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Strengthening the State Bank autonomy

January 12, 2009

THE measures for strengthening autonomy of the State Bank of Pakistan (SBP) can broadly be divided into three categories First, the SBP has to act within the legal framework to realise its operational autonomy.

Second, the executive and legislative branches of the government have to make it possible for the SBP to function as an autonomous institution within the legal framework. Third, additional legislative action is required for this purpose.

The prospect of the SBP becoming operationally autonomous crucially depends on the resolve and competence of the SBP itself. The personality of SBP governor, nature and composition of the board of directors, its support to the governor as its chairman and the professional competence of the staff and its continuous strengthening, have a lot to do with the degree of operational autonomy that the SBP can acquire.

The SBP should continue on its difficult and long journey of institution building in an environment that is not very favourable. In the present fast-changing globalised banking world, the SBP needs to strengthen its own skills through creative and competitive human resource policies. The SBP has complete administrative autonomy, and if it is unable to develop professional expertise, it cannot blame the government.

The core functions of any successful organisation are performed by the middle level professional staff, and it is the responsibility of the SBP governors to create working and career environment to attract, incentivise and retain the best talent. While at times lateral entry at higher levels may be necessary to meet certain skill needs, it is the internal career stream that needs to be developed. In particular, the two core career streams of the SBP related to economic research and banking supervision need continuous upgradation.

In addition, both on the operations and policy side, the positions of deputy governors must be filled through promotion from within, as had been the practice for a long time, so that young officers entering SBP service can aspire to reach at least that level through internal competition and progression.

For the position of deputy governor, institutional memory and work experience in the SBP itself is critically needed, and it can best be acquired through internal training and experience. Lateral entry at these and other senior levels on a large scale is demoralising and disruptive for the regular career staff, and such practices stifle talent from growing from within. Accordingly, an essential requirement for the SBP to function as an autonomous institution is to adopt creative human resource polices to attract, retain and motivate talented staff to work on a sustained and stable basis.

A most glaring error made to keep the position of the deputy governor (policy) vacant for almost ten years, perhaps on the erroneous assumption that an economist-governor does not need the services of a deputy governor (policy). If anything, an economist-governor should have all the more awareness of the need to have a strong economic research team working under a leading economist as deputy governor (policy).

In fact in the past, even some of the non-economist governors had recognised that it is its overwhelming technical superiority with which the SBP can provide advisory services to the government, increase its input in macro- economic policy matters and effectively deal with foreign central banks, governments and multilateral agencies.

Similarly, SBP needs a deputy governor (banking supervision) who has mastery over the latest supervision literature and techniques produced by BIS and similar other professional organisations, and vast experience in bank supervision in the country, and such persons can only be groomed from within.

Skill development is not a one-time affair and there is a need for continuous strengthening of the SBP's banking supervision capacity. The recent banking crisis in Europe and US quite clearly demonstrates the importance of timely and continuous improvements in banking supervision capacity of the regulators.

Section 9A and 9B of the State Bank Act mandates that the SBP central board must be the final authority to approve monetary policy, to set a credit limit to be extended by the SBP to all layers of government, to determine cut off interest rates for government borrowing from commercial banks and to ensure adequate credit to the private sector.

Some serving and retired government economists confuse the matter by stating that section 9A and 9B of SBP Act could be interpreted otherwise. Recently, SBP management has also not fully owned and exercised the authority vested in the central board of directors by the amended charter. There is a need for the SBP management to enhance its understanding of the relevant provisions of the Act and the legislative history, and to make renewed commitment and carry the board with it in enhancing SBP autonomy.

For the SBP to perform its duties as enshrined in Section 9A and 9B of SBP Act, following sequence for the formulation and implementation of monetary policy,(followed by SBP during 1997-99),

must be reactivated* The SBP should advise the government to hold a meeting of the Fiscal and Monetary Policy Coordination Board to agree on the growth, inflation and foreign exchange reserve targets for the coming fiscal year on whose basis all organs of the government and the SBP should make their macro projections of other aggregates.

* The SBP should prepare the estimates of the safe limit of monetary expansion in May for the next year consistent with agreed targets.

* In consultation with representatives of trade, industry, services, agriculture and other participants from the private sector, the SBP should estimate in May the credit requirements of the private sector that would help achieve the agreed growth target

* Deducting from the estimates of safe limits of monetary expansion, the estimated credit requirements of the private sector, and adjusting the net effect on money supply of the anticipated changes in foreign exchange reserves, the SBP should determine residually, the maximum limit of government borrowing from the banking system.

* Using its reserve money programme, SBP should divide the scope of government borrowing between that from SBP and commercial banks

* After getting the approval by the board, the SBP should inform the government in late May the maximum government borrowing to be allowed from the SBP and from commercial banking system. The government should take that into account in preparing the budget.

* The SBP should implement its monetary policy through market based instruments, and enforce the limit on government borrowing through consultation, persuasion and, if need be, direct action

* The SBP should prepare a quarterly review of monetary, fiscal, commerce and growth policies for co-ordination in quarterly meetings of the Monetary and Fiscal Policies Co-ordination Board, with a clear understanding that this forum was created for co-ordination of macroeconomic policies and it cannot take any decision that compromises the SBP autonomy in the matter of monetary policy and determination of government borrowing from the banking system.

* The SBP needs to be autonomous within the government and not from the government. Accordingly, it should be treated as equal and cooperative partner in economic management.

Government measures The second most important prerequisite for SBP operational autonomy is for the political leadership to own it as an essential element of good governance. With this commitment, it can exert pressure on the bureaucracy to extend cooperation to the SBP. Such cooperation necessitates the following measures at the government level, for which, the ministry of finance needs to

* accept in letter and spirit the SBP autonomy and prepare its budget keeping in view the limit on government borrowing from the banking system set by the SBP.

* provide to the SBP monthly cash flow estimates and its weekly borrowing requirements from the banking system within the overall SBP ceiling.

* indicate to the SBP the maturity structure of its borrowing.

* accept the cut off rate as determined by the market for its borrowing and also accept the general principle that rates of return are an instrument of monetary and not of fiscal policy

* manage its debt in consultation with the SBP to ensure that the rate structure of non-bank debt is in harmony with that prevailing in the banking sector

* use the privatisation proceeds more to retire debt than to finance additional expenditure. If that does not happen, the SBP should account for them in determining the safe limits of monetary expansion and of government borrowing.

* The National Assembly and the Senate should take the Quarterly SBP Report seriously, assign its study to a relevant committee, which should hold a hearing in which SBP governor should be invited to explain and other experts invited to comment, and based on such discussions, the report should be taken to the floor of both the houses.

Legislative action The government should take some additional legislative measures to make SBP autonomy more effective. Three legislative measures taken by the Musharraf government need to be repealed.

First, the SBP Banking Services Corporation Ordinance 2001, promulgated on the recommendations of Dr Ishrat Husain, must be repealed. It has set up two separate legal entities, one called SBP and the other SBP BSC, with two legally independent chief executives, on the erroneous assumption that the so-called core and non-core functions of the SBP can be carried out more efficiently by two separate legal entities. Formulation and implementation of monetary and banking policies are two sides of the same coin and their separation has had a very detrimental effect on the efficiency and functioning of the SBP as a central bank.

For the health and strength of SBP as the central monetary authority and regulatory body, it is very vital that this ordinance be repealed immediately.

Second, distortion created by separation of appointment of the SBP Board and SBP governor by two different offices of the president and the prime Minister, should be removed. It has created an anomalous situation with potential of conflict and disharmony in the functioning of the SBP. The bifurcation of authority can prove very disruptive in a situation in which differences may develop between a prime minister and a president.

The SBP governor has to work very closely with the executive branch, and should be appointed by the Prime Minister along with the board. The appointment of deputy governors should be made by the SBP board.

Third, the Ordinance issued by the Musharraf government whereby the federal government has been authorised to direct the SBP to set up funds for special purposes, should be withdrawn because it undermines the SBP autonomy.

Moreover, the government should revert to the original stipulation of the Moin Qureshi regime for appointing the governor on a non-renewable term of five years. The rationale behind the one five-year term for the governor was to give him enough time to create an impact but not to yield to the temptation of working to secure a second term.

Unfortunately, in approving the ordinance, the National Assembly reduced the term of appointment of the governor to three years but allowed a second term.

The Banking Companies Ordinance gives wide powers to the SBP to take action against unlawful activities of bank staff, managements and boards. However, there is a need for a fresh look at the ordinance to enhance the power of the SBP over commercial banks, enabling it to independently change managements, appoint administrators, temporarily take over the commercial banks and restructure them. This has also been recommended by the IMF and accepted in the Letter of Intent signed by the Advisor Finance and SBP Governor.