An aimless central bank

In 1997, while proposing to the then government changes in the State Bank of Pakistan (SBP) Act to strengthen SBP autonomy and define and legislate the scope and mechanism of monetary policy, the SBP had suggested the inclusion of a clause mandating itself to prepare and submit a quarterly economic report to the legislative branch of the government. The proposed addition, along with other amendments, was passed by the legislature.
The purposes of that provision were fourfold. First, the SBP, having been legally freed from the stranglehold of the Ministry of Finance, was made accountable to the legislative branch of the government in explaining and defending the rationale of its monetary policy. For this purpose, the report was to particularly explain the use of instruments of monetary policy, its coordination with fiscal and other economic policies and its success/ failure in achieving its objectives of relative price stability, financing of private sector economic activities and promotion of the country’s economic growth.
Second, the hope was that the National Assembly and the Senate would take the reports seriously, review their contents in relevant committees, hold hearings on them with the SBP governor invited to seek clarifications and explanations from him/her, and subsequently take the reports to the floors of the two houses. The SBP governor could, in turn, get feedback from the legislative branch of the government on the SBP’s monetary policy.
Third, the legislative branch was to benefit from a professional view on the state of the economy by an autonomous central bank that was not adulterated by the biases and political cover up of the Ministry of Finance. Its contents were expected to give to the legislative branch, particularly the opposition parties, an objective economic analysis that could be helpful in better understanding the state of the economy and taking economic policy measures that were brought to the floor of the National Assembly. Thus, instead of becoming dependent only on one source of economic data and analysis presented to it by the Ministry of Finance, the National Assembly would have another channel of communication in the form of SBP quarterly reports.
Fourth, the process was to help the SBP become a truly autonomous and effective central bank with no political affiliations, providing the government and the people its professional analysis that could help better understand the state of the economy and strengthen macroeconomic management. If followed in letter and spirit, these provisions could become a milestone in economic institution-building in the country.
Unfortunately, while the ritual of issuing a quarterly report is being maintained, the spirit with which the legislative reforms were undertaken has been crushed in actual practice.
The Ministry of Finance could not reconcile with legislative reforms that ensured autonomy of the SBP and, notwithstanding the statutory provisions, its interference in the affairs of the SBP has actually increased with the passage of time.
At the same time, weak and incompetent managements have been installed at the SBP itself with the result that it has failed to pursue an independent monetary policy and use the forum of the quarterly reports to provide an objective review of the economy.
The legislative branch itself has not lived up to the laws passed by it. It has not cared to ensure adherence by the executive branch and the SBP to the amendments in the SBP Act enacted by it and has made no use of the quarterly reports of the SBP that have been submitted to it regularly. The reports are never taken up in appropriate committees and on the floor of the house. We are not sure if any member of the National Assembly and the Senate even reads them carefully.
The above assessment is confirmed by a reading of the SBP report for the first quarter of FY15 released on February 17, lack of interest in it by the legislatures and its inadequate coverage in the electronic and print media.
Furthermore, the value of the report is lost not only because of its quality and coverage but also due to the inordinate delay in its publication. A report pertaining to July-September quarter should be made available in November at the latest for it to remain relevant. It has been released five months after the end of the quarter under review.
With such a time lag, the report would become irrelevant even if it was of high quality. But the quality of the report itself is very poor. It wanders around aimlessly covering all micro aspects of the economy without stitching them together to present a coherent and consistent macroeconomic picture.
The chapter on the real sector gives a very exhaustive review of developments in the agricultural, large-scale manufacturing, services and trade sectors. The production of sugarcane and cotton, the two major kharif crops is reported to be lower from last year and below the targets for FY15. The growth rate of the large-scale manufacturing sector in the first quarter of FY15 at 2 percent is lower than 7 percent in the same period last year and a similar target for FY15. However, the SBP is unable or unwilling to take the next step of stating that the growth target of 5.1 percent for FY15 constantly paraded by the finance minister will not materialise – except if figures are fudged.
The micro analysis of the fiscal situation in the report shows that revenue growth is inadequate, an increasing amount of circular debt is being kept out of the budget expenditure and provinces are set on a path that will lead to a decline in their budget surpluses from that in FY14 and target for FY15. But the SBP is not willing to draw the important macroeconomic conclusion that the government will not be able to achieve its target for the fiscal deficit of 4.9 percent of GDP in FY15 – except through fudging of figures.
Similarly, analysis of the individual items of the balance of payments has not been consolidated to draw the worrisome conclusion of the inherently weak structure of the balance of payments and its high dependence on the inflows of foreign loans and grants and remittances. Falling exports and appreciating real effective exchange rate should be a real cause for concern for the SBP, which shows nowhere in the report.
The macro indicators of GDP growth, budgetary outlook and the balance of developments situation have a direct bearing on the statutory responsibilities of the SBP to control money supply through its monetary policy. However, it is in the chapter on monetary policy and inflation where the SBP uses least and objectivity – and shows no awareness of its statutory responsibilities.
In economic literature as well in policies being followed by other central banks, it is recognised that the rate of inflation is mainly determined by monetary policy. The SBP is perhaps the only central bank in the world that treats inflation as an exogenously determined variable to be taken into account to set the level of the policy rate regardless of whether or not it controls money supply. But a central bank that equates monetary policy with the level of the policy rate, does not consider inflation a monetary phenomenon and has no concern about the expansion of liquidity in the economy has no right to exist.
The writer is a former governor of the State Bank of Pakistan.
Email: doctoryaqub@hotmail.com