Does SBP need further independence?

There has been significant interest on the debate about the independence of the SBP. There is utter confusion and lack of economic content in the discussion. In order to understand the issue, one requires an understanding of macroeconomic management; the linkages between the monetary, fiscal and external sectors; the process of money creation; the role of central banks vis-a-vis commercial banks; and the difference in the monetary and economic impact of financing the budget through alternative means.

This is a subject I have dealt with extensively at the IMF since I designed a number of stabilisation programmes for countries facing macroeconomic instability i.e. inflation and balance of payments difficulties, exchange rate instability or depletion of forex reserves. I have also taught the subject, financial programming, at the central banks of Sri Lanka and Egypt for the IMF. An extremely important subject though, financial programming is not taught at NDU or any civil service training institutions, probably because they do not know that such a subject exists.

The independence of the central bank that is at stake has to be understood in terms of macroeconomics.

Starting from the basics, the SBP is a government institution, but for purposes of macroeconomic management it is viewed distinctly. It has two major roles in accordance with its act — one, as a regulator of the commercial banks; and two, as custodian of the value of the rupee and maintaining the exchange rate.

The role of regulator of commercial banks is not being debated nor is it under explicit threat from the government even though the SBP has grossly failed on that score: Just look at the big spread between the lending rate and deposit rate; look at the crowding out of the private sector from the commercial bank lending; look at the market failure in availability of project finance — and all this while commercial banks have made huge profits, and colluded to keep treasury interest rates high, thus draining scarce budgetary resources. Last year interest payments used up nearly 2 trillion rupees from the budget. Yes 2 trillion! Over 70% of total tax revenue. By the way, the government is again raising taxes to make even higher interest payments due to the recent hike in the interest rate by the SBP.

It is the independence of the SBP that is a subject to consider when we look at whether the central bank can fulfil its responsibility to keep inflation under control and protect the exchange rate. It’s about the independence of policymaking, and not a declaration of an independent state within state. I have personally been asked twice by the government and the SBP in the late 1990s to amend the SBP act in the context of macroeconomic necessity. It has been done! The present failure to control inflation and the exchange rate are policy failures of the SBP to control the money supply.

The amendments proposed to the current SBP act are irrelevant to the policy requirements to control inflation or stabilise the exchange rate. These amendments are not designed to increase the central bank’s ability to control money supply which is the primary determinant of inflation. While direct borrowing by the government from the SBP is creation of high powered money or reserve money with a multiplier effect on M2, the latter can be suppressed and reduced by the SBP through other instruments. And it must be understood that if the government is completely denied borrowing from the SBP, it will be left to the mercy of the commercial banks which extract higher interest rate from the government in the auction of treasury papers. And the impact on the money supply of borrowing from the commercial banks is also expansive, adding to total domestic credit. The problem in Pakistan is not so much the different impacts of the source of financing, but the size of the budget deficit. The Fiscal Responsibility and Debt Reduction law exists to deal with the adverse impact of fiscal spending, if only the government would abide by it. At current levels of budget deficit, the contribution to inflation is substantial which the SBP has not tried to offset other than by raising the interest rate which is ineffective and counterproductive.

If anything the proposed amendments to the SBP act are an infringement on the ability of the government to conduct fiscal policy. Monetary and fiscal policies are intricately intertwined. By eliminating the monetary and fiscal policy coordination committee and by relegating the secretary finance to a mere spectator in other committees of the SBP, while reducing an independent say and oversight of these committees by professional members, the SBP has acquired powers that would be suspect in any democratic accountable system even if the bank had performed very well under its present management. But the performance has been dismal and scandalous. Not only has the SBP failed to control inflation under a functioning IMF programme, the exchange rate has been subjected to a continuous depreciation, at times perilously unstable due to the policy actions of the SBP under the present governor. The scheme to attract hot money through a high interest rate was a scheme to hoodwink the government to believe it built reserves. It was not only an illusion but it also cost Pakistan scarce foreign exchange in terms of interest payments and also destabilised the forex markets with adverse impact on foreign trade. The original scheme has been replaced by other similar hot money schemes but with more beguiling names like Roshan Pakistan etc. The present SBP governor has not revealed the beneficiaries of the scheme despite public clamour. A high interest rate has not only failed to control inflation but has also hurt Pakistan’s industry and burdened the budget.

To grant the proposed autonomy to the SBP under a badly performing governor — who is committed to returning to the institution which is Pakistan’s creditor — is ignoring conflict of interest as well.

Published in The Express Tribune, January 8^th, 2022.

Like Opinion & Editorial on Facebook, follow @ETOpEd on Twitter to receive all updates on all our daily pieces.