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April 12, 2015



The history of autonomy

At present, the State Bank of Pakistan is legally autonomous but operationally subservient to the Ministry of Finance. From the point of view of good economic governance, it is a worrisome situation which has been recognised by the IMF in its recent reports. But the solution of this problem is not what the IMF is proposing in the form of further amendments in the SBP Act and further fragmentation of the SBP as an institution.
There are existing laws enacted in consultation with the IMF that give autonomy to the SBP, and there are competent economists in the SBP who can guide its management and board to the right path. What is missing is not appropriate laws or proper institutional framework but rather a strong management and board at the SBP and a realisation by the government that an autonomous central bank is in the best national economic interests.
The laws are as good as their implementation and professionally competent economists are as good as they are used for. What is really needed is adherence to the laws that already exist by both the government and the SBP, and strengthening of the management and the board of the SBP in a way that they begin to operate independently.
Historically, the SBP Act passed in 1956 gave no legal autonomy to the central bank and all major administrative decisions made by the SBP were subject to approval by the Ministry of Finance before their implementation. Similarly, in the matter of monetary policy, the SBP could not use any of the traditional instruments of credit management without prior permission of the federal government. The annual credit programme for the private sector was approved by the Ministry of Finance, and the SBP obeyed government instructions for the launching of specialised and subsidised credit programmes to patronise certain borrowers.
In the matter of government borrowing from the SBP, the government had a free hand to borrow any amount at the interest rates of its choice regardless of what

was happening to reserve money base and discount rate. The SBP had no control on its own balance sheet or on short-term interest rates and without it no central bank can conduct an independent and effective monetary policy. It could not even freely express its views on the economy in its annual report that was subject to clearance by the Ministry of Finance. In the sanctioning and regulation of banks, the final authority rested with the government. With the nationalisation of banks in 1974, the authority to regulate the banking system was also substantially transferred to the Pakistan Banking Council which began to issue parallel instructions to banks in administrative, management and credit policy matters.
The complete lack of SBP autonomy was concealed somewhat in the earlier period by the stature of the governors who were appointed from among retiring federal secretaries, and to remain relevant they used their personal clout with the government emanating from their previous positions. But they derived no authority from being SBP governors.
In such a depressing and hopeless situation, a determined effort was mounted by the SBP in the 1990s to initiate measures for its autonomy. The first steps were taken during the tenure of the interim government headed by Moeen Qureshi culminating in the promulgation of an ordinance in October, 1993 that gave autonomy to the SBP in its internal administration, provided statutory protection to the tenure of the governor and prescribed a legal role for the SBP in determining the limit on government borrowing from it.
The transition was facilitated by the IMF, which gave full support to the initiatives for SBP autonomy in the context of its standby arrangement. It made the approval of the ordinance by the National Assembly a prior action for the standby arrangement to become effective. As a result, the government of Benazir Bhutto got the ordinance approved from the National Assembly in February, 1994.
In the subsequent period, the SBP adopted a dual approach of effecting improvements in the banking and monetary sectors based on the new law – along with building up its internal institutional capacity – and simultaneously campaigning for further changes in the legal and institutional framework to remove the remaining bottlenecks.
With the Pakistan Banking Council already liquidated by an ordinance issued by the interim government of Miraj Khalid, this round of reforms concluded in May, 1997 when the Nawaz Sharif government legislated amendments in the Banks Nationalisation Act to improve the governance of nationalised banks, in the Banking Companies Ordinance to enhance the regulatory and supervisory authority of the SBP and in the SBP Act to give it powers to “determine and enforce” the limit on government borrowing from the SBP. The SBP was also empowered to give its independent views on the state of the economy to the legislative branch of government through its quarterly reports. This new framework remained in operation for about two years till 1999.
During the Musharraf government, an ambitious commercial banker who became the finance minister, and later on the prime minister of the country, tried to restrict the autonomy of the SBP in practice. However, as professionals were appointed as SBP governors by Pervez Musharraf, they made an effort to retain a measure of autonomy of the SBP, although some ground was lost in the matter of interest rates and government borrowing from the SBP. Since then, it has all been downhill in so far as the operational autonomy of the SBP is concerned, with the de jure situation remaining unchanged.
The PPP and PML-N governments have bypassed the laws in several different ways while the Ministry of Finance had already taken back from the SBP the right to determine the cut-off rates for government borrowing from commercial banks during Musharraf’s time in power. The government also reverted back to the old system of unilateral determination of its borrowing from the SBP on fiscal policy considerations.
Additionally, the Ministry of Finance has openly interfered in the banking business in defiance of section 46(B) of the SBP Act that stipulates that “no governmental or quasi-governmental body or agency shall issue any directive, directly or indirectly, to any banking company or any other financial institution regulated by the State Bank ….”.
Most important of all, the PPP and PML-N governments appointed SBP governors who had neither the technical competence nor personal courage to take a stand in defence of the autonomy of the SBP and rule of law. The result is that the SBP is back to where it was before the legislative reforms of the 1990s, excepting its administrative independence in staffing and salary matters.
The IMF recognises that there is lack of operational autonomy of the SBP in the conduct of monetary policy but has taken a wrong turn in proposing more amendments in the SBP Act. By doing so, the IMF has given legitimacy to the government for violation of the existing laws. Moreover, it enables the government to continue the existing practice of operationally controlling the SBP while promising to enact the amendments proposed by the IMF.
The IMF should understand that even if the PML-N government amends the SBP Act as proposed by the IMF, its track record shows that operationally it is likely to continue to keep the SBP and monetary policy under its thumb. By giving poor advice to the government, the IMF is contributing to further erosion rather than improvement in the operational autonomy of the SBP and conduct of a prudent monetary policy.

The writer is a former governor of the State Bank of Pakistan.
Email: [email protected]