Three things the govt must consider when revising the State Bank Act

Provisions for prohibition of govt borrowings are necessary and must be retained in SBP Act, writes former SBP governor

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State Bank of Pakistan (SBP) building. — AFP/File
State Bank of Pakistan (SBP) building. — AFP/File

The recent public debate about the autonomy of SBP needs to be reviewed in its historical perspective. Till 1993, the SBP was administratively treated as a subordinate entity of the Ministry of Finance (MOF), the banking sector was controlled by the government mainly through the Pakistan Banking Council (PBC) and monetary policy was taken as an extension of the fiscal policy.

The SBP, being administratively under the control of MOF, its Board of Directors and the governor could take no major management or policy decision without prior approval of MOF. Moreover, the SBP Board of Directors and its governor could be hired and fired without any basis by MOF, and SBP could not release any statement or analysis of the economic situation in Pakistan or even its own mandatory Annual Report without prior clearance of MOF.

In the matter of overall financial system, licensing, inspection, supervision, regulation and management of nationalised banks and non-bank financial institutions were in the hands of MOF, and it mainly used the PBC for this purpose. In the process, the SBP was relegated to a secondary position and marginalised as the regulatory authority of the banking system.

There was no monetary policy worth the name as the government was deciding on its own how much to borrow from the SBP and commercial banks and on what terms and how much-subsidised loans were to be made available to priority sectors and the public enterprises. As regards credit to the private sector, the annual credit plan prepared for it by SBP was subject to approval by MOF, and thereafter implemented by SBP through administrative decisions. In spite of it being the central bank of the country, SBP was not authorised to use the conventional instruments of credit management without the approval of the MOF.

During 1993-1997, all aspects of the functioning of SBP in relation to the requirements of a modern state were fully reviewed in policy circles and thereafter necessary legislation was passed to give statutory autonomy to SBP. It was done in two installments, in 1993 and 1997, by the PPP and PML-N governments respectively.

Those indigenously-developed legislative reforms covering SBP’s own management and administration, regulation and supervision of the banking sector and formulation and conduct of monetary policy were introduced through appropriate amendments in the SBP Act, the Banks Nationalisation Act and the Banking Companies Ordinance.

These reforms gave to SBP for the first time administrative and regulatory autonomy and independence in the formulation and implementation of monetary policy. Under those reforms, the tenures of the Board of Directors and the governor of SBP were given legal protection, the SBP management and administration were freed from the supervision of MOF, PBC was liquidated and SBP was made the sole regulatory authority of the banking and financial system.

Most importantly, it was mandated that market-based monetary policy was to be formulated and implemented independently by SBP based on the targets for growth, inflation and balance of payments agreed in a high-powered Monetary and Fiscal Policy Coordination Board (MAFPB). These solid reforms legislated by PPP and PML-N governments were endorsed but not dictated by the IMF.

The SBP took prompt action to assert its administrative and regulatory autonomy and promptly recruited and trained additional professional staff to take up its enhanced responsibilities effectively. Its administrative and regulatory autonomy has remained intact since then, requiring no major revisions in the law.

However, in the matter of monetary policy, every government resisted the SBP's effort to limit its borrowing at a level consistent with the monetary targets set under the monetary policy. Instead of taking politically difficult fiscal and pricing measures, all governments continued to indulge in easy recourse to reckless borrowing from the SBP, violating the relevant provisions of the revised SBP Act. Beginning with the period of the Musharraf government, Section 9A and 9B of the then SBP Act relating to government borrowings from SBP and commercial banks were initially openly violated and subsequently muted, revised and withdrawn.

When the IMF staff mission visited Pakistan to begin negotiations for a policy package for a new program to bail out the Imran government from its emerging balance of payment crisis, it rightly pointed out that excessive government borrowing from the SBP needed to be controlled effectively. As the previous framework had failed to achieve the objective, the IMF staff proposed new legislation to forbid the government from borrowing from SBP altogether. In addition, many other changes were introduced in the draft SBP Act. Moreover, IMF made legislative approval of the proposed SBP Act a prior condition for the approval of their lending facility.

Some of the provisions of the proposed SBP Act leaked to the press spreading rumours that the IMF wanted to give extraordinary powers to SBP and use its sitting governor, who was appointed on their suggestion, for the ulterior purpose of directly managing the economy, thereby, undermining the authority of the government and sovereignty of the country. It created an environment of hostility towards the amendments in the SBP Act and provided an opportunity for the opposition political parties to use it to criticise the government for its mismanagement of the economy and failure to stand up to the IMF to protect the sovereignty of the country. However, the then government got the Act passed by the National Assembly on January 28, 2022.

After the fall of the Imran government through a no-confidence vote, the politically-powerful defence minister of the present government came out with a strong statement that they intended to revise the newly-enacted SBP Act and remove the sitting governor on the completion of his first term. The governor has indeed been replaced by promoting a deputy governor who also joined the SBP after serving the IMF for several years

At the same time, the finance minister has invited an IMF mission to visit Pakistan for negotiations to continue the fund program. In the circumstances, the government may ultimately face a dilemma to either not have access to fund resources or swallow the sour pill of accepting the revised SBP Act, in addition to other policy adjustments. In my judgment, IMF is unlikely to accept amendments to the SBP Act.

If IMF agrees to modifications, many exceptions and exclusions from investigation and prosecution given to Board and the Monetary Policy Committee members, management and staff, which are really not relevant for SBP autonomy, should be withdrawn. Nobody should be above the law in a law-abiding society. In addition, the SBP Act may be reviewed in three areas on professional and not political considerations.

First, the Act sets price stability as the primary objective of monetary policy following the tradition that is in vogue in developed countries. But in the case of Pakistan, monetary policy has to play an important role in increasing savings, investment and economic growth. In determining the price target, there can be differences of opinion within the Monetary Policy Committee of SBP and between the committee and the government. 

Moreover, in Pakistan, inflation is not exclusively a monetary phenomenon and is affected by a whole host of other factors and policies including supply-side policies, weather conditions, import policies and world prices, exchange rate and fiscal policy and pattern of income distribution and population growth. With the abolition of the Monetary and Fiscal Policy Coordination Board, prospects for agreement on inflation targets have diminished greatly.

Second, the abolition of the Monetary and Fiscal Policy Coordination Board is a retrogressive step for other reasons as well including the need for the development of a macroeconomic policy framework to anchor all policies in a consistent way. Informal contacts between the SBP governor and minister of finance cannot replace the formal institutional framework that has been dismantled.

Third, exchange rate policy cannot be exclusively determined by SBP because it has a bearing on the budget, foreign trade, price level and economic growth. A broad-based intergovernmental committee should be set up to approve the basic parameters of the policy that should guide SBP to manage the exchange rate on a day-to-day basis.

The provisions for the prohibition of government borrowings are necessary and must be retained in the SBP Act. Similarly, the provisions that protect the tenure of the governor and Board and Monetary Policy Committee members from arbitrary government decisions must be retained.

Originally published in The News