To some commentators, the proposed reinforcement of State Bank of Pakistan (SBP) powers appears to be appropriate; to others, it gives the SBP unbridled power over the economy, outside the oversight of, or accountability to, any National authority. There is other criticism as well - why has inflation-targeting been given paramountcy when it may not be what is most hampering our economic growth, and is our ‘type’ of inflation susceptible to containment by higher interest rates; also, why has SBP commitment for growth and development weakened…
This writer thinks the misgivings may be misplaced. SBP is now gaining authority over Monetary and Exchange rate policy that has been given to Central banks in practically all the Advanced countries, and in most of the larger Emerging Markets (EMs). Its objectives are stated transparently and unambiguously in the proposed Law – with the SBP’s increased independence, has come, inevitably, increased accountability. SBP officials have not actually been placed above the law. Interest rate policy already recognizes and acts appropriately with “supply’ side pressure. And Pakistan is indeed poorly served with respect to Development Finance support; though Central Bank can support the Government’s development policies, it is not a Development Finance Institution (DFI) itself.
Internationally, control over Monetary and Exchange rate policy started moving from Governments to Central Banks during the early ‘90s. It is now the practice in the Advanced countries, and in most of the larger EMs. While Inflation targeting was originally directed at containing price pressure, most Advanced countries are reversing its direction, and trying to stimulate price inflation to avoid a slump - the result of stagnant/falling demand, a lingering consequence of the 2008 Financial crisis. Either way, reaching an Inflation target is still the objective, and it is managed by Central Banks.
In the context of Pakistan, high’ish inflation is a problem. We rank the 26th highest out of 185 countries for CPI inflation, as of Feb 2021. Our 8.7% rate compares to a world average of 2.5%. Advanced countries average 1.5%, and EMs around 3%. Based on these interest-differentials with the rest of the world, improvement in our terms of trade will need either consistent Rupee devaluation, itself spurring inflation, or a strong inflation targeting effort, which SBP will now have to manage.
Inflationary trends in Pakistan have been aggravated by unrestrained reserve-money creation through Government borrowings from the Central bank, which have substituted for revenue not raised through rigorous Tax enforcement. The result is lower than potential Tax revenues, and higher inflation.
Past efforts to limit Ministry of Finance (MoF) borrowings from the SBP have floundered badly. A rule added to the SBP 1956 Act in 2011 required that government debt outstanding at the Central Bank at the time, about Rs 2 trillion, be reduced to zero within the next 10 years, and simultaneously required that any subsequent borrowing be fully repaid by the end of the quarter that it was drawn. An attached clause stated that if the Government breached the rule, the Finance Minister would present a detailed justification before Parliament, implying that such event would be exceptional.
This restriction (somewhat qualified, if the MoF chose to read it that way), has been honoured more in the breach than in the observance.
Since 2011, government borrowings from the SBP have seen a low of Rs 1.4 trillion (6/16), and a high of Rs 9.1 trillion (5/19), with the scale varying according to whether or not Pakistan was in an International Monetary Fund (IMF) programme. During IMF programmes, there would be a switch, from SBP to Commercial bank debt – correspondingly, debt from Commercial banks shows a low of Rs 1.9 trillion (5/19), and a high of Rs 9.4 trillion (3/21). The only constant has been the steady, fourfold, rise in the sum of both – from Rs4 trillion (6/16) to Rs 15.7 trillion (3/21).
Central Bank finance for government debt, and past MoF influence over exchange rate management, has led to periods of fiscal and monetary recklessness where subsidised exchange rates aggravated import demand, itself spurred by low interest rates.
Such excess has regularly caused a current account blow-out, sharp rupee devaluation, high inflation and, inevitably, IMF-related growth-compression. The recurring cycle has led to long-term misallocation of domestic savings e.g., to trading and land/real estate instead of industrial investment, which would be vulnerable in periods of an overvalued rupee, and also to demand-restraining austerity policies that would follow. Our sustainable GDP growth rate, since 1990, appears to be about 4% per annum, with higher growth periods only induced by excess money creation.
It appears the MoF, on behalf of the government, has now volunteered ‘handcuffs’ on itself with respect to additional SBP debt. The Rs 6.3 trillion now outstanding will run off as it matures, and no new debt will be taken. The MoF will sponsor the SBP law before Parliament. This augurs well for SBP control on GoP debt becoming a de jure reality.
Moving on to inflation targeting: the target everywhere is normally set by government in consultation with the Central bank, and that must be the case in Pakistan.
As regards characteristics of inflation in Pakistan, SBP’s interest rate policy, in recent periods, acknowledges that consumer price pressures can flow from the high share of Food and Energy in our CPI, as both are vulnerable to unforeseeable price spikes. Since these can be transitory, countervailing interest-rate increase is avoided, unless the impact appears to crystallize into core (i.e., non-food/non-energy) inflation.
When we set our Inflation target, we should do this as a range, rather than a single number. Apart from in some half a dozen countries, Central Banks do target within a range; e.g., India has a 4% target within a plus/minus band of 2%, so the range is 2% to 6% (actual inflation 5.2%); Turkey has 5%, with a 2% band either side, so 3%-7% (actual inflation 16%; this aberration has political background, two central Bank Governors have been removed, reportedly for raising interest rates to get inflation within the range); Brazil, 4.5% with a 2% band, so 2.5% to 6.5% (actual inflation 3.8%). We could set a range target of 3% to 7%, for example.
While the Central bank must have Inflation control as its only target, economic conditions could require forbearance; the challenge is to manage interest rates, output trends and inflation within a framework of consistency, with ‘forward guidance’ providing the market transparency for what to expect. This is where a range spectrum will provide the elbow-room that monetary policy will need.
As a separate subject, the proposed increase (after decades) of SBP’s paid-up capital to Rs 100 billion, from Rs 100 million, and building its General Reserves, to be funded from SBP profits, is reasonable. The aim is to raise capital to 8% of liabilities. Eliminating quasi-fiscal funding, i.e., items booked with the SBP, that should be reflected in the Government Budget (such as financing Pakistan Railways, or absorbing the capital losses of ZTBL, as in the past) is fair, as well.
Moving on to concerns about SBP oversight and accountability.
Accountability for Monetary policy outcomes is evident, as the SBP’s objectives, in the new law, have been set out unambiguously. Against the general objective in the 1956 Act, of “securing monetary stability and ensuring fuller utilization of the country’s productive resources”, the proposed law states the primary objective as “to achieve domestic price stability”, and subject to that “contribute to the stability of the financial system, and subject to both these, “contribute to the fuller utilization and development of Pakistan’s productive resources”.
Because the primary objective is singular, specific and overriding, the performance of the SBP will now be transparent to the Executive, and to Parliamentary bodies, to businesses, investors, and to the general public. Data presented, logic and quality of analysis of forecasts, and divergences from previous assessments, etc., will leave large markers that will make evident the quality of SBP performance.
SBP will provide reports to Parliament, which besides reviewing the economy as whole, will specifically track progress and performance, against Inflation targets. Once annually, the Governor will appear in person before Parliament, and Parliament can ask any senior officer to appear personally, at any time.
Independent Directors of the SBP Board, non-SBP members of the SBP, and the Governor and the three Deputy Governors, are all appointed by government – while the proposed procedure may vary from the earlier, government’s authority over top-level appointments remains absolute.
As practical reality, SBP will, and critically, need recurring dialogue with the MoF. Pragmatism will require good mutual understanding, and, if exceptional conditions justify it, some accommodation. The SBP must not be found ‘surprised’ by any MoF action that disrupts its forecast projections, as SBP’s ‘forward guidance’ would begin to lose credibility.
SBP will continue to have the MoF as its sponsoring entity for putting matters before Parliament, for changes to its Act, and to the Banking Company Ordinance. The SBP Executive Committee now proposed is not a ‘legislative’ body; it will deal with operational matters, within powers already granted.
As for actions being brought against SBP officials by government’s investigating agencies, the new act proposes prior consent of SBP’s Board of Directors before an investigation can proceed. The 9-man (voting) Board has 8 non-executive directors, besides the Governor. The outside Directors are appointed by the Government based on their professional experience and expertise, and their opinion should carry weight.
Thus, the concerns about SBP being free from oversight, its lack of accountability, complete independence from government or Parliament in terms of making its own laws, etc., appear exaggerated.
The concern about SBP relegating responsibility for development to a tertiary objective is understandable. But the primary responsibility for Development lies with the government.
The SBP provides refinance to priority sectors, sets increasing targets for commercial bank lending to small businesses, agriculture, and for housing, expanding its refinance facilities in times of economic difficulty, etc.
But SBP cannot fill-in for our sorely-felt lack of institutions that could provide medium and long-term capital for productive investment to our small and medium enterprise, coupled with technical and strategy development advice. Nor do we have proper project finance institutions, for infrastructure. In all the large EMs, public-sector institutions to service these needs have been set up by Government, and many, have grown to very substantial size.
To conclude: SBP autonomy is necessary to strengthen our economic infrastructure. It’s application will inject urgency into the Fiscal revenue effort; inflation containment should encourage longer-term savings and investment decisions, in the confidence that the SBP has the authority, the tools and the will to contain sharp price and exchange-rate movements; and all this should contribute to higher growth than we can presently sustain.
(The writer is a former Governor of SBP)
Copyright Business Recorder, 2021