The SBP autonomy

Wathra the acting governor of the State Bank of Pakistan (SBP) was confirmed the day before Ishaq Dar left the country on a two-country tour – the UK with the Prime Minister to participate in an investment conference and then to Dubai to attend the third International Monetary Fund (IMF) staff review on the 6.64 billion dollar Extended Fund Facility (EFF). The timing of the confirmation is indeed important as the IMF was unlikely to accept claims by Dar that he has been too busy for the past four months to select the next SBP Governor.

Many sources within and outside the PML-N have cited Dar claiming responsibility for the resignation of former SBP Governor Yaseen Anwar who, even his most ardent supporters acknowledge, was not one to take decisions in defiance of the Finance Minister’s instructions. Unfortunately for Anwar’s career in the SBP he developed a tendency to leak damning information to the media which embarrassed Dar not only within the country, which was not of paramount concern to a man with no constituency, but with the IMF because it disabled him from presenting a flawed defence when challenged by the IMF team during quarterly reviews. As the acting governor Wathra must have provided a comfort level to Dar, which led to his subsequent confirmation. In all fairness to Dar few Pakistani finance ministers have supported granting financial autonomy to their central bank governors, however, this holds more-true for Dar than most of his predecessors.

The paper titled Central Bank Autonomy, Accountability, and Governance: Conceptual Framework unambiguously states: “the IMF supports central bank autonomy and accountability, since it facilitates price and financial sector stability, which are conducive to sustainable economic growth. In the literature, autonomy is sometimes preferred to the frequently-used term independence, as autonomy entails operational freedom, while independence indicates a lack of institutional constraints. A central bank must have clearly defined and prioritised objectives, sufficient authority to achieve these objectives and be autonomous to remain credible”. In other words, an autonomous SBP can ensure price stability by refusing to lend irresponsibly to the government, and intervening in the market to shore up an unrealistic exchange rate with negative consequences on its reserve position. It comes as no surprises that Dar compelled the SBP under Anwar and then acting SBP Wathra to engage in such activities that would have been refused by an autonomous SBP represented by a Governor with the necessary backbone.

The IMF paper defines four kinds of central bank autonomy namely goal, target, instrument and limited autonomy. Goal autonomy entrusts the central bank with responsibility for determining the monetary policy and exchange rate regime (through market intervention), or simply the monetary policy if the exchange rate is floating. An example is the Federal Reserve Board which is empowered to include full employment and price stability as its major objectives. SBP during the PPP-led coalition government set a discount rate as per IMF conditions while Dar reduced the rate to encourage private sector growth but then proceeded to crowd out private sector borrowing.

Target autonomy entrusts the central bank with the same responsibilities as goal autonomy but with one major objective overriding all others for example the European Central Bank’s primary objective is price stability with the actual inflation target to be determined by the bank. The SBP remains subservient to the Finance Ministry to determine its primary objectives.

Instrument autonomy implies that the government or the legislature decides the monetary policy or target, in agreement with the central bank and the exchange rate regime, but the central bank retains sufficient authority to implement the monetary policy target using the instruments it sees fit. Not evident in recent years with respect to the SBP and finally there is limited or no autonomy implying that the central bank is almost a government agency. Unfortunately this is the closest definition of SBP.

There is no doubt that the SBP has absolutely no control over how much to lend to the government and governor after governor has either publicly expressed concern at the government’s heavy reliance on bank borrowing or else surreptitiously released data to the media in an attempt to forestall further lending to the government without collateral and without guarantees. While central banks do set a target for monetary financing of the budget, which is a component of monetary policy, yet in countries like Pakistan there are no explicit limits’ that disable the SBP from performing its primary responsibility of price stability. In other words the SBP has little if any control on capping government borrowing.

The SBP also does not determine the exchange rate. The exchange rate is directly being controlled by the government with both Dar and his Prime Minister insisting on under 100 rupee per dollar parity. The rate of exchange is dependent on the country’s reserve position, and in December Pakistan’s net international reserves did not meet the target set by the IMF under the EFF – a target which was then downgraded, yet Dar continues to exert pressure on the SBP to engage in market interventions through purchase/sale of dollars in the market. In recent months the rupee has strengthened in value, however, its negative impact on exports is also becoming evident. Had Dar allowed the SBP to use its expertise and determine the extent of market intervention to mitigate the negative impact on exports the rupee dollar parity may have been more realistic.

There is a potential conflict between conducting monetary policy and banking supervision as a central bank could be tempted to relax monetary policy to address financial sector problems that might have arisen because of weaknesses in its supervision instead of addressing the underlying structural problems, the IMF report argues. This, combined with the growing integration of financial service providers, is viewed by some as a good reason to separate the responsibility for prudential supervision from the central bank and to entrust it to an autonomous, specialised agency. On the other hand, a government agency in charge of banking supervision may be more prone to political pressures to license weak banks and not to enforce prudential regulation – particularly for state-owned banks which in turn may undermine monetary policy more than an autonomous central bank in charge of banking supervision, the report adds. The IMF in its March second review under the EFF maintains that “as of end December 2013 overall capital adequacy was around 15 percent (or the amount of capital each bank has to hold as determine by the regulator) and remained well above the statutory minimum capital requirement. Going forward profitability may decline due to the rising NPL provisions (with rise in provisions due to supervisory measures that classified loans in NPLs wherein during June-December 2013 provisions increased by one percent) the floor imposed administratively on the rate of return on savings deposits and declining financial intermediation. Deposits have grown at slower pace (14 percent year on year) due to low real interest rates, better returns on equity and real estate, and increase in withholding tax on cash withdrawals.” The signature of the Ministry of Finance is therefore clearly visible.

Political autonomy of the SBP also remains suspect. The Monetary Policy Committee (MPC) was set up in 2008 with five senior SBP employees and 2 eminent economists with the power to fix key policy rates (that would impact on government borrowing rates as well as private sector borrowing). Dar as a member of the then Senate Standing Committee on Finance opposed this and recently proposed a bill to create a new MPC but which would have recommendatory powers only. Somewhat akin to Dar’s economic advisory body staffed by many of his critics, many of whom have now tempered criticism of his policies because of the membership of a toothless body.

SBP, besides discharging its orthodox/traditional functions of regulating money and credit, according to its website, also plays an active developmental role to promote the realisation of macroeconomic goals. This accounts for the bank setting lending targets for specific sectors which reflect the priorities of each government but may well partly account for the high NPLs.

Global recession has focused attention of major western economies on the role of central banks once again: should central banks be focused only on inflation or should they pay attention to growth as well. Federal Reserve Board’s Bernanke maintained during his visit to India that “inflation targeting should not mean you should forget everything else. Central banks should also pay some attention to growth,” especially those in the developing countries.

Thus while one may urge SBP to take note of both inflation and growth yet unfortunately without any autonomy it is simply disabled from taking decisions that should have been its major responsibility. SBP should be allowed to regulate the money supply in the country through changing its discount rate (which explains why the IMF has been insistent that the Pakistan government raises rates with the objective of mopping up excess liquidity) and be the lender of last resort to the government which implies ability to refuse to lend to the Finance Ministry. However, with Dar in the driving seat this would remain a pipedream.