SBP gears up efforts to introduce flexible inflation targets

KARACHI: The State Bank of Pakistan (SBP) geared up efforts to set flexible inflation targets in a bid to keep them abreast with the economic growth.   

SBP, in an emailed reply on Monday, said the central bank aims to introduce a flexible inflation targeting (FIT) framework to reduce inflation to the low levels and balance price stability with economic growth.    

“A comprehensive, multipronged research study has been initiated on the steps required to adopt flexible inflation targeting by 2020,” the SBP said. “Critical review of existing environment has helped identify the gaps from the precondition (and best practices) for inflation targeting.”

The International Monetary Fund (IMF) supported the plans to move towards inflation targeting over the medium-term. IMF, in its recent report, said allowing greater exchange rate flexibility, strengthening reserves buffers, maintaining fiscal discipline, limiting government borrowing from the SBP and ensuring its operational independence will be important preconditions “that will need to be in place for effective inflation targeting.”

Former SBP’s governors, however, believe that the requirements for inflation targeting do not exist in Pakistan due to lower revenue base of the government. Furthermore, the financial markets lack depth to absorb placements of public debt, they added.

“The SBP could face hurdles in selecting an appropriate price index itself to define the target in the choice of exchange rate regimes,” said Isharat Husain, a former central bank’s governor. Another ex-governor SBP said the SBP is not autonomous and is completely subservient to the dictates of the ministry of finance, notwithstanding the current SBP Act.

“The SBP is sacrificing some of their independence to coordinate monetary policy more closely with the government’s fiscal decisions,” the governor added. “With the SBP having no control over its balance sheet due to excessive government borrowing and interest rate policy being dictated by the ministry of finance, a prudent monetary policy is nonexistent.” 

SBP, however, argued that it has already achieved a key milestone to strengthen its independence for the formulation and implementation of monetary policy, which is one the crucial steps to develop a flexible inflation targeting framework. 

The SBP acquired autonomy in the conduct of monetary and exchange rate policies through legislative reforms in 1993-1997 in the SBP Act, Banking Companies ordinance, Banks Nationalization Act and the exchange regulations. 

Specifically, the SBP Act 1956 has been amended for the establishment of monetary policy committee, which is fully empowered to decide the stance of monetary policy, intermediate monetary objectives, and to make regulations for the effective implementation of monetary policy. 

The independence of monetary policy committee is further strengthened by including three external economic experts with full voting powers.

“In accordance with international best practices on the implementation of monetary policy in a transparent manner, SBP has revised its interest rate corridor framework in May 2015 by introducing an explicit target rate within the existing corridor to unambiguously signal its monetary policy stance,” the SBP said. “As a result, not only the pass-through of the policy rate to the market rate has improved, but the volatility in the money market overnight repo rate has also reduced significantly.”