SBP reforms and the IMF

Pakistan has finally taken a bold step in the right direction with regard to the autonomy of the SBP. However, there are some serious flaws with the proposed amendments, and the optics are appalling – it has been done under pressure of the IMF and in absence of an informed debate in the cabinet.

The proposed reform once again highlights that the IMF has very limited understanding of how institutions work in a country-specific context; it also highlights the economic team’s weakness in blindly accepting the IMF’s cookie-cutter approach.

There has been a largely misplaced outcry from many analysts that this step will: make the SBP governor, who is seen as an IMF insider, an Economic Viceroy; Pakistan will lose its sovereignty; the SBP governor and management will not be accountable, and so on. While some of the concerns need to be taken seriously, for the most part the criticism is emotive, lacks rigor and seems to be led by the anti-reformers in the bureaucracy.

All developing countries are in hot pursuit of the twin objectives of low inflation and inclusive and sustained high growth. An independent central bank is a necessary tool for achieving these two objectives. At the same time ‘independence’ is a very nuanced and contextual concept, whose design has to be carefully crafted so that the central bank is effectively contributing to the achievement of the twin objectives.

Our history is replete with supposedly ‘independent and apolitical’ civil, military, judicial and accountability institutions taking decisions that have led to grave political and economic consequences for the country. Our parliaments have an abysmal track record in either enforcing laws for which they are the guardians – for example, the Debt limitation Law – or having a serious debate on legislation affecting economic, political or social issues.

Merely changing the SBP law to give it independence on paper, without other pieces of puzzle in place, is unlikely to yield the desired outcome. There needs to be an informed debate, before the law gets to parliament, on the most effective way forward in making the SBP one of the best central banks in developing countries.

A critical rationale for making central banks independent is that inflation is lower in countries with independent central banks. The causality that independence leads to lower inflation, in developing countries, is weak at best. Over the last few decades, our policymakers and the Ministry of Finance have been very irresponsible in respect of fiscal and exchange rate management. While an independent central bank is necessary for countries to tread on a low-inflation path, the key is instituting financial policy reforms that bolster opposition to inflation and institutional arrangements that force discipline on fiscal policy.

Another rationale for central bank independence is that governments often fail to improve economic outcomes because of either incompetence or self-interest on the part of politicians and bureaucrats. The independence argument begs the fundamental problem of ‘who will guard the guardian?’ Replacing one policymaker with another is no guarantee that policy outcomes would be better.

Also, since central bank policies involve significant discretion and judgment, there needs to be a thorough debate on the right balance, within the Pakistan context, of ‘rules versus discretion’. Independence works best when central banks follow rules. However, there is now widespread agreement that discretion is superior in times of systemic crisis – the 2008 crisis, the recent pandemic crisis, etc. Also, discretion renders monetary policy intrinsically political and many central bank policies have huge distributional consequences. Consequently, the ‘independence and accountability of SBP’ need to be carefully crafted. The proposed first step needs to be complemented with other actions, which will ensure that the new law yields the desired outcomes.

While legislative reforms are necessary, ‘bad drivers’ can wreck a new car. Therefore, critical to establishing an independent central bank, which is a ‘center of excellence’, is the quality of staff – especially those appointed as governor, deputy governor and members of the board.

A gold standard for people that should occupy these positions in Pakistan is Dr Raghuram Rajan who until recently was governor of the Reserve Bank of India. After he stepped down from this job to protest Modi’s pressure on interest rates and growth numbers, he was a front runner for the job of governor of the Bank of England. He was considered one of the best under-40 financial economists in the world, was distinguished professor of finance at the University of Chicago, president of the American Finance Association, chief economist of the IMF, winner of the Fischer Black Prize, author of several internationally acclaimed books on finance and economics, and economic adviser to the government of India. It is people of such caliber that make institutions, not simply rewriting of laws. In comparison to Dr Rajan, the majority of past SBP governors and board members were at best mediocre and bronze standard.

The process for identifying and selecting the best and the brightest people to the above noted positions is crucial for achieving the objectives of the new law and ensuring that the SBP becomes a ‘center of excellence’. In this respect, the following mechanism has the potential for appointing people of the best caliber. First, appointing a new board which comprises the best Pakistani economists who can be the ‘guards of the guardian’. Reporting to parliament is a good practice, but for the foreseeable future parliamentarians are unlikely to have the skill set to exercise the needed accountability and oversight.

The first level of effective accountability for sound policy must come from the board members, who can analytically challenge the governor and offer robust competing views on exchange rate and interest policies proposed by the governor. The first board of the SBP, under the new law, must comprise well-known economists such as Atif Mian, Asim Khawaja, Masood Ahmed, Zubair Khan, Hafeez Pasha, Nadeem ul Haq, and Ashfaq Khan. Such a board should also be made responsible for proposing to the government candidates for the vacant board position.

Second, the following is necessary: first, responsibility for identifying people for the governor and deputy governor positions should rest with the board. The government should be the appointing authority, but the short list of candidates must come from the board. Second, all key staff of the SBP must have PhDs in economics from the best universities internationally, with senior staff having international experience. Third, the governor’s appointment should be for one term only. Any time a person is eligible for reappointment, it is but natural that most will succumb to pleasing the appointing authority and compromising on principles. With regard to the present incumbent, he needs to be re-appointed for a fresh term, by the new board, to remove the lingering stigma that he is an IMF insider.

The provision to protect the governor and his staff from harassment by NAB and FIA on operational decisions is a very good step. However, the law must make it clear that if the board determines that SBP staff have profited from insider information on exchange rate or interest rate policy or have indulged in abuse of office, they will be prosecuted.

In conclusion, the government has taken the first right step. But more informed debate and complementary reforms, as noted above, are necessary to convert the SBP into a center of excellence that acts independently and responsibly.

The writer is a former adviser to the World Bank.