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The State Bank of Pakistan (SBP) amendment bill was approved by the cabinet on 9 March 2021 after less than a 10-minute debate. Subsequent reports circulating in the media indicate that there was considerable difference of opinion between the SBP and the Finance Ministry officials on some of the clauses however the latter capitulated when the International Monetary Fund (IMF) insisted on the inclusion of the clauses as a ‘prior’ condition for the release of the 500 million dollars under the staff agreement reached on the second to fifth review on 16 February 2021 – an amount which is around 500 million dollars less than what was originally envisaged up to the fifth review.

Two observations are in order. First and foremost, the bill has been approved by the cabinet but would require parliamentary sanction. While the government has sufficient numbers to ensure its passage yet skeptics argue that the Ministry of Finance may work through the members of the standing committee (government and opposition members alike) to ensure that its concerns, reportedly overruled by the IMF, may be inserted/deleted, while legitimately disclaiming any responsibility for the changes.

And secondly, the media has been inundated by former finance ministers, or senior officials associated with the Ministry of Finance, vociferously arguing against the SBP bill by pointing out that this would result in lack of the critical coordination between the policies of SBP and Ministry of Finance. Sadly, previous governors of the SBP have either not been invited to share their thoughts on the amendment or are naturally reticent about expressing their opinion in public and hence the one-sided view has gained prevalence.

There is no doubt that our ministers of finance, including the incumbent, have engaged in policies detrimental to the health of the economy and have persistently abused their power to force the SBP to take decisions that are patently flawed. Two recent decisions come to mind. First, the trend by all recent ministers of finance, including the incumbent, to borrow domestically as well as internationally to meet the rise in expenditure has not only raised the country’s total indebtedness, with ever rising annual debt servicing payments, but also stifled its own capacity to invest in development and thereby fuel growth. While the outlay on the Prime Minister, the President and some ministries has declined, yet this decline is cosmetic as current expenditure continues to rise. The containment of expenditure in 2020-21’s budget is sourced not to any economies by the government but to G20’s debt deferment initiative in response to Covid-19 - a deferment, not a write off. External borrowing has risen in two years with the Ministry of Finance acknowledging in the relevant standing committee recently that it borrowed 19 billion dollars to pay loans associated with previous administrations (a not unusual situation as this situation is faced by all incoming administrations globally) while 5 billion dollars was procured to meet the primary surplus (minus interest/debt repayments) target agreed with the IMF.

From end August 2018 when the PTI administration came to power till September 2020 domestic borrowing rose from 16.5 trillion rupees to 23.7 trillion rupees – a 44 percent rise in just two years. The SBP as a lender of the last resort, though our history suggests it has, at times, been used as the lender of the first resort, if granted autonomy would be enabled to challenge the government’s insistence on printing more money to meet the steady rise in its current expenditure or indeed to support it in procuring loans domestically.

Second, former finance minister, Ishaq Dar, is responsible for browbeating the SBP to keep the rupee overvalued which throttled the export sector and encouraged imports leading to the highest ever current account deficit of 20 billion dollars in 2018. If the government’s interference in pressuring the SBP to set an exchange rate that is not market based ends with the grant of autonomy then one must support SBP autonomy.

However, the foregoing is premised on the SBPs ability as well as capability to discharge its responsibilities. There has been much concern over the draft of the SBP amendment bill giving SBP the primary responsibility of keeping a lid on inflation. This is supported in economic theory as well as in the objectives of central banks of advanced countries however it is relevant to note that: (i) SBP’s ability to check inflation is severely curtailed due to the large informal sector in the country, parallel to the legal economy; (ii) supply side issues which a recent SBP report acknowledged were associated with mafias operating in the supply chain; (iii) taxes imposed on utilities as well as on other products/services in the economy impact on inflation but are beyond its influence; (iv) the SBP’s ability to contain inflation is limited to raising the discount rate which mainly impacts negatively on the output of the large scale manufacturing (LSM) sector – a fact made evident from July 2019 to March 2020 with 13.25 percent discount rate which stifled economic activity and exports; and finally (v) the SBP has yet to undertake research on why it linked the discount rate to consumer price index (CPI) effective May 2019 to March 2020 (pre-Covid19) even though a 2006 research paper indicates that the discount rate has little impact on several components of CPI and that core inflation should be the determinant of the discount rate. Of equal relevance is the SBP’s failure to provide research on whether the real effective exchange rate is undervalued as widely believed. In a recent addition on its website SBP notes that “for an assessment of a country’s exchange rate misalignment a more sophisticated analysis is required taking into account demographics external and fiscal sustainability and some other macroeconomic fundamentals over the medium term.” What constitutes the medium term and why cannot the SBP research team go back the number of years that would satisfy its definition of a short-term?

It is therefore high time that the SBP team provides a research paper on what determines the discount rate (linkage to CPI or core inflation) and an annual report on the real effective exchange rate.

Secondly, the system of appointment of the governor SBP needs to go through vigorous vetting by the cabinet and/or by parliament. At present the general perception is that the chief executive of the country needs to be convinced of a particular candidate’s credentials which he himself may not be qualified to determine. Take the case of the Governor of the Bank of England whose position was advertised in 2013 as follows: “The successful candidate will have experience of working in, or with, a central bank or similar institution; or will have worked at the most senior level in a major bank or other financial institution.”

And finally, one would have hoped that indemnity be provided not only to the senior most officials, the governor and deputy governor, but also to the entire staff of the Bank and the unusual mention of NAB and FIA be removed from the bill – an inclusion that reportedly is based on the domestic experience and provide relief to a former governor facing a NAB inquiry. Accountability of senior staff must not be limited to ‘good faith’ given serious concerns over the decisions of SBP with respect to the discount rate and the rupee valuation which have wide implications on inflation and productivity and are being challenged.

Business Recorder editorial on the subject correctly highlighted the gap between de jure and de facto governance scenarios in Pakistan that has led to resignations by governors well before expiry of their term, however, the procedure for selection, the application of the indemnity and last but not least the competence of the appointees need to be clearly set out in the bill.

Copyright Business Recorder, 2021

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