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Thursday March 28, 2024

SBP’s precarious autonomy to bring new challanges

By Erum Zaidi
March 14, 2021

KARACHI: Pakistan is poised to give its central bank independence from the government influence to implement the structural reforms agreed with the IMF under its $6 billion rescue package that will send good signals to international markets, experts say.

They added it would also help create an opportunity for deepening the local capital debt markets, alleviating the need to rely on the central bank to finance the budget deficit.

The cabinet on Tuesday approved amendments to the law allowing the State Bank of Pakistan to operate without the control of the government. The SBP’s Amendment Act 2021 is expected to be approved by the parliament soon as the approval of this law is meant to meet the conditionality for the completion of the sixth review of the Fund’s Extended Fund Facility.

Experts say granting more autonomy to the SBP will boost foreign investor’s confidence in the country's economy. They should be influenced by the ability of the central bank to be perceived as an independent institution, but it also gives rise to some challenges for the government and the central bank as well.

The government is needed to develop capital markets that are weak in Pakistan in a bid to diversify funding sources and cover the budget deficit, says Dr Salman Shah, the former finance minister, referring to the central bank independence.

“The government will have to improve its finances and reduce the cost of borrowing to narrow the budget deficit. It [the government] should take steps to deepen the capital markets. This will help reduce the burden of the deficit financing on banks,” Shah said.

“The government's large borrowing from the banking system crowds out credit to the private sector. The SBP also needs to enhance its capacity to deal with the issues on its own.” Dr Shah said the market-based exchange rate regime, positive real interest rates, and no borrowing from the central bank, being the main features of the IMF-supported economic reforms, had already been implemented.

The current IMF lending program, the 22nd, which Pakistan entered in 2019, is lying halted for more than one year.

Experts are concerned about the implementation of the provisions of the SBP’s Amended Act, 2021 when the present program ends. Laws are good, but they become meaningless without enforcement.

Dr Muhammad Yaqub, the former SBP’s governor said in Pakistan changes in laws meant nothing if governments violated them as they pleased and heads of the institutions were subservient and weak. “There is a fiscal law that limits government debt which is being violated left and right,” Yaqub added.

“Dig out the amendments made in the SBP Act in 1997 and flash section 9A as originally approved by the parliament at that time. It was also done because IMF wanted it as a condition of its loan,” said he.

“It gave much more authority to the SBP to refuse government borrowing from it and to conduct an independent monetary policy. Its provisions were never honored by any government after 1999 and were subsequently diluted or abolished. The same will be the fate of the current provisions about government borrowing and autonomous monetary policy once the stranglehold of IMF is gone,” Yaqub said.

“A government must believe on its own that national interests are served best by surrendering its authority to use banknote printing as a source of budget financing … and not to do it to meet a condition imposed by the IMF … for it to become a part of ground reality.”

He said the proposed amendments set the main objective of the central bank to target inflation, rather than taking care of growth. “How does inflation targeting does work in Pakistan where it comes from the supply side bottlenecks. In the developed countries, the increase in inflation is due to excessive demand. However, in our country the government itself creates inflation by raising government administered prices such as electricity and gas prices,” said Dr Ashfaque Hasan Khan former advisor to the finance ministry and a renowned economist.

The proposed draft says the SBP will take decisions on their monetary policy and exchange rate in an independent manner and environment without intervention from the government whose policies have always been subject to political control.

The law will abolish the monetary and fiscal policy coordination board of the central bank, and the central bank's governor will be made accountable to the parliament. The government wouldn't borrow in terms of loans and guarantees from the SBP.

The proposed draft gives five-year tenure to the central bank governor to ensure a continuation of policies.

It is yet to be seen whether the SBP transforms itself into a modern and Western style institution after getting more autonomy. It is however a fact that it did a decent job to keep the economy afloat in the coronavirus crisis.

The SBP’s measures to support the economy during COVID-19 injected an estimated 4.8 percent of gross domestic product in business and household cash flows.