State Bank’s terms of reference

The State Bank of Pakistan (SBP) report comes in the wake of the commitment in the August as well as December 2013 Letter of Intent (LoI) signed by the government represented by the Federal Finance Minister Ishaq Dar and the Governor of the State Bank of Pakistan (SBP) Yasin Anwar to the International Monetary Fund (IMF) under the 6.4 billion dollar Extended Fund Facility to make the State Bank of Pakistan autonomous.

The report focuses on last fiscal year and most of its findings relate to decisions taken during the tenure of the PPP-led coalition government. However, some of the macro indicators performance is due to the PML-N government’s decisions taken in June 2013, including the decision to retire the inter-circular energy debt through borrowing, and making some budgetary tax measures applicable from June 11, 2013 notably the rise in the general sales tax from 16 to 17 percent. Both these decisions, economic theory argues, are highly inflationary which account for a rise in inflationary pressures. However, the State Bank Governor publicly opposed the then Finance Minister Hafeez Sheikh’s recommendation to go on an IMF programme sometime in November/December 2012, a view supported by former President Zardari due to expected negative political implications on May 11 general elections, he fully supported the September 2013 Extended Fund Facility (EFF) programme. The reason could well be that the EFF conditions especially with reference to the SBP were supported by the Governor, as indeed they would be by any central bank governor.

The August LoIs contained the following commitment: “Amendments to the SBP law, incorporating the recommendations of the recent IMF safeguards assessment, will be enacted to strengthen the autonomy of the SBP, including full operational independence in its pursuit of price stability as its primary objective, complemented with enhanced governance structure including strong internal controls, by end-March 2014 (structural benchmark). Among other things, the amendments will establish an independent, decision-making monetary policy committee to design and implement monetary policy and prohibit any form of new direct lending from the SBP to the government”. The December 5, 2013 LoI reiterates this condition given that its compliance date is set as end March. However significantly the December LoI contains a commitment not contained in the August LoI namely: “The SBP will establish a Board committee to centralise and oversee risk management activities across the bank by end-January 2013. The SBP will approve a plan to fully implement International Financial Reporting Standards (IFRS)” – with IFRS designed to ensure that company accounts are understandable and comparable across international boundaries.

At present the Internal Audit and Compliance Department in the SBP has the following terms of reference: to “transform into a modern, efficient, proactive and IT-oriented department, fully capable to conduct independent audit of all activities of SBP, aiming to add value, improve operational efficiency, risk management and internal control system in line with international best practices, for accomplishment of Bank’s mission”. The divisions that come under this department are as follows: (i) Financial & Operational Audit Division; (ii) IT Audit Division; (iii) Quality Assurance Division; (iv) Compliance Division; and (v) Support Services Division. At present the committees of the SBP Board of Directors include committee on audit, human resources, investment and an advisory committee on monetary policy. Or in other words, the debt management function “currently fragmented across different agencies” needs to be centralised. Thus the condition, if and when implemented in letter and spirit, would strengthen the risk management function of the SBP by the end of the current month – two months before the time-bound condition to strengthen the autonomy of the SBP. In other words neither the Fund nor indeed the SBP is convinced of the claims made repeatedly by Ishaq Dar that the SBP is autonomous.

The major responsibility of a central bank is to formulate and implement a monetary policy designed to pursue price stability and that is currently being compromised in Pakistan by heavy domestic borrowing by the government. In the first staff review dated 11th December 2013 the Fund states “the significant increase in banks’ holdings of government securities from 22 percent of the banking system total assets by 2010 to 37 percent in June 2013” (and needless to add the June 2013 figure includes over 300 billion rupees used by the PML-N government to retire the circular debt that has since resurfaced) “is contributing to a contraction in private sector credit. Banks hold around 75 percent of government securities and 90 percent of these securities are held as Available for Sale, exposing banks’ balance sheets to revaluation risks. Staff and authorities agreed that ultimately the key to sovereign risk reduction is the achievement of a lower deficit, together with recovery of private sector lending over time.” What is equally disturbing is the Fund’s statement that “the government has been financing around 85 percent of fiscal deficit through the domestic debt market… given uncertainty in the policy interest rate and the increase in government domestic debt (around 25 percent during the last fiscal year) banks have been reluctant to invest in government bonds and have heavily concentrated in three-month tenor T-bills.” Technical work, as per the Fund has begun for developing a medium-term debt strategy. In effect the government is compelled to rely on short-term credit at higher rate of interest with its consequent impact on the rate of inflation.