When the SBP autonomy bill was first presented in Parliament in March 2021, it met with resistance on multiple fronts. Some critics were appalled by the opaque manner in which the bill was rushed through the legislature, though these concerns were relatively limited. The broader criticism came from those hesitant about ceding the sovereign’s right to finance deficits by printing new money or engaging in monetary financing through the central bank. For many, including leading economists, the legislation was perceived as tantamount to surrendering Pakistan’s fiscal and monetary sovereignty in exchange for what they derisively called “peanuts” in IMF funding.
Criticism of the SBP’s autonomy, however, was not merely rooted in pseudo-nationalistic arguments. Many seasoned policymakers, including prominent economists who have influenced macroeconomic decision-making for decades, voiced concerns about the revisions to the SBP’s mandate. The bill limited the central bank’s primary objective to price stability, sidelining other crucial facets of monetary policy. Critics argued that inflation in Pakistan is largely driven by cost-push factors—such as rising energy prices, exchange rate depreciation, and supply chain inefficiencies—making price stability and inflation targeting inadequate as sole objectives. One prominent policy advisor highlighted a counterintuitive dynamic: in Pakistan, higher interest rates could exacerbate inflation by increasing the government’s debt-servicing burden, which is ultimately passed on to consumers through higher prices, rather than addressing demand-side pressures.
Since 2021, Pakistan’s policy landscape has undergone a seismic shift. The country has endured unprecedented levels of inflation, which have eroded purchasing power, especially for lower-income segments. Yet amidst this economic turmoil, the SBP has emerged as a victor, establishing its autonomy and demonstrating the efficacy of positive real interest rates in combating inflation. However, while the battle may seem won, the war for comprehensive monetary reform is far from over.
A critical but less-discussed provision in the SBP autonomy bill allows the central bank to indirectly finance fiscal deficits through commercial banks. The government now relies on primary dealers—commercial banks—to raise funds by auctioning market-based securities. Yet, when these banks lack sufficient liquidity to satiate the sovereign’s borrowing appetite, the central bank steps in, injecting liquidity into the money market via open market operations (OMOs). Consequently, since the autonomy bill’s enactment, the SBP’s monetary assets have grown by nearly Rs10 trillion, mirroring the scale of its liquidity injections.
This indirect lending mechanism raises a fundamental question: has the central bank’s so-called autonomy meaningfully curtailed fiscal indiscipline? While direct borrowing from the central bank has ceased, indirect borrowing through commercial banks facilitated by OMOs introduces inefficiencies. One potential benefit is market-based price discovery for government borrowing, which aligns with the SBP’s benchmark policy rate. However, this intermediary process does little to address the root problem: the government’s persistent reliance on debt to plug fiscal deficits.
To its credit, the SBP’s autonomy has delivered measurable results in moderating the growth of reserve money (M0). In the years preceding the autonomy bill, M0 grew at an average annual rate of 18%. Since the bill’s enactment, this has slowed to just under 11%. This moderation reflects the central bank’s operational independence, underscored by its commitment to maintaining positive real interest rates. For the first time in Pakistan’s monetary history, M0 growth is broadly aligned with the sum of real GDP growth and target inflation (4% + 6%). This is a significant achievement, as excessive M0 growth—particularly through currency in circulation—has historically been a major driver of demand-side inflation.
While the SBP has brought M0 under control, the indirect lending mechanism has led to erratic growth in broad money (M2). Over the past three years, the Rs9 trillion increase in bank borrowing from the SBP has fueled a Rs13 trillion expansion in commercial banks’ investment portfolios, with nearly 60% of this incremental lending financed by central bank OMOs. This growth in M2 has far-reaching implications that may not yet be fully understood.
Although the long-run correlation between M2 and inflation is complex, economic literature suggests that unchecked M2 growth eventually filters down into M1—via channels such as asset price inflation or the wealth effect. For instance, the equity base of commercial banks has doubled during this period, enhancing their capacity to take on riskier lending. As monetary policy shifts toward an expansionary stance, this could lead to increased private-sector borrowing and, potentially, asset price inflation. In some cases, this unchecked growth could even result in asset bubbles, with destabilizing consequences during an economic downturn.
To ensure the sustainability of its monetary policy achievements, the SBP must adopt a more vigilant approach to broad money trends. Enhanced monitoring of M2 growth is essential, with robust frameworks to track its impact on inflation, asset prices, and private-sector credit expansion. Targeted liquidity management is also critical, as excessive OMOs risk undermining the progress achieved in moderating M0 growth. The central bank should carefully calibrate liquidity injections and transparently communicate their purpose to enhance market confidence.
The relationship between reserve money, broad money, sovereign borrowing, consumer price inflation, and asset prices remains complex and not fully understood. While progress has been made in moderating reserve money growth, the surge in broad money fueled by indirect lending through OMOs raises critical questions. Existing economic literature suggests that unchecked broad money expansion could eventually spill over into consumer inflation or asset price inflation, either through transmission mechanisms like the wealth effect or speculative pressures. However, these dynamics need further investigation to identify the precise causal links and mitigate potential risks effectively.
The SBP must remain extremely vigilant, as the fight against inflation is far from over. The next inflationary crisis might not originate from reserve money but from the unchecked growth of broad money, potentially destabilizing financial markets and consumer prices. Enhanced monitoring, proactive policy interventions, and rigorous research into these monetary interdependencies are essential. Without these measures, the progress made in stabilizing inflation and fostering economic resilience could be undermined by emerging risks from broad money growth.
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