July 31, 2006	Monday	Rajab 4, 1427

THE monetary policy is designed to maintain monetary and credit expansion at a pace required to achieve targeted economic growth and inflation rates.

To effectively formulate/manage the monetary policy, the State Bank of Pakistan (SBP) has been empowered by an act of the Parliament.

An ordinance was promulgated on January 21, 1997 which conferred autonomy on the central bank. In February, 1997, the Ordinance was passed by the National Assembly and became a permanent law on May 31, 1997 after the assent of the President of Pakistan.

By inserting Sec 9(A) in the State Bank of Pakistan Act,1956 its board of directors got unambiguous powers to formulate and implement the monetary and credit policy and to determine and enforce the volume of credit to be extended by the SBP to the federal and provincial governments and public sector corporations and decide overall expansion of liquidity.

This section further stipulates that the government will meet its additional requirements directly from commercial banks through market-based auctioning system to be conducted by the SBP.

Other tools available to SBP for monetary management are: fixing of CRR (cash reserve requirement) and SLR (statutory liquidity ratio) viz-a-viz the deposits with the banks; putting margins on loans/ ban the loans to specified sectors where it is felt that funds are being misused-say for speculative purposes, targeting credit ceilings and credit/deposit ratios etc.

The question is whether the autonomy given to the SBP in the sphere of monetary policy has been enforced by it at any time and particularly after the October,1999 take-over. No record is available for public with regard to the credit ceilings fixed by the SBP for the federal or provincial governments.

The annual credit plan is drawn by the National Credit Consultative Council (NCCC) which meets annually under the chairmanship of the SBP governor. The plan is subsequently approved by the SBP’s board of directors. The credit plan- as published for the public- contains credit allocations for the federal government and the private sector while no limit for government borrowing from SBP is indicated.

What had been actually happening since the fiscal 03-04 (FY-04), 04-05 (FY-05) and 05-06 (FY-06 –up to June 10, 2006 ) is that almost entire borrowing requirement of the federal government is being met by the SBP. For instance, in FY-04 Rs60 billion were lent by the SBP while merely Rs3.7 billion were borrowed from commercial banks while in FY0- 05, the sum of Rs155.6 billion was lent by the SBP by simultaneously retiring the commercial banks’ debt amounting to Rs87.6 billion [Table 5.1-page 104 of SBP annual report for FY-05].

During FY-06 [up to 10th June,2006] SBP’s lending to the government was Rs112.3 billion while borrowings from the commercial bank amounted to merely Rs8.1 billion. (Table 4.2 page 46 of SBP report for the third quarter of FY-06).

SBP’s responsibility is to contain/reduce inflation through monetary policy. The Bank’s reports admit that government borrowings from SBP are inflationary. Then why is SBP pursuing pro-inflationary policies through lending to the government by getting the commercial banks’ debt retired [or arranging borrowing from the commercial banks of meagre amounts as in FY-04 and FY-06].

The expectations for the fiscal 06-07 in respect of government borrowings from SBP seem to be no different from the last three fiscals as the SBP has expressed its helplessness in using its autonomy and shifting government’s entire borrowings to the commercial banks in the following words:

“ The expansionary fiscal instance will add to aggregate demand, and therefore to inflationary pressures. The impact could be worsened if the government depends heavily on the central bank borrowings to finance the deficit”[ page 5 of SBP report for the 3rd quarter of FY-06].

The question also is: why is the government borrowing from the SBP when it is inflationary. In fact, SBP’s major earnings come from interest on government Treasury bills which ultimately reverts back to the government as SBP’s profits are transferable to the government. Thus practically the government borrowings from SBP become cost free. Is be prudent to sacrifice the objective of containing/reducing inflation over providing cost-free funds to the government?

The SBP’s responsibility also is to ensure that bank funds do not flow to the sectors who are engaged in hoarding the essential commodities.

SBP’s report for the quarter October-December,2003 admitted that bank loans were being used for hoarding wheat but it (SBP) remained inactive and imposed 50 per cent margin on loans against wheat belatedly in May,04 when, according to the press reports, the hoarders had already earned about Rs3 billion.

The SBP also remained inactive with respect to the loans against sugar. It has recently issued directives to the banks to adjust the old sugar loans by end-July,06 and has put the future loans against this commodity on 50 per cent margin. The belated action on the part of SBP enabled the sugar millers to hoard the stocks with a view to making billions of rupees by raising the prices.

To what extent the sugar miller utilized the bank loans in hoarding the commodity. The interest payable to the banks is very small portion of what is gained from the hoarding, thereby escalating the market prices.

One of the tools of monetary policy management i.e. fixation of credit ceilings is now termed out-dated. The SBP governor, in her post-budget interview to the local television channel, had asserted that “ in fact it is old fashioned thing to use SLR as a monetary tool”. But there has been a very swift change of mind in the central bank authorities. Is it not strange that soon after the interview , SBP authorities used CRR/SLR as a monetary management tool by raising the CRR from five to seven per cent and SLR from 15 to 18 per cent of the deposits of the commercial banks effective 22nd July, 2006?