Major amendments were made by the parliament in 1994 and 1997 in the State Bank of Pakistan (SBP) Act on the initiative of the SBP itself that gave it, inter alia, legal authority to conduct an independent market-based monetary policy, including the power to “determine and enforce” limits on government borrowing from the SBP.
The capacity to have a complete control on its own balance sheet by the SBP, and to have a firm handle on all the sources of reserve money creation, is a prerequisite for an effective and autonomous monetary policy geared to promote the twin objectives of containing money supply within safe limits to ensure relative price stability [c1] and channelling bank credit to productive sectors to promote economic growth. In the absence of the SBP’s complete control in actual operations over all sources of reserve money creation, including government borrowing from the SBP, any other legal provision that gives it autonomy in the conduct of monetary policy becomes a farce.
These amendments were strengthened further by the enactment of the Fiscal Responsibility and Debt Limitation Act in 2005 by the Musharraf government, and addition of Section 9C in the SBP Act by the PPP-led government in 2012 to meet IMF conditionality.
While such laws were being enacted, under one compulsion or the other, by successive governments ostensibly to enhance the SBP autonomy, in actual practice the SBP was being made operationally more subservient to the government. This was being done by appointing weak and incompetent management in the SBP that would abide by the instructions of the government and show no resistance to government’s excessive bank borrowing to finance fiscal operations.
Laws are only as good as their implementation and none of the recent governments or SBP governors have shown resolve in adhering to the revised SBP Act. The result is that the SBP was never as ineffective as at present in contributing to sound macroeconomic management of the country and conducting a comprehensive and coherent monetary policy in co-ordination with the fiscal and exchange rate policies.
From the past experience, it should be clear to everybody, including the IMF, that further amendments to the SBP Act alone will not make the SBP operationally more autonomous. However, the IMF came up with certain new proposals to further amend the SBP Act as if those will solve the problem.
To satisfy the IMF conditionality under its current EFF arrangement, the present government has introduced a bill in the National Assembly to further amend the SBP Act. Most of the amendments relate to the sections that had become redundant as a result of the separation of East Pakistan and the nationalisation of the banking system, including the SBP, by the government of Zulfiqar Ali Bhutto. All the deletions/amendments to those sections and some other minor changes are welcome and would help remove confusion but will have no practical significance for the functioning or autonomy of the SBP.
However, there are three substantive revisions proposed to be made in the SBP Act that deserve attention.
First, and most important, a new Section 9D is proposed to be added to establish an “independent monetary policy committee” to “formulate, support and recommend” monetary and exchange rate policies, “determine the nature and limits” of the SBP lending to the government and “assist” in other monetary policy measures.
Second, the period of retirement of the outstanding debt of the SBP as provided for in Section 9C is proposed to be extended from eight to twelve years.
Third, a new Section 8(d) has been proposed to enable the SBP to establish a deposit protection fund.
It is easy to dispose of the last two proposals. The explicit authority given to the SBP to establish a deposit protection fund is a welcome step even though the SBP was implicitly empowered to do so even in its absence if it so desired.
The extension of the deadline for the retirement of the SBP debt by the government from eight to twelve years has no practical significance. Some of us had pointed out when this provision was introduced in 2012 on the recommendations of the IMF that it was impractical and unnecessary. It is highly unlikely that the government budgetary position would improve to an extent that, instead of additional borrowing, it will be able to retire its outstanding debt to the SBP.
The most substantive proposal in the new amendments of the SBP Act is that relating to the creation of the monetary policy committee under a new Section 9D.
It is not clear from the draft bill whether the committee decisions will be final, and if not, who will review and approve/reject the recommendations/decisions of the monetary policy committee. The most charitable interpretation can be that the SBP board of directors will remain the final authority for the approval of the monetary policy because Section 9A has been retained unchanged and Section 9D (d) itself confirms its authority by stating that in an emergency the governor alone could take decisions about monetary and exchange rate policies and get them “approved from the board of directors in its next meeting”. The more sinister interpretation could be that the final decision will rest with the government.
Regardless, formulation and implementation of monetary and exchange rate policies is a highly professional, specialised, and sensitive job requiring skills, experience, research and responsibility of the highest order and is indeed the core function of a central bank. Taking away the core function of a central bank from the SBP and handing it over to a heterogeneous committee is not a step towards strengthening of the SBP as a vital national institution.
Section 9A of the SBP Act had given exclusive right to the board of directors of the SBP to “determine and enforce” limits on government borrowing on monetary policy considerations. It basically meant that the chairman of the board, who happens to be the governor SBP, would guide and lead the board in the matter based on extensive staff studies, and after having had extensive prior consultations with the government through its Monetary and Fiscal Policies Co-ordination Board.
The addition of Section 9C in the SBP Act in 2012 had already created confusion about who will determine government borrowing from the SBP. Now comes the addition of Section 9D that fragments even the institutional arrangement for the formulation and conduct of monetary and exchange rate policies, restricts the authority of the board of directors and of the governor in the matter and leaves confusion as to who will be in charge of monetary and exchange rate policies.
Under Section 9D the task of formulating monetary and exchange rate policies has apparently been shifted to the proposed monetary policy committee consisting of ten members, including the governor as its chairman, three senior executives of the SBP nominated by him, four members of the board nominated by it and two outside economists to be appointed by the federal government. At the same time, section 9A and 9B of the SBP Act are retained without any change that prescribe a totally different approach to decision-making for monetary management.
For a competent SBP governor who would like to decisively handle the monetary policy by adhering to the law, such a contradictory and confusing institutional structure will create a nightmare for the following reasons:
First, the three subordinates of the governor will be members of the monetary policy committee with the same voting right as the governor. If they act subserviently to the governor in voting in the committee in the interest of their careers, their votes will always go with the governor and they will have no independent input in policy approval. If they act independently, there is a potential of an internal paralysis of discussion, decisions and governance in the SBP. The inclusion of three SBP staff members in the committee with a voting right at par with the governor, therefore, would weaken the authority of the governor and adversely affect governance of the SBP.
Second, the four board members on the committee would either have to be educated and guided by the SBP staff and/or the governor separately from the general board meetings or they would not have knowledge of the background and economic analysis undertaken by the SBP staff. In the circumstances, there may be lack of co-ordination and even chaos and conflict between the board members on the committee and the governor and his three staff members in the committee deliberations.
Third, the induction of two outside economists in the committee to approve the monetary policy carries with it equally dangerous consequences. First of all, appointment of outside economists as committee members, over and above the board, amounts to a no-confidence vote in the professional competence and calibre of the governor, the board of directors and the technical staff of the SBP. Moreover, monetary policy is a very specialised branch of economics and an outside economist having no training in monetary economics or experience in macroeconomic policy formulation may turn out to be an obstacle rather than help in the deliberations of the committee. As the saying goes, a ‘neem hakeem’ may be dangerous for the life of a patient under his treatment.
Fourth, Several permutations and combinations of voting blocs could not only make a competent governor helpless but also paralyse the conduct of the monetary and exchange rate policies. If a combination of the representatives of the board of directors and the two external economists appointed by the government muster a majority of votes in the committee, the governor and the three staff members of the committee would need to accept the committee decisions in policy matters even if those go against their professional views and advice.
Fifth, the implementation of the monetary and exchange rate policies so approved would rest in the hands of the governor and his professional staff. If the decision is against their professional judgement, there would be reluctance on their part to implement it in letter and spirit. Imagine what will happen to the government budget if its formulation was given to an independent group of people and its implementation left with the ministry of finance.
Instead of fragmenting the institutional framework for monetary policy formulation, it would make sense to take steps to enhance the capacity and autonomy of the SBP itself by appointing competent governors and qualified members of the board, and further strengthening the technical and economic research capability of the SBP by undertaking the following reforms, some of which will require amendments to the SBP Act:
First, the board of directors should be reconstituted consisting of professional people from the private sector with the finance secretary removed from the board. The governor SBP should prepare an annual list of such professional people based on an objective criteria of qualifications and experience out of which the federal government could pick up people to fill in the vacancies. The governor and its professional staff would act as a brain trust to guide such a board regularly with background studies, briefings on economic developments and monetary policy options and their implications.
Second, the governor should be a qualified monetary economist, preferably with a Ph.D. from a foreign university, and having enough national or international experience in macroeconomic policy formulation and implementation. A survey of the educational background and policy experience of governors of other central banks would show that these indeed are the requirements for the post. Either the board of directors of the SBP or an independent commission set up for the purpose should come up with three names out of which the federal government could pick up one for appointment as governor.
Third, the governor’s tenure should be for five years with no clause for extension/renewal of his/her tenure. Three years are too short a period for a governor to leave his/her mark on the institution and renewability of his/her term after three years may weaken his/her resolve to act boldly and independently.
Fourth, the appointment of deputy governors should be taken out of the hands of the federal government and given to the board of directors to be made on the recommendations of the governor. They should be treated as senior staff members of the SBP rather than nominees of the government. Moreover, the vacant position of the deputy governor (policy) should be filled by appointing a competent and experienced macroeconomist.
Fifth, quarterly meeting of the Monetary and Fiscal Policies Co-ordination Board must be held to co-ordinate fiscal, monetary and exchange rate policies as specified in Section 9B of the SBP Act. In the conduct of these meeting, the provisions of Section 9C (6) of the SBP Act should be respected that states that “the Co-ordination Board shall not take any measure that would adversely affect the autonomy of the State Bank of Pakistan.”
Sixth, the government should abide by the existing provisions of Section 46B (1) of the SBP Act that states that ” no government or semi-government body or agency shall issue any directive, directly or indirectly, to any banking company or any other financial institution regulated by the Bank which is inconsistent with the policies, regulations and directives issued by the Bank”.
Seventh, and most important of all, the government should “own” the autonomy of the SBP as an essential prerequisite for improvement in economic governance of the country rather than fulfilling a conditionality of the IMF.
The above institutional and staffing improvements should constitute an integral part of any attempt to enhance the operational autonomy of the SBP and insulate the monetary policy from undue interference of the ministry of finance.
(The writer is a former governor of the State Bank of Pakistan)Dr. Muhammad Yaqub, "Legal vs operational autonomy of SBP," Business recorder. 2014-04-09.
Keywords: Economics , Economic issues , Management , Banks and banking , State Bank-Pakistan , Pakistan , IMF , SBP