The country is faced with a high rate of inflation that has never been experienced before. A part of it could be attributed to higher international prices of petroleum and food items, which have begun to ease by now, but inflation is not going to go away.

The reason is that fundamentally inflation represents too much money chasing too few goods. This state of affairs is the outcome of excessive money creation by the State Bank of Pakistan (SBP) due to printing of notes to feed the unlimited government appetite to engage in unproductive spending by SBP’s borrowing.

Government borrowing over the last few years has surpassed any before, even the pre-reform period when the central bank had no legal authority to close the tap of government borrowing.

But in 1997 the State Bank Act was amended to give autonomy to the central bank in determining the limit of government borrowing for all purposes with the expectation that the SBP Central Board would use this authority to stop governments from reckless borrowings that fuels inflation and hurts the poor and the powerless.

However, neither Dr Ishrat Husain nor the current governor has come even close to exercising this authority, perhaps fearing that it could threaten their positions. But the then amendments introduced to the State Bank Act had assured the security of their tenure precisely in such situations. They were also authorised to send a quarterly report to the parliament so that the Legislature could help it withstand the pressure tactics of the executive.

In such a framework, an autonomous central board of directors under strong leadership of a professionally competent governor and board chairman could generate a debate in the country to expose the recklessness of a government before an irreparable damage was done to the economy and the poor through runaway inflation.

Unfortunately, the recent SBP governors and its central boards have failed to discharge their legal responsibility. But instead, a news report attributes to Dr Ishrat Husain, a former SBP governor, a statement alleging that flaws in the SBP laws allowed the government to indulge in unrestricted borrowing. I had worked with Dr Ishrat Husain at the SBP and cannot believe that he can make such an inaccurate statement. Regardless, let me clarify the legal position.

The State Bank Act, as amended in 1977, had added a new section, section 9A, which reads as follows:

“The Central Board shall, in order to secure monetary stability and soundness of the financial system: (a) formulate and monitor monetary and credit policy…. (b) determine and enforce, in addition to the overall expansion of liquidity, the limit of credit to be extended by the Bank to the federal government, provincial governments and other agencies of the federal and provincial governments for all purposes it being understood that the governments will meet their additional credit requirement directly from commercial banks through market based auctioning system to be conducted by the bank.”

Thus the legal reforms introduced in May 1997 specifically stipulated that the SBP’s Central Board was to determine and enforce, in addition to the overall expansion of liquidity, the limit of credit to be extended by the SBP to the federal and provincial governments and their other agencies for all purposes.

If the federal government was to borrow additional amounts from commercial banks, it had to take into account the credit requirements of the private sector as determined by the SBP’s Central Board; and any such borrowings were to be made at market rates through SBP conducted market-based auctioning system.

Under these provisions of the law, proper sequencing for the formulation and implementation of monetary policy is as follows:

(a) Much before the beginning of a fiscal year, the macroeconomic management team sets the targets for economic growth and inflation for the next fiscal year and makes a projection of the balance of payments outcome based on growth and inflation targets, trade and exchange rate policies and other variables affecting the economy.

(b) These macroeconomic targets are presented to the Monetary and Fiscal Policies Coordination Board, which adopts them, with or without modifications, to serve as a basis for other macro economic projections.

(c) Based on its framework for economic analysis and demand for money function, the SBP determines the safe limit of monetary expansion for that year consistent with the growth, inflation, and balance of payment targets.

(d) The SBP estimates the credit requirements of the private sector, in consultation with representatives of the private sector; and keeping in view investment levels that is required to achieve the growth target.

(e) Based on the safe limit of monetary expansion, anticipated changes in net foreign assets and the requirements of the private sector, the SBP estimates the scope for government borrowing from the banking system.

(f) Using its reserve money programme, the SBP estimates the scope of government borrowing from the SBP and the remaining amount that can be raised from the rest of the banking system.

(g) The above estimates are presented to the SBP Central Board for its approval with or without amendments.

(h) The credit plan approved by the SBP Central Board is forwarded to the ministry of finance so that in preparing the budget it keeps in view the limit on government borrowing from the SBP and commercial banks approved by the Central Board of the SBP.

(i) The SBP implements monetary policy through market based instruments, mainly open market operations, to keep credit and monetary expansion in line with the projections. It is also mandated to enforce the limit on government borrowing approved by its Central Board, and

(j) A quarterly review of developments is undertaken and macro policy indicators reviewed in meetings of the Monetary and Fiscal Policies Coordination Board to make any adjustments in the respective areas by the respective institutions, if necessary, and to ensure consistency in macro economic policies.

The above sequencing based on the legal framework for the formulation and implementation of monetary policy leaves no scope for the government to unilaterally determine its borrowing from the banking system. While attempt needs to be made to develop a consensus, in the case of difference of views, the legal position is that the government is required to accept the limit on its borrowing from the banking system as determined by the SBP Central Board.

In this regard, Section 9A of the State Bank Act also gives enforcement power to the SBP, implying that the SBP can decline credit to the government in excess of the limit prescribed by its Central Board.

There is no ambiguity in the laws about the respective roles of the government and the SBP in the matter of government borrowing from the banking system.

Moreover, the State Bank was legally obliged to keep the legislature informed on a regular basis on the state of affairs of the economy through its independent and objective analysis as a counter to the propaganda that usually emanates from the executive that all is well.

The above provisions were used in earlier years. When persuasion failed to achieve adherence to set borrowing limit, the State Bank, for the first time, refused to honour payments order issued by provinces in excess of their limits.

More specifically, the State Bank had on six different occasions stopped payments of cheques issued by the governments of Sindh and Balochistan..

To conclude, the law is there that mandated that the State Bank determines and enforces government borrowing based on its assessment of the safe limits of such a borrowing consistent with the inflation target; the law is unambiguous and the responsibility of the State Bank is clear and enormous.

What was needed was a leadership that enforced the law even if it carried personal risks to its governors and the boards. Accordingly, it is the failure of leadership and not the absence or inadequacy of laws that has led to reckless printing of notes.

To repeat, the State Bank has failed to live up to its amended charter and legal obligations, and expectations of the people after granting it its long overdue autonomy.

The writer is Dean of College of Business Management and former deputy governor of the State Bank of Pakistan