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.

Thus, under the legal reforms introduced in May 1997 Pakistan Banking Council was abolished, and it was 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 purpose. The SBP board was required to submit an independent quarterly report to the parliament, the government was banned from issuing any direct or indirect instructions to the banking system that were in conflict with SBP policies, the activities of the trade unions were severely curtailed, the regulatory authority of SBP was strengthened, and in general, autonomy of the SBP was enhanced with vast powers given to its board of directors.

An effective and continuous enforcement of all the new legal provisions would have made SBP a truly independent central bank by now and led to the creation of its own non-political institutional personality embodying professionalism, competence and objectivity.

The fact that the results have fallen short of the intent of the law, and SBP has not demonstrated true autonomy in the recent past in its areas of jurisdiction, gives one a reason to pause and appraise the inhibiting factors with a view to proposing measures to remove them for steady progress.

Autonomy in practice: At the time of legislative reforms, it was recognised that the enforcement of new laws may turn out to be a more daunting task than their legislation. Old order is difficult to dismantle in practice even with the changes in laws, and new traditions and practices take time to strike roots. However, during 1997-99, a promising beginning was made to make decisive moves in that direction and to assert in practice independence of SBP that had been enshrined in its charter through legislative reforms during 1993-1997.

In particular, in the matter of government borrowing from the banking system, SBP began to follow section 9A and 9B of the State Bank Act and established an institutional procedure and an analytical framework to determine the safe limits of monetary expansion and of government borrowing from the banking system that were consistent with national economic objectives of growth, inflation and balance of payment.

For example, in fiscal year 1997-98, the SBP board determined, based on SBP developed analytical framework, the safe limit of government borrowing and indicted it to the government before the formulation of the budget on whose basis the financing of the budget was finalised by the government. In indicating the limit, the then governor made it clear to the government that SBP board intended to take all necessary steps to enforce those limits during the year.

The federal government adhered to those limits voluntarily and when some of the provincial governments violated them their checks were bounced under instructions from SBP. Strong reaction from the relevant provincial governments to this action could not deter SBP from adhering to its decisions. Thus a very healthy tradition was initiated to enforce SBP autonomy in the most critical area of government borrowing, and it is fully documented in communications with the government.

The SBP board also developed the practice of discussing government borrowing and other policy matters in its jurisdiction in its monthly meetings and began issuing press releases on their conclusion informing the public in specific terms of its stance on the matter. In its quarterly reports to the parliament, the board provided an independent analysis of the state of the economy giving warning signals of any weakening trends. Commercial banks were instructed in writing to ignore any orders from any quarters that were not consistent with SBP policies conveyed to them, trade unions were stopped from interference in management of banks, and loan defaulters and corrupt bankers were taken to task.

With the initiation of enforcement of new laws on the above lines the banking system and monetary situation began to improve but at the same time, vested interests, including some government quarters, were up in arms against SBP. However, SBP stuck to its policy of enforcing the laws during the initial period, raising hopes that continuation of the enforcement effort in the subsequent years could entrench the autonomy as much in practice as it was in laws. Enforcing the law: With the military takeover of the government in 1999, and change of leadership in SBP, the trend of enforcement of new provisions of law with regard to government borrowing and banking supervision began to weaken, with a serious setback to progress in SBP autonomy in reality.

Instead of continuing to do its home work as required by the law, giving the limit of borrowing to the government within which it had to arrange for financing of the budget, and using enforcement tools at its disposal, SBP stumbled back to the old practice of accommodating whatever borrowing from the banking system was dictated by the government in its budget. Not only that, the government was allowed in the name of “teamwork” to borrow from SBP even larger than the budgeted amount either to finance additional expenditure or replace more expensive commercial bank debt by cheaper borrowing from SBP . This resulted in a substantial dilution of institutional autonomy in practice.

At the same time, privatisation proceeds, which are inflationary like printing of notes if used to finance current expenditure, were allowed by SBP to be used as ordinary revenue by the government. Previously, SBP had insisted that such proceeds should mostly be used to retire debt. Government mandated credit requests began to be accommodated against the legal provisions of section 9A and 9B of the amended State bank Act.

For the first time after legislative reforms, SBP practically lost control on its own balance sheet starting in 2000-2001, and the government was given a free hand to inflate the economy as before the reforms of 1993-97 through printing of notes. In addition, the banking system was encouraged to provide cheap credit for consumption in the private sector to promote consumption-led growth.

Ill effects of all these practices and policies remained hidden for several years because of inflow of foreign exchange, reflecting the impact of events of 9/11 terrorist attacks in US resulting in reverse inflow of funds into Pakistan through the banking system, provision of larger bilateral aid by the US and softening of the stance by the international financial institutions in providing loans and arranging debt relief, and sale of assets to foreigners to earn foreign exchange. Together, these inflows cushioned the impact on the external sector of consumerism and high imports and helped build up reserves.

The most painful aspect of this period was that SBP became an enthusiastic partner with the government in misleading the public about macro economic trends and creating an allusion of prosperity.

The State Bank was given autonomy to do independent analysis and sift the ordinary factors from the extraordinary and to give an objective assessment of the underlying macroeconomic trends. Not only did SBP fail to do so, it became a partner in the cover up. In the process, it also surrendered the authority that was given to it to limit government borrowing and to ensure monetary stability.

The most damage to autonomy came during 2000-2006 and with the best of efforts and intentions Dr Shamshad Akhtar was unable to reverse this trend during her tenure. The unlawful practices began to overshadow the laws, and desires of the government began to be accepted over the rule of law. The doctrine of necessity began to replace the laws on the books. Like the constitutional autonomy of the superior court, the legal autonomy of SBP became a causality of expediency.

There were other factors also that diluted SBP autonomy. Division of SBP in two independent legal entities and distribution of authority for appointment of the governor and the board between the president and the prime minister respectively added to the confusion and weakening of SBP authority. Failure to insist on the holding of the quarterly mandatory meetings of the Monetary and Fiscal Coordination Board set up under section 9 B of the State Bank Act increasingly isolated SBP from participation in the formulation of policies having a bearing on monetary policy.

No wonder the government engaged in reckless borrowing from SBP which fueled hyper inflation and contributed to fast depletion of foreign exchange reserves and a sharp devaluation of the rupee. Had SBP stood its ground that was created for it through legislative reforms in 1993-97, and followed the practices adopted in 1997-99, the country would have been alerted far ahead of time about the emerging macroeconomic dangers, a virtual collapse of the economy by 2007-08 could have been avoided, and in the process by now an autonomous SBP would have become a pillar of strength for the e country’s financial and economic system.

Restoring autonomy: Several measures are necessary to restore to SBP its hard earned autonomy. Those measures are enlisted here:

* State Bank should insist that the government convene regular meetings of the Monetary and Fiscal Policy Coordination Board as required by law, in which the targets of growth, inflation and reserve changes should be agreed on for all macro economic projections for a fiscal year

* Based on those agreed targets and estimates of private sector credit requirements, SBP should determine the limit of government borrowing both from SBP and the banking system and inform the government in order for it to prepare its budget on that basis so far as borrowing from the banking system is concerned

* SBP should enforce those limits through consultation, persuasion, and, if necessary, denial of access to its resources beyond the indicated limit.

* A quarterly exercise should be undertaken to review and revise those limits in line with the growth, inflation and balance of payments trends.

* It should be made clear that interest rate policy is a monetary instrument and cannot be allowed to be manipulated on fiscal considerations.

* As a regulator, SBP should make it clear to banks that their acceptance of any instructions from any quarter that conflict with SBP regulations would provoke penalty and punishment as provided by law.

* SBP Banking Services Corporation Ordinance 2001 should be repealed to integrate the policies and operations of SBP

* The appointment of the governor and the board should be for a non-renewable period of five years and both should be appointed either by the president or prime minister. Criteria should be agreed upon for the qualifications and experience of the governor and the board members

* Deputy governors should not be appointed by the government. Their appointment should be made by the SBP board

* Ministry of finance should exert no administrative control either on SBP or on any bank or DFI

* All sections of the SBP Act that became redundant due to its nationalisation should be deleted.

* No change should be made in Section 9A and 9B of SBP Act that would dilute the authority given to SBP board in the conduct of monetary policy and in determination and enforcement of government borrowing.

* To enhance enforcement powers of SBP over commercial banks, necessary amendments may be made in the Banking Companies Ordinance enabling SBP to change managements, appoint administrators, temporarily take over the banks and restructure them

In the end, it may be mentioned that Mr Shaukat Tareen, Adviser Finance, was there on the scene as president of Habib Bank when SBP struggled to attain a measure of autonomy through hard fought legislative reforms, and took the banking system out of the clutches of the vested interest groups. It is hoped that in his present position of authority he will take concrete measures on the above lines to ensure de-facto SBP autonomy. The human temptation for concentration of power in one’s individual hands at the cost of the institutions must be avoided in the larger interests of good governance.

The writer is the Dean, College of Business Management, Karachi and a former deputy governor (Policy), SBP.


Zero carbon race
22 Jan 2021

Zero carbon race

Over 100 countries, including Pakistan, have failed to submit their national commitments to cut emissions.
Sports for all
22 Jan 2021

Sports for all

We need a certain level of fitness to observe God’s law.
Normalcy restored
Updated 22 Jan 2021

Normalcy restored

So long as invoking domestic and foreign ‘enemies’ is our ‘normal’, expect our tryst with praetorianism to continue unabated.
The hazards of governance
Updated 21 Jan 2021

The hazards of governance

The most efficient administrations derive their strength from the quality and regularity of intra-department consultation.


Updated 22 Jan 2021

Time to heal

A multitude of foreign issues will test Biden’s mettle and require progressive thinking.
22 Jan 2021

Foreign funding

AS the pressure builds on his party in the foreign funding case, Prime Minister Imran Khan has called for an ...
22 Jan 2021

Decaying PTV

THE Cabinet Committee on State-Owned Enterprises has decided to remove Pakistan Television from the list of...
Updated 21 Jan 2021

Agosta kickbacks trial

A POLITICALLY significant trial opened in Paris yesterday. Former French prime minister Edouard Balladur is in the...
Updated 21 Jan 2021

Indian media scandal

Common sense, factual reporting and ethics are all chucked out the window in the maddening race for ratings, influence and power.
21 Jan 2021

Rising food prices

FOOD inflation continues to challenge the resolve of the government to control the prices of essential kitchen items...