June 05, 2006	Monday	Jumadi-ul-Awwal 8, 1427

THE Governor, State Bank of Pakistan (SBP), Dr Shamshad Akhtar recently identified eight factors, which she viewed as the major drivers of change in the financial industry. One of the factors was the, ‘changing role of and demands on the regulator—the central bank — which needs to be discussed keeping in view the ground reality in respect of the following two propositions: the central bank’s independence should not be compromised in terms of the conduct of monetary policy as well as the oversight of the financial sector, and secondly, the SBP has to be accountable before the Parliament and the Senate, and work in conformity with the federal government’s goals.

Following the introduction of financial sector reforms, a paradigm shift in the government’s policy with regard to appointment of the governors at the central bank was discernible. Unlike the past when senior bankers and bureaucrats were selected for the top slot, foreign qualified economists working in IMF, the World Bank and the Asian Development Bank were appointed.

A comparison of the actual monetary and credit expansion during the past with the relevant sectoral target set in the Annual Credit Plan would reveal a situation devoid of financial discipline and lack of national responsibility.

The latest annual SBP Report (p106), inter alia, stated that in setting the credit plan, basically there were two broad factors viz., (i) net domestic assets-NDA; and (ii) net foreign assets-NFA.

The NDA was estimated by including the credit to government sector and the non- government sector- where the former involves the SBP coordination with fiscal authorities and the latter is reflective of SBP’s monetary stance for the year.

The NFA is estimated by making projections of all expected foreign inflows and outflows which are vulnerable to exogenous changes. There is an inherent risk that the estimates of NFA may go astray of the credit plan targets.

However, one expects that projections of NDA would be more accurate as monetary and fiscal authorities have reasonable control over the underlying variables, and the likelihood of external shocks affecting the NDA projections vis-a –vis NFA is relatively lower. The report further stated that the experience of the last 15 years showed that the two components of the NDA either exceeded or fell short of their initial estimates.

In simple words, it may be stated that the NDA - composed of SBP NDA and the NDA of scheduled banks play a catalytic role in monetary expansion. The growth in scheduled banks NDA is caused by the increase in the credit to the non- government sector i.e. credit to private sector proper and the public sector enterprises (PSEs) which is attributable to the expansion in the commodity producing sector that is real sector of the economy.

The increase in scheduled banks’ NDA should not pose a threat to the macro economic stability so long as the bank credit is used for productive purposes. On the contrary, the growth in SBP NDA is directly linked with that portion of the government’s budgetary deficit that has to be financed by borrowings from the SBP. This is the grey area in the conduct of monetary policy where the SBP wittingly or un-wittingly facilitate the Finance Division to satisfy its appetite for borrowings from the SBP.

The main thrust of the domestic public debt management reforms introduced in the country in 1991 i.e. prior to the implementation of banking reforms was to enable the federal government to finance its budgetary deficit through auction of market-related government securities in the money market.

The underlying intention was to minimize the government’s borrowings directly from the SBP even at the prevalent market rate of interest as that was causing accumulation in the government’s domestic debt liability both in the form of higher debt servicing and repayment of the principal amount which could create destabilization of the macroeconomic conditions.

Unfortunately, more than 15 years have lapsed but the finance division has not so far improved its fund raising capacity to lower its dependence on the borrowing from SBP (outside the regular auction of market-related government securities). The SBP, too, cannot absolve itself from the undesirable government’s action as they failed to take appropriate monetary management measures at their disposal.

The SBP’s easy and accommodative monetary policy pursued FY2003 was catalytic in augmenting the flow of bank credit to the private sector at an alarming rate without any perceptible increase in the size of local investment in the commodity producing sector.

This was the main reason that the sustainability of the GDP growth rate at seven per cent per annum during the current fiscal year (FY06) now seems impossible. On the contrary, the low interest policy helped the government to borrow heavily from the SBP (outside the regular auction) that in turn heated the inflationary pressure in the economy.

The official data on the rate of inflation as measured by the consumer price index (CPI) shows that there has been consistent decline on year-to-year basis since April 05 when the CPI had registered an increase of 11 per cent. Nonetheless, the future expectations are that due to many local and international factors, the rate of inflation may increase from the present rate of 8.25—9 per cent per annum by the close of the current year.

Taking into account all the aforementioned factors, the SBP should make use of the monetary management instrument – increase in the SBP repo rate (discount rate) – to the level higher than the prevailing maximum lending rate charged by commercial banks to their borrowers.

While no citizen would disagree with the present SBP Governor that the independence of the central bank should not be compromised in the conduct of monetary policy and the SBP should be accountable to the Parliament, it is essential that the SBP should first determine the true objective of the monetary policy and make the same known to the public.