IN a democratic setup, the government and the central bank often develop a love-hate relationship. When economic challenges deepen or grow out of proportion, this relationship becomes all the more intricate and demanding. This is what is happening in Pakistan now as the Covid-19 pandemic peaks, unleashing a range of economic miseries.
The pandemic hit the country at a time when the State Bank of Pakistan (SBP) was to get greater autonomy anyway. That was one of the conditions attached to the $6 billion loan from the International Monetary Fund (IMF) secured in July last year. Now the issue is not just that of resetting relationship boundaries. It is about fulfilling the promise, which the government had made to the SBP and the IMF, at a time of national emergency when it can hardly afford to cede more powers to the central bank.
The SBP has drafted some amendments to the piece of law that governs its functioning. It has forwarded the same to the Ministry of Finance for vetting and initiating the actions required for the ultimate approval from parliament. The media is reporting on the changes that the SBP wants in the SBP Act 1956. The central bank is avoiding commenting and is waiting for the official word from the government. This is happening while Pakistan is pressing the IMF for the release of the third tranche of the loan and is combating the socio-economic — and even political — fallouts of the pandemic.
Naturally, the government wants the IMF to delay discussions on the SBP’s autonomy for some other time.
Regardless of whether the IMF would agree to it, one thing is clear. The government will have to act decisively. Newspaper reports suggest that the Ministry of Finance has developed a response to the amendments to the SBP Act 1956 sought by the central bank. The Ministry of Law is now vetting them. The IMF, according to people privy to this matter, wants that the issue be settled by the close of this fiscal year.
Central banks often help commercial banks make profits at the cost of depriving credit-worthy sectors of their due share
The essence of the amendments to the SBP Act 1956 sought by the central bank is that it should be allowed inflation targeting. In plainer words, the SBP wants to design monetary policies keeping just one key variable in mind: inflation. Currently, it is supposed to use monetary tools to influence both inflation and economic growth besides discharging another tricky obligation ie stemming the volatility in the foreign exchange rates.
Theoretically, inflation targeting helps achieve price stability quickly. A monetary policy designed under this regime normally keeps inflation in a pre-defined range for years. Under normal circumstances, that creates room for the government to make and implement medium-to-long term economic growth policies with greater peace of mind.
But the implementation of a monetary policy so formulated requires much greater fiscal discipline. Fiscal targets need to be achieved on a regular basis, year after year. That is why Pakistan has long been avoiding the introduction of the concept of inflation targeting in the monetary policy formulation. The breakout of the Covid-19 pandemic has made meeting initial fiscal targets impossible.
So in all probability, the SBP can hardly succeed in convincing the government to allow changes in the laws paving the way for inflation targeting — not only during this fiscal year but also in the next year.
However, the central bank may not find it difficult to continue to restrict the government’s borrowing from it — a practice that had started from the beginning of this fiscal year on the insistence of the IMF.
The purpose was to rein in inflation and gradually prepare the government to learn to live under an inflation-targeted monetary policy regime, whenever introduced.
The government is apparently irked by the central bank’s suggestion that it be allowed to pursue inflation targeting — a proposition that would place the responsibility of chasing the economic growth target squarely on the government. So the Ministry of Finance wants to contain the role of the SBP governor in policymaking. It wants the board of directors of the SBP under the chairmanship of someone other than the governor himself to set policies. This, too, is not going to happen as the IMF is fiercely opposed to it. But the government, of course, may consider changes in the constitution of the board of directors. It may appoint as board members more independent economists of high repute.
Giving greater autonomy to the central bank not only entails greater responsibility for the government of the day regarding fiscal discipline and debt management. It also leaves little room for the Ministry of Finance and the Federal Board of Revenue to maintain the status quo in the relationship with the private sector. The SBP knows it. That is why some amendments to the SBP Act 1956 seek for the central bank the authority for creating funds to redirect or accelerate the credit flow towards most deserving sectors.
As a first step towards achieving this broader goal, the SBP wants the government to abolish five existing funds, including the Export Credit Fund. Here again, the Ministry of Finance and the SBP need to reach a consensus. It is true that the existing Export credit Fund and the likes of it have failed to achieve their ultimate objective.
But it is also true that no political government can afford to give up its prerogative of creating such funds and requiring the central bank to run them. The reason is this may deprive the government of an opportunity to promote faster growth where it is most needed. Central banks in the developing world notoriously facilitate banks in profit-making, often at the cost of depriving the credit-worthy sectors of their due share.
We have experienced this in the past and are still experiencing it. The new version of the SBP Act 1956 that will eventually be presented before parliament as the SBP Amendment Bill 2020 must ingrain a well-defined and balanced responsibility-sharing mechanism between the fiscal and monetary authorities.
Published in Dawn, The Business and Finance Weekly, April 27th, 2020