THE State Bank’s annual report 2007 shows that SBP Governor Dr Shamshad Akhtar is following in the foot steps of Dr Ishrat Hussain, who is primarily responsible for the institutionalisation of the market-based monetary policy. The SBP has taken no new policy initiatives and its continued inefficiency is reflected in areas such as mismanaged foreign reserve transactions.

The State Bank’s liquid reserves rose from $10.7 billion in fiscal year (FY) 2006 to $13.3 billion in FY 2007 i.e.by 24.3 per cent. But the gain in foreign exchange transactions dropped from Rs4.37 billion in FY 2006 to Rs1.95 billion in FY 2007, a massive fall of over 42 per cent.

On an asset portfolio of $13.3 billion, the SBP earned about $32 million, a pathetic rate of return of 2.4 per cent, surely one of the lowest in the world. India’s comparative rate of return for FY 2007 is almost double of this figure and China’s even higher.

Dr Ishrat Hussain had made a net loss of over Rs30 billion on foreign exchange transaction during his tenure as the governor of State Bank (1999-2005). Why does Shamshad Akhtar fail to realise that keeping the bulk of our foreign reserves in dollars, the world’s weakest and rapidly weakening hard currency, is not prudent? Why have gains from placements fallen by almost 30 per cent and open market transactions during FY 2007 yielded a net loss of Rs7.6 billion? Does America continue to influence our reserve management policy?

The increase in the SBP’s income during FY 2007 is entirely due to its relentless jacking up of interest rates. It is not due to any improvement in its operational efficiency.

The share of net interest income in non-investment disposal, the SBP’s earnings continue to be a staggering 90 per cent in both FY 2006 and FY 2007. The SBP continues to increase its profit by increasing domestic lending rates and the cost of this increased profitability is borne by the poor. The increased profitability is also due to a reduction in provisioning which fell by 75 per cent in FY 2007. There is no justification for this reduction in the notes attached to its annual accounts.

The SBP’s inefficiency is also evident in the nearly 37 per cent increase in FY 2007 in administrative expenses. Forced retirement benefit payments have continued to spiral since the previous governor’s days. In FY 2007, they rose by a massive 69 per cent and accounted for almost 40 per cent of the total administrative expenses.

Salary expenses have gone up by 14 per cent. Depreciation charges have more than doubled despite substantial asset disposal and this is not explained. Forced ‘(voluntary)’ retirements have increased from 73 in FY 2006 to 88 in FY 2007. Almost all senior executives have been “voluntarily” retired and the vacancies filled by specialists on contracts.

The operational inefficiency is more tragically reflected in the SBP’s incompetent management of monetary system. As an institution committed to neo-liberal monetarist doctrines, the SBP should have only one policy objective - price stability. Its foreign neo-liberal mentors have taught the SBP management to believe that if price stability is assured every thing else will follow. The achievements of an ‘optimum’ growth rate and the most equitable distribution of income and wealth follow automatically and unintentionally from the achievements of macroeconomic stabilisation. The SBP’s claims on autonomy are based on the universal applicability of this false doctrine.

But market-based monetary policy has shown to be quite incapable of achieving even price stability alone. In FY 2007 food inflation was significantly higher than in India, China and Iran. The sensitive price index rose by 8.1 and the CPI by seven per cent in FY 2007. Food inflation increased from 7.9 per cent in FY 2006 to 10.3 per cent in FY 2007. The common man will, of course, never believe in these figures. The commodity composition of the CPI, the SPI and the WPI are woefully unrepresentative of the common man’s consumption pattern.

Inflation impacts negatively on lower income groups. The SPI figures show that the inflation rate experienced by the lowest income-group in FY 2007 is significantly higher than that experienced by its highest income-group which in the SBP’s table is shown to earn only Rs12,000 and the top 0.1 per cent of the population -- generals, senior level bureaucrats, corporate CEO, etc.-- have incomes averaging Rs1 million per month. To them inflation is of no concern at all. That is why the SBP continues to set such modest inflationary targets.

But even these modest targets are not being achieved. The SBP target for inflation in FY 2007 was six per cent but it estimates inflation in FY 2007 at 7.8 per cent, virtually unchanged from the FY 2006 level. The SBP’s target M2 growth rate for FY 2007 was 13.5 per cent, but M2 is expected to have grown by at least 20 per cent during FY 2007.

Moreover, the discrepancy between the M2 targets and M2 actually realised growth rate have been increasing. In FY 2006 for, example, the M2 grew by 15.1 per cent whereas the SBP’s M2 growth target had been 12.9 per cent. This increased discrepancy between targeted and actual monetary asset growth rates shows that the adoption of a market-based monetary policy stance is slowly but surely weakening the control of SBP over the national monetary system.

As the monetary management system is market-based, it is the private sector players, especially the foreign banks, who determine the volume and composition of money supply. The central bank becomes subservient to the universal international money market. This is happening in Pakistan.

The SBP’s ineffectiveness to ensure price stability is not limited to food inflation. The core inflation has been rising, especially during the last months of FY 2007. Moreover, the increased international vulnerability of the SBP is shown by the fact that the Net Foreign Asset’s (NFA’s) actual contribution to M2 growth during FY 2007 was as high as eight per cent as against an SBP targeted rate of only about two per cent. The NFA grew by Rs274.6 billion during FY 2007.

This clearly shows the inability of the SBP to control the foreign component of total money supply. Econometrics research has conclusively shown that it is movement in the NFA and not the SBP policy initiatives which determine M2. The SBP is a passive respondent to the autonomous NFA changes. Like most other central banks operating market-based monetary policy, the SBP has lost the ability to control money supply growth and interest rates.

Interestingly, neither government’s nor private sector’s borrowings were a major cause of the substantial excess of the M2 growth over the FY 2007 credit plan target. This excess was entirely due to the NFA growth which the SBP cannot control as long as it adheres to the market-based monetary policy. The government borrowing fell short of FY 2007 credit plan target by 29 per cent. The FY 2007 credit plan had expected private sector credit growth to Rs390 billion. It was only Rs365 billion during FY 2007.

The rate of NFA growth, especially the SBP-cum-NFA, was a major cause of inflationary pressure for it stimulated reserve money growth. The SBP could not resist its own building up of the NFA as the principal cause of this was accelerated disbursement by US agencies to provide logistic support to American subsidised military operations in Waziristan and also the very expensive floatation of the GDRs.

Movements in the NFA were a major cause of the increase in interest rates as the SBP admits “International interest rates now have great influence on domestic interest rates”. The sad fact is that as long as Pakistan adheres to market-based monetary policy the SBP will not be autonomous. It will remain subservient to international markets.

There is evidence to show that increase in interest rates has effectively restrained the growth of fixed investment particularly in the textile sector. The negative impact of jacked up interest rates on credit growth is evident from the fact that the credit to GDP ratio has fallen in FY 2007 and the value of this ratio is now lower for Pakistan than for India, Bangladesh, Sri Lanka or any other major South East Asian economy.

The aggregate bank spread remained well over seven per cent, the highest by far in South Asia during FY 2007. The advances to deposit ratio fell from about 78 per cent in FY 2006 to about 72 per cent in FY 2007. That neither Pakistanis nor foreigners have been convinced that financial vulnerability has been reduced as indicated by the fact that despite significant increase in the NFA to M2 ratio in FY 2007, the foreign currency deposit to M2 ratio has continued to fall.

The SBP remains committed to a tight monetary policy as indicated by the recent rise in the discount rate. This hurts the poor as the SBP’s own research has shown that increase in policy rates passes through much more rapidly to the weighted average loan rate (WALR) than it does to the weighted averaged deposit rate (WADR) and therefore raises bank spread. The impact of SBP money market operations during both the first and recent half of FY 2007 has been to reduce liquidity and jack up the WALR structure. This has also been the impact of heightened liquidity requirements.

That monetary policy stance is increasing macroeconomics vulnerability is evident in the widening gap between the gross domestic saving and the gross capital formation. The gross domestic saving as a ratio of the GDP fell from 16 per cent in 2000 to 13.7 per cent in 2006 and the investment saving gap as percentage of the GDP rose. In India in 2006 this gap was only one per cent and in Bangladesh 4.3. In China domestic savings exceeded gross capital formation by 2.4 per cent, in Indonesia by 4.6 and in Malaysia by a massive 23.7 per cent. The saving-investment to the GDP gap increased in Pakistan to over eight per cent by FY 2007.

The average weighted lending rate in FY 2007 was 11.55 per cent (up from 10.65 per cent in FY 2006), the average weighted rate of return of savings in FY 2007 was only 2.59 per cent. Savers were thus receiving a massive negative rate of return for their deposits, for inflation was running at eight per cent during that year according to the SBP.

The anti-poor character of the market-based monetary policy becomes more evident when we look at the distribution of bank deposit and bank investment accounts. In 2007, there were a total of about 25 million deposit accounts in the country. About 22 million of these had deposits of less than Rs0.1 million each. The share of this over 80 per cent of deposit holders in total deposits was, however, only about 14 per cent.

As against this, the deposit holders who had more than Rs10 million each in their individual deposit accounts were less than 0.1 per cent of total deposit account holders, but their share of total deposits was as high on 39.6 per cent in FY 2007.

Now let us look at the loan accounts. The total number of loan accounts in FY 2007 was about 5.2 million. Of this number, accounts of those that had borrowed less than Rs0.1 million each was about 66 per cent. But the share of the small borrower in the total amount lent by the bank was only 6.5 per cent.

As against this, large borrowers with investment account limits of Rs10 million and above represented only 0.42 per cent of the total number of investment account holders. But their share in total bank loans in FY 2007 was about 65 per cent. This means that just 22,000 account holders, many of them holding multiple accounts, obtained two thirds of all bank loans in FY 2007. This is ten times more than the share of the small borrowers whose share of total investment accounts was more than ten times higher than that of the large investors.

Moreover, the total deposits of the large account holders in scheduled banks in FY 2007 were about Rs1.3 trillion, whereas the total loan obtained by the large account holders was about Rs1.5 trillion. There was thus a net transfer of about Rs200 billion to these borrowers through the banking system during FY 2007.

As against this, the total deposits of the small deposit holders in scheduled banks in FY 2007 was about Rs560 billion. The amount lent to them by the scheduled banks in FY 2007 was only Rs126 billion. There was thus a net transfer of about Rs334 billion from the small borrowers though the banking system in FY 2007.

The adoption of the market-based monetary policy allows the market (i.e. the banks themselves) to determine interest rates and lending patterns discriminates against the poor.

A bank always uses public (the depositors’) money. The share of equity to total capital employed is necessarily miniscule. In FY 2006, the share of equity and resources was only four per cent of the total liabilities. When a bank is allowed to use public money for maximising its own profits, it necessarily exploits the public.

The adoption of the market-based monetary policy deprives the state of its monetary sovereignty and converts the central bank into a pawn of global finance. The SBP has lost control over movements in the NFA which determines changes in reserve money, level of money supply, cost of credit and the allocation of financial resource.

Empirical research at the CBM, the AERC, PIDE and indeed the State Bank itself has shown that the pre-conditions for the operation of successful monetary policy simply do not exist here. The M1 is an endogenous, not an exogenous variable. Investment demand is not interest elastic nor is the supply of savings.

Changes in broad money are gangrenes caused by nominal GDP and the level of foreign reserves. The relationship between the M1 and the M2 is weak and in any case bi-directional. The market-based monetary policy cannot assure price stability in this situation.

The market-based monetary policy has converted the State Bank into a colonial currency board with declining levels of operational efficiency. It has deprived the government of its monetary sovereignty, and has enabled foreign banks to establish a stranglehold over the national financial system. They have committed injustice against the poor by institutionalising mass financial exploitation.