At the outset of this series, we had explained that economic reform essentially means bringing the values of economic variables to a well-established notion of ‘natural state’.
Ideally, this natural state is best approximated by the equilibrium price under a competitive environment, free of monopolistic or regulatory constraints. Monopoly is antithetical to competition, as it charges a higher price by restricting supplies. Price controls through regulations are the exception to this rule – admissible on account of natural monopolies under public control, such as railways and, previously, many infrastructure services such telecommunication and energy supplies.
There are few occasions where economists have consented to the government’s role in price setting. To prevent high volatility in prices of grains, support programmes would set floor prices to ensure adequate compensation for farmers on the premise that not doing so may result in abandonment of future crops, thereby leading to bigger asocial upheavals. Significant storage of grains, and incidental costs are required to support such programmes.
Another area where price controls are justified is the case of prices of petroleum, gas and electricity, where price ceilings are imposed leading either to subsidisation (when actual prices are higher) or accrual of windfall gains (when they fall below the ceiling). The justification here is the centrality of these prices in affecting the economy. In all these cases, it must be noted that a very elaborate system of price determination has been entrusted to regulatory bodies like Nepra and Ogra. Yet, the government interferes with these determinations which often results in unsustainable budgetary obligations.
Curiously, there is another price that has been controlled universally by countries facing a supply constraint of foreign exchange reserves. This is called the exchange rate. There was a time when fixed exchange rate regimes were the rule the world over. However, today – barring a few countries with strong economies – the exchange rate regime is called ‘managed float’, where authorities actively manage a varying rate within a narrow band to achieve stability. Pakistan also operates under this regime.
Our finance minister has declared that the exchange rate is not the domain of the government and that it is up to the central bank to determine it. This is a major departure from past practice, and apportionment of responsibility. For a variable whose significance for the economy is all-pervasive, and given the responsibility of the federal government in economic stabilisation, a signal of such novel abdication of responsibility is unwarranted and should be reconsidered. Evidently, the minister has not taken a similar position in several other matters. For instance, the decisions of regulators for the prices of petroleum, gas and electricity were not accepted as it was felt appropriate to modify them, keeping in view appropriate exigencies.
Let us examine the legal position applicable to exchange rate determination. Section-9A(b) of the SBP Act 1956, provides the following as the function of the SBP Board of Directors: to oversee foreign exchange reserve management and approve strategic investment and risk policy.
Evidently, it is the responsibility of the SBP Board of Directors to look after the management of foreign exchange which clearly would include exchange rate as well. However, the SBP handout is silent if the board has taken exchange rate decisions or otherwise.
More importantly, the above provision has to be read with Section 9B, which provides for a Monetary and Fiscal Policies Coordination Board, headed by the finance minister and including the commerce and planning ministers, governor of the SBP and secretary finance with the responsibility to “coordinate fiscal, monetary and exchange-rate policies”, together with a host of other functions to ensure consistency in economic policies. Incidentally, no public reports have indicated if the coordination board has held a meeting under the present finance minister – or even under the caretaker finance minister, though much of the exchange rate adjustment has taken place under their watch.
In view of the above, it is unwarranted to let the SBP take the responsibility for setting the exchange rate. There is an enormous amount of support that the government provides for maintaining exchange rate stability. All government foreign borrowings are surrendered to the SBP, unlike the private sector which would either pre-emptively make purchases abroad or, if something is brought into the country, it would be sold in the inter-bank market. Without the resources provided by the government, there would be no reserves with the SBP since the country runs a perennial current account deficit. Why should the government also not sell its earnings and borrowings in the interbank market and also make its purchases from there? Why should the central bank have anything to do with the foreign exchange? The US Federal Reserves doesn’t have any reserves nor does the European Central Bank. The job of holding reserves is left to the banking system.
Of course, we are neither suggesting nor advocating that this course of action should be pursued as it would be hugely destabilising. When the primary variable of an economy’s strength is the level of reserves, it must be conserved and priced through a coordinated consultation process with key stakeholders under the leadership of the finance minister. He’s responsible to the cabinet and to parliament on all matters related to the SBP, which is not an
elected body.
The last three exchange rate adjustments have completely shattered the confidence of markets, investors and people alike. The minister has also removed the impression that the last action was a part of any prior actions agreed with the Fund.
This has added to the uncertainty regarding the future. Never have we witnessed ordinary people worrying about the loss of their wealth and looking for ways to protect it. It is agonising to see TV anchors advising viewers to be careful and find ways to protect their savings as going forward there will be more turbulence.
The writer is a former finance secretary. Email: waqarmkngmail.com