With the recent excessive money creation and consequent high inflation, and the toeing of government line by the State Bank of Pakistan (SBP) in its analysis of macroeconomic trends, there has been a renewed debate in financial circles about the autonomy of SBP or lack thereof.
The Letter of Intent signed by Advisor Finance and SBP Governor in concluding a recent stand-by arrangement with IMF makes a pointed reference to the desirability of enhancement of SBP autonomy. It raises a fundamental issue as to whether strengthening of autonomy requires changes in laws or in enforcement/practices/attitudes or both. Accordingly, it is imperative to revisit this question, both in a historical and legal perspective and in the context of the ground realities standing in the way of achieving operational SBP autonomy.
Laws are a necessary but not sufficient condition to ensure SBP autonomy, or for that matter autonomy of any institution. If constitutional autonomy can be trampled in practice, it is easy to get away with stepping aside of legal autonomy. If the lack of progress in this area reflects the practical hurdles rather than inadequacy of laws, then the government, SBP and indeed IMF ought to shift their focus from further refinements of laws to enforcement of, and adherence to, the existing laws relating to SBP autonomy to promote the national economic and financial objectives for which autonomy is being advocated.
Historical perspective Legally, SBP was not at all autonomous prior to 1993 in any sense of the word. A number of successive developments since the establishment of SBP in 1948 as the central monetary authority had relegated it to the status of an attached department of the ministry of finance. These developments included the provisions in the original State Bank Act (1956) for the dominance of the federal government (ministry of finance) in matters falling in the jurisdiction of a central bank, nationalisation of the banking system in 1974 and the creation of Pakistan Banking Council, with its parallel authority similar to that of SBP, succession of governors after Mr Zahid Husain who came mainly from the federal bureaucracy, having no training or background in monetary economics or familiarity with the conceptual separation of functions of a central bank from the government, upsurge in trade union activities and their interference with the management of banks, politicisation of the banking system to promote vested interests, and working procedures whereby the ministry of finance began to treat SBP as another subordinate entity.
The rubber stamp SBP board of directors, appointed by the ministry of finance without any regard to required expertise, was of no consequence, and all major board decisions, relating to staffing, lending and regulatory policies, or analytical contents of the SBP Annual Report, were subject to approval by the ministry of finance.
The cumulative impact of all these developments and factors was that by early 1990s, SBP was completely marginalised, monetary policy became subservient to financing requirements of the public sector, government-directed and subsidised lending accounted for a large part of private sector credit, political, bureaucratic and union interference in the banking business became rampant, supervision of banking fragmented and became very weak, loan portfolio became heavily infected, quality of services took a nosedive, and the banking system was on the verge of collapse.
The ministry of finance, with clear conflict of interest between sound banking practices and government's financial needs, was effectively making all the decisions relating to loaning policy and banking practices either directly or through directives to Pakistan Banking Council and SBP. With the passage of time, SBP got used to acting as the most obedient servant of the ministry of finance, and some of the governors that asserted independence in monetary policy and banking supervision were summarily removed. It is in the above context, and fast deteriorating economic and financial conditions, that a movement was started in 1993 to introduce legal reforms to give independence and traditional central banking authority to SBP. This effort was completed in several phases by May 1997 with the incorporation of comprehensive reform in the SBP Act, Pakistan Banking Companies Ordinance and enactment of some additional laws.
Legal autonomy Broadly speaking, the legislative changes made during 1993-97 gave SBP autonomy in three broad areas, namely (i) administrative autonomy (ii) autonomy in the formulation and implementation of monetary policy and (iii) autonomy in the regulation and control of the banking system.
The administrative autonomy of SBP secured in the first round of legislative changes in 1993 has not been questioned, and has been fully exercised since then. The administrative and management decisions of SBP board become final, not requiring any government approval which was not the case before. Substantive administrative matters such as creation or reorganisation of departments, recruitment and promotion of staff, fixation and revision of salary structure and benefits got placed in the exclusive jurisdiction of the board.
In addition, the governor and the board once appointed could not be removed before the expiry of their tenure except for misconduct proven by the government. All monetary instruments were restored to SBP to be used by the board without prior approval of the government in the conduct of monetary policy. The board was to publish an independent annual report on the state of the economy without government interference. The
government was required to consult the SBP board to determine its borrowing limits from the banking system and sanctioning and supervision of the banking system was given back to SBP.
These were in themselves giant steps but not enough to separate monetary from fiscal policy and to allow SBP to conduct independent monetary and banking regulation policies. Accordingly, the weaknesses and anomalies that were not addressed in the 1993 legislative reforms, including but not limited to continuation of Pakistan Banking Council (PBC) and authority of the government to determine the borrowing from banking system, were removed in 1997, and interference of the government in supervision of the banking system was legally prohibited.