A fractured central bank  

May 03, 2014 

Dr Muhammad Yaqub, former Governor of the State Bank of Pakistan.:

The State Bank of Pakistan (SBP) has been handed over to a governor and a deputy governor whose academic training is not even remotely related to monetary economics and central banking functions. Moreover, their work experience has been confined to retail commercial banking which is of no use or relevance to central banking.

The senior deputy governor, who had acquired some expertise in banking supervision by serving for a considerable time in staff positions at the SBP, has been sidelined with the result that vital monetary policy and bank regulatory decisions will basically be made by the two raw hands at the helm of SBP affairs. These two have to rub shoulders with competent and experienced counterparts from other countries, both bilaterally and in multilateral settings, and are bound to cut a sorry figure.

These appointments, based on political expediency and personal loyalty rather than professional competence and personal integrity, can enable the rulers to exploit national financial resources without SBP hindrance and are hurtful for institution-building and macroeconomic management. Imagine what would happen to the defence of the country if a poorly trained head of a private security company is appointed as the chief of army staff. One side effect of undeserving appointments at the top of the SBP is that these vital positions will gradually degenerate to become subservient to the illegal dictates of the appointing authorities. 

The SBP governor is the regulator of the banking system and custodian of monetary stability and is important for prudent economic management of the country and a sound financial system. He/she is supposed to be non-political, professionally qualified and personally strong to face and overcome challenges. 

With no professional standing or stature or relevant work experience, a governor or a deputy governor appointed on political considerations will be unable to measure up to his/her difficult task. The situation becomes all the more grim with an accountant finance minister and a businessman prime minister using their political muscles to keep the central bank and the banking system under their control. 

With the present weak and vulnerable SBP management, the political leaders would have a free hand in starting yellow cab schemes, doling out subsidised loans to their fellow businessmen in the name of investment promotion, giving collateral-free loans to young people in the name of employment generation, writing off large loans to their cronies, printing notes to finance their low-priority prestige projects and setting the level of interest rates to subsidise their own businesses or those of the business community at large rather than to promote macroeconomic stability.

These appointments are also a slap on the face of the IMF and expose its hollow statements about strengthening of the operational autonomy of the SBP. It has been stressing in its reports and press statements the importance of an operationally autonomous and professionally competent SBP for monetary and price stability and advocating further legislative reforms to enhance it. 

Their conditionality for enactment of more laws may be met on paper but there will be no qualified and courageous management team at the SBP to enforce them. It will change nothing in reality but the IMF staff will be able to show to their executive board that the government has enacted new laws to enhance SBP autonomy and score some career-enhancing brownie points within their own organisation.

It is also interesting and unusual that the new governor issued a press release a day after the assumption of office with some unfounded observations about the existing ‘monetary stability’ and prospects “to make further strides in improving economic welfare, while ensuring macroeconomic and financial stability”.

The press release claimed that the “State Bank had been playing an active role in improving the monetary and financial conditions together with the betterment of overall economy at large”. In making this statement, the honourable governor must be talking about a country other than Pakistan.

In the last decade, the economy of Pakistan has suffered from stagflation which combined in it a low growth and high inflation. One of the main reasons for this state of affairs was the inability of the SBP to stop the government from forcing it to print excessive currency notes and pre-empting the bulk of commercial bank credit to finance fiscal operations. The money supply was allowed to grow at a rate five times faster than the rate of growth of the economy creating intense inflationary pressures. For the first time in the history of the country, the annual rate of inflation has been running in double digits for almost a decade. 

This happened because of excessive government bank borrowing crowding out the private sector, which is the real engine of economic growth, and the government forcing the SBP to keep real interest rates in negative territory. It is very unfortunate that a period of rapid money creation due to excessive government bank borrowing and negative real interest rates has been characterised by the SBP governor as one of “monetary stability”.

Going forward, the governor is not committing to working off inflationary pressures by perusing a prudent monetary policy as required by the SBP Act, but rather to hold “workshops for media persons to carve out a stronger interface between SBP and people of Pakistan”. 

The people of Pakistan have been burdened with a high rate of inflation, rising unemployment, grinding poverty and mounting internal and external debt and are not interested in carving out a stronger interface with the central bank, which has contributed to their problems by its incompetence and lack of effectiveness.

What is really needed is not a stronger interface between the SBP and the people of Pakistan but rather between the governor and central banking functions prescribed in economics textbooks. Moreover, before making more monetary data available to the people, he should devote some time in studying the available data and understand what is going on in the monetary sector.

The central banks of the world have moved on to conducting monetary policies based on inflation targeting and regulating the banking system through stress testing of individual banks. The SBP is stuck in the ceremony of announcing the policy rate and issuing outdated prudential regulations. It is about time the SBP catches up with other central banks with whom the governor will have to interact, both bilaterally and in international settings.

The governor has also reiterated the “SBP’s commitment in working to achieve its national goals of maintaining monetary and financial stability”. He may or may not understand what monetary and financial stability means in economics or in the real world but let us remind him what he will have to do to honour this commitment.

He needs to become conversant with the legal requirements stipulated in the SBP Act for the formulation and conduct of a monetary policy to regulate “the expansion of liquidity” in the economy so as to ensure a sharp reduction in inflationary pressures. As required by the SBP Act, it must formulate monetary policy without excessive accommodation of government by using its authority to “determine and enforce” prudent limits on government borrowing from the SBP. 

The governor will need to safeguard the jurisdiction of the central bank and conduct monetary policy with the main aim of controlling growth in money supply to reduce inflation and channel commercial bank credit to the private sector to promote economic growth.

He also has to do a better job of regulating the banking system by effectively enforcing prudential regulations to direct the commercial banks to undertake more intensely their financial intermediation function through improvement in efficiency and enhancement of competition and narrowing of the interest spread. It is his job to ensure that commercial banks serve the interest of the country rather than earn fat profits by locking their deposits in the purchase of government securities. 

Most importantly, the governor should not blindly accept government instructions to print more currency notes but be prepared to ‘determine and enforce’ a limit on its borrowing from the SBP, if necessary.

The writer is a former governor of the State Bank of Pakistan.

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