tax them through a transparent and fair tax system. It is reported that SBP Act is being amended again to make two changes. First, approval of credit policy will be handed over to a Committee, including outside experts.
Second, government borrowing from SBP will be linked with tax revenue or some other variable of the budget in a mechanical manner. This is being done in the name of enhancing autonomy of SBP and on the recommendations of some exert or experts from IMF. SBP has enough de jure autonomy and what is needed is de facto autonomy which depends on the personality and professional competence of the governor and the Board and not on further legal changes.
These so-called IMF experts, having no experience or knowledge of the socio economic conditions in Pakistan can go off the mark if proper guidance is not available to them from within the country. Linking government borrowing to a fiscal variable and not to the safe limit of monetary expansion derived from monetary policy considerations will make SBP again de jure subservient to the budget.
Handing over the core central banking function of formulation of monetary policy to an outside Committee will make SBP Board redundant. Many in SBP may not be aware that the same IMF had fully endorsed the indigenously produced reforms of 1994 and 1997, and in fact made them a prior condition of their standby program.
If at all further reforms are to be made, those should relate to the reformation of the composition and qualifications of the Board, and the way it is appointed, and further clarification of the functions of Monetary and Fiscal Co-ordination Board rather than its abolition. Making the SBP Board redundant by renting out its functions to an outside group or enabling the government to automatically borrow from SBP a certain percentage of their revenue receipts or making Prime Minister Chairman of MFPCB will diminish and not enhance SBP autonomy.
The fact that such recommendations are made by a so-called legal expert of IMF taken from a developed country does not make them right for Pakistan. What is required is courage to enforce SBP autonomy and not to continue to flirt with the law. Laws are as good as their implementation.
(To be continued)
(The writer is former Governor, State Bank of Pakistan)
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