The move to make the State Bank of Pakistan an autonomous institution has become a favourite topic of a heated debate in the country. Recently, the federal cabinet approved amendments to the State Bank of Pakistan (SBP) Act in the name of the central bank’s autonomy, accountability and price stability. If the parliament approves the amendments, the SBP will hold more sway to target inflation. In line with global practices, the State Bank of Pakistan has been taking measures to shift to flexible inflation targeting (FIT). In FIT, price stability becomes the overriding objective of monetary policy. The enactment of the SBP Amendment Act is an important milestone in this regard.
It may be added here that until now the State Bank of Pakistan has been working under the 1956 law with the mandate “to regulate the monetary and credit system of Pakistan and to foster its growth in the best national interest with a view to securing monetary stability and fuller utilisation of the country’s productive resources”. According to experts, there was no clarity on the exact role of the SBP pertaining to inflation, credit, employment or economic growth.
The new SBP Act will assign the task of price stability and inflation targeting to the central bank. Though it would only be possible to understand the underlying implications of the amendments after they are approved by the parliament, yet it appears that price stability would now be the SBP’s primary function, while financial stability and support for economic policies will be its secondary objectives.
In order for the State Bank of Pakistan to meet the ends, the grant of unprecedented autonomy is on the cards. The move would take the edge off the role of the Ministry of Finance and the government as it entails the abolition of the Monetary and Fiscal Policies Coordination Board (MFPCB) to minimise the “risk of undue political influence over the SBP’s monetary policy.” The MFPCB is predominantly managed by the finance ministry, which plays a defining role in the implementation of the monetary and exchange rate policy. But after the passage of the new law, the State Bank of Pakistan will have the freedom to determine and implement the monetary and exchange rate policy. Furthermore, the SBP shall not extend any direct credits to or guarantee any obligation of the government, or a government-owned entity or any other public entity. Earlier, the government borrowed from the SBP to meet fiscal expenses.
Furthermore, the State Bank of Pakistan will abolish the Rural Credit Fund, Industrial Credit Fund, Export Credit Fund, Loans Credit Fund and Housing Credit Fund. It implies that the SBP will not fund quasi-fiscal operations and economic growth-related activities. However, the SBP will provide the refinance facility only to financial institutions, and can provide the short-term facility to a troubled commercial bank, provided the federal government acts as a guarantor for the sanction of such a loan.
The governor of the State Bank of Pakistan shall be appointed by the President of Pakistan for five years, and the federal government will appoint the deputy governors. The external members of the Monetary Policy Committee (MPC) will be appointed by the federal government on the recommendation of the SBP board. Members of the parliament or a provincial assembly and members of a political party cannot be members of the SBP board or the MPC. Importantly, the government cannot remove the governor or deputy governor except under extraordinary circumstances.
The new law provides that an “executive committee” of the SBP will be set up under the governor and with the deputy governor and executive directors of the SBP. The executive committee will decide any “residual matter” that has not been explicitly addressed by the new law. The governor shall submit the annual report before the parliament regarding the achievement of the SBP’s objectives, the conduct of the monetary policy, the state of the economy and the financial system.
There are three important ramifications of the amendments: first, price stability is declared as the prime objective of the SBP. This is significant keeping in view the country’s history of sudden jumps in inflation. It goes without saying that inflation erodes the purchasing power of the consumers and the confidence of the investors.
In the new scheme of things, the government cannot directly borrow from the State Bank of Pakistan. Government borrowing is inflationary and it crowds out private investment and, consequently, the country’s economic activities bear the brunt. If autonomy is given to the SBP, the Ministry of Finance and the government’s role will be minimised. However, this is not the first time that such autonomy will be given to the State Bank of Pakistan. According to the website of the SBP, “Under financial sector reforms, the State Bank of Pakistan was granted autonomy in February 1994. On 21st January 1997, this autonomy was further strengthened by issuing three Amendment Ordinances.”
All said, it remains to be seen how the whole scheme works out. Will more autonomy be good for the economy? If the results are not as expected, will the decision be reviewed and reversed? Only the time will answer these questions.